Five proposals for enforceable EU fiscal rules
Sander Tordoir, Jasper H. van Dijk en Vinzenz Ziesemer
Recently, the European Commission proposed a reform of the fiscal rules. In September, we made some recommendations regarding this reform. However, reforming the rules is not enough; enforcement must also be improved. Together with Sander Tordoir of the Centre for European Reform, we present five recommendations for the enforcement of the Stability and Growth Pact. The report can be downloaded below.
Summary
The EU’s fiscal rules, which guide and constrain member-states’ budget policies, are in desperate need of reform. They are too complicated, impose unrealistic demands on some countries, and lead to government overspending in economic booms and underspending in recessions. Unsurprisingly, countries barely comply with them.
The EU should learn from its enforcement mistakes. Technocratic bodies cannot enforce the rules on their own: only the European Commission with support from member-states has the legitimacy to press a democratically elected EU government to change its budget. Hard-wired numerical rules that are imposed on a ‘one size fits all’ basis are supposed to lead to strict enforcement, but they cannot account for big economic shifts or unforeseen crises – like Putin’s invasion of Ukraine, or the Covid pandemic.
The tension between rigid enforcement and economic reality has prompted the Commission to develop a flexible, but opaque, interpretation of the rulebook. At the same time, the political cost of sanctioning non-complying countries has time and again deterred the Commission and member-states from enforcing the rules.
After suspending the rules in the wake of the pandemic, member-states recently asked the European Commission for a reform proposal. The Commission’s first proposal, published in November 2022, had flaws, but rightly replaced hard-coded rules that applied to all member-states with multi-year debt-reduction plans individually negotiated with each memberstate, enabling each country to take ownership of its own fiscal trajectory.
This has not pleased all member-states, though. Some capitals, worried that the Commission would use its discretion to be soft on high-debt countries, want to maintain inflexible debt reduction targets. Germany has proposed that member-states with high debts cut debt-to-GDP ratios by 1 percentage point a year, which would be very difficult in periods of recession. That would once again tempt the European Commission to weaken enforcement, because some member-states would struggle to stick to the rules.
While the Commission needs discretion to apply the rules in a way that keeps pace with economic developments, it cannot ask member-states to blindly trust it to be strict enough. The way to solve this dilemma is by strengthening EU institutions, and giving them more ways to encourage member-states to follow the rules, an area where the Commission’s original proposal fell short.
This policy brief makes several proposals to make fiscal rule enforcement work better in the future.
I. Add more positive incentives
First, member-states and the Commission should agree that a portion of future EU funds will be used as incentives for good fiscal behaviour. The new fiscal framework tries to replicate the logic of the EU pandemic recovery fund by bilaterally negotiating fiscal policy with countries, rather than seeking to constrain them solely through rules. However, under the Commission’s proposal, EU funding will not be conditional on investment and reform, unlike the recovery fund, which will expire in 2026. The EU will launch its new budget in 2027: its pay-outs should be conditional on following the rules and some funds should be set aside as rewards for high-debt countries running sustainable fiscal policies.
II. Align fiscal policy supervision with national electoral cycles
Second, EU fiscal policy enforcement should closely align with national electoral cycles. The Commission initially proposed that each country should submit a fouryear fiscal plan, extendable up to three years, to reduce public debt. That would be too lenient: there would be little incentive for a government with one year left to vigorously pursue reforms or public investment to avoid sanctions, or to obtain rewards from the EU institutions that only benefit the next government. Countries’ fiscal plans should cover a shorter period, such as two or three years, so that a government can reap the rewards of obeying the rules or frontloading key investments during its time in office, rather than letting its successor benefit from extra leeway or EU funds.
III. Focus on gross fiscal policy errors
Third, the new framework should prevent dangerous fiscal policy errors rather than seeking to fine-tune policy. There should be a threshold before the Commission starts investigations. An example of such a threshold would be a fiscal balance that makes a falling debt ratio probable for the most indebted EU-countries. The Commission would only spring into action if a country was on the verge of enacting policies that would lead to increasing debt levels, and turn to enforcement if it assessed that a dangerous policy error was in the making.
IV. Consider sanctions as signals
Fourth, when a country’s budget is on the wrong track, the EU should redesign enforcement actions and fines so they act as a scale of escalating warning signals to bond markets, even if fines are unlikely to be imposed in practice. Making fines for less egregious fiscal mis-steps financially smaller would not reduce the political cost of imposing them – the EU has not imposed fines for non-compliance to date. But it would add more of a range of signals to bond markets about the Commission’s assessment of risks to debt sustainability. Past stand-offs between Brussels and capitals over fiscal policy have fed into higher government borrowing costs.
V. Strengthen independent fiscal institutions
Fifth, technocratic institutions like independent fiscal watchdogs can play a significant role in evaluating policy and providing technical analysis, even if they cannot be enforcers. The British Office of Budget Responsibility is a strong model. But the quality of these institutions varies widely across Europe, and whether they gain proper independence, prominence and capacity depends on the political economy of each country. To help these institutions across the continent, the EU should provide a funding base to all national fiscal institutions if conditions of independence and quality are met.
