Fiscal integration as a Pareto improvement

Giovanni Bonfanti

No 3297, Working Paper Series from European Central Bank

Abstract: Fiscal integration in a currency union is generally understood as a transfer from fiscally strong to fiscally weak countries. I show that this changes when common debt is paired with a non-defaultable common tax, even if national debt remains defaultable. The risky country gains from intertemporal trade: it receives a grant financed by a perpetual obligation it discounts more heavily than lenders do. The cost to the safe member is second-order and the tax removes it by insuring imperfectly correlated cycles rather than transferring resources in expectation. The calibration delivers a narrow Pareto-improving region: the tax that eliminates the risky country’s perverse incentive to default is negligible, while the tax that compensates the safe country is an order of magnitude larger. Joint spending on a public good expands the region and reverses that ordering: the safe country gains even before the common budget balances. JEL Classification: F34, F36, F45, H63, H87

Keywords: common debt; fiscal union; non-defaultable taxation; Pareto improvement; sovereign default (search for similar items in EconPapers)
Date: 2026-10
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