Fiscal Centralization Will Accelerate Europe's Debt Crisis

David Ignatius continues his odd habit of drawing wrong conclusions from Europe's fiscal crisis. In a previous post, we made fun of one of his columns because he said America needed a value-added tax to avoid a Greek-style crisis. Yet since Greece has a VAT, he was, for all intents and purposes, arguing that we should copy Greece's policies to avoid Greece's problems. Now he has a column saying that Europe needs fiscal centralization to make the euro work. This is a rather interesting assertion since Ignatius comes from a nation that shows that it is possible to have a common currency with 50 different states with 50 different fiscal policies. Perhaps this is why he wrote an entire column on the topic without ever offering any analysis or evidence for his position. Here's an excerpt:

...there's a radical mismatch between the ideal of economic integration and the reality that the eurozone has 16 different fiscal regimes -- a disconnect that helped produce this crisis. ...With this crisis, [Italian President Giorgio Napolitano] argued, Europeans must finally accept that union "implies a partial transfer of national sovereignty." The current halfway integration simply isn't strong enough to support a common currency, he suggested. ...Investors keep pounding Europe in part because they don't yet see the mechanisms that will enforce discipline. The European Union just established a trillion-dollar bailout fund, but what happens when it runs out? There's a pledge to impose strict conditions on Greece, Portugal and the rest in exchange for loans, but it still isn't clear how Brussels will make this austerity regime work. ...What worries me is that the dictates of economics and politics are now in conflict in Europe. To sustain its common currency, Europe needs integrated fiscal policies that are enforceable on all members.

Given his reliance on empty assertions, let's step into the vacuum and make two observations. First, letting Greece officially default would have been the best way to enforce fiscal discipline. A default would have radically curtailed Greece's ability (and the ability of other European nations) to overspend by borrowing cheap money and leaving the bill for future generations. The bailout, by contrast, rewarded profligacy and sent a signal to other European nations that it is possible to over-tax and over-spend and send the bill to taxpayers in other nations.

Second, a centralized fiscal policy would exacerbate Europe's fiscal problems by creating a tragedy of the commons. The existence of a pot of money in Brussels would encourage every nation to maximize its share of the loot, in the same way that a bloated federal government in Washington subsidizes bad fiscal behavior by state politicians. It wouldn't matter whether the centralized fiscal policy replaced a portion of national budgets or (more likely) represented an additional source of government largesse. Europe's problems exist because too many people have learned to try to live off the labor of too few people. Another layer of government makes that problem worse, not better - especially since it would open up the possibility of having people from other nations bear the burden.