THE NEW CHALLENGE: A COMMON FISCAL POLICY

1. THE NEW CHALLENGE: A COMMON FISCAL POLICY Week 9

2. References • These slides. • Additional Material: • - European Commission (2000) “Tax Policy in the European Union” • - European Commission (2006), “Coordinating Member States’ Direct Tax System in the Internal Market” – Communication from the Commission.

3. REMEMBER WHERE WE COME FROM • WHAT IS EMU AND WHAT HAS BEEN NEEDED TO CREATE IT (MAASTRICHT CRITERIA) AND MAINTAIN IT (STABILITY AND GROWTH PACT), AND TO ENLARGE IT. • EMU: unification of two out of three macroeconomic policy branches: 1) monetary policy (run by ECB : first part of the course) 2) exchange rate policy (disappeared) 3) fiscal policy

4. In the first part of Week 10 (Fiscal Policy in the Monetary Union I) we discussed the situation in detail. • SUM UP • Such a “discrepancy” (in particular between a common monetary policy and national fiscal policies) would call for a common fiscal policy (or at least a substantial centralization of the budget). • Why? • To provide automatic redistribution (insurance) during temporary asymmetric shock

5. We also noted that this task can be accomplished also by better integration of financial markets, which we’ll examine next week. • Since common fiscal policy is hard to achieve, in Week 8 we examined the two alternatives we are left with: ok, national fiscal policies….but with or without common rules? • With. Otherwise EMU cannot work.SGP (Old and New version). • Now we take one small step back……are we sure that a common fiscal policy is not on the agenda?

6. WHAT IS FISCAL POLICY? • 1) Collecting resources (elegant way to say money) from citizens (taxation and bonds). • 2) Spend them in government expenditure, public investments, transfers, debt service. COMMON FISCAL POLICY IN THE EU MEANS TO INVESTIGATE 1) AND 2) AND CHECK HOW MUCH OF THESE ACTIVITIES ARE RUN AT EU LEVEL.

7. Remember: 1) and 2) are at the heart of the social contract between individuals and the political power. It’s the clearest form of political legitimation (No taxation without representation). • So we can start the discussion, and even the path to a common fiscal policy. • But it’s gonna be really hard to go all the way if political integration does not accelerate. • Substantially.

8. 1) COMMON COLLECTION OF RESOURCES • a) Taxation (Direct, Indirect) • b) Social security contribution • c) Bonds emission b) and c) are totally absent. You can tell me why. We are going to deal with harmonization of direct and indirect taxation (which is anyway the biggest part of it).

9. COMMON FP HERE MEANS: • Ideally, common fiscal policy in this respect (=collection of resources from taxation) means: a) EU decides tax base and tax rate of direct and indirect taxation (= what has to be taxed and how much) b) A substantial part of it is devoluted to member states (the total absence of fiscal federalism would be unrealistic and inefficient).

10. DIRECT vs INDIRECT 1) DIRECT TAXATION: they hit the direct expressions of the individual capability to contribute (income, wealth). 2) INDIRECT TAXATION: they hit the indirect expression of it (consumption, bequest). • Income tax (1) and VAT (2). • What’s the current status of harmonization for 1) and 2)?

11. INDIRECT TAXATION • VAT (Value Added Tax) hits consumption and production of goods and services, and it’s included in the final price that consumers face. • The seller collects the tax revenue and, at a later stage, pays it to the government. • Examples: VAT=20% • A bookstore wants to sell a book for 30 euro. VAT is 6 euro. Final price to the consumer is 36 euro. • Later in the year, the bookstore pays those 6 euro to the government.

12. Mmmmh…… • Take two identical firms competing with each other, producing the same car, in two different countries. • Car costs 30.000 euro. • VAT in country A=20% • VAT in country B = 10% • Price of the car in country A = 36.000 euro • Price of the car in country B = 33.000 euro BUT THE CAR IS THE SAME! And the price differential does not depend on transport costs, or different demand condition (as it would be normal).

13. This is in contrast with the concept of custom union and, even more, economic union. • This kind of discrimination is not compatible with the notion of single market (as well as state subsidies). • This inconsistency was clear since the very beginning: art.90 of CEE Treaty forbids any kind of tax discrimination aimed at distorting the market. • Even more explicitly, art.93 “invites” harmonization of indirect tax rates. • First action is Directive 77/388 in 1977, who has been modified more that 30 times since then, in the pursuit of more advanced solutions in the harmonization of tax base and tax rates for indirect taxation.

14. Where are we now in this continuous updating? • The most recent update is Directive 112/2006 (November 2006). • Common EU (not only EMU) criteria for VAT tax rate: • - the standard rate cannot be less than 15% • - member states can introduce one or two reduced tax rates on a given list of goods and services (agreed at EU level), but not less than 5%. • These (and others) criteria are fixed until 2010 and then will be rediscussed.

15. ….however…… • Two exceptions: • 1) Member states who applied before 31° March 2006 can keep (until 2010) a reduced tax rates for labour-intensive goods provided locally. • 2) Member states can, from time to time, be authorized to keep futher reductions in given sectors. • What do we think about them? • 1) is reasonable: it aims at preserving employment level in peripheral regions where, given local providing, the EU market distortion is less likely and less dangerous. • 2) is much less reasonable….too discretionary.

16. DIRECT TAXATION • Things are much more complicated here…… • EU debate is much more recent, and infinitely slow (understandable). • Efforts have been made mainly to prevent “double taxation” of multinational firms, or anyway, to reduce transaction costs that are needed for firms that produce in two or more EU member states (with different income and profit tax policies). • Valentino Rossi, summer 2007. • In 2006, EU commission announced for 2008 a policy proposal: CCCTB (Common Consolidated Corporate Tax Base), aimed at harmonizing only tax bases (and not tax rates) across EU.

17. 2) COMMONG SPENDING OF RESOURCES • In this respect, common fiscal policy means a centralized EU government that spends (in government expenditure, transfers or investment) the common budget in any of the EU regions (whose boundaries may, or may not, coincide with nation states). • What are, at the moment, the common EU resources? • a) traditional resources (agricultural duties) • b) resources proportional to national VAT revenues • c) resources proportional to national GDPs

18. Oh, so we have a common budget? Have we not?! • This “common budget” is 1% of EU overall GDP. • 2.1% of the sum of government expenditures of all member States. • EU costs each citizens 63 cents per day. • 22% of this “budget” is managed by Bruxelles • 76% by member States under EU supervision • 2% by no-profit organizations. • Total expenditures must be equal to total revenue, so EU debt emission is not allowed. • And it would help a lot in going towards a common fiscal policy.

19. SOURCES OF THE “COMMON BUDGET” OVER TIME

20. HOW THE “COMMON BUDGET” IS SPENT

21. Agricultural spending (CAP: Common Agricultural Policy): primary sector produces 2% of EU GDP. • Until recently, it absorbed 70% of common EU budget. • Most striking inconsistency in EU policy. • Structural funds spending has been increasing because of the more and more pressing need to reduce inequality in regional development among member States (social cohesion policy).

22. HOW TO REFORM THE BUDGET • In June 2007 EU Commission started a budget revision process (including public consultation through email, websites, academic involvement, and so on) aimed at reforming (and improving) the common budget framework, with two particular objectives: • a) Increasing the amount of resources of the common budget • b) Improving its composition

23. THE TWO MAIN OBSTACLES • 1) CAP: Such a high level of spending makes no economic sense….but politically……. • 2) UK rebate: In the EU, each member State: a) gives contribution to the common budget based on the size of its national economy. b) It receives contributions from the EU mainly based on the size of its agricultural sector. In UK, a) is big, b) is small. UK felt it was victim of an injustice, and in 1984 Prime Minister Margaret Thatcher obtained an annual “rebate” from EU. Other member States had to increase their contributions (more than half of the cost is beared by France and Italy).

24. Obviously, 1) and 2) are related: • UK won’t accept the end of the rebate until common EU spending becomes less focused on agriculture. • And this can’t happen before UK stops claiming the right to the rebate. • There’s been infinite attempts to swap 1) with 2). • The most recent one (June 2005) produced a small step forward: UK accepted to cut rebate by 20%, provided that the resulting increased availability of common EU resources won’t be devoted to CAP, but to new EU member States. • But there’s still a lot of work to be done.

25. CONCLUSION • Going towards a common fiscal policy means: • 1) Unifying the way EU collects common resources • 2) Centralizing the spending of those 1)is mainly about taxation, 2) is about the EU spending. Indirect taxation: not harmonizing VAT tax rate would jeopardize the single market. Significant steps have already been made. Direct taxation: things are more complicated. Efforts have mainly been made to prevent double taxation; CCCTB is the first significant proposal to harmonize tax bases.

26. EU common budget is still ridicolously small (1% of EU GDP). • It needs to be increased. • Its financing and its use have to change: a) introduction of EU taxes b) shift the focus from agricultural spending to other objectives (EU welfare state, R&D, infrastracture, etc). Particularly important would be the introduction of EU debt emission. • It’d accelerate infrastracture building • It’d really push us towards a common fiscal policy.