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Brendan Keenan: Federal model shows unity of purpose missing in eurozone

MITT Romney, contender for the Republican nomination in the US presidential election, may not pay a lot of tax himself, but one of his problems is that they do in Massachusetts, the State where he was Governor.

They do not like that idea in a lot of other states, such as South Carolina. Texans dismiss Massachusetts -- the most European of New England states as "Taxachusetts". There is a wider range of tax regimes in the states of the USA than the nations of the eurozone, or even the EU-15.

As the "fiscal union" looms up to save the euro, it does seem odd that American states can enjoy greater fiscal freedom than eurozone nation states, with no apparent threat to the dollar monetary union, or to individual states' credit rating.

Indeed, it often seems odd that the centuries' experience of the creation of the USA does not figure more in the debates on the creation and development of the European Union. "From Many, One" is the motto of the US, with "Ever Closer Union" being the nearest equivalent for the EU. The differences in the two phrases may be significant.

There is, apparently, plenty of academic literature on the subject. A new essay* by two European analysts tries to place the lessons to be learnt from American experience into the general public European debate. They argue that the eurozone fiscal union, and the possibility of collective euro bond issues, make the financing of US states more relevant than for any previous EU developments.

As the authors say, the USA is not the only federation in the world. There may be lessons to learn from the creation of the political systems of Canada and Australia, or Switzerland. The German federal structure almost certainly influences German attitudes to the eurozone. French centralism does the same, but in the opposite direction.

However, the US union is old, complex and the best-known of all. Its development followed a path quite different -- in some cases the exact opposite -- of the EU approach. The difference between the US motto, "From many, one" and the EU's "Ever closer union" may be significant.

It comes as something of a surprise, for instance, that the US works on a strict "no bailout" regime for states. Even the bankruptcy of New York City was resolved without overt Federal assistance -- provoking the legendary newspaper headline: "(President) Ford to City: Drop Dead."

The only bailout since the 1840s has been that of the District of Columbia, otherwise known as Washington. That's politicians for you. Even more remarkably, Arkansas in 1933 is the only state to have defaulted on its debts since the 1840s. It took it ten years to return fully to the markets.

This was supposed to be the strict rule in the eurozone as well. In what may turn out to have been a major error, the policy was abandoned for fear that default in Greece would threaten the single currency.

In fairness, the same thinking may explain why the early USA bailed out indebted states before the Civil War settled the question of membership for good. The euro area cannot wait that long before deciding where risk should fall.

A more subtle difference is the fact that debt limits on the states are not imposed from Washington. They are state laws, and only Virginia does not have one. The authors think this may give them more legitimacy than fiscal rules imposed from the centre, as is planned for the euro area

That would be a great irony for Ireland. There is good reason to think that, after the experience of the 1980s, the Irish electorate would not have tolerated another government borrowing spree in the 2000s. But the government finances looked ridiculously healthy. The private sector borrowing spree hid the underlying deficits, and then the private losses were added to the public finances. The danger is that the hard-won commitment to sound money will be replaced by little more than incoherent rage against perceived injustices from abroad.

There is little love for Washington in many US states, but the debt brakes are state rules, not federal, born of the experience of busts and defaults in the early years. If states are not to be bailed out, nor can other entities. Although no state defaulted, around 60 local authorities reneged on their debts in the past 30 years.

Busted banks have always been a feature of the American way.

One critical difference, especially for Ireland, between this and Frankfurt's way is that while the American states are responsible for their own debts, they are not responsible for those of banks. The essay authors see this as a difference which needs urgent examination in Europe.

Federal cash to stabilise the US banking system after 2008 did not threaten the solvency of the individual states. Banking regulation is also far more federal than in the euro area, where the introduction of national debt brakes under the fiscal union collides with the need to mount large-scale rescues of banking systems by member states. Such collisions are damaging to the credibility of the fiscal union itself.

The state budget rules do not always work. California, the largest of them all, is currently in deep trouble. But there seems to be limited contagion from one state's difficulties to other states. There may be several reasons for this, but one is the clear understanding that the cost will not fall, directly or indirectly, on other states.

Perhaps the most chilling warning of all is that states are able to run balanced budgets because the federal government can counter the ups and downs of the economic cycle with its own budget.

The European plan is balanced budgets for all. There are new rules outside the public finances to curb booms, but little or nothing to alleviate downturns. It took a long time, and a civil war, to fashion the United States. Europe does not have time, but war, albeit of the political rather than military kind, cannot be ruled out.

* Fiscal Federalism: US History for Architects of Europe's Fiscal Union. Randall Henning and Martin Kessler. Available at www.Bruegel.org

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