Transcript Harmonization of Fiscal Policies

Harmonization of Fiscal Policies
EUROPEAN ECONOMIC INTEGRATION
Oldřich Dědek
Institute of Economic Studies, Charles University
Unique features of EU budget
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Small relative size of budgetary spending
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Expenditures side
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Spending ministries remained in MS (pensions, education,
defence, infrastructure, police and justice), only agriculture is split
(accounted for approx. 90 % in early years of the Community)
Revenues side
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Starting from 0.3 % of joint GDP in 1960, fixed at 1.05 % of joint
GNI for 2007-13 period (120 bl. EUR in 2010), around 2-3 % of all
national budgets
In contrast EU-27 average spending relative to GNP in 2007 was
46 % (Sweden 51 %, Czech Republic 41 %, Estonia 34 %)
No direct or indirect taxation of EU citizens and companies
Blend of own resources and MS contributions
Principle of equilibrium
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EU cannot run a deficit (estimated revenues for a financial year
have to equal expenditures for that year), borrowing is severely
restricted (no counterpart to national debt)
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Size of European budget
160
1,4
140
1,2
120
100
0,8
80
0,6
Percent
Billion EUR
1,0
60
0,4
40
0,2
20
0
0,0
58
60
62
64
66
68
70
72
74
76
78
Total expenditure
80
82
84
86
88
90
92
94
96
98
00
02
04
06
08
10
12
Share on Community GNI
Source: European Commission, Financial Report 2004 and Financial Framework 2007-2013
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Contributions from member states (in 2002)
20
15
Billion EUR
10
5
0
DE FR IT UK ES NL BL SE AT DK EL PT FI
IE LU
-5
-10
Own resources
Net position
EC: Financial Report 2004; Wallace et al.: Policy-Making in the EU (2005)
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History – first reforms
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Initial transition period 1958–1970
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Financing obtained directly from member states (complex system of
national quotas)
Individual contributions adjusted according to the importance of policies
for each member states
Negligible amounts covering administrative functioning of European
institutions
Since 1965 sky-rocketing increase in CAP expenditures (approx. 80% of
budgetary outlays)
Reforms 1970, 1975
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System of own resources adopted (allocated to the Community
automatically) – initially strong opposition by France
Institutional framework established for budgetary cycle (timetable for
individual phases in preparing budget, competences of European
institutions)
Competences of European Parliament strengthened (power to adopt or
reject the whole budget and propose amendments over so called noncompulsory expenditures)
European Court of Auditors founded (1977)
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Sources of budget
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Traditional own resources (TOR)
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Share in VAT
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Source established in 1979 (erosion of traditional resources and need to
provide financing for Structural Funds)
Declining importance from peak of 65% to 11% (2011)
Complexities due to different VAT tax rates and tax bases
Contributions linked to GNP (since 1995 to GNI)
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Revenue from tariffs on industrial products (common external tariff)
Agricultural levies on imports from third countries
Initially sufficient to cover expenditures, then constantly declining share
(due to lower tariffs in GATT/WTO, growing EU membership,
agreements with EFTA); currently approx. 12% (2011)
Source established in 1988 (enhancing principle of ability to contribute)
Maximum percentage of GNP/GNI
Balancing item (activated if other sources prove inadequate)
Ceiling 1.27 % for 2000-06, 1.05 % for 2007-13 (76 % in 2011)
Others
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Surpluses from previous years, fines, personal taxes of staff of European
institutions, etc.
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History – conflicts in 1970s and 1980s
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Complaints from UK about being second-largest net
contributor
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Little inflow from European budget: small share in agriculture meant
small CAP expenditure; extra money lacking for new titles
High outflow to European budget: large imports from third countries but
tariff revenue being Community’s own source; highly industrialised
country meant larger VAT contributions
Summit in Fontainebleau (June 1984) agreed so-called British rebate:
return of approx. 2/3 of net UK contributions (in exchange for increase in
ceiling on VAT from 1% to 1.4%)
Controversies between Council and EP
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Struggle of EP to strengthen budgetary competences (vacuum in
Treaties)
1980, 1985 EP rejected budget proposal (on grounds of excessive
growth in agricultural spending)
1982, 1986 Council sued EP at ECJ for breaching competences
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History – multi-annual financial frameworks
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Financial perspective sets out priorities and multi-annual
financial framework fixes maximum amount and
composition of EU expenditure over given period
Benefits
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Greater certainty and stability (priorities are known from the
outset)
Ensuring adequate financing for projects extending over several
years
Annual budgetary procedure determines the exact level and
breakdown of expenditures
Financial perspective negotiated as package of reforms, more
room for manoeuvre in finding compromises (grand bargains)
Chronology
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Delors 1: 1988 – 1992
Delors 2: 1993 – 1999
Berlin Agreement (Agenda 2000): 2000 – 2006
New financial perspective: 2007 – 2113
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Delors 1 and Delors 2
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Delors 1: 1988–1992 (bill for Single Market)
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Changing power balance after entry of poorer countries (1981
and 1986)
Idea of close relationship between deepening of internal market
(SEA) and deepening of economic and social cohesion
Measures
Expansion of Structural Funds and capping of CAP expenditure
Fourth own source established – link to GNI (1.4 %)
Preservation of British rebate
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Delors 2: 1993–1999 (bill for Maastricht)
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Extension of financial perspective from 5 to 7 years
Approval of link between EMU and social cohesion
Measures
Higher expenditure limit at 1.27% of GNI
Suppressed VAT own source (more emphasis on ability to contribute)
Cohesion Fund established and increase on spending on Structural Funds
Preservation of British rebate
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Berlin agreement (Agenda 2000)
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Financial perspective for 2000-2006 (background Commission
paper Agenda 2000)
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Concept of “budgetary stabilisation”
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Preparing the way for Eastern enlargement
Agreement on reforming CAP and SF
Stronger voice of net contributors after 1995 enlargement
Costly unification of Germany
Worries about costly Eastern enlargement
More attention paid to budgetary management (resignation of Santer
Commission in March 1999)
Measures
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Expenditure ceiling preserved at 1.27% of GNI
Gradual drop of VAT source (from 1% in 2000 to 0.5 % in 2004)
Moderate drop in assistance to cohesion countries accompanied by preaccession aid to prospective members (PHARE, SAPARD, SPA)
Cosmetic changes in size and structure of CAP expenditures (France
blocked deeper reform)
Preservation of British rebate (approx. 4 bl. EUR per year)
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Financial framework 2007–2013
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Bill for the Lisbon Strategy and Europe 2020
Controversy about resources for the budget and budget ceiling
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Spending priorities
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Many EU countries faced sluggish growth (Germany, France, Italy), difficult
compliance with SGP
December 2003: joint letter of major contributors (GE, FR, UK, NL, AT, SE) to EC
President calling for a ceiling of 1 %
Commission proposed to fix own resources at ceiling 1.24 % GNI, Final
agreement was 1.05 % of EU GNI
Budget headings: 1.Competitiveness, 2. Cohesion, 3. Natural resources, 4.
Citizenship, freedom, security and justice, 5. Global partner, 6. Administration
Heated debate over the draft budget for 2011 to fund addition tasks arising from
Lisbon Treaty
British rebate
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Without correction increase to 7 bl. EUR per year and new members would have
to pay part of it
British Prime Minister Blair linked the question to reduced spending on agriculture
but France opposed further CAP reform
By way of compromise Britain agreed to give up one-fifth of rebate attributable to
Eastern enlargement
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Tax harmonisation
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Arguments in favour of harmonisation
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Arguments against tax harmonisation
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Different tax rates may harm tax neutrality and distort competition in internal
market
Race to bottom: Benefits of tax competition are temporary, in long run all
countries are worse off (lower tax revenues, higher taxation of less mobile
factors)
Maintaining fiscal frontiers is costly, particularly after tariff frontiers have
been dismantled (fiscal frontier = crossing-point which frees exports from
domestic taxes and introduces tax duty for imports)
Tax issues should in principle be the responsibility of sovereign national
governments (power to tax is central power of a country)
Tax uniformity may have differentiated outcomes in individual countries
(different consumption patterns, different social systems, different factor
mobility, etc.)
A number of independent policy-making tools needed after centralisation of
some others (i.e. monetary or trade policy)
Tax competition disciplines governments
Areas of tax harmonisation
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Harmonisation of tax rates (indirect and direct taxes)
Harmonisation of tax base
Harmonisation of tax exemptions
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Classification of taxes
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Indirect taxes
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Direct taxes
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Levied on consumption of a good or service
Substantial impact on inflation
Types: value added tax (VAT), consumption tax (excise
duty)
Levied on incomes of firms and individuals
Impact on labour and capital mobility
Types: corporate tax, personal tax, withholding tax, social
and health insurance
Tax issues are subject to unanimity rule in EU
decision-making
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Origin versus destination principle
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Origin principle
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Goods should be taxed where they are produced (regardless of
whether they are exported or consumed domestically)
No fiscal frontiers are needed (consistent with abolishing tariff
frontiers in internal market)
Possible tax distortions in consumption (encouraging imports
from countries with lower taxation)
Destination principle
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Goods should be taxed where they are consumed (regardless of
whether they are imported or produced domestically)
Domestic and imported goods compete under equal tax
conditions (common principle in international trade)
Fiscal frontiers are needed (refund of taxes paid domestically on
exported goods)
Stronger motivation for avoiding taxes (fictitious exports,
smuggling)
Possible tax distortions in production (higher indirect taxes on
imported goods and lower indirect taxes on domestic goods)
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Value added tax
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Added value is the difference between price paid for inputs
and price obtained for outputs
Since 1967 introduced throughout Community (in France
since 1954) – destination principle (tax paid in the exporting
country is refunded)
Benefits
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Non-discriminating between production for domestic and foreign
market and between inputs produced domestically and imported
Non-stimulating vertical integration motivated by tax savings only
(better than older cascade tax)
Natural safeguard against tax evasion (claims for VAT refund
only after subcontractors have documented their tax liabilities)
Degree of harmonisation
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Standard rate within band 15 – 25 %
Reduced rate 5 % applicable to a list of products (food,
pharmaceutics, energy , water passenger transport, etc.)
Zero rate (existing rates can be continued but not extended)
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Consumption tax
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Tax levied on consumption of selected goods
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Construction
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Ad valorem (proportional to price of good)
Specific (linked to physical quantity of good)
Important impacts of harmonisation
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Usual items: alcoholic, tobacco and petroleum products
Less usual: coffee, tea, salt, playing cards
Inflation level (tax rates tend to be high)
Budgetary revenues (trend towards higher reliance on indirect taxes)
Health and environmental issues
Consumption tax is included in tax base for VAT (distortions in
consumption taxes may translate into distortions in VAT)
Degree of harmonisation
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Common list of products on which excise duties apply
Minimum tax rates for selected products
Abolition of duty-free sales
Abolition of limits for personal consumption taken from one MS to
another
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Corporate tax
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Low degree of harmonisation not corresponding to complete capital
mobility in internal market
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Different tax system
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Classical (firm is seen as legal entity, double taxation of dividends): DE,
NL, AT, BE, …
Imputed (firm is seen as representation of shareholders, who are eligible
for tax credit): UK, FR, IT, ES, IE, …
Many differences in details: taxation of distributed and non-distributed
profits, tax levied on profits transferred abroad, depreciation policies,
inflation accounting, preferential treatment of SMEs, etc.
Different tax bases
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Migration of production capacities from higher to lower rate countries
Tax avoidance in multinational corporations: transfer pricing (profit
shifting in multinational firms)
Initiative of Commission towards unification of rules
Different levels of taxation
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Anglo-Saxon system based on lower taxation of firms (UK, IE, some new
member states)
Continental system traditionally based on higher taxation of corporations
(GE, FR, Scandinavian countries, etc.)
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Personal income tax
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Substantial impact on price of labour and mobility of
labour force
Part of extremely heterogeneous social systems
(contributions to social insurance cover social
transfers)
Practically zero degree of harmonisation and zero
ambitions to harmonise this area
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Exceptions: agreements preventing double taxation of
migrants
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SGP – basic facts
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Motivation: preservation of fiscal discipline not only at the
time of fulfilling Maastricht criteria but on a permanent
basis after getting membership in EMU
Adopted in June 1997 at the Amsterdam meeting of the
European Council
Came into force with the creation of the Euro Area
(beginning of the Stage 3 of EMU)
Legal background
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Ban on excessive deficits in Maastricht Treaty (defined in terms
of 3 % limit for general government deficit and 60 % for general
government debt)
Practical details worked out in the SGP
SGP is not a Treaty but a set of European Council Resolutions
and Council Regulations
SGP is mandatory for all EU members, except for
financial sanctions, which can be applied to Eurozone
members only (non-members can be punished by
suspending payments from Cohesion Fund)
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SGP – economic justification
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Spillover effects of excessive government borrowing
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Free-rider effect: undisciplined behaviour brings benefits only
when other countries preserve discipline
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Growing aggregate demand encourages inflation in monetary union
Appreciation of single currency in short run that damages exports
Financial instability in longer run triggered by excessive debt
Strength of spillover effects depends on economic size of national
economy
An individual member of monetary union cannot be punished separately
for undisciplined policies
A higher number of undisciplined governments undermines agreed fiscal
rules
Deficit bias effect: tendency of democratically elected
governments to run excessive budget deficits for purely
political reasons
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Politically more convenient to shift burden of repaying debt to future
generations
Influential election cycle
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SGP – preventive arm (initial version)
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Medium-term objective (MTO)
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Defined as deficit which is „close to balance or in surplus“
(CTBOIS)
CTBOIS creates sufficient room for smooth functioning of
automatic stabilisers and discretionary outlays while proximity to
the 3 % limit prevents the fiscal policy to counteract economic
downturn
Member countries are expected to meet the MTO in medium term
(structural deficit should improve by 0.5 pp per year)
Framework for multilateral surveillance
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Member states prepare stabilisation programs (Eurozone
countries) or convergence programs (non-Eurozone countries)
Commission assesses these programs
Council can address, on the basis of a proposal by the
Commission, an early warning to prevent the occurrence of
excessive deficit
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Structural and cyclical deficit
PO
€
NOG
POG
AO
CD
AO … Actual output
PO … Potential output
NOG .. Negative output gap
POG .. Positive output gap
AD … Actual deficit
CD … Cyclical deficit
SD … Structural deficit
ε … elasticity
SD
AD
𝐴𝑂−𝑃𝑂
Output gap =
Cyclical deficit = 𝜖 × output gap
SD = AD - CD
𝑃𝑂
Example: POG = +3 %, AD = -2 % GDP, 𝜖 = 1.2 
CD = 1.2 × 3 = +3.6 % GDP, SD = -2 % - (+3.6 %) = -5.6 %
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SGP – corrective arm (initial version)
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Excessive Deficit Procedure (EDP)
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Exceptional circumstances
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EDP is initiated by Commission if during three consecutive years actual or
planned deficit exceeds limiting value of 3%
Commission prepares recommendations for Council containing remedial
measures
Council may approve recommendations (EDP comes into effect) or ask for new
ones
EDP is approved by qualified majority voting rule
Country with excessive deficit is hit by severe recession (GDP decline of more
than 2% – EDP is not automatically initiated)
GDP decline is lower than 2% but higher than 0.75% (exceptional circumstances
must be documented)
Sanctions
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Obligation to create non-interest bearing deposit
Fixed component = 0.2% of GDP
Variable component = 10 % of an amount by which actual deficit exceeds 3 % limit,
maximum 0.5 % GDP
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If excessive deficit is not corrected, deposit balances are turned into fine
Example
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Deficit 5.7 %  0.2 % + 0.1× (5.7 – 3) = 0.47 % GDP
Approx. 18 bil. CZK, 0.7 bil EUR for CR (nominal GDP in 2007 = 3600 bil. CZK)
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SGP – arguments of critics
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In favour of weakening
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SGP is too restrictive: sanctions can be avoided only in deep
recession
SGP is too rigid: unified rules do not take into account national
specifics (different indebtedness, modernisation of infrastructure,
financing of pension reform, etc.)
Problematic objective (deficits close to balance or in surplus):
economy without government debt restricts investment in safe
securities
In favour of strengthening
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Asymmetry: fiscal development is closely monitored only after
appearance of difficulties and not in “good times”
Failure to initiate EDP for breaching the debt criterion
Politicisation: approval of sanctions is in hands of politicians
(members of ECOFIN)
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SGP – arguments of defenders
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Criticism comes from undisciplined
governments that are not courageous enough
to adopt unpopular reforms in “good times”
Dilution of SGP rules is counterproductive visà-vis deficit bias of European governments
Operational and transparent Pact requires
simple and unambiguous rules
Without sanctions SGP becomes toothless
device for enforcing fiscal discipline
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SGP – credibility crisis
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Germany and France 2002–2004
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Legal dispute seriously undermined credibility of the Pact
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EDP initiated with both countries (plus Portugal)
Portugal brought its deficit below the 3 % ceiling
In case of France and Germany Council revised Commission‘s
recommendations and adopted conclusions declaring that
sanctions against the two countries are in abeyance
Legal dispute: Commission took the Council to the CoJ for not
respecting the Treaty, CoJ ruled that Council made a procedural
error
ECB warned against serious dangers by suspending the Pact
Smaller countries attacked the failure of lager members to
respect the fiscal constraints
Sharp disputes lead to the reform of SGP rules in May
2005
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SGP – March 2005 reform
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Differentiation in MTOs
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Speed in meeting MTO
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Appeal to faster consolidation effort in “good times”
Possibility to take into account structural reforms without
jeopardising 3% limit
EDP implementation
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Eurozone and ERM-II members: deficit -1% of GDP for lowdebt and fast-growing countries, balanced budget for highdebt and slow-growing countries (cyclically adjusted deficit)
Others: safe limit of 3% should be respected
Confirmation of benchmark values of 3% and 60% of GDP
Enlarged list of exceptional circumstances (sluggish growth,
contribution to EU policies and international solidarity, other
relevant factors)
More time for adjustment
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Six-pack
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Six-pack is a package of six legal norms that were
adopted to reinforce the system of economic
governance in EU and Eurozone
Entered into force in December 2011
Applies to all member states with some specific
rules for euro-area members especially regarding
financial sanctions
Content
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Reinforced preventive and corrective arms of Stability and
Growth Pact
New surveillance mechanism over macro-economic
imbalances
Directive on the requirements for the fiscal frameworks of
the Member States (technical features of formulation and
implementation of fiscal policy)
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SGP – Six-pack reform
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Preventive arm
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Corrective arm
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Prudential expenditure rule for countries that are missing their
MTOs
Expenditure growth should not exceed a reference rate linked to
potential GDP growth
Significant deviations from the prudential rule can be punished
with a sanction of interest-bearing deposit of 0.2 % of GDP
Non-interest bearing deposit of 0.2 % of GDP at opening of the
EDP
Numerical benchmark for sufficiently diminishing debt-to-GDP
ratio = distance with the 60 % reference value declines over 3
preceding years at an average rage of 1/20 the per year
Non-respect of the rule may result in opening the EDP (after
assessment of all relevant factors)
Reverse qualified majority voting
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Commission‘s recommendation is adopted by the Council unless
a qualified majority of MS vote against
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Surveillance over macro-economic imbalances
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Preventive arm
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Corrective arm
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Alert mechanism : a set of early warning indicators with
thresholds arranged in the scoreboard whose aim is to detect MS
with potential harmful imbalances
In-depth review: detailed analyses focused on MS economies in
which alert mechanism detected potential harmful imbalances
Possible actions: 1. No problem, 2. Imbalances exist but are not
severe, 3. Severe imbalances  MS is placed in Excessive
Imbalance Procedure
MS prepares Corrective Action Plan (fine 0.1 % GDP if found
insufficient)
Surveillance of Plan‘s commitments (interest-bearing deposit 0.1
% GDP if found insufficient eventually converted into fine)
Reverse qualified majority voting
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Fiscal Compact
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Treaty on Stability, Coordination and Governance in the
Economic and Monetary Union
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Content
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Mirroring EU rules at national level
Signed by all EU countries except for UK and CR
Balanced Budget Rule: structural balance meets the country
MTO, rapid convergence towards MTO, temporary deviations in
line with SGP
Benchmark for government debt reductions (as foreseen in the
reinforced SGP)
Public debt issuance plans reported ex ante
Enforcement
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If MS fails to transpose correctly, the matter will be brought to EU
CoJ (possibility of sanction of up to 0.1 % of GDP)
Compliance with national rule monitored at the national level by
independent institutions
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