The Locke Institute series
Edited by Ram Mudambi, Pietro Maria Navarra and Giuseppe Sobbrio
Chapter 6: Fiscal Federalism and the Stability and Growth Pact: A Difficult Union
Fabrizio Balassone and Daniele Franco 1. INTRODUCTION1 During the 1990s, the process of integration between EU countries accelerated and monetary union was started. Over the same years, the degree of fiscal decentralisation in EU Member States increased. A process to enlarge the responsibilities of local governments in the management of public expenditure and taxation was set in motion in some countries not organised on a federal basis.2 While the European Monetary Union (EMU) renewed interest in institutional reform at the European level, less attention was paid to developments at the national level. The foundation of EMU and the process of national decentralisation had both political and economic motivations. Focusing on the latter, one can see that the two levels of institutional reform share a common denominator in that they aim at creating a more growth-oriented economic environment. Decentralisation at the national level can foster an efficient allocation of resources. Monetary union can consolidate the progress made with the liberalisation of goods and capital markets. It can also create a wider area of monetary stability and lower uncertainty, thus acting as an incentive to investment. Traditional theories of fiscal federalism, while pointing to the allocative advantages of local autonomy, stress the need to guarantee both control of national public finances and the possibility of carrying out countercyclical policies at the national level. To that end, the introduction of limits on transfers from the central government and on recourse to market financing by local governments is necessary. These constraints must be flexible...
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