The EU’s Slow, Sneaky Attempt to Engineer a Fiscal Union

National Review Online, August 18, 2020

There is a certain disreputable genius to how EU summits (or, more accurately, meetings of the EU’s Council, the body made up of the leaders of each member-state, the EU’s president, and its top bureaucrat) are organized. Typically arranged to last just a day or two, the tight timing ensures that talks will run late — so late, in fact, that those participating might agree to anything to grab some sleep. As the EU’s overall direction is, with pauses, forever forward, these long nights can have a way of ending up with another step or more being taken on the path to ever closer union.

July’s EU Council in Brussels was originally scheduled to last two days but ended up lasting four, just missing, by 20 minutes, the record set in 2000. True to form, it involved late nights and angry scenes. But what emerged represented quite a few turns in the ratchet of the EU’s integration.

There was not one deal, but two. The first concerned the EU’s budget for 2021–2027, a “multi-annual financial framework” amounting to €1.07 trillion, up more than 10 percent over 2014–20, despite the departure of the U.K., one of the EU’s largest members. The budget is funded from sources that include import duties, a percentage of the VAT paid within the EU, and direct contributions from member states. But like any would-be state on the make, the EU wants to increase its power to tax. It has now secured agreement to an EU-wide tax on non-recyclable plastic, a move under consideration well before now. Nevertheless, as the EU takes steps to combat the pandemic’s effects, COVID-19 has come in handy as an excuse to push this measure through. Never let a virus go to waste.

Other taxes too may be on the way, including a long-planned “carbon tax” on imports, a tax that not only would generate cash, but is also rich with protectionist possibility. These two qualities are also inherent in a potential EU-wide “digital services tax,” another idea given fresh impetus by the coronavirus. Reinforcing the protectionist theme (and in line with the EU’s entrenched antipathy to “Anglo-Saxon finance capitalism”), there was also renewed talk of a Financial Transactions Tax.

The second deal — a €750 billion stimulus package designed to alleviate the economic disruption caused by the coronavirus — was even more contentious and, although smaller, will eventually matter far more. The European Central Bank (ECB) has already supplemented its existing quantitative-easing program with another, the Pandemic Emergency Purchase Program (PEPP). As its name would suggest, it is designed to provide additional assistance in the wake of COVID-19. It was initially capped at €750 billion, but, after a decision taken in early June, could now reach €1.3 trillion. Underlying this expansion was, above all, the fear of a stampede out of the debt markets in parts of the euro zone’s “south.” Much as COVID-19 is most dangerous to patients who are not in the best health, its economic consequences will generally be more destructive in financially vulnerable countries.

Amongst the euro zone’s laggards, the most concern surrounds Italy, where anxiety over the country’s finances is matched by apprehension over what an Italian crisis could mean for the euro zone as a whole. When Greece ran into trouble in 2009, it accounted for a little over 1 percent of the EU’s GDP. Italy today represents just under 13 percent of the EU’s GDP. It is the EU’s third-largest economy. Pulling tiny Greece back from the brink took massive bailouts and set off a schism within the currency union that — as was evident in Brussels — has not healed. Yet the euro zone’s leadership decided that it was too risky to cut Greece off. So, what does that imply for Italy?

An Italian crisis is not hard to foresee. Since cheating its way into the euro — a currency for which it was then, and is now, fundamentally unsuited — Italy has been in and out of recession. Its real GDP (measured in constant dollars) is no higher than it was in 2000, and its debt/GDP ratio stood at over 130 percent well before things went so wrong in Wuhan. According to a Fitch report from early July, Italy’s GDP will shrink by 9.5 percent this year, and its debt/GDP ratio will hit 160 per cent.

It was — more than anything else, I suspect — the desire to avoid an Italian crisis that persuaded the more reluctant Brussels summiteers to agree to a stimulus package totaling €750 billion, or roughly 5 percent of the EU’s GDP. The package was divided into two parts, €390 billion in grants and €360 billion in cheap loans, both targeted at the EU members deemed least equipped to cope with COVID-19. It has been estimated that Italy could receive funds equivalent to over 4 percent of its current GDP, albeit spread out over a number of years. Whether the rackety Italian state can process this money effectively, however, is a different question. Its record offers little basis for optimism.

The deal required unanimity, and the balance between loans and grants shifted over the course of the negotiations. The opening bid, backed by the Brussels establishment and, critically, the EU’s sometimes sputtering Franco-German motor, was for a package more heavily weighted towards grants. In the end, that was partially reversed by resistance from the EU’s latest ‘frugal four’ (or five, if Finland is included): Austria, Denmark, Sweden and, in the lead, the Netherlands. In return, they agreed to a lower degree of supervision over how the money was spent than some of them would have preferred. That won’t have been easy to accept. In 2017, the then Dutch finance minister Jeroen Dijsselbloem commented that:

During the crisis of the euro, the countries of the North have shown solidarity with the countries affected by the crisis. As a Social Democrat, I attribute exceptional importance to solidarity. [But] you also have obligations. You cannot spend all the money on drinks and women and then ask for help.

This may not have been Dutch diplomacy’s finest moment, even if Dijsselbloem underplayed the creativity that goes into the southern euro zone’s appropriation of public resources, but the sentiment it reflected was widely shared in the frugal zone, and it hasn’t gone away. Under the circumstances, agreeing to leave it to the EU bureaucracy — which is not known for its carefulness with taxpayer money — to watch over the spending of the €750 billion was a considerable concession by the frugals. Their only consolation — not much of one — was the addition of an “emergency brake” to temporarily stop payments to an EU state that is not living up to the plans that it put together to qualify for loans or grants under the program. Note that “temporarily.”

\The rescue package is formally known as the “Next Generation EU” (NGEU) fund, a name unremarkable — in Brussels — for its pomposity, but unusual in that it may really mean something this time. This is less a matter of all those billions than how they will be raised –through direct EU borrowing on the international markets — and then dispensed by Brussels. This is an innovative (to use a kind word) development in that, as Päivi Leino points out in an article for the Centre for European Policy Studies (CEPS) written before the Brussels summit, the EU treaty was “universally seen as prohibiting the EU from borrowing to finance its expenditure.”

Oh.

The money must be repaid no later than 2058, with the help of the revenues from new EU taxes. Presumably this will act as an incentive for member states, which will be reluctant to be seen to be picking up the tab, to ensure that the grant of new taxing authority to Brussels will not stop with the levy on non-recyclable plastic — another advance towards ever closer union.

Even assuming that the loans to struggling member-states are repaid, the grants will constitute a significant transfer from the EU’s richer countries to its poorer. This is made explicit in aspects of how — independent of any damage done by the coronavirus — some of the money payable under the NGEU will be allocated on the basis of economic benchmarks set before the coronavirus struck.

In one respect, there is nothing new about this. The EU has redistributed money towards the union’s less developed regions and countries for a long time. Some member states pay in less than they receive; others receive less than they pay in. While that has been a source of some resentment within the contributor nations (it was no coincidence that securing agreement to the Brussels deal was made easier by billions in “rebates” on the payments made by the frugals to the EU budget), that resentment was kept in check by a broad consensus — at least among the EU’s political class — that this was the right and indeed sensible thing to do. To take one example: After half a century of communist rule, the EU’s new Eastern European members were clearly going to need a hand to fit in.

But, to use a Victorian phrase, there are the “deserving” poor, and then there are the rest. The EU’s most prosperous states (which tend, mysteriously, to be its more fiscally disciplined) have long worried that the union would be run in a manner that transformed them into milch cows for its more feckless members. Aiding, say, thrifty Estonia after nearly 50 years of Soviet occupation was one thing; being made to pay for Italy’s perennial failure to get its house in order is quite another. Thinking of this type helps explain why the euro zone was set up as a currency union without the safety net of a fiscal union. A fiscal union, fretted some (most importantly in Germany), would be a “transfer union,” a means to siphon taxpayers’ money elsewhere.

About a decade later, the Greek crisis broke out. Christine Lagarde, then the French finance minister (and now, less than reassuringly, the president of the ECB), related what happened next:

We violated all the rules because we wanted to close ranks and really rescue the euro zone. . . . The [EU] Treaty . . . was very straight-forward. No bailout.

And so, Ireland was bailed out, as was Greece (for the first time). The treaties were later amended to put the bailouts on a sounder legal footing, and to create the European Stability Mechanism (ESM), essentially a fund to handle the bailouts that followed. The principle that members of the monetary union were responsible for their own finances was shattered, and suspicions of the “north” about the south were confirmed, with Greece in particular becoming a poster child for waste and worse. Significantly, the ESM came without a sunset clause. It is still open for business, ready to help “to help euro area countries in severe financial distress.” It is, however, worth noting that, unlike the NGEU, the ESM is, legally speaking, not part of the EU. Its founders may have waded in the Rubicon, but they did not cross it.

Of the frugal four, neither Sweden nor Denmark is in the currency union. But the euro zone’s long Calvary won’t have alleviated fears in those countries that, despite all the denials, a “transfer union” is under construction. Now, with the NGEU encompassing all EU member-states, not just those in the euro zone, the bill collector has come calling. Adding insult to injury, the reason why some larger countries will have to turn to the NGEU is the structural damage done to their economies by a currency that Swedish and Danish voters wisely rejected. Dutch prime minister Mark Rutte may like to claim that the NGEU is a “one-off,” but among the promises that won him reelection in 2012 was that the Netherlands would not participate (“not one more cent”) in a third Greek bailout. But in 2015, it did.

Meanwhile, Charles Michel, the president of the EU Council, commented that he was “quite certain that in a few years, probably, we will observe this political moment as one of the pivotal moments in the history of the building of this European integration.” The inclusion of “probably” might be read as diluting the “certain” with which Michel began that proud sentence, but if he is certain, it’s not without cause.

On the other hand, there were those who looked at the NGEU (which has, incidentally, yet to complete what could be a relatively prolonged ratification process) as yet another failure by the EU to reach its “Hamilton moment.”

The Economist explained:

The deal falls short of the “Hamiltonian moment” some had hoped for, referring to the US national government’s assumption of state debts in 1790. No one has proposed mutualizing EU countries’ legacy debts; even the new common debt will not enjoy joint-and-several guarantees.

Yes and no. Although the EU’s long march towards “ever-closer union” has, on occasion, taken place in the sunlight, with declarations, fanfares, and flags flying high, it has often crept ahead, not exactly under cover of darkness but assisted by the inability or the unwillingness of some of its enablers to come to grips with the implications of what they are agreeing to.

And part of that process has, from the beginning, included the creation of institutions ready and waiting to take that next step, ranging from the European Court of Justice, which started showing its federalist colors in the early 1960s, to the ESM to, now, the NGEU.

In her article for CEPS, Päivi Leino recognized the institutional significance of the NGEU:

By precedent, and by its very long duration (until 2058), the NGEU will, in practice, ultimately become a permanent structure. With the taboo [against borrowing] broken and legal limits dissolved, there will be little to stop it resorting to similar measures again. New emergencies will arise, and debt will each time appear to be a convenient way of financing them. Union debt will become a matter of contemporary political decision. The result would be a fiscal capacity for the EU, with a permanently altered division of competences. Such fundamental changes to the functioning of the EU should be agreed through a Treaty change, not through heroic reinterpretations [of its existing provisions].

Leino is correct. However, amending the Treaty requires not only unanimity, which is perilous enough, but, in some countries, it might require a referendum too — and that would not do.

Whether or not those who signed up for the NGEU were ready to admit to its Hamiltonian characteristics, markets appeared to be impressed. Measures taken by the ECB were already holding down Italy’s borrowing costs, but the yield spread between Italian and German ten-year government bonds narrowed further after Brussels. The euro strengthened against the dollar, although other factors — including political uncertainty in the U.S. and a fresh surge in the coronavirus there — played a part in that. What’s more, if any investors had earlier been seriously worried about a break-up of the euro, they cannot have been paying attention to the lesson of the last decade or so. While it has long been obvious that a one-size-fits-all currency union has been a catastrophe for some of its members, it has also been evident that there is almost no limit to what will be done to keep it alive — if only for fear of the alternative.

That means that when the next crisis comes as, inevitably (thanks to the euro zone’s in-built failings), it will, its leaders will turn either (as Leino suggests) to the NGEU, or to something like it, to rescue the country or countries that have gotten into fresh difficulty, countries that will not be in the frugal zone. Those additional debts will have to be repaid, and Brussels will be given yet more power to tax. Thus, the fiscal union, which will also be a transfer union, whether acknowledged or not, will continue its slow birth. There will be no turning back.