Creeping Federalization: Limits on Economic Harmonization in The United States and The European Union

The U.S. Constitution importantly limits the degree to which the federal governmentcan impose harmonization across member states. This paper reviews these limitations andhow they have evolved substantially over time in the U.S. It also discusses some of thebenefits and costs of such limitations, and argues that the EU may benefit from adoptingsimilar limitations. Harmonization of EU tax codes is likely to be economically harmful. Ontheoretical grounds, tax rates are likely to be harmonized at a common rate that is higher thanoptimal for the EU. This suggests the benefits of constitutional provisions that make taxharmonization difficult to impose. Other types of harmonization have a less clear-cut costbenefitanalysis. A federal commercial code that is uniform across member states reducestransaction and information costs, compared to leaving important code issues to memberstates; further, many states may keep codes for long periods that are sub-optimal compared toa given federal code. A federal code may, however, fit poorly with other institutions ofmember states, potentially causing large costs. Leaving codes to the states leads tocompetition across states, and may generate forces for change for the better. Competition alsogenerates information about the effectiveness and costs of different commercial codes.Because any country's initial code is likely to be sub-optimal, and is likely to become lessoptimal over time, information on how to improve codes is valuable. Likely it is easier tolearn and adapt from member states than from other countries.