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1. Dilemmas for the EU in deficit-financing of defence expenditure and maintenance of fiscal discipline

Author:
Lucio Pench
Publication Date:
03-2025
Content Type:
Working Paper
Institution:
Bruegel
Abstract:
The European Union is grappling with the challenge of increasing defence expenditure while maintaining fiscal discipline under the Stability and Growth Pact (SGP). The European Commission has proposed activating the national escape clause available under the SGP to accommodate defence spending without triggering the excessive deficit procedure (EDP). However, the scope and enforcement of this measure remain uncertain. A proposed 1.5 percent of GDP cap on extra fiscal flexibility is legally questionable and unlikely to be enforced. While low-debt countries do not require the clause due to existing flexibility, highly indebted nations may find it insufficient in the face of rising debt costs. The escape clause may also serve as a backdoor for European Central Bank interventions under the Transmission Protection Instrument, which requires compliance with EU fiscal rules. The Commission has also proposed the Security Action for Europe (SAFE) funding mechanism, a €150 billion loan programme to finance national defence investments. SAFE relies on national borrowing and follows the model of the SURE (Support to mitigate Unemployment Risks in an Emergency) facility, put in place during the COVID-19 pandemic. However, SAFE’s limited scale and dependence on national fiscal capacities mean it falls short of the collective security funding approach advocated by economists. Meanwhile, Germany’s decision to reform its constitutional debt brake marks a major departure from its traditional fiscal policies. The reform establishes a permanent ‘defence golden rule’, exempting military spending from borrowing limits, alongside a €10 trillion infrastructure fund. Although this move does not endanger Germany’s fiscal sustainability, it undermines EU-wide fiscal coordination and conflicts with the SGP. This could weaken the European Central Bank’s position in future market interventions. Given these challenges, discussions on a new EU fiscal framework are necessary to ensure fiscal flexibility while maintaining debt sustainability.
Topic:
Security, Budget, European Union, Fiscal Policy, and Defense Spending
Political Geography:
Europe

2. Not yet Trump-proof: an evaluation of the European Commission’s emerging policy platform

Author:
Heather Grabbe and Jeromin Zettelmeyer
Publication Date:
01-2025
Content Type:
Policy Brief
Institution:
Bruegel
Abstract:
The economic strategy being defined by the 2024-2029 European Commission seems to follow the prescriptions on innovation and single market reform, and the expansive approach to industrial policy, set out by Mario Draghi in his September 2024 report on European Union competitiveness, with two important differences. First, the Commission stops short of calling for World Trade Organisation-prohibited subsidies – this is welcome. Second, the Commission proposes a new state aid framework for national industrial policy rather than expansion of EU-level public investment funding. This runs the risk of weakening the single market and harming competition, with the unintended consequence of protecting incumbents and inhibiting structural change. In terms of specific policies, on defence, the Commission is right to face up to the challenge of defining an EU procurement mechanism that offers sufficient speed and cost advantages to justify large-scale funding. On economic security and international partnerships, the Commission is right to take a broader approach than a foreign economic policy focused only on supply chains. What is lacking is a much greater commitment to providing support for climate mitigation in developing countries. The second Trump presidency creates risks for the Commission strategy. President Trump has gone further than expected in threatening territorial expansion and with the speed, aggression and disregard for the rule of law with which he has started to implement his policies. These factors will complicate the EU-United States relationship. The best defence against both Trump and the competitive and security threats posed by China is to accelerate policies that address the EU’s structural weaknesses: raising productivity growth, defence capacity and economic security. Economic security, in turn, requires more resilient trade relationships, less financial dependence on the US and an improved standing with emerging market and developing economies. The EU should also seize the opportunity offered by the shift in US policy from subsidies to deregulation. While the EU should not race Trump to the bottom on environmental or financial deregulation, it should rapidly improve its own regulatory framework while building on its core strengths: human capital and the rule of law. Unlike tariff wars or discriminatory subsidies, a competition to provide a good business environment is not a zero-sum game.
Topic:
Security, Economics, Industrial Policy, Budget, European Union, Digital Economy, Trade Policy, Donald Trump, Sustainability, European Commission, and Energy
Political Geography:
Europe and United States of America

3. The German 'Schuldenbremse' crisis: a symptom to be taken seriously in Europe

Author:
Clara Bösche
Publication Date:
01-2024
Content Type:
Working Paper
Institution:
Robert Schuman Foundation (RSF)
Abstract:
The priority to be given to the ecological transition and its practical implementation are dividing Germany and Europe. The European Union is being accused of making the conditions of production for farmers even more difficult: the number of demonstrations across the European Union has been rising after the Germans began their protests on 15 January 2024, as they denounced the ambitions of the European Green Deal, as well as the human and financial costs. At the start of 2024, the German coalition government (SPD, Greens and FDP Liberals) led by Chancellor Olaf Scholz (SPD) is struggling, since its draft budget has been cut by around €60 billion. The origins of the budget cuts to which the government has had to resort lie in a decision taken by the Constitutional Court of Karlsruhe dated 15 November 2023. The latter censured the decision to reallocate 60 billion €, initially intended to cushion the economic impact of the pandemic crisis, to a special fund for the transformation of the economy and the climate. For two months now, opposition has been growing in Germany over the resources allocated, the priorities to be defined and the rules governing public debt. The constitutional appeal was lodged by CDU-CSU members of parliament, who denounced the government's "sleight of hand". As Germany enters a recession, the debate is whether or not it is still appropriate to limit public debt to 0.35% of GDP. Current circumstances no longer justify bending the rule: the pandemic crisis is over, and the exceptional funds earmarked should not be used for the economy or the environment. As a result, since the Constitutional Court's ruling against the federal budget, in addition to opposition over the priority to be given to the green transition in economic and agricultural life, further opposition has emerged: regarding whether the constitutional principle of the debt brake (Schuldenbremse) should be reformed or not. This principle is firmly defended by Friedrich Merz, leader of the CDU and of the CDU/CSU in the Bundestag. In his view, the debt brake is the only way to avoid saddling future generations with debt, and he fears that lifting it might have a knock-on effect in terms of the financial stability of other European Union countries. Within the government, the SPD and the Greens (led by the Vice-Chancellor and Minister for the Economy, Robert Habeck), would like to reform the debt brake to facilitate the necessary investments, in line with the European Green Deal. However, within the same government, the FDP Liberals, led by Finance Minister Christian Lindner, have long refused to challenge this constitutional principle, in the same way as the CDU/CSU opposition. Christian Lindner is therefore in a difficult situation, caught between traditional positions, his coalition partners and the opposition. A hard-won agreement on the 2024 budget, on 13 December 2023, provides for cuts that will result, in particular, in the reduction of tax relief on diesel on agricultural machinery - the main focus of demonstrations in Germany – but also in a postponement of the “climate bonus”. Priorities have had to be set because of this cutback, but they are the source of dissatisfaction both on the part of the farmers, as well as the promoters of the European Green Deal. The debate on Germany's levels of debt, in the light of the demonstrations now rocking the country, is further weakening the coalition - the aim in this paper is not to take position on this - but above all, to consider the problem of the priorities to be identified, not only in Germany but also in Europe.
Topic:
Budget, European Union, Tax Systems, and Green Transition
Political Geography:
Europe and Germany

4. The implications of the European Union’s new fiscal rules

Author:
Zsolt Darvas, Lennard Welslau, and Jeromin Zettelmeyer
Publication Date:
06-2024
Content Type:
Policy Brief
Institution:
Bruegel
Abstract:
European Union countries are required by the EU Treaty to keep their budget deficits within 3 percent of GDP, and their public debt within 60 percent of GDP. A new framework to enforce these rules is based on country-specific debt sustainability analyses (DSA) and uses a single indicator, a measure of public expenditure, as the annual fiscal policy target. These changes are welcome. To assess the sustainability of public finances, it is much better to focus on the likely evolution of the debt path than to rely on simple numerical rules. Public expenditures net of changes to tax policy are a far better target for fiscal policy than the deficit, since they are under the control of the government and cannot give rise to pro-cyclical fiscal policy (excess spending in good times, fiscal cuts in bad times). These features could increase the framework’s efficiency and improve compliance. However, the new framework also contains numerical safeguards to ensure a minimum pace of debt and deficit reduction. These might overwrite the DSA-based requirements and could undermine the rationale for the new rules and the incentives for compliance. The safeguards could also introduce some pro-cyclicality and, more importantly, could hold back increases in public investment. Our calculations show that the new framework will require ambitious fiscal adjustments from high-debt countries, though less than would have been required by the previous framework. Numerical safeguards will not be a significant constraint in the first application of the framework in 2024, except in the case of Finland. In the next application, in 2028, they imply for France and Italy greater fiscal adjustment than required by the DSA and the 3 percent benchmark. There is ambiguity about the consistency of the new fiscal rules and the largely-unchanged excessive deficit procedure (EDP), and whether proposed reforms and investment will influence the DSA. This could interfere with the successful application of the framework. We recommend that the EDP should require the same adjustment as the DSA, a method- ology should be developed to estimate the quantitative impact of proposed investments and reforms, and the DSA methodology should be revised. In case EU countries’ investment plans on aggregate do not fill the green public-investment gap, we recommend a new EU facility to foster such investments.
Topic:
Budget, European Union, Investment, and Fiscal Policy
Political Geography:
Europe

5. Broader border taxes: a new option for European Union budget resources

Author:
Pascal Saint-Amans
Publication Date:
03-2024
Content Type:
Policy Brief
Institution:
Bruegel
Abstract:
There is widespread agreement on the need for new resources to fund the European Union's budget in order to meet increasing spending demands, not least repayment of debt incurred as part of the EU’s post-pandemic economic recovery. In particular it is seen as desirable that the EU should have ‘own’ resources, or reliable ongoing revenue streams. But there is little agreement on what new own resources could consist of. Limited reform so far has led to the introduction of a levy paid by EU members depending on plastic packaging waste generated in their territory and not recycled. Meanwhile, the European Commission has proposed resources for the EU budget from emissions trading revenues, and from levies collected under the EU carbon border adjustment mechanism (CBAM). There proposals are pragmatic and move in the right direction, but do not go far enough. The debate about own resources should focus on whether the EU will be able to build genuine own resources based on common tax policies. The EU suffers from ‘tax leakage’ in which profits are shifted from high-tax to low-tax EU countries, and from there onto no or low-tax non-EU jurisdictions, often without the application of withholding taxes. It may not be too much of a stretch to compare this situation of tax leakage with the situation addressed by CBAM – a quasi-tax at the border. So far, an opportunity for what could be seen as a tax at the border of the internal market, aiming to protect the market from harmful competition, may have been missed. Such a tax could reflect the undertaxed profit rule agreed as part of the international deal on the corporate minimum tax. Focusing on protecting the revenues of EU members by common tax borders could offer scope for new own resources.
Topic:
Budget, European Union, Borders, and Tax Systems
Political Geography:
Europe

6. Designing conditionality in the supply of European public goods

Author:
Roel Beetsma and Marco Buti
Publication Date:
12-2024
Content Type:
Working Paper
Institution:
Bruegel
Abstract:
The European Union will need in the coming years to invest a substantial amount of resources in European public goods (EPGs), including for the digital and climate transitions, and for defence and security. Funding for this could be provided in a centralised way at EU level, via either a fund or from the EU budget, but for this to be politically viable, and to create the necessary trust, national budgetary policies need to comply with the common EU fiscal rules. Setting adequate conditions for access to central financing is, however, not straightforward. The tightness of the conditionality needs to balance the desirability of a country pursuing sound fiscal policies with the need to deliver on the provision of EPGs that benefit several or all EU countries. The optimal tightness should reassure fiscally-conservative countries that EU money would not result in opportunistic behaviour that results in less discipline at national level. More fiscally fragile countries should be reassured that their fiscal retrenchment efforts will be duly rewarded.
Topic:
Governance, Budget, European Union, Finance, and Macroeconomics
Political Geography:
Europe

7. The changing dynamics of the Western Balkans on the road to European Union membership: an update

Author:
Marek Dabrowski and Luca Léry Moffat
Publication Date:
07-2024
Content Type:
Policy Brief
Institution:
Bruegel
Abstract:
The slow pace of European Union enlargement to the Western Balkans can be attributed to EU member countries losing their political appetite for further enlargement in the 2010s and early 2020s, and to the fact that Western Balkan countries have failed to make visible progress in meeting the criteria for EU accession The income per capita convergence of Western Balkan countries towards the German level (as a proxy for the EU) has been rather slow, with some acceleration in the second half of the 2010s and early 2020s. However, Western Balkan countries continue to suffer from several socio-economic vulnerabilities, including high unemployment rates (especially of young people) and low rates of participation of women in the workforce. After the beginning of the war in Ukraine in 2022, the EU gave higher political priority to further enlargement. It opened a new eastern front of potential enlargement (Ukraine, Moldova and Georgia) and activated the stalled accession process in the Western Balkans. Bosnia and Herzegovina obtained candidate status in December 2022 and was approved for accession negotiations in March 2024. Accession negotiations with Albania and North Macedonia were started in July 2022. With the new government in Montenegro from the end of 2023, the accession negotiation with this most advanced candidate country moved forward. Overcoming the legacy of the tragic conflicts in the 1990s is another key geopolitical challenge in the region. This involves the normalisation of Serbia-Kosovo relations and the reconciliation process inside Bosnia and Herzegovina. In the economic sphere, speeding up income per capita convergence with the EU requires further domestic economic reforms, accelerating intra-regional economic integration and creating new EU initiatives to support growth and social cohesion in the Western Balkans. Accelerating EU accession negotiations with indicative target dates, at least for frontrunners, can reduce the perception of geopolitical and economic uncertainty and stimulate foreign direct investment inflows.
Topic:
Economics, Governance, Budget, European Union, Institutions, and Regional Politics
Political Geography:
Europe and Western Balkans

8. An uphill struggle: a long-term perspective on the European public goods debate

Author:
Emmanuel Mourlon-Druol
Publication Date:
10-2024
Content Type:
Policy Brief
Institution:
Bruegel
Abstract:
The historical track record of centralisation of public expenditures at European Union level is patchy, and the prospects of agreement on future common spending are not good. However, Russia’s attack on Ukraine, NextGenerationEU, ensuring the stability of the euro and the climate crisis have been cited as justifying a further step-up in public spending at EU level. In recent years, the economic debate over the definition and provision of so-called European public goods (EPGs) has also revived and has put upfront the question of what to spend at EU level, based on an economic interpretation of where spending would be more efficient. To provide a counterpart to the more abstract debate on EPGs, this paper analyses major discussions that have taken place since the beginning of European integration about increasing the EU’s fiscal capacity. It shows how heavily EU agreements on what public expenditure should be centralised have relied on political considerations, in addition to, or instead of, reasoning about economic efficiency. These precedents should inform today’s discussions. In particular, it should be remembered that: (a) very specific historical and political contexts made proposals to centralise expenditure at EU level convincing and successful; (b) the notion of ‘fiscal federalism’ was and is occasionally invoked but rarely put into practice; (c) progress depends on clearly delineated issues; and (d) a political agreement on a ‘non-market definition of the common interest’ remains crucial to any change.
Topic:
Governance, Budget, European Union, Public Spending, and Public Goods
Political Geography:
Europe

9. The rising cost of European Union borrowing and what to do about it

Author:
Gregory Claeys and Conor McCaffrey
Publication Date:
05-2023
Content Type:
Working Paper
Institution:
Bruegel
Abstract:
Debt issuance by the European Commission on behalf of the European Union has increased massively. Of the approximately €400 billion in outstanding EU debt as of May 2023, 85 percent has arisen from borrowing since 2020. Large-scale borrowing is expected to continue until 2026 to fund the remainder of NextGenerationEU, and concessional loans to support Ukraine. When these programmes were launched, interest rates were at historic lows – even negative for maturities below 10 years. However, interest rates rose sharply in 2022. Beyond the widespread rise in euro-denominated interest rates due to monetary tightening by the European Central Bank in response to the inflation surge, the EU has also faced a widening of the spread between its yields and those of major European issuers, including France and Germany. This widening is driven by a combination of market features, circumstantial factors and institutional features. The EU cannot affect the overall cyclical movement of interest rates and will have to learn to live with it, like sovereigns do. However, the European Commission should continue to try to narrow the spread with major European sovereigns by further developing the relevant market infrastructure and improving its issuance strategy. The Commission will not be able to do this alone. Institutional developments, including progress on the development of new own resources and a long-term substantial presence in the bond market, will be necessary to fully reap the benefits of EU borrowing. A large share of EU borrowing (around €421 billion in total by the end of 2026, in current prices) is intended to finance unprecedented non-repayable support: Recovery and Resilience Fund grants and additional funding for existing EU programmes under the EU budget. The interest costs associated with this part of the debt lie with the EU budget. Our estimates suggest that, because of the high current and expected levels of interest rates, this cost could be twice as high as what was initially estimated at the start of the EU’s 2021-27 budget cycle. As a result, because interest costs for the borrowing of the non-repayable support are accounted for under the EU budget’s ‘expenditure ceiling’, this will exert further pressure on the funding of important EU programmes, which are already affected by inflation. The EU should thus quickly review how interest costs are accounted for in its budget and financial framework.
Topic:
Debt, Budget, European Union, and European Commission
Political Geography:
Europe

10. German Defense Spending: A Repeat of the Past Instead of a New Era

Author:
Christian Mölling, Torben Schütz, and Sören Hellmonds
Publication Date:
06-2023
Content Type:
Policy Brief
Institution:
German Council on Foreign Relations (DGAP)
Abstract:
The historic aspiration of Germany’s Zeitenwende – the new era in its foreign and security policy – will fail without the proposed funding. The growing tension between its demands for the Bundeswehr and missing resources is already driving Germany back to the old and shortsighted approach of cutting and stretching budgets and fragile procurement plans. The country needs a security decade: a ten-year systematic spending effort that closes its substantial security gap. Without sustainable funding for military security and other existential government tasks, Germany will continue to pose a risk to itself and others.
Topic:
Security, Defense Policy, Budget, and Defense Spending
Political Geography:
Europe and Germany