EU: A Fund is Born

Published on July 21, 2020
SGH Insight
The leaders also agreed that the Commission borrowing, unprecedented in size, will be repaid by 2058, and assigned new revenue streams to the EU to raise money for eventual repayment, but with much still to be determined.

Beginning next year, EU countries will levy a 0.8 euro per kilogram tax on un-recycled plastic, and those funds will be passed on to the EU. More controversially, starting in 2023, the EU will introduce a tax on goods imported into the bloc from countries that have lower emissions standards than the EU (see also SGH 6/19/2020, “EU: A Slipping Negotiating Box”).
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(Reuters 9/17/20)

European Parliament votes for new taxes in EU to repay recovery borrowing

The European Parliament voted on Wednesday in favour of assigning new tax revenues to the European Union to repay the bloc’s intended joint borrowing of 750 billion euros ($888 billion) for economic recovery after the COVID-19 pandemic.
Lawmakers voted 455 votes in favour and 146 against, with 88 abstentions, to introduce new sources of revenue - so called “own resources” - to the EU budget that should at least cover the costs related to the recovery plan.
They could include a tax on unrecycled plastic and on goods imported into the EU from countries with less ambitious climate-change fighting standards. Also under consideration is taxing digital giants and extending an EU CO2 emissions trading scheme into the maritime and aviation sectors.

After a grueling four days and nights of negotiations, European Union leaders finally reached agreement early this morning on a highly anticipated “Recovery Fund” designed to help counter the COVID-19 pandemic recession, as well as on the next, 1.074 trillion, seven-year EU budget for 2021-27.

*** The European Commission will borrow a total of 750 billion euros on the market, 390 billion of which will be disbursed over the next three years to member states in the form of grants, and 360 billion in cheap loans.  But just as relevant as the headline figures to markets is the deal EU leaders struck with the “Frugal Four” holdouts on the criteria for the allocation of the funds, and on the conditionality that will be attached, ostensibly, to the disbursement of grants (see below). ***

*** And as to funding the Commission’s 750 billion capital raise, the EU agreed to some temporary revenue raisers — which we suspect are likely to end up not so temporary. But with math far less of a priority these days than employment and growth, the EU also appears to have left a few “to be determined” potential pay-for tax hikes for discussion at some point, further, down the road. ***

The new taxes and revenue streams are expressly assigned to repay the Commission borrowing, and so in theory should be scrapped once this goal is achieved. But given they will be part of the EU fabric for the next 38 years, it is hard to imagine that they will not evolve into a permanent fixture of the EU budget, both boosting the EU financially, and bringing it one step closer to fiscal union.

Spend Now, Pay Later

The breakdown of the 750 billion euro Recovery Fun into a 390/360 billion euro proportion of grants to loans is of course a tad less generous than the original 500/250 billion euro Franco-German proposal, and is a compromise that was reached in a series of bazaar-like negotiating rounds with the “Frugal Four” holdouts of Austria, Sweden, Denmark, and especially the Netherlands, where Prime Minister Mark Rutte leads a minority government that is facing elections next year.

More interesting, we believe, were the changes made to the allocation criteria and conditionality that will be attached to the disbursement of grants, and the discussion that will now ensue over how to fund the whole thing.

As to the allocation criteria, 70% of the grants will be allocated over the first two years (2021-22) based on a member state’s population size, GDP per capita, and average unemployment rate from 2015-19. The remaining 30% will be disbursed in 2023, at which point the historic unemployment metric will be replaced by the severity of each member state’s GDP contraction through the 2020-21 pandemic crisis (see SGH 7/10/2020, “EU: Recovery Fund Talks”).

The leaders also agreed that the Commission borrowing, unprecedented in size, will be repaid by 2058, and assigned new revenue streams to the EU to raise money for eventual repayment, but with much still to be determined.

Beginning next year, EU countries will levy a 0.8 euro per kilogram tax on un-recycled plastic, and those funds will be passed on to the EU. More controversially, starting in 2023, the EU will introduce a tax on goods imported into the bloc from countries that have lower emissions standards than the EU (see also SGH 6/19/2020, “EU: A Slipping Negotiating Box”).

Beyond that, the Commission is to present proposals for how to extend the Emissions Trading System (ETS) into the maritime and aviation sectors. There could also be a renewed push to introduce the financial transactions tax that has failed so far to garner the breadth of support needed for enactment.

Finally, Germany, the Netherlands, and Sweden will phase out the rebates they have enjoyed on the portion of Value-Added Tax (VAT) revenues that are passed on to the EU — as it currently stands, these three enjoy a rate of 0.15%, while other countries pass 0.30% of their VAT receipts on to the EU.

No Gift is Truly Free

As we had also expected, negotiators hammered some conditionality terms out as well for the disbursal of grants as a compromise with the hardline states, and to reinforce broader EU goals.

First, in order to qualify, borrowers will have to propose a spending plan that assigns 30% of the funds received towards meeting the EU goals of digitalization and achieving climate neutrality by 2050 (not emitting more CO2 than is absorbed).

The borrowing countries will also have to follow the Commission’s annual economic recommendations – now widely ignored – and show they are aiming to boost potential growth, jobs, and the general resilience of their economies. How exactly this is to be implemented, we do not know.

All decisions to disburse funds will be made by the EU “qualified majority” vote process, on a recommendation by the Commission based in turn on the borrowing country having met various milestones and targets. Should any member state believe these targets have not been met, it can bring its objections up to the summit level.

The EU also added as a condition for the receipt of funds the observation of the rule of law – an innocuous condition on the face of it, but a stipulation directly pointed at Hungary and Poland which are under probes by the EU for their increasingly authoritarian regimes.

Should the EU decide that the rule of law is not observed, it will be able to propose measures that limit the flow of money to the offending country. That sanction would now also be passed under a qualified majority vote, rather than requiring the unanimity that under current rules gives veto power to any one member.

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