The European Union is a monetary union, but not a fiscal union. Twenty of the 27 member states use the euro but maintain public accounts. Apart from the small EU budget (equivalent to just 1% of EU GDP), there is no fiscal union. That means Brussels imposes almost no taxes and spends almost nothing on the EU. However, European economies are highly interdependent and member states' fiscal policies generate important externalities, so common rules need to be agreed. These rules are contained in the so-called Stability and Growth Pact (SGP), whose purpose is to coordinate the fiscal policies of the various member states and ensure fiscal sustainability.
Created in 1997 and reformed during the eurozone crisis of the 2010s, SGP rules require countries to spend as much as necessary to first combat the COVID-19 crisis and then cushion the economic impact of Russian aggression. It was suspended in 2020 to allow for of Ukraine. However, this suspension clause is only temporary, and the rules will need to be reapplied in the future. In 2023, there was intense debate to reform existing rules that were considered overly restrictive, opaque and inflexible. In particular, the rules required extreme austerity policies, forcing member states with debt-to-GDP ratios above 60% to reduce their debt by one-twentieth annually. On 20 December 2023, the Council of the European Union finally reached an agreement on fiscal rules, which will be debated in the European Parliament in the first quarter of 2024 and come into force a few months later. After all, the new EU fiscal rules will create a conflict between fiscal hawks in central and northern Europe, led by Germany, and southern European countries, led by France, who argue for the need to avoid a return to austerity in the EU. This is a compromise solution. (potentially triggering a recession) and the need to give fiscal space to invest in climate change, defense and industrial policy.
Q1: What does the new rule include?
A1: The new fiscal rules are based on an ex-ante assessment of the sustainability of each country's fiscal strategy based on a debt sustainability analysis. It classifies countries by risk level through a transparent and jointly agreed methodology.
Once a Member State's fiscal sustainability is demonstrated, its fiscal path must lead to the ultimate goal of reducing fiscal deficits to less than 3% of GDP and public debt to less than 60% of GDP. Member states could have taken this opportunity to revise these numbers, but these numbers date back to the early days of the euro and are of little relevance today, although these numbers were codified in the EU Treaties. and requires long-term legislative reform, which is unlikely in the current political climate. .
If either of the two objectives (deficit or debt) is not achieved, the European Commission will intervene. Develop fiscal adjustment plans to bring member states back into compliance. This is known as the “technical path'' and takes the form of a “national medium-term structural financial plan'' with a duration of four years, which can be extended to seven years if certain reforms and investments are implemented.
The main novelty in setting the adjustment path towards equilibrium is that it is not uniform in each country, but is adapted to national characteristics through negotiations between the European Commission and each Member State. The negotiations require approval by the Council of the EU. .
Once the adjustment path towards equilibrium is established, a country's progress will be measured by the development of net primary expenditure. The latter is defined as observable expenditures less discretionary income indicators (i.e. temporary income), excluding interest on debt expenditures, expenditures with EU funds and periodic unemployment expenditures. This is a clear methodological improvement over the previous rule, which relied on the concept of “structural defects,” an unobserved variable that was difficult to estimate and caused much methodological controversy.
The new regulations retain the Excess Deficit Procedure (EDP) of the previous regulations, but clarify some aspects. EDP is caused by both excessive deficits and excessive debt, and in assessing it, the Commission and the Board will consider, inter alia, the “government debt challenge”, the magnitude of the divergence, the progress in implementing reforms and investments, etc. will be taken into consideration. and “an increase in government defense spending, as appropriate.” Debt-based EDPs are triggered when debt exceeds 60%, the deficit is not close to equilibrium, and when deviations recorded in a member state's administrative accounts exceed a certain maximum amount.
Q2: What are the new rules and safety measures?
A2: In order to ensure fiscal coordination, the Council of the EU has established the application of several safeguards or conditions applicable to structural fiscal planning. First, the minimum annual structural deficit reduction rate is 0.4%, but this could be limited to 0.25% if the country commits to reforms and investments in its seven-year plan. If a Member State is subject to her EDP, this minimum reduction will be even more severe at 0.5 percent. Second, so-called deficit recovery safeguards force all countries to reduce their structural deficits to 1.5% even after the 3% rule is met, in order to create a fiscal cushion for difficult times. There is. Thirdly, with regard to the pace of public debt reduction, “debt sustainability safeguards” mean that the debt at the end of the adjustment period will be reduced by an average of 0.5% per year in countries with less than 60% of GDP. It has been demanded. The 1% applies to countries with over 90% of GDP and 90% of debt, but only if the deficit falls below 3%.
Finally, for countries covered by the EDP, additional safeguards related to the maximum deviation of expenditures from the planned adjustment path are included to avoid systematic errors. Therefore, actual net primary expenditure in each year cannot deviate from the annual target by more than 0.3 percent of GDP and cumulatively over the adjustment period by more than 0.6 percent.
The evaluation of these safeguards is complex, pending details from the Commission regarding specific calculation rules. It should be noted that although deficit safeguards reduce flexibility, they still have some meaning. However, debt protection measures are unnecessarily complex.
Q3: Will the new rules work?
A3: While the new regulations undoubtedly represent considerable progress and modernization compared to the previous regulations, there are two fundamental problems. It only partially fulfills the objective of creating a simple, flexible and reliable framework, and is inadequate in the current geopolitical situation.
As far as simplification is concerned, the abandonment of 'structural deficit' as a control variable for criteria such as net primary expenditure should be welcomed as it would reduce the controversy surrounding the 'structural deficit' and 'output gap' debate. It is. ” However, structural variables still exist (e.g. debt sustainability analysis, cyclical unemployment spending calculations, minimum deficit reduction and deficit resilience safeguards, etc.). On the other hand, safety measures unnecessarily increase control variables and reduce simplicity.
Regarding flexibility, it has been improved by the customization of the adjustment plan and the possibility of its extension, but has been limited by various restrictions, such as maintaining the 3% deficit and 60% debt benchmarks. It is a legacy of the era that created the euro and has little relevance to the investment needs of today's world. This is also true from both a green and digital transition and defense perspective. It also applies to safeguards that introduce strong limits on the customization of this adjustment path, forcing the adoption of minimum deficit and debt reduction rules that often do not make economic sense.
Unfortunately, the weakest part of the new rules is reliability. The likelihood that they will be effectively complied with is influenced by several factors. First, maintaining the 3% budget deficit and 60% debt standards, which have no theoretical basis and therefore their compliance is not very reliable. The second issue is the institutional division of roles. A purely advisory role for the independent fiscal agency places the burden of compliance on commissions and councils, similar to previous rules (a model that has proven ineffective). Furthermore, the Commission's credibility has been undermined by the management of the NextGenerationEU funds, in particular calls for structural reforms (mainly limited to calls for legislative milestones, regardless of actual implementation) and assessment of investments (spending (focusing on the control of legality) is undermined. (rather than controlling for efficiency or structural effects).
As for sanctions, their amount was reduced in exchange for theoretically stricter enforcement. Violations are subject to semi-annual fines equal to his 0.05% of GDP (no limit on cumulative fines) until the country takes action. Other proposals for moral sanctions or conditionality on EU funds were ultimately rejected. The problem is that fines continue to be pro-cyclical, further worsening member states' fiscal positions and undermining their credibility.
Finally, the essential problem with these rules is that they are inappropriate in the current geopolitical situation and that their negotiations are not linked to the creation of permanent fiscal capacity at EU level. The current rules are solely focused on ensuring the fiscal sustainability of embers and endanger the growth of the European Union as a whole. If implemented effectively, these would significantly reduce public investment in the most indebted Member States, widening real inequality within the Union and underinvesting in the provision of public goods at European level. It turns out. There is no doubt that the European Union needs fiscal rules, but one that is agile enough to compete with other blocs that have long-term investment needs, a green and digital transition, and an aggressive industrial policy. We also need to finance competitive industries. , a defense framework capable of addressing growing global threats.
Federico Steinberg is a visiting fellow in the Europe, Russia, and Eurasia Program at the Center for Strategic and International Studies in Washington, DC, and a senior analyst at the Royal Elcano Institute. Enrique Feras is a senior analyst at the Royal Elcano Institute.
