The EU budget is being sacrificed for the Recovery Fund

EU leaders meet on Friday for a Special European Council – their first in-person meeting since Covid-19 took hold in Europe. This meeting is dedicated solely to two items: first, a proposed Recovery Fund in response to the outbreak; and second, the next EU budget.

What will EU leaders be discussing?

Since they last spoke in mid-June, via videoconference, the European Council President Charles Michel has been holding bilateral talks with EU leaders in an attempt to find a compromise. Prior to the summit, Mr Michel set out the measure EU leaders will discuss:

  • a proposed EU budget of €1.07trn – €26bn below the Commission’s proposal in May and €56bn below its proposal in 2018.
  • a Recovery Fund of €750bn, with the balance of loans and grants to be decided.
  • a proposal for member states to produce Reform and Resilience Plans to access the Recovery Fund, each of which would need to be approved by a qualified majority.
  • the maintenance of rebates for net contributor countries (including the so-called frugal countries: Austria, Denmark, the Netherlands and Sweden) until the next budget in 2028.
  • new EU income sources to pay for the Recovery Fund including a tax on plastic waste, a carbon tax on imports, a digital services levy and reforms of the EU’s emissions trading system.

Will any of this fly?

The subtext of Mr Michel’s proposals is an attempt to strike a balance between competing groups. The frugal countries, as well as Finland, dislike the idea of giving grants to member states and the size of the Recovery Fund while a substantial majority of EU countries, including the four biggest economies (Germany, France, Italy and Spain), see the proposed scale of grants as crucial to address the scale of the crisis and avoid further national debt.

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The budget proposal, which may yet be chipped away further, is an attempt to gain acceptance of the Recovery Fund among the frugals by reducing their contributions to the ordinary budget. When initial negotiations on the EU budget began a couple of years ago, the frugals argued for a reduced budget in line with reduced membership after Brexit. They may well get that now, effectively accepting a Brexit gap, but at the price of the Recovery Fund. Such is the frugals’ resistance, at his press conference on Friday Mr Michel felt compelled to stress that “our goal is not to burn money.”

In theory at least, the Recovery Fund should not mean increased contributions from member states if – and it is a big if – they sign up to all the new proposed sources of EU income. But while the frugals might accept some of the climate-related sources, such as the plastic and carbon border taxes, they are unlikely to accept a digital tax or a mooted common EU corporation tax. This would mean a funding gap to be filled by net contributors to the fund – the biggest being Germany, France and the Netherlands.

On the other side of the argument, the fact that Mr Michel stuck with the €750bn proposal suggests the amount is symbolically important. For many, the EU needs to appear to be making a major intervention to give confidence to markets, businesses and citizens. The emphasis that German Chancellor Angela Merkel in particular has placed on reaching a deal at this summit demonstrates the political necessity she sees in acting quickly and decisively.

How will member states find a landing zone for agreement?

The answer is probably with a great deal of rancour and bad feeling.

The size of the Recovery Fund could be vulnerable. Media reports suggest parts of the package, amounting to around €50bn, are being targeted by the frugals. A reduction in its overall size, along with a shift in the ratio of loans and grants, would be a sour pill for a number of Mediterranean countries to swallow, especially if accompanied by close monitoring of spending and reforms akin to that for EU fiscal rules. This would set the scene for years of wrangling over domestic reforms, access to funds, and back and forth between member states and the Commission.

[Escuche el ‘podcast’ de Agenda Pública: ¿Cómo saldrá Brasil de esta crisis?]

Less discussed, but just as important, is the EU budget itself. A reduced budget would probably mean a reduction in EU cohesion funds. In the previous budget these funds accounted for 34% of the total; the Commission proposal in May reduced this to 29%; an even smaller budget would likely mean even less. There would be no small contradiction in a Recovery Fund that attempted to alleviate regional and sectoral inequities arising from Covid while reducing ordinary EU funds aimed at doing similar.

The gap between the EU leaders’ rhetoric – no doubt part of each country’s negotiating strategy – is so wide currently that reaching a deal this week seems optimistic to say the least. Politically, however, speed is crucial.

Chancellor Merkel as much as anyone appears keenly aware of the reputational risk for the EU in appearing incapable of acting decisively at such a crucial time. Although much of the Recovery Fund would take years to reach affected sectors and regions, the main thing is to signal clearly to worst-affected member states that Europe is coming.

There are practical reasons for expediency as well. No-one knows whether there will be a widespread second wave of Covid-19 and whether future physical summits would even be possible. While they can be physically in the room together, leaders will want to make the most of it.

We could be heading for a compromise at a later summit in July or August, and one could leave all member states at least partly disappointed: a budget with the Brexit hole unfilled; a Recovery Fund with grants but fewer than some hoped for, and with strict surveillance; and some new sources of income, but not enough to pay for the Recovery Fund alone.

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