The Court ruled on Tuesday that the issuance of childcare payments does not fall under the central government's “duty of care” to the general public and such kinds of benefits should be determined by individual states.
The Betreuungsgeld payment, one of Chancellor Angela Merkel's pet projects, came into effect in 2013 and has met with controversy from the beginning.
The policy - also nicknamed the “stove bonus” - ensures care for every child aged one to three. It offers a monthly benefit payment of €150 to parents who choose not to place their children in a Kindergarten or in a “day mother” childcare programme.
But critics say it reinforces inequality because it is more likely to be taken up by lower-income families, particularly those of immigrant backgrounds, thus setting them behind their peers who get a head start in Kindergarten.
The city-state of Hamburg brought the case before the Constitutional Court, saying that the law goes against the constitution because it neglects the government's duty to treat all parents equally.
The unanimous court ruled in favour of Hamburg on Tuesday, saying it should be up to individual states, but did not rule definitively on the principle of equality.
“Because the federal government lacks the proper authority, the Senate is not concerned with the question of whether child care money would be compatible with fundamental rights,” said court vice president Ferdinand Kirchhof.
The payments may be continued only in hardship cases where families have come to rely on the money, ruled the court based in the southwestern city of Karlsruhe.
In Bavaria, conservative leader Horst Seehofer said his state government would keep paying the subsidy and demanded the federal government compensate it for the expense.
The court did not set terms for ending the policy, allowing the government to determine how to handle the validity of current services.