WORKING PAPER 12-1

Fiscal Federalism: US History for Architects of Europe's Fiscal Union

by C. Randall Henning, Peterson Institute for International Economics
and Martin Kessler, Peterson Institute for International Economics

January 2012

European debates over reform of the fiscal governance of the euro area frequently reference fiscal federalism in the United States. The "fiscal compact" agreed by the European Council during 2011 provided for the introduction of, among other things, constitutional rules or framework laws known as "debt brakes" in the member states of the euro area. In light of the compact and proposals for deeper fiscal union, Henning and Kessler review US fiscal federalism from Alexander Hamilton to the present. They note that within the US system the states are "sovereign": The federal government does not mandate balanced budgets nor, since the 1840s, does it bail out states in fiscal trouble. States adopted balanced budget rules of varying strength during the nineteenth century and these rules limit debt accumulation. Before introducing debt brakes for euro area member states, however, Europeans should consider three important caveats. First, debt brakes are likely to be more durable and effective when "owned" locally rather than mandated centrally. Second, maintaining a capacity for countercyclical macroeconomic stabilization is essential. Balanced budget rules have been viable in the US states because the federal government has a broad set of fiscal powers, including countercyclical fiscal action. Finally, because debt brakes threaten to collide with bank rescues, the euro area should unify bank regulation and create a common fiscal pool for restructuring the banking system.

View full document [pdf]


RELATED LINKS

Policy Brief 13-23: How to Form a More Perfect European Banking Union October 2013

Policy Brief 13-17: A Realistic Bridge Towards European Banking Union June 2013

Op-ed: Five Myths about the Euro Crisis September 7, 2012

Article: Why the Euro Will Survive: Completing the Continent's Half-Built House August 22, 2012

Testimony: Challenges of Europe's Fourfold Union August 1, 2012

Policy Brief 12-18: The Coming Resolution of the European Crisis: An Update June 2012

Book: Transatlantic Economic Challenges in an Era of Growing Multipolarity July 2012

Book: Resolving the European Debt Crisis March 2012

Working Paper 12-12: Sovereign Debt Sustainability in Italy and Spain: A Probabilistic Approach August 2012

Policy Brief 12-20: Why a Breakup of the Euro Area Must Be Avoided: Lessons from Previous Breakups August 2012

Policy Brief 12-5: Interest Rate Shock and Sustainability of Italy's Sovereign Debt February 2012

Speech: Italy's Effect on the Global Economy February 9, 2012

Policy Brief 12-4: The European Crisis Deepens January 2012

Policy Brief 11-21: What Can and Cannot Be Done about Rating Agencies November 2011

Policy Brief 11-13: Europe on the Brink July 2011

Working Paper 11-2: Too Big to Fail: The Transatlantic Debate January 2011

Policy Brief 10-27: How Europe Can Muddle Through Its Crisis December 2010

Policy Brief 10-14: In Defense of Europe's Grand Bargain June 2010

Op-ed: Greek Deal Lets Banks Profit from "Immoral Hazard" May 6, 2010

Op-ed: The Follies of Federalism August 5, 2007

Op-ed: Liberalism Needs Central Power July 4, 2007

Book: Transforming the European Economy September 2004



© 2014 Peter G. Peterson Institute for International Economics. 1750 Massachusetts Avenue, NW.
Washington, DC 20036. Tel: 202-328-9000 Fax: 202-659-3225 / 202-328-5432
Site development and hosting by Digital Division