How Is the EU Paying for the Economic Crisis?
The European Union is stepping up to the economic challenges posed by the coronavirus pandemic with a €750 billion recovery plan called Next Generation EU. Together with its new multiannual budget, the response rounds up at almost €2 trillion to be dispersed through grants and loans to member states. But, as countries rally in solidarity and mutualize debt, it is important to ask whether the next generation will foot the bill and whether the burden will be worth it.
There is very little room for the austerity-based approach to the earlier financial crisis, which 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 electorates’ reaction to what has been characterized as a “Hamiltonian moment” for Europe?
Recent polls show Europeans are more inclined to support further integration, as the pandemic has convinced many of the need for more EU cooperation. This is all about common action in the end—the elusive convergence and cohesion among all member states, north and south, east and west. The move toward common action in the health sector in the context of the coronavirus 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” for its current presidency of the Council of the EU, Germany seems forced to take the lead and pay the bill as the largest economic power in Europe. 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 percent 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 certainly, but also likely for France, Poland, and Romania.
Therefore, a new strategy to rein in public deficits is needed. Rather than slashing spending, another approach would be to strengthen tax administration and fiscal collection. The EU-level tax gap is estimated at approximately €825 billion per year, and in many member states it exceeds healthcare spending. In contrast to northern European countries, southern and eastern ones 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 GDP.
Even before the coronavirus pandemic, the tide was turning worldwide toward 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. They 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 European countries like Romania and Poland, or southern ones with consolidated informal traditions like Greece or Italy.
Institutional capacity is clearly another driving factor of fiscal collection. In our large scale behavioral experimental study of Europe and the United States, we found that cross-national differences in fiscal compliance could be associated with institutional differences. It is time EU realizes that broad conditionalities for accessing its funds (for example, based on fiscal deficits or rule of law) do little in the way of convergence, and realistic technical assistance packages should be geared toward 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 central and southern Europe. It is also useful for insulating EU funds from political opportunism and clientelism in countries with authoritarian tendencies such as Poland and Hungary.
Improving administrative capacity is not a panacea for the tax gap and any fiscal reform must realistically account for other factors, such as the number of small and medium-sized enterprises in an economy, informal norms, political opportunism, and poor institutional capacity. The stakes are much higher in the context of the unprecedented financial package put forth by the EU. But further institutional integration and harmonization of practices means more than paying for deficits; it is also about internal cohesion and common action, and it is the only way forward for the European project.
Clara Volintiru is a GMF ReThink.CEE fellow and an associate professor at the Bucharest University of Economic Studies. John D’Attoma is a lecturer at the University of Exeter Business School.