29 November 2022

Bruegel - The European Commission's fiscal rules proposal: a bold plan with flaws that can be fixed

After long debate, the European Commission has presented its vision for revamping the European Union framework to guide member states on their fiscal policies in light of recent challenging circumstances, including the pandemic and Russia’s invasion of Ukraine. The Commission could have taken the path of incremental reform, as in previous rounds, in 2005, 2011, 2013 and 2015. It did not, and the result is welcome and far-reaching. But the proposals, published on 9 November, also contain many shortcomings that can and should be addressed.

The core proposal is to replace the current ‘preventive arm’ of the Stability and Growth Pact (SGP), which was originally adopted by member states in the 1990s. The SGP has become a confusing thicket of rules that attempts to map debt and deficit levels into adjustment requirements, with a medium-term adjustment plan guided by debt sustainability analysis (DSA). The requirements for countries to keep debt within 60% of GDP and deficits within 3% of GDP would be maintained – hence avoiding the need to change the excessive deficit procedure protocol annexed to the EU treaty – but they would be embedded into an entirely new framework.

First, the Commission would classify countries as high, medium and low risk using a DSA methodology agreed with member states. For countries facing high and medium sustainability risks, the Commission would propose a “reference multiannual adjustment path in terms of net primary expenditure.” Net primary expenditure combines the elements of discretionary fiscal policy that governments can control: expenditure net of discretionary revenue measures and excluding interest expenditure, as well as cyclical unemployment expenditure. High debt risk countries must ensure that after a maximum of four years, their debt is on a “plausibly and continuously declining path” for at least 10 years, based on unchanged policies. Countries with medium debt risks would get an extra three years before debt must start continuously declining.

Second, following a discussion with the Commission, each member state concerned would submit a “medium-term fiscal structural plan” outlining fiscal adjustment, reform and public investment commitments. This could involve a more gradual adjustment path than the standard four-year horizon, provided it “is underpinned by a set of priority reform and investment commitments.” The Commission would assess the trade-off between reforms/investment and adjustment based on a common EU framework (in essence, assessing whether and to what extent the growth impact of the proposed reforms or investment offset the higher deficits).

The third and final step would be the adoption or rejection of the member state’s plan by the Council of the EU, based on a Commission assessment. If a country and the Commission can’t agree “the reference path would be used by the Commission and the Council for the purpose of fiscal surveillance and enforcement.”

Like the current SGP, enforcement would happen through the excessive deficit procedure (EDP). For countries with debt above 60% of GDP, this would generally be triggered by failure to comply with the Council-endorsed expenditure path. According to the proposal, “in case the original path is no longer feasible, due to objective circumstances, the Commission could propose to the Council an amended path under the EDP.” Failure to comply with this amended path (or indeed the original path, in the absence of “objective circumstances” that might justify an amendment) could lead to suspension of EU financing and reputational sanctions (for example, “Ministers of Member States could be required to present in the European Parliament the measures to comply with the EDP recommendations”). Fines could still be imposed, but their amounts would be lowered to make it more likely that they would be used (in effect, turning them into a variant of reputational sanctions).  

Far-reaching improvements

Three elements in the proposal represent a big step forward...

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