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Fiscal Federalism and Optimum Currency Areas: Evidence for Europe From the United States

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  • Xavier Sala-i-Martin
  • Jeffrey Sachs

Abstract

The main goal of this paper is to estimate to what extent the federal government of the United States insures member states against regional income shocks. We find that a one dollar reduction in a region's per capita personal income triggers a decrease in federal taxes of about 34 cents and an increase in federal transfers of about 6 cents. Hence, the final reduction in disposable per capita income is on the order of 60 cents. That is, between one third and one half of the initial shock is absorbed by the federal government. The much larger reaction of taxes than transfers to these regional imbalances reflects the fact that the main mechanism at work is the federal income tax system which in turn means that the stabilization process is automatic rather than specifically designed each time there is a cyclical movement in income. Some economists may want to argue that this regional insurance scheme provided by the federal government is an important reason why the system of fixed exchange rates that exists within the United States today has survived without major problems. Under this view, the creation of a European Central Bank that issues unified European currency without the simultaneous introduction (or expansion) of a fiscal federalist system could put the project at risk. Rough calculations of the impact of the existing European tax system on regional income suggests that a one dollar shock to regional GDP will reduce tax payments to the EEC government by half a cent!. Hence, the current European tax system has a long way to go before it reaches the 34 cents of the U.S. Federal Government.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 3855.

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Date of creation: Oct 1991
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Publication status: published as De Grauwe, Paul (ed.) The political economy of monetary union, Elgar Reference Collection. International Library of Critical Writings in Economics, vol. 134. Cheltenham, U.K. and Northampton, MA: Elgar, 2001.
Handle: RePEc:nbr:nberwo:3855

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  1. Maurice Obstfeld, 1984. "Capital Controls, The Dual Exchange Rate, and Devaluation," NBER Working Papers 1324, National Bureau of Economic Research, Inc.
  2. Barro, Robert J., 1974. "Are Government Bonds Net Wealth?," Scholarly Articles 3451399, Harvard University Department of Economics.
  3. Olivier J. Blanchard, 1984. "Debt, Deficits and Finite Horizons," NBER Working Papers 1389, National Bureau of Economic Research, Inc.
  4. Barro, Robert J. & Gordon, David B., 1983. "Rules, discretion and reputation in a model of monetary policy," Journal of Monetary Economics, Elsevier, Elsevier, vol. 12(1), pages 101-121.
  5. Thomas Willett & Edward Tower, 1970. "Currency areas and exchange-rate flexibility," Review of World Economics (Weltwirtschaftliches Archiv), Springer, vol. 105(1), pages 48-65, September.
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  1. L'uscita dell'euro redux: la Realpolitik colpisce ancora
    by Alberto Bagnai in Goofynomics on 2011-11-29 08:56:00
  2. A domanda rispondo
    by Alberto Bagnai in Goofynomics on 2012-11-25 22:59:00
  3. Convergiamo? In tanto tempo forse ci riusciamo...
    by Alberto Bagnai in Goofynomics on 2013-09-11 10:19:00
  4. Le aporie del piĆ¹ Europa
    by Alberto Bagnai in Goofynomics on 2012-08-05 15:59:00
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