Fiscal Union L harmonisation fiscale européenne nécessaire?

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1 Fiscal Union L harmonisation fiscale européenne nécessaire? Guntram Wolff Bercy September

2 Fiscal union: yes or no? Many new measures introduced since the crisis: increased surveillance, ESM, liquidity provision by the ECB, OMT Main risk absorption channel in monetary union is capital and credit markets (~70%) (Asdrubali et al 1996). complete single market for capital and banking union banking union: principle aim to de-link financing conditions from the government sector. It is imperative to break the vicious circle between banks and sovereigns 9/25/2013 Bruegel

3 Credit default swap risk premia on 5 year bonds by sector Italy

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5 Banking union: progress report Banking union clearly not finished. Correlation between banks and soverereigns remains high. What else is needed? More European banks, balance sheet exposure spread across several countries, including in terms of sovereign debt identical standards as regards the pecking order of creditors single resolution authority common fiscal backstop (i.e. limited fiscal union) If this is achieved, more fiscal union needed? 9/25/2013 Bruegel

6 Italy/Spain in the future? government corporote /25/2013 Bruegel

7 How to complete single market for capital? Harmonization of regulation and taxation Capital markets are underdeveloped in Europe They are predominantly national This renders monetary union unstable as the main risk absorption channel is absent Corporate governance, insolvency law, regulation and differences in taxation! 9/25/2013 Bruegel

8 Fiscal union: yes or no? Musgrave: public good, stabilization, redistribution Capital markets: enough to provide adequate regional/aggregate stabilization in extraordinary circumstances? How to deal with deep balance sheet recessions? Net federal transfers to Nevada averaged $20 billion annually during the crisis, dwarfing the state government s $2 billion average deficit and accounting for a significant fraction of its $130 billion GDP. Aggregate fiscal stabilization With decentralized fiscal policy, the aggregate stablization effort will be sub-optimal euro area public good? (or EU?) 9/25/2013 Bruegel

9 Options for stabilization mechanisms (i) (ii) A federal euro area budget of 2 % of GDP Federal unemployment expenditure financed with a federal corporate tax A support scheme based on deviations from potential output Introduce clear rules that trigger federal transfer payments when deviation is large (iii) Quotas for the issuance of mutually guaranteed debt Recourse to limited federal borrowing during financial market volatility 9/25/2013 Bruegel

10 Options for stabilization mechanisms Euro-area budget Automatic transfer scheme Guaranteed bonds quota Principle Automatic stabilization role of federal budget Transfers based on output gap Right to issue jointly guaranteed bonds (several tranches with increased withdrawal of sovereignty Origin of stabilisation Income transfer from partners Income transfer from partners Borrowing capacity, mutualisation of default risk Advantages True budget Maximises stabilization power for any given level of contributions Re-establishes credibility of public debt Drawbacks Difficulty to agree on euro-area public goods. Budget balance prone to volatility Relies on technical potential output assumptions. Mechanical with little flexibility. Requires Eurobonds with difficult to impossible governance challenge 9/25/2013 Bruegel

11 Governance What kind of commitment devices for mutual guarantees? operate on flows, not stocks Creation of a euro area treasury Key is the creation of tax resources, which the EA treasury can directly tax on households/corporations or else With credible tax resources, borrowing is easy and aggregate stabilization becomes possible Credible tax resources require sound legal basis They also require sound administrative control (tax collection effort in Bavaria is lower than other German states) Political accountability 9/25/2013 Bruegel

12 Conclusions Some degree of fiscal harmonization (but also corporate governance and insolvency practice and legislation) is necessary to complete the single market for capital. Key immediate priority is to finalize banking union Minimum fiscal union beyond banking union is desirable to accommodate massive shocks and provide aggregate stabilization Key issue is the governance of fiscal union Question of the legacy: More OSI? More PSI? 9/25/2013 Bruegel