COVID-19 AND EU PUBLIC FINANCES(1)


Edith Kitzmantel2

  1. Introduction

EU Public finances have always been a hotly debated subject. Parliament (EP) and, to a lesser extent, the Commission have pushed for „more Europe“ while Member States (MS) have been reluctant to cede control. Today, the lion‘s share of EU citizens‘ tax money – as much as 98 % – is still directly spent at national level, and only a slim 2 % are channeled through the joint EU-Budget.3 Taxes – an area where the Single Market would call for close policy alignment – are among the few subjects which still require unanimity in the Council, and consensus is rarely achieved.

Reflecting this tug-of-war, the EU Budget is tightly framed both in size and structural detail. The main elements are a legally firmly anchored receipts ceiling, a balanced-budget requirement, a multi-annual framework, detailed annual budget decisions, stringent reporting obligations, and a robust discharge procedure.

It was recognized from early on that a monetary union ties participating countries closely together, and thus also exposes them more than before to each other‘s potential policy slips. Creation of European Monetary Union (EMU) was thus preceded by efforts to restrict national macropolicies. This historical context explains why the EU fiscal governance framework focusses so meticulously on national budget discipline.

In a first step, the Maastricht-Treaty of 1992 established common debt and deficit ceilings („Maastricht-criteria“, subsequently set at 60 % and 3%, respectively). From 1997 on these benchmarks were complemented by a periodically refined Stability and Growth Pact which has now reached a high degree of technical sophistication and complexity.

However, in spite of all this, the right to determine the size and structure of national budgets has remained in the hands of MS, and constitutes their most important economic policy tool.

  1. The World before Covid-19

Only a year ago, EU public finances – though still far from perfect – appeared clearly walking the path of fiscal virtue.

  • True, MS had never fully complied with established rules, but after the 2008 financial crisis had thrown public budgets off-balance, progress had been made every single year. And 2019 was the first year in nearly two decades that not a single MS was assessed to be in an „excessive deficit“. The aggregate deficit had been brought down to a modest 1/2 % of EU and Euro area GDP.
  • True, MS‘ political commitment had not always been strong, but now it necessarily was, because since 2011 budgetary rules and procedures had been considerably tightened. Were there not a „reversed majority-rule“, a new „debt rule“ and, in some MS, a „constitutional debt brake“, an „expenditure rule“, a „European Semester“ with „ex ante co-ordination“ of economic and employment policies, conditional „adjustment programmes“, and „fiscal councils“ in all MS?
  • True, financial emergency assistance had been tied to harsh fiscal conditions which had also had some unwelcome longer-term side effects and had contributed to souring North-South relations, but the root of the problem had been unsustainable policies, not calls to fiscal discipline.
  • True, the fiscal architecture was still incomplete – a tiny slice for the joint EU budget, no Europe-wide taxes, no anti-cyclical „fiscal capacity“, no common debt emissions – but European integration had always been a stepwise process and new instruments had already been developed, e.g. the European Stability Mechanism (ESM) and asset purchasing programmes by the European Central Bank (ECB). Moreover, the EU could also rely on off-budget operations, in particular through the EIB Group.
  • True, focussing on individual MS‘ budget performance had necessarily resulted in a random fiscal stance at EU level, but the effect of fiscal policy on the economy („fiscal multipliers“) was an elusive subject anyway.
  • True, the focus on „budgetary discipline“ lacked a common political vision, but this argument was off the point, because substantive budget decisions were a competence of MS.
  • True, common flagship programmes like EU-2020 had suffered from fiscal rules, by restricting MS‘ capacity to finance them, but it was up to MS to set the right priorities.
  • True, the focus on budgetary restraint had disproportionately hit the most „growth-enhancing“ spending categories, from infrastructure investment to education and R&D, but again, it was up to MS to get their „spending house“ in order. Moreover, private markets should be flexible enough to step in.
  • True, with increasing sophistication, fiscal rules had also become complex, opaque and cumbersome, but they had also raised budgetary expertise and standards to a high common level.
  1. A Strong, Co-ordinated Policy Response

When the Covid-19 pandemic broke out early last year, the EU Institutions agreed swiftly on a strong and co-ordinated policy response to cushion the impact on incomes and employment and to keep credit channels open.

As early as March, fiscal rules were temporarily suspended, by invoking the General Escape Clause, and state aid rules were temporarily softened. The objective was to provide MS with sufficient flexibility to fight the pandemic and to support the sectors and individuals most affected by the related containment measures.

At EU level, the Commission set up a new loan programme „SURE“4 which supports short-time work schemes („Kurzarbeit“) and other measures with up to € 100 billion. The European Investment Bank made available an emergency support package for severely affected small and medium-sized enterprises of up to € 200 billion. The European Stability Mechanism (ESM) offered a Pandemic Crisis Support scheme available to all Euro area Members, with credit ceilings of 2 % of each country’s GDP, and coming with the sole requirement to use the funds for Covid-19-related health spending.

The ECB took a set of further monetary easing measures. The existing programme for asset purchases („APP“) was stepped up and extended for „as long as necessary“. In addition, a new, more flexible programme „PEPP“5 was set up with an eventual envelope of € 1.850 billion, running at least until end-2023. Moreover, the ECB decided additional liquidity-enhancing measures to support the flow of credit to households and firms, and extended measures to provide an effective liquidity backstop to EU central banks inside and outside the Euro area.

In December, after 2 ½ years of inter-Institutional negotiation, political agreement was finally reached on the budget framework for 2021-27 („Multiannual Financial Framework 2021-27“, MFF). In parallel, a sizeable second medium-term package was adopted („NextGenerationEU“), with an overall volume of € 750 billion, to be committed by end-2024.6 Core piece is a new „Recovery and Resilience Facility“ (RFF) amounting to € 672,5 billion, of which € 312,5 billion will be given as grants. The RFF constitutes a historic political breakthrough in several ways: (1) In combination with the MFF it is the largest package ever passed, with priorities co-ordinated between EU and national levels, (2) it is the first time that the Council has, if only temporarily, agreed to deficit financing, and (3) it is the first time that the Council has agreed to the principle of introducing European taxes, to repay the incurred debt.

Both the regular EU budget and spending under the „NextGenerationEU“ will be guided by the four objectives already identified in the 2020 Annual Sustainable Growth Strategy, i.e. environmental sustainability, productivity, fairness and macroeconomic stability. The same applies to the „Recovery and Resilience Plans“ (RRP) which MS are expected to submit to the Commission by end-April 2021.7 At least 37 % of spending must be allocted to the „green transition“ and at least 20 % to the „digital transition“.

Member States, too, have engaged in an emergency response of unprecedented size. By August, MS had reported measures decided under the General Escape Clause totalling € 524 billion,8 equivalent to a remarkable 3 ¾ % of EU-GDP. To these „discretionary“ emergency measures have to be added the considerable „automatic“ effects stemming from lower tax receipts and higher unemployment compensation due to a contracting economy, and the RRP stimulus packages in preparation.

Germany last summer9 reported a wide range of emergency measures, spread over 2020/1 and beyond.10 Grants to small businesses may be extended up to a total of € 50 billion, while another 10 billion each are foreseen for the short-time working scheme („Kurzarbeitergeld“) and for easier access to basic income support. The Länder intend to provide liquidity support and immediate assistance up to about € 30 billion. Access to guarantees for loans from the promotional bank KfW will be eased and broadened while a newly set up Economic Stabilization Fund will provide the corporate sector with loan guarantees and equity up to € 600 billion. To ease financial strain, tax deferrals, suspension of tax enforcement measures, protection of tenants from eviction and extended insolvency deadlines have been enacted. An additional € 19 billion are reserved for health spending.

Similarly, Austria last August reported comprehensive emergency measures for the period 2020/1 and beyond.11 These include € 15 billion for a Corona aid-fund which extends grants for compensating certain fixed costs incurred by enterprises and provides state guarantees for loans. Another € 12 billion are foreseen for immediate help in hardship cases, with € 10 billion for the short-time work scheme and the remainder for aid to small firms, self-employed, NPOs and agricultural enterprises. Support to associations and individuals in culture, sport, and the arts adds up to another € 1 billion. Tax relief is also significant. It includes deferrals (€ 10 billion), retroactive offsetting of losses (€ 2 billion), income tax reduction (€ 2billion), degressive depreciation, corporate equity allowance, temporary VAT reduction (€1 billion), as well as sector-specific packages (gastronomy, agriculture and forestry). Guarantees and emergency loans amount to another € 7 billion. A basic investment premium of 7 % will apply for companies which is topped by another 7 % for investment in health, environment and digitalisation.

  1. The challenges ahead

In 2020, the pandemic has thrown large parts of the world into recession, with global economic output contracting by some 3 ½ %.12 Because it is too early to judge how successful containment measures will be, the outlook for this year and next is surrounded by an unusually high degree of uncertainty.

In the Union pandemic containment measures in 2020 have strongly relied on shutdowns and social distancing. As a result, the recession has been more pronounced than in other advanced economies, with GDP falling by over 6 % in the Union and by nearly 7 % in the Euro area (but by „only“ 3 1/2 % in the US). All MS have been affected, with income losses ranging from less than 1% (Lithuania) to 11 % (Spain). Disparities in income and wealth distribution have further widened, as the young, women, low-skilled workers and minorities have been disproportionately hit.13

The German economy contracted by 5%, as support to disposable income was outweighed by a rise in the savings rate, and as private investment and exports declined. Due to generous grants for short-time work, employment fell by only 1 %. For 20021/22 the Commission expects growth to resume at a rate of about 3 % p.a..

The Austrian economy was even more affected. During the first half of the year, the country recorded the deepest recession in post-War history, and on yearly average, output contracted by some 7 1/2%. The Commission expects an only gradual recovery, with GDP expanding by 2 % in 2021 and about 5 % in 2022.14

Public finances around the world have been seriously thrown off balance again, even more than by the 2008 financial crisis. Fiscal deficits in 2020 soared to about 8 1/2 % of GDP in both the Union and the Euro area15 (and to nearly 19% (!) of GDP in the US16). Debt ratios have shot up accordingly.

European fiscal policy now stands at a crossroads, with three major decisions to be taken:

  1. In view of a historic slump, urgent spending priorities (pandemic-related spending, green and digital transitions) and historic fiscal imbalances: How to handle the conflict that both robust public spending and restoration of prudent fiscal positions are highly desirable?
  1. In view of growing unemployment and inequality, and of high indebtedness of firms and households: How to manage the shift from protective emergency response to structurally sound „NextGenerationEU“ stimulus packages?
  1. In view of rising criticism of the EU fiscal governance framework and the fact that central concepts (e.g. „structural balance“, „expenditure rule“) lack meaning in the current context: How to make fiscal rules fully productive in both fat and lean years, and how to simplify them?

All three decisions will require a considerable amount of fresh and bold thinking. For many EU households and firms, the first two decisions will also touch upon existential issues, and thus upon the very functioning of European societies. Much is at stake.

1 An abbreviated version of this paper willl appear in AIACE VOX no. 118, see http://www.aiace-europa.eu

2 Economist, many years in leading functions in the Austrian Ministry of Finance and in the EU Commission, Member of the Austrian Fiscal Council.

3 2019 figures: € 7.524 billion and € 148 billion, respectively.

4 „Support Mitigating Unemployment Risks in Emergency“.

5 „Pandemic Emergency Purchase Programme“.

6 Figures in 2018 prices.

7 See Communication from the Commission „Annual Sustainable Growth Strategy 2021“ of Sept. 17, 2020.

8 See Economic Commission: Jobs and economy during the coronavirus pandemic, https://ec.europa.eu/info/live-work-travel-eu/coronavirus-response/jobs-and-economy-during-the-coronavirus-pandemic_en#flexibilityundertheeusfiscal rules

9 Since then, most countries have reported additional measures, since infection rates have increased once more

10 See European Commission: Policy measures taken against the spread and impact of the coronavirus, 14 January 2021.

11 See same source.

12 See European Commission: European Economy, Institutional Paper 144, Economic Forecast Winter 2021 (Interim), Feb. 11, 2021.

13 In the words of Joseph Stiglitz „COVID-19 has not been an equal opportunity virus.“

14 Source: See footnote 9.

15 Commission Autumn 2020 Economic Forecast of Nov. 5, 2020. However, the IMF expects fiscal deficits for both areas to rise to about 10 % of GDP (see IMF World Economic Outlook (WEO) of Oct. 2020).

16 Source: See footnote 12.

1 Comment

Filed under article in english, Crisis Response, European Union, Fiscal Policy

One response to “COVID-19 AND EU PUBLIC FINANCES(1)

  1. I highly appreciate this thought provoking contribution to the dialogue on European governance; in particular, since it is written by an old colleague and friend. Please keep up the good work, Edith!
    Emil Ems

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s