* Govt hopes for legislation to take effect next year dashed
* Cabinet to decide next Weds if to engage mediation committee
* Switzerland says still committed to successful ratification
* Opposition parties say deal too soft on tax evaders (Adds background, German Finance Ministry comment)
By Alexandra Hudson
BERLIN, Nov 23 Germany's upper house of parliament on Friday rejected a deal with Switzerland to tax assets stashed by German citizens in Swiss bank accounts, dashing Chancellor Angela Merkel's hopes of having the lucrative agreement in place by 2013.
Despite a last-ditch appeal to the assembly by Finance Minister Wolfgang Schaeuble, the agreement was rejected by states run by the opposition Greens and Social Democrats, who said the legislation would have let off tax evaders too easily.
Merkel's centre-right government had struck the deal with Switzerland in April, but without a majority in the Bundesrat upper house, where Germany's 16 states are represented, it needed opposition support.
Schaeuble's spokesman said the outcome was regrettable and the cabinet would decide next Wednesday whether to start a mediation procedure that seeks to resolve differences between the Bundestag lower house and the Bundesrat.
"When you consider how many decades we have been struggling over this, and how many attempts we have had to solve this problem, then this deal is worth fighting for," Martin Kotthaus told reporters.
The deal would have required Swiss banks to levy a punitive charge on an estimated 150 billion Swiss francs ($160 billion) in undeclared funds squirrelled away by Germans in Swiss accounts.
The proceeds would be passed on to Germany, including its 16 Laender, or states, without the identities of the account holders being revealed.
SPD-led German states like North Rhine-Westphalia have resorted to buying Swiss banking data from whistleblowers in order to pursue tax dodgers, angering the Swiss and only catching a fraction of the wrongdoers.
Peer Steinbrueck, the SPD's candidate for chancellor in next year's German election, cracked down hard on bank secrecy when he was finance minister in Merkel's 2005-09 "grand coalition" government, famously referring to the Swiss as Indians running from the cavalry.
His party is planning to trumpet its rejection of the deal in the looming election campaign to try to paint Merkel as soft on financial wrongdoing by the wealthy.
With the SPD dead-set on torpedoing the deal and legislation already fully ratified in Switzerland, there is little scope for change to the terms already agreed or for mediation to succeed.
"The German upper house has missed a major opportunity to reach a fair, optimum and sustainable solution for all parties to definitively settle the bilateral tax issues," the Swiss Bankers Association said in a statement.
Swiss Finance Minister Eveline Widmer-Schlumpf said her government remained "committed to a successful ratification".
Britain and Austria have ratified similar deals, which will come into force next year, and Switzerland hopes other countries - including Greece and Italy - will follow suit.
An Italian source close to the negotiations with Switzerland said the Bundesrat vote had not changed anything for them and officials would meet as planned next week. ($1 = 0.9350 Swiss francs) (Additional reporting by Silke Koltrowitz in Zurich and Elvira Pollina in Milan; Editing by Noah Barkin and Patrick Graham)