A Proposal to Revive the European Fiscal Framework

Written by | Tuesday, May 17th, 2016

Grégory Clayes and team (Bruegel)

The EU’s fiscal policy has gone through a number of changes since its humble beginnings in the 1990s, but it is now necessary to significantly reform it. This policy covers the processes and rules governing the creation of the budgets of the EU members and related institutions. It has two main objectives: to dissuade governments from increasing their deficits in the interest of long-term sustainability and to leave a space for the implementation of counter-cyclical steps. However, its current form is not efficient enough in fulfilling this intention.

There are ongoing problems with achieving both these objectives. Several states have for long had their debts at higher levels than they should have been according to the rules, and they are not anywhere close to reaching the desired level of 60 percent of GDP in the foreseeable future. Insufficient anti-cyclical measures in times of growth then lead to an increase in debt as well as the inability to provide sufficient stability during an economic downturn. It can bring long-term negative consequences and deepen or accentuate social problems. The main shortcomings of these measures are related to the inaccuracies in the estimation of future development, which the Commission uses to provide recommendations to individual countries.

Those are derived from the annual forecasts, which in turn undergo major revisions, whereby deviations increase especially in times of uncertainty. Fiscal rules are difficult to be implemented and the threat of sanctions is not a sufficient motivation. If a country has problems, sanctions will deepen them, but they are actually negligible in the context of such a situation. Yet, if only for political reasons, they are not the preferred ‘tool’ to be deployed. Even though the current system is inefficient, it cannot be replaced by an entirely new system, since it would be necessary to revise the EU Treaty framework.

The only solution is a reform of the EU fiscal policy. The new rules should put more emphasis on the relationship between the spending and indebtedness of a particular EU Member State. A detailed accounting of the funds spent from the state budget would be done in the same way as in companies where costs are distributed during the whole duration of the investment. To formulate predictions, medium-term growth forecasts would be used, as they are more adequate than the current indicators based on the annual change of the balance. The expenditure growth would be limited to the difference between the current debt and the 60 percent of GDP. In addition, proposals for new/increased costs for the state budget would have to be accompanied by adequate measures on the revenue side. By introducing new rules, states would not be motivated by fear of sanctions anymore, but by their own recognition that those rules provide the best way to achieve sustainable and counter-cyclical fiscal policies.

(The study can be downloaded herehttp://bruegel.org/2016/03/a-proposal-to-revive-the-european-fiscal-framework/)

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