Does EMU need a fiscal federation?

The stabilization provided by the US federal budget has been used as an example of the adjustment mechanism that are lacking in Europe and which are needed to make a currency area viable. This paper presents four sets of findings that surest that the benefits of a European fiscal federation would be modest. First, we show that some of the previous estimates of the benefits of the US federal budget overestimate the amount of interstate insurance by a factor of 3. Second, Europe already has national tax system which, according to our estimates, can insure more than 50% of a European fiscal federation. Third, we find evidence that the potential insurance benefits of a European fiscal federation have decreased over time. Fourth, there are large cross-country differences in the benefits provided by federation. We conclude that the potential to provide interregional insurance by creating a European fiscal federation is too small to compensate for the many problems associated with its design and implementation.