Blog Post

The Commission’s proposal for the next MFF: A glass half-full

The Commission’s proposal for the next Multiannual Financial Framework provides a good basis for subsequent negotiations and includes a number of bold suggestions. But it has a number of deficiencies and some of the proposed tools are conceptually weak. We make proposals as to how to improve them.

By: , and Date: May 25, 2018 Topic: Macroeconomic policy

On May 2nd, the European Commission published its proposal for the broad outline of the next seven-year EU budget, the Multiannual Financial Framework (MFF) for the period 2021-27. The proposal is the subject of intense debates. Politicians form various Member States and across the political spectrum expressed deep concern about various aspects of the plan, while others rejected it entirely.

In this column we provide our overall assessment of the proposal and make recommendations on how to improve it in the coming negotiations. Our assessment can be summarised as “glass half-full”, a cautiously positive assessment. We highlight a number of shortcomings of the proposal, yet given the various constraints we regard a number of elements of the proposal as reasonable, and some of them even as innovative.

Squaring the circle

Spending more with fewer resources is mission impossible, but this is the trade-off that EU countries are currently facing.

On one side, a number of spending priorities have gained importance in recent years – such as border control, migration, security, defence, external actions, research, digital transformation and youth mobility. This could be compensated with deep cuts in the two largest traditional EU programmes – the Common Agricultural Policy (CAP) and cohesion policy – but some countries reject this strategy.

On the other side, Brexit will leave a large hole in the EU budget (see our calculations) but some net contributor countries reject the idea to increase their contributions as a share of GNI. Therefore, the Commission faced major constraints and challenges when drafting the proposal.

Positives of the Commission proposal

We list seven positive elements in the MFF proposal.

First, increased spending was proposed in a number of spending categories that really constitute European public goods: huge increase in border control and defence; significant increase in research/innovation/digital fields; some increase in migration spending. For example, the way Greek and Italian borders are protected has an impact on the arrival of illegal migrants in Denmark or the Netherlands. There are also major synergies in pan-European projects, like research for example. Some projects would perhaps be unfeasible at the national level, like the EU’s satellite programme. The details need to be discussed and properly analysed, but the direction and the boldness of some of the proposals are clearly welcome.

Second, considering the impossible task of spending more with fewer resources, we find the reallocations across spending categories reasonable. CAP is proposed to be reduced by 5% in nominal terms and even more so if we consider inflation, i.e. in real terms (15%), while cohesion policy is proposed to increase by 6% in nominal terms, but reduced by 7% in real terms (see our calculations). In our March Policy Brief we assessed the rationale of these two main spending areas and the empirical experience of their implementation: we concluded that they have major weaknesses, especially the income subsidy component of CAP. Therefore, we welcome the attempt to shift resources away from these two traditional programmes (and especially from CAP) towards new priorities.

Third, it is also welcome that the Commission aims at a major reform of CAP, by shifting the focus from compliance to results, by supporting more small farmers, and by correcting the imbalances in country-allocations. We look forward to seeing the details of these proposals, which are to be published in the coming weeks.

Fourth, increased national co-financing of spending in cohesion and CAP pillar II is also welcome. Given the improved economic situation, Member States have the resources to complement EU funding at a higher rate. While EU funding ultimately comes from Member States too, an increase in national co-financing would require an overall larger contribution to EU spending programmes from Member States, while the political perspective of money coming from the EU budget or directly from the national budget might be different. Furthermore, a comprehensive literature survey (done by Benedicta Marzinotto in 2012) found that EU cohesion funds have a growth potential, but may not always deliver in practice either because they are poorly managed or used for the wrong types of investment. Larger national contributions might improve project selection, ownership and the management of these funds.

Fifth, the proposal includes increased flexibility and emergency tools, including extra flexibility between headings and years, possible re-programming at mid-term, and programme reserves within each programme. Such flexibility would help redirect EU spending in case of unforeseen developments.

Sixth, we welcome the attempt to formally monitor the rule of law in EU countries. The respect of the rule of law is a fundamental value of the EU, and a pre-condition to enter the union in the first place. Deficiencies on this front could hinder the proper implementation of the EU budget and therefore the rule of law is an essential precondition for managing EU funds.

The proposed procedure would assess, among others, whether investigation and public prosecution of fraud or corruption works well, if judicial review by independent court is effective, and whether Member States cooperate with EU’s Anti-Fraud Office and the EU’s Public Prosecutor’s Office. Good aspects of the proposal are that it would apply to all funds managed by Member States and thereby all EU countries could be subject to that, while an eventual sanction under this proposal should not disadvantage non-governmental beneficiaries of EU funds. The Commission would draw on the opinions of the EU Court of Justice and the European Court of Auditors. A major criticism raised by some Member States is that deficiencies to the rule of law cannot be measured objectively. However, ultimately Member States would decide collectively and we have to trust in the collective wisdom of various European institutions and Members States.

Nonetheless we call for a much broader approach to the rule of law: a regular analysis of all EU Member States, similar to the EU’s fiscal surveillance and the Macroeconomic Imbalances Procedure (MIP), as recommended earlier by Maria Demertzis and Inês Gonçalves Raposo (see here and here). As they argue: “Despite its compliance problems, the MIP has emphasised the need for monitoring policies, identifying risks and even considering penalties when countries are in clear breach of agreements. The same must happen when it comes to the quality of institutions.” Such a regular monitoring would ensure equal treatment of Member States.

Seventh, the Commission also made some proposals to change the revenue side of the EU budget in the next MFF, many of which appear to be quite reasonable.

Gradually phasing out “rebates on rebates” and other revenue correction mechanisms is the logical outcome of Brexit, since the UK benefitted from the largest rebate and some rebates to other countries were introduced with a view to reducing the increased burden originating from the UK rebate. National contributions to the EU budget should be based on a commonly agreed formula, to which ad-hoc corrections (like the rebates) are not necessary. In our view, moving national contributions even closer to the distribution of GNI is sensible, given the proposed increase in the provision of truly European public goods that benefit every European country.

Another good proposal is to introduce a basket of “genuine” own resources, which could represent as much as 12% of revenues over the next MFF. This would originate from three main sources: a share of corporate taxes collected by Member States with a 3% call rate based on the Common Consolidated Corporate Tax Base (CCCTB); 20% of the revenues of the EU Emission Trading System [ETS]); and the introduction of an EU plastic-packaging waste tax. An agreement on CCCTB would help tax avoidance, which is a major goal of the EU, while a plastic-waste levy, along with the ETS, would contribute to the EU’s climate goals. Therefore, these proposals would make a step towards aligning some objectives of the EU with the revenue sources of the EU, which we find sensible.

The Commission also proposes an increase of the revenues from customs duties: currently, a 20% share of customs duties is retained by Member States in the form of “collection cost”, which is proposed to be reduced to 10% (the level from 1970 to 2000). Since the EU is a customs union with common external trade policy, we find it reasonable to direct customs revenues to the EU budget. We note, however, that 10% for collection costs would be still much higher than actual costs and therefore we recommend a much more ambitious approach – reduce the retained value to that of the actual cost.

Negatives of the Commission proposal

We also list seven drawbacks and make suggestions on how to improve.

First, while the proposal includes some simplifications, like reorganising several spending programmes and reducing the total number of such programmes, the structure of the proposed budget remains complex. Also, the continued distinction between “commitments” and “payments” makes the structure thorny. No other country, federation or international organisation – like the United Nations, IMF, OECD, and also organisations that make long-term investments, like the World Bank and the European Investment Bank – uses such a complex budgeting framework. A fundamental reform is badly needed, such as a proper accrual-based multiannual budgeting framework augmented with a cash budget, according to best practices of international organisations.

Second, while a stated principle of the proposal is improved transparency, it does not include a proper comparison of the spending priorities of the current and the proposed next MFF. Such comparison is made somewhat difficult by Brexit, because the UK should be excluded from the current MFF for a proper comparison with the next MFF. Another complicating factor is inflation, because a stable 2% inflation was assumed when the current 2014-20 MFF was approved, but inflation has been much lower (which has led to higher spending in real terms in the current MFF than planned). Also, the spending programmes of the proposed next MFF somewhat differ from the current MFF, so one has to be careful in comparing the old and new frameworks. But these difficulties should not hinder a proper comparison under transparent assumptions. In fact, the Commission presented and widely popularised current-price comparisons for seven main spending categories (by excluding the UK from the current MFF) – but it did not do this for the two largest spending categories, CAP and cohesion policy, which is astonishing (see our own calculations). Furthermore, even for the seven categories for which a current price comparison is made, constant comparison (i.e. inflation-adjusted) is not made. Proper facts should form the basis of negotiations. We suggest to present clear comparisons along the lines of (a) current prices, (b) constant prices, (c) the share of total EU spending, (d) the share of GNI.

Third, there is little European value added in direct income transfers to farmers. As the renowned Sapir report noted as long ago as 2003, “The current EU budget is a relic of the past”, a conclusion that still largely characterises the next MFF proposal. Certainly, CAP has a number of crucial goals with pan-European value – like food security, biodiversity and limiting climate change. But the goal of providing a fair standard of living for the agricultural community is clearly a social policy and is limited to one particular sector. For example, the health-care sector is crucial for the health of European citizens, but the EU budget does not provide income support for hospitals, doctors and nurses. Equally, the educational sector is crucial for raising our children and the youth, but schools and teachers do not get income support from the EU budget. Why provide EU income support to one particular sector, even if that is an important sector, if other important sectors do not receive income support?

A radical change would be the renationalisation of direct transfers along with the amendment of state aid rules to make this possible. A less radical solution would be the introduction of national co-financing of direct transfers, as proposed in our March Policy Brief, similar to the national co-financing of the CAP pillar II rural development fund. National co-financing would allow for the lowering of the EU budget contribution to that policy and thereby free up resources for other spending areas. Unfortunately, neither full nor partial renationalisation of income support has been proposed, and in fact the proposal suggests an unfortunate increase of the share of direct payments and a reduction of the share of the rural development fund in total CAP allocations.

Fourth, we find the increase in external action commitments too timid. The Commission communication shows that certain elements of this spending category are multiplied by a factor of either 1.2 or 1.3 compared to the current MFF (at current prices, excluding the UK form the current MFF). Yet EU27 GNI is expected to increase by a factor of 1.28 (again, at current prices), so an increase with a factor of 1.2 implies a decline as a share of GNI. The EU has a responsibility for helping its less-fortunate neighbours and other parts of the world, and has an interest in doing so if it wants to reduce the migration pressure in the long run. Instead of a relative decline, we propose a relative increase in external action commitments (with resources coming from the reduction of EU-financed direct transfers to farmers, as we argued in the previous point).

Fifth, while we welcome the attempt to propose a euro-area stabilisation instrument, its actual design is disappointing. If approved as proposed, it will be ineffective. A loan instrument has been proposed that could be granted to countries facing a large shock, who followed sound fiscal and macroeconomic policies before the economic downturn. The volume of such loans could total €30bn and could be potentially interest-free. However, no country likes to take a financial assistance loan from official lenders like the EU, and this facility could be seen as such. Countries with sound fundamentals are less in need of financial assistance as they can borrow themselves, unless they suffer a liquidity crisis – but in such a case, the ECB’s Outright Monetary Transactions (OMT) programme should be used. Moreover, €30bn is a very low amount (compared, for example, to the decline in investment after 2008), and the use of this facility would take resources away from other financial assistance facilities (see our detailed analysis here).

How to improve this proposal? There is an extensive discussion of various options for a euro-area stabilisation instrument – a discussion we do not wish to enter here. Yet we highlight a (modest) possible design not that far from the proposal of the Commission, which might be politically feasible: accumulating all ECB profits in a rainy-day fund, which would be used in a crisis to foster investment throughout the euro area.

Sixth, the reform delivery tool to foster structural reforms will likely be ineffective. There are major implementation problems with the European Semester recommendations (see here). It’s hard to see how, for example, Germany and France would be more eager to implement the recommendations to obtain a few million euros from the EU budget. We do not see how the EU budget could incentivise implementation, and we suggest this limitation be recognised. Instead, the best hope for a higher rate of implementation is to increase reform ownership, in which the already-proposed national competitiveness councils should play a large role, because such councils must comprise a trusted group of domestic experts.

And seventh, the euro-adoption tool is conceptually weak (and also too small in size, but that’s a secondary problem). Countries like Sweden, the Czech Republic and Hungary will not change their mind about adopting the euro just because a few hundred million euros is offered for preparation – i.e. money will not incentivise euro membership, in our view. And countries wishing to join will do so even without this small financial facility. For example, ever since Bulgaria joined the EU in 2007 its major aim was to join the euro area. But Bulgaria was not allowed to enter the European exchange rate mechanism (ERM II), which is a precondition to enter the euro zone. While there are clear criteria for entering the euro area (the so-called “Maastricht criteria”, enshrined in the EU Treaty), the decision to join the ERM II is based on a non-transparent discretionary decision. If non-euro countries are to be encouraged to join the euro, the very first step should be a transparent clarification of the conditions to enter the ERM II.

Overall, in our view, the Commission’s MFF proposal provides a good basis for subsequent negotiations, but many details are unclear and it has a number of deficiencies which require improvements.

The blogpost formed the basis of the presentation of Zsolt Darvas at the 15 May 2018 conference of the European Economic and Social Committee on the next MFF.


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