REPORT: From Maastricht to Paris: Why climate change should be considered in a reformed EU fiscal framework

FROM MAASTRICHT TO PARIS
Why climate change should be considered in a reformed EU fiscal framework

A report by CAN Europe and Finance Watch

INTRODUCTION
Adopted 30 years ago, the Maastricht Treaty placed limits on EU Member States debt and deficit levels to 60% and 3% of a country’s GDP. Historically, debt servicing costs were a significant part of Member States budgets. Binding numerical fiscal limits were therefore perceived as a necessity to ensure that Member States could continue to service their debt – hence limiting contagion risks inside the euro area – without assistance by other members or by the European Central Bank. The Treaty arbitrarily limits the debt and deficit levels to, respectively, 60% and 3% of a country’s GDP. How to implement those rules has been further detailed in the Stability and Growth Pact.

Concerns about debt sustainability risks appear today inflated compared to climate, environmental, and socio-economic challenges Europe is facing. Whilst servicing public debt has never cost so little to European governments, the existential threat from climate change and its impacts on the economy and public finance is becoming clearer every day – from agricultural productivity to energy production, health impacts from water, air and soil pollution, to the destruction of infrastructure due to extreme weather events.

In 2015, with the Paris Agreement on climate change, governments committed to limit the increase in global average temperature to well below 2°C degrees, and to pursue efforts to limit global temperature rise to an even more ambitious 1.5°C target. The Paris Agreement indicates that private and public financial flows need to be made “consistent with a pathway towards low greenhouse gas emissions and climate-resilient development.”

Connections between climate change, debt sustainability, and the reform of the EU economic governance are often overlooked. This briefing seeks to unpack these connections, and formulates key recommendations which can shape the reform of the EU fiscal rules in order to limit the vast economic, social and environmental damages threatening our future.

KEY RECOMMENDATIONS

1. Task IFIs with country-specific debt sustainability analysis. Acknowledging that the sustainable level of government debt hinges on each sovereign’s macroeconomic fundamentals, the independent fiscal institutions (IFIs)^[1] should be tasked with conducting country-specific debt sustainability analyses^[2] that would receive a more prominent role in the European fiscal framework. Crucially, climate-related fiscal risks need to be better understood and monitored.

2. Develop a methodology to assess climate-related fiscal risk. We call upon Member States to urge the European Commission, in partnership with the European Fiscal Board and IFIs, to propose a common EU methodology to measure climate-related fiscal risks (physical and transition risks). More generally, we call upon Member States to support the efforts of the European Commission and EU IFIs in this field, by providing them with the needed political and financial resources.^[3]

3. Task IFIs with estimating green funding gap. As part of a future review of the minimum standards for national fiscal frameworks^[4], the independent fiscal institutions should be tasked with estimating national climate mitigation and adaptation funding gaps (i.e. green funding gaps).

4. Develop an EU methodology to assess green funding gaps. Member States should call upon the European Commission to elaborate a consistent methodology that could be used across Member States to measure the national green funding gaps (public and private). The public green funding gap, as well as a mapping of environmentally-harmful subsidies, should be integrated in revised NECPs and guide fiscal decisions under the European Semester.

5. Move to conditionalised country-specific debt pathway. Acknowledging that the sustainable level of government debt hinges on each sovereign’s macroeconomic fundamentals, country-specific debt sustainability analyses should become the basis of country-specific debt pathways. To disincentivise the misuse of taxpayers’ money, country-specific debt pathway should be linked to the respect of minimum standards.

6. Create unique National Reform & Investment Plans (NRIPs). These multiannual plans would integrate and streamline economic reform and fiscal plans that Member States submit as part of the European Semester – respectively National Reform Plans and Stability or Convergence Programmes. These NRIPs would have to align with country-specific debt pathways, country-specific recommendations (CSRs), and commonly-defined EU priorities (e.g. Green Deal, REPowerEU). This could improve the interplay between economic and fiscal policies while simplifying the European Semester and facilitating the delivery of EU social and climate goals.

7. Treat future-oriented expenditures differently. Allow newly-formed governments to submit, as part of their NRIPs, a list of future-oriented expenditures^[5] to be excluded from their deficit (and/or expenditure) limits. To address concerns around negative incentives to circumvent the rules, we suggest the following: The decision to exclude some spending from a Member State’s expenditure ceiling should be part of a broader process of ex-ante technical assessment by the European Commission (e.g. respect of the Do-No-Significant-Harm principle, quality, EU objectives), dialogue between the Commission and Member States, and political validation by the Council. Ex-post, the Member State would have to report on pre-agreed result indicators.

8. Improve the European Semester. The European Semester should be used to assess countries’ progress towards the achievement of EU objectives (e.g. EU Green Deal, European pillar of social rights, European Industrial Policy). Country-Specific Recommendations (CSRs) should be tailored according to countries’ distance to the target. To improve relevance and compliance, CSRs should (i) better account for EU objectives and European Monetary Union (EMU) dimensions (e.g. euro area fiscal stance, spillovers, externalities), (ii) be associated with specific indicators, (iii) be formulated in a way that makes progress measurable, and (iv) be prioritised according to their significance.

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