CAN Europe position on the reform of the EU fiscal framework

Financing the transition

Massive public and private investments in climate mitigation and adaptation are urgent to avoid runaway catastrophic climate scenarios. As noted by the European Central Bank (ECB), “there are clear benefits to acting early: the short-term costs of the transition pale in comparison to the costs of unfettered climate change in the medium to long term”. More frequent and severe natural disasters could lead to a decrease in European GDP, should policies to mitigate climate change not be introduced. But beyond the impact on GDP, the cost of inaction would be immense in terms of humanitarian needs to deal with climate-related disasters and increase in food prices, public health impacts, or additional annual welfare loss in Europe (175bn € under a 3°C global warming scenario, and 83bn € under a 2°C global warming scenario).

While estimates of the green investment gap vary and it is very complex to measure in some environmental policy areas, according to the European Commission, the additional investments needed to reach the EU’s 2030 climate and environmental policy goals are around €470bn per year. These estimates predate the increase in policy ambition to 55% GHG emission reductions by 2030, but they do not consider the possible effect of the removal of environmentally harmful subsidies and internalisation of external costs. The Commission more recently estimated the gap at 520 billion euros each year. In a nutshell: in order to deliver the objectives of the European Green Deal, important investments in climate and nature protection are needed right now.

Private finance is huge and invested properly, it could be a game changer for the just transformation of our economies and societies. However, so far the market failed to deliver the investments needed in climate action. The Polluter Pays Principle has not been properly applied and external costs have not been internalized. This has generated enormous price distortions, which greatly contribute to the fact that economic activities harmful for the climate or the environment are often profitable. Proper carbon taxation could incentivize private investments in alternative cleaner models of production, with reduced GHG emissions. Regulation of private finance, ending fossil fuels subsidies, putting in place environmental taxation as part of a broader tax reform are necessary as well to shift private finance towards climate action.

However, public spending also has a key role to play to drive the just transformation of our economies and societies. Some areas requiring massive investments are not attractive to private finance seeking a (quick) return, such as building renovation, or many adaptation measures. According to McKinsey & Company, half the required €28 trillion necessary investments to be done in the EU before 2030 would not have a positive business case.

Public investments are necessary to ensure alternatives to high-carbon activities are available early enough, including for low-income people. Robust carbon price is also indispensable to steer and leverage private finance towards climate action. And effective measures are needed to reduce corruption and misuse of public money, which is still frequently financing climate-damaging and environmentally harmful activities. We therefore need a reformed EU economic governance, an enabling monetary policy, and a fiscal framework able to incentivize genuinely green public investments. While current EU fiscal rules have contributed to a certain economic stability in the EU, they have failed on many other accounts and are not fit to help achieve the EU’s  economic, social and environmental goals. Therefore, they need to be fundamentally changed. We need a fiscal framework which is a tool to respond to societal challenges while ensuring sustainable public finances.

The EU fiscal framework is a set of rules to coordinate and monitor Member States’ fiscal policies, in particular Eurozone members’ budgetary status, in order to avoid that economic difficulties facing one country (‘unsustainable’ debt) could affect the others. These rules notably include two major so-called numerical fiscal rules:

  • The total debt of Member States should not exceed 60% of their Gross Domestic Product (GDP). If it is higher, it should decline annually at a certain pace.

  • Member States’ annual budget deficit should not exceed 3% of their GDP.

These EU fiscal rules are enshrined in the Treaty on the Functioning of the European Union, while the specific reference values of 3% and 60% are set in Protocol 12 to the Maastricht Treaty, and further detailed in EU Regulations called the Stability and Growth Pact (SGP). They have been suspended (via the activation of the ‘general escape clause’) in the aftermath of the covid-19 pandemic to allow Member States to increase public spending to respond to the health, economic and social needs caused by the pandemic. These rules will be suspended till the end of 2022. By then, the European Commission wants “to build a consensus among Member States on the way forward well in time for 2023”. The Commission launched a public consultation on the review of the EU economic governance in October 2021.

Why do we need a reform?

  • The EU fiscal framework contributed to constrain public spending and investments in a number of Member States before the pandemic, and will translate in austerity and cuts in public spending if applied again from 2023.
  • The EU economic governance framework has not effectively encouraged Member States to invest sufficiently in the just transition so far, nor to end environmentally harmful subsidies. This is problematic as the quality of public spending is fundamental, i.e. public money must be used for genuine climate and environmental action and for providing high quality public services (education, health care, etc).
  • The EU fiscal framework is based on reference values (3% annual fiscal deficit to GDP ratio/60% debt to GDP ratio) that are 30-year old, not robustly evidenced and miss other important criteria (including climate risk for public budgets) which increasingly matter to ensure the trust of creditors, and thereby the sustainability of our public finances.
  • Current rules are too complex and not flexible enough to accommodate national situations.
  • Current procedures are not democratic enough, with little space for civic engagement and public debate, including in national and the European parliaments.
  • Current rules have been implemented with negative social consequences in several member states, with differentiated gender impacts. This contributed to rising inequality and made our societies less resilient to shocks such as pandemics or climate havoc (cuts in social spending, public health, public services). Promoting the care economy through investments in gender-responsive public services (childcare, elderly care, dependency care, etc.) is an indispensable ingredient for a just transition.
  • Debt has been rising in all EU member States as a result of governments’ response to covid, with a majority of Eurozone members reaching 100% debt to GDP ratio; a return to the 60% debt to GDP ratio starting in January 2023 without fundamental reforms would inevitably entail austerity in these Member States. This in turn would risk exacerbating anti-EU feelings and votes and might generate a political and economic context profoundly unfavourable to ambitious climate action.
  • Recommendations from the EC to member States regarding macroeconomic decisions are largely based on economic estimates that often prove to be wrong (e.g. expected potential growth), and these estimates risk to be even more inaccurate in a less predictable post-covid economy.
  • The EU fiscal rules are not receptive to societal challenges, in particular climate change and social rights. We urgently need to fund the just transition/the transformation of our societies and economies, to protect all people, particularly the rights of young people and future generations.

CAN Europe urges a fundamental reform of EU fiscal rules and economic governance in order to ensure that any additional fiscal space will translate into targeted and effective climate action by Member States.

The experience of NGEU could be an important step in this direction, seeking to channel the fiscal stimulus on climate action to a certain extent. However, while EU countries seem to have performed better than other G20 economies in terms of the greenness of the fiscal stimulus in response to the pandemic,  a number of recovery and resilience plans paid little attention to nature and biodiversity, and may harm nature.

Therefore, very strict common criteria will have to be agreed at EU level to avoid greenwashing, environmental harm, inefficient use and misuse of public money, and to make sure that any public spending escaping the debt and deficit rules will meet the highest quality standards regarding nature protection and climate. The permission for public spending to escape the debt and deficit rules should be tied to a requirement that national funding will not contradict the EU’s climate and environmental objectives (greening national budgets so that public money will never be used for projects and activities which increase CO2 emissions or harm nature and biodiversity); that fossil fuel subsidies will be terminated with a binding pathway; and that accompanying measures will be in place to mitigate the possible adverse social impacts. Last but not least, CSOs will have a crucial role to play to monitor whether those conditions are respected by governments.

To read more about our short and long term demands, please click below: