The EU Needs New Financial Arrangements 

The EU Needs New Financial Arrangements

Is there something left for economists to do in the ongoing process of revising the "European Constitution"? Many would answer no: economic integration in Europe is by and large achieved. And it is certainly true that the main new challenges for Europe lie elsewhere: in foreign policy, internal and external security, and immigration.

Nevertheless, economics remains a central issue even in this late stage of European integration. One reason is that it is difficult to build a more effective Europe in these new policy dimensions without a deep rethinking of the financial arrangements of the EU.

The next steps for European integration concern the provision of public goods: defence, security, foreign policy, border control, are all public goods. Currently, they are provided by nation states, but the benefits of these public goods cross national borders. Hence the widespread perception that it would be efficient to coordinate their provision at the European level. The main challenge is how to achieve that.

But it is not just a matter of coordinating what to do, what decisions to take and how to take them. A central issue is also how to pay for these public goods. Military spending in Europe lags way behind the US and more resources are needed. Border controls and fighting organised crime costs money. Elements of a common foreign policy may require revamping the EU diplomatic corps. It is highly inefficient to rely exclusively on national budgets to bear these costs: each member state has a strong incentive to "free ride" on the others and under-provide the public goods that benefit all. The natural solution is to pay for them out of the EU budget. But then, the decision process is forced to internalise all the benefits.

The EU budget at present, however, is almost entirely devoted to redistribution, not to public goods provision. Out of a budget that is just over 1% of the European Union's GDP, almost half is spent to support agriculture, while another 35% are transfers to poor regions. As a result, the discussion on the EU budget is now only focused on who gains and who loses, and in particular on which countries are net beneficiaries or net payers. No attention is paid as to whether the money is well spent for the average European tax payer, or whether a reallocation across alternative programmes is desirable. The redistributive focus of the EU budget is aggravated by how it is financed. Since the EU has no tax authority, it relies on transfers from member states. So again, the centre of the debate is on redistributive flows across member states.

From an economic point of view, it would make more sense to finance the provision of true European public goods with the proceeds of a European tax levied for the purpose. For instance, a fraction of the personal income tax base, or of the value-added tax base, could be reserved for a specific EU tax, with the tax rate set by the Council and the European Parliament. The proceeds of that tax, collected by national tax authorities, could then be earmarked to pay for a European border guard corps, a diplomatic corps, a specific subset of military expenditures, and so on.

This would have several advantages. It would focus the minds of the politicians on what is the appropriate level of public good provision, rather than on who can bring home bigger trophies to show to his voters. It would also stimulate a European-wide debate on genuine European policy issues: how much are we prepared to spend to have a more effective military capability, or a more efficient border patrol? Now, political debates on these issues are inevitably distorted by a national perspective: why should Italy enforce border control if illegal immigrants are then free to move to Germany or the Netherlands? And why should Spain boost its military capability if it can free ride on the UK? Finally, having a European tax earmarked for concrete and specific European public goods would increase the transparency and legitimacy of EU decisions on those matters.

But this idea of providing specific European public goods in the realm of security, defence and foreign policy out of a common EU budget financed by a specific European tax stumbles against an important objection. How do we know that a European tax will not be abused to finance redistributive transfers that disproportionately benefit some groups or some countries? After all, this is exactly what the EU budget is currently being used for.

In principle, this can be prevented by earmarking the tax proceeds for specific public goods, and prohibiting their use for redistributive purposes. But this would be much more credible if the purely redistributive programmes of the EU budget (CAP and Structural Funds) were scaled down or cancelled. These programmes are inefficient and deserve to be scrapped anyway, particularly in view of the imminent enlargement. But there is an additional argument to take this action without delay. Their mere existence casts legitimate suspicion on how the EU budget would be spent if more resources were available. Thus, these programmes are a political obstacle to the creation of a more efficient system of providing and financing badly needed European public goods.

This is why rethinking some fundamental aspects of the economic constitution in Europe is important in order to move forward in other (non-economic) dimensions.

Guido Tabellini, Bocconi University, June 2002.

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