Select Committee on European Communities Sixth Report


FUTURE FINANCING OF THE EU: WHO PAYS AND HOW?

remedies on the revenue side

60.  We examine here the three options on the revenue side covered in the Commission's report[54]:

  • a revision of the own resources system;
  • a modification of the United Kingdom abatement;
  • the introduction of a "generalised correction mechanism" (that is, a general reassessment of contributions).

REVISION OF THE OWN RESOURCES SYSTEM

61.  The basis on which the EU budget is funded is prescribed in the own resources decision[55], which specifies the four sources of funds: agricultural and sugar levies; customs duties; VAT-based contributions; and GNP-based contributions. As HM Treasury told us, "that decision remains in force until replaced or amended. Amendments to the decision require the unanimous agreement of the Council and ratification by Member States' domestic procedures, which in the United Kingdom require an Act of Parliament" (p1).

62.  The Commission takes the view that "neither the need for an increase in the financial resources of the Union, nor the limited shortcomings of the financing system provide grounds to modify the own resources decision at an early stage"[56]. The Government agrees with the Commission. Although Mr McIntyre accepted that "certainly one can make criticisms of the traditional own resources and also perhaps of the VAT resource", his hunch was that "there probably would not be … a consensus" that the existing own resources decision should be renegotiated to produce a different system (Q 19). The Economic Secretary reinforced this point when she told us that renegotiation of the decision would be "a rather large upheaval and a complicated process for what in our view, and I believe that of many other Member States, would be a small gain" (Q 122).

63.  While it may not be appropriate in the short term to renegotiate the own resources decision, we believe that a renegotiation will be necessary in due course—and that it should come sooner rather than later. Accordingly, we considered the existing own resources system against the criteria suggested by the Commission:

    "resource adequacy, ie the resource must have a significant yield relative to the size of the EU budget;

    equity in gross contributions, ie the burden should be fairly shared among Member States;

    financial autonomy, ie the resources should increase the independence of the EU budget from national treasuries;

    transparency and simplicity, ie the determination of the tax should be easily understood by citizens; and

    cost effectiveness, ie the collection and administration costs of the resource should be low relative to its yield"[57].

We added the criterion of susceptibility to fraud and errors, on which the European Court of Auditors has focused in relation both to traditional own resources and to the VAT based resource.

64.  Traditional own resources[58] are collected by Member States and passed on to the EU. In its annual report for 1997, the European Court of Auditors said that because of this "… it is not possible to provide an assurance that all taxable imports have actually been declared and have generated the corresponding revenue"[59]. As in previous years, the report urges that "in order to eliminate repeated irregularities, the Commission should … improve collaboration between itself and the Member States as regards the management and control of traditional own resources"[60]. The persistence of irregularities in the collection of traditional own resources despite constant pressure for improvement suggests that the problems are inherent in the system.

65.  The position with regard to the VAT based resource is no better. We were particularly astonished by the finding of the European Court of Auditors that "an indirect calculation of the discrepancy between VAT collected and theoretical VAT for nine Member States revealed an average annual difference of 70 billion ecu (1991-93)"[61]. We asked HM Treasury whether these figures, which seemed extraordinarily high, could possibly be correct, and if so what effect such a discrepancy would have on EU receipts from VAT.

66.  The Treasury representatives explained that any shortfall in receipts from VAT would automatically be made up by a greater call on the GNP based resource, but agreed that this could cause a distortion in the contribution pattern as between Member States (Q 10). HM Treasury later provided a detailed memorandum (pp18-20), confirming that:

    "A shortfall in VAT [based] resources … alters each Member State's total contribution. Those Member States not responsible for the shortfall pay more, as a result of their GNP based contributions. Member States responsible for the shortfall could pay more or less: they pay more if their extra GNP based contribution outweighs their VAT shortfall but less if the reverse is true."

However, the effect will be mitigated because the VAT base on which Member States have to contribute is limited to 50 per cent of GNP: no VAT revenue would be lost to the EU from shortfalls in Member States which had reached their capping thresholds. HM Treasury cannot estimate the extent of the switch in contributions arising from the VAT shortfall, because the European Court of Auditors did not give details of the countries involved in its study. We regret this, but we note that (on "heroic assumptions", spelt out in the memorandum) the Treasury memorandum estimates that the shortfall "could have been of the order of 3-4 billion ecu per year" - without doubt a significant sum. It is not possible to say how much of this shortfall arises from fraud[62], but HM Treasury concludes that it is "certainly reasonable" to assume that a proportion of it does.

67.  We conclude that the VAT based resource system is also inherently susceptible to fraud; this distorts the pattern of contributions as between Member States, and the situation could worsen. It is naïve to suppose that the tendency to use the black economy to avoid VAT will not increase as VAT rates rise.

68.  The proportion of revenue raised from traditional own resources and from the VAT based resource has been declining. As the Economic Secretary explained, traditional own resources are "falling in absolute terms as a proportion of total EU budget simply as a result of the reduction in tariffs and greater liberalisation of world trade" (Q 122). Moreover, the revenue from them which is due from each Member State depends crucially on whether that country happens to have an important port[63]. And the call made on the VAT based resource has deliberately been reduced: the Economic Secretary explained that this reduction "reflects an awareness that, just as VAT is regressive within a Member State's population, so it is regressive between Member States across the European Union, because obviously in poorer Member States a larger proportion of the national income tends to go on consumption expenditure which is then subject to VAT" (Q 122).

69.  Commissioner Liikanen pointed out that if both traditional own resources and the VAT resource were abolished, "there would be no fraud on the revenue side" (Q 104). He explained that "when we have enquired into the really detailed fraud cases, by far the biggest numbers are on the traditional own resources side… Because member countries retain only ten per cent out of the traditional own resources for administration, the incentive is perhaps not sufficient". Moreover, moving to a single GNP based resource would, he said, "do away with a major part of the bureaucracy in member countries and in Brussels".

70.  Traditional own resources and the VAT based resource are not only generators of bureaucracy and highly prone to fraud, but also arguably systematic sources of inequitable burdens. We can see considerable advantages in abolishing them, leaving only the existing GNP based resource. We considered whether it would be appropriate for the EU budget to be financed solely on the basis of that resource (or some variant of it), or whether an additional "fifth resource" should be introduced.

71.  Commissioner Liikanen argued for relying solely on the GNP based resource as a means of improving the fairness of the system, because GNP is "simply the most objective criterion for national capacity to contribute" (Q 104). The Economic Secretary agreed that this change would bring "a small improvement in equity" (Q 122). This resource at present is collected simply in proportion to Member States' GNPs. We considered two possible variants, which might further improve equity.

72.  First, we considered whether contributions from Member States should be based on their population. We rejected as inequitable the concept of a national contribution based on a flat rate per head of population (the equivalent of an EU poll tax). But we think that consideration should be given to basing the proportion of revenue raised from each Member State on GNP per capita, rather than on total GNP.

73.  Secondly, we considered whether Gross Domestic Product (GDP), which is used for example in judging eligibility for structural funding, would be a better proxy for the contributory capacity of Member States than Gross National Product (GNP)[64]. The choice between the two could make a real difference: Professor Begg points out, for example, that Ireland's GNP remains "well below the more frequently quoted GDP" (p22). We have not considered this point in enough detail to reach a recommendation, but we consider that the choice between GNP and GDP as a proxy for national prosperity should be addressed, particularly if the resource based on it is to assume even greater importance.

74.  We noted, however, that the idea of relying solely on a GNP (or GDP) based resource does not meet with universal approbation. Mr Colom I Naval argued that the EU needed "real own resources that do not transit through national budgets and do not appear at all as national contributions" (Q 80). Legally, he said, "there are no more national contributions", following the adoption of the Maastricht Treaty[65]. He suggested that "the real equity debate should not be about the imbalance or unfair treatment of Germany, the United Kingdom, Spain or Denmark, but about the fact that the citizen, the taxpayer, will pay substantially different amounts to the budget of the Community according to the Member State where he or she is living".

75.  This was a point also made strongly by Professor Begg: "In principle, own resources are taxes assigned to the supranational level and, therefore, not subject to direct control by (or the whims of) Member States" (p21). In his view, increasing reliance on the GNP based resource "has meant that the principle of 'ownership' of the resources has been flouted. In practice, the EU has reverted to a system of national contributions similar to that with which it began in 1958. This has undermined the autonomy of the EU" (p23). If the EU is seen as being like a local authority, with its own identity and functions, he argues that "there are sound arguments for giving it its own financial capacity" (Q 37).

76.  The Government takes a different view: the Economic Secretary told us that it does not see "increasing the financial autonomy of the European Union … as a desirable objective" (Q 119). Mr McIntyre elaborated: "The assumption that we and a lot of other Member States have [is] that it is Member States' taxpayers who are responsible for bearing the burden of the contribution to the Community budget and therefore it is right that transfers from governments should be the primary way in which the Community is financed" (Q 27). Moreover, as the Economic Secretary said, "it is right that national taxpayers should be able to hold their national governments to account and that the national parliaments should be able to hold those governments to account for tax decisions" (Q 128). She reported the Chancellor of the Exchequer's concept of "fairness to the taxpayer" as meaning "that within each Member State the net contributions to the [EU] budget are consistent with sound public finances" (Q 125) - a fundamentally different definition from that suggested by Mr Colom I Naval.

77.  It is not self-evident that accountability for the funds raised and spent by the EU should rest with national parliaments and governments. Professor Begg suggested that in fact the European Parliament is the "obvious democratic authority" (Q 74), and Mr Colom I Naval told us:

    "You say in England no taxation without representation, and I think one of the main political problems of this European Union is that we have representation without taxation" (Q 101).

This approach is seductive, but of course its implications would be profound. Remedying the "democratic deficit" demands that those responsible for the raising of funds and for their expenditure should themselves either be directly elected or be answerable to a democratically elected body. As Commissioner Liikanen said: "In Britain the Parliament can censure the Government but the Government can then dissolve Parliament, so that keeps it balanced" (Q 115). He accepted that in principle it would be desirable for Europe to have "this perfect financial autonomy where the revenue and expenditure side are dealt with by the same body … but it is only theory" (Q 109). In the longer term he thought that things might be different: "The institutions are young and the final form has not yet taken shape… Perhaps it is a good idea that Commissioners should go for European elections also in future" (Q 115).

78.  We fully support the principle that there should be proper accountability for the funds spent by the EU, as for all funds collected from taxpayers and spent by the public sector at whatever level. Consideration must be given as to how this accountability can best be achieved, which depends partly on how the funds are raised.

79.  It has been argued that accountability would be improved by introducing a direct source of revenue for the EU (a "fifth resource"). We noted that the Commission itself had considered eight possible candidates for a fifth resource[66]:

  • a CO2/energy tax;
  • a new form of VAT (with a specific percentage rate levied together with national VAT but passed directly to the EU);
  • excise duties on tobacco, alcohol and mineral oil;
  • a corporate income tax;
  • communications taxes (on road and air transport and on telecommunications);
  • personal income tax;
  • withholding tax on interest income[67];
  • seigniorage (a tax on the profits derived by the European Central Bank from issuing notes).

80.  The Commission gives most prominence to the idea of a modified VAT resource, which it says had been favoured by the European Parliament. However it points out that this resource would be regressive unless an equalisation mechanism was introduced—in which case it would lose the benefits of simplicity and transparency. Professor Begg considered that this would be "a fairly robust means of financing the European Union in the short-term, largely because it would be easy to implement and is familiar". The analysis which he had undertaken[68] also suggested that "taxes on communications … might be considered" and that "longer-term a good case can be made for using business taxes or energy taxes as the main tax base".

81.  On the other hand, Mr Colom I Naval favoured an income tax "because it is the one which relates the citizen more with the budget and with the [European] Parliament or the budgetary authority" (Q 101). We were not attracted by the prospect of a separate layer of income tax superimposed on national income tax regimes. We can see that a designated proportion of the national tax revenue in each Member State could be allocated to the EU, but this could be done equitably only if tax bases and rates were harmonised, and agreement on such an arrangement appears unlikely at present.

82.  In the Economic Secretary's view, "although one can have theoretical discussions on these matters and I am sure the Commission would like to add to its list of possibilities, they are not serious runners in terms of the Agenda 2000 negotiations" (Q 134). We agree with her, and with Commissioner Liikanen (Q 109), that a fundamental reform of the own resources decision is not likely to be agreed together with the Agenda 2000 package. Indeed, as Mr Terry Wynn MEP suggests in his written evidence (pp64-66), we think that it could be preferable to decouple the two issues. As he says, "whilst Agenda 2000 has been discussed for 18 months, the issue linking it to a new system of [own] resources only raised its head some 3-4 months ago", and the heat of the Agenda 2000 discussions may not provide the best climate for a cool look at the principles of future financing.

83.  We do not see a directly collected own resource as a viable option at present, in either political or practical terms. The issue of whether such a resource would be desirable in order to give the EU greater financial autonomy obviously goes beyond the scope of our present enquiry.

84.  However, we also conclude that in the meanwhile it is crucial for citizens of the EU to know what their stake in EU policies and operations really is. We believe that this increased transparency is possible even while the EU continues to be funded by national contributions. We are already being taxed to finance EU expenditure, yet we have virtually no knowledge of what we are paying - or what we are paying for. We call on the Government to consider without delay how this transparency can be achieved even under the present financing system.

THE UNITED KINGDOM ABATEMENT

85.  The United Kingdom abatement is based on the decision of the June 1984 Fontainebleau Council that any Member State which was bearing excessive budgetary costs in relation to its relative prosperity could benefit from a correction.[69] We recognise that the negotiation of the abatement produced a significant benefit to the United Kingdom. But Commissioner Liikanen suggested to us that "if one says that nothing in the world has changed since 1984 and that all the other changes in Europe will be blocked for mechanical and technical redefinitions of rebate, it is not an easy case to defend" (Q 111).

86.  The British Government is nevertheless making a strong effort to defend the rebate. The Economic Secretary said that it "remains justified on the grounds of fairness under the present system of contributions to the EU budget… The Government [is] determined to maintain it" (Q 119). The justification put forward by the Government in support of the rebate is that "the UK receives less from the EC Budget than any other Member State both in per capita terms and as a share of GNP. This is true both of receipts under the CAP and of other receipts. This distribution of spending carries through to the pattern of net contributions" (p3)[70]. Moreover, the Government claims that, because it contributes more than the average, increased receipts actually cost the United Kingdom money. The Economic Secretary told us that "even with our abatement every pound of expenditure from the European Union budget in the United Kingdom costs us more than a pound in terms of net contribution".

87.  The Commission has suggested that the United Kingdom abatement is no longer justified because the proportion of spending represented by the CAP (from which the United Kingdom does particularly badly) has decreased, and because the gap in relative prosperity between the United Kingdom and some other large net contributors has narrowed. In addition, it notes that the budgetary imbalance of the United Kingdom is no longer unique[71].

88.  The Government responds that the justification for the United Kingdom abatement "does not rest entirely on the CAP, and has never done so (although it is plainly an important element distorting the pattern of EC spending). Total EC spending is still lower in the United Kingdom than in any other Member State (in per capita terms) at around 55 per cent of the EU average, despite being one of the less well off Member States" (p7). In any case, the CAP element is still important: CAP spending still represents about half of total EU expenditure, and United Kingdom receipts from it are still disproportionately low. The Government supports fundamental reform of the CAP, but the Economic Secretary explained that although such reform would "deliver substantial economic benefits in the form of lower prices to consumers, there would be no substantial benefit for the United Kingdom taxpayer in the form of our own net contribution. Therefore, a successful outcome of negotiations on CAP reform does not mean that in turn we can make concessions on the abatement" (Q 119)[72].

89.  The Economic Secretary pointed out that the United Kingdom has not done well from the Structural and Cohesion Funds either, having received "only just over half the average receipts from those funds" (Q 130). She considered that there might be some hope of improvement there, following a recent exercise with EUROSTAT "to achieve an up-to date assessment of the boundaries of regions and the per capita income within them which forms the basis for the allocation of much of this expenditure". She added: "Obviously we shall do everything that we can to ensure that we get a fair deal for the United Kingdom regions. We are particularly hopeful of getting a safety net to protect our [current] Objective 2 regions[73] and good treatment of both Wales and Cornwall which are in a special position in relation to the Structural Funds" (Q 133).

90.  As to the argument that the United Kingdom's relative prosperity has "caught up", the Government says that this is not so. "Depending on exactly how it is measured and over which period, our net contribution per head is typically the fourth or fifth highest across the Union, whereas in the league tables of income we are ninth, tenth or eleventh depending on the exact measurement used" (Q 119). This effectively mirrors the position in 1984, when the United Kingdom was the tenth most prosperous of the 15 Member States now in the Union (p7). Asked whether she expected this state of affairs to continue, or whether the United Kingdom hoped to improve on its present position in the ranking, the Economic Secretary said: "We have not set ourselves such a target. What we have done is to set the target of increasing macro-economic stability within the United Kingdom and in so doing to lay the path coupled with our supply side reforms, for a higher sustainable rate of growth" (Q 127). But, as Mr McIntyre pointed out, the results in relative terms are unpredictable: "I do not think it would be sensible now to make projections based on one degree of success or another of the Government's economic policies, compared with the success of the economic policies of other Member States and to conclude from that that the league table will be changed" (Q 8). We agree that it would be unwise to rely on relative growth rates to eliminate the disparities in the "league table" of net contributions compared with per capita GNP.

91.  The Government also rebuts the so-called "technical drawbacks" identified by the Commission[74]. The Commission implies that because the United Kingdom's marginal contribution to the budget is lower than of other Member States, it might take a different attitude towards increases in expenditure. The Government responds that the existence of the abatement "has certainly not affected its approach to EC spending issues"; on the contrary, "the United Kingdom has consistently been among the firmest advocates of budgetary discipline in the Council" (p8). The Government does not accept that administrative expenditure[75] should be disregarded in comparing net contributions: it "has an obvious and positive effect on the economies of those Member States which host major EC institutions, [and] contributions to that spending have precisely the same effect on taxpayers as contributions towards the financing of other expenditure". And it sees no reason why the rebate should not apply to expenditure in the new Member States[76].

92.  We accept that, without abatement, the United Kingdom would remain one of the largest net contributors, and we agree that some way of remedying that situation would need to be found.

GENERAL REASSESSMENT OF CONTRIBUTIONS

93.  The Commission has examined the possibility that the countries with the largest net contributions per capita should have those contributions reduced, or at least capped. It estimates that "applying the present abatement mechanism to all countries that have a negative budgetary balance or simply extending [it] to the four countries that have made the request[77] would result in a three to fourfold increase of cost of the mechanism".[78] In Professor Begg's view, "if the others were to obtain a rebate on the same mechanism as the British one, it would blow such a hole in the budget that the whole thing would collapse" (Q 41). We agree that applying the existing rebate mechanism to all Member States which are making excessive net contributions is not a viable option.

94.  The Commission says that the four Member States now seeking abatements (Germany, the Netherlands, Austria and Sweden) have put forward proposals "for granting budgetary corrections, in a non-discriminatory manner, to all Member States that qualify"[79]. It explores the effects of granting compensation only after a certain level of negative budgetary balance (net contribution) is exceeded, say 0.3 or 0.4 per cent of GNP; it also looks at the effect of compensation at various different rates[80]. It shows how, by adjusting these two factors, the abatement system could be generalised at the same cost as the present arrangement for the United Kingdom. But this would of course involve reducing the amount of the United Kingdom's abatement[81]. The Economic Secretary's response is that the Government "very much understands the concerns of the largest net contributors, because we have found ourselves, and still do, in that position… We cannot help other states with their difficulties by worsening our own position." (Q 120) Setting a threshold for abatement would mean that "the other net contributors' burden would be reduced by increasing that of the United Kingdom, leaving others broadly unaffected… Such a solution would be grossly unjust" (p6).

95.  We agree with the Economic Secretary that "to substitute one injustice for another will not improve matters", but we were encouraged to hear that the Government was "prepared to look at other options" (Q 120). Nevertheless, as late as the "conclave" of foreign ministers on 21 February 1999 the Foreign Secretary reportedly reiterated the Government's position that there was nothing in the rest of Agenda 2000 that would compensate the United Kingdom for giving up the rebate[82].

96.  We agree that there is still a problem for the United Kingdom, but we consider that the rebate itself may no longer be the best way of solving it. We therefore take the view that the rebate should be negotiable as part of an overall settlement delivering the result of fairer net contributions. It would be regrettable if the entire package (including CAP reform and the possibility of funding enlargement) were to be lost because the United Kingdom Government insisted that there was only one way of solving its problem. Equipping the European Union to handle enlargement is a very big prize: we urge the Government not to throw it away. It seems to us that a realistic negotiating result for the United Kingdom would be agreement to forgo the rebate on condition that - and only when - the loss can be made up on a permanent basis through the savings of a reformed CAP and a stabilisation of expenditure overall by 2006, and possibly[83] through increased EU expenditure in the United Kingdom.


54   11666/98 COM(98) 560. Back

55   94/728/EC: see paragraph 26. Back

56   11666/98, page iii. Back

57   ibid, paragraph 1.2. Back

58   Agricultural and sugar levies, and customs duties on imports from non-member countries. Back

59   European Court of Auditors, Annual Report concerning the financial year 1997, OJ No C349, 17 November 1998, paragraph 8.4(b). Back

60   ibid, paragraph 1.9. Back

61   ibid, paragraph 1.27. "Theoretical" VAT is derived by multiplying data for expenditure on taxable goods and services by the relevant weighted average VAT rate in each country. Back

62   The Treasury memorandum explains that "it is likely that 'theoretical' VAT will tend to exceed actual VAT, even in the absence of fraud, because the 'theoretical' calculation does not take account of a number of factors which in practice depress VAT collections below their 'theoretical' level. These include, for example, the bankruptcies of traders, which result in some VAT becoming irrecoverable, and the operation of VAT registration thresholds which means that some proportion of the goods and services reflect[s] the transactions of small businesses which are not registered for VAT". Back

63   The so-called "Rotterdam/Antwerp effect": see Q 58. It is possible to argue either that this is unfair, or on the contrary that customs duties on goods destined for one Member State which are imported through another do represent a truly "European" resource, but in any case the comparison of net contributions is affected. Back

64   As suggested by the European Court of Auditors in special report no. 6/98, op cit, paragraph 3.9. GDP measures the output of an economy resulting from the production of marketed goods and services within the national boundary, whereas GNP includes net income from abroad from investments, earnings remitted by migrants, etc. Back

65   The Maastricht Treaty replaced Articles 200 and 201 of the EC Treaty (which provided for national contributions) with a new Article 201, which provides that "without prejudice to other revenue, the budget shall be financed wholly from own resources". Back

66   11666/98, Annex 2. Back

67   Not to be confused with the separate proposal to ensure a harmonised minimum rate of taxation on investment income (8781/98). Back

68   Assessing the options against three categories of criteria: economic, administrative and political: see p24 and pp26-28. Back

69   For more detail, see paragraph 30. Back

70   And see Table 3 above. Back

71   We address this point in paragraphs 94 ff. Back

72   In her letter of 29 January (p55) the Economic Secretary says that CAP reform would lead to a decrease in the United Kingdom's net contribution only if it led to an increase in the United Kingdom's share of CAP receipts: she explains why such an increase cannot be expected, at least in the period covered by Agenda 2000. Back

73   Under the present Objective 2, funding is available for regions seriously affected by industrial decline. Under the proposed new Structural Fund arrangements, funding would be more narrowly focused: see our previous Report, The reform of the Structural Funds and the Cohesion Fund, HL Paper 138, 30th Report Session 1997-98 and paragraphs 105 ff. Back

74   11666/98, paragraph 2.1. Back

75   Expenditure related to the running costs of EU institutions. Back

76   Even though it does not currently apply to pre-accession expenditure funded under the "external action" head. Back

77   Germany, the Netherlands, Austria and Sweden. Back

78   11666/98, paragraph 2.4.3. Back

79   ibid, Annex 6, paragraph 1. Back

80   The present rate for the United Kingdom is 66 per cent: see paragraph 30. Back

81   So would any formula like that suggested by Rebecca Stokes, based on the arithmetic mean of the relative weight of each Member State in terms of its GNP and GNP per capita. As Ms Stokes says, "it is unlikely in practice that a formula could be found which produces a politically acceptable result for each and every Member State" (see How to Share the Burden of the EU Budget, published and submitted by the European Policy Forum, page 23). Back

82   Financial Times, 22 February 1999. Back

83   Though we have noted the difficulties with this while the United Kingdom remains a net contributor: see paragraph 87. Back


 
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