EU Fiscal Policy: Provide Funding for Policies that Benefit Europe
The EU Budget Allocates Too Much for the Wrong Policies
One of the most difficult challenges for the German government in the European Council will be determining the Multiannual Financial Framework (MFF) for the period after 2027.
Agriculture and cohesion spending marked by distribution problems and low effectiveness
Today, the EU budget is dominated by spending on Common Agricultural Policy (CAP) and cohesion policy, which together account for around a third of total current expenditures. Nevertheless, these spending areas are highly controversial. The CAP's flat-rate land subsidies have been criticised for their distribution policy, which primarily favours land ownership and provides little incentive for ecological, animal-friendly, and climate-friendly agriculture. In addition, empirical studies have repeatedly found that the effectiveness of cohesion policy is limited. Decades of heavy spending have produced little demonstrable convergence. Moreover, cohesion policy has lost its focus over the years and now addresses many different objectives throughout the EU, in some cases even providing for transfers to wealthy countries and regions.
Mobilise funding for policy areas that benefit the EU
Officials at the upcoming EU budget negotiations must figure out how to spend more on policy areas that stand to bring a high degree of value to the union. These include the expansion of European defence; financial and military support for Ukraine in the Russian war of aggression and help with post-war reconstruction; climate and energy; and innovation, research, and industry. No matter how one quantifies the funding requirements, the EU budget has clearly neglected these policy areas relative to CAP and cohesion, where spending is massive. But the other policy areas represent common goals that promise genuine benefits for the EU, provided that appropriate funding is set aside.
The high interest costs of EU debt
Two approaches are conceivable for funding the new policy priorities: cutting CAP and cohesion spending and/or increasing the EU budget. Alone or in combination, these approaches will set aside more money for defence, climate, science, and industry. When increasing the EU budget, however, it is important that higher revenues be generated to avoid compensatory cuts in traditional policy areas. Both the Letta and Draghi reports favour stabilising EU debt along the lines of the Next Generation EU (NGEU) extra-budgetary fund financed by EU bonds.
But permanent deficit spending is a controversial issue in the EU. Debt from NGEU already represents a major financial burden on the EU’s budget. The cost of servicing the debt rose significantly more than was projected when the NGEU was introduced. The original plan assumed that the interest rate on EU bonds would rise from 0.55 per cent in 2021 to 1.15 per cent in 2027. However, these projections became worthless in 2022, when interest rates rose to 2.5 per cent and then to just over 3 per cent for ten-year EU bonds. The higher rates significantly increased debt-servicing costs, as did the EU’s comparatively poor financing terms.
There is also the risk that the EU’s new options for taking on debt will only be used to circumvent its own debt regulations. The recently reformed rules on fiscal governance oblige Member States to maintain sustainable debt levels. But the rules do not consider the liability of Member States for debt at the EU level. Accordingly, Member States may seek to sidestep the rules by replacing their national debt with European debt. Were this to happen, it would further undermine the transparency of public finances and the sustainability of public debt in the EU and would disincentivise the creation of responsible national budgetary policies.
Recommendations
Germany Should Take the Lead in Reprioritising the EU Budget
During the MFF negotiations for the post-2027 period, Germany – in keeping with its long-standing commitment to the EU – should urge the other Member States to reprioritise the EU budget. The numbers justify German leadership in the negotiations. For one, Germany is by far the largest net contributor to the EU budget in absolute terms. What is more, according to the Bundesbank, its net contribution to the NGEU and the EU core budget is, relative to economic output, higher than that of any other Member State. Germany should use its high level of financial solidarity with the EU to push for a more pro-Europe budget.
Support spending cuts to CAP and cohesion policy
The German government should support budget increases for policies that benefit the EU, preferably through spending cuts to the CAP and cohesion policy. It would run contrary to the principles of results-oriented budgeting if the EU continued to pump massive amounts of money into existing cohesion and agriculture policies that are poorly targeted, ill-conceived in distribution, and, in many instances, lacking measurable impact.
Resolve internal divisions that undermine Germany's bargaining position
Germany’s new government should also develop strategies to persuade the federal states to accept cuts in cohesion policy spending. While the German government has repeatedly shown itself to be open to such cuts, the German states have remained strictly opposed. From their point of view, transfers from the EU represent EU acquis and further financial equalisation. But the German government needs to prepare the federal states for the phase-out of EU cohesion programmes in rich Member States. To do so, it needs to negotiate instruments that provide them compensation for the cuts. Similarly, a Germany that embraces a leadership role in the EU will have to keep special interest groups in the agricultural sector at bay.
Continue to reject deficit spending for the EU’s core budget
Since the euro debt crisis, Germany has taken a cautious stance towards EU debt instruments. In moments of acute crisis, Germany has accepted particular debt instruments, but it has always vetoed EU debt as the general funding instrument for the EU’s core budget. The new German government should do the same. Giving the EU a general debt function for its core budget would remove a crucial debt limit without bringing any advantages. Any new debt instruments should be limited in scope and used only as a last resort for funding demands that cannot be postponed and that cannot be realistically covered through the reallocation of other expenditures. One such demand that looks likely from today’s perspective is further aid for Ukraine.
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