Economics / Politics

Financing Europe’s economic recovery measures

A visual summary of the EP report on the cost of non Europe (copyright EP)

A visual summary of the EP report on the cost of non Europe (copyright EP)

There has been a lot of talk in the past months about relaunching Europe’s fragile economies through major investments programmes. As recently as the last European Parliament’s session in late July 2014, Jean-Claude Juncker, the new European Commission president, announced an ambitious plan to invest €300 million. But where is this money to come from?

At present, the EU’s resources are meagre, to say the very least. Most of the resources of the Union come from contributions by the Member States. In addition, the EU gets a small share of VAT. Finally, the EU receives custom duties, but with the process of globalisation and the multiplication of bilateral or multilateral trade agreements, this resource is shrinking.

Some people always put forward an EU Financial Transaction Tax (FTT) and an EU-wide Carbon Tax. But both proposals face some stiff opposition, so it’s important to also look for other resources. A good start could be the European Parliament’s report on the cost of non-Europe, which was issued in March 2014 (accessible here).

A summary of the EP report on the cost of non-Europe

This section intends to summarise the report which details 19 measures where, if integration were adequately deepened and if connections between Member States were improved. Together, these improvements could add some €800 billion/year to the European GDP.

The biggest gains would come from completing the single market: developing the digital single market (€260 billion) and deepening the single market for consumers and citizens (€235 billion). These imply a mix of structural reforms and targeted investments, with a number of gains deriving from a multiplying effect, e.g., the productivity increase through faster flow of information. Some studies reckon the ICT/new technologies sector will be the major source of economic growth in the EU in the coming years. However, obstacles such as e-privacy, consumer protection, online data protection and difficulties with VAT payments remain. Setting them aside will require careful legislation. Regarding more “traditional” market integration (i.e., for goods and services), much also remains to be done, especially in matters of cross-border services, where many hurdles remain to cross-border exercise and recognition of qualifications, and in matters of public procurement. Measures to deal with these issues, including a better implementation of existing rules, would not cost any public money.

A further step is the full implementation of the banking union, which will help avert a renewal of the crisis. Some studies estimate that, had the banking union rules (including the bail-in) existed in 2008, approximately 10% of the overall cost of this crisis would have been saved. So, while the banking union cannot reduce the risk of a new crisis to 0, it can give rise to some €65 billion efficiency gains in the future. On a similar level, completing the financial markets integration would also yield major benefits such as reduced borrowing costs, safer behaviour by financial institutions, and more equal access to funding for all SMEs wherever they are located. In addition, another measure in the area of finance would be the establishment of a common deposit guarantee scheme, estimated to generate €30 billion efficiency gains thanks to reduced deposit/capital flight and overall lower costs for recapitalising banks.

Furthermore, a common minimum unemployment insurance scheme would have saved Member States some €15 billion during the past years, had it existed before the crisis struck. The underlying assumption for this amount is that the fund would cover only short-term unemployment, so that no permanent transfers would take place. Such a scheme would reduce the consequences of negative asymmetric shocks and would support the living standards of millions of unemployed people. Countries such as Spain, Ireland and Greece would have yielded significant benefits from such a measure and would therefore not have faced such a deep economic downturn. Research in the USA confirms the positive effect of a wide unemployment insurance scheme.

Next to this social innovation, the authors of the EP report also call for improving the coordination of fiscal policies, which is another request of federalists. Such coordination, which has already gone forward with the adoption of the Six-pack, the Two-pack and the “Fiscal Compact”, is essential to the stability of the Eurozone. Gains would also result from improved fight against tax evasion and some mutualisation of national debts.

Furthermore, agreeing with the USA on the Transatlantic Trade and Investment Partnership (TTIP) could generate around €60 billion gains in the EU (although some studies put the figure tens of billions higher). Although some industries would inevitably become more fragile and weaker, there would be overall job creation and SMEs would benefit from bigger markets. Both Jean-Claude Juncker and Martin Schulz (the EP President) are committed to reaching an agreement without, however, sacrificing the consumer, social and environmental protection standards that are essential to preserving the European living standards.

Another very topical issue, the single market for energy, would also generate major gains (in the range of €50 billion) with more integration: more interconnections would mean greater energy safety (less dependence on foreign energy-rich powers) and lower energy prices in many countries.

Member States could also save €26 billion if they integrated their military structures, developed the interoperability of military equipment and integrated the defence procurement markets. Therefore, significant improvements in the Common Security and Defence Policy would not only be positive for the EU’s standing on the world scene, but also for its finances.

A last measure very effective measure would be truly implementing equal pay for equal work (€13 billion). Indeed, numerous studies show that the gender pay gap remains a drag on economic growth, as it reduced female employment and reduces the income of couples and families.

A number of other measures would generate smaller yearly efficiency gains. The EP report names “VAT and action against tax evasion” – the VAT rules are complex, so that compliance is indeed quite patchy – (€7 billion); combatting violence against women (€7 billion/year); improving the information and consultation of workers – to reduce redundancies – (€3 billion); a single European transport area (€2.5 billion); develop a European research area (€1 billion); improving EU donor coordination to make development policy more efficient (€800 million); facilitating cross-border transfer of company seats (€200 million); and codifying private international law in the EU (€98 million).

The effect of such measures on public finances

It would require much more time and economic data and knowledge to figure out the impact of the implementation of the above-suggested measures on public finances. For now, let us try to keep it (excessively) simple by assuming that the EU Member States’ average tax rate on private income is 20%. Furthermore, let us keep in mind that some of the measures above will generate private gains, some will directly generate more tax intakes, and some will reduce public expenditure. Quite obviously, many of them need some public expenses to be set up and adequately implemented. Here as well, for the purpose of simplicity, we will assume that the amount of expenditure required is €300 billion, as this is the amount of “additional public and private investments in the real economy over the next three years” mentioned by Jean-Claude Juncker in his speech to the MEPs before his election to the position of European Commission’s President.

Without entering into the details of what are approximate calculations based on a number of estimates, it can, however, be claimed that the full implementation of the above-listed measures would be enough to cover around €300 billion of public expenditure to exit the crisis, through a mix of savings and additional receipts for the tax authorities. Of course, for the EU to finance the recovery measures, these €300 billion available public money should be transferred to the EU. This could happen, at least partly, by attributing (part of?) the VAT resources to the EU. Furthermore, such a move would represent a positive and significant step towards a European budget fully deserving its name.

A few words about the FTT…

If that is not convincing, it is still possible to turn to the “old recipes” such as the FTT and the carbon tax. It would be hypocrisy not to admit that adding a new tax at EU level without reducing taxes at Member States’ level would upset citizens and generate a negative a priori towards this EU-wide tax. But that is not the key issue for the current discussion.

The FTT is theoretically a laudable initiative, especially for federalists: it aims at contributing to the harmonisation of indirect taxation, requiring the financial sector to pay its fair share of taxes and creating “appropriate disincentives for certain transaction”, thus making the financial sector safer.

But it is a contentious issue. Indeed, some Member States publicly raised fears for the impact that an FTT would have on the European financial industry. In the end, if the FTT is ever launched, it will be through an enhanced cooperation gathering, in a first step, only 11 Member States.

Furthermore, the current proposal of the European Commission is vulnerable to legal challenges. Indeed, the proposal foresees that each party to a taxable financial transaction will be liable to tax, even if one of the parties is outside the territory of a participating Member State. It is even worse to think that taxation would arise if two parties, none of which is established in a Member State, trade an instrument issued in one of the participating Member States. This probably constitutes a violation of the fiscal sovereignty of other Member States and of the generally accepted principle of territorial taxation (only the USA tax Americans living abroad…). Although the CJEU dismissed the case brought before it by the UK, it did not rule on the British arguments but simply declared that the challenge was premature as there was not yet a final decision on the implementation of the FTT.

Finally, the FTT was originally meant to generate tens of billions of euros in EU own income. But a diminished FTT could in fact add only a few billions to the EU budget and is therefore certainly not the (only) solution to the EU budget requirements.

Pierre-Antoine KLETHI

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