29 June 2011

Commission released 'Multiannual Financial Framework (MFF) - Q&As'

The Memo covers (1) the main background elements on MFF definition and functioning, (2) the main novelties proposed by the Commission on policies and (3) new ideas on the financing of the future budget.

1. Definition, historical background and procedures

The Multiannual Financial Framework (MFF) translates into financial terms the Union's political priorities for at least 5 years. Article 312 of the Lisbon Treaty provides that the MFF is laid down in a regulation adopted unanimously by Council after obtaining the consent (adopts or rejects the whole package, no amendments) from the European Parliament. It sets annual maximum amounts (ceilings) for EU expenditure as a whole and for the main categories of expenditure (headings). It is not as detailed as an annual budget.

By specifying the spending limits for each category of expenditure, the MFF imposes budgetary discipline and ensures that the Union's expenditure develops in an orderly manner within the limits of its own resources and in line with Union's policy objectives. In addition, this system ensures a predictable inflow of resources for the Union's long-term priorities and gives greater certainty to beneficiaries of EU funds, such as SME's, regions catching up, students, researchers, civil society organisations.

The MFF sets the cornerstones for the annual budgetary procedure. It considerably facilitates agreement on the yearly budget between the European Parliament and the Council which are the two branches of the Union's budgetary authority. At the same time it ensures continuity towards achieving the priorities set for the benefit of Europe. The financial framework also lays down any other provisions required for the annual budgetary procedure to run smoothly.

The MFF is part of the European Union's functioning since 1988 and has covered periods varying from 5 to 7 years.

• The first Financial Framework, the so called Delors Package I, covered the years 1988-1992 and focused on establishing the Internal Market and consolidating the multi annual research and development framework programme.
• The second framework 1993-1999, the Delors Package II, gave priority to social and cohesion policy and the introduction of the euro.
• The "Agenda 2000" covered the period 2000-2006 and focused on the
  enlargement of the Union.
• Finally, the MFF 2007-2013 gave priority to sustainable growth and competitiveness, in order to create more jobs.

The next MFF will present the budgetary priorities of the Union for the years 2014 to 2020.

How does the entry into force of the Lisbon Treaty in 2009 affect the MFF 2014-2020? Prior to the entry into force of the Lisbon Treaty, MFF was the result of an interinstitutional agreement. Yet, the article 312 of the Treaty on the Functioning of the European Union also confers a legally binding value to the Multiannual Financial Framework to determine "the amounts of the annual ceilings on commitment appropriations by category of expenditure and of the annual ceiling on payment appropriations". Besides, under the new treaty, the decision on the MFF will have to be taken by the Council deciding unanimously after receiving the Parliament's consent.

Why should the Financial Framework be agreed no later than 2012? It takes 12-18 months to agree on the legal bases for all the multi-annual programmes and projects which will be financed under the MFF, in areas such as research, education, cohesion, development aid, neighbourhood policy etc. In order to allow these programmes to start in January 2014, a political agreement on the ceiling in the MFF should be taken no later than one and a half year before the framework enters into force. Furthermore, the political agreement will need to be translated into a Council Regulation requiring the consent of the European Parliament.

What happens if there is no agreement? If there is no agreement before the end of 2013, the 2013 ceilings will be extended to 2014, plus a 2 per cent inflation adjustment. The Treaty also foresees the extension of the "other provisions" corresponding to the last year of the financial framework. This means that all the provisions on the adjustments and revisions of the financial framework and instruments outside the financial framework would be extended. Whether or not there is an agreement on the next MFF, there will be financial framework ceilings in place for 2014 and the budget could thus be adopted in conformity with the Treaty.

The absence of an agreed financial framework 2014-20 would considerably complicate the adoption of new programmes. And in the absence of new legal bases, including their indicative financial envelopes, no commitments could be made for those multiannual spending programmes for which the legal base expires in 2013. So, as in the case of late agreement, the 2014 budget would probably only cover the agricultural payments and the payments on outstanding commitments. In other terms, citizens benefiting from EU-funds, such as researchers, students, civil society organisations, would face severe drawbacks.

2. Novelties on expenditure side of the MFF

What is new for Cohesion policy? The Commission proposes to allocate 36.7 per cent of the MFF to Cohesion policy as compared to 35 per cent in the previous exercise. The main changes proposed by the Commission are as follows:

• The proposal foresees the creation of a category of intermediate regions whose GDP is between 75 per cent and 90 per cent of the average EU GDP. This new category will complement the two existing ones (convergence regions and competitiveness regions).Those "transition regions" should retain two thirds of their previous allocations for the next MFF period. The poorest regions and Member States of the European Union would then be helped in priority in order for them to catch up with the more prosperous Member States.
• Introducing conditionality in cohesion policy: it will be based on results and incentives to implement the reforms needed to ensure effective use of the financial resources. In addition, 5 per cent of the cohesion budget for each Member State will be set aside as a performance reserve and allocated, following a mid-term review, to those Member States whose programmes have contributed most to progress in meeting agreed milestones set in the development and investment partnership contracts.
• The Commission proposes the creation of a common strategic framework for all structural funds to translate the Europe 2020 objectives into investment priorities. In operational terms, the Commission proposes to conclude a partnership contracts with each MemberState. These contracts will set out the commitment of partners at national and regional level to utilise the allocated funds to implement the Europe 2020 strategy.
• The European Social Fund (ESF) will continue to play a key role in fighting unemployment and high rates of poverty, and delivering headlines targets of Europe 2020. The ESF will represent 25 per cent of the budget allocated to cohesion policy, i.e. €84 billion. 

The Commission proposes to allocate €376 billion to Cohesion policy instruments in general (including the Connecting Europe facility – see below).

What is new for Infrastructure and Interconnection of Internal Market? The Commission proposes the creation of a Connecting Europe Facility to accelerate the infrastructure development in transport, energy and ICT across the EU to the benefit of all. Experience shows that national budgets will never give sufficiently high priority to multi-country, cross-border investments to equip the Single Market with the infrastructure it needs. EU budget can secure funding for the pan-European projects that connect the centre and the periphery.

This Facility will be centrally managed and will be funded from a new section of the budget. Co-financing rates from the EU budget will be higher when the investments take place in 'convergence' regions than in 'competitiveness' regions. Local and regional infrastructures will be linked to the priority EU infrastructures, connecting all citizens throughout the EU, and can be (co-) financed by the structural funds (cohesion fund and/or ERDF, depending on the situation of each Member State/region).

3. Financing and own resources

Where does the money come from? The European Union has three types own resources to finance its expenditure:

• traditional own resource (sugar levies and agricultural and customs duties),
• VAT-based own resource (a portion of the national VAT collected by Member States at national level),
• GNI-based own resource (the "national contributions" based on each Member State GNI).

In 2011, 76 per cent of the revenue of the EU budget will come from the GNI-based resource, 12 per cent from customs duties and sugar levies and 11 per cent from the VAT based resource. The remaining 1 per cent comes from taxes paid by EU staff and from other miscellaneous sources such as fines on companies that breach competition or other laws, unspent amounts from previous years.

Why propose new own resources? Because the current system has a number of drawbacks. It is opaque and complex. It is perceived as lacking fairness by most Member States – notably with regard to corrections, of which the British rebate is the most well known, but it is less known that Germany, the Netherlands, Austria and Sweden have exceptions from financing the UK reduction (a "rebate on the rebate!"). The same countries have lower rate of their VAT contributions and the Netherland and Sweden in addition decreased national contributions based on a country's GNI. The current financing also relies excessively on national contributions. For many, these are seen as expenditures to minimise and for which a national return must be justified. Finally, with the exception of customs duties stemming from the customs union, existing resources do not display a clear link to EU policies.

Our aim with this proposal is therefore to decrease national contributions and thus contribute to budgetary consolidation efforts in the Member States; to create a link between EU policy objectives and the EU financing; and to make the system more transparent and fairer. This is not about increasing EU budget.

The Connecting Europe Facility offers opportunities for using innovative financing tools to speed up and secure greater investment than could be achieved only through public funding. The Commission will work closely with the EIB and other public investment banks to combine funding of these projects. In particular, the Commission will promote the use of EU project bonds as a means of bringing forward the realisation of these important projects.

The Commission proposes to allocate €40 billion to this priority, to be complemented by an additional €10 billion ring fenced to related transport investments inside the Cohesion Fund. This amount comprises €9.1 billion for the energy sector, €31.6 billion for transport (including €10 billion inside the Cohesion Fund) and €9.1 billion for ICT.

Has the financing of the EU budget been changed before? Six own resources decisions have been adopted since 1970. In fact, the structure of the financing side has evolved considerably over time. Reforms on the expenditure side have generally been accompanied by reforms of the way the Union is financed. The contribution based on Gross National Income (GNI), i.e. proportional to each Member State's wealth, has taken on a growing importance and now represents three-quarters of the budget. And a large number of complex corrections and special arrangements have been introduced over time, both on the revenue and expenditure side of the budget.

The result of these changes is that budget negotiations have recently been heavily influenced by Member States' focus on the notion of net positions ("juste retour" debate) with the consequence of favouring instruments with geographically pre-allocated financial envelopes, rather than those with the greatest EU added value.

What would be the new resources then? The changes proposed by the Commission are as follows:

• Simplify Member States' contribution by ending the complex VAT-based own resource from 2014. This will render the system of contributions simpler and more transparent.
• Introduce two new own resources: a tax on the financial transactions (FTT) and a modernised VAT. This will facilitate budgetary consolidation in the Member States by reducing their contributions to the EU budget, bring a new impetus to the development of the Internal Market in the areas of VAT and financial sector taxation.
• Reform the correction mechanisms by replacing all existing corrections by a simple and transparent system of lump sums related to the prosperity of the Member States.

The present Commission proposals make full use of the possibilities offered by the Lisbon Treaty to establish new categories of own resources or to abolish existing ones. The report on the operation of the own resources system highlights how each of these proposals relates to and complement the others.

Why dropping the VAT-based resource? The Commission proposes to eliminate the complex VAT-based own resource. Compared to the GNI-based own resource, the current VAT-based own resource has little added value. To create a comparable tax base, VAT-based contributions result from a mathematical calculation rather than passing directly from the citizen to the EU. Furthermore, VAT-based contributions are capped in proportion to GNI and thus, partly comparable to GNI-based contributions. As such the VAT-based own resource contributes to the complexity and the opacity of the EU budget financing system.

Why choose EU taxation of the financial sector and EU VAT? The analysis of the various potential candidates as own resources gave rise to a substantial technical work. The following key elements were highlighted:

• EU taxation of the financial transaction (FTT): It would give extra room for manoeuvre to national governments and contribute to general budgetary consolidation efforts. Such taxation exists at national level in some Member States, but action at EU level could prove more effective and efficient, and it could play a role in reducing the existing fragmentation of the Internal Market. The Commission will make this proposal after the summer.
• Modernised VAT: It would create a genuine link between national and EU VAT and foster additional harmonisation of national VAT systems. It would provide significant and stable receipts to the EU with limited administrative and compliance costs for national administrations and business. It forms part of a broader recent Commission initiative launched in December 2010 with the issuance of the Green Paper on the future of VAT aimed at reducing the extent of tax-induced distortions in the internal market. Broadening the tax base, reducing the scope for fraud, improving the administration of the tax and reducing compliance costs administrative cooperation in the context of a broad reform of VAT could deliver important results and generate new revenue streams for the Member States and the EU.

How much revenue do you expect from those new own resources? It is estimated that by 2020, the new own resources could amount to almost half of EU Budget revenue, while the share of GNI-based contributions will go down to around one third (from over three quarters today). The national contributions of Member States will decrease accordingly, in proportion to their respective GNI (that is in proportion to their relative wealth).

What are the correction mechanisms? The 1984 Fontainebleau European Council set out important guiding principles to ensure fairness in the EU budget. It indicated in particular that "expenditure policy is ultimately the essential means of resolving the question of budgetary imbalances". It acknowledged, nevertheless, that "any Member State sustaining a budgetary burden which is excessive in relation to its relative prosperity may benefit from a correction at the appropriate time". These principles have been confirmed and consistently applied in successive own resources decisions.

Different complex correction mechanisms have been added since then, including:

• a correction in favour of the UK (UK rebate);
• reduced financing of the UK correction for Germany, the Netherlands, Austria and Sweden ("rebates on the rebate");
• a share of 25 per cent retained by Member States as "collection costs" for traditional own resources (notably customs duties), which constitutes a hidden correction to the benefit of a limited number of Member States;
• temporary reduction in VAT-based contributions for Germany, the Netherlands, Austria and Sweden; and
• temporary reduction in GNI-based contributions for the Netherlands and Sweden.

Full Memo 11/468

© European Commission