Towards a More Perfect (Fiscal) Union

Lessons for the Euro Area From the Formation of America’s Fiscal Union

Jacob Funk KirkegaardSenior Fellow

Peterson Institute for International Economics | 1750 Massachusetts Ave., NW | Washington, DC 200366/22/2017 1

AgendaI. The Lesson(s) of U.S. Fiscal History

II. The Public Goods a Central Budget Could Deliver

III. A Path to a Larger and More Politically Sustainable EU Budget

America’s Fiscal Union will be forged in crises, and will be the sum of the

solutions adopted for those crises……John Monnet – Fictitious Founding Father

(psst – its the federal government that wages war!)

US Federal Government Expenditures 1792-2020p, % GDP

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35%

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45%

50%

Total Federal Government Expenditure 1792-2020p

Total Federal Government Expenditure, Excl. War Department, Naval Department and Interest onthe National Debt 1792-1945

EU Budget in 2014 = ~1.17% of EU GDP

Source: Williamson (2014). Expenditure data from 1792-1945 from US Census (1949); data from 1945-2020p OMB (2015).

War of 1812: 1812-1815

Mexican-American War:

1846-1848

U.S. CIvil War: 1861-1865

Spanish-American War:

1898

World War I: 1917-1918

World War II: 1941-1945

U.S. Federal, State and Local Governments' Gross Debt, By Level of Government 1790-1860, $USmn

26

175

190

257

200

0

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$US

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State

Local

Federal

Source: US Treasury; Studenski and Krooss (1952)

War of1812 against Great

War of1846 against Mexico

Panic of 1819-21

Panic of 1837-43

Panic of 1857-59

U.S. Federal, State and Local Government Gross Debt, By Level of Government 1860-1940, $US Million

257450 211 270 423

2,907200 1,924 4,075

16,680

0

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10,000

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45,000

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$US

Mill

ions

StateLocalFederal

U.S. Civil War 1861-1865

U.S. Participation in World War I 1917-1920 (Armed forcesreduced in size with a delay)

Great Depression

and its aftermath 1929-1940

Source: US Treasury; Studenski and Krooss (1952)

Public Goods a Central Budget Could Deliver

I. “Economic Convergence”• Hard if not impossible to deliver• Required budget size politically impossible to (ever) achieve

II. “Counter-Cyclical Buffer”• Not easy to do through regular EU budget items (automatic stabilizers are MS)• Banking Union is not part of the EU budget• Best done by “debt financing” (but Eurobonds are for the future)• Possible to give the ESM/EMF a banking license and do it conditionally• Supplementary “European level” catastrophic level unemployment insurance

III. “Best Solved at Regional Level (Subsidiarity)”• EU powers determined by where “EU-level value-added” exist• Subsidiarity is a “living concept” that evolves over time• How to best finance the regional solution of policy challenges?

Today’s EU Budget~$165bn/year and 80% is direct GNI/VAT-based transfers

Focus on “national net contributions” similar to US pre-XIV Amendment federal budget

Lesson From U.S. fiscal history –Direct centralized taxation requires changes to Constitution/Treaty

100,517

18,087

18,730

8,693

EU Budget Resources by Category, Euro Billion, 2015

GNI-based Own Resource VAT-based Own Resource Traditional Own Resources (TOR) Other Revenue

Source: DG Budget

Direct Tax Financing Not Happening

0%

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100%

Share of Residents Feeling National Only or Predominantly

National, Fall 2016

Answer to the question: In the near future - Do you see yourself as ? Source: European Commission

0%

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100%

3/1/

1992

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Feelings of Self-Identity, Share of EU Residents 1992-2016

National Only National and Then European

European and Then National European Only

Don't Know

Answer to the question: In the near future - Do you see yourself as.... ? Source: European Commission

Earmarked Revenue Widely Used in U.S.

U.S. states derive a minority of revenue from general taxes with full discretion over use

Earmarked U.S. state revenue over 25% of total revenues

35% of U.S. federal budget is earmarked “trust fund revenue”

0

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800,000

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1,400,000

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2,000,000

U.S. State Revenues, By Source, $USmn 1987-2015 General Fund Revenue Federal Government Grants

Earmarked State Revenues Bond Revenue

Earmarked Revenues = Bigger EU Budget?

• With voters’ self-identity/allegiance at member state level, single tax for single public service may be EU’s only avenue to raise indirect tax/fee revenue

• Simpler and therefore democratically more legitimate than current complex budget process

• Some applications:– Explicit user fees; polluter pays principle or €5 ETIAS fees– Fees on related use items; Highway TF structures that for

instance finances infrastructure through gas taxes, climate mitigation through ETS (EU Carbon Dividend?) revenue

– Broad taxes earmarked for specific EU budget items; finance a CAP through a 2% VAT on food?

Concluding Remarks• Lessons from U.S. fiscal history – fiscal unions takes a long time to

construct and you really do need crises to do it

• Being a “Project of Peace” sets the EU back in the process of “state/fiscal union building”

• EU budget should focus on funding solutions to regional challenges

• Financing the EU budget through an increasing use of earmarked revenue from targeted indirect taxes/fees best available path for now to more direct European revenue

• Earmarked revenue probably best path to a larger and politically sustainable EU budget