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Getting a piece of the EU cake — not only from the expenditure side

Source: IQoncept/shutterstock

When talking about European added value, some people think mainly of net balances and adding and subtracting budgetary flows. While there are several arguments for looking at European added value from a wider perspective, there is also some merit in looking closer at the premises and logic underlying these net balance figures, which serve as important ingredients in a ‘zero-sum game’ approach. Lars Michael Luplow, Assistant to the Director in the Directorate of the Presidency, does that for the revenue part of the EU budget calculations, a side often considered as set in stone and rather technical when assessing the EU’s income side. A revealing exercise…

By Lars Michael Luplow, Directorate of the Presidency

MFF negotiations triggering wider and narrow EAV discussions

There is a budgetary cycle in the European Union, related to the Multiannual Financial Framework (MFF). During the negotiations for any new MFF — which normally already start years before it is adopted, inevitably the question of European added value (EAV) is brought up and quite often EAV is assessed in terms of the net balance and whether a Member State is a net payer or net receiver (see also page 157).

Such a ‘zero-sum game’ approach, which considers only the direct flows of contributions to and receipts from the EU budget without taking into account other benefits or costs, if only of limited value. But even looking at the net balances is more complicated than it may seem at first sight. When assessing these balances most attention and discussion normally goes to the expenditure side. Instead, my focus is more on the EU’s revenue side — also known as the EU’s own resources system. I will not touch on the July 2020 Special European Council conclusions on the new MFF and the NextGenerationEU (NG EU), mainly because the budget authority has not adopted those yet, and the proposal would not change drastically the principles of the EU’s current revenue system (that is with leaving out the NG EU and its financing), which remains my primary topic in this article.

I want my money back! — From Brexit to the frugal four

The notion of an excessive budgetary imbalance was raised as early as in the mid-seventies by the UK government. Its prime minister had put it in simple words, I want my money back, and I want it now! As from 1985 the UK obtained a correction mechanism (the ‘UK rebate’) that reduced its contributions to the EC/EU budget substantially.

In 2016, a majority of British voters decided in a referendum to leave the EU. Subsequently, the UK left the EU at the beginning of 2020. Until now, the UK has been a substantial net contributor to the EU budget (1). With the UK leaving the EU, the topic of fair burden sharing remains a political concern in Member States that are net contributors:

We have been dubbed the ‘frugal four’ and I and my fellow leaders want to set the record straight. Being ‘frugal’ does not mean that we are any less committed to the EU than those member states who are arguing for an expanded budget. (…) Now that we have a smaller union of 27 member states, we simply have to cut our coat according to our cloth. The responsible approach in this situation is to prioritise in the interest of our taxpayers.( …) Currently, more than two-thirds of the budget is redistributed. That means the financial burden of the union is increasingly being put on the shoulders of a small number of member states, including ours. (…) We benefit greatly from being a member of the EU and the single market. However, there are limits. We insist on permanent net corrections to prevent excessive budgetary imbalances and achieve a fair, sustainable outcome. (2)

European officials avoid plain language and love abbreviations. When addressing the fact that some Member States pay more than they receive from the EU budget, we refer to ‘OBBs’, the operating budgetary balances.

OBBs — a more dispassionate concept

The European Commission has been calculating the OBBs since 2000, following the 1999 Berlin European Council summit. The OBBs are publically accessible and the methodology is explained . The OBBs are the difference between the operating expenditure (excluding administration) allocated to each Member State and the adjusted national contributions of each Member State to the Union’s budget. Data for 2018 indicates that the five biggest net contributors (by decreasing importance) were Germany, the UK, France, Italy and the Netherlands.

OBBs are quantifiable — the benefit of being part of the Union is not

The concept of negative OBBs entails significant limitations, as it is primarily a cash-oriented approach. The European Parliament’s services have recently produced several attention-grabbing papers on that topic (see also page 134) (3). I am unable to attain the level of knowledge in those contributions, and therefore will not even try. Basically, the OBB is not the sole indicator for the cost-effectiveness of EU membership, and inappropriate for assessing the wider benefit of being part of the Union.

That said, we have to recognise an important limitation: one cannot monetise that benefit, contrary to the OBB. So another concept is used to justify negative OBBs: ‘European added value.’ The notion goes back to the 1980s, with the 1988 Cecchini Report identifying the advantages of the 1992 Single Market. More recent works are the European Parliament Research Service (EPRS) 2019 study ‘Europe’s two trillion dividend — Mapping the Cost of Non-Europe 2019–2024’. For the purpose of this article, I will stay within the narrower OBB discourse.

The EU’s own resources system — is the ‘taxation’ for being in the EU fair?

The OBBs are the result of both the EU budget’s expenditure and revenue sides. The expenditure depends on the EU’s political priorities and the allocation methods and eligibility criteria agreed between all Member States when negotiating the MFF in seemingly endless negotiations and nightly last-minute compromises. I remain somewhat doubtful about the rationality such compromises can attain. Therefore, I propose to look at the revenue side of the budget.

The EU’s budget is financed by what are known as traditional own resources (TOR) — EU uniform customs duties on imports from outside the EU, earmarked from 1971 onwards exclusively for the EU budget; and contributions based on statistical aggregates relating to Value Added Tax (VAT) and Gross National Income (GNI). Member States currently retain 20% (soon 25%) of the duties for the work of collecting TOR. That mainly concerns the Netherlands and Belgium with their large ports where imports enter the EU. Remarkably, Member States collecting TOR tend to count them in their national contributions to the EU budget, though they are excluded from the OBB calculations.

With TOR reflecting custom duties, can we consider the VAT- and GNI-based national contributions as a sort of tax? Both represent statistical aggregates on which a ‘call rate’ (a levy) is applied. Applying a levy on an economic flow (such as consumption or income) is what modern taxation is about, so that may well work. I will take a further shortcut and disregard the VAT own resource, chiefly because its significance has been constantly diminishing in favour of GNI that was initially only a supplementary resource; but nowadays represents the largest source of revenue for the EU Budget accounting, for around 70% of total financing. So let us stay with the concept of the GNI own resource as an ‘income tax’ Member States have to pay.

In national tax schemes, income taxes are commonly progressive taxes: the more you earn the more tax you will pay on your income, in absolute terms and in relative terms. Income taxation systems operate generally with a zero percentage taxation for the lowest income categories, an increasing marginal taxation and capping at a higher value of income. Such income taxation entails in itself a redistribution factor, as the lowest incomes are not taxed and higher incomes are taxed with a greater average percentage than each inferior income. Admittedly, applying such taxation to Member States could only be done on a per capita basis: the Member States with a higher per capita GNI would be taxed more than those with a lower per capita GNI.

None of this applies though to the GNI own resource: all Member States are taxed with the same levy on their GNI; none is exempted from the payment. The EU income tax has no redistributive function and, applied to a national framework, it would be a simple flat-rate tax. But it gets even worse when we consider the corrections.

Under the current MFF, we have the UK rebate (a correction method), gross reductions for the Netherlands, Sweden and Denmark (you might remember them, the self-declared frugal ones), and a reduced contribution by Germany, the Netherlands and Sweden to the UK rebate (a reduction on a correction, if you still follow) (4). All that leads to a ‘tax system’ where the UK, the Netherlands, Sweden and Germany pay — relative to their GNI — less than other Member States, less than Bulgaria for instance (5).

The self-declared frugal ones are not so penny-wise when it comes to paying the bill

Compared to ideal income taxation, the EU’s revenue system is far from being fair: the current own resources system not only misses the redistribution factor, but the capping has been perverted into a tax discount for richer Member States, leading to a system which is regressive overall. To put it mildly: there is a lot of tax optimisation on the revenue side. So penny foolish and pound wise?

When we discuss the OBBs, the undeniable distributive effects on the expenditure side have to be offset against the regressive effect on the revenue side. Such an approach would only be fair if taken into account in the overall discussions on European added value.

(1) See House of Commons, The UK’s contribution to the EU budget, Research Briefing number CBP 7886, August 2020

(2) Sebastian Kurz, Chancellor of Austria, and Mark Rutte, Prime Minister of the Netherlands, Mette Frederiksen, Prime Minister of Denmark, and Stefan Lofven, Prime Minister of Sweden; The ‘frugal four’ advocate a responsible EU budget in the Financial Times; 16 February 2020; see: https://www.ft.com/content/7faae690-4e65-11ea-95a0-43d18ec715f5

(3) European Parliament ; IPOL — Policy Department for Budgetary Affairs; Briefings; February 2020: The benefits of EU membership are not measured by net operating balances; PE 648.145; Why net operating balances are a distorted indicator of a Member State’s benefit from the EU budget; PE 648.148; The net operating balances: Variants, emerging numbers and history; PE 648.183; Strategies to overcome the ‘juste retour’ perspective on the EU budget; PE 648.186

(4) Under the current MFF, Germany, the Netherlands and Sweden also profit from a reduced call rate on their VAT-based contributions.

(5) Deutsche Bundesbank, The EU budget and its financing: looking back and ahead, Monthly Report April 2020, pages 45 ff.

This article was first published on the 3/2020 issue of the ECA Journal. The contents of the interviews and the articles are the sole responsibility of the interviewees and authors and do not necessarily reflect the opinion of the European Court of Auditors.

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