Fiscal Federalism and Optimum Currency Areas: Evidence for Europe from the United States
Jeffrey Sachs and
Xavier Sala-i-Martin
No 632, CEPR Discussion Papers from C.E.P.R. Discussion Papers
Abstract:
The main aim of this paper is to estimate the extent to which 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 reduction 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 around 60 cents. That is, between one-third and one-half of the initial shock to the region is absorbed by the Federal Government. Taxes respond more strongly to regional imbalances than do transfers. The main mechanism at work is the federal income tax system, which implies that the stabilization process is automatic rather than specifically designed each time there is a cyclical movement in income. Some economists may argue that this regional insurance scheme, provided by the Federal Government, is an important reason why the US system of fixed exchange rates has survived without major difficulties. According to this view, Europeans who look to the United States as a model for Europe should seriously consider the creation (or expansion) of a federal fiscal system at the same time as they create a European Central Bank that issues a unified European currency. The creation of the latter without the insurance mechanism provided by the former could endanger the entire process of monetary unification. Approximate 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 EC government by half a cent. Hence, the current European tax system has a long way to go before it reaches the 34 cents response of the US system.
Keywords: Exchange Rate; Exchange Rate Arrangements; Fiscal Federalism (search for similar items in EconPapers)
JEL-codes: F31 F33 H00 (search for similar items in EconPapers)
Date: 1992-03
References: Add references at CitEc
Citations: View citations in EconPapers (231)
Downloads: (external link)
http://www.cepr.org/active/publications/discussion_papers/dp.php?dpno=632 (application/pdf)
CEPR Discussion Papers are free to download for our researchers, subscribers and members. If you fall into one of these categories but have trouble downloading our papers, please contact us at subscribers@cepr.org
Related works:
Working Paper: Fiscal Federalism and Optimum Currency Areas: Evidence for Europe From the United States (1991) 
This item may be available elsewhere in EconPapers: Search for items with the same title.
Export reference: BibTeX
RIS (EndNote, ProCite, RefMan)
HTML/Text
Persistent link: https://EconPapers.repec.org/RePEc:cpr:ceprdp:632
Ordering information: This working paper can be ordered from
http://www.cepr.org/ ... pers/dp.php?dpno=632
Access Statistics for this paper
More papers in CEPR Discussion Papers from C.E.P.R. Discussion Papers Centre for Economic Policy Research, 33 Great Sutton Street, London EC1V 0DX.
Bibliographic data for series maintained by ().