We need a modern fiscal framework fit for climate change. Now.

Financing the transition

We need a modern fiscal framework fit for climate change. Now.

  • The reform of the EU’s fiscal rules should consider the need for investments and spending to achieve a just green transition that is currently being hampered by the austere fiscal rules, argues Isabelle Brachet.

In a few weeks, the European Commission will propose orientations to reform the EU rules governing member states’ budgets, deficits and debt. A couple of days ago, the IMF published its recommendations regarding this reform, while the coalition government in Germany made its position on the topic public last month.

Both the German government and the IMF acknowledge that this reform is urgent. Current rules are so inadequate to the current context that they have been suspended for more than two years.

When this suspension ends in late 2023, austerity will prevail in many member states, as the current debt reduction pace imposed under the EU rules is too fast for highly-indebted countries. Massive cuts in public spending would kill the recovery, erode social rights and deepen people’s distrust towards decision-makers in general and the EU in particular. Right during an election year for the European Parliament!

The EU rules on member states’ debt and budget deficit are blind to the quality of public spending: whether member states invest in public services and the energy transition or fossil gas and the car industry is not relevant to current EU fiscal rules.

Under the set of regulations called the EU Stability and Growth Pact, the only thing that matters is to cap member states’ debt at 60% of their GDP and their budget deficit at 3% of their GDP.

At best, these so-called EU fiscal rules allow some leeway for indiscriminate public investment that generates GDP growth. Whether or not this growth is emitting greenhouse gases and causing massive extraction of natural resources is being overlooked.

The EU fiscal rules are conducive to an economic model not aligned with our climate and environmental objectives instead of incentivising public spending needed to ensure a safe and dignified future.

Do you know what most member states and European Commission officials answer when we raise this concern? “Let’s not overburden the fiscal rules! Any proposal must be measured by whether it ensures debt sustainability and sound budgets”. This raises two big questions, though.

What is a sustainable deficit?

First, how we define what is a “sustainable debt and deficit” matters incredibly. As long as this definition is based on GDP, increasing the overall economic output will remain the ultimate objective of economic policies, sidelining or contradicting social and environmental goals. This is prominent in the position of the German government: By growing GDP, debt will remain a smaller proportion of GDP – which means it will be sustainable.

This one-size-fits-all approach ignores the other elements linked to the national context of each member state, which should allow determining whether financial markets consider a debt stock will be repaid (i.e. is sustainable).

The IMF proposals are engaging in this regard, as they call for a standard EU methodology that all member states would use to assess the sustainability of their debt – something CAN Europe and Finance Watch has been asking for. And such an assessment, which we believe would have to consider climate-related fiscal risks for public finances, would play a crucial role in decisions about the level of budgetary deficit tolerated from member states. The sacrosanct but unsubstantiated 60% and 3% rules would remain untouched but wouldn’t guide much macroeconomic decisions anymore.

What is a “sound budget”?

Second, how we define what a “sound budget” is matters as well. Obsessed with short-term debt and deficit levels, European governments have not spent enough on climate action and public services, leaving our societies unprepared for heatwaves, floods and pandemics.

This unpreparedness and massive delay in the transformation of our economies is now generating growing costs for the public purse – to extinguish wildfires, compensate farmers for droughts or rebuild infrastructure destroyed by floods.

If we want to grow food and ensure a decent income for farmers in ten-year time, we need to support farmers now to farm with and not against nature. If we want bees to pollinate our plants, we must now invest in alternatives to replace deadly pesticides. If we want to be able to pay our heating and cooling bills, we need to invest now to allow low- and middle-income people to shift towards heat pumps, wind and solar energy. If we want people to prefer trains and public transport over cars and flights, we must provide them with attractive and affordable options.

The just and green transition requires huge additional public and private investments and robust social protection and public services to bring everyone on board. In most member states, because the EU fiscal rules severely constrain public spending, investments in the just transition did not happen at scale – which is why we are still so dependent on fossil fuels.

The IMF proposes a new EU fund for climate, energy and “pandemic preparation”. That may be needed, but member states’ national budgets must also become greener and contribute to climate action. For this to happen, the future EU fiscal rules need to pay attention to the quality of spending proposed by member states in their national budget plans.

In the climate movement, we believe that the reform of the EU fiscal rules is a significant opportunity to better ensure debt sustainability while encouraging public spending in the just and green transition. Governments must tax wealth, stop greenwashing, and end fossil fuel subsidies. But let’s say it loud and clear: If we don’t also change the EU fiscal rules on debt and deficit, we can’t win the battle against climate change.

Op-ed written by Fiscal Reform Policy Coordinator, Isabelle Brachet.

Published at Euractiv on 9 September 2022