Will the Coronavirus Pandemic Cure the EU Budget?

Frans Vanistendael

Frans Vanistendael is professor emeritus at KU Leuven in Belgium.

In this article, the author discusses the European Union’s economic response to the coronavirus pandemic.

In Europe these days you cannot look anywhere without seeing coronavirus news flashes. The COVID-19 pandemic is first and foremost a health crisis, and healthcare is an area in which the EU has no competence at all. The Treaty on the Functioning of the European Union clearly states that member states have the right to close their national borders when public health is at stake. Member state national sovereignty in healthcare is even stronger than in taxation. This was evident in the disparate member state reactions to the pandemic. The EU as an institution was almost nonexistent in the health crisis.

As weeks passed, it became clear that the coronavirus was not only a health crisis, but also an economic crisis affecting many more people than the direct victims of the disease. The immediate and V-shaped economic recovery of which some people dreamed quickly became an illusion. Until there is an effective and universal vaccine available, business as usual is excluded for large sectors of the economy: mass entertainment, sports, tourism, hotels, restaurants, and even traditional activities like retail trade. Economically we will learn to do things differently. But these changes will take time and require fresh ideas. Economic crisis and the resultant change in economic behavior is an area in which the EU is competent. Action by the European Commission is therefore to be expected.

In targeting economic recovery, most governments have been looking first for financial resources. This is exactly what European Commission President Ursula von der Leyen has been doing when she presented her proposal for a multiannual financial framework for 2021-2027. In the EU, where we are used to three steps forward and two steps back, von der Leyen’s proposal was a bold move in the EU budget financing mechanism.

Financing the EU Budget

Two major documents control current EU budget financing: the multiannual financial framework (2014-2020) and the annual budget 2020. The multiannual framework establishes the financing principles for a seven-year period, while the annual budget fills in the precise figures of revenue and expenses. In volume, the 2020 EU budget includes €168 billion of spending, representing approximately 1 percent of total EU GDP, and about 2 percent of all public spending by the member states. That is, all member states together are spending 50 times more public money than the European Commission. The EU budget is peanuts compared with the original 2020 U.S. budget of $4.79 trillion in spending (€4.36 trillion). The annual U.S. budget is 26 times larger than the budget for the whole EU.

The original intent was to finance the EU budget with EU taxes and levies. But from the start, that was a complete failure. Only a very small part of the revenue for the EU budget comes from EU customs duties (12.8 percent). The lion’s share comes directly from member state contributions (77 percent), including a part of member-collected VAT revenue (11.1 percent) and a direct member state contribution based on gross national income (GNI) (65.9 percent). That means that the budget of the EU is considered by most member states to be a burden on their national budgets and their only interest is to get as much return from the EU budget as they can.

In the perception of many member states, the EU is a huge game of national minuses and pluses, which led former U.K. Prime Minister Margaret Thatcher to her famous battle cry: “I want my money back!” Furthermore, the situation leaves individual member states with de facto power over the total volume of the EU budget, by controlling the VAT and GNI contributions to the EU budget. Any new large-scale EU initiative, including any initiative to relaunch economic activity after the coronavirus calamity, depends on member state consent. Also, during the euro crisis, initiatives to help eurozone member states in distress took the form of loans, which had to be repaid by the member states and were contingent on promises of good budgetary behavior by the recipients.

The Coronavirus Economic Impact

The full economic impact of the coronavirus crisis is gradually becoming clear. With this comes the realization that until we are capable of an effective and massive COVID-19 vaccination we will have to settle for what The Economist has labeled the 90 percent (or less) economy. This period may last 18 months to two years. During this period, a sizeable minority of businesses will go bankrupt, with the resulting unemployment. Within the EU, the damage will be unevenly spread among the member states. It will be worse in member states like Italy and Spain that have been harder hit by the health crisis, and that are also facing larger public deficits and a bigger public debt. The so-called thrifty states of Austria, Denmark, Finland, Germany, and the Netherlands have had more luck. Because the health crisis has been less severe in these states, their lockdown measures have been less disruptive.

The significant role played by simple bad luck was a big part of the groundswell of emotional protest in Italy and Spain against the first EU proposals for a rescue plan that took the form of loans that would have to be repaid, like during the Greek euro crisis. Analysis of the situation by the thrifty states was merciless: Because the two big Mediterranean member states had not put their public finances in order after the euro crisis, there was no money available for the hospitals and medical supplies needed when COVID-19 struck. This led to the ugly consequences of tens of thousands of deaths and horrible hospital scenes splashed across television and computer screens. There was a moment when it seemed seriously possible that the two Mediterranean powers (together representing more than 100 million Europeans) would leave the EU. This would have been fatal to the whole Union.

A Surprising Change in the German Position

The thrifty state analysis was also not correct. The public budget of a member state like Belgium was anything but in order, and yet Belgian hospitals were capable of dealing with the emergency situation, although economically debilitating lockdown measures were needed to stop the disease. In May, the faultiness of the thrifty state analysis became apparent to German decisionmakers. They realized that it was in the German interest to keep more than 100 million Europeans in the Union as a potential market for German products. This more flexible budgetary position has always been the official French position even before the pandemic. That’s why French President Emmanuel Macron and German Chancellor Angela Merkel on May 18 offered a proposal to borrow €500 billion for a rescue plan, the repayment of which would come not from the member states involved, but rather EU sources.

On May 26 von der Leyen came out with an even bigger proposal, to spend €750 billion, of which €500 billion would be pure subsidies to member states and €250 billion would be long-term loans. The German position on strict budgetary discipline had rotated 180 degrees. The proposal is still subject to approval by all member states through the EU Council of Ministers, but the thrifty opponents (Austria, Denmark, Finland, the Netherlands, and also Sweden, but no longer Germany) together represent only 10 percent of the total EU population. Furthermore, all are heavily dependent on German trade. If this change is accepted, it would represent not only a change in the amounts to be made available to fight the economic crisis, but also a change in the way in which future EU budgets will be financed.

The Quantitative Change in the EU Budget

The past EU multiannual financial framework amounted to €1.1 trillion for the seven-year period 2014-2020. The €750 billion is therefore an increase of 68 percent over the past multiannual budget. Of course, we must take into account some inflation because the next multiannual framework runs to 2027. Even so, this massive increase in spending is clearly a game-changer in the coronavirus crisis economic recovery. Most of the money will be spent in the early years of the seven-year period. The proposed €750 billion is 4.5 times the size of a typical annual EU budget; for example, the 2020 annual budget is €168 billion. The goal is to double annual EU budgetary spending from approximately 1 percent to 2 percent of EU GDP.

The Qualitative Change in the EU Budget

There are three qualitative changes in this proposal:

• unlike earlier rescue operations in which money was made available to member states in distress, there is no obligation for the member states receiving the aid to pay interest or to pay back the principal;

• payment of interest and principal repayment will be charged to the ordinary annual EU budget; and

• because payment of the interest and principal repayment are EU obligations, the EU budget will need additional revenue that would mainly come from new EU-level green taxes.

This proposal is revolutionary and bold. It is revolutionary because it breaks with the iron rule of the euro crisis that every penny a member state receives in cash from the European Central Bank or the European Stability Mechanism must be repaid by that member state. This iron rule has not always been 100 percent applied. On occasion there have been “haircuts” on the amount of the outstanding debt an individual member state must repay. But it has always been the rule in principle.

In the new proposal, called the Next Generation EU, it is the EU itself that acts as a borrower and distributes the proceeds of the loan in the form of subsidies — €173 billion for Italy and €140 billion for Spain. The repayment is guaranteed by the collective EU budget. It should be noted that the Next Generation EU spending is quite different from euro crisis spending. During the euro crisis, assistance was mainly used to meet member states’ international financial deadlines; for example, preventing Greece from going bankrupt. The Next Generation EU fund does not cover purely financial needs. It finances a program of new initiatives to allow the next generation of Europeans to occupy their place in the world: a fund for economic change and transition, a special fund for a green deal, recapitalization of business and research and development, and inevitably a fund for a new health program. Member states are expected to work with the new money, not sit back and merely pay their debts.

The proposal is also bold because it allows the EU and the member states to engage in new ventures, without any guarantee of how the debt will be repaid. In this sense, the proposal is politically very smart. It promises a new EU initiative, but it is crystal clear that it will have to be financed in some way. The goodies of the new ventures are obvious to everyone and can hardly be stopped. But the EU budget’s present way of financing will be totally inadequate. The commission is therefore suggesting new forms of revenue, including EU taxes: revenue from emission rights by extending the emission scheme to maritime transport and aviation; environmental levies; border adjustments on CO2-containing products from third countries; a tax on businesses that profit from the internal market; and finally, some form of digital services tax. The big unanswered question is whether these new taxes will be real EU taxes or just national taxes that member states, like now, will contribute to the EU budget from their own national budgets.

The Perspective of Real EU Taxes

The proposal’s boldest aspect is that it opens the door to real and independent EU taxes, as described in a letter from a group of European tax professors published in Tax Notes International. These taxes would be uniform throughout the EU in terms of the scope of the tax, the tax base, and the tax rate. The revenue would not pass through member states’ national budgets, but would flow directly into the EU budget. The general opinion among most EU tax experts is that the introduction of such taxes is impossible without an amendment of the Treaty of the European Union (TEU) and the TFEU. But failure of the last exercise in treaty revision does not bode well for this possibility.

However, article 192 TFEU authorizes the EU to take initiatives regarding the environment, including provisions primarily of a fiscal nature, although in that case there must be unanimity in the Council of Ministers. But the TFEU does not define fiscal provisions. It could be directives or regulations harmonizing national environmental taxation, or regulations addressing independent and separate European environmental taxation provisions that feed directly into the EU budget.

Because there is strong support for a European green deal while many national governments are reluctant to impose new environmental taxes, it would be convenient if the EU did the tax job and took the blame in public opinion for implementing these taxes. Also, the CO2 adjustments on products imported from third countries is a matter of international trade for which the EU has a clear competence. This would allow a direct financing of the EU budget by way of independent and separate EU taxes uniform across the institution. It would be the opening to EU budget self-financing, without any member state intervention.

A Final Breakthrough

Of course, the solution under article 192 TFEU is only available for taxes closely related to the environment. It does not apply to other taxes like a tax on businesses that profit from the internal market or a DST. Moreover, in view of the far-reaching consequences of the introduction of independent and separate taxes, it is highly unlikely that the five thrifty EU states will agree with this proposal without a fierce political fight. Brexit may make the difference here. If the United Kingdom were still an EU member, the five thrifty states together with the United Kingdom might be able to stop the proposal. But without the United Kingdom, opponents will have to concede defeat, because Germany holds all the cards and has changed position to one of support for the proposal. Trade with Germany is so important for the thrifty member states that they cannot risk antagonizing their former fiscal ally. A threat to leave the EU would not be credible, either, because these member states have benefited more than most from EU membership.

More than two years ago, I wrote a Letter From Europe with the following conclusion:

Merkel did not move for the euro, and I had given up hope that she would move at all before she leaves the European scene. Merkel has been characterized as a sphinx. The hallmark of her policy is patience and silence. Only once did she act with her heart, and that was in September 2015 when she said the historic words: “Wir schaffen das” (the equivalent of “Yes, we can!”) during the immigration crisis. In Germany she has been buried by criticism ever since. Although she has remained patient and silent, she finally acted again with her heart during the coronavirus crisis. This time she moved decisively together with Macron. Von der Leyen, who was once a minister in Merkel’s government, acted with the blessing of her former boss. This is the move for which I was waiting. It came not because of a financial crisis, but, like immigration, because of a human crisis. I have no doubt that Merkel and von der Leyen will succeed, and their success will fit neatly into the EU’s multiannual financial framework for 2021-2027.