The Fiscal Centralization of Europe Will Not End Well

One of the side effects of the corona pandemic has been a new, integrated fiscal response from European governments. After five days of negotiation (estimated by some commentators to be the longest in EU history) the EU27 agreed, last month, to allow the raising of debt at the federal level. The amount is a mere Eur750bln but the action marks the beginning of a new phase in the European experiment.

The new Multiannual Financial Framework (MFF), as the EU budget deal is known, will cover seven years between 2021 and 2027. The deal has two parts, the regular EU budget, worth nearly Eur1.1trln and a Eur750bln Next Generation fund – or NGEU. It is worth noting that, in a departure from previous policy, Eur390bln will take the form of grants. Not only will this not add directly to European governments’ debt loads, but it breaches what had always been deemed to be a red line in allowing intra-EU fiscal transfers.

The ‘exceptional and temporary’ nature of the NGEU has gone some way towards appeasing the ‘Frugal Four;’ Austria, Denmark, the Netherlands and Sweden. On closer inspection, however, they appear to have been incentivised rather than undergoing a damascene conversion. The principal inducement has been the award of substantial budget rebates as part of the final settlement. Nonetheless, commentators are already heralding this brave new federal solution as a template for dealing with future crises. 

The new federal era has not quite got underway, and there remain a number of technical issues which need to be addressed. The new debt will not be guaranteed by member states, which immediately raises the question of how the borrowing will be repaid. Individual governments, frugal or otherwise, have long resisted calls for the European Commission to be granted tax-raising capabilities, and, more importantly, investors will need to be confident, not just of the return on their investment, but the return of their investment, if they are to be relied upon to finance these new federal obligations.  

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