Europe: From Monetary Unification to Fiscal Uniformity? Joseph Zeira Hebrew University of Jerusalem and LUISS IASEI

The Euro in Times of Crisis Since the financial global crisis of several countries in the Euro-zone have experienced severe increases of public debts. As a result these countries were offered support from the EU and the ECB conditioned on severe austerity measures. One result of this condition is that it severely reduced their ability to implement independent economic-social policies. This is a long-run structural result of the policy of austerity, in addition to its short-run adverse effects.

Fiscal Discipline, Expenditures and Income Originally, the Euro mattered mainly for the size of debt and the size of the deficit, which makes sense, since using seignorage to finance deficit is problematic in a monetary union. But fiscal discipline can be maintained with high public expenditures and high taxation, as it can be maintained with low levels of both. Austerity means choosing the combination of lower public expenditures and lower taxes. This choice is a most important social decision.

Gini and Public Expenditures in OECD 2012

Possible Reasons The negative relation between public expenditures and inequality can be explained by many mechanisms. First, public services supply education, housing and health care. Those cater for the poor by more than to the rich and thus reduce inequality. Expenditures also include welfare payments, which are mainly directed to the poor. But main mechanism is through direct taxes.

Public Expenditures and Redistribution When public expenditures are higher, public income should rise and that calls for higher taxation, including for higher direct taxation. Since direct taxes are progressive, inequality falls. This redistribution was examined in a recent paper by Michele Battisti and myself, which is forthcoming. The paper examines how fiscal policy changes the distribution of market income to disposable (net) income on a large set of more than 80 countries.

Cross-Section Regression Dependent Variable: GN 5 (2005) Independent Variables (1)(2)(3)(4)(5) GM 5 (2005)0.816*** (0.09) GM 5 (2000)0.935*** (0.09) 0.961*** (0.11) 0.959*** (0.09) 0.993*** (0.20) E 5 (2005)-0.406*** (0.09) *** (0.07) EMD 5 (2005)-0.439*** (0.08) DT 5 (2005)-.493*** (0.19) *** (0.19) SB 5 (2005) (1.40) R-Squared Number of Countries

Testing for Reverse Causality Our tests examine how inequality is related to fiscal policy. But it is possible that fiscal policy reacts to inequality. Actually, Meltzer and Richard (1981) claim that fiscal policy increases as a result of inequality, due to public demands for redistribution. We test this possibility by using a 2SLS regression. In first stage we regress fiscal policy on inequality, openness (Rodrik, 1998), development, ethnic fractionalization, dependency rate and a dummy before and after In the second stage we regress GN over GM and derived E.

2SLS Estimation of Gini Regression(1)(2) Dependent VariableE 5 (t) – 1 st stageGN 5 (t) – 2 nd stage GM 5 (t – 5)-0.196*** (0.07) 0.737*** (0.05) D 5 (t)4.767*** (0.70) OPEN 5 (t) *** (3.89) FRAC-9.817*** (2.54) DEP0.166*** (0.06) D (1.04) 2SLS E 5 (t)-.603*** (0.07) R-squared No. of observations304

Discussion of the Results The effect of the level of development on fiscal policy is as expected. It fits the view of public services as a luxury good. Ethnic fractionalization has a negative effect as expected, and the dependency rate has a strong positive effect, as expected. Market inequality has a negative effect, opposite to the prediction of Meltzer and Richard. Openness has a negative effect, opposite to the prediction by Rodrik. The second stage results support the previous results.

Final Conclusions The recent crisis in Europe led the EU and the ECB to pressure a number of countries to cut public expenditures. That change in fiscal policy will lead to an increase in inequality in these countries, as demonstrated by this research. These countries could instead increase tax collection. This change in social policy has not been a result of public deliberation, but was imposed from outside. It therefore raises the question: does monetary unification lead to fiscal uniformity? To a race to the bottom of redistribution?