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A European Fiscal Union? No, Thank You

Before addressing the topic of a European fiscal union, it is important to remember that the EU is made up out of different countries. These nations are represented by their elected governments who in turn have to create solutions for local problems. This is important because of the fact that local government is closer to the people it represents, and it is therefore better held accountable. Also, national governments are better informed and equipped to create policies that are in line with the local economic preferences and conditions. Normally a country has two powerful economic tools at its disposal: monetary policy and fiscal policy. However, after the Maastricht Treaty (1993) countries gave up on their national monetary policy in favor of having a shared currency: the euro. Looking back now we can see that doing this has not led to the success that was promised.

The proposal of a fiscal union would mean that national governments can no longer do what is best for their own nation but instead they would have to do what is best for the EU. It would require that part of the spending and tax levels of countries is controlled by a central European fiscal authority. To be able to create this authority the EU would have to circumvent the principle of subsidiarity, formally enshrined in the Maastricht Treaty, which demands a decentralization of fiscal policy.

The practical implication of a fiscal union is that countries would share fiscal risks. Member states would share this risk by transferring part of their GDP to the member states that are struggling during an economic downturn. Theoretically, this would be effective if the transfers are transitionary and unsystematic. If this is the case, then regional economic fluctuations would smooth out over time and a fiscal union would provide automatic stabilization of the economy. In effect: when there is a boom in the Netherlands and Portugal is in a recession, the system would make a net transfer from the Netherlands to Portugal. If the economic situation is reversed the funds would flow the other way. Clearly a precondition of this system is that unemployment risk is independent and that economic fluctuations are uncorrelated. If these conditions are violated this would instantly lead to the transformation of a fiscal union into a transfer union.

These conditions are clearly violated: The Southern-and Eastern-European countries have systemic higher unemployment and are a lot more volatile than their Northern-European counterparts. Therefore, the corruption of a fiscal union into a transfer union is inevitable. What is meant by a transfer union is that within the fiscal union there is a long-lasting income transfer and redistribution to the same region. This has two effects. First, it will increase extra political tension between countries, as can be seen on a small scale in Belgium where this creates additional tension between the Flemish and French region. This additional tension would be destabilizing for the EU. Secondly, this would lead to a massive moral hazard problem. Nations that spend loosely will be bailed out by economically sound countries. By doing so, high debt countries would be kept afloat even though an economic correction should take place.

Another problem that comes with having both a European monetary policy and fiscal policy is that of competitiveness. The EU is already a currency union. This means that exchange rate adjustments that would have normally happened between countries has to be replaced by wage adjustments in order to stay competitive. The creation of an EU fiscal policy might reduce the incentive for politically painful labor reform and thus increase the problem. The transfer of funds would not at all help with the tendency of countries towards a balance of payments imbalances and their accumulation of foreign debt.

An argument made by those who are in favor of a fiscal union is that this system would end fiscal competition – what they see as “a race to the bottom” – between countries. However, this decentralized competition also leads to more experimentation in policy making and in return leads to political innovation. This “race to the bottom” could also be seen as a needed discipline in the case of excessive growth of the government that arises due to adverse incentives within the political process.

The often-proposed solutions of the above-mentioned critiques is that we can legislate the creation of the fiscal union in such a way that would minimize these problems. In their eyes it would be possible to minimize the moral hazards by creating benefit rules – rules that a country needs to follow in order to receive benefits – and differing contribution rates – make it a less attractive tax ratio for economically weak countries and more attractive for economically strong countries. Indeed, these proposals sound like good ideas. However, what credibility does the EU have when it comes to actually following these rules? The Maastricht Treaty, which demanded that the annual government deficit be limited to 3% of GDP and that gross government debt must not exceed 60%, has been violated  since the start. Clearly, the EU has a history of not following its own agreements.

The only countries that would benefit from a European fiscal policy are the impactful economies that are unstable. Smaller economies would suffer during economic downturns because their impact is a miniscule part of the total European economy. It would therefore be judged more urgent to save a country such as Italy than a country such as Slovenia. Meaning that even though these countries were promised help they would have to suffer in the short term in order to supposedly achieve a long-term vision that has been arbitrarily determined by the EU.

A European fiscal policy – no thank you! Clearly the guaranteed net problems that would follow from this proposal outweigh the supposed future benefits. We should let countries keep the few tools that they can use during economic downturns. The envisioned greater good from this proposal does not appear to be the realistic consequence of its creation.


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