Voters in the northern region are going to the polls today in an election likely to hand the Social Democrats (SPD) a narrow victory.
If Mrs Merkel loses, it will deprive her conservative Christian Democratic Union (CDU) of a boost ahead of looming national coalition talks.
Germans disgruntled with Mrs Merkel’s liberal migrant policy abandoned her party in droves in September’s national election.
Mrs Merkel, Chancellor since 2005, suffered the worst conservative result since 1949 in terms of vote share.
The CDU and its Bavarian sister-party won 33 per cent of the popular vote – down from 41.5 per cent in 2013 – as the right-wing Alternative for Germany (AfD) surged.
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She must now try to piece together an awkward alliance with the pro-business Free Democrats (FDP) and environmentalist Greens.
Those parties will this week begin negotiations, which could drag on for months.
The latest opinion poll put the SPD on 34.5 percent in the swing state of Lower Saxony, giving it a 1.5 point lead over Mrs Merkel’s party, who had been 12 points ahead at the start of the campaign in August.
Lower Saxony, which is about the same size as the Netherlands, is known for hosting major companies such as carmaker Volkswagen.
Exit polls are expected at 4pm British time.
Simon Fink, political scientist at the University of Goettingen, said no-one had dared to start coalition negotiations in Berlin ahead of the election in Lower Saxony.
He said: “Everyone was scared that if they did something at the national level or committed themselves to something, then their colleagues in Lower Saxony could end up suffering.”
Cem Ozdemir, co-leader of the Greens, said the three parties had not ‘sought each other out’ but now had a responsibility to form a coalition.
He told the Welt am Sonntag newspaper: ”If the coalition comes off, it must not be a coalition that only agrees on the lowest common denominator. That won’t work.”
Mrs Merkel has acknowledged the difficulties ahead in bridging the huge divides between her coalition partners on immigration, EU reform, taxation and environmental protection.
On the campaign trail in Lower Saxony she said: ”Now we need to put our noses to the grindstone.”
An SPD-Green coalition has governed Lower Saxony for almost four years, but lost its majority when a Green politician defected to the CDU, triggering a snap election.