26 October 2018

Vox EU: Reforming the EU fiscal framework: A proposal by the European Fiscal Board

This column outlines the European Fiscal Board’s proposals for a major overhaul of the EU fiscal framework, which it argues would result in a simpler and more transparent framework thanks to the use of a single budgetary anchor and a single observable operational target.

[...] In its 2018 annual report, the European Fiscal Board proposes a major overhaul of the EU fiscal framework. The proposed new framework relies on a single fiscal anchor: the 60% reference value for the debt ratio. This is directly translated into a single operational target: a constant ceiling on the growth rate of primary nominal expenditure net of discretionary revenue measures, ensuring that the debt ratio would reach 60% in, say, 15 years if the economy were at its potential and inflation at 2%. The expenditure ceiling thus includes a built-in debt brake. The ceiling is fixed for a three-year period to ensure a medium-term orientation of fiscal policies; at the end of the three years, it is recalculated based on what is needed to reach the 60% reference value 15 years ahead. The debt reference value is therefore reached asymptotically.

This reform can be implemented by changes in secondary legislation, not the Treaty itself. The 3% Treaty reference value for the budget deficit therefore remains, but it is no longer used to set fiscal targets. While a member state could still face an excessive deficit procedure, this would require deviation from the expenditure rule outlined above.  The only difference between the preventive and the corrective arms of the SGP consists in stronger enforcement, but not in more stringent fiscal targets. Finally, the expenditure rule will not apply to member states with debt below 60% of GDP; in this case, the 3% deficit ceiling remains the only constraint.

Compliance with the rule is assessed on the basis of a single indicator of net primary expenditure growth. In line with the current methodology used in the expenditure benchmark of the SGP, the impact of cyclical unemployment benefits is excluded, together with EU-funded investments. At the same time, gross fixed capital formation is smoothed over four years to avoid penalising public investments. Under the preventive arm, deviations from fiscal targets are recorded in a compensation account and need to be corrected in later years. A breach of the rules will occur whenever the cumulative deviation in the compensation account exceeds, say, 1% of GDP. Under the excessive deficit procedure, any deviation above the net expenditure ceiling will be considered a breach and may lead to sanctions. 

A general escape clause should replace the complex system of waivers and flexibilities currently embedded in the rules. This escape clause will allow member states to deviate from the expenditure ceiling under a limited set of exceptional circumstances, such as during a severe economic downturn or following highly unusual events outside the control of the government, such as natural disasters.

Sanctions for non-compliance will apply equally in the preventive and the corrective arm. A revamped sanction framework could involve removing the discretion that exists when setting fines under the SGP. Additionally, the economic conditionality currently foreseen for European Structural and Investment (ESI) funds could be extended to the whole EU budget. Finally, positive conditionality should be introduced, for instance, adherence to the rule could allow access to the recently proposed European Investment Stabilisation Function, or any other future central fiscal capacity.

The Board finally proposes to reform the overall governance of the rules by assigning a greater role to independent institutions in assessing compliance, particularly in relation to the use of the escape clause. This would strengthen the framework by providing a greater separation between the ‘assessor’ and the ‘decision maker’. Concretely, whenever a breach of the expenditure rule is observed, it will be up to an independent assessor to conduct an evaluation of whether the escape clause can be triggered. Such assessor could for instance be an EU-level independent fiscal institution (IFI), possibly in combination with national IFIs. The European Commission and the Council will then take the ultimate policy decision based on this independent assessment and, in case they decide to deviate from it, they will explain the reasons for such deviation. 

The implementation of the full reform package will result in a simpler and more transparent framework thanks to the use of a single budgetary anchor and a single observable operational target. Enforcement will also be more effective, because a stronger system of sanctions – which applies also under the preventive arm – and a limited use of escape clauses are backed up by the need to comply or explain by the decision makers. Moreover, the three-year interval for recalculating the expenditure ceiling enhances the medium-term orientation of the budget. [...]

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