Keywords

An obvious outstanding feature of a federal union is that its citizens become taxpayers to a federal exchequer in return for public goods. The European Union stands today on the cusp of that change. It has never been more important, therefore, to bolster citizen confidence in the EU’s system of governance and to enlarge the capacity of that system to act effectively.

There is much speculation about the European fiscal policy of the new German coalition government of Chancellor Scholz and Finance Minister Lindner. One hopes that it will not fall victim to what Jürgen Habermas criticises as the smug self-deception of German pro-Europeans.Footnote 1 Germany has a central responsibility to secure the future of the eurozone. The current Bundestag may well have to approve changes to Germany’s Basic Law that will allow the EU to move forward to fiscal union. Another critical player, as we have seen, is the Federal Constitutional Court at Karlsruhe, not altogether a stranger to zealotry, which has remained vigilant against any unorthodox fiscal behaviour that might breach the EU treaties or the German constitution.

One Money, One Polity

Few people outside Germany, however, still cling to the notion that the construct of Economic and Monetary Union (EMU) designed in the conditions of the 1990s is durable. In fact, both President Delors and Chancellor Helmut Kohl were adamant at the outset that the process of EMU would not ultimately be complete without fiscal and political union. Inventing a single currency before the Union created a treasury seemed mighty odd. Centralising monetary policy while leaving fiscal policy in the hands of the member states was never going to be a long-term solution. Obliging the Commission to coordinate national economic policies while denying it the powers to run a common economic policy for the whole of the eurozone was a fool’s errand. That these flaws were known from the beginning accentuated the fear of moral hazard and lessened the appetite for risk sharing.

The Maastricht Treaty was grounded on the belief that pressure from the financial markets would impose self-discipline on all stakeholders to respect the EMU rules. This proved not to be the case as investors chased cheap money across the eurozone [Stiglitz]. Britain’s refusal to join the euro club, which effectively gave the City of London a free ride, weakened the EU’s ability to regulate banks on a supranational basis. The next generation of political leaders was less committed politically than Kohl and Delors to the completion of the EMU architecture. Economic convergence was not sustained. Without fiscal instruments to correct disequilibrium, regional imbalances inside the eurozone rose. No attempt was made to form a core group of the eurozone states under the enhanced cooperation provisions of the treaties which would have reinforced political leadership.

The Maastricht provisions have been widely disrespected. The convergence criteria for joining up to the single currency were treated in a cavalier fashion from the start, particularly by Greece.Footnote 2 Denmark and Sweden met the criteria but refused to join the eurozone. The excessive deficit procedures have proved unworkable in practice.Footnote 3 The fiscal rules first adopted in 1998 in the form of the Stability and Growth Pact have never been scrupulously applied and are now unsustainable.Footnote 4 German-led efforts to impose even tighter rules through an additional fiscal compact treaty of 2012 have failed to be implemented.Footnote 5 For both procedural and substantive reasons, the fiscal compact has not been incorporated into Union law, as was intended. The valiant attempts by the Commission to restrain the tax and spend plans of the member states during an annual ‘European semester’ lack punch and are in danger of becoming little more than an academic exercise.

The Financial Crash

After the financial crash in 2008, the EU moved swiftly if belatedly to reform its hitherto weak system of supervision and surveillance of the financial sector [Tooze]. The European Central Bank chaired a new European Systemic Risk Board (ESRB) for monitoring macro-prudential risks. Three autonomous supervisory authorities were created and began work in 2011: the European Banking Authority (EBA), the European Securities and Markets Authority (ESMA), and the European Insurance and Occupational Pensions Authority (EIOPA). A single rule book was invented for the whole financial sector whose aim was to impose stronger prudential requirements on banks, improve protection for investors and manage failing banks. A European Fiscal Board was set up to advise the Commission. As the financial crisis morphed into a eurozone debt crisis, a single supervisory mechanism was introduced to allow the ECB to supervise Europe’s largest banks alongside a single resolution mechanism to manage failing banks. In 2015, the Commission proposed a deposit insurers’ scheme as a further pillar of ‘banking union’.

All these arrangements made by way of crisis management now need to be reviewed. The powers granted to the supervisory authorities should be used with an alacrity and a confidence that so far seem lacking. Further powers must be granted to the regulators as seems necessary if the EU is to finally break the doom loop between bad banking and bad government. In addition, the scope of the ECB’s formal remit to supervise the whole financial industry should be extended to include insurance.Footnote 6 Although the Bank emerged from the crash with de facto wider powers to trade government bonds in the secondary markets, it faced legal challenges from Germany, as we have seen, about conformity with treaty constraints concerning market intervention. A treaty adjustment is called for to regularise the legal situation.Footnote 7

The European Stability Mechanism (ESM) was established in 2012 to bypass the famous no bail-out rule.Footnote 8 But the ESM clause inserted into the treaty has served to complicate and not to simplify or clarify how financial risk is to be shared between member states.Footnote 9 The ESM, founded by an intergovernmental agreement, is still not an EU official institution. Its use is far from unconditional, and with its lending capacity capped at €500 billion, it is too small to cope with another major financial crash. Although a reform is in train to let the ESM act as the backstop to the single resolution mechanism for failing banks, decisions within the ESM are still to be taken confederally—which means that Germany has an effective veto in its deployment.

The ESM is not the only weak element in the governance of the euro system. The Eurogroup of the nineteen eurozone finance ministers remains ‘informal’ and lacks coherence.Footnote 10 Meeting too often in the surreal ‘inclusive format’—that is, with all twenty-seven states—it manages to duplicate ECOFIN as well as evade proper parliamentary scrutiny. Once again, it falls to the Commission to assume political leadership on the supranational plane.

Looking back at the crash (and preparing for the next shock), it is not the Maastricht rules but pragmatism, improvisation and a good deal of luck that have saved the euro—being “ready to do whatever it takes to preserve the euro”, as Mario Draghi famously said in July 2012. The ECB’s unorthodox monetary policy has weathered the legal and financial storms. Grexit has not happened. The weaker states have returned to the market. But the relief that the stability of the eurozone has been recovered should not blind us to the basic defects in the construction of EMU.Footnote 11 While national central banks have lost control of their currencies, the ECB does not yet enjoy the status of the Union’s lender of last resort. The first elements of a banking union have been erected, but progress on the deposit insurance scheme is stalled. A plan for the better integration of capital markets, reducing tax, legal and regulatory barriers to trade, has been launched by the Commission but also remains stuck in the Council. The case for the structural reform of EMU must be made prominently in the anticipated new round of treaty amendment.

The COVID-19 Crash

The coronavirus pandemic was an unforeseen exogenous shock. As the plague spread quickly across Europe, there has been no denying that, unlike the financial crisis, we are indeed all in this together. There is no moral hazard. At first it was clear that the EU institutions had no contingency plans to deal with the emergency. Their formal treaty competences were slim and the exercise of their powers unrehearsed.Footnote 12 The Commission botched its early steps on vaccine procurement, to general consternation, but quickly assumed executive responsibility for the coordination of member state response to the pandemic, including the collective purchase of vaccine. Although the plague knows no boundaries its impact is asymmetric and the need for a firm EU hand on the tiller is obvious. The Union should emerge out of the COVID-19 crisis with a clearer sense of European solidarity and civic duty. Intense interest is now paid by the press and public to what is happening in other EU states in terms of vaccination, hospitalisation, statistics, social restrictions, travel bans and health security measures [Van Middelaar 2021].

For Europe, this is a very political pandemic—with severe economic consequences, especially for labour and supply-side shortages. Its social impact will be long felt, and it will take time to rebuild public trust in institutions. The EU’s short-term response is in complete contrast to the rapidly enforced austerity measures taken a decade ago after the financial crash and eurozone scare. Keynesianism is back—a veritable sea change which the mechanics of EMU governance struggle to ingest. Germany under Merkel changed its tune about lending to the poorer south, and even the frugalist Dutch have softened their tone. The EU quickly suspended its normal fiscal rules for the duration of the crisis—at least until 2023.

In July 2020, at an arduous meeting of the European Council, an ambitious economic recovery programme was agreed involving the Union itself (helpfully shorn of the UK) in unprecedented levels of borrowing and lending. To finance ‘Next Generation EU’, the Commission, on behalf of the member states, will borrow up to €800 billion on the capital markets—about €150 billion per year between 2021 and 2026. As the holders of the eurobonds are to be paid out of the EU budget, the cap on the Union’s revenue (‘own resources’) is raised to accommodate the extra spending from 1.4 per cent of GNI to 2.0 per cent. The first eurobonds were launched successfully in 2021, being many times over-subscribed. The Commission is charged with overseeing how the money is spent by the states according to established criteria, mainly through a Recovery and Resilience Facility (RRF). A total of €407.5 billion is to be made available in grants and €386 billion for loans. The Council must approve by QMV the implementation of the Commission’s spending proposals.

The RRF places a premium on structural reforms aimed at boosting sustained productivity. Although European added value is not an explicit criterion, the importance of greening the economy, advancing digitalisation and modernising transport infrastructure are challenges which clearly demand the investment of public money on the supranational dimension. The loan element of the programme is less attractive to EU states already labouring under huge public debt—and at a time when interest rates were in any case at rock bottom. The grant element, by contrast, provides a real fiscal boost, especially to Italy and Spain. The innovation represents a significant rebalancing of EU fiscal and monetary policies, relieving the ECB of its hitherto almost lone responsibility for macroeconomic stabilisation. Both the loan and grant elements will become steadily more attractive as and when, during 2022, the ECB ends its programme of quantitative easing and raises interest rates to counter high inflation.

Although the economic recovery scheme involves significant short-term fiscal transfers between member states, it does not promise a centralised fiscal policy for the longer term. The so-called frugal member states, led by the Netherlands, have until now insisted that Next Generation EU must be a one-off, never to be repeated, emergency risk-sharing measure. No permanent European safe asset has therefore been created. One hopes for more agile thinking from the new governments in Germany and Holland. When the current bond issue concludes in 2026, it will also be time to renegotiate the EU’s new medium-term budgetary settlement. If the eurobonds have been a success—and how can they not be?—it will be crazy not to continue with a similar scheme. Why would the Union opt to reduce its fiscal instruments and downgrade its assets? A political decision by the EU to renationalise bonds would be certain to discombobulate investors. It is more likely, in truth, that the Union, bolstered by its new fiscal capacity, will seize its next chance to extend and enlarge its eurobond operation to establish permanent, effective measures for contracyclical macroeconomic policy.

The outbreak of war on the borders of the Union—the latest exogenous shock—adds a new element to the argument for the creation by the EU of public goods, this time in defence expenditure. It becomes more important than ever that the RRF experiment works for all concerned and that the Commission is trusted by the Council to take the lead in fashioning the Union’s countercyclical fiscal stance, simplifying the mechanisms of economic governance and reinforcing both the vertical and horizontal coordination between the federal and national levels.

Eurobonds and Budget Reform

Thus armed, the EU will have to learn how to conduct its fiscal affairs in a federal manner. The fiscal union will not come about by magic but by an orderly and determined package of constitutional reform on the basis of which capital market integration and banking union can be fully accomplished. There are three elements to the necessary reforms.

First, federal eurobonds must be issued not on the joint guarantee of individual member states but on the joint and several liability of the Union as a whole. To ensure this change in gear, bondholders should no longer be paid by that part of the EU budget financed by contributions from the states but by revenue accruing directly to the Union from federal taxation and customs duties. The Commission has recently unveiled its proposals for the next generation of its own resources amounting to €17 billion per annum. It proposes that 25 per cent of revenue from the carbon emission trading scheme should accrue directly to the EU budget, along with 75 per cent of proceeds from the carbon border adjustment mechanism and 15 per cent of the share of residual profits of multinational corporations under a scheme launched by the OECD and G20.

These advanced reforms imply compartmentalising the EU budget into two tiers: the top slice financed by the EU taxpayer and levies, as proposed by the Commission and voted by the European Parliament. The bottom slice would continue to be financed by the fees paid by national finance ministries according to the GNI peg and voted, as now, by national parliaments.Footnote 13 Such a rebalancing of the federal and confederal elements of the EU budget will accelerate pending decisions on introducing new forms of own resources. When the debt and deficit rules come to be rewritten after the COVID-19 crash, the Union should submit itself to the same budgetary disciplines as it imposes on its member states.

A restructuring of the European budget in the way suggested will allow the EU to reduce its unhealthy obsession with juste retour—the unseemly scramble between net gainers and net losers in which Margaret Thatcher, pre-eminently, indulged. The departure of the British opens up the possibility of ending all rebates and abatements that clutter and obscure the financing system. The opportunity to cleanse the system of Thatcherite legacy should not be missed at the next revision of the MFF in 2026. The duration of the next MFF should be aligned with the term of office of the Parliament and Commission, to last five years rather than seven. This would enhance the transparency and democratic foundation of the budgetary process.

The European Parliament, rightly, wants to tighten financial control on the many EU agencies which have proliferated in an ad hoc way over recent years as the Commission’s regulatory and executive powers have grown. MEPs insist that there should be one specific legal basis for the establishment of the agencies in the hope of rationalising their management and improving their effectiveness.Footnote 14 Other criticisms have been levelled at the Court of Auditors, whose remit needs to be more understood, and its advice respected. Parliament wants a say in the appointment of the auditors equal to that of the Council—and it should use that power to see that the size of the Court is reduced commensurately to that of the smaller college of Commissioners.Footnote 15

More assured financial regulation at the EU level is a concomitant to fiscal union. Together these reforms will usher in a period of more rational debate about how to bring supranational added value to the delivery of European public goods. The size of the EU budget should be determined rationally by the legislature to match federal spending priorities and debt commitments. One notes that the Union starts from a very low budgetary base. Even with the post-pandemic recovery programme, the MFF for 2021–2027 amounts to some €2 trillion, or barely 2 per cent of the Union’s GNI. This is not a European superstate. As we propose in Chap. 3, an organic law should be used for the purpose of growing the budget.

Our second necessary element is that the ESM must be transformed into a European Monetary Fund and fully incorporated into the law of the Union. Its mandate should be expanded to include crisis prevention as well as crisis management. The EMF, like the IMF, will take decisions by QMV not unanimity, building political and market confidence. The Treasury Secretary, whose incarnation we witnessed in Chap. 2, will chair the EMF board. Permission to float federal eurobonds must be put beyond legal peradventure by a treaty amendment that provides the treasury with a regular source of federal revenue without compromising the fiscal liabilities of national governments.

Building the Eurozone

And third, the Eurogroup should be formally reconstituted under the enhanced cooperation provisions of the treaty.Footnote 16 In the interest of fidelity to the general interest, the Eurogroup should be chaired by the Treasury Secretary, who would vote only on executive and not legislative matters. Ideally, the new Eurogroup would comprise all nineteen eurozone states, but so long as few as nine countries are willing to act as pioneers, the critical step towards fiscal union can be taken, with others joining later, including Denmark and Sweden. Once inside enhanced cooperation, the vanguard should decide to leave unanimity behind and operate only by QMV.Footnote 17 The likelihood of such differentiated integration based on the eurozone is much facilitated by the retreat of the UK from the field of play. A better run eurozone will make membership of the single currency more attractive and accessible to non-euro states.

The role of the economic affairs and budgetary committees of the European Parliament is already powerful, but any reform of the governance of EMU must pay greater heed to the need for parliamentary accountability. Acquiring the right of co-decision under the organic law procedure for decisions on revenue, as we propose, will be the single most important boost to the powers of the European Parliament. We can go further to democratise the emerging fiscal union. Under the Lisbon Treaty, Parliament is only informed but not consulted by the European Council and Council about their recommendations to member states on the conduct of economic policy.Footnote 18 If these macroeconomic policy guidelines, aimed at increased economic convergence, were turned into a legislative act co-decided by Council and Parliament, they would have more force and a higher profile. In the case where the excessive deficit procedure had to be applied, the national parliament of the member state concerned should be granted an automatic hearing under the auspices of the European Parliament.Footnote 19

The new-style Eurogroup and EMF can become the valid fiscal policy interlocutor of the ECB as it conducts monetary policy, working together to consolidate the currency and advance economic convergence. The bloc needs to attain high standards of fiscal prudence that command democratic respect and enable the eurozone to withstand future shocks. The more coherent leadership will reinforce the international role of the euro. Participation of the Treasury Secretary in the IMF and other global monetary institutions will clarify usefully for its international partners the EU’s direction of travel. The treaties will have to be adjusted to codify these changes, simplify the rules and eliminate the legal uncertainty that prevails at present.

The bloc will not have a ‘Hamiltonian moment’ when a new federal state, like the US, assumes the sovereign national debt of its members. Rather, Europe’s fiscal union will permit the gradual and incremental growth of federal debt in a framework that is coordinated with that of the member states. National treasuries, not least the Bundesministerium der Finanzen in Berlin, will save money out of European fiscal union. Banking union will be assured. The EU citizen taxpayer will benefit from a more state-like, capable federation with decent spending power at all appropriate levels of government.