The Finances of the European Union

April 1, 2008 - nr.58
Summary

Executive summary

In preparing this report, the AIV was guided by the wording of the request the European Council made to the European Commission in December 2005, i.e. to:

‘perform a full, comprehensive and wide-ranging review with regard to all aspects of EU expenditure, including the Common Agricultural Policy (CAP), and its revenue, including the British rebate, and to report on its findings in 2008-2009.’

The AIV took as its starting point an advisory report entitled Europe: a priority!, which it published in November 2006.

The first part of the report contains a brief review of the system of own resources in relation to the EU’s spending policy. The conclusions drawn by the AIV are fully in line with those drawn in the earlier report referred to above. Since the system of own resources was ‘derailed’ in 1984, the British rebate is still in force. Moreover, a constant stream of amendments (most recently in 2006) has turned the system into an extremely complex and opaque patchwork of corrections and exceptions.

The negotiations on the EU’s multi-annual financial framework (known as the Financial Perspectives), as well as the talks on the annual budgets, have been increasingly dominated by the way in which the EU is funded by the member states. The term ‘net contribution’ is used to describe the difference between the amount each member state pays the EU and the amount it receives from the EU. This issue has been a source of fierce argument and has undermined discussion on EU’s spending priorities. The AIV already noted on a previous occasion that this has encouraged the general public, particularly in the Netherlands, to regard EU membership primarily in terms of the size of their country’s net contribution. Against this background, the AIV has a number of critical comments to make about the budgetary imbalances, the member states’ net positions and the method used by the Netherlands for calculating its net contribution.

The AIV’s evaluation shows that, because of the British rebate and the way it is funded, the budgetary imbalances originally stemming from the expenditure side have been transferred to the revenue side. This has severely disrupted the own resources system and paved the way for the predominance of the principle of ‘fair returns’. For this reason, the AIV believes that the first priority in assessing the issue of the budgetary imbalances is to analyse expenditure policy. Both the historic trend and the criteria used for assessing expenditure policy are key points in this regard.

On this basis, the AIV believes that there are grounds for reviewing the CAP. More particularly, a stronger link needs to be made between the payment of income support and the upholding of social values, and the member states should be willing to co-fund income support. The AIV also believes that, alongside other desirable reforms, there are good reasons for concentrating convergence support (part of the cohesion policy) on the poorer member states, notably those states whose per capita gross national income (GNI) is less than 90% of the average per capita GNI for the EU as a whole, known as the GNIEU. These measures will gradually reduce the proportion of the budget that is spent on the CAP and cohesion policy, and free up resources for spending on policy to strengthen the EU’s competitiveness and on the EU’s external policy. They should also create an opportunity for compensating for the remaining budgetary imbalances on the expenditure side.

At the same time, it is clear that a review of expenditure policy will not immediately resolve the problem of the budgetary imbalances: a correction mechanism will continue to be needed for the time being. However, this mechanism will need to be general, transparent and of limited scope (i.e. it should apply only to excessive imbalances). The AIV believes that these compensations should be paid on the expenditure side of the budget. On the other hand, if expenditure policy is adjusted as the AIV recommends, the value of the compensation, and eventually the need for paying it, should decline. The European Commission’s 2004 proposals are a useful first step on the road towards this type of general correction mechanism.

As regards the EU’s revenue, the AIV examined the options available to the EU for raising its own tax-based revenue. In particular, the AIV discussed the possibility of generating own resources from energy consumption, VAT and corporation tax. Its conclusion is that, for technical and political reasons, there is no likelihood of agreement being reached in the medium term on a completely new system of tax-based own resources. In the light of the foregoing, however, the AIV does believe that the current system of own resources should be rationalised so that corrections are henceforth effected only on the expenditure side.

Having said this, it would still be preferable for the EU to be allocated resources that by definition fall outside the scope of national budgets. Indeed, this was the original idea behind the system of own resources. This is the only way in which the EU can have a stable budget, the size of which does not depend on budget talks in the member states.

This is in line with the recommendations made by the AIV in its previous report. The risk inherent to the current system, after all, is that EU policy is overshadowed by the debate on the size of net contributions that has dominated the past few decades. A review of expenditure policy and the introduction of a general, limited correction mechanism that applies to all member states could solve the problem in the medium term.

In the longer term, the AIV believes that the door should be kept open to a system of own resources that by definition does not draw on national budget allocations.

Advice request

The Advisory Council on International Affairs (AIV) prepared this advisory report on its
own initiative.

Government reactions

Mr F. Korthals Altes
Chairman of the Advisory Council
on International Affairs
Postbus 20061
2500 EB Den Haag                                                                 

 

Date            11 April 2008
Our ref.       DIE 529/08

Cc                 Presidents of the House of Representatives and the Senate of the States General

Re                 Response to the AIV advisory report “The finances of the European Union”

 

Dear Mr Korthals Altes,

On behalf of the government I would like to thank the Advisory Council on International Affairs (AIV) for the advisory report “The finances of the European Union”, which was prepared on the AIV’s own initiative. The government’s response to this report is set out in this letter, of which I have sent copies to the Presidents of the House of Representatives and the Senate of the States General.

General

The government believes that the report contains a number of useful recommendations to bring into the European debate on the budget review. It considers it important that we are having this debate and it is therefore commendable that the AIV has addressed this issue.

The government welcomes the AIV’s contribution of its report to the internet consultation launched by the Commission on the EU budget review.1 The government will be contributing its response as set out in this letter and its attached response to the consultation paper (“Reforming the budget, changing Europe”).

Your advisory report contains 20 recommendations. Broadly speaking you take the view that “further reform of the CAP” and concentration of convergence support on the poorer member states will reduce the proportion of the budget that is spent on the CAP and cohesion policy. This could “free up resources” for spending in other areas, such as policy to strengthen the EU’s competitiveness (the Lisbon agenda) and the EU’s external policy. As you will be able to see from the government’s response to the Commission’s consultation paper, your advisory report corresponds to a large extent with the government’s position.

The starting points identified in your report for the EU budget review are also broadly similar to those of the governmment. The government’s view is that EU policy should be based on subsidiarity, added value and solidarity. EU policy must also be efficient and capable of being carried out effectively. It is natural to adopt a European approach to activities that transcend national boundaries and cannot be addressed by member states on their own and where European policy clearly provides additional benefits compared with action taken at national or local level.

Core principle

During the EU budget review, the government’s core principle will be that the Netherlands advocates a broad reassessment covering all spending and the entire system of own resources for the new multi-annual financial framework for the period from 2014. The aim is fundamental reform and modernisation of EU spending and the EU revenue system. But the review of the budget begins with the reform of expenditure. This demands an ambitious agenda that does not avoid controversial subjects, starting with a discussion of policy, added value, subsidiarity and solidarity. Adjustments on the revenue side only make sense once it is apparent that insufficient reforms can be achieved on the expenditure side.

Spending

The government supports your recommendation that a larger share of the EU budget should be spent on knowledge and innovation, especially on projects generating benefits of scale by means of a Europe-wide approach, with quality as the principal criterion.To become more competitive, the EU also needs good infrastructure, in terms of transport, energy networks and telecommunications. The government feels that, besides the Lisbon agenda, the EU budget should focus more on climate and energy policy, external policy, and justice and home affairs.

The government supports the AIV’s recommendation to limit cohesion and structural funds to the least prosperous EU member states. It also agrees with the recommendation to maintain the GNI-based ceiling.  It sees a role for the EU, as mentioned in your report, in carrying out transnational projects promoting stronger growth in economically interdependent border regions and addressing transnational societal and social questions.

In your report you conclude that there are grounds for reviewing the CAP. You state that the coalition agreement of February 2007 points in the right direction. But you argue that a link between the payment of income support and the upholding of social values needs to be worked out in more detail.

The government will send a memorandum to the House of Representatives, covering all these points in outline, sometime this year. The upcoming advisory report of the Social and Economic Council and the reports already received from the Rural Areas Council and the Netherlands Environmental Assessment Agency will provide useful input for this memorandum.

Own resources

The modernisation of the EU revenue system must be an essential part of the budget review. You note that the own resources system has been “seriously disrupted” (partly by the UK rebate and the way it is funded) and that the “principle of fair returns” now predominates.

The government agrees with the AIV that the own resources system must be fair, transparent and simple, with low collection costs. Also, revenue should preferably be predictable and cover spending in full. The government considers payments based on relative wealth (the resource based on GNI) to be the most suitable way of funding EU spending. It is transparent, simple and the strongest shoulders bear the heaviest burden.

On the long-term perspective, however, the views of the government and those of the AIV diverge. You argue in favour of an own resources system related to VAT.  However, the government does not support a European tax, such as the allocation of part of national VAT revenue to the EU. Its position is based on the following considerations:

  • The GNI resource is fairer than the VAT resource. Not for nothing were compensatory measures taken in respect of the VAT resource in the past. 
  • A European tax may make the EU’s costs more visible, but this will not necessarily increase public support for the EU.
  • If the EU had its own tax-based resources, this would not prevent revenue and expenditure being converted into national revenue and contributions, even if only because virtually any tax-based system would involve member states having to perform administrative procedures.
  • Another disadvantage of tax-based systems is that revenue is uncertain while EU expenditure is definite. This is inconsistent with the European principle that revenue must cover annual spending in full.

The term “net contribution”

Your advisory report makes critical comments about the definition of the term “net contribution” employed by the Netherlands.2 You contend that agricultural levies and import duties are not national. The government takes a different view. The economic burden of imported goods is borne largely by economic actors in this country. It is therefore logical to count import duties as part of the payments to the EU.

The Netherlands believes that the definition of the term net contribution should include all financial advantages and disadvantages, as this approach offers greatest transparency.

Correction mechanisms

The government believes that the current compensation mechanism on the revenue side can be discontinued as soon as the expenditure side has been substantially reformed. There is in any case no need for a correction mechanism on the expenditure side. The government shares your view that the solution lies in policy reforms.

The government also agrees with the AIV that, should excessive imbalances remain, correction mechanisms will – unfortunately – remain necessary. In your advisory report you advocate a correction mechanism that compensates for excessive imbalances on the expenditure side of the budget. The government’s preference is for a correction mechanism on the revenue side, that is to say by means of lower payments to the EU. This would avoid pumping funds back and forth unnecessarily, and would result in resources being spent more effectively and efficiently.  Making corrections on the revenue side also means no additional EU expenditure is created that might limit the freedom to spend resources according to national priorities. Finally, a correction mechanism on the expenditure side of the budget generates an unnecessary additional administrative burden.

Conclusion

The government concludes that the advisory report “The finances of the European Union” is largely in line with government policy and makes a useful contribution to the ongoing discussion. The government thanks you again for the report.

 

Yours sincerely,

 

Frans Timmermans
Minister for European Affairs

___________________________

1 See http://ec.europa.eu/budget/reform/issues/issues_nl.htm for the responses received so far.
2 The Dutch definition attributes not only traditional own resources (customs duties and agricultural levies) to the member states, but also administrative expenses.
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