Fiscal federalism and monetary unions: A quantitative assessment

Abstract

In this paper, I provide a quantitative analysis of three different forms of fiscal federalism in monetary unions: fully decentralized regional fiscal authorities as the benchmark, fiscal equalization with nominal tax revenue sharing, and a common central fiscal authority. I assess the capability of the different arrangements to stabilize regional consumption, output, and employment over the business cycle. I also study the implications for interregional income, consumption risk sharing and welfare. From this analysis, the following results emerge. First, a central fiscal authority stabilizes consumption fluctuations and increases the scope of interregional income and consumption risk sharing. Second, fiscal equalization destabilizes consumption fluctuations and also reduces the scope of interregional income and consumption risk smoothing. Third, a central fiscal authority leads to welfare gains, whereas fiscal equalization leads to welfare losses.