FUTURE FINANCING OF THE EU: WHO PAYS AND
remedies on the revenue
60. We examine here the three options on the
revenue side covered in the Commission's report:
- 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).
OF THE OWN RESOURCES SYSTEM
61. The basis on which the EU budget is funded
is prescribed in the own resources decision,
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".
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
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 courseand
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
cost effectiveness, ie
the collection and administration costs of the resource should
be low relative to its yield".
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
64. Traditional own resources
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".
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".
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)".
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
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
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.
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"
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
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).
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.
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:
- a CO2/energy tax;
- a new form of VAT (with a specific percentage
rate levied together with national VAT but passed directly to
- excise duties on tobacco, alcohol and mineral
- a corporate income tax;
- communications taxes (on road and air transport
and on telecommunications);
- personal income tax;
- withholding tax on interest income;
- 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 introducedin
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
also suggested that "taxes on communications
be considered" and that "longer-term a good case can
be made for using business taxes or energy taxes as the main tax
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.
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.
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
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).
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.
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"
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
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.
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
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.
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.
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
would result in a three to fourfold increase of cost of the mechanism".
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
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.
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.
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
Such a solution would be grossly unjust"
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
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
through increased EU expenditure in the United Kingdom.
54 11666/98 COM(98) 560. Back
94/728/EC: see paragraph 26. Back
11666/98, page iii. Back
ibid, paragraph 1.2. Back
Agricultural and sugar levies, and customs duties on imports from
non-member countries. Back
European Court of Auditors, Annual Report concerning the financial
year 1997, OJ No C349, 17 November 1998, paragraph
ibid, paragraph 1.9. Back
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
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
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
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
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
11666/98, Annex 2. Back
Not to be confused with the separate proposal to ensure a harmonised
minimum rate of taxation on investment income (8781/98). Back
Assessing the options against three categories of criteria: economic,
administrative and political: see p24 and pp26-28. Back
For more detail, see paragraph 30. Back
And see Table 3 above. Back
We address this point in paragraphs 94 ff. Back
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
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
11666/98, paragraph 2.1. Back
Expenditure related to the running costs of EU institutions. Back
Even though it does not currently apply to pre-accession expenditure
funded under the "external action" head. Back
Germany, the Netherlands, Austria and Sweden. Back
11666/98, paragraph 2.4.3. Back
ibid, Annex 6, paragraph 1. Back
The present rate for the United Kingdom is 66 per cent: see paragraph
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
Financial Times, 22 February 1999. Back
Though we have noted the difficulties with this while the United
Kingdom remains a net contributor: see paragraph 87. Back