The details may seem arcane, but the agreement – or compromise – that finally emerged in the early hours of Tuesday morning of 21st July is historic. It also raises some big questions for the EU – economic, but also political.  Juuso Järviniemi discusses.

The EU’s “Next Generation EU” COVID recovery fund, debated day and night at the marathon summit for the past five days, has been dubbed as an historic step for increasing the Union’s financial capacity. The fund of €750 billion adds to the EU’s next €1.074 trillion seven-year budget agreed early Tuesday morning. The big goal of the fund is to provide a European response to the economic catastrophe triggered by the coronavirus.

Remarkably, the recovery fund involves the European Commission borrowing money from the financial markets – to be paid back slowly from future EU budgets by the year 2058. Of the fund, €360 billion will be channelled into loans for the member states, which they must pay back; the other €390 billion are grants, and payback responsibility therefore rests on the Union. Before it’s time for the EU to pay up, the question that arises is where the money will come from: we are in for a new round of the age-old debate about the EU’s powers to collect taxes and levies.

New “own resources” for the EU?

The biggest source of revenue in the EU budget has been contributions from member states, calculated based on the countries’ Gross National Income (GNI). In 2018, these resources accounted for 65.9% of the EU budget, while just 12.8% came from the EU’s “traditional own resources”, such as customs duties. In other words, as long as EU budgets are mainly based on national contributions, the Commission will end up paying back its loans with money coming from the Member States’ coffers.

That said, the European Commission’s original May proposal for the recovery fund already featured a pledge that the Commission will later make new bids for EU “own resources”. Possible targets identified by the Commission are corporations, a carbon border tax, and an extended Emission Trading System, each of which could bring around €10 billion to the EU every year. Additionally, the Commission envisaged a digital tax that could bring over €1 billion yearly.

In 2018, the Commission had estimated that it could raise €7 billion a year by charging the Member States for plastic package waste generated within their territory. The summit conclusions from this morning gave a thumbs-up to the goal of introducing new “own resources” for the EU, and the plastic package fees will already apply from January 2021.

The various environmental taxes would connect the need for “own resources” with the EU’s climate agenda. Meanwhile, income for the EU coming from a common corporate tax base could not only boost the EU budget, but also address the issue of countries with lax rules acting as intra-EU tax havens for companies engaged in aggressive tax planning. While neither of these topics is politically easy, corporate taxation is even more sensitive – and received no mention in today’s summit conclusions.

If all of the proposals were applied in practice, their effect would be modest, though not insignificant: even a revenue of €40 billion would have covered just over a quarter of the EU’s 2019 budget, which amounted to around €148 billion. However, once one remembers that the EU budget has only totalled around 1% of the Union’s total GDP, it is easy to conclude that the proposed measures alone would not be enough to turn the EU into a fiscal giant. (For comparison, according to the European Commission, the average figure for member states’ budgets is 46%.)

The big picture: How can the EU get its hands on some big money?

Looking further into the future, one big elephant in the room is direct taxation of citizens’ incomes. Income tax is a key cornerstone of budget planning for other levels of government from the local to the national, yet the subject has largely been taboo at the European level. The broad tax base would be reliable and provide for ample revenue – the kind of financial muscle that Europe needs for addressing big economic shocks. Admittedly, income tax at a European level would require a fundamental rethink of what the EU is, and a revision of the Treaties. Yet in the long run, it seems like one logical tool for addressing Europe’s economic woes.

Another big source of income for the member states is Value Added Tax (VAT), which indeed already brings money into the EU budget. The member states generally pay 0.3% of their VAT incomes to the EU, which accounted for around 11% of the EU’s revenue in 2018. However, the size of the VAT contribution and its share of the EU budget have decreased over time, not increased. Much as high VAT within member states hurts less well-off consumers in relative terms, basing the EU budget on VAT contributions would add financial burden on the poorer member states.

A more capable EU: A goal that cuts across ideological lines

The €750bn COVID recovery fund is an ad hoc response specifically aimed at recovery from the current crisis, much as aid instruments during previous crises were habitually agreed on a case-by-case basis. Having to resort to one-off solutions time after time is a sign that the EU budget itself has been insufficient.

For years, it has been repeated that the Eurozone is vulnerable to new economic crises if it has no proper budgetary capacity for absorbing shocks, and for fostering convergence in markets during normal times. Spending at times of crisis often takes the form of social investment, in line with the idea of a “social Europe”. One small example has been the EU Youth Guarantee launched in 2013 to fight youth unemployment, which has been backed up with a budget of €8.8 billion since its creation. The pandemic has offered other examples, including the €100 billion SURE unemployment package which offers favourable loans from the EU to the member states. However, truly large-scale initiatives inevitably go beyond the scope of ordinary EU budgets, unless the budget is significantly increased.

In the history of European integration, removing trade barriers within the Single Market has been associated with the centre-right, while the development of so-called ‘market-cushioning’ tools like European social protections has above all pleased the centre-left. Likewise, a danger with substantial European taxes is that the notion hits the wrong nerve with economic liberals, for whom relaxed taxation is a powerful rallying cry. If the legendary “Read my lips: No new taxes” promise helped George H. W. Bush win the 1988 US presidential election, right-leaning European parties could appeal to their supporters with the same phrase.

Despite appearances, the notion of taxes to enable a higher level of public spending at a European level should not be viewed as something only left-leaning parties can support. For example, as was mentioned above, income taxation is widely taken for granted at other levels of government – few Europeans think that “all tax is theft”. Across ideological lines, then, people committed to the European project should feel comfortable with a stronger EU budget, bolstered by stable “own resources”.

The economic argument

One concern is that with more revenue for the EU level, the overall level of public spending would become higher. Yet at this moment, we should not forget that the money we threw at the previous economic crises also was public, though much of it was mustered hastily from reluctant national governments. Ideally, trust in the EU’s capacity to respond to crises in an orderly way would boost confidence and stability in the markets, and thereby decrease the need for crisis spending.

In terms of economic efficiency, a 2004 report for the European Commission assessed that an EU income tax would likely have few positive or negative effects. However, the report points out that introducing a new European income tax system could create significant administrative costs, and make the system more complex for taxpayers if they had to fill in tax returns not only for the national, but also for the European tax collector.

One way to circumvent the administrative problems would be to take the money from an EU surcharge on national income tax, rather than a separate European tax. In any case, besides potentially making for a bigger EU budget, one can conclude that the advantage of an income tax would not so much be economic efficiency, but rather the clarity for citizens who could easily see how much they personally contribute to the EU budget from their salary.

Meanwhile, a common European company tax rate could improve economic efficiency within the EU. As it stands, tax competition between European countries is distorting competition within the Single Market, and can lead to capital being invested in a place where it would otherwise not be most productive. In that way, the logic behind common corporate taxation would be the same as with the EU’s existing rules against unfair state aid that distorts competition. While a common tax base would of course lead to tax rates increasing in some countries, correspondingly the tax burden could decrease in others.

However, one should note that company tax is vulnerable to fluctuations in the market, and therefore not the most reliable source of revenue. Additionally, company tax is not the biggest cash cow in state budgets, which limits its potential to provide a backbone for a strong EU budget, especially if most company tax money continues to go into national budgets. For example, the €10 billion yearly income currently envisaged by the Commission would not yet be enough to move mountains.

Small wins, eyes on the prize

Finding the necessary funds for a strong EU is no easy task. The summit negotiations over the COVID recovery fund already were an exhausting arm-wrestling match with 27 pairs of elbows on the table – yet they are nothing compared to the talks that will be needed to give proper taxation capacity to the EU.

But the road to a better Europe has always required ambition, goodwill and compromises. There already are a range of options, big and small, that can help the EU achieve the fiscal capacity that is necessary for the euro area to prosper and to withstand crises. Any budget is a combination of different taxes and sources of revenue, and this is no different at the EU level. Mixing different options is essential if the EU is to multiply its budget from the current minuscule 1%-of-GDP levels.

The most ambitious ideas come too late for the 2021–2027 budget period, and alas, most likely for the 2028–2034 period, too. Nonetheless, in the next years, small wins like those already suggested by the Commission could begin preparing the ground for bigger increases in the EU’s “own resources” in the future.

The author thanks Markus Nieminen for his helpful comments on the drafts. 

Juuso Järviniemi
Juuso Järviniemi studies International Relations at the University of Edinburgh. A member of the Young European Federalists, he has been the Editor-in-Chief of The New Federalist in 2017–2019. Juuso is also a former President of the British JEF section.

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