The European Commission has published its proposed legislation for fiscal governance reform, which preserves the main ideas of its original November communication. Countries with deficits or debt above the 3 percent deficit and 60 percent debt reference values will be required to submit a fiscal-structural plan, normally covering four years. This plan would target a reduction in debt guided by a debt sustainability analysis (DSA), which is a comprehensive assessment of debt risks. Countries with “substantial debt challenges” (high debt risks) would be required to bring down their debts faster than countries with more moderate risks.
But there are important differences between the legislative proposals and the ideas presented last November. For countries with deficits above 3 percent, there is a minimum pace of deficit reduction, by 0.5 percent of GDP per year. By the end of the planning period, the debt ratio must be lower than it was at the beginning of the period. This is much tougher than the November proposal, whereby debt had to start declining after four years (or even seven years, for countries undertaking investments and reforms that justified the extension).
These changes are a reaction to German misgivings about the original proposal. The German government fears that the DSA-based approach gives significant discretion to the European Commission. Germany’s preferred way to address this discretion is to set boundaries around the guidance which the DSA can produce, in the form of mechanical rules. But the point of the DSA approach is precisely to move away from rules that may not make sense in individual situations. A better way to address the German concern would be to reduce the discretion that the DSA requires to operate and aim to make it more transparent.
The European Commission has, to some extent, adopted the German approach. This is a significant concession, and it comes at a price, which is to impose faster debt reduction on countries that may both deserve and need more time, and possibly to reduce the willingness of such countries to implement the new framework. In the coming weeks, Bruegel will analyse how high this price is. At the same time, the Commission’s latest proposals show that it is serious about compromise. Hopefully Germany is, too.