Fiscal Policy in Economic and Monetary Union

Fiscal Policy in Economic and Monetary Union

Theory, Evidence and Institutions

Marco Buti and Daniele Franco

This book explores the origins, rationale, problems and prospects of the European fiscal policy framework. It provides the reader with a roadmap to EMU’s budgetary framework by exploring its theoretical and empirical foundations, uncovering its historical roots and emphasising its supranational nature.

Chapter 8: Fiscal Federalism

Marco Buti and Daniele Franco

Subjects: economics and finance, money and banking, public finance


* INTRODUCTION During the 1990s, the degree of fiscal decentralization 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 countries not organized on a federal basis.195 During the same years, budget rules aimed at guaranteeing the soundness of the public finances of EU member states and ensuring margins for counter-cyclical policies were defined and introduced at the European level. These rules are based on the consolidated budgets of general governments. The existence of different levels of government is not taken into account. The interaction between these two developments has not yet been adequately examined. This chapter proposes a first analysis of the compatibility between the degree of decentralization decided at national level and the budget rules introduced at European level. In highlighting the allocative advantages of local autonomy, traditional theories of fiscal federalism stress the need to guarantee both control of national public finances and the possibility of carrying out counter-cyclical 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, in relation to cyclical events and to the need to spread the burden of publicsector investment over several generations. These theoretical indications have been confirmed by the legislation adopted in many countries. When regulating the activities of local governments, it is unusual to rely solely...

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