Year XLI, 1999, Number 3, Page 194



1. The current EU financial constitution, and particularly the current financing system, violate several principles which can be derived from the economic theory of federalism:[1]
The congruence principle. This demands that the spatial sphere of action of an official task and the taxes set up to finance it should generally coincide with the territorial sphere of responsibility of the institution or body responsible for it. For the financing of EU expenditure therefore, EU-wide revenues should be available, for which the Union bodies have to bear political responsibility. This is currently not the case.
The correspondence principle. This means that those who decide on, those who benefit from and those who pay taxes for public expenditure should be represented in the decision-making bodies. If the beneficiaries dominate, the budget turns out too large; if the taxpayers are in the majority, and if they do not simultaneously profit adequately from the expenditure financed by themselves, the budget will end up too small. Only where the three sides correspond to a large degree can budgetary discipline and something approaching an “optimal” budget be expected. Correspondence at EU-level means that the individual political decision-makers — whether these are the voters or the members of the Commission, the European Parliament, or the Council — have decision-making competence both as to expenditure and as to revenues. These preconditions do not however obtain in the EU, since the EU has no fiscal sovereignty, and decisions on expenditure therefore need not be weighed up against the burden of taxation. This explains the longstanding practice of largely leaving decisions on agricultural prices and agricultural expenditure to the Council of Agricultural Ministers in particular. This resulted in an over-large agricultural budget, which used to represent over two-thirds of the Community budget, and still accounts for half of it today. Coming down from such an excessive level, once reached, proves extraordinarily difficult, as shown by the efforts to achieve agricultural reform in 1992 and now the current reform.
The principle of optimal endowment, differentiation and utilization of competences. The EU decision-making system must, to the demands of the principles of democracy and the division of powers, be provided with a large and differentiated decision-making capacity. Relative to the current state of European integration, this is also basically the case. This large and expensive decision-making capacity could however be better used, if the EU took over more responsibilities with a European dimension, realised a clearer division of responsibilities between the Union and the member-states in accordance with the principle of subsidiarity, and if the, in many areas excessive, “interdependency of policies” between the Union and member-states were reduced. A further requisite for optimal organization of competence is the power to levy taxes.
The principle of fair distribution. At the moment the EU is mainly financed through customs duties and agricultural levies, a VAT sharing and member states’ contributions. Agricultural levies, a proportion of the customs duties and the EU VAT system tend to be regressive, in other words, poorer citizens and families contribute more than richer ones relative to their income. Correspondingly, the poorer member states are also relatively more heavily burdened. The financial contributions of member states, oriented towards GNP, are of course formally proportional, but also burden the poorer citizens and families disproportionately. The reason for this is that these must be raised through the respective national taxation systems, which also includes the VAT system. The latter is therefore raised both directly and indirectly, twice in fact; moreover, in the poorer countries in general it accounts for a higher share of total tax revenue than in the richer ones. Although all member state taxation systems also present progressive taxes such as income tax, which in the national context at least partially compensate for the regressiveness of consumption taxes, this compensatory effect is considerably diluted in EU financing. From the perspective of a fair distribution of the taxation burden, the EU should therefore be given a new, progressive source of income. There have already been made suggestions for a progressive new source of revenue in the McDougall Report,[2] which were taken up by the Spinelli Committee of the EP. The EP however later moved away from this with the Lange Report and proposed value-added tax as a European tax. I myself proposed a surtax on income and corporation tax back in the eighties. And finally in 1998 Spain, with the support of Greece and Portugal, presented a progressive tax solution in the context of the discussions on AGENDA 2000. None of these proposals for a progressive solution has yet found a majority however.
The principle of financial equalization. Here we must distinguish between implicit and explicit equalization. Explicit equalization rests on a comparison between the taxable capacity and expenditure requirements of a corporate entity. If the required expenditure exceeds the taxable capacity, the entity in question is entitled to financial aid. This must be raised from those entities which have a greater taxable capacity. There is a legal claim on this financial assistance, and the beneficiary can generally freely avail itself of it without constraints as to its use. Such explicit financial equalization presupposes a more homogeneous system of social values underpinning a greater degree of solidarity, than in my view exists in the EU, either currently or in the foreseeable future.
Implicit financial equalization does however exist in the EU. This consists in the fact that through certain community policies, such as the structural funds policy, more resources flow to poorer regions than to rich ones. These resources are moreover basically committed to investment purposes. In the McDougall Report of 1977 we had already indicated that such implicit equalization through the central budgets exists within the unitary and the federal states examined in our survey. It consists of transferring a portion of the profits from international and inter-regional trade of the richer regions within a country to the poorer regions. The rich regions tend to be net payers in this, the poorer regions net beneficiaries.
The implicit equalization which exists in the EU budget is however partly disproportionate, and partly distorted. It is disproportionate in so far as Germany, with about 60 per cent of all net transfers, is by far the biggest net payer. All prominent German politicians have of course always recognised that Germany will be a net payer — what concerns them is to reduce the excessive amount of the German net contribution. The Netherlands too, Austria and Sweden are net payers; Great Britain would have been the second biggest net payer after Germany were it not for the so-called “British rebate” since the Fontainebleau Summit. In addition, the states favoured by the current system include not only the financially weak member states, who are rightly net beneficiaries, but also richer ones, who really ought to be net payers.
The position of a country as net payer or net beneficiary depends however not only on the distribution of the burden as regards financing, but also on the distribution of EU expenditure. One of the factors is that the EU is only responsible for a few competences, which incur high expenditure. Prominent among these are the agricultural policy, accounting for about 50 per cent, and the structural policy, accounting for about 30 per cent of total expenditure. Structural policy expenditure is largely in harmony with fair implicit equalization, since this goes predominantly to member states with economically weak regions. This is not true however for agricultural expenditure. This has already been shown by the calculations for the proposal developed by the EP Budgetary Committee to introduce national co-financing of the CAP income transfer. With a 25 per cent co-financing Germany would be greatly relieved of its burden, but France and Greece for example would be very burdened. This suggestion was therefore rightly not accepted at the Berlin Summit. Instead the Commission’s suggestions for lowering agricultural prices were extensively modified; among other things, in order for more to flow back to Germany.
2. The analysis carried out so far makes the twofold problem of the EU financing system quite clear: neither the burdens of financing on the one hand nor the benefits from expenditure on the other are distributed. There is full agreement that there can be no principe de juste retour by which every member state receives back as much as it has paid in. This would destroy the foundations of the Community, which has solemnly committed itself toeconomic and social solidarity and therefore in principle also to re-distribution through the EU budget. Economic and social solidarity must however be measurable iagainst deals of fairness, and therefore demands a reform of the EU financial constitution.
The basic features of such a reform might look like this:[3]
a) The EU is to be vested with the power to levy taxes. This will make it possible for the EU to charge surtaxes both on indirect taxes, particularly VAT, and on direct taxes, particularly on income and tax.
b) Through the introduction of a progressive surtax, the currently dominant regressive financing, which puts too a burden on the poorer strata of the population and on the economically weaker member states, could be reduced and a fairer division of the burden realised. Depending on the design and combination of both forms of surtax, any desired degree of progressiveness can beachieved. This undertaking is an eminently important political decision, on which experts can of course advise, but for which there is no scientific basis. The degree of progressiveness could be low at the beginning and be adjusted in the course of further integration.
c) The division of the budget into a “compulsory” and a “non-compulsory” part should be lifted; joint, undivided responsibility for the total budget will be transferred to the Council and the EP. This requires the setting up of a negotiation procedure in case of dissent between the Council and the EP.
d) The one-sided and asymmetrical maximum rate of increase (EC Treaty Art. 203), which only applies to non-compulsory expenditure, will be done away with. It was already out of place, since it was precisely the increase in compulsory CAP expenditure which had led to the budget crisis of 1987/88. Fiscal sovereignty correlative to the correspondence principle will generally take care of more budgetary discipline. If the participants however still have doubts as to whether this is enough to curb their decisions on expenditure, then another, general solution must be found.
3. The European Commission’s proposal to introduce a solution to financial contributions oriented purely according to GNP, with no EC fiscal sovereignty, is incompatible with these suggestions. To my mind, the Commission’s proposal presents a short-term technocratic solution, but not a long-term, political solution which can be democratically legitimized. Their idea is particularly surprising since the Commission itself observes that the lack of financial autonomy leads to “an erosion of accountability”, “since for the European citizens, taxes diverted to the EU budget are not directly recognisable as such”.[4]
A further argument, that progressiveness should be realised not on the revenues side, but on the expenditure side,[5] is neither convincing and nor sound. It neglects the reasons why such an attempt at expenditure side progression in the case of Great Britain failed and had to be replaced by the Fontainebleau rebate on contributions: namely, that it is scarcely possible to draft so many community policies, as progressively as would be required. The disadvantage of this method also showed itself at the Berlin summit, when the total package of agricultural price decreases proposed by the Commission had to be set aside, not least because of the need to achieve greater flows back to Germany.
Finally it is embarrassing to have to point out that EU member states participate in the financing of the United Nations in the context of a contribution system which even in the eighties was slightly progressive, and in any case proportional, when EC financing was still regressive.[6] Should one somehow conclude from this that in the United Nations and therefore world-wide there is more solidarity, or at least as much as in the EU? The essential advantage of the Commission’s solution to the financial contributions is that the system will become slightly less regressive, but then the correspondence principle in particular and the principle of a fair distribution of burden would be further violated. Altogether, in view of the many solemn summit declarations, the solution to financial contributions represents in my wiew a backwards step into the early phases of European integration.
Dieter Biehl

* English translation by Elspeth Wardrop of a German text presented at the UEF Congress 1999.
[1] Cf. for a full overview on the twelve principles of Fiscal Federalism Dieter Biehl, “Economic Theory of Federalism and its Application to the European Union”, in U.T. Ritter (ed.) Problems of Structural Change in the 21st Century, Frankfurt/Madrid 1966, pp. 144-172.
[2] The author was the German member of the McDougall Committee. Cf. EC Commission (pub.), Report of the study group on the role of public finance in European integration (McDougall Report). 2 Vols. Brussels, 1977.
[3] In addition to my article mentioned in footnote 1 more recent publications, for example Dieter Biehl, “Zur ökonomischen Theorie des Föderalismus, Grundelemente und ihre Anwendung auf eine EU-Finanzunion”, in H. Schneider and W. Wessels (eds.) Föderale Union — Europas Zukunft?, Munich, 1994, pp. 99-122; “Wechselspiel zwischen Prozeß und Institutionalisierung im Zuge des europäischen Integration”, in Bertram Schefold (ed.), Wandlungsprozesse in den Wirtschaftssystem Westeuropas, Marburg, 1995, pp. 109-152; “Braucht die Europäische Union eine eigene Steuerhoheit? Ein Plädoyer für eine Reform der Finanzverfassung der Gemeinschaft”, in W. Gick (ed.) Die zukünftige Ausgestaltung der Regionalpolitik in der EU, Munich, 1996, pp. 29-54.
[4] European Commission, AGENDA 2000: Financing the European Union; Commission Report on the Operation of the Own Resources System, Appendix 2/98 to the European Commission Bulletin, Luxembourg 1998.
[5] Ibid., p. 23.
[6] Dieter Biehl, “Finanzausgleich IV: Internationaler Finanzausgleich” in: Handwörterbuch der Wirtschaftswissenschaft, Vol. 2, Stuttgart p. 689-713.

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