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THE THORNY PATH TOWARDS A FISCAL UNION, AN EUROPEAN SAGA

THE THORNY PATH TOWARDS A FISCAL UNION, AN EUROPEAN SAGA

Since the Dawn of time (or at least the Middle Ages according to Norbert Elias’s Western World Dynamic’ theory), the rights of issue coins and raise taxes have been both great privileges of sovereign states. According to Boissinot Jean and Taly Michel,these rights, at the basis of our modern societies and economics, formed two sides of a unique coin and serving a common objective: “Financing the Treasure”. Money and taxes are not true synonyms, nonetheless their respective history are intertwined, and they embody the two state’s economic means: monetary and fiscal policy.

That’s why, considering the constant struggle of European countries towards economic stability and transparency (within their custom and banking union), calls for integrating also fiscal policies of Member States in the Supranational institutions’ prerogatives, have flourished in recent years.

Legacy of the Euro and Greek financial crisis, fiscal union is viewed by some as an answer to Member States’ public debt, and a mean to ensure fiscal discipline amongst them. Its supporters see it as a new mighty step in the European integration history. Nonetheless, many voices questioned the relevance and true outcomes of this project at a time where EU’s future is broadly jeopardised.

Explaining the roots of this European dreamas well as its will first require deeper explanations on the notion of Fiscal Union as well as on the current European economic instruments. A focus on the European 2010’s crisis and aftermaths will then highlight the Fiscal policies framework as well as the ‘pros and cons’ Fiscal Federalism. Lastly, analysing the consequence of this idea on key European policies will give us a broader understanding of this issue.

CURRENT EUROPEAN FISCAL ENVIRONMENT AT A GLANCE

The fiscal union is basically the integration of fiscal policies of states and nations. Decisions about the collection and expenditure of taxes are, in this case, taken by a common and central institution shared by the participating governments.

In 1992 the Maastricht Treaty established the European Monetary Union (EMU) wich led to standardize monetary policies amongst member states. Since he implementation of the Euro as a common policy, 19 out of the 28 member states which formed the EU shared a common currency: Germany, Austria, Belgium, Cyprus, Spain, Estonia, Finland, France, Greece, Ireland, Italia, Leetonia, Lithuania, Luxembourg, Netherlands, Portugal, Slovakia and Slovenia. The Eurozone is completed by 4 states allowed to use the Euro: The Vatican, Andorra, Saint-Martin and Monaco.

While most of its member take part in a monetary and Economic Union, it’s often propose that the EU should adopt a proper Fiscal Union. Indeed, as researchers of the International Monetary Fund stressed it, the EMU is not indeed, a political union.

Hence, most of the decisions about taxations and spending (in a word: their budget) remain to the national authorities making de facto EU a monetary and not a fiscal union. So far, Member States (MS) could also individually raise funds in order to meet their borrowing requirement – France for instance has a national debt of 97% of GDP (for further info on this – link). This cumbersome public debt is financed by Paris through issue bonds on the financial markets.

According to IFM’ experts,due to its own limits, the EMU would leave the members states’ economy defenceless against financial and economic shocks. Especially in the current context characterised by an alarming rise of public debts (largely own by euro area banks).

Additionally, teaching of the euro financial crisis, various negative spill over effects tie sovereign European states both inside and outside EMU. For the IFM experts, this situation open “the door to a vicious cycle in which sovereign and financial distress reinforce each other” calling for further integration steps.

Discrepancies amongst MS with regards to their fiscal policies is moreover another challenge for EU’s resilience to external shocks. In some states, multinational companies are still not liable on corporation taxes, while Luxembourg continue to implemented a VAT anticompetitive system. For instance, Ireland and Leetonia still rely on low corporation taxes rates (correspondingly 13% and 15% of GDP – Link) whereas others charged them twice this figure (30% of GDP in Germany, 34% in France – Link). These gaps and differences cruelly affect Member States’ solidarity and EU coherence (Thenewfederalist).Tax optimisation methods are indeed only one of the dark sides of the various economic, social and political imbalance within the Eurozone. Even though establishing a standardized and equitable taxation system would a major challenge for EU institutions, many experts view it as a prerequisite for establishing a coherent and progressive political union in Europe

Indeed, according the Alan Gray, Chairman of London Economics, many distinctive policy initiatives could be “called fiscal union” (McGill University Report).

Therefore, one could underline four main option for fiscal union in his report:

Option 1:   Centralised EU fiscal policy with centralised expenditure and tax decisions., in other words the United States model.

Option 2:   Fiscal transfers between Member States.

Option 3:   Co-ordination of aspects of taxation including VAT, excise duties, income tax and possibly corporate tax.

Option 4: Centralised co-ordination of fiscal budgets. One should remind that this option is already in place to some extent – as we will see below – the challenge however is a clear and effective sanction mechanismtoward countries which do not meet targeted objectives.

As option 1 identified it, considering the American Case to design a fiscal union might be a tempting idea. Nevertheless, as some LSE researchers suggested it, one must keep in mind the discrepancies between the EU and the US’s economical structures. (Further info – LSE BlogEPRS Think tank)

Notwithstanding, UE institutions already have indeed some fiscal powers in their hands: they have a role in deciding the level of VAT consumption and taxes on external trades (Europa -Link), the members of the Eurozone area also tend to coordinate their fiscal policy as it will be discuss later and the council of Economics and Finance ministers (ECOFIN) decide by qualify majority. Finally, MS economic plan are reviewed and evaluated the European Commission. In this process, MS’s representatives have to demonstrate how they plan to achieve their respective medium terms budget plans.

TO MAKE A LONG STORY SHORT: THE EUROBONDS CASE

Common bonds to finance the global debt are a common pattern of fiscal unions.

Nonetheless, the existence of Eurobonds and their relevance to finance the so-called “Euro debt” are another kettle of fish. Establishing Eurobonds would indeed lead to consider the EU as one entity and to pool together individual states’ public debt.

If seen by markets as a safe investment, Eurobonds would benefit from a low interest rate cost, and will be very beneficial for states with currently high interest rate costs. Nonetheless, states who have avoided debt crisis – and implemented fiscal discipline policies – would see their interest rate risen. Hence, this tool is fairly unpopular in some states as Germany. Additionally, some considered that Eurobonds (since they constitute a further step towards a political union), would endangered state sovereignty and increase the supranational pressure on countries who struggle in reducing their deficit.

According to its followers, this measure would prevent repeated financial crisis as well as austerity policies. It would give investors more security and more time to countries in reducing long term deficits (without threating their growth). Moreover, some view them ad a logical conclusion of the single currency market.As stated previously, some economic tend to consider money and taxes as both intertwined sides of a same coin. In this approach implementing a monetary union and a single currency will automatically require establishing a fiscal union.

Although, many counter this perspective, stressing the hazardous behaviours that could also provide this mean: countries would be less incentive to reduce their spending, and would more easily borrow. The current lack of fiscal discipline (and current public debts) within European authorities make some experts questioned the relevance of Eurobonds – A cumbersome overall Eurozone debt would only lose more ‘credit worthiness’ over time. As long as European solidarity and identity is not stronger as national identity, implementing common bonds may indeed jeopardise even more the European Project.Further info on Eurobonds

IMPACTS AND LEGACIES OF THE FINANCIAL CRISIS ON THE EURO AREA

Although Eurozone economies have not been directly affected by the financial crisis of the subprimes (since most of these loans were held by American banks), they were harshly hit by its consequences. For many experts of the European Parliament Research Service (Link)the Euro area have not yet recovered from the “great recession” started in spring 2008.

Since the financial crisis did not impact all the MS in the same way, their recovery has also been uneven: with states less hardly hit (Germany, Austria and the Netherlands) than others (Spain, Ireland, Greece and Portugal). Some annalists even predict the threat of secular stagnation (Europa Parliament – Link).

Figures speak from themselves – according to Eurostat the global financial crisis has entailed a decline in investment in the euro area of about 15%, from 23.44% (2007) to 19.88% (2014) (Eurostat-Link). Even though short-term predictions look a bit more encouraging the euro area various forecasts predict average GDP Growth of 1,9% (2019), and inflation rates around. Heightened unemployment rates are another outcome of this crisis: they approached 10,35% in January 2016 compared to 7.29% in January 2008. Especially in some country of the EU’s periphery where unemployment rates approximated 25%, whereas core nations ‘ones reached only 5.4 and 6.8 % (LSE Blog – Link)

To make a long story short: the financial crisis of the Eurozone

To put in a nutshell, the global European banking and financial systems were affected first: European banks faced capital loss, a liquidity crisis as well as a declining net banking income – which ended in bankruptcy or insolvency procedures. The crisis spread throughout the whole banking system and real economy field and resulted in 2008 in recession measures and a shrinkage in the access to credits (For further info – Link). Nevertheless, fiscal regulation remains at the national level. Thus Europe response to the Financial crisis has been longer and more disorderly than in the United States. In fact, governments and banks are tied strongly together. Banks hold bonds issued by their governments because these bonds are traditionally considered safe – an implication is that banks will suffer large losses if a government defaults on its debt obligations / At the same time governments must rescue banks in difficulty. That’s how the debt of the banks then become debts of the government. The situation became pretty desperate when the government is in fragile position. This crisis ushered in rapid progress toward the 2010-12 debt crisis – At it will be explained later, the fiscal framework of the EU is a direct legacy of this economic slump.

FROM A FINANCIAL CHAOS TO FISCAL INEGRATION?

In June 2013, Greek and Spanish unemployment rate were standing at respectively 26,9 and 26,3% GDP. Since governments as the ones mentioned were unable to borrow or finance expansionary policies, and taking into account the general risk of individual national situations on the Eurozone, some policy makers advocated much more effective fiscal integration across Eu MS. The French President François Holland, Mariano Raroy the Spanish Prime minister, and the German Chancellor Angela Merkel, embodied this position (LSE Blog – Link).

Indeed, France and Germany presented on the 4thof February 2011 their fiscal coordination project to their 16 Eurozone homologues with the aim to fulfil the gap and discrepancies among Eurozone countries (Euractiv – Link). This joint decision was surprising reckoning Berlin’s strong objections to this fiscal union project. However, the two governments reached an agreement deepening the coordination mechanisms already implemented between Paris and Berlin. Nonetheless, this project was quite limited since it did not take into account an EU bailout plan or the integration of MS’s fiscal policies into a common European framework (Euractiv- Link).

The financial crisis has emphasized the lack and limits of the EMU. Negative spill over effects across MS economy raise awareness for a more coherent and disciplined fiscal strategy amongst them. Although it appears as a Utopian project for some expert, Wolfgang Munchau’s conclusions for the Financial Times is that, there really is no alternative than a fiscal union to save the EMU and more broadly the European project (Financial Times – Link), others as the former IFM, Dominique Strauss-Kahn, stressed at this time the limits of a such disjointed approach – only a structured common strategy would prevent the plague of worsening public debts (Euractiv- Link).

WEIGHING THE PROS AND CONS OF A FISCAL UNION

WORDS IN FAVOUR OF A FISCAL UNION…

Responding to economic shocks and business cycle risks

The financial crisis highlighted how external economic and political shocks distinctively affect European countries. As the EMU’s states are not able to use their monetary policy’s tools, (depreciating their currencies separately for instance) they are in a difficult spot when it comes to respond to negative shocks. Due to this challenge, some economists as Martin Feldstein advocated against the Eurozone project at the time of its implementation (LSE Blog – Link).

Sovereign states are deprived of their monetary policy tools. They could only rely on fiscal policy ones and are force to endure internal price and wage deflation alongside with recession in order to meet their objectives. These policies are unpopular and painful for national authorities and citizens. The Greek case and its last years political saga illustrates it quite well, as its former finance minister Yanis Varoufakis exposed it in his book “Adults in the Room”.

By late 2007 – Greek public debt stood at 105 per cent of GDP more or less the same as in 2000. But by late 2009 the debt had jumped to 127 % of GDP. Some quibble about whether the Greek government could honour its debt at the pre-crisis interest rate. However, there is little doubt that a country that borrow at 10 percent, then 20 per cent would do so. By early 2010 – the Greek government was facing a desperate situation.

In May 2010, the Troika (made of the IFM, the BCE and the European Commission) released its program and its joint “rescue deal” towards Athens. Greece was offered a 110-billion-euro loan under strict conditions set and monitored but the Troika. Unsurprisingly, one year later the Greek economy was locked in a severe recession and the deficit situation was not seriously impacted. The Troika declared itself disappointed and requested stronger measures in exchange for a new 100-billion-euro loan. Their measures led to a 16% drop in GDP between 2008 and 2012 (LSE Blog – Link), high unemployment rates, a freeze on public sector salaries until 2014, inflation and has several social consequences as a rise of poverty, a reform of the pension system, leading to a greater political instability (For Further Information – OXFAM Report).

Why did the Troika get it so systematically wrong?The technical aspects of the answer lies in the so-called “ battle of the multipliers”(Link) – other aspects resulted from a combination of factors “ larger than expected fall in economic output” (André Sapir et al 2014 – EP Report).

To make a long story short: the phenomenon of multiple equilibria

Why did markets start to worry about Greek Debt? – Because of what might happen if other market participants were worried – the debt could rise quickly in addition to the deciding which would trigger further interest rate increases larger deficit and so on. This scenario involves a self fulfilling prophecy called the case of multiple equilibria: a crisis may or may not occur depending on what markets worry about. Multiple equilibria are suspected in various crises – as the collapse of Lehman Brothers which triggered the global financial crisis.

Business cycle risks are another upcoming challenge for European economies. Effectively some Eurozone states as Germany, France and Italy have already embraced the late stage of their business cycle. Business cycle risks matter to investors – especially their late stage whose average duration is a year and a half– where markets are called “bear markets”. The latter is characterized by below average returns on a sustained basis , a weak or slowing or sluggish economy with low employment and weak productivity (Investopedia – Link). Last but not least, bear markets precede recessions periods.Germany, Europe’slargest economy is precisely continuing to slow down – and just narrowly avoided a technical recession after its flat growth figures’ were released on Thursday 12thFebruary. Reuters’s experts even talked about “a black eye” of the German Economy ( Reuters – Link).

There is an urgent need to prevent the vulnerability of Eurozone countries to shocks, upcoming business cycle risks and ease the financing need of states hit by large financial shock. This call for rethinking the whole economic architecture supporting Europe’s currency according to the IFM’s (Link).

Including more fiscal risk sharing mechanisms – setting up an EMU-wide unemployment insurance system – fostering common responses to economic of financial shocks – implementing a central government (or jointly run institutions) to deal with main fiscal challenges – stabilizing private incomes, feature amongst the cures to European economic weaknesses studied by the Institution.

According to Gilles Thirion (European Fiscal Union: Economic rationale and design challenges, CEPS Working Documents) from the European Centre for Policy Studies « by having a stand-alone central bank able to purchase federal debt securities, it also largely reduces the risk that the government will be unable to borrow during hard times ». Which is clearly « A fundamental weakness of EMU and constitutes the core of the rationale for a fiscal capacity »

In another paper « Filling a Gap in the Euro Area Architecture: A Central Fiscal Capacity for Macroeconomic Stabilization », the IFMimagined a dedicated central fiscal capacity in charge of collecting annual contributions from members. In exchange, this central fiscal authority would manage transfers linked to local shocks when they occur.

Foster fiscal discipline across member states

Introducing fiscal risk sharing mechanism would also call for more fiscal discipline amongst states. It’s often said to fiscal union would add more moral hazard and temptations to make riskier decisions (since an insurance mechanism would be in place) or would entail less government’s efforts to meet fiscal targets. However, fiscal risk sharing might reduce the spill overs effects and shrink probabilities of bailout. Moral hazard would nevertheless need to be contain through rules and institutions to make on fiscal union effective.

Additionally, as mentioned previously a common currency and common interest rate are harder to manage without a fiscal union. Ensuring through its mechanisms similar borrowing cost would lead to a simple logical completion of single currency. Even more considering the spill over effects that lock European states between them.

To make a long story short: Fiscal Policy externalities and Spill overs – a case for policy coordination

Fiscal policy actions by one country may spill over to other through a variety of channels such as income and spending, inflation, borrowing cost and financial distress. Other spill overs might come arise since the business cycles of each country are highly synchronized. Lastly Borrowing costs represent another channel for spill overs. Once they share the same currency Eurozone member countries share the same interest rate – one country deficits especially if the country is large and its deficits sizeable – may impose higher interest rates throughout the Eurozone. Such externalities can hurt (or help) other countries, hence countries subject to each other’s spill overs might benefit from coordination their fiscal policies. While formally fiscal policy remains a national prerogative – one may ask whether the deepening economic integration among Euro area countries calls for some degree of coordination.

Furthermore, taking into account the various methods of taxation optimisation and no competitive measures endorsed by some states – and their consequences on the global economic stability of the area, many request sharing fiscal risks to prevent these behaviours.

To exemplify this idea, give a quick glance to the discrepancies across MS regarding VAT Rates.

Whereas Nordic countries’ VAT rates reach on average 25%, Cyprus or Luxembourg ‘one reach only 15% (Le Taurillon – Link). It seems sensible that companies and economic entities would subsequently prefer to locate their corporate headquarters in low-VAT rates countries.

Measures have already been implemented to prevent such fiscal privileges and discrepancies (Council directive 2006/112/CE on the common system of value added tax) – nonetheless their limits still allow some states to conserve their privilege over others European countries. Indeed, the lack of standardization in the fiscal fieldat the European levelis troublingand put at riskthe consequences on its global economic health.

In their paper « Do Subnational Fiscal Rules Foster Fiscal Discipline? New Empirical Evidence from Europe” (Link) IFM’s experts Ananya Kotia ; Victor Duarte Lledo pointed out empirical evidences suggesting that stronger fiscal rules improve subnational fiscal balances. “Discipline enhancing effect” of fiscal rules tends to decrease as the level of vertical fiscal imbalance rise, they suggest to address weaknesses in rules design and to also implement reforms aimed to eliminate excessive vertical fiscal imbalances. This criterion is above all required in the case of poorest European countries. Indeed, promoting greater regional equality is precisely our following argument in favour of a fiscal union.

Promote greater regional equality

It is a common view that pooling up fiscal decisions on expenditures and taxes would ease transfers to poorer areas of the Eurozone. This argument could indeed offset the greater fiscal discipline and pressures within a fiscal union.

Note – The consequences and impacts of fiscal union on EU’s structural and regional policies would be studied later in this paper.

…AND THEIR COUNTERPARTS

The existence of spill overs is one argument for sharing policy responsibilities among independent countries but powerful counter argument exists. A broader question is also – at which level of government – regional national supranational should policies be conducted?

In his paper entitled – European Fiscal Union: Economic rationale and design challenges, Gilles Thirion shaped three main criticisms to this project (ECPS – Link).

First and foremost, domestic fiscal policy and sovereignty

Indeed, according to this ECPS’s researcher, domestic fiscal policy should be sufficient to address asymmetric shocks, and national government should (in theory) be able to undertake fiscal policies that ensure their economy’s stability, by smoothing consumption patterns over time.

Taking decisions about taxes and expenditures have always been a national prerogative and alternative (supranational) rules should indeed on soften the constraint on domestic fiscal policy. Since MS ‘economic tools are reduced to their framework – they would lose sovereignty in polling up their spending and tax levels.

Also, since according to a democratic principle, parliament should review and agree on the national budget – give this prerogative to a central institution raise many objections.

As some LSE’s researchers pointed it out – European fiscal integration might not be political possible « Or even desirable » for many MS (LSE- Blog – Link) – Indeed a fiscal union will trigger various pressures on MS, especially the ones that operate with near balanced budgets as Ireland. These pressures would definitely reduce the rate growth of such countries (Mc Gill Report)

To make a long story short: Fiscal Federalism versus Subsidiarity

The theory of Fiscal Federalism asks how in one country fiscal responsibilities should be assigned between the various levels of government.

In the Europe’s case fiscal responsibilities would be transferred to Brussels. Whereas it might help to reduce negative externalities and reduce risk, the heterogeneity of national preferences (and arrangement) and asymmetries of information would make it inefficient.

Behind these ideas the practical question here is whether Brussels performs better than the national governments?

The Eu has taken the view that answer lies in the principle of subsidiaritypresented in Article 5 of the European Treaty (Link). Due to this article, unless there is strong case of increasing the returns of scale or of externalities the presumption is that decisions remain at the national level.

Private risk sharing and channels of risk-sharing among states

Besides, why governments should integrate their taxation and spending when capital and credit markets could provide « adequate insurance against shocks »? That’s indeed the thesis supported by Eichengreenin 1993, (Is Europe an optimum currency area – Link). More than seeking unnecessary inter regional fiscal transfers – governments should be looking for implementing perfect and complete markets. Subsequently, these ones would prevent asymmetric shocks.

As Gilles Thirion stressed it, this argument is representative of the US case, a usual benchmark for EMU. According to Pier Federico Asdrubal’s studies (Channels ofInterstate Risk Sharing : United States 1963-1990, Pierfederico Asdrubali, Bent E . Sorensesn Oved Yosha, 1996) emphasize that 75% of an external shock to GDP in a federal state is cushioned through the combined role of capital markets (39%), international credit markets (23%) and federal tax and transfers (14%). In other words, the majority of the smoothing is achieved in US thanks to the market.

Another study on EMU (Furceri & Zdzienicka, 2013 and Alcidi & Thirion, 2016) highlighted that risk-smoothing among Eurozone states barely reaches 50% of the US’s level. The very low degree of risk-sharing via international factor income in EMU is another striking discrepancy between these two fiscal area. Since « Fiscal and factor income risk-sharing through the EU budget is insignificant » (Gilles Thirion – ECPS – Link), the only potential working channel in EMU appears to be the : «ex-post inter-temporal consumption-smoothing through the international credit market and net savings ».

Rather than smoothing shocks, international credit markets might also deepen them (Furceri & Zdzienicka, 2013 and Alcidi & Thirion, 2016).

Finally, one could quote Mundell. According to him since economical cycles are not synchronised in the EMU, financial integration could create opportunities for private risk-taking (Mundell, the Euro and Optimum Currency Areas, by Ronald McKinnon). Even though, some argue that the capacity of markets to deliver risk-sharing is not independent of the existence of fiscal insurance mechanism, there is a need to reconsider markets’ role in this question.

Last but not least: already implemented elements of fiscal risk-sharing,

When it comes to looking at the European fiscal framework, one could argue that external shocks absorption mechanisms are already in place. Gill Thirion recorded especially the European Central Bank’s liquidity provisions, official cross-country flows (TARGET2 settlement mechanism) and the EFSF and ESM.

The latter contributed to smooth the lack of credit provision at the height of the crisis (ECPS – Link). Nevertheless, their resources are limited and might not be sufficient to face others external shocks. Moreover, they operate more as tools for ex-post inter-temporal consumption-smoothing, whereas ESM’s main aim is to ensure financial stability. Finally, one could raise their intergovernmental nature which might entail late responses and create uncertainty. Actually, the European fiscal framework is our next point.

A JOURNEY THROUGH THE EU’S FISCAL POLICIES FRAMEWORK

Communal fiscal policies architecture seeks to base the EU on a « robust and effective framework » and ensure the coordination of MS’s fiscal policies of the Member States. The sovereign debt crisis, and the experiences of EMU’s design failure entailed the 2011-2013 reforms. The EU Framework is legally based on articles 3, 119-144, 136, 219and 282-284 of the Treaty on the Functioning of the European Union (TFEU) and on Protocol (No 12) (Relating to the excessive deficit procedure) and Protocol (No 13) (relating to the convergence criteria annexed to the TFEU). According to economic theory, various approach could be studying to tackle economic slumps and boosting economies. The ECB’s President Mario Draghi aim to preserver the euro – “whatever it takes” (as he stated in his speech of the 29thof July 2012 – Link) led to several measures. To stimulate the demand side, the European Commission European Commission launched the European Fund for Strategic Investments (EFSI).

On the supply side – improve innovation and increase employment (especially in vulnerable countries, the Commission triggered amongst others the shift in their activities form non-tradable to tradable sectors (Europa –Link). Reforming of the fiscal framework entailed the amendment of Stability and Growth Pact (SGP) (part of the ‘Six-Pack’) entered into force at the end of 2011.

Additionally, the intergovernmental Treaty on Stability, Coordination and Governance(TSCG), including the Fiscal Compact, entered into force in early 2013.

Finally, a regulation on assessing national draft budgetary plans (part of the ‘Two-Pack’) entered into force in May 2013. Although the EFSI is broadly seen as a positive initiative, the ECB approach has been contested as well as the approach of its president.

Reforming the Eurozone’s bailout policy

The legacies of the financial crisis that hit harshly several MS led firstly to the creation of a specific fund to assist Eurozone states in trouble. The EFSFor European Financial Stability Facilityalongside with the European Financial Stability MechanismEFSMwere created to answer this objective and to fund to bail out members. Since they were temporary and lacked of legal basis. Therefore, European Members established a European Stability Mechanism in 2011– or simply ESM.

Representative of the intergovernmental shift, the ESM is funded by Eurozone states – whereas the previous funds (EFSF and EFSM) were funded by the EU as a whole. Thereafter, the UK confirmed that European countries outside the Eurozone won’t be required to contribute to these bailout funds.

To make a long story short: Peer review

The “Peer review” idea widens the surveillance mechanisms and practices within the EU. By allowing each member states to estimate each other’s budgets, prior to their assessment to national parliament, this proposal (ratified in June 2010) expand the taxation systems harmonisation among MS (Euobserver – Link). Henceforth, each European government would have to present to their peers and the European Commission their forecasts for growth, inflation, revenue and expenditure levels six months before they introduce them to their national parliament.

For states with a debt higher than 60% of GDP this method implies to justify to the rest of the EU their policies. Furthermore, this controversial plan sought to apply to every EU member, not just the Eurozone ones.

Stability and Growth Pact (SGP) at a glance,

“I know very well that the Stability Pact is stupid like all decisions which are rigid” –

Romano Prodi (Eu Commission President), – Le monde 17 October 2002

Firstly, on a legal approach, the Union law provided the legal foundation for such an instrument:Articles 121 (on multilateral surveillance) – 126 of the TFEU (relating to excessive deficit procedure) as well as Protocol No 12. Additionally, on 13 December 2011the new-bornEconomic Governance Package (nicknamed the « Six-Pack ») amending the rules of the SGP.

The reformed SGP providing a preventive aim – a set of instruments for the monitoring of MS’s fiscal policies based on regulation (EC) No 1055/2005 (27 June 2005) and regulation (EU) No 1175/2011 (16 November 2011). The SGP also provide a corrective arm: the correction of excessive deficits founded on Council Regulation (EU) No 1177/2011 (8 November 2011).

The SGP has been completed by a ‘Code of Conduct’ (guidelines on its format and content) – which specifies how to implement the pact (it has been updated on 15 May 2017).

The Preventive arm of the SGP: Core concepts and tools

A core concept introduced by the 2005 reform of the SGP, is the country-specific medium-term budgetary objective (MTO). Each country’s MTO has to be in a range of between -1% of GDP and balance or surplus. Their MTO is revised every three years or when major structural reforms are implemented – if they impact the state’s fiscal position. As part of the multilateral surveillance, the preventive arm of the SGP is based on two main tools, the Stabilityand ConvergenceProgrammes (SCPs).

Submission: under Article 121 of the TFEU, in April of each year, MS submit a « stability programme » (in the case of euro area Member States) or a « convergence programme » (for non-euro area Member States) to the Commission and the Council.

The stability programmes have to include the MTO, the state’s adjustment path to this objective as well as a scenario analysis (which examine the effects of changes). Calculations have to be the most likely macro-fiscal (or more prudent) scenarios.

Assessment: The Council is in charge of the examination of these programmes. It analyses especially the progress made towards achieving the MTO and consider he development of expenditure in the assessment.

Opinion: Since the Council has adopted an opinion on these programmes it can ask the MS for some adjustments.

Monitoring: Lastly, the Commission and the Council are in charge of monitoring the implementation of the SCPs.

Early warning: If major deviations from the adjustment path to the MTO occurred, the Commission addresses a warning to the MS concerned (Article 121(4) of the TFEU (Articles 6 and 10 of amended Regulation (EC) No 1466/97). This warning takes the form of a Council recommendation.

Sanctions: SGP also provides the possibility of imposing sanctions: interest-bearing deposit amounting to 0.2% of the previous year’s GDP. (Only for Eurozone MS who would diverge from appropriate adjustment policies) 

To make a long story short: The European semester

The European Semester is a broader process of economic policy coordination within Eu countries. Even though this annual cycle of coordination and surveillancecovers “three blocks of economic policy coordination: structural reforms, macroeconomic imbalances, it also targets the fiscal policies in line with the SGP. Indeed, it included, in its strict schedule, the preventive arm of the SGP, especially the submission and assessments steps describe above. The following page present the several steps as well as their actors (Consilium-Link)

Corrective arm of the SGP: core concepts and instruments

First and Foremost, the Corrective arm of the SGP is characterized by the Excessive deficit procedure (EDP). The EDP purpose is to prevent excessive deficits and to ensure their prompt correction. It is ruled under Article 126 of the TFEU,Protocol No12, regulations (EC) No 1467/97 and(EU) No 1173/2011) and triggered by the « deficit criterion » or the « debt criterion »:

– Deficit criterion: Public deficits are considered excessive if they are higher than of 3% of GDP at market prices (the reference value)

– Debt criterion: when pubic debts are higher than 60% of GDP – and when the annual debt reduction target (1/20 of the debt threshold) has not been achieved over the last three years.

A deficit higher than the stated reference value could be considered exceptional (resulting from an unusual event or a severe economic slump) or temporary (if forecasts indicate that it will fall below the reference value after the end of the downturn).

The EDP process:The Commission (under articles 126(3) to 126(6) of the TFEU) prepares a report if a MS does not comply with at least one of the two criteria. The Institution also addresses an opinion to the MS concerned and informs the Council.

As usual, the Council has the final decision on whether an excessive deficit exists. It subsequently, the council adopts a recommendation addressed to the MS demanding effective actions and measure to reduce the deficit and setting a deadline (no longer than six months to implement them).

The recommendation could be made publicif the Council establishes that the State has not taken appropriate actions. Then the council notify the MS to take efficient measures within a given time limit. The corrective arm of the SGP also provides sanctions in cases of non-compliance, only for Eurozone MS (resulting in a fine of a fixed component (0.2% of GDP) and a variable component up to a maximum of 0.5% of GDP).

Additional sanctions relating on the effective enforcement of budgetary surveillance (and statistical manipulation) in the Eurozone are also insured in regulation (EU) No 1173/2011. These sanctions entail non-interest-bearing deposits (of 0.2%) and a penalty of 0.2% of previous years’ GDP.

Further Information on the SGP: Europa – Link

From the TSCG to the “golden rules” of the Fiscal Compact:

A part of the UK and the Czech Republic, European MS ratified « the Fiscal Compact » of the intergovernmental Treaty on Stability, Coordination and Governance, (TSCG) in March 2012. This supranational fiscal component provides « golden rules » for the balanced budget. Furtherore, based on the German constitution, the concept that a lower limit of structural deficit of 0.5% of GDP, debt brakehas been adding. This limit has to be enshrined in national law, preferablyat constitutional level.

The Fiscal Compactalso states that when public debt is lower than 60% of GDP, this debt brake has to set at 1% of GDP – even though only a few countries meet nowadays these objectives  (Statista – Link). According to this instrument, MS could bring proceedings against other Member States before the CJUE– if this golden rule has not been properly implemented.

Indeed, MS are tied and bound to this rulethrough various mechanism – For instance financial assistance from the European Stability Mechanism will only be provided to Member States which have signed the Fiscal Compact. Countries, as Poland, strongly criticised the idea of withholding regional funding for those who break the deficit limits, as that would only impact the poorer states (Euobserver – Link).

The Arrangements is said to have many advantages over the EDP:

Simplicity/it is defined in cyclically adjusted terms/ it allows that automatic stabilizersto fully operate /deviationsare allowed/ correction do not have to executed immediatelybut in an appropriate manner/ finally this rule is a constitutional requirement.

Nonetheless, the TSCG is not very precise – it recommends “in principle” the German rule of the debt brake and asks that it be written “in principle” into each country’s constitution.

Deepening economic governance in the Eurozone

The 2011-2013 reforms relating to the fiscal policies framework also includes two more regulations: regulation (EU) No 473/2013 and regulation (EU) No 472/2013.

The first one strengthened the common budgetary timelines for all Eurozone MS and defined the monitoring of the Commission relating to MS’s budget plans. Moreover, it stipulates that MS which are subjects to an EDP (as seen above) must present an « Economic Partnership Programme ». This Programme will detail the policy measures and structural reforms needed to implement an effective and lasting correction of the excessive deficit.

The second one mentioned regulation targets MS experiencing (or threatened with) serious difficulties as for their financial stability. This Act sets rules for triggered monitoring as well as a financial assistance and a post-programme surveillance (as long as a minimum of 75% of the financial assistance perceived has not been repaid).

To maker a long story short: the SIXPACK/TWOPACK – two packages to widen the SGP

On the one hand, “Six pack” (Official Journal of European Union – Link) describes a set of European legislative measures aimed to reform the Stability and Growth Pact  and agreed by EU lawmakers in September 2011.These measures sought to introduce greater macroeconomic surveillance amongst MS. Bundled into a « six pack » of regulations they were separately presented in September 2010 by the ECOFIN council and the Commission. A preliminary agreement for the Six-pack’s content was ratified in March 2011. Following the negotiation with the EP, these six regulations entered into force 13 December 2011. Four of the six instruments in the Six-pack seek to endorse further reforms of the SGP and to enforce greater budgetary discipline amongst the MS, whereas the last its two measures relate to the “Macroeconomic Imbalance Procedure” (a warning system and correction mechanism for excessive macroeconomic imbalances)

On the other hand, the “Two Pack”(Official Journal of European Union – Link) requests that Eurozone MS present Draft Budgetary Plans for the following year in mid-October. This measure insures that fiscal policy matters are addressed early in the budgetary process In February 2013 the EU lawmakers approved this legislation, and t he two pack entered into force in May 2013.

COMING TO THE END OF THIS JOURNEY

Taking a stroll along the European complex history, the shape of the EU has never appeared so deeply unpredictable than on these days of February 2019.

From the deadly waters of the Mediterranean Sea – to the inner divisions between MS on crucial geopolitical matters, wanderers may stop by, and admire the upcoming Brexit chaos while some others would wait for the great global warming storm.

Is the whole EU hopeless?

No. Indeed, one small bunch of indomitable scholars and experts might still hold out against disarrays and sorrows and discuss on a fiscal union.

For them, and to deepen our understanding on this subject – let’s briefly draft the shape of a Europe having a fiscal Union.

Firstly, fiscal union may entail a broader reform of Common resources – considering the limits of the European’s Budget and its consequences on its actions (L’Opinion). The Eu budget is small by any reasonable standard and of marginal economic importance. The ceiling in the seven-year Financial perspectives is 1.24 % of GNI. The whole revenue system of the EU lacks an underlying logic : the “own resources” idea is undermined, there is no taxations, the ability to pay principle for revenue does not apply. According to Guy Verhofstadt, president of the Parliamentary group ALDE – a progressive revenue basis would be a useful reform with many advantages. A greater European budget would provide for instance the require resources to implement the main promises for the 2021-2013 (such as a European Army).

Secondly, structural policies. Another Aspect of European regulation that might be strongly impacted by the creation of a centralized fiscal union are the so-called development and regional policies (RP) (LeTaurillon). Both originated in political motives to reduce antagonisms and inequalities of economic outcome and to further social cohesion in the process of European integration by reducing the economic disparities (at it is recommended in Article 2, Treaty of Lisbon, 2009) .

Some think that a fiscal union would provide the Eu with serious tools to foster more social policies. Indeed, it said that each of the steps taken in the process of economic integration has its own distinctive ‘regional footprint’.

At a time when discrepancies amongst member states don’t seem to reduce at a desirable pace as (Frédéric Mérand and Julien Weisbein remind us of in their textbook “Introduction to the European Union”), such a positive outcome should offset the loss of individual sovereignty.

Some aspects and limits of the currently implemented policies might benefit for a more global transfers system. The core-periphery effects – and regional divergence patterns of EU’s RP (caused by economies of scale, localization and agglomeration effects lack of competitiveness in peripheral regions, selective labour migration effects) call for fair and centralized fiscal mechanisms.

Up to now, the European Commission is driving the implementation, the organization, the direction of the European Budget.

Is the case of a European Budget – would it be necessary re considering the monitoring and execution of fiscal resources? According to the democratic approach of the fiscal policy – it appears crucial that decisions about taxations and expenditure belong to an Institution embodying the citizens ‘interest – as the European Parliament. The role of the ECOFIN Council might be as well enhancing. Henceforth, a fiscal might entail adapting the whole European structure.

That’s why according to some ( Jean Leca – the State between Policy, Politics and Policy) , prior to the implementation of a fiscal union – the UE would first seek for more coherent and efficient supranational policies – concerned and inspired politics and finally an effective polity (a community of committed European citizens).

To put in a nutshell, considering the upcoming economic risks and the own Euro dynamic – one could distinguish an increasing threat of instability towards external shock / debt defaults and austerity measures (Thenewfederalist) – many arguments in favour of a centralized- risk sharing fiscal mechanism raise. Nevertheless, due to the amount of issues and priorities arising in European agendas – this project is currently at a stalemate. The joint influence of three main counterarguments plague and hamper this project.

Firstly, the “interference and loss of sovereignty” argument. Indeed, MS lost their monetary policy (because of the EMU) – their custom policy and commercial sovereignty (due to the free movements of goods and services) as well as their control of people’s movements (LeTaurillon).

Secondly– the questioned legitimacy of the EU on this matter. As a report of the Robert Shuman Foundation (Robert Schuman Foundation : « Eurozone, its legitimacy and Democracy), the Euro area is weaken by an increasing democratic deficit as well as a reassessment of the EU’s political system and leadership. The five presidents report, presented in 2015, actually sought to address these challenges – supporting a fresh approach of democracy and sovereignty within the 19 states of the Euro areas. (More info on the five presidents’ report – LSE Blog& the entire text of their proposals – Europa).

To make a long story short: The five presidents Report

On the 22nd of June 2015, Jean-Claude Juncker, Donald Tusk, Jeroen Dijsselbloem, Mario Draghi, and Martin Schulz – the five presidents of the EU released a report in reaction to the limits of the European measures designed to overcome the EMU Crisis. In this report, the five European Musketeers, drafted plans for strengthening economic and monetary union.

On the fiscal side – the five Presidents showed more caution than it was the case in 2012. Nonetheless, they stressed the importance of « responsible budgetary policies », in other words – fiscal discipline. Their plans included a fresh approach to fiscal stabilisation and the creation of a European Fiscal Board. Although many states already set up their own fiscal council (For instance, the UK’s equivalent is the Office for Budget Responsibility – OBR) this centralized one would independently control the conduct of an efficient and European fiscal policy.

According to the five Presidents this new Board would allow a « better compliance with the common fiscal rules » and a « stronger coordination of national fiscal policies » (LSE – Blog)

Thirdly, there is no public support – Indeed the EU is broadly victim of the misconceptions, misunderstandings of its policies. Although the structural and regional policies impact us every day in various ways – European citizens are not aware of it. The politics of the Eu budget debate distort also the functionally of what the EU does. Indeed, citizens in net paying countries hear only about the “sacrifices” and little or anything about he joint benefits. Those in net receiving countries hear only about he political unwillingness of the net payers to live up the “solidarity” written in the treaty. Worst of all citizens are not made aware that the EU Budget is a marginal issue in European integration. Therefore, many argue than a greater fiscal justice might go along with the support of Public Opinions (LeTaurillon).

For these reasons, the Chairman of London Economics, Alan W. Gray, believed that a centralised EU Fiscal policy and centralised expenditure and taxation decisions are «  very unlikely to happen » or would have «  messy, piecemeal and less than ideal » outcomes (McGill – Report).

According to him to four main challenges that he identified – won’t be solved simply by a fiscal union:

1) Recession or low growth and escalation of high levels of long-term unemployment.

2) A dramatic sovereign debt crisis – even rich and large European countries are being excluded from borrowing at reasonable rates on international bond markets. 

3) Near collapse of the banking sector in most EU countries combined with recognition of the scale of undercapitalization.

4) A crisis in the public finances in many countries, with painful austerity adjustment programmes under way.

Therefore, instead of a fiscal union – he advocated for :

– Additional automatic measures to ensure budget targets are met

– Long-term planning for « nearly balanced budgets » and lower debt in euro states likely to be subject to risk in sovereign debt markets

– Increased measures to support fiscal transfers between EU states to deal with the banking crisis

– Bail out partially financed by the Member States

– A Eurozone deposit insurance and effective EU banking supervision /

To conclude this brief journey throughout the fiscal union, it is worth mentioning that a strict one-size fits all approach should be avoided at all costs. Indeed, according to the Economist (EU – the Case for flexibility) , the EU should remind the Aesop’s fable « The oak and the Reed » (Link) . And consider in every of its policy that it is better to bow gracefully and lowthan to proudly erect and endured the blow

Gabrielle Bernoville

EU ECONOMIC AND FISCAL GOVERNANCE – TIMELINE

Source- Link

2015 – October: European Semester and five President’s Report

Adoption of a package of measures to begin implementing the Five Presidents’ Reportand a revised approach to the European Semester as well as an advisory European Fiscal Board; a more unified representation of the euro area in international financial institutions.

June- EMU: The Five Presidents’ Report “Completing Europe’s Economic and Monetary Union”

An ambitious plan on how to deepen the Economic and Monetary Union in three stages. It proposes to complete four Unions, an Economic, Financial, Fiscal, and Political Union.

January – Flexibility on SGP rules

Commission’s guidance on how it will apply the SGP rules to strengthen the link between structural reforms, investment and fiscal responsibility in support of jobs and growth.

2014 – November: Review of the Six-Pack and Two-Pack rules

A review calls for improved transparency and simplicity.

2013 – February: The « two-pack » is passed

Euro area Member States agree to prepare their budgets according to common standards and a common timeline, submitting drafts to the Commission and each other.

The two pack entered into force in May 2013.

Regulation No 472/2013

Regulation No 473/2013

2012 – March – The Fiscal Compact is passed

Euro area Member States agree to make the goal of balanced budgets part of their national constitutions and future euro area members agree to do so once they adopt the common currency. The fiscal compact is part of a treaty known as the Treaty on Stability, Coordination and Governance, which entered into force in

January 2013.

The TSCG also introduced Euro Summits, i.e. meetings of euro area leaders which take place at least twice a year.

2011 – September: the ‘six-pack’ is agreed by EU lawmakers

With the future of the euro area in question, the monitoring, coordination and enforcement of economic governance moves up a gear.  The Stability and Growth Pact becomes more comprehensive and easier to enforce. The Six-Pack entered into force in December 2011.

2010 – November: Kick-off first ‘European Semester’

2005 – Amendment the ‘Stability and Growth Pact’

Surveillance and coordination are strengthened.

The excessive deficit is clarified and made faster

2004 – ECJ rules on the Stability and Growth Pact

The European Court of Justice overturns the Council’s rejection of the Commission’s recommendations citing procedural issues but rules that responsibility for enforcing the Stability and Growth Pact lies with the Council.

1999 – Stability and Growth Pact: Entry into force of SGP corrective arm.

1998 – Stability and Growth Pact: Entry into force of the SGP preventive arm

1997 – The ‘Stability and Growth Pact’ is born

EU Member States agree to strengthen the surveillance and coordination of national fiscal and economic policies to enforce the Maastricht rules.

1992 – EU Member States sign the Treaty of Maastricht

The Treaty of Maastricht limits government deficits and public debt levels to 3% and 60% of GDP respectively.

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