Fiscal Policy and Democracy in Europe Ö sterreichische Nationalbank, Wien, 5.11. 2004

1. Fiscal Policy and Democracy in Europe Österreichische Nationalbank, Wien, 5.11. 2004 Stefan CollignonProfessor of European Political Economy LSE

2. Europe’s fiscal Constitution The Constitutional Treaty brings many innovations • Efficiency in policy making • Greater role of EP • Citizens and states as equal source of European sovereignty (art.1)

3. Europe’s fiscal Constitution But the Constitutional Treaty • Has not innovated on fiscal policy • Has even reduced the EU-budget powers of the European Parliament • Instead: SGP passes from rule-based to arbitrary arrangement among governments  Pre-democratic fiscal policy

4. Europe’s fiscal Constitution Fiscal policy matters for economy • Automatic stabilizers smoothen disposable income and demand • Discretionary tax policies aim at supply side effects • ECB Monthly Bulletin, April2004 But also for democracy • Imposing rules on democratically elected Govts? • The irony of new MS: surrender democracy at the door • “No taxation without representation” • Therefore: only national competence?

5. Europe’s fiscal Constitution Fiscal federalism assigns functions to jurisdictions: • Allocation policy : decentralised • Preference heterogeneity • Stabilisation policy: centralised • Collective action problem • Redistribution policy : centralised • Collective action problem

6. Europe’s fiscal Constitution Europe’s fiscal Constitution is not optimal: • The bulk of spending is through national budgets • EU budget only 1% of GDP • SGP is only loose coordination tool • What matters for macroeconomic stability is the interaction of monetary policy with the aggregate fiscal stance

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8. Europe’s fiscal Constitution Stabilisation policy is not optimal • Automatic stabilisers work • But SGP is far from being applied • Uncoordinated fiscal policy led to monetary tightening • SGP can not guarantee coherent aggregate fiscal policy stance • SGP introduces rigidity into the conduct of fiscal policy

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10. Europe’s fiscal Constitution Efficient stabilisation requires: • Capacity to respond to symmetric and asymmetric shocks • Vertical flexibility responds to symmetric shocks • Horizontal flexibility responds to asymmetric shocks • Reflect collective preferences about the intergenerational burden sharing

11. Europe’s fiscal Constitution Vertical flexibility • In EMU the appropriate response to symmetric shocks are determined by the interaction between monetary and aggregate fiscal policy • At the moment fiscal policy is constrained by Excessive deficit procedure • Balanced structural budgets are not realised • the main burden is on monetary policy • Performance since the start of EMU has been benign • Shocks have been less severe • What about the future?

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13. Europe’s fiscal Constitution Horizontal flexibility • Asymmetric shocks also have been less severe • Are symmetric shocks disappearing in EMU? • Danger of heterogeneous collective preferences if political system does not allow collective deliberation and choice

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15. Europe’s fiscal Constitution Horizontal flexibility can be achieved by • Intertemporal transfers • Regional governments borrow to sooth income • Constrained by SGP • Interregional transfers • Federal system compensates asymmetric shocks • E.g. Länderfinanzausgleich

16. Europe’s fiscal Constitution • In the EU interregional transfers do not reflect asymmetric shocks • EU interregional transfers exclusively follow a redistribution logic • EU budget redistributes income to farmers and poor regions

17. Europe’s fiscal Constitution • Asymmetric shocks lead to transnational intertemporal borrowing • The mode of financing the EU budget causes distortions in national budget policies • EU budget is financed by a levy on national budgets • Net contributors use domestically raised income for expenditure elsewhere • Hence, they borrow for others

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19. Europe’s fiscal Constitution For example: • Germany’s net contribution is 0.24% of GDP • Its actual deficit in 2002 was 3.53% • Without Net Contribution: 3.28 % • France: Net Contribution of 0.14 % • Actual deficit 3.10 % • Without net contribution: 2.96 % • Portugal received net contribution of 2.08 % • Actual deficit: 2.71 • Without net contribution: 4.79 %

20. Europe’s fiscal Constitution This system is unsustainable ! • National finance ministers will wish to reduce net contributions • especially when under the pressure of reducing deficits under the SGP • The European Union will have less and less the financial means to implement its policies  Europe’s present fiscal constitution carries the risk of European Disintegration

21. Europe’s fiscal Constitution • What is the solution? • We need to integrate fiscal policy at the European level • Integrate national and EU budgets • Define aggregate fiscal policy stance in Euroland • Finance EU budget by Euro-tax • Create democratic input legitimacy in addition to efficient output legitimacy

22. Europe’s fiscal Constitution • Defining the aggregate fiscal policy stance • Top down: define the aggregate deficit that is desirable given the economic environment • Vertical flexibility • Give democratic legitimacy to this choice • If EU policy stance must have authority over partial national preferences, it requires a vote reflecting all European citizens • European Parliament should vote macroeconomic framework law: BEPG • Democratic debates will transform collective preferences • Josef Christl: “dialogue will help bridge the gap between political European elite and European citizens”

23. Europe’s fiscal Constitution • Assign deficit quota to decentralised jurisdictions • Horizontal flexibility • Tradable deficit permits most elegant solution • Solves problem with “domestic stability pacts” • Makes decentralised fiscals decisions accountable and coherent with monetary policy

24. Europe’s fiscal Constitution • Reform the financing of EU Budget • The “own resources” must become own resources • Introduce Eurotax • Vat • Corporate tax • Capital income • Energy tax • Make the European Parliament responsible for taxing and spending • Only European-wide debates can foster European collective preferences for public goods • Co-legislation with Council as there may exist esternalities

25. Europe’s fiscal Constitution To summarise • Europe’s fiscal constitution is severely handicapped • The Constitutional Treaty does not remedy • With the single market and the euro European citizens share many more public goods, their res publica • These goods need an efficient and democratic common management

26. Europe’s fiscal Constitution Conclusion Ceterum censeo: pactum stabilitatis esse delendum Et rem publicam europaeam esse errigendam