Essays on Heterogeneity in Fiscal Unions

Abstract

This dissertation investigates the implications of heterogeneity in fiscal unions for risk sharing and the welfare cost of business cycles. Each chapter considers the United States as a fiscal union, with a heterogeneous intergovernmental composition of public goods, in a two-region, open economy DSGE framework. Chapter 1 adds the asymmetry of the regional tax systems into the research framework and demonstrates that the productivity of public goods is the unique parameter that determines the specific type of the welfare-maximizing tax system. Conditional on sufficiently high (low) public good productivity, the cost of business cycles is minimized if the union members collect the consumption (labor income) taxes. Chapter 2 focuses on the state-specific borrowing limits as a source of interregional asymmetry, and shows that the asymmetry of balanced-budget rules is detrimental for the risk sharing in the union. The degree of risk sharing is a function of the public good productivity, specification of the technology process, and distribution of productivity shocks in the fiscal union. Chapter 3 explores how the design of the balanced-budget rules should be altered to increase efficiency in the union. It is shown that by adopting symmetric borrowing limits, the shift of resources between the regions is minimized, which increases efficiency as well as improves risk sharing. The space for policy coordination is explored, and it is shown that the objectives of the regional governments and the federal government do not contradict each other. Moreover, welfare gains associated with the adoption of alternative policies are estimated.