Fiscal Federalism and Dynamic Credence Capital in the U.S.

Abstract

In this study we argue that the U.S. should follow the Swiss precedent, restoring a strong fiscal federalist system, with fiscal autonomy for state and local governments. A ‘no-bailout’ principle should be restored, such that state as well as local governments are subject to bankruptcy laws. Like their Swiss counterparts, state and local governments would then have an incentive to enact effective fiscal rules, mandating a balanced budget and reduction in unsustainable levels of debt. Swiss style fiscal rules are proposed for the federal government as well as state and local governments. With these fiscal rules in place elected officials would have an incentive to address the debt crisis. With effective fiscal rules, and enforcement of a ‘no-bailout principle, citizens would gain confidence in the ability of elected officials to pursue prudent fiscal policies. However, after a half century of declining dynamic credence capital, enacting the institutional reforms required for effective fiscal rules in the U.S. will be a formidable challenge.