25 October 2013

ECB/Asmussen: Cooperation and diversity - Principles for a stable euro area

Asmussen laid out what he saw as a realistic medium-term vision for the euro area, combining the twin needs of cooperation and diversity. "But for the euro area to prosper, we also need a third concept: responsibility", he concluded.

On Banking Union, Asmussen said credible national backstops must be put in place before the ECB concludes its health check of banks in October 2014. "If not, the credibility of the whole exercise is put at risk as the outcome will then almost certainly be negatively perceived by market participants", he said. "Doing this balance sheet assessment without a backstop in place would be a bit like getting on a boat in rough weather conditions, and not taking a life jacket on board." The ECB still supported plans for a Single Resolution Mechanism to deal with troubled banks entering into force in January 2015, Asmussen said.

Fiscal Union

"For the fiscal union, finding the balance between cooperation and diversity is more difficult. National preferences for taxing and spending are stronger, and the case for elevating certain functions to the European level is more complex. And there can be no taxation without representation, meaning any shift to a more European fiscal policy must be accompanied by the same shift towards European democratic control.

So to frame the discussion, I think it is helpful to recall the taxonomy of economic policy functions described by Richard Musgrave. He distinguished between stabilisation, allocation and distribution. Broadly speaking, stabilisation helps smooth the business cycle, allocation ensures that resources are used efficiently and distribution ensures an equitable sharing of income.

Which of these functions do we need at the European level for fiscal policy, and in what form?

Stabilisation

As you know, stabilisation in Europe takes place through national budgets and, in normal circumstances, they are sufficient to smooth the cycle. A recent study demonstrates that 47 per cent of an unemployment shock is absorbed by the automatic stabilisers in the EU, compared with only 34 per cent in the US. They were insufficient in some countries during the crisis only because they faced an exceptional circumstance: a very large shock from the financial sector.

With a genuine Banking Union, however, the risk of this happening again should be lower. First, we expect the SSM to increase the quality of supervision and the assessment of systemic risk. Second, if a financial shock were still to appear, national budgets should be better insulated. The costs of banking sector repair would be shared with the private sector through the Single Resolution Mechanism and a more integrated European financial market.

All this suggests that stabilisation at the national level could be more effective in future. Or put differently, the more successful we are in building a genuine Banking Union, the less we would need a central budget for stabilisation purposes.

However, this does not mean I see no role for fiscal union in the stabilisation area.

First, we would need the public backstop, namely for the resolution fund, which would be fiscally neutral over the medium-term. In my view the ESM could play this role.

Second, we would need an insurance mechanism against tail events that may still arise and endanger euro area financial stability. Here we already have the ESM to act as lender of last resort to sovereigns.

Allocation

Differences in tax regimes create hidden barriers and inefficiencies in the single market, and in my view one function of the fiscal union should be to remove them. These hidden barriers hinder both financial and economic integration. Different rules for taxing dividends, for example, discourage cross-border investments in equity. Different corporate tax regimes mean companies do not necessarily invest where production is most efficient, but where they receive the higher after-tax return.

While the Commission has made some progress in addressing these issues, the overall approach to tax policy in Europe remains piecemeal. Yet at this time, when growth is stalling and markets are fragmented, I see clear benefits to greater cooperation that deepens the single market, focusing on the taxes that are most important for the functioning of the single market, e.g. corporate taxation and capital taxation.

In my view, this implies a more coherent strategy based on three prongs.

The first is harmonising tax codes. This would mean removing distortions to cross-border activity created by problems such as double taxation or different treatment of residents and non-residents.

The second is harmonising tax bases. I see the common consolidated corporate tax base as a good way forward here, as it would make tax levels more comparable and allow firms to file a single consolidated tax return for their EU activity, thus supporting the single market.

The third step would be to focus on harmonising tax rates. Some tax competition is healthy, but in a single market it has to be within limits. For example, we could think of agreeing a minimum floor for corporation taxes.

Ideally, such a strategy would involve all EU countries. But if this is not feasible, euro area countries could lead the way by deepening the fiscal union in this area.

Distribution

A harmonised approach to tax policies could also have a distributive function – the third part of Musgrave’s taxonomy. I see this as an appropriate role for a euro area fiscal union to play.

We have witnessed several examples in recent years of multinationals arbitraging tax systems to pay less than their fair share to society. We have also witnessed the possibility for cross-border tax evasion from wealthy individuals. A more cooperative approach to tax policy could counteract this and would be in the interest of all countries. It would also be a timely reminder to citizens of how the Union can defend their interests.

It goes without saying, however, that there is too much diversity on the wider questions of distribution for these to be answered at the European level in the medium term.

To sum up: a functioning Banking Union reduces the need for the stabilisation function of a fiscal union, but not to zero. Greater efforts should be invested in the allocation function."

Full speech

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