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DISCUSSION PAPER
1/June 2026

Why European debt requires European fiscal capacity
by Stefano Chiesa

Abstract

In recent years, the debate on the economic governance of the European Union has seen an almost unprecedented convergence on the need for common debt. Enrico Letta identified joint debt capacity as an essential tool to guarantee the future of European competitiveness by investing in strategic infrastructure and creating a new safe asset (Letta, 2024). Subsequently, Mario Draghi confirmed this thesis, adding that the capacity to issue debt must be accompanied by an increase in own resources or national contributions to the EU budget. French President Emmanuel Macron continues to push for a common debt capacity to finance future Union challenges, such as joint defence procurement. Some scholars theorise gradual approaches as current challenges make them necessary (Dorrucci and Rossi, 2026), while others warn against the costs of European gradualism and enhanced cooperation regarding debt (Scandizzo, 2026), whilst acknowledging its importance. However, many current proposals for European debt share a marked structural weakness: they propose the issuance of common liabilities without providing a symmetrical institutional architecture that grants the Union a true autonomous tax-raising capacity^[1], a fundamental pillar of a European fiscal capacity. This is problematic because, for debt to be considered safe, it must be accompanied by clear and certain guarantees so that markets can lend at a low price. In this paper I will focus on the limits and risks of intermediate arrangements. I aim to highlight how the possibility of this joint debt is part of a coherent path towards the federal transformation of the European Union, in which the attribution of an autonomous tax-raising capacity at the European level is an integral part.

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[1] Autonomous tax-raising capacity refers to the authority to collect its own permanent revenue independently of direct contributions from national budgets, without the need for unanimous agreement among Member States.

Chapter I
The need for a debt instrument to finance the European budget and experiences to date^[2]

In recent years, the debate on the economic governance of the European Union has seen an almost unprecedented convergence on the need for common debt. Enrico Letta identified joint debt capacity as an essential tool to guarantee the future of European competitiveness by investing in strategic infrastructure and creating a new safe asset (Letta, 2024). Subsequently, Mario Draghi confirmed this thesis, adding that the capacity to issue debt must be accompanied by an increase in own resources or national contributions to the EU budget. French President Emmanuel Macron continues to push for a common debt capacity to finance future Union challenges, such as joint defence procurement. Some scholars theorise gradual approaches as current challenges make them necessary (Dorrucci and Rossi, 2026), while others warn against the costs of European gradualism and enhanced cooperation regarding debt (Scandizzo, 2026), whilst acknowledging its importance.
This need clashes with the limits set by the Treaties. Article 310 of the TFEU states that "revenue and expenditure shown in the budget shall be in balance", and Article 17, paragraph 2, of the Union's Financial Regulation reiterates that the Union and its bodies may not raise loans within the framework of the budget.
The presence of these provisions has not prevented the Union from issuing debt on several occasions, starting from the 1970s with debt issuances to assist Member States most affected by the oil crisis, through to more recent cases such as the European Financial Stabilisation Mechanism (EFSM), the medium-term financial assistance facility for Member States' balances of payments, or SURE. These were back-to-back loans, meaning authorisations for the Commission to borrow on behalf of the Union to provide loans to Member States or third countries. The funds raised and the expenses resulting from the disbursement to States in these cases are not recorded as revenue and expenditure, as they offset each other entirely; these operations are therefore neutral and off budget.
In recent years, the need to address the consequences of the pandemic and the requirement for resources to help Ukraine have led to forms of borrowing on a much larger scale than in the past.

In particular, Next Generation EU (NGEU), the package of measures adopted in response to the COVID-19 crisis, constituted a real turning point: a debt issuance of 750 billion euros guaranteed by the Union budget and used both for providing loans and for financing grants and operational expenditure. To enable this operation, the 2020 Own Resources Decision temporarily raised the budget ceiling to 2% of Gross National Income (GNI), thus increasing it by 0.6%, a figure to be covered through the establishment of new own resources or, failing that, by additional contributions from Member States.
Since the debt contracted with NGEU is not a neutral operation, the possibility of allowing its issuance in accordance with the principle of a balanced budget was based on qualifying the revenue from the debt issuance not as own resources, but as "external assigned revenue" not usable for the Union's current expenditure, but to be used for financing pandemic recovery measures. Indeed, Article 311 TFEU provides that the budget, without prejudice to other revenue, shall be financed wholly from own resources, thus admitting that alongside own resources, which finance all Union expenditure, other revenue exists.
A reflection on the limits of NGEU is useful for understanding the role that debt can play in the future financing of the Union. In particular, it emerges that, in this case, European debt has proved more expensive than expected: markets have contradicted the Commission's forecasts, and interest rates have turned out to be higher than anticipated. European debt has, in other words, been priced unfavourably by financial markets.

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[2] This chapter draws on the analysis by Giulia Rossolillo on this specific point, contained in the policy paper being prepared by the Working Group on Budget and Taxation of the European Federalist Movement (Movimento Federalista Europeo).

Chapter II
The theory supporting the need for European fiscal capacity

The weakness of this intermediate arrangement without a European fiscal capacity can be formally explained through bond pricing models; i.e. how much it costs to borrow money. This price is described by the risk-free rate r_t, the probability of default h_t , the loss given default L_t, and the liquidity premium L  (Duffie and Singleton, 1999):

R_t = r_t + h_tL_t + l

Since no absolute zero-risk assets exist in financial markets, the "risk-free rate" parameter is operationally approximated using the yields of the safest sovereign bonds, which in the Eurozone find their benchmark in German debt. The impact of the probability of default on the cost of debt follows an intuitive logic: creditors demand a premium directly proportional to the estimated risk of insolvency. The liquidity premium is less immediate: an asset is more liquid the greater the critical mass of capital invested in it. A deep and liquid market absorbs transactions better, reducing price impact and mitigating the overall volatility of the security. Since variability is a penalising risk factor, investors are willing to accept a lower interest rate in exchange for the stability guaranteed by a highly liquid asset.

Many proponents of European debt argue that aggregating national issuances into a single European asset would create a liquidly vast market, consequently lowering the cost of debt. However, the cost advantages resulting from greater liquidity are negligible, and the true driver of yield is the perception of risk (Favero and Missale, 2011). In fact, supranational debt such as that of the European Investment Bank (EIB) is not priced by markets with the same yields as German debt, but likely as a weighted average of Member States' interest rates. This happens because EIB debt is guaranteed by the capital shares of Member States, not unlimitedly by European taxation. This institutional architecture generates deep uncertainty regarding the scenarios of a potential EIB insolvency.

The central issue for markets concerns the enforceability of guarantees: in the event of default, would Member States intervene to settle liabilities? Furthermore, should some countries fail to meet their commitments, would the remaining States bear the shortfall, effectively operating under a regime of unlimited joint and several liability? These question marks lead creditors to demand a higher interest rate and, consequently, make the debt more expensive.

As mentioned, recent data regarding NGEU also confirm this thesis. As shown in Figure 1, the absence of a fiscal union has made NGEU debt not only more expensive than expected, but also more expensive than German national debt and at times higher than French and Spanish debt (Claeys et al., 2023). Indeed, for the 2021-2027 Multiannual Financial Framework, the European Commission had planned a maximum amount of 14.9 billion euros to cover annual NGEU interest payments, assuming that average yields would increase gradually from 0.55% in 2021 to 1.15% in
2027 (European Commission, 2023). By the Commission's own admission, markets have contradicted this projection (European Commission, 2025). Interest rates have exploded (Table 1), reaching a peak of 3.63% in 2023, approximately more than four times higher than anticipated.

Figure 1: Yields Comparison (2021-2023) and Yield Curve (2022-2023)

Table 1: Comparison of Estimated Interest Rates and Actual Interest Rates on NGEU (2021-2024)

Note: The estimate assumes a statistical interpolation between 2021 and 2024.
Source: Author’s calculation based on the Half-yearly report (March 2025) data.

These figures show an asymmetry between the hopes placed in European debt and its actual costs, given that markets demand a risk premium to finance an entity lacking direct tax-raising capacity. Some suggest the problem is that Member States do not provide an unlimited joint and several guarantee for NGEU debt. The current architecture provides for a maximum limit of strictly national liability: should the Union budget have insufficient funds, the European Commission is authorised to request an extraordinary increase in State contributions, but each country is legally bound to intervene only up to an insurmountable ceiling equal to 0.6% of its GNI. This brings potential debt guarantees to approximately 108 billion euros per year^[3], much higher than annual interest projections according to Bruegel (Figure 2), which estimate annual interest portions ranging from
7.8 to 12.4 billion euros (with a 50% confidence interval), or between 3.2 and 18.1 billion euros (with a 90% confidence interval).

A spontaneous question therefore arises: why, despite collaterals being much higher than required, does the market punish the European Union with interest rates higher than German ones? Because the fact that guarantees depend on transfers from Member States rather than resources directly collected by the Union creates uncertainty. In the event of a crisis, States could initiate political disputes, arguing for example that the burden of repayment should fall more heavily on countries that benefited most from the programmes. Or they could simply refuse to pay. Lacking coercive power, the current institutional structure of the EU fuels creditor doubts. Specifically, the unanimity requirement provided by Art. 311 TFEU for the introduction of new own resources weakens the Union's ability to honour its debts, as it makes the actual possibility of raising supplementary capital in case of need uncertain.

Figure 2: Projections of annual interest charges on EU debt: comparison between European Commission estimates and market scenarios

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[3] Calculated considering 0.6% of EU GNI, estimated based on Eurostat (2024) data at approximately 18 trillion euros.

Chapter III
The democratic problem

In the absence of a centralised fiscal capacity, European debt would entail a transmission of credit risk from citizens of countries deemed less reliable by markets to those of more reliable countries. If implemented as an intermediate step, without accompanying this architecture with a cohesive political power, common debt would pose a democratic deficit problem.
Any structural transfer policy is controversial, even in contexts of consolidated political and identity integration: this is clearly shown by persistent fiscal tensions between North and South in Italy or the complexities related to reunification between West and East in Germany. In these national cases, however, the transfer is mediated by a Parliament and a central government accountable to a single electorate; the very fact of belonging to a single state community creates the conditions for the legitimacy and consensus necessary to implement concrete mechanisms of solidarity and redistribution directly among citizens. In the absence of a federal government and parliament, conversely, the mutualisation of risk could appear as an external imposition, potentially fueling nationalist rhetoric seen in other contexts. The paradox is that citizens of some Member States could find themselves financially guaranteeing political decisions on which they have no voting power, as they are taken by the parliaments of other States.
The problem would be even more critical should the new debt be used to cover national spending instead of cross-border and European projects. Despite the intent of common debt proponents to favour integration through European projects, evidence regarding NGEU shows that funds were primarily used to finance national spending, whether preexisting or newly programmed (Corti et al., 2022). In the case of Germany, Austria, and Belgium, spending for projects with cross-border spillover effects amounted in 2022 to only 26%, 24%, and 15% of the total plan volume respectively (Figure 3).

The current architecture of the EU, confederal and biased in the decision-making process towards national governments, thus hinders the realisation of true Union projects. Since Member States are accountable exclusively to their own electorates, they tend to retain control over spending, fragmenting resources into local projects to seek internal consensus. Until the current political arrangement is overcome in favour of a federal one, it will be almost impossible to overcome national egoism in a structural way.

Figure 3: Share of projects and volume used for projects with cross-border spillover effects

Chapter IV
European debt and differentiated integration

In the current stalemate, where the heterogeneity of national interests and the differing visions of governments block the political-institutional evolution of the European Union of 27, many today propose proceeding with the integration process at multiple speeds, also regarding debt. This idea requires some clarification.

Firstly, multi-speed integration must not translate into a Europe à la carte, where the fragmentation of States into different groups for the debt-financing of individual temporary policies would risk weakening the European project. True differentiated integration would instead require the birth of a cohesive vanguard, capable of advancing simultaneously on multiple fronts and not just on single policies. Within the treaties, the instrument provided for integration on single policies is enhanced cooperation, which however presents several legal limits if one attempted to use this institution to issue new debt. These include the impossibility of establishing permanent debt programmes due to Articles 310 and 312 TFEU, the prohibition on renewing securities at maturity, the maintenance of purely proportional guarantees excluding joint and several liability, and the complexities in combining debt issuance with joint defence procurement due to the restrictive interpretation of Article 346 TFEU (Dorrucci and Rossi, 2026). When attempts were made to use it in other political contexts, such as for the proposed financial transaction tax back in 2013, this instrument proved ineffective precisely due to Treaty-imposed limits (Rossolillo, 2022).

Even if a vanguard outside the treaties were hypothesised, this should be conceived as a political core, and common debt should correspond to a tax-raising capacity. Indeed, it is important to highlight that, in the absence of federal tax-raising capacity and a political union, forms of differentiation relating to sectors involving redistributive elements do not work. The possibility of choosing whether to join or not (opt-out) would drive wealthier or less risk-exposed States not to participate to avoid costs, thus isolating more vulnerable countries and allowing national interests to prevail (Schimmelfennig, 2020).

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Conclusion

The Federalist Political Proposal

The current political consensus around common debt represents a historic opportunity; all the more reason, therefore, why it must not translate into yet another partial path. If the euphoria for the European "Hamiltonian moment" is limited to the creation of European debt without corresponding fiscal capacity, the Union risks crystallising definitively into an inefficient and expensive institutional hybrid. Federalist action must therefore reverse the narrative: debt is not the end, but the functional consequence of a shared fiscal sovereignty, which in turn is part of a political-institutional development of the Union indispensable for making it adequate for the current international context. To transform European debt into a true instrument of stability and investment, it is therefore necessary to make the leap towards a European federation founded on two inseparable pillars:

• Autonomous tax-raising capacity: This implies moving beyond the system of national transfers to provide the Union with direct European taxes. Only a certain tax revenue, autonomous from Member State contributions, can make the EU solvent in the eyes of markets, freeing the budget from the current cross-vetoes of unanimity provided by Art. 311 TFEU and potentially lowering interest rates on debt.
• Democratic legitimacy: The power to tax and to borrow must be balanced by parliamentary power. It is necessary to overcome the current democratic deficit by granting the European Parliament full budgetary powers and establishing a federal government accountable to voters, capable of directing resources towards European public goods instead of fragmenting them into national interest spending.

The function of federalists is not indulging politics whenever it hints at a step towards integration, but rather in exposing its national and intermediate limits. If today almost the entire political spectrum evokes European debt, it is crucial that the insufficiency of such instruments in the absence of a federal leap be highlighted (with the political consequences that such insufficiency entails). Without federalists, proposals for new debt would continue to exist, but the ability to highlight their structural limits and to claim the necessary condition for their effectiveness, namely the transformation of Europe in a federal sense, might not emerge.

Bibliography

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