25 July 2016

CEPS: The potential and limitations of reforming the financing of the EU budget

The study has reviewed potential new own resources, but has shortlisted four instruments: value added tax (VAT), corporate income tax (CIT), the FTT and options for carbon levies. The economic efficiency aspects of these four instruments and their various possible specifications are considerable. The first two taxes already exist in all Member States and raise issues of horizontal and vertical externalities: both an EU VAT and an EU CIT would be an additional levy on a tax base that is already taxed by national – and sometimes infra-national – governments. The strategic interplay between tax authorities at various levels generate forces pointing in opposite directions: while horizontal externalities, currently at play, generate tax competition, the vertical externalities that would result from using these instruments at the EU level would mitigate tax competition, and in most cases lead to an outcome closer to optimum in terms of public goods provision by the various levels of government.

Although CIT appears attractive, especially in the present context of fighting aggressive tax optimisation by multinational corporations and base-erosion practices, it also poses technical and macroeconomic difficulties. First, the tax bases are currently quite different among Member States, which probably makes use of CIT as an EU resource conditional on some harmonisation of the base, the most obvious solution being the proposal for a common consolidated corporate tax base already put forward by the Commission.

The pros and cons of an FTT have been described in various studies, in particular in the Commission’s proposal. In the current context, it is not clear that this instrument would meet most of the economic criteria. In addition, it is likely to be accepted by only a minority of Member States, raising the issue of variable geometry in the EU budget or its financing (or both). [...]

There is already a need to enhance flexibility in the years leading up to the next MFF and maybe revise the payment ceilings. There is a potential risk that the RAL (reste à liquider) could increase considerably, creating a payment crisis. Some of the present flexibility options may exacerbate this. First and most importantly, some inconsistencies in the budget can be quickly removed, for example the reimbursement by the European Commission of revenues from fines, which could either be used as a reserve for unexpected events or as income for the budget in the following year.

A key proposal for the future is to create a well-endowed budget line for unforeseen events (above €10 billion). The logic would be similar to the Solidarity Fund, but should be an actual fund quickly deployable and within the budget ceilings of the MFF, and subject to co-decision. [...]

Reforms of the main expenditure items – the CAP and structural funds – should aim at generating genuine EU added value. A financial system based on cohesion can be devised, with reforms in expenditure areas being accompanied by reforms in resources, using transitional periods. A gradual introduction of co-financing or other reforms in agriculture could reduce 18 agreed corrections or allow the increased use of genuine own resources. Carbon levies could be introduced with stronger decarbonisation assistance for the most affected countries.

A solution would also have to be found to the difficulties arising from the combination of a new own resource with the residual GNI resource that might have to be maintained – first, if the resources do not cover the whole budget, and second, if the resources are not accepted as fully owned by the EU and factored in the national contributions or the new resource is not adopted by all Member States (variable geometry). [...]

A look into the future – Should there be a separate eurozone budget?

In addition to covering the finances of the EU budget as it stands today, the report explores the potential implications of a eurozone budget. This eurozone budget could be financed by cyclically sensitive revenue sources (such as a eurozone CIT or even VAT) and could fund cyclically sensitive expenditures (such as a eurozone-wide unemployment insurance scheme). It would have a built-in automatic stabiliser impact on eurozone economic activity. The aggregate fiscal stance for the eurozone could also be set more easily in line with business cycle conditions, and possibly with the monetary policy stance set by the European Central Bank.

Another major rationale for the creation of a separate eurozone budget is directly inspired by the theory of optimal currency areas. In this line of reasoning, member countries of a currency union may be hit by asymmetric macroeconomic shocks; yet because they can no longer use exchange rate adjustments, and because the other channels of adjustments – such as labour mobility and wage flexibility or capital mobility – may prove insufficient, the existence of a common budget would facilitate adjustment. For this to take place, the revenue levied by the common budget from each Member State would have to be sensitive to cyclical fluctuations in that country and the same would apply to expenditures directed towards that specific country. The common budget would then function as a device for inter-country, automatic fiscal stabilisation, much as the federal budget does in existing federations.

Full report

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