Fiscal Union Explained

Fiscal union involves individual countries sharing the same common budget. It means spending and tax levels would be taken by a central fiscal authority. Fiscal union also means debt would be financed by a common bond rather than individual countries.

Fiscal union is proposed as a step for further European integration. It would mean a central European authority would set spending and tax rates for all member countries. Rather than individual country bonds, there would be a common Eurobond for financing Euro debt.

The United States is a fiscal union of different American states. Some states receive net inflows of money from federal government, others put more in than they get out. For example New Mexico receives a net fiscal flow (federal spending – federal taxes) of over 250% of its GDP. States like Delaware, New York and Illinois are net creditors.

At the moment, members of the Eurozone are responsible for their own budget (government spending and taxes). Individual countries also need to raise sufficient funds to meet their borrowing requirements.

For example, France has a national debt of 83% of GDP. To finance this, the French government will issue bonds on the financial markets. Other countries like Germany, Italy and Greece also issue their own bonds.

However, fears over some countries credit worthiness has led to a divergence in interest rate costs. This has put pressure on the Euro, because some countries are at risk of default.

Partial Fiscal Union

The European Financial  Stabilisation Facility is a partial attempt to share some fiscal burden amongst different member countries. Countries agree to offer security for part of the debt of other countries. To some extent this has satisfied markets, but because it is partial it may not be sufficient. Fiscal Union would replace this with a common budget.

Eurobonds

Eurobonds would be another step towards fiscal union. It would mean there is just one common Euro bond for all Eurozone government debt. It is possible to have the existence of Eurobonds with individual countries still setting tax and spending levels. However, with Eurobonds, there would be greater pressure for countries to stick to limits and rules about levels of spending and borrowing.

Problems of Fiscal Union

Political. A big disadvantage of fiscal union is that individual countries lose sovereignty in setting spending and tax levels. Spending cuts may be even harder to implement when they are set by ‘outside’ European institutions. There is a strong danger of a democratic deficit involved in fiscal union.

Advantages of Fiscal Union

  • Helps to promote greater regional equality, transferring funds to poorer areas.
  • Would prevent some countries suffering from sovereign debt crisis. Weaker Euro countries would benefit from sharing same Euro bonds as more credit worthy countries.
  • Logical completion of single currency. A common currency and common interest rate is hard to manage without fiscal union to ensure similar borrowing costs.

See more on pros and cons of Euro bonds

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