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

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Professor Stefan Collignon

Fiscal Policy and Democracy in EuropeÖsterreichische Nationalbank, Wien, 5.11. 2004

Stefan Collignon

Professor of European Political Economy LSE

http://images.google.com/imgres?imgurl=www.inf.ethz.ch/personal/stengel/Gif/lse-new.gif&imgrefurl=http://www.inf.ethz.ch/personal/stengel/&h=524&w=522&prev=/images%3Fq%3DLSE%26start%3D40%26svnum%3D10%26hl%3Den%26lr%3D%26ie%3DUTF-8%26oe%3DUTF-8%26sa%3DN

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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)


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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


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Fiscal policy matters for economy• Automatic stabilizers smoothen disposable income and

demand• Discretionary tax policies aim at supply side effects

» ECB Monthly Bulletin, April 2004

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?


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Fiscal federalism assigns functions to jurisdictions:

• Allocation policy : decentralised – Preference heterogeneity

• Stabilisation policy: centralised– Collective action problem

• Redistribution policy : centralised– Collective action problem


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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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Europe’s fiscal ConstitutionFigure 1. Tota l P ublic S pe nding a s pe rce nt o f G DP

26.9%

33.2%

37.0%

36.8%

37.8%

39.9%

42.0%

42.6%

43.5%

44.2%

46.0%

47.0%

47.4%

50.6%

50.9% 0.6%

0.8%

0.8%

0.9%0.8%

1.0%

0.8%0.9%

0.8%

0.9%

0.9%0.9%

0.8%

0.9%

1.1%

0% 10% 20% 30% 40% 50% 60%

Ireland

United Kingdom

Lux embourg

Netherlands

Fin land

A us tr ia

Franc e

Sw eden

N ational Public Sector 2003EU spending


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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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Firgure 2. Euroland aggregate fiscal stance

-6

-5

-4

-3

-2

-1

0

1

2

3

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Euro area actual def icitExcessive Deficitstructural deficitAutomatic stabiliser

EM


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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


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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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1960 1965 1970 1975 1980 1985 1990 1995 2000 2005

-0.04

-0.03

-0.02

-0.01

0.00

0.01

0.02

0.03

Figure 4. Euroland output gap and economic shocks

output gap (deviation from potential) forcast error LeuroGDP(L8)


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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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Figure 4. Asymmetry of shocks in Euroland

-0.02-0.01

00.010.020.030.040.050.060.070.08

1960

1962

1964

1966

1968

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

grow

th ra

te

0

0.005

0.01

0.015

0.02

0.025

0.03

0.035

0.04

stan

dard

dev

iatio

n

Euro area grow th rateStandard deviation Euro area grow thStandard deviation EU15

Bretton Woods

Euro

German unification


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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


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• 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


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• 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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Table 1. European net contributions and budget deficits 2002 in percent of GDP Net contribution Cycle deficit Structural deficit SD-NC actual deficit AD-NC NC SD AD Portugal 2.08 0.02 -2.72 -4.81 -2.71 -4.79 FR. Germany -0.24 -0.15 -3.37 -3.13 -3.52 -3.28 France -0.14 0.56 -3.66 -3.52 -3.10 -2.96 Greece 2.40 1.31 -1.46 -3.86 -0.16 -2.55 Italy -0.23 -0.01 -2.30 -2.07 -2.31 -2.08 Austria -0.10 -1.43 -0.15 -0.04 -1.58 -1.47 Belgium -0.10 -1.54 0.02 0.12 -1.52 -1.43 Spain 1.27 -0.12 0.21 -1.07 0.09 -1.18 United Kingdom -0.17 1.18 -1.41 -1.24 -0.24 -0.06 Ireland 1.22 3.16 -1.87 -3.09 1.29 0.07 Netherlands -0.49 2.11 -2.05 -1.56 0.05 0.54 Sweden -0.29 1.06 0.81 1.10 1.87 2.16 Denmark -0.09 1.33 1.11 1.20 2.44 2.53 Finland 0.00 0.44 3.75 3.76 4.20 4.20


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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 %


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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


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• 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


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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 preferencesJosef Christl: “dialogue will help bridge the gap between political European

elite and European citizens”


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• 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


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• 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


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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


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Conclusion

Ceterum censeo: pactum stabilitatis esse delendum

Et rem publicam europaeam esse errigendam


Documents

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