Fiscal federalism: US history for architects of Europe's fiscal union

Ever since first the blueprints for monetary union in Europe were drawn up, the United States, considered as a collection of individual states or regions, has served as a benchmark for assessing its feasibility and evaluating alternative policy options. Starting with Robert Mundellâ??s seminal 1961 article on optimal currency areas, countless papers have explored the inner workings of US labour, product and capital markets, and of its public finances, in the hope of learning lessons for Europe. It could be argued that this US inspiration is mistaken. After all, it is not the only economic and monetary federation in the world. Other federations work on different principles â?? especially when it comes to public finances â?? and there is no guarantee that US arrangements are optimal â?? especially, again, regarding public finances. But we know the US better and we think we understand it better, so success or failure relative to the US test carries much more weight than with the Australian, Canadian, Indian or Swiss tests. For better or worse, the US remains our ultimate policy laboratory. This essay on US fiscal federalism by Randall Henning and Martin Kessler builds on the established tradition. But unlike many papers that take current US features as a given, they tell us what present arrangements governing responsibility over public debt gradually emerged from, and why. By bringing in the historical dimension and the trial-and-error process that took place over more than two centuries, they help us understand the logic behind alternative arrangements and why the current one has in the end prevailed. Their careful historical account yields several important lessons. It first recalls that the US system as we know it, with its combination of a large federal budget responsible for the bulk of public debt and limited thrifty state budgets subject to balanced budget rules, emerged gradually from a sequence of events; in fact the initial set-up, as designed and enforced by Alexander Hamilton, was almost exactly the opposite. Second, it makes clear that beyond economic principles, attitudes towards what was in the aftermath of independence called the â??assumptionâ?? of state debt were shaped by broader political considerations â?? not least the aim of building a genuine federal government. Third, it explains how after the US was firmly established as a federation, changing political conditions led to a reversal of the federal governmentâ??s stance and to the enforcement of a â??no bail-outâ?? principle. An intriguing feature of US history is therefore that the competences and features of federal government grew out of its assumption of state debt, and that the centre imposed a de-facto no bail-out regime only after having assumed essential powers. Another interesting observation by Henning and Kessler is that balanced budget rules were adopted spontaneously by states in response to financial stress and defaults, rather than as a disciplinary device mandated by the centre. Thus, there is still significant variability between states regarding the modus operandi and strictness of budget rules. The question remains if what matters is the strictness of the rule, or deeper political preferences at state level, of which the rule is only an expression. Finally, Henning and Kessler emphasise, a no less important lesson for Europe is that policy principles and institutions should be looked at as a system rather than in isolation. As the authors point out, it may seem obvious to recall that states in the US can abide by strict budget balance rules to the extent the federal government is responsible for stabilisation and the bail-out of insolvent banks, but this simple lesson is sometimes overlooked in European discussion. Jean Pisani-Ferry Director of Bruegel

Capital Accumulation and Social Welfare in Fiscal Federalism and the Unitary System

This paper presents an analysis on capital accumulation and social welfare in fiscal federalism and the unitary system by using an overlapping generations model. We introduce three possible cases pertaining to how government tax policy towards individuals could be formulated: the government imposes tax on young and old generations under fiscal federalism (case A); the government imposes tax only on young generation under fiscal federalism (case B) as well as under the unitary system (case C). We show that, the level of steady-state capital accumulation as well as social welfare in case A is greater than those in cases B and C if certain conditions are satisfied. Our results suggest that, fiscal federalism is more preferable than the unitary system.Capital accumulation; Fiscal federalism; Unitary system; Overlapping generations

Old and New Theories of Fiscal Federalism, Organizational Design Problems, and Tiebout

This work is a contribution to the Second Generation Theory (SGT) of fiscal federalism that studies fiscal federalism through contemporary economic and industrial organization theory. First, it establishes context by introducing the two classic motivations in support of federalism, namely, incentives and knowledge. Second, it succinctly discusses the incentive-based organizational approach of the SGT. Third, it shows that the Tiebout model already embeds an organizational approach, which instead rests on a knowledge motivation. The underlying theme is that the SGT should include both the incentive and knowledge motivations for fiscal decentralization.Economic organization, Incentives, Knowledge, Second Generation Theory of fiscal federalism.

Tax federalization – an important step in the process of decentralization

The “theory of fiscal federalism” concerns the division of public-sector functions and finances in a logical way among multiple layers of government. An important aspect in analyzing the fiscal federalism is represented by a corresponding balance between the authority and the necessary financial resources in order to exercise that authority.tax federalization, decentralization, fiscal federalism

The Economic Effects of Federalism and Decentralization – A Cross-Country Assessment

This paper is based on the conjecture that institutional details matter and that attempts to estimate the economic effects of federalism by drawing on a simple dummy variable neglect potentially important institutional details. Based on a principal component analysis, seven aspects of both federalism and decentralization are used as variables for explaining differences in (1) fiscal policy, (2) government effectiveness, (3) economic productivity, and (4) happiness. The results show that institutional details do, indeed, matter. Different aspects of federalism impact on the outcome variables in different degrees. This study adds to our knowledge on the transmission mechanisms of federalism and decentralization.Federalism, Federalism, decentralization, Fiscal federalism, Economic Effects of constitutions, constitutional economics.

Fiscal Decentralization in China and India: Competitive, Cooperative or Market Preserving Federalism?

This paper provides a comparative assessment of fiscal decentralization in China and India, including the standard components of expenditure and revenue assignments and institutions for intergovernmental transfers, as well as the nature of subnational authorities over general economic activity. In particular, the case of China, where town and village enterprises have been very active, is contrasted with that of India, where local governments remain circumscribed in their authority, despite decentralizing reforms. The implications of differences in decentralization for fiscal outcomes and economic growth are discussed. The characterization of each country in terms of concepts of federalism, i.e., competitive, cooperative and market preserving federalism, is discussed, in attempting to abstract from the two cases to more general lessons for fiscal decentralization.cooperative federalism; competitive federalism; market-preserving federalism; decentralization; economic development

Fiscal Federalism and Economic Performance: Evidence from Swiss Cantons

The advantages and disadvantages of fiscal federalism are widely discussed in economics and political science. While some authors argue that federalism favors individual initiatives and serves as a market preserving device, others emphasize the dangers arising from an increasing corruption and local capture due to decentralization. In this paper, we empirically study the impact of different instruments of fiscal federalism on economic performance measured by GDP per capita using panel data for the 26 Swiss cantons from 1980 to 1998. In our econometric production function approach, the impact of fiscal federalism, tax competition and grants on economic performance is analyzed by additionally using controls for physical and human capital investment as well as further controls and indicators of fiscal federalism. According to our results, the intensity of tax competition, which is measured by the difference between a cantons tax rate and the average of its neighbors’ tax rates, is at least not harmful for economic performance. Moreover, the fragmentation of cantons in communities does not affect real GDP per capita indicating that economies of scale do not necessarily provide a good argument for a merger of communities.Fiscal Federalism, Economic Performance, Tax Competition, Grants.

The Economic Effects of Federalism and Decentralization - A Cross-Country Assessment

This paper explores the idea that institutional details matter and that attempts to estimate the economic effects of federalism by employing a simple dummy variable neglect potentially important institutional details. Based on a principal component analysis, seven aspects of both federalism and decentralization are used as variables for explaining differences in (1) fiscal policy, (2) government effectiveness, (3) economic productivity, and (4) happiness. The results show that institutional details do, indeed, matter. Different aspects of federalism impact on the outcome variables to different degrees. This study adds to our knowledge on the transmission mechanisms of federalism and decentralization.federalism, decentralization, fiscal federalism, economic effects of constitutions, constitutional economics

Contemporary Issues in the Management of Nigeria’s Fiscal Federalism

This paper x-rays the contemporary issues in the management of Nigeria fiscal federalism. In so doing, the first section of this paper conceptualizes the concept of federalism, fiscal federalism and management as well as the decentralization theorem which served as the theoretical discourse. the second section dwells on the Nigerian  fiscal federalism,  heralding its historical ontology to this point and observed that fiscal  federalism in Nigeria has been skewed in favour of the federal government hence the recent clamour by the state governors for bigger share of the federation account. The third section however, reveals the major fiscal federalism challenges in Nigeria in comparative analogy which heralds the four challenges of fiscal federalism in Nigeria. The fourth section discuses  the contemporary issues in the management of the Nigeria’s the fourth section discusses the contemporary issues in the management of the Nigeria’s  fiscal federalism  such as the minimum wage saga, the federal character principle; the state and local government creation; oil revenue issues and the principle of derivation  application as well as the statutory  role of the Revenue mobilization allocation and fiscal commission (RMAFC) in the fiscal federalism management of Nigeria, while the last section recommends policy options and concludes the work.   Keywords: Federalism, Fiscal Federalism, Revenue Allocation, Derivation of power, Decentralization and Decentralization theorem

Scotland: A New Fiscal Settlement

Tax and Expenditure Devolution, Inter-Government Relations, Fiscal Federalism, State Budget, Fiscal Coordination.