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How are we paying for this economic crisis? EU’s new budget

Clara Volintiru and John D’Attoma

The EU is stepping up to the economic challenges posed by Covid19 with a recovery plan titled Next Generation EU of 750 billion euros. Together with the new multiannual EU budget it all rounds up at almost 2 trillion euro, which are to be dispersed through grants and loans to member states. As member states rally in solidarity, mutualizing debt, a looming issue persists: will the next generation foot the bill? Will it be worth the burden?

There is very little room for the austerity-based approach of the previous crisis which has left governments across Europe with little political capital. The continent shifts from the concept of European sovereignty to that of European solidarity, but leaders stumble on how to proceed with the European project. As always, it is a question of money: will countries pool together their resources and further the political union, or will they continue to stand apart, cautious of their national electorates’ reaction to what is characterized by many to be a “Hamiltonian moment” for Europe? Interestingly enough, recent polls show Europeans more inclined to support further integration, as the pandemic has convinced many of the need for more EU cooperation. And this is all about common action in the end – the ever-elusive convergence and cohesion across all member states, North and South, East and West. The move towards common action in the health sector in the context of the Covid19 could be the very thing to jumpstart the next phase of a more political EU.

Given the current context, with the motto of standing “together for Europe’s recovery”, Germany seems forced to take the lead and pay the bill, as the single largest economic power in the EU. But it is highly unlikely it will do so without a clear contingency plan on public finances at the national level.

Global public debt is expected to reach an all-time high, exceeding 101% of GDP, and the average overall fiscal deficit is expected to soar to 14 percent of GDP in 2020, according to the latest IMF projections. For many EU countries, the year could close with double-digit public deficits—for Spain and Italy for sure, but also likely for France, Poland and Romania.

Therefore, a new strategy to reign in public deficits is needed. Rather than slashing spending, another approach could be to strengthen tax administrations and fiscal collection through digitalization and tax administration reform. At the EU level, estimates placed the tax gap at approximately 825 billion euros per year, and in many EU member states tax gaps exceed healthcare spending. In contrast to Northern states, Southern and Eastern European countries have extensive tax gaps that could be addressed through digitalization and public administration reform. In many of the newer member states, tax revenues are only about a third of their GDP.

Even before the Covid19 pandemics, the tide was turning towards a new digital era for fiscal authorities. Governments play a pivotal role when it comes to digitizing payments in an economy—from tax collection to shifting government wages and social transfers into accounts, governments can lead by example and play a catalytic role in building a digital payments infrastructure and ecosystem where all kinds of payments—including private-sector wages, payments for the sale of agricultural goods, utility bills, school fees, remittances, and everyday purchases—are done digitally. This process yields better traceability of payments, thus countering fiscal evasion, and it has shown its merits in many European countries. However, such solutions are difficult to implement in contexts of ample subnational disparities of development as in the case of larger Central and Eastern European countries like Romania and  Poland or Southern countries with consolidated informal traditions like Italy or Greece.

Institutional capacity is clearly another driving factor of fiscal collection. In our large scale behavioral experimental study of Europe and America, we found that cross-national differences in fiscal compliance could be associated with institutional differences. It is time EU realizes that general conditionalities do little in the way of convergence, and realistic technical assistance packages should be geared towards meaningful institutional reform and harmonization of practices across the EU. This is particularly important for countries with a poor track record on state capacity in Eastern or Southern Europe. It is also useful for insulating these funds from political opportunism and clientelism in countries with authoritarian tendencies such as Poland and Hungary.

We understand that improving administrative capacity is not a panacea for the tax gap and that any reform plan must realistically account for a number of other factors, such as the number of SMEs in an economy, informal norms, political opportunism, and poor institutional capacity. And the stakes are literally much higher in the context of the unprecedented financial package put forth by the EU.

Clara Volintiru is an Associate Professor at the Bucharest University of Economic Studies (ASE) and a GMF Rethink.CEE fellow 2020.

John D’Attoma is a Lecturer at the University of Exeter Business School and a member of TARC.

 


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