European Union Sovereign Debt Level Control

The European Union is a monetary union where member states control their fiscal budget. Yet some overborrow, imposing debt-spiraling risks for themselves and financial externalities for the rest. I propose a taxation mechanism imposed by the EU monetary authorities to restrain irresponsible fiscal behaviors, corresponding to the twofold concern of deficit spending and the overall debt level. The optimal tax estimation model incorporates a country-specific financial distress cost measure, historical European Central Bank assistance programs, and a replication of the debt sustainability condition. The proposed mechanism has positive implications for EU financial stability. Although I do not find evidence for a Covid-period structural break, the taxation mechanism has much room for evolvement in today’s changing EU regulatory policy landscape.