European Parliament's Fiscal Rules Proposal: Even better than the Commission’s

Jonás Fernández Álvarez

17 mins - 12 de Diciembre de 2023, 07:00

Last April, the European Commission put its proposal for the revision of the fiscal rules on the table of the co-legislators, Parliament and Council. Months before, the Parliament had already issued a report on these lines of reform, the Council had also set out its priorities and the Commission itself had opened a public consultation. With all this information and the Commission’s own political and technical work, last spring we were presented with texts that were well received by the progressives, although there was still the whole negotiation process ahead in Parliament and the Council, first in parallel, and then the trialogues, where we would try to improve the global framework of economic governance. Well, the work of this first stage in Parliament is coming to an end and it is time to explain the pact that has been reached between various political groups.

First, it is necessary to clarify the negotiating framework and the consequences of a “no deal”. Over the last few years, the Commission proposed, and the Council approved, with Parliament’s support, the activation of the escape clause of the current budgetary rules. The impact of COVID, first, and, later, the consequences of the start of Russia’s war over Ukraine made it advisable to leave national governments free to implement a counter-cyclical fiscal policy, supported by the ECB’s expansionary policies. However, inflationary pressures and the exhaustion of fiscal space have begun to strain states’ budgetary management and maintaining the escape clause sine die has become impracticable. 

Last spring the Commission opted for a return to the application of the rules, although the publication of a proposal made it clear that we would not go back to applying the current rules. Some of us were critical of this lifting of the escape clause, which we believed should be extended for at least one more year, until the pre-COVID GDP levels were fully restored. The Council finally approved the Commission’s proposal, amidst the doubts of many. Thus, all that remained was the negotiation of new rules that would de jure prevent the current ones from being applied.

Certainly, the most complicated budgetary restriction of the current rules comes from the obligatory reduction of public debt levels in relation to GDP by one-twentieth of the difference with respect to the limit of 60% of GDP, defined in the Protocol implementing the Pact and whose reform requires unanimity among the States, a consensus that would be impossible to reach at this time. 

Thus, it is important to specify that, in the absence of new rules, the previous ones would come into force with such a legal requirement, which would mean returning to the worst moments of “austericide”, which followed the last financial crisis, and even worse. This should therefore be a scenario to be avoided at all costs. 

Yet there are those in the corridors of Parliament and beyond who argue that, insofar as such a legal provision is “impossible” to comply with, there is no urgency to agree new rules, suggesting that the Union enters an environment of not just fragrant but outright intentional non-compliance, hoping that neither the Commission nor the Court of Justice of the EU will act. This position is irresponsible to say the least, forgetting the legal obligations that flow from the current rules and that, even if the Commission wanted to ignore their application, the judiciary could and should act.

Moreover, the hope of inaction by the Commission is also doubtful. After the next European elections, a new Commission will be at the helm of the Union, and I doubt that its first decision would be not to apply the current rules, leaving it at the mercy of the Court of Justice of the EU itself. Moreover, not approving new rules would mean that states would design their budget plans for 2025 next spring with a compulsory reduction of public debts in their budgets, even though they may or may not be able to meet these targets afterwards. 

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In short, the economic and legal imbroglio would reach such embarrassing levels, without having yet closed, by the way, the agreements for the entry into force of the Union’s new own resources aimed at amortising the debt issued by the Next Generation EU, with inflation still above the ECB’s target and far from the deflation that allowed a hyper-expansionary monetary policy after the impact of covid, that the fiscal crisis that opened in the eurozone in 2010 could become so small.

The current rules may be more or less credible, and the Commission may also be more or less legalistic. But, on the one hand, the EU Court of Justice cannot fail to act in the face of intentional breaches. And, on the other hand, even worse, regardless of what the Commission or the courts do or fail to do, the markets can respond at any time to the morass and the absolute uncertainty in budgetary management which, in this case, would reach the debt issued by the Union. 

We must not be frivolous about voluntary non-compliance with the rules. The scenario would be worse than the one suffered in 2010, although perhaps those who defend the possibility of ignoring the rules did not have first-hand knowledge of the drama of that time.

A Summary of the Commission’s Proposal
The Commission’s proposal is based on a new approach to assessing the budgetary sustainability of states, centred on individual country-specific analyses that focus on the evolution, essentially, of public debt. Thus, the Commission should carry out an analysis of the sustainability of public debts for each country and, by virtue of such scenarios, designed to constant policies, issue public spending paths, net of the cyclical component of unemployment insurance, interest payments and tax increases, which the states should comply with the objective of reducing public debt to below 60% of GDP in the medium term. Thus, this net public expenditure would be the control variable for monitoring compliance with the set of rules. 

With these data, states should plan for four years to comply with these requirements, with the possibility of extending the period by three years to seven years if governments commit themselves to reforms or investments in line with the Union’s objectives, which could require short-term spending.

On this base, the Commission introduced some safeguards that limited the flexibility of the model, but which responded to the uncertainties of some actors who considered the overall framework too flexible and discretionary. 

In this sense, the Commission proposed that, irrespective of the other elements, if a country had a government deficit above three per cent of GDP, it should make additional efforts to adjust debt so that the structural deficit would be reduced by 0.5 percentage points. Also, for states with public debts above 60% of GDP or deficits above 3% of GDP, net public expenditure would not be allowed to grow above GDP estimates over the medium term.

Broadly speaking, this is the Commission’s proposal. A flexible, ad hoc model with quantitative limits to be met, in any case, and this is on what Parliament and our group should work.

S&D Position and Agreements Reached
The S&D group welcomed the Commission’s proposal last April. The proposed new model was sufficiently flexible to avoid a new period of austerity, also taking into account the necessary consolidation of public accounts, but without falling into a generalised compliance with rigid quantitative figures without regard to individual cases. However, the safeguards introduced in the final proposal were a cause for concern, as was the slight attention to the social objectives set out in the European Pillar of Social Rights. Our priority was therefore to enlarge the fiscal space to undertake the necessary investments for the green and digital transition, as well as to strengthen the Social Pillar, while allowing for fiscal consolidation to improve the fiscal space for possible future crises.

The agreement reached maintains, firstly, a fiscal surveillance model focused on the medium-term sustainability of public debt controlled by a public expenditure variable net of various expenditure items. It also maintains the elimination of interest expenditure and the cyclical component of unemployment expenditure from the public expenditure computation, as proposed by the Commission. However, expenditure arising from EU-funded Community programmes, purely national expenditure arising from the co-financing of European funds, and expenditure on financing appropriations linked to the Recovery and Resilience Facility, all subject to a ceiling of 0.25 of national GDP, are also removed from the public expenditure count. S&D has therefore succeeded in widening the investment spaces of the general model proposed by the Commission by removing additional expenditure and investment channels from the control variable.

Secondly, the Commission proposes to establish a single control account to facilitate the monitoring of compliance with budgetary targets. Well, S&D succeeded, firstly, in allowing deviations from the control account in case of recessions, so that years with negative growth are netted. Secondly, however, S&D has ensured that strategic investments addressing EU priorities (I will mention later the extension of priorities to the European Pillar of Social Rights) can be counted over five years, thus allowing deviations from the agreed path of the public expenditure variable, subject to the Commission’s authorisation. In this way, investments whose disbursement could temporarily divert compliance with the public expenditure variable would have an “amortisation” period of up to five years on account of their computation, thus widening the space for undertaking strategic investments.

These two additional measures significantly improve the investment incentives that the Commission had introduced in its proposal by possibly increasing the lifetime of budget plans from four to seven years, if they contained investment or reform programmes linked to EU priorities. 

In view of these developments on the Commission’s proposal, one might wonder about the concessions that S&D, without a majority in the Parliament, had to make to the conservative groups. EPP and Renew argued throughout the negotiations for the introduction of new figures for the control of debt and public deficit, which would reduce the flexibility framework defined by the Commission and which would be extended by the progress made by S&D in this direction. 

Thus, the right, like some governments in the Council, some of them led by socialist colleagues, insisted on setting quantitative targets for compulsory, universal and linear reduction of public deficits and debt.

However, S&D did not accept any limitation on the government deficit, which would contravene the net government expenditure path (made more flexible, by the way, by our proposals) consistent with the consolidation agreed for public debt, outside the general framework defined by the Commission’s proposal. Moreover, the limitation established by the Commission on the necessary reduction of the structural public deficit if the nominal deficit exceeded 3% at the time of drawing up the medium-term budget plans was removed from the text, so that this requirement will only be applicable ex post once a State enters the Excessive Deficit Procedure, but not ex ante in the design of the plan for the whole period. 

However, and also in view of the evolution of the negotiation in the Council, S&D eventually accepted a limitation on the evolution of debt. The design of states’ plans should incorporate an average annual reduction in public debt of one percentage point of GDP if public liabilities exceed 90% of GDP and half a percentage point for debts between 60% and 90%.

This safeguard, which we did not want, is softened, in any case, in a critical way by extending the period of compliance by ten years with respect to the years of validity of the States’ medium-term budget plans. In other words, the States will have to design their plans for 4 or 7 years, depending on how they negotiate with the Commission, but the calculation of this obligatory average annually reduction of public debt would be extended to 14 or 17 years, extraordinarily broadening the space for parsimonious fiscal consolidation. Given that the calculation of debt reduction is carried out in annual average terms and in such a long-term (14 or 17 years), member States will have a wide margin of manoeuvre. Such is the flexibility that, according to the Commission’s first calculations, this additional constraint does not imply any restriction on the central model based on debt sustainability analyses. This safeguard is completely innocuous at these figures and within these compliance deadlines.  

The social chapter has also been particularly strengthened. Firstly, the European Semester will from now on have a strong social chapter. To this end, the design of a “Social Convergence Framework” has been incorporated to complement the essentially budgetary and economic indicators in the framework of the monitoring and implementation of the European Semester. This new “Social Convergence Framework” will provide information to analyse the evolution of European convergence in social and employment terms, will make it possible to identify progress and possible setbacks, and will entail a common examination of the implementation of the European Pillar of Social Rights.

Likewise, the medium-term budgetary plans of the Member States should include a chapter detailing the consistency between budgetary balances and the achievement of social and employment objectives. In the same vein, the possible extension of this plan from four to seven years should also respond to the commitment of the States to the development of the objectives of the European Pillar of Social Rights, identified and monitored through the Social Convergence Framework, which is incorporated into the European Semester monitoring package. 

Finally, Parliament’s proposal also revises the governance model for the Semester as a whole, its monitoring and implementation. On the one hand, the ownership of the Member States is strengthened to avoid the “Brussels diktat” with which we live under the current rules. Thus, the reference path of the net public expenditure variable under the supervision of the Commission to ensure the sustainable evolution of public debt will be drawn up, in the first instance, by the national governments. In this way, it will be the states that initiate the negotiation with the Commission when setting spending commitments. 

In addition, the Parliament’s text requires that such medium-term plans must be debated with social partners, civil society and regional authorities and must be discussed to their respective national parliaments, before being forwarded to the Commission. Of course, a new government will have the right not to be bound by previously negotiated medium-term plans and will be able to draw up a new programme.

The European Parliament improves its position of monitoring and control of the Semester with respect to the Commission’s proposal and within the framework granted to us by the Treaties. Thus, all information on Member States’ plans, debt sustainability exercises and any other data will have to be made public. Parliament will monitor the Commission through structured dialogue. 

And, last but not least, Parliament removes from the proposal the Annex which diffusely details the methods for assessing the medium-term public debt path forecasts, where the heart of the whole new model lies. The Commission will have to present a delegated act specifying not only the variables but also the econometric models for such exercises.

The Group of the Progressive Alliance of Socialists and Democrats approached the negotiation on the revision of the fiscal rules with several objectives. Firstly, we wanted new rules that would first and foremost leave behind the requirements introduced in the six and two packs passed during the financial crisis, especially the mandatory reduction of debt by more than 60% at a ratio of one twentieth of the excess per year, which would force unprecedented austerity. 

In this sense, allowing time to pass without new rules, trusting not to apply the present ones, is not only highly irresponsible, but also means subjecting the states and the Union itself, which has issued its own debt, to extraordinary market tensions in an environment where inflation hinders potentially expansionary measures by the European Central Bank. If the Commission’s actions, subject in any case to the EU Court of Justice, are more or less credible, the markets can be brutally credible, and it would be suicide to take this risk, as it would be to approve fiscal rules that would take us back to austerity.

With regard to the Commission’s proposal, which S&D welcomed, the Parliament widens the scope for investment, eliminates the quantitative safeguards proposed by the Commission, and accepts only a requirement on the evolution of debt which, by extending the calculation period to ten years (until 14 or 17 years), on the Commission’s own proposal, renders such a requirement harmless. 

At the same time, the Parliament strengthens the weight of the European Pillar of Social Rights, and opts for a Social convergence framework that changes the nature of the whole Semester. Moreover, it improves governance, legitimacy, and control in the implementation of the new rules from the very beginning by requiring a delegated act to define the model for estimating debt sustainability in the medium term.

Undoubtedly, we Socialists would have liked to go further on the basis of the improvements achieved around the Commission’s initial proposal. But this agreement by Parliament substantially improves on the initial draft in all areas. There remains, however, the trialogue with the Council, the final text of which we do not yet know.
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