Fiscal Union in Europe? Redistributing and stabilising effects of a European Tax Benefit System and Fiscal Equalisation Mechanism

Economic Policy, 28(75), pp.375-422

Abstract

The current debt crisis has given rise to a debate concerning deeper fiscal integration in Europe. The view is widespread that moving towards a ‘fiscal union’ would have stabilizing effects in case of macroeconomic shocks. We study the economic effects of introducing two elements of a fiscal union: an EU-wide tax and transfer system and a fiscal equalization mechanism. Using the European tax-benefit calculator EUROMOD, we exploit representative household micro data from 11 eurozone countries to simulate these policy reforms and study their effects on the income distribution and automatic stabilizers. We find that replacing one third of the national tax-benefit systems with a European system would lead to significant redistributive effects both within and across countries. These effects depend on income levels and the structures of existing national systems. The EU system would particularly improve fiscal stabilization in credit constrained countries absorbing 10–15% of a macroeconomic income shock. Introducing a fiscal equalization mechanism would redistribute revenues from high to low income countries. However, the stabilization properties of this system are ambiguous. The results suggest that it might be necessary for Europe to explore alternative ways of improving macroeconomic stability without redistributing income ex ante.

Research Highlight 2013

Redistributive and stabilising effects of a European tax-benefit system

The current debt crisis has given rise to a debate about deeper fiscal integration in Europe. There is a widespread view that moving towards a ‘fiscal union’ would increase the ability of the currency union to maintain economic stability in situations where some member states are affected by economic shocks. At the same time the idea of deepening fiscal integration raises a number of concerns. In particular, residents of high income countries fear that more fiscal integration may lead to massive redistribution in favour of low income countries. Higher taxes in high income countries and higher transfers in low income countries could both increase and undermine incentives to work and invest.

This research addresses these issues by analysing the economic effects of two key elements of fiscal integration, i) the introduction of an EU-wide integrated tax and transfer system which partly or fully replaces the existing national systems and ii) the introduction of a system of fiscal equalisation. These reforms would be far-reaching, but they reflect the widespread view that radical steps towards more fiscal integration are necessary. The research draws on representative household micro data from 11 Eurozone countries to simulate these policy reforms and to study their effects on the distribution of income as well as their impact on automatic fiscal stabilisers.

Replacing one third of the national tax and transfer systems by a European system would lead to significant redistributive effects both within and across countries. Labour supply incentives may be undermined in both low and high income countries. But the reform would improve fiscal stabilisation especially in countries which cannot rely on national automatic fiscal stabilisers because they face borrowing constraints. A horizontal fiscal equalisation system based on taxing capacity would redistribute revenues from high to low income countries, but the stabilisation properties of this system are ambiguous.

Olivier Bargain, Mathias Dolls, Clemens Fuest, Dirk Neumann, Andreas Peichl, Nico Pestel, Sebastian Siegloch

Author/s

Oliver Bargain, Mathias Dolls, Clemens Fuest, Dirk Neumann, Andreas Peichl, Nico Pestel, and Sebastian Siegloch