Economie

EU Budget Review: An opportunity for a

thorough reform or minor adjustments?

Executive Summary of the Final Report of the EU Budget Reform Taskforce

Members of the Taskforce

Mojmir Mrak (coordinator)

Mitja Drobni Emil Erjavec Mitja Mavko Vasja Rant

Branko Ravnik Janez uteri

Uro Vajgl Peter Wostner

October 2007

EU Budget Review: An opportunity for a thorough reform or minor adjustments Executive Summary of the Final Report of the EU Budget Reform Taskforce

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Chapter 1: Introduction 1. Subject of the EU budget review and its scope; The subject of the EU budget review was defined in the final stage of the EU 2007-2013 Financial Perspective negotiations. The European Council called upon the European Commission to undertake a full, wide ranging review covering all aspects of EU spending, including the Common Agriculture Policy (CAP), and of resources, including the UK rebate, to report in 2008 / 2009. This mandate was given by the highest political representatives of the Member States and involves a comprehensive review of the EU budget in which no expenditure or revenue item in the budget will be excluded. The mandate clearly acknowledges that the existing EU budget requires a thorough reform. Nevertheless, there are still two rather different views regarding the scope of the agreed budget review. According to the first, the agreement on the review was primarily aimed at successfully completing the long and demanding mid-term financial perspective (hereinafter: MFP) negotiations for the 2007-2013 period and does not reflect a serious ambition to comprehensively reform European public finances. According to the second view, this agreement represents an opportunity to perform a comprehensive analysis of all segments of the EU budget for the first time since 1988 and to adopt the changes necessary for the EU to confront the changing environment and new challenges. 2. The mandate and composition of the EU budget reform project; In order for Slovenia to prepare itself for discussions on EU budget reform and later negotiations on this topic, in November 2006 Janez Lenari, Head of the Government Office of the Republic of Slovenia for European Affairs, established an EU Budget Reform Taskforce. The taskforce was comprised of individuals from both the government and the academic sphere involved in various aspects of EU financing, all acting in their personal capacity and not on behalf of the institutions they are affiliated with The mandate of the taskforce was first to prepare an analytical basis for budget reform and second to articulate possible scenarios for both expenditure and revenue sides of the EU budget. The final result of the taskforces work is a final report and this is its executive summary1 2. It is necessary to emphasise that the taskforces mandate did not include formulation of the draft official Slovene positions with regard to reforming the EU budget. This report nevertheless represents a substantive input to the Slovene Government for articulation of its views with respect to the EU budget reform when the Government assesses this is appropriate and/or necessary. At the same time, the report also represents a contribution to the general European public debate regarding the EU budget which was launched by the European Commission in September this year.

1 The text of the executive summary has been translated from the Slovene language original and is available on the web site of the Government Office for European Affairs of the Republic of Slovenia (www.svez.gov.si). Taskforce may be contacted through its coordinator Mojmir Mrak ([email protected]). 2 Members of the taskforce also produced the following four texts, which represented contributions to taskforce discussions:

Janez uteri (2007) What does economic theory tell us about the suitability of different kinds of EU budget expenditure?; the text represented the conceptual input for Subchapter 3.3.

Emil Erjavec (2007) The future of the Common Agriculture Policy in light of the EU budget an attempt at an economic-policy analysis; the text represented the conceptual input for Subchapter 4.1.

Peter Wostner (2007) Reform of the Cohesion Policy; the text represented the conceptual input for Subchapter 4.2.

Uro Vajgl (2007) The Own Resource system; the text represented the conceptual input for Subchapter 4.4.


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3. Structure of the report; As the final result of the taskforces work, this report includes six basic chapters in addition to the Introduction. Chapter 2 presents the basic characteristics of the two key instruments of public finance at the EU level, namely the MFP as an instrument of strategic, medium-term financial programming, and the annual budget as an instrument for its operational implementation. Chapter 3 aims at analysing the 2007-2013 MFP agreement and establishing the basic starting-points which a serious review should follow. Chapter 4 presents a detailed analysis and searches for possible trends in individual groups of expenditure and revenues of the EU budget and its institutional aspects, all for the purpose of identifying possible alternatives of the future development of the EU budget. The main intention of the following two chapters is to set out in detail these alternatives. Within this framework, Chapter 5 presents possible scenarios for development of the EU budget in the period immediately following 2013, while Chapter 6 presents alternative visions of the EU budget in the long-term, i.e. for the period from 2018 or 2020 onward. Chapter 7 provides a final assessment of the feasibility of individual medium-term scenarios and long-term visions for the EU budget, as dealt with in the previous two chapters. Chapter 2: The basic characteristics of EU public finances 4. The medium-term financial perspective and annual budget as fundamental instruments of EU public finances; Budgetary public finances at the EU level are shaped and implemented through two basic instruments. The first of these is the MFP as an instrument of the EU's strategic financial planning. With the assistance of the MFP, Member States agree on budget priorities for the medium-term period which in turn facilitate the management of various budget items and enable smooth and efficient procedure for adoption of annual budgets. Further, within the scope of the MFP agreement Member States define EU budget expenditure limits for the entire MFP period at the level of total expenditure and for the main expenditure categories. The other instrument at the EU's disposal in the area of budgetary public finances is the annual EU budget. This is de facto an MFP implementing instrument whereby the annual EU budget is adopted in a precisely defined procedure involving all three major European institutions. 5. The EU budget represents only a small part of the consolidated public finances of EU Member States; The EU budget is distinctly small as its size is approximately 1% of the EUs GDP, or just over 2% of the total public finances of the Member States. The EU budget does not represent a significant factor in almost any consolidated public finance category. Three key elements of expenditure of practically every national budget, i.e., defence, security and public order expenditure, as well as healthcare are not even included in the EU budget3. The presence of certain other items, such as education and housing, is minimal. 6. Domination of the CAP and Cohesion Policy on the expenditure side of the EU budget and of Member States national contributions on its revenue side; The expenditures of two policies, the Common Agricultural Policy (hereinafter: the CAP) and the Cohesion Policy, are dominant on the expenditure side of the EU budget. In the last two decades approximately 80% of all EU budget funds were earmarked for these two policies. The remaining share of the budget was allocated for external EU activities and internal policies aimed at boosting competitiveness and the implementation of other objectives. Since its last major reform in

3 In 2003, nearly two-thirds of the US federal budget was earmarked for social security (22%), healthcare (22%) and defence (19%).


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1988, the Community Own Resource system has comprised three major resources: (i) traditional own-resources (hereinafter: TOR) which include customs duties and agriculture levies; (ii) funds levied on the basis of value-added tax (hereinafter: the VAT-based resource) defined on the basis of a statistically adjusted VAT base of the Member States; and (iii) funds levied on the basis of the Gross National Income of the Member States (hereinafter: the GNI-based resource), i.e. funds earmarked for balancing the budget measured in proportion with the GNI of every Member State. The share of the latter already represents nearly three-quarters of all budget revenues. 7. The UK rebate and rebates of other net contributors to this rebate; Formally, the so-called UK rebate is an integral part of the Own Resources system. The UK rebate is a mechanism introduced in 1984 due to the UKs specific position as regards the EU budget. Its purpose is to improve the UKs net financial positions in relation to the Community. When establishing the UK rebate it was determined that all other Member States would finance its costs. Over the years, additional ad-hoc mechanisms approving caps on the payment of the rebate to the UK for Austria, Germany, the Netherlands and Sweden have been adopted within the scope of negotiations for individual MFPs. Chapter 3: Assessment of the existing EU budget and main starting-points for its reform 8. The MFP agreement for the 2007-2013 period clearly exposed the need for a comprehensive reform of the EU budget; Although the EU faced new challenges linked to its enlargement as well as lofty ambitions in the areas of competitiveness and its role on the global scale, the Member States focus on own net positions rather than content led to an unsuitable and non-transparent financial agreement for the 2007-2013 period as regards the declared Lisbon-oriented and ambitious policy goals. Aware of these facts and with some remorse, the Member States agreed on a review clause as an integral part of the final agreement. 9. The review must provide answers to a number of challenges and issues; Which elements must be thoroughly examined within the scope of the EU budget review? First of all, the review entails a re-verification of the budget's two key principles: subsidiarity, or what should be financed at the EU and Member State levels, and proportionality, or an agreement on the size of the EU budget. Vital to these discussions will be the question of which European public goods should be financed from the EU budget. If the EU truly wishes to restructure its budget from a predominantly redistribution-based budget to a more allocation-based budget (i.e. the earmarked financing of European policies), then it is essential to include a rigorous analysis of all existing budget policies in the review in terms of their added value at the European level. Funds which should be earmarked for meeting the challenges of globalisation as well as energy and climate change, along with funds facilitating the EUs enlargement to the countries of South-east Europe and possibly Turkey, must also pass this test. The assessment of what should be financed from the EU budget will lead to answers regarding the size of the EU budget and the method of its financing. Should the financing of the European budget remain as it is today, occurring primarily through the national contributions of Member States, or should the review propose the introduction of a new genuine EU budget resource in the form of a European tax? If the answer is positive, how should this tax function and what should its fundamental characteristics be? Much is expected from the EU budget review also as regards the so-called equitable repayment or juste retour problem, whereby


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any solution in this area which encompasses the UK rebate and other rebate mechanisms largely depends on the course of the reform on the expenditure side. Ultimately, a review in which no topic is exempt should also analyse the institutional context of EU public finances. 10. Basic starting-points for a review of the EU budget: (i) assessment of the current situation; (ii) analysis of the challenges; (iii), economic theory, particularly the theory of public finances and fiscal federalism; and (iv) the political reality; The EU budget review must be based on four starting-points. The first is a critical assessment of the existing budget. The second is an analysis of the new challenges faced by an expanded EU in an ever more globalised and changing world. The third starting-point of the review is economic theory and more precisely a theory of public finances and fiscal federalism which must find an answer to the question of what type of expenditure should in theory be financed at the EU level. The fourth starting-point reflects the political-institutional reality of the EU. Taking into account the previous two starting-points, this must lead to a comprehensive reform in a manner that is politically acceptable for Member States and their citizens. 3.1. Assessment of the current EU budget 11. The EU budget has changed little substantively and institutionally in the last two decades; Today, the EU budget is one of the most problematic areas of economic management within the EU. At the same time, it is also an area which is extremely resistant to any serious change. Although there have been dramatic changes to the EU itself and its environment in the last two decades, the EU budget has changed little since its last major transformation in 1988. From then until now the EU budget has remained, in size terms, practically unchanged and is still at a level of approximately 1% of GDP/GNI. Within the budgets structure, CAP expenditure is still prevalent although agriculture is a sector that is losing significant economic importance as is expenditure for less developed geographical regions of the EU, where still close to half of the funds are funnelled to developed Member States. Not much has changed on the revenue side of the budget either. In this regard, transfers from national budgets to the EU budget still easily play the most important role. In addition, the UK rebate remains a subject of intense controversy. Further changes for the worse are linked to the introduction of new rebates and exceptions for individual Member States on the revenue and expenditure sides of the EU budget, which have bogged down negotiations on the last two MFPs (for the 2000-2006 period and the current MFP for the 2007-2013 period). It is clear that, with these ad-hoc solutions, the EU budget has become even more complicated and difficult to follow, while pressure for its eventual change is growing. Institutional reforms, first foreseen within the scope of the failed constitutional reform in 2005, are now included in the proposed Reform Treaty of June 2007 in a slightly different form, and have largely bypassed the EU budget. 3.2. New substantive challenges of the EU and their potential impact on the European budget 12. While so far the EU has been primarily focused inwards and given priority to dealing with internal issues, in the future the EU must turn its attention outwards from where its key challenges come; In contrast to the previous 50 years when the EU primarily focused on itself, as its activities were primarily aimed at addressing internal challenges (resolving the problem of the safety of foodstuffs, environmental protection, Member States convergence, the establishment of a single economic area, the introduction of a common currency etc.), the


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EU must turn a significant share of its attention outwards in the future. The EU must find effective answers to the new challenges stemming from the external environment if it wishes to maintain and even strengthen its relative position in the world. 13. Challenges linked to globalisation; The economic environment is changing faster than ever, driven by the universal processes of globalisation. Due to rapid technological changes, particularly in the areas of information-communication technology, transport, logistics and services, geographical distance is becoming less of an obstacle for a number of economic activities which logically stimulates the processes of internationalisation and economic integration on the global scale. The world is simply becoming smaller. For the EU globalisation challenges are of two types. The first challenge is how to replace jobs lost in traditional industries, primarily due to the relocation of certain activities outside the EU, with new, quality jobs. In the future this challenge will become critical as exports from developing countries will increase rapidly and not just in the segment of traditional, labour-intensive products, but also in product segments with higher added value. The second challenge is how to stop lagging behind the US and Japan as regards innovation in high technology sectors and how to increase the EUs long-term international competitiveness. With a marked increase in investment by China, India and certain other newly developing countries in research and development and education, it is realistic to expect these countries will in the future become the EUs real competitors in terms of innovation. The EU is aware of both globalisation challenges. The answer to both is a knowledge-based transformation from declining traditional manufacturing to knowledge-based economy. Although the majority of structural changes for such a transformation are of a regulatory nature, there are also changes which must be supported by the European budget. 14. An integral part of the globalisation process is its evolution into a multi-polarised world; Following the Cold-War era and the demise of the socialist bloc, only one superpower remained on the world stage in the 1990s: the US. Under pressure from growing external political and the economic problems faced by the US in recent years along with the considerable economic strengthening of a number of other large countries, the world is in the process of rapidly changing from a phase of mono-polarisation to a phase of multi-polarisation. Characteristic of multi-polarisation is the rise of new superpowers, particularly, China, India and Brazil, and the return of Russia as a global political and economic superpower. The bolstering of the economic strength of new global centres is clearly reflected in their political behaviour. Russia, for example, is openly using oil and natural gas as a material basis for achieving its strategic interests, not only with neighbouring countries, but also with the EU. The concept of establishing a multi-polarised world means that the importance of small countries (i.e. all EU Member States, viewed by global standards) declines, while the relative power of large countries or regional unions such as the EU increases. Today, competitive world powers view the EU as: (i) a respected economic power; (ii) an initiator of new political guidelines (i.e. in terms of the environment, climate, energy etc.); (iii) a potential political power; and (iv) a model of regional co-operation. The perception of the EU's external strength is largely dependent on its internal strength and the coherence of its Member States. 15. Challenges linked to climate change and energy; The next great challenge faced not only by the EU but by the world as a whole is climate change. The messages of experts are clear. If the world does not change its attitude to the environment and begin a determined reduction of greenhouse gas emissions the entire population of the planet, including all EU citizens, will


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encounter significant long-term negative consequences of atmospheric warming in the decades ahead. Challenges in the area of climate change are linked to potential food production problems and even more so to the challenges the world faces regarding energy. For EU, these challenges are further complicated by its high energy import dependence. Today, the EU covers approximately one-half of its energy needs by importing oil, gas and coal from third countries. This share is expected to rise to 70% by 2030 what is a clear indication of the vulnerability of EU Member States in the area of energy supply. The EU can solve its high energy imports dependence only in the long-term and only with the use of technologies which are still in the research phase. Energy is clearly an area in which the EU must resolve at least some problems collectively. In this context, investments in the research and development of new technologies and the construction of networks (for transferring energy between Member States to increase the stability of the European energy system, and for linking with energy sources within the EU environment) are increasingly recognised as European public goods. In the context of planning the construction of oil and gas pipelines, through which the EU can expect to provide an additional source of energy from its direct environment, the strategically important geographical position of Turkey should be emphasized as most of these links will likely cross its territory. Special emphasis is also placed on renewable energy sources where significant questions regarding the use of agricultural products for energy purposes arise. 16. Ageing population and immigration; The next great challenge the EU will encounter in the coming decades is the ageing of its population, whereby it is clear that immigration flows to the EU will not only be likely but urgent. Attention must be given to the fact that immigration is not a shortcut to resolving the problem of an ageing population in Europe. In addition to immigration, directly or indirectly stimulated by the ageing of the European population, or immigration which is the result of the search for opportunities for a better life, the EU will face immigration driven by other reasons in the coming decades. Climate change, which according to assessments will have the greatest negative effects on countries located in the south of the European continent, could result in famine, poverty and even the outbreak of related regional conflicts in these territories. In the search for solutions to their existential problems populations from the aforementioned area will begin to emigrate. It is realistic to expect that the EU will be a very attractive destination. The EU is already responding to these immigration challenges in various ways which will need to be supplemented and strengthened and, in some cases, completely re-developed. The EU's strategy in this area by and large consists of two sets of measures. The first set includes measures in the area of legal immigration where, in addition to visa and asylum policies, measures for the comprehensive integration of immigrants into society are particularly important. The second significant set of measures includes measures aimed at preventing illegal immigration, with the most important being those linked to terrorism, trafficking in persons and smuggling. Co-operation with countries where illegal immigrants come from, or from which illegal immigrants are expected to come to a greater extent in the future, must take on more meaning than in the past. The fight for human rights and against poverty in these countries, the support of their economic development and thus an improved standard of living for their populations must play a greater role in the EU's overall approach to immigration policy. 17. Further enlargement of the EU and related challenges; Similar to all previous enlargements with the exception of the one in 1995, the EU is also in future expected to expand with countries that are relatively underdeveloped. This applies to the countries of South-east Europe and Turkey. With the exception of Croatia, which is expected to accede


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somewhere around 2011, the accession date of other countries remains unclear. In this respect, there is also a significant difference between enlargement to South-east Europe and to Turkey. Given the previously adopted political decisions and the fact that the countries of South-east Europe are already geographically surrounded by EU Member States, there is an almost complete political agreement among Member States that it makes sense to enlarge the EU to countries from the region when they are ready to accede. For most countries in the region, this European perspective is the key element on which they base their political stability. A possible loss of this perspective could plunge certain countries in the region back into the maelstrom of inter-ethnic conflict. While the latest enlargement to Central European countries was viewed by EU-15 Member States as important both, in political and economic terms, enlargement to South-east Europe is viewed in many circles more as a kind of damage control activity. However, the situation regarding Turkey's membership in the EU is different with the opinions of Member States varying significantly. Despite strategic interests which are and will in the future be even stronger arguments in favour of Turkish membership in the EU, there is resistance and clearly expressed positions of rejection based on the assessment that the EU should refrain from enlarging so as to include a Muslim country with the majority of its territory located in Asia. In addition to these two reasons, which are most frequently expressed as an argument against Turkey's inclusion in the EU, several other reasons are being mentioned as well. For example, the entry of Turkey with its 75 million inhabitants into the EU would significantly change its institutional structure and decision-making mechanism, not to mention the serious consequences Turkeys inclusion would have for the EU budget. 3.3. Economic theory as an orientation for a pure economic approach to reforming the EU budget 18. The theory of public finances and fiscal federalism as an orientation for a pure economic approach to reforming the EU budget; Economic theory must contribute to the EU budget review in order to indicate which categories/purposes of expenditure should be financed at the Community level. It should not be assumed from this that it is possible to actually bring the EU budget in line with these principles in the next period. This pure economic approach could instead be used as a benchmark case or an example to facilitate the achievement of two objectives. The first is to show how the current structure of the European budget differs from the optimal structure, thus strengthening the belief that budget reform is indeed necessary, and the second is to provide a signpost for actual reform in terms of the course we wish to take, although it will still be some time before we arrive at that objective. The answer to the questions of which categories/purposes of expenditure should be financed at the EU level from the overall budget essentially has two dimensions. The first is: which goods and services should be and need to be financed from public funds? An economic theory of public finance, in which a government has a three-pronged function of allocation, redistribution and stabilisation, is crucial to finding the answer to the above question. The second dimension is: which of these goods and services does it make economic sense to finance at the central level of government and which goods and services should be financed in a decentralised manner? A theory of fiscal federalism, based on the principles of fiscal equivalence and a cost benefit comparison, is crucial to identifying the answer to this question. Taking into account these two principles, the allocation function of the government should be carried out at various levels, depending on the level at which most benefits and costs of a specific policy accrue. The redistribution function of the government should be decentralised, in order to better meet the needs of target groups of the population, while at the


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centralised level only the transfers between wealthier and poorer parts of a country should take place. Responsibility for the stabilisation function should be concentrated at the central level. 3.4. Political-institutional reality of the EU 19. The institutional and political reality of the EU requires moving away from the classical concept of fiscal federalism as a basis for defining appropriate areas for financing from the EU budget; The classical theory of fiscal federalism, which implies that everything that can be financed more efficiently at the EU level than at the national level should be financed at the EU level and vice versa, has significant limitations for a direct application to the EU example. As a first and perhaps less important one, let us repeat the fact that the EU budget, expressed as a share of its GNI, is significantly smaller than the central government budgets of contemporary federal countries. A second and more important limitation is the fact the EU does not represent the highest level of government in the EU but is a specific political entity established for specific purposes. According to its institutional structure, the EU is not a federation but is much closer to the concept of a confederation since practically all important decisions are taken by the governments of its Member States (although not necessarily by consensus) and not through legislation or an executive body superior to the governments of the Member States. Besides economies of scale and externalities as fundamental arguments of classical fiscal federalism, agreements of Member States regarding what function the EU budget has in legal acts of the Community, particularly in the Treaty establishing the European Community, must therefore be taken into account when analysing what makes sense to finance at the EU level. Based on the second article of the Treaty, the following four areas can be identified in which EU intervention makes sense. These are: (i) economic growth and sustainable development; (ii) cohesion based on solidarity amongst the Member States; (iii) external security, relating primarily to common foreign and security policy, including a common defence policy; and (iv) internal policy from areas such as the defence of external borders and asylum and immigration policy. 20. Definition of European public goods as a reflection of the political reality in the EU; Pursuant to the Treaty establishing the European Community, the EU budget is only a subsidiary instrument of European public finances whose added value in this respect is directly linked to the concept of European public goods, i.e. those public goods which require financial intervention at the EU level. European public goods is a dynamic concept which changes over time so that one of the key challenges of an EU budget review is to identify and articulate European public goods for the next period. The definition of European public goods can be approached at two levels: technical and political. At the technical level, the distinction between European and national public goods can be made by applying the criteria of added value, subsidiarity and kinds of externalities. While the definition of European public goods is somewhat clearer at the technical level, several issues arise with the definition of this concept at the political level. 21. Political economy as a key element of the debate on what should be financed by the EU budget; In the context of discussions on the definition of European public goods at the political level and what should be financed from the EU budget, it should be emphasised that political economy plays an important role in formulating this definition. In this context, discussions on public goods become a discussion on the desired purposes and objectives of budget financing which, in a democracy, should reflect the preferences of voters and citizens


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of the EU, whether these preferences are appropriately represented throughout the political process and if they are based on perfect information regarding the effects of financing specific policies with public funds. This means that European public goods are all public goods recognised and/or defined as such by citizens of the EU or their representatives. Of course, this raises another question: which institution should be responsible for deciding what constitutes European public goods, the European Parliament, the European Council, the European Commission or another institution altogether? Of course, none of these institutions merely take the will of the people into account in their decisions. Their decisions are the result of a political equilibrium involving varying interests. So far, this fact has significantly decreased the quality of the European budget. Indeed, the fact is that agreements regarding those policies, for which the majority of EU budget funds are earmarked, have frequently been reached more as the result of political equilibrium than economic rationale. In some cases, the EU budget has even played the role of some kind of side payment to obtain general consensus in a specific area critical to European integration. Chapter 4: Fundamental substantive and institutional challenges of the EU budget review 22. Fundamental substantive and institutional questions to be answered by the EU budget review; Based on the four basic starting-points for a review of the EU budget discussed in Chapter 3, the main objective of this chapter is to present an in-depth analysis of individual substantive and institutional aspects of the European budget review and to thereby to prepare solid analytical foundations for identification and articulation of various possible alternatives for its development in the future. The fundamental questions to be answered in this chapter are as follows: (i) What types of changes should the structure of EU budget expenditure undergo to reflect the current needs of an expanded EU? (ii) What size should the EU budget be to meet these needs? (iii) How should the EU budget be financed in the future? (iv) How important are political and institutional changes in the EU for substantive changes to the EU budget? Through the search for answers to these four questions, a substantive basis will be established for defining baseline scenarios of EU budget development for the period immediately following 2013 and for identifying and articulating possible visions of development of the European budget for the period from 2018 or 2020 onwards. 23. Substantive basis of the four scenarios of the EU budget for the period immediately following 2013, technically presented in Chapter 5; The basic starting-point for articulating various scenarios for the period immediately following 2013 is the existing EU budget. Already this status quo position requires drawing up of two scenarios which differ as to how they include the costs of further EU enlargements. The first scenario is called the existing expenditure level scenario and derives from the position that total EU expenditure, expressed as a share of EU GNI, remains unchanged. As a consequence, this means that expenditure for new Member States must be included in existing budget limits. According to the second scenario, called the existing policies scenario, existing Member States would not be financially deprived due to EU enlargement since existing EU policies in every Member State would continue to be financed by the same amounts of funds regardless of the enlargement. In addition to the two status quo scenarios which primarily serve as a benchmark for the anticipated reform of the EU budget, two scenarios completely contrasting in terms of their underlying concept will be formulated based on our analysis. The fundamental difference between these two scenarios stems from the very different approaches as to which common European policies make sense to be financed through the EU budget. The restrictive


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scenario is based on a distinctly fiscally restrictive and politically confederal approach. According to this concept, the size of the EU budget, expressed as percentage of the EU GNI, would be significantly smaller than it is today as a result of decreasing expenditure on two traditional EU policies: the CAP and the Cohesion Policy. In strong contrast to this scenario stands the so-called community scenario which is based on the relatively broad concept of common European policies and, consequently, European public goods. In accordance with this scenario, a substantial share of future EU budget funds would still be earmarked for cohesion and agriculture, while expenditure on competitiveness would also rise significantly. Further, the future EU budget would become an important factor for financing certain, altogether new categories of expenditure in the areas of environmental protection, energy, migration and most likely some other areas. 24. Three visions of the EU budget for the long-term period from 2018 or 2020 onwards are presented in detail in Chapter 6; While scenarios for the period immediately following 2013 are formulated on the assumption that the political and institutional organisation of the EU remain more or less unchanged in this period, alternative visions of the EU budget for the long-term period from 2018 or 2020 differ primarily in their dependence on whether or not Member States at that time will be prepared for closer political and institutional co-operation. If the answer is negative, development of the EU budget can be expected to continue on substantively the same or at least conceptually similar starting-points on which the restrictive scenario is based for the period after 2013. This would represent a vision of a continuing financially minimalist EU in which a distinctly fiscally restrictive and politically confederal concept would prevail. If, on the other hand, Member States opt for closer political and institutional co-operation, i.e. in the direction of a United States of Europe (which would be conditional on the adoption of a new constitutional treaty), this would lead to an EU budget based on a vision of a financially stronger EU whose basis would be a relatively broad definition of common European policies and, consequently, European public goods similar to that applied in the community scenario after 2013. According to this vision, the EU budget would increase significantly with more realistic expectations of considerable changes to its financing as well. There is also a third vision or a lack thereof which implies a political and institutional status quo. It is based on the assumption that the EU lingers for another decade or two in its search for a pragmatic balance between an international and supranational institutional structure. This process would continue on an ad-hoc basis without any serious and long-term political vision of the EU. 4.1. Common Agricultural Policy 25. Fundamental question of the EU budget review with regard to the CAP; As a fundamental policy of European integration since its establishment, the CAP has undergone a number of reforms over time. Of particular importance are the MacSherry reform of 1992 and the Fischler reform of 2003 which conceptually changed the CAP, as it was ultimately redirected from providing market-price support with import protection, export subsidies and other forms of intervention (necessary following World War II in order for the EU to ensure food security) to direct payment (mostly income) support. Liberalisation of the agriculture market and the gradual elimination of market-price supports were also accompanied by a pointed redirection to a rural development policy as the second pillar of the CAP. The fundamental question of the EU budget review with regard to the CAP is: Why should the EU budget, with its limited funds, continue to finance an activity which represents a relatively small share of total EU added value and is in terms of international trade relations? A related


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question is: Which segments of agriculture is it appropriate to finance from the EU budget? This also includes the financing of expenditure earmarked for tackling certain new challenges which have a direct impact on agriculture such as climate change and limiting production due to environmental requirements, and an indirect impact such as the availability of water resources, the increased production of bio-fuels, a decreasing amount of agricultural land etc. 26. Assessment of the justification for the continued financing of individual segments of the CAP from the EU budget; Arguments justifying the more substantial financing of agriculture policy from the EU budget vary with regard to both pillars of the CAP. With regard to the first pillar of the CAP, there are two possible interpretations of direct payments with very different arguments in favour of continued financing from the EU budget. According to the first argument, direct payments are primarily income support to farmers and, as such, follow the concept of redistribution. In this case, the argument that funds for this purpose need to be provided from the EU budget is entirely dubious since, according to the theory of fiscal federalism, the redistribution function amongst individuals is decentralised, which in the case of the EU implies the level of national budgets. Further, payments under the first pillar of the CAP are contrary to the principle of equity since the differences in aid received per hectare amongst Member States (even by taking into account full phasing-in for agricultural payments of new Member States) are extremely large (EUR 90-680/ha). According to the second interpretation, direct payments as refunds to farmers are meant to ensure specific cost-free public services such as landscape appearance, safe and healthy food and the sustained management of agricultural resources, and therefore more closely adhere to the concept of public goods. Even if the argument that these types of direct payments adhere to the concept of public goods is accepted, it remains to be proved that it is more appropriate to finance these payments from the EU budget than from national budgets. By contrast, the second pillar of the CAP is closer to the concept of public goods since measures for improving competitiveness, implementing above-standard services and allocating activities and income to rural areas should receive the highest priority for financing. It should be noted, however, that these are already tasks of the Cohesion Policy, and that most public goods provided by the second pillar of the CAP are local in nature and should therefore be financed from national (regional) budgets and not from the EU budget. 27. Factors affecting the dynamics of the CAP reform; It is realistic to expect that EU budget CAP funds will not rise after 2013. The questions remains: Will there be a decrease in the real level of funds for this purpose? If the answer is yes, what will the dynamics be? A closely linked question is: Will a share of payments from the first pillar of the CAP be co-financed from national budgets? A positive answer would mean a partial re-nationalisation of this policy, leading to a second question: Will national co-financing be obligatory or voluntary? The dynamics of the CAP reform will depend on the inter-relationship of factors for and against furthering the reform. Key factors supporting rapid changes to the CAP after 2013 are as follows: The first is the erosion of the consensus of Member States regarding the role and importance of agriculture. In a number of countries, the first pillar of the CAP has never had or at least lost support as part of European public goods. Second, the CAP is losing public confidence due to dissatisfaction with the objectives and mechanisms of the policy as it is frequently viewed as socially biased (large landowners receive the biggest direct payments) and administratively too expensive. Foodstuffs scandals and BSE have led to the additional undermining of consumer and public confidence in agriculture policy. A third factor is external pressures linked to the WTO negotiations framework. The conclusion of the Doha Round would certainly hasten reform in the direction of a further market liberalisation


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and elimination of export support as the main burden for international partners. Even an eventual breakdown of the negotiations would not alleviate international pressure for the continued liberalisation of the first-pillar CAP measures. The fourth factor is budget limits and the public finance pressures of net contributors to the EU budget. Experience indicates that the financial position of an individual Member State in relation to the CAP has a significant impact on CAP-related decisions. The main factors impeding the more rapid and determined enforcement of the CAP reform are organised pressure to maintain the income level of agricultural producers (income pressure), and the pressure to reach a common agreement in Community bodies (institutional pressure). 28. Two contrasting concepts of CAP development after 2013; Based on the factors presented above for changing (or not changing) the CAP and the reforms adopted in 2003, two contrasting concepts of CAP development after 2013 can be identified. The first, which best articulates the French initiative of March 2005, attempts to maintain the current system which would be somewhat updated after 2013. This initiative confirms the correctness of the 2003 reforms, reinforces the concept of multifunctionalism and substantiates the view that the CAP and European farmers primarily need stability and that no significant changes are required up until 2013. This initiative further supports the position that the introduction of unrestrained production itself would be a significant step towards a better CAP, committed to the simplification of requirements and procedures. The second concept of CAP development is most clearly articulated in the United Kingdom's position from 2005 which supports a radical reduction in first-pillar support, the reduction of foreign trade protection to a level consistent with other economic sectors and the abolition of all other forms of trade intervention. The proposal practically abolishes the first pillar and accepts the continuation of the rural development policy, but not in any significant form of budgetary funds increases. Consequently, this means that the position supports a substantial reduction of EU budget funds. 29. The contrasting concepts of the development of the CAP open up opportunities for various scenarios of its development after 2013; Based on the presented factors for the CAP reform and the completely contrasting concepts of future CAP development, the following three possible scenarios for CAP developments can be formulated. The first is the status quo scenario which is in substance terms similar to the French proposal in which the real level of CAP expenditure would remain at the 2013 level. The second possible scenario is the scenario of a drastic reform which is substantively similar to the UK proposal and embraces a considerable reduction in CAP funding up until 2020. The third is the community scenario according to which the level of CAP funding would increase somewhat with regard to the period up until 2013. At the same time, it calls for significant changes in the balance of expenditure between the first and second pillars in favour of the second, or even the elimination of the pillar division. 4.2. Cohesion Policy 30. Justification of the Cohesion Policy in the Treaty establishing the European Community and other arguments supporting the financing of the Cohesion Policy from the EU budget; Economic and social cohesion, with its special emphasis on reducing development disparities between regions, represents one of the fundamental objectives of European Union as enshrined in the Treaty. This objective and policy is based on a number of economic arguments. The most of important of these are as follows: (i) without public


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intervention at the EU level, there would be insufficient and suboptimal level of investment, particularly in less developed, remote regions of the EU, (ii) the EU is faced with marked development disparities, which are of a structural nature, are enduring and which therefore cannot be diminished without assistance, (iii) aid is not only required for the elimination of structural imbalances and for strengthening of comparable advantages, but also for the successful functioning of the single internal market, (iv) Cohesion Policy is not just about equality in terms of curtailing of disparities, but is also designed to ensure equal development opportunities for countries, regions and citizens, and (v) Cohesion Policy is not only necessary for the less developed, but is also in the interest of the more developed since, in addition to facilitating the functioning and emergence of the internal market, it prevents bottlenecks and inflationary pressures from arising, thus also increasing growth potential of the EU level. In addition to economic arguments, an important political argument supports Cohesion Policy. It is namely difficult to imagine social cohesion in the EU without real convergence of its constituent parts, which is particularly relevant in conditions of significantly increased disparities between Member States after the last enlargement. Based on the aforementioned, it is possible to conclude that deliberations regarding Cohesion Policy in the scope of an EU budget review will not go in the direction of "do we need Cohesion Policy or not", but rather in the direction of an analysis of "what type of Cohesion Policy do we need". The segment of Cohesion Policy which is aimed at the least developed regions has the strongest theoretical foundation and the most support amongst Member States. Theoretically more questionable and with less support is that part of Cohesion Policy, which is earmarked for regions in more developed Member States, and which is based on the argument of cost restructuring, access to people (employment and inclusion) and political visibility arguments. 31. Varying assessments regarding the effects of Cohesion Policy and criticisms regarding the efficiency of its implementation; Empirical evaluations regarding the effects of Cohesion Policy are mixed, whereby macroeconomic models for the most part identify a positive long-term effect of Cohesion Policy on economic growth, while econometric studies provide considerably more mixed results. Nevertheless, there is relative consensus amongst the professional community that besides direct effects on demand, Cohesion Policy also has longer-positive effects on strengthening competitiveness on the supply side. Taking into account conceptual justification and the positive effects identified, we can characterise Cohesion Policy as a necessary and important EU policy for ensuring equal conditions on the single internal market. Apart from insufficient concentration of cohesion funds, the strongest criticism is directed towards complex, bureaucratised and rigid implementation systems, which reflect themselves in high operating costs and over emphasis on disbursement of funds instead of their impact. One of the conditions for continued support to the present Cohesion Policy model is, by some, argued to be increased efficiency of the implementation systems. This efficiency is in turns strongly marked by the multi-level governance context and associated complexity of allocation of responsibilities amongst Member States and the European Commission. Apart from the definition of the legal framework, the responsibilities of the latter should remain primarily limited to ensuring and verifying that the management and controls systems function effectively and to ensuring the effective use of resources on the basis of substantive and financial monitoring and evaluation. 32. Three possible scenarios for the future of cohesion policy. Although more specific positions on Cohesion Policy beyond 2013 have not yet been formulated, it is more or less clear that the key parameter, which will define the context of Cohesion Policy, will be the size


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of EU budget. Based on facts known today it is possible to anticipate three basic scenarios of EU Cohesion Policy after 2013. The first one, status quo scenario, basically represents the continuation of the current scope of Cohesion Policy. This is a scenario which, in substantive terms, is based on the Cohesion Policy as implemented during the current MFP. The second scenario, restrictive scenario, calls for reduced Cohesion Policy funding. The scenario has several variations. The first and very unlikely variation is Cohesion Policy as a fiscal transfer. This is an extremely radical variation which would completely change the existing logic and concept of Cohesion Policy. The second variation of the restrictive scenario is the so-called cohesion approach. This entails the allocation of funds only to Member States which do not reach a predetermined eligibility rule (for the Cohesion Fund, this is currently 90% of the average EU GNI per capita), but not to regions. This would mean that responsibility for less developed regions of more developed countries would automatically be renationalised, i.e. transferred back to Member States in question. The third and final variation of the restrictive scenario builds on the so-called cohesion approach, thus on the eligibility of the Member States only, but with the additional mechanism, which would reduce the risks of those who would potentially lose out with the implementation of a cohesion approach. More developed Member States advocating the reduction of the EU budget, have namely offered an agreement to the loosing out regions in which lost receipts from the EU would be compensated for from national budgets, Member States however could make their commitment to do so also on the EU level, on the basis of the so called open method of coordination. In the opposite direction to the restrictive scenario, thus in the direction of strengthened Cohesion Policy, goes the community scenario which is broadly based on the existing understanding of the Cohesion Policy as one of the EU's key policies. Cohesion Policy in this scenario would be justified on the basis of economic effects, both redistributional and allocative, but would put additional weight on political significance of Cohesion Policy, which would also justify further increases in the cohesion policies budget. 33. EU enlargement as an important factor for the future of Cohesion Policy; EU enlargement represents a key factor in all three scenarios for the future of Cohesion Policy, because this factor, particularly the inclusion of Turkey, will determine whether a particular scenario is financially sustainable or not. With regard to cohesion funds, the EU will need to decide for one of the two following approaches: allocating funds for new Member States by reducing allocations of the old Member States (current recipients of cohesion funds would have strong objections to such an approach); or leaving the policy in its existing form, which would require a significant increase of the budget for cohesion (such an approach would be opposed by large contributors to the EU budget). In terms of political acceptability both approaches (and especially the latter among the two) do not seem at all promising in the current state of affairs. 4.3. Overall size of EU budget expenditure 34. A top down or bottom up approach as the basis for defining total EU budget expenditure. So far, various types of expenditure regarded as the core of future EU budget expenditure have been analysed. There has, however, been no discussion of what the budget's overall size should be in the medium-term (in the period immediately following 2013) or in the long-term (in the period from 2018 or 2020 onwards). This question holds great significance since it has been one of the most controversial questions in all previous negotiations regarding the EUs MFP, particularly for the 2007-2013 period. In principle, this question can be approached in two ways. The first, so-called top down approach, implies


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that a level of total expenditure is determined first, for example 1% of EU GNI, followed by discussions of what to finance from the available funds. The second, so-called bottom up approach, does not accept the logic of first defining the total size of the budget, but supports the position that it should be determined in the second phase on the basis of the discussion about the policy priorities and their budgetary considerations. 35. In the period immediately following 2013, it is unrealistic to expect a considerable increase in EU budget expenditure, expressed as a share of GNI; The political and institutional structure of the EU, including the structure foreseen by the political agreement in the Reform Treaty in June this year, does not introduce any significant changes to the EU budget. This is of course an important argument for the conclusion that there will be no institutional-political incentives in favour of a significantly increased EU budget expenditure expressed as a share of GNI for the period immediately following 2013. Several substantive arguments support this conclusion as well. Some of them are the following. It is realistic to expect that the relative significance of the two most important groups of expenditure in the EU budget will decrease considerably in that period. A decrease in agricultural expenditure, expressed as a share of EU GNI, can be expected with a great degree of certainty. How steep this falling trend will be depends on the outcome of the international trade negotiations. Further, Cohesion Policy expenditure as a share of EU GNI is not expected to rise and should remain at a level near the present one. This is primarily due to the limited absorption capacity of the new Member States and the anticipated considerable reduction of allocations to the old Member States. Reducing relative volume of expenditure for these two purposes should facilitate increased expenditure for certain other purposes, while roughly maintaining the current relative level of EU budget expenditure. Relative increases of European budget expenditure can be foreseen in categories aimed at achieving the Lisbon objectives, particularly those regarding research, development and training, as well as in internal policy programmes including the protection of the common border, and expenditure linked to implementing foreign policy, including official development assistance, assistance to neighbouring countries and pre-accession assistance. Finally, some entirely new categories of expenditure will need to be developed in the EU budget due to the new challenges. What changes in EU budget expenditure will be linked to globalisation, climate change, energy and possible other developments depends on the agreement amongst Member States on what really constitutes European public goods and which therefore deserve a place in the EU budget. 36. Possible relative increases to the EU budget could only become a reality in the long-term (i.e. beyond 2018 or 2020) and if certain important assumptions are met; If the EU budget review will provide convincing answers to questions regarding European public goods and thus regarding the structure of EU budget expenditure (this would also mitigate the problem of net financial positions), and if public opinion takes on a more positive impression on the changed EU budget then it would become more realistic to expect that in the long-term perspective total EU budget expenditure, expressed in both nominal and relative amounts, will increase. How big such an increase will be depends largely on whether Member States will be prepared for closer political and institutional co-operation, and partially also on the further enlargement of the EU.


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4.4. The EUs own-resources system, including correction mechanisms 37. Fundamental characteristics of the existing own resources system and two basic courses for reform; The EUs existing own-resources system is effective for ensuring necessary EU budget revenues. Due to the existence of a GNI resource, every year it ensures sufficient funds to finance the EU budget while adapting the total funds collected to total annual expenditure. The latter is important due to the underlying principle of a balanced EU budget which states that the revenues of the EU budget must equal its expenditure. Further, it can be said that the system is relatively equitable as every Member State contributes approximately the same percentage of its GNI to the EU budget. Despite these assessments, the current system of financing also has its weaknesses. The drawbacks of the existing own-resources system are that it is complicated, it is untransparent and full of corrections and corrections of corrections. Further, the existing system can be justifiably blamed for focusing attention on the so-called juste retour or equitable repayments, which means that during MFP discussions Member States are not focused on the contents of policy discussions but on their net financial gains or losses. Last but not least, financing the EU budget which is increasingly based on the contributions of Member States more closely resembles the financing of an international organisation such as the UN than an economic-political integration such as the EU. There are basically two approaches to reforming the own-resources system; through some corrections of the existing system, or through a comprehensive reform which would include the introduction of a new tax resource at the EU level. 38. Correction of the existing own-resources system; Carrying out a correction of the existing own-resources system would largely be enabled by the two following simplifications. The first would be the abolition of the VAT-based resource in its current form since the existence of this resource, which is very similar to the GNI source in terms of substance, does not bring any substantive benefits to the existing system. On the contrary, it makes it more complicated and less transparent. The other simplification would be to recast the existing system of corrections. However, the fact is that the existence of any mechanism of corrections threatens the simplicity and transparency of the own-resources system. It is therefore necessary in the long-term to establish an EU budget expenditure structure which no longer requires a correction mechanism or to establish a general correction mechanism which would retain the concept of corrections and eliminate the deficiencies of the current system in which net financial position problems are resolved on an ad-hoc basis and according to a case-by-case principle. 39. Introduction of a new tax resource at the EU level: yes or no?; A second, considerably more comprehensive method for reforming the own-resources system anticipates the introduction of a new tax resource which would help replace a share of the existing resources, thus facilitating the elimination of their weaknesses. Discussions on the introduction of a new tax resource at the EU level have been going on for at least the last two decades, but apparently the time for its introduction has not yet come. Without doubt, the EU budget review represents an opportunity to discuss the criteria that such a tax would have to meet, as well as specific individual candidates for a European tax. The possible introduction of such a tax should be judged in terms of economic criteria and economic-political criteria. Professional opinions are mixed with regard to economic criteria. With regard to economic-political criteria, it should be pointed out that this is a very politically sensitive issue since the introduction of a tax at the EU level in fact means a partial transfer of a fundamental element


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of the financial sovereignty of Member States (i.e. their taxation capacity) to the European level. In previous discussions a number of additional criteria have arisen which a genuine fiscal resource at the EU level would have to meet. In addition to classical financial criteria of ensuring sufficient and stable revenues, a tax of this type should be transparent for taxpayers in the sense that they are aware of their personal contributions to the EU budget, and fiscally neutral, meaning that it may not increase the total tax burden of citizens. The two most important criteria for the politically acceptable introduction of a common tax are equity and a link to Community policies. Taking into account these criteria, in its 2004 report on the functioning of the own resource system the European Commission proposed three candidates for an EU tax: (i) an excise duty on motor fuels and kerosene (energy tax); (ii) a real VAT; and (iii) a corporate income tax. At that time, a large majority of Member States expressed their opposition, some categorically and intensely, to the introduction of a European tax. In contrast to Member States, European institutions are traditionally in favour of a new tax resource. The European Commission has been in favour of a new tax resource for some time, while the European Parliament also takes a favourable view of this. The latter expressed its support for a two-phased introduction of a genuine tax source in the Lamassoure Report of March 2007. The first phase would represent a complete transition to a GNI-based source, while the second phase would entail the introduction of a genuine own resource. 40. The concepts of equitable repayment and net financial position; The concepts of equitable repayment and net financial position of the Member States and a correction mechanism for these positions are closely linked to questions regarding both the revenue and expenditure sides of the budget. The concept of equitable repayment is understood as the tendency of Member States to ensure a position comparable to similarly developed Member States, taking into account the implementation of specific policies and specific degrees of solidarity. As long as a large imbalance with regard to the geographical allocation of some categories of EU budget expenditure and the current structure of budget revenues (based on national contributions through a GNI resource) exist, so too will considerable concerns that the system of own resources will change from a transparent system into an instrument for improving the net financial positions of the largest net contributors to the EU budget. Over time, the net financial position concept has been recognised as the main measure of the equity of an individual Member State's contribution to the EU budget. Yet it should be emphasised that this concept is deficient as the possible definitions used to assess net positions are all linked with a number of accounting, substantive and methodological problems. Further, such net financial positions of Member States never reflect the true benefits and/or costs associated with membership. Due to the questionable bases on which the concept of net financial position rests, it can be used primarily in a political context. Whether some financial position is equitable or not is then also finally dependent on which criteria are considered as the basis for assessing equity. 41. Correction mechanisms as a fundamental way of resolving the problems of net financial positions; Although from the viewpoint of EU budget reform there is no doubt that the best solution is the complete elimination of all correction mechanisms, it makes sense to prepare for a second-best solution which would nevertheless require some sort of corrections due to the considerable differences in the future interests of Member States on the revenue side of the budget. Countries which in recent negotiations supported the introduction of correction mechanisms typically argued their point by pointing out the uneven financial burden of Member States at approximately the same level of economic development, which was seen as the result of the considerably imbalanced expenditure structure of the EU budget.


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The result of the introduction of the UK rebate, as well as of other subsequent ad-hoc corrections and exceptions for four other net contributors, with which these countries succeeded in passing on a proportion of their financial burdens to other Member States, is that the EU budget is less transparent and distanced from systemic solutions. In 2004, the European Commission proposed the introduction of a general correction mechanism for the purpose of solving net financial position problems. The underlying quality of this mechanism, which was rejected by Member States, was the fact that it would treat all countries equally through excessive net contributions to the EU budget. At the same time, the mechanism's weakness should not be overlooked. There is no guarantee that the introduction of a general correction mechanism would dissuade Member States from arguing for and obtaining additional individual corrections. 42. Two alternative proposals for resolving net financial position problems; As stated, any correction mechanism used to resolve net financial position problems would have to meet one key criterion: it must be universal. Beside a general correction mechanism which fully meets this criterion and is technically developed, there are other alternative proposals which would facilitate an approach to resolving the problem of excessive net financial positions in a systematic and universal way. Two proposals deserve particular attention. The first proposal is that of De La Fuente and Domenech4. The fundamental logic of this proposal is that a net financial position, which all countries regard as equitable, is ensured for every Member State notwithstanding any actual EU policy expenditure agreement. This means that Member States agree on an objective criterion of equitable redistribution in the scope of the budget in advance. An ex-post correction mechanism ensures the achievement of previously agreed equitable net financial positions through a system of fiscal transfers whenever actual net financial positions derived from the agreement on EU budget expenditure and revenues are no longer equitable. Due to the formal provision for a balanced EU budget an additional assumption is necessary, i.e., that the total fiscal transfers of all Member States must equal zero. The second proposal is that of Heinemann5 which proposes the distribution of EU budget expenditure into two groups. The first group would include expenditure, universally recognised as European public goods and which would be excluded from net financial position calculations. The second group would be comprised of expenditure with a clear redistribution function, for which net financial positions would be calculated. Since the redistribution portion of the EU budget would not include all budget funds, it can be argued that an agreement regarding acceptable net financial positions amongst Member States would be reached with less difficulty than at present. 43. Possible upgrade of both proposals for resolving net financial position problems; This is an approach6 to resolving net financial position problems which combines and upgrades the proposals of De La Fuente and Domenech and Heinemann. The proposal involves both, the idea of dividing MFP negotiations into several phases and the idea of dividing the EU budget

4 De la Fuente, A. and Domenech, R. (2001), The Redistributive Effects of the EU Budget: An Analysis and Proposal for Reform, Journal of Common Market Studies, Vol. 39, No. 2, pp. 307-330. 5 Heinemann, F. Solving the Common Pool Problem in the EU Fiscal Constitution, presentation at the conference, Challenges to the EU Budgetary Reform, Ljubljana, 7 May 2007. 6 For a more elaborate presentation of the proposal see Peter Wostner (2007) On the character of the EU and it's budget: look into the future. The full text is available on the web site of the Slovene Government Office for European Affairs (www.svez.gov)


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into two parts. Pursuant to this alternative proposal, Member States would first agree on the division of individual categories of EU budget expenditure into two groups. The first group would include expenditure which cannot or should logically not be allocated (in terms of their benefits) to a specific Member State, such as administrative expenditure, expenditure aimed at external relations or the Solidarity fund. This expenditure would be excluded from calculations of Members States' net financial positions and the procedure for its adoption would be simplified and single-phased. The second and considerably larger group of expenditure would include all other expenditure. This expenditure would be included in the calculation of the net financial positions, while the procedure for the adoption of this part of the EU budget would be carried out in three phases. In the first phase, Member States would agree exclusively on extent of redistribution, in absolute terms, between net receiver and net contributor countries, and as a consequence, on the target net financial positions of every Member State. The primary objective of the second phase of the process would be an agreement of Member States on: (i) individual policies which would be financed from the budget, which would sum up to the overall size of the EU budget, (ii) sources of financing, and (iii) the spontaneous net financial positions of individual Member States. The latter would no longer be at the forefront of negotiations, since the target net financial positions of Member States were decided on in the first phase of the process. In the third and final phase of the process, the spontaneous net financial positions of individual Member States, determined in the second phase, would be brought in line with the target net financial positions, agreed in the first phase, through a fiscal transfer mechanism. Besides substantive and procedural aspects, the proposal also includes an institutional aspect and defines the role of individual European institutions in specific phases of the process. 44. Three possible scenarios of the own-resources system; Based on the analysis presented here, the following three main scenarios of the own-resources system in the period immediately following 2013 can be conceived. The first one is the status quo scenario which foresees no change to its current form but eliminates transitional exceptions defined for the 2007-2013 period. The second possible scenario, the simplification scenario, is based on a simplification of the existing own-resources system, including the abolition of the VAT resource and the UK rebate. The system of EU budget revenues would only include the TOR and the GNI resources. The third possible course of development, the reform scenario foresees the introduction of a new genuine tax resource as a step towards EU integration and the replacement of the UK rebate with the introduction of the universal correction mechanism proposed by the European Commission for the 2007-2013 period. It should be emphasised that, given the existing institutional arrangement and the current political reality of the EU, this scenario is very unlikely. 4.5. Institutional challenges 45. The search for a balance between the principles of legitimacy and efficiency as the basis of managing public finances in the EU; A highly specific institutional structure is characteristic of the EU. In the EU's overall management and therefore in its management of public finances elements of international and supranational management intertwine, hence the search for a balance between the principles of legitimacy and efficiency. The basic challenge of the review of procedures linked to the preparation and adoption of the MFP must be the search for new balance between these fundamentally opposed principles. The principle of efficiency should ensure the timely and substantively flexible distribution of resources and the provision of public goods. It should be emphasised that the efficiency of the procedure


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depends on the institutional framework in which decisions are made. A more complicated structure typically means bigger problems with efficiency. The principle of legitimacy should fundamentally ensure control, i.e. a checks and balances logic. If a system is efficient, but is not complemented by an efficient delegation of authority and control of the process, its legitimacy suffers. A still relatively low degree of political and institutional integration has a considerable impact on the relationship between the principles of efficiency and legitimacy with the regard to public finances in the EU. 46. The existing method of managing European public finances with a legally non-binding MFP is justifiably criticised due to its insufficient efficiency, although it does ensure a high degree of legitimacy; According to the existing procedure for preparing and adopting the MFP, the procedure is concluded by the inter-institutional agreement of the European Parliament, the European Council and the European Commission. It must be stressed that the MFP is not a legally binding act but a voluntary agreement of three key European institutions which will collectively take a decision regarding the EU's medium-term financial framework. With the help of an inter-institutional agreement, the EU achieves two important objectives: stability in the planning of EU budget expenditure and the prevention of most conflicts amongst the three institutions during adoption of the annual budget. The MFP also has its negative aspects. It is a very rigid instrument as it sets the status quo for the entire financial perspective period, which may in a rapidly changing world create significant problems. Further, Member States use the threat of veto as a tool for maximising their negotiating power during MFP negotiations. In the past, the threat of a veto has proven to be an effective tool for maintaining the status quo or the very gradual implementation of changes, which the cases of expenditure for the CAP, Cohesion Policy and the UK rebate clearly confirm. In such an environment, it is understandable that no fundamental changes in the process of adopting the MFP will be made if these changes are not stimulated by more significant shifts in the area of EU political and institutional integration. Events in the EU in recent years, substantiated by complications regarding the Constitutional Treaty, along with various studies and public opinion all send a very clear signal that, at least for now, EU citizens are not prepared to transfer sovereignty from their countries to the EU. This is particularly true with regard to public finances. 47. Major institutional dilemmas linked to the EU MFP as a strategic instrument of its medium-term financial programming; In previous discussions, a number of dilemmas linked to the EUs institutional structure in the area of preparing and adopting the MFP have been exposed. The most significant three are as follows: First, should the MFP be adopted by consensus or a qualified majority? Although the abolition of the veto during adoption of the MFP is vitally important in terms of efficiency, taking into account the current degree of political integration in the EU this would significantly aggravate the problem of ensuring the principle of legitimacy. Serious questions then emerge: What interest would outvoted Member States still have in the MFP as an instrument of strategic financial planning in the EU? Second, should the MFP become legally binding or not? The proposed Reform Treaty foresees the MFP becoming legally binding, with which the formal weight of the MFP in budget planning would undoubtedly increase. In this regard, the argument against, which states that the abolition of the principle of self-determination actually eliminates the possibility of using the MFP as an instrument for reducing tensions amongst Member States, should not be overlooked. Further, the binding character of the MFP could also be a reason for maintaining the status quo on the expenditure side of the budget. Third, should the MFP be adopted by a budget Council of Ministers in the future or, as it is now, by the European


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Council? There is wording in the proposed Reform Treaty that would facilitate adoption by the European Council and also within the scope of the Council of Ministers. Although once again there are arguments in favour of both solutions, it makes sense for decisions regarding the MFP to remain the responsibility of the European Council. Only the European Council can expand the manoeuvring room of negotiations in such a way that certain other, less urgent financial problems are resolved in a package with MFP negotiations. This is important if taken in terms of the previous practice in which MFP agreements frequently formed part of some broader agreement. Besides the three dilemmas presented, it is also important from an institutional perspective to bring the duration of the MFP in line with the term of office of the European Parliament, which would mean shortening the duration of the MFP from 7 to 5 years, and to increase the flexibility of spending within the scope of the MFP. 48. The current and future role of individual European institutions in MFP consultations; A core dilemma related to the preparation and adoption of the MFP lies in the search for an answer to the question: What should be the roles of the European Council, European Parliament and the European Commission in this process? Currently, negotiations regarding the MFP are largely concentrated in the European Council in which Member States are directly represented. This of course means that as long as budget negotiations are carried out primarily within the scope of the European Council, national interests will prevail. Further, the European Council is also the most status quo oriented of all three European institutions. This all supports the conclusion that as long as the European Council plays such a dominant role in the process of preparing, negotiating and adopting the MFP as it does now, no serious, substantive changes in the EU budget can realistically be expected. There is a specific change in the process of preparing and adopting the MFP foreseen in the proposed Reform Treaty. Yet today it is difficult to predict its actual effect. The Reform Treaty changes the order of decision-making by individual European institutions as it lays down a provision that is different to the provision in practice today. According to this provision, a proposal of the European Commission would first be adopted by a simple majority of the European Parliament and then sent to the European Council which would still make its decision with the consent of Member States, at least in the first phase. Member States, within the scope of the European Council, would be under greater pressure in such a revised order for discussions and decisions regarding the MFP than at present since it would be more difficult to completely or significantly change the decisions of the European Parliament regarding the structure and/or size of expenditure. Chapter 5: EU budget scenarios for the period immediately following 20137 49. Technical specifications of scenarios and their methodological assumptions. The content of all four scenarios (existing expenditure level scenario, existing policies scenario, restrictive scenario and the community scenario) set out in general in Chapter 4, are presented at a completely technical level in Table 1. All scenarios are based on the same macroeconomic assumptions and assumptions regarding anticipated demographic trends. Further, three variations with regard to possible EU enlargements are foreseen for every scenario. For every scenario, the following variations have been prepared: (i) the existing number of Member States (variation EU-27), (ii) EU enlargement to the countries of South-

7 Based on technical specifications of the four scenarios articulated by the taskforce, all the calculations for the scenarios have been prepared by the taskforces member Vasja Rant.


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east Europe (variation EU-34)8 according to which Croatia would join the EU in 2011, with other countries in the region joining in 2014, and (iii) enlargement to the Western Balkans and Turkey (variation EU-35) which is based on the same assumption with regard to the dynamics of the EUs enlargement to South-east Europe, but additionally also assumes the inclusion of Turkey in 2014. The assumption of the dynamics of further enlargements does not reflect realistic expectations with regard to the timing of the accession of new countries to the EU with the possible exception of Croatias entry in 2011. The purpose of the timing assumptions with regard to the EUs enlargement is primarily to assess its effect on the EU budget in a quantitative manner, if and when enlargement actually takes place. All scenarios are analytically prepared in the same methodological manner. The technical assumptions on which the preparation of the scenarios is based are presented first, followed by a presentation and analysis of calculations which are presented in summary form in Table 2. Finally, a substantive assessment of the scenarios is given. 50. Substantive assessment of the existing expenditure level scenario (EELS); This is a status quo scenario whose sole purpose is to present a benchmark for subsequent comparison with other, substantively more interesting scenarios. In this regard, it is clear that this scenario

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