Fiscal federalism in monetary unions: hypothetical fiscal transfers within the Euro-zone

Abstract

Net fiscal transfers are commonly seen as a possible means to ensure the wellfunctioning of a currency area. We show that U.S. net fiscal transfers, measured as the difference between gross federal revenues and federal expenditures per state, are enormous. Moreover, we run panel regressions that suggest their dependence on relative GDP and relative GDP growth during crisis periods, an evidence of net fiscal transfers from relatively rich to relatively poor states (redistributive effect) and to states with an underperforming economic development (stabilization effect).The Euro-zone (EZ) lacks a system of fiscal federalism which raises the question whether it should be established in the medium-and long-run. If so, which should be the magnitude of net fiscal transfers? We calculate these transfers hypothetically for 1999-2010, using a relative volume comparable to the one in the USA.

Fiscal federalism and a separate budget for the euro area

“…In the Eurozone, so far, repeated rescue operations in the case of Greece and other Member States make for incredible reading any declarations that some countries are not responsible for the obligations of other states. Dreyer and Schmid [2015] stress that fiscal transfers are a necessary condition for the proper functioning of the monetary union because they increase the possibilities of participating regions to react both in the case of symmetric shocks, i.e., affecting all these regions, and asymmetric shocks affecting only some. In the United States, net fiscal transfers (which are the difference between what a given state receives from the federal budget and what it pays to it) from richer to poorer states have a significant stabilizing and redistributive effect.…”

“…Fiscal federalism would mean economically weaker countries of the euro area possibly obtaining huge transfers for themselves and, for countries that have been net contributors so far, a significant increase in the burden necessary to finance these transfers. At the same time, it is important that some countries such as Italy (a net payer) would become net beneficiaries of funds from the common budget while others, such as Ireland, would cease to be such beneficiaries and would become net payers, which can be explained mainly by their relatively high GDP per capita [Dreyer and Schmid, 2015].…”

“…In the United States, fiscal federalism is the result of a certain balance provided by state and federal elections, while in the Eurozone, there is no such solution or something similar to it. Dreyer and Schmid [2015] point out that the introduction of a large-scale system of transfers without a proper democratic system may end up destroying the euro project. Therefore, the long way is to go through to achieve, in the Eurozone, an institutional order that would provide similar fiscal federalism as in the United States.…”

Inflation and Euro Membership

“…Conforming to the criteria of Mundell (1961), there are many studies questioning if the EZ can be considered as an optimal currency area and also questioning the viability of the Euro without a complete fiscal federalism among its member countries (Dreyer & Schmid, 2015;Kalemli-Ozcan, Sørensen & Yosha, 2001;Kenen, 1995;Krugman, 1991Krugman, , 1993. Others try to measure the impacts of membership in the European Union (EU) or Eurozone (EZ) on trade (Baldwin, 1992;Baldwin & Taglioni, 2007;Berger & Nitsch, 2008;Bun & Klaassen, 2002Rose, 2000).…”

A Fiscal Capacity For the Euro Area: Lessons from Existing Fiscal-Federal Systems

“…15 According to Melitz (2004) and Cimadomo et al (2018), private and fiscal risk-sharing in the euro area lags behind the United States. Dreyer and Schmid (2015) show that a risk-sharing capacity providing a similar degree of redistribution and stabilisation to the US system would require significantly larger intergovernmental transfers in the euro area.…”