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1 The EU Budget and Economic and Social Cohesion

The objective of strengthening economic and social cohesion is mentioned explicitly in Article 2 of the Treaty and as the first objective of the Union. More specifically, Article 158 states that cohesion is a precondition for harmonious development in the EU:

'in order to promote its overall harmonious development, the Community shall develop and pursue its actions leading to the strengthening of its economic and social cohesion.' This article, moreover, goes on to stress that fostering cohesion requires that 'the Community shall aim at reducing disparities between the levels of development of the various regions and the backwardness of the least favoured regions or islands, including rural areas.'

The Treaty, by making explicit the aim of reducing disparities in economic development, implicitly requires that EU policies, and cohesion measures in particular, should influence factor endowment and resource allocation and, in turn, promote economic growth. More specifically, cohesion policies are aimed at increasing investment to achieve higher growth and are not specifically concerned either with expanding consumption directly or with redistribution of income. This differs fundamentally from national cohesion policies which are in part aimed at transferring income to the poorest areas.1

The EU Budget is a key instrument for enhancing economic and social cohesion. First, even though part of expenditure is not directed explicitly towards this objective, most of it is.

Secondly, it is recognised in the Treaty that contributions to the Budget must take account of the differential ability to pay and that measures need to be taken to ameliorate the adverse situation of the less wealthy Member States.

Member States which are less well off, therefore, tend to emerge as net recipients from the Budget2 (see Graph 21).Such an aggregate measure may, however, be misleading since only part of overall EU expenditure (included in the data plotted in graph), is explicitly of a cohesion nature. Although the cohesion countries are net beneficiaries from the Budget, there is not necessarily a negative relationship between budgetary positions and levels of GNP across Member States, since expenditure includes that devoted to purposes other than cohesion.

Types of EU expenditure and cohesion

The EU Budget contains no stabilisation function as such. Nevertheless, according to 1999 data, 23.3% of expenditure was on to allocative objectives, 71.4% on redistributive ones and the remainder on administration.

Allocative expenditure is intended to alter the market allocation of goods and/or services, either to correct market failure or to improve the market outcome. Examples of the former are expenditure on research, trans-European networks and the environment, while expenditure on the CAP is an example of the latter.

Expenditure for correcting market failure is not related to the prosperity of the countries in which it is made and, therefore, does not directly impinge on cohesion (see Graph 22, which shows the absence of any correlation between GNP and Internal Market expenditure).

Allocative expenditure aimed at improving the free market outcome poses more difficulties. In the case of the CAP, for example, it is intended to support prices at a level which gives a fair income to farmers. The cost of this depends on the gap between market prices and support prices, while farmers' income depends only on the level of the latter.

However, an important part of the CAP takes the form of direct income support to farmers and is, therefore, redistributive in nature. CAP support in total is, accordingly, mildly negatively correlated with income (Graph 23) mainly because of the income support component (Graph 24).

EU redistributive expenditure

Redistributive expenditure is the main instrument of cohesion policy. This was boosted by the Delors I and II packages, which first institutionalised structural spending and its programming and then expanded the amount and established the Cohesion Fund. The Financial Perspectives 2000 to 2006 put structural expenditure at the centre of the enlargement strategy, allocating around 80% of the total funds for the new Member States to this.

As noted above, the key objective of EU redistributive policy is to reduce regional differences in the level of development through fostering investment. The aim, therefore, is to improve the structural endowment of less prosperous regions or where development needs are greatest. This is pursued through the Structural Funds and many other EU policies which are directed at improving the level of infrastructure, education and scientific research in the regions in question.
The emphasis on growth and investment explains the importance attached to the principle of additionality, under which Community transfers may not lead to a reduction in the structural expenditure financed by Member States themselves. In other words, EU structural aid must be additional to and supplement national investment.

The present system of structural expenditure can then be thought of as a rules-based system in which spending for convergence is tied to specific projects and to explicit financial and other parameters.

An important aspect of EU structural expenditure is multilateral monitoring under which both recipient Member States and the EU, through the Commission, agree on the Community Support Framework (CSF) and its implementation. One rationale for this is to ensure that convergence aid is used as intended, so providing reassurance to EU taxpayers. The involvement of recipient Member States is for reasons of subsidiarity, in that they are acknowledged to be in the best position to propose projects and to judge the appropriateness of expenditure.

Structural expenditure increased over the two programming periods, 1988 to 1993 and 1994 to 1999, but is due to decline in the period 2000 to 2006 (Graph 25, in which funds going to the acceding Member States are shown separately).3 There is a clear inverse relationship between structural expenditure and the relative prosperity of Member States, but it is not entirely systematic (See Graph 26).

Whilst the largest part of the Structural Funds is allocated on a regional basis, the Guidance section of the European Agricultural Guidance and Guarantee Fund (EAGGF) and the Cohesion Fund are allocated to Member States. The limited importance of the latter in relation to the former (the EAGGF-Guidance and Cohesion Fund account for about 23% of total structural expenditure) can mean that Member States with similar GDP per head have different access to funds, as in the case of Sweden and Italy, for example. In Italy, therefore, there are six regions (accounting for some 33% of the population) eligible for Objective 1 funds, while in Sweden, only a small proportion of the population is similarly covered (under 6%).

As noted above, however, direct income support to farmers under the CAP is different from other EU redistributive expenditure, in that it is aimed at redistributing income between people rather than at fostering investment in particular regions. Indeed, the more the CAP moves away from price support towards income support, the more it becomes a means of interpersonal redistribution, with no direct intention of reducing regional disparities in growth potential. The European Commission has suggested that at least part of this income support could be co-financed by Member States (see European Commission 1998), but this so far has failed to gain unanimous support.

EU Budget revenue

The EU Budget is financed by the EU's own resources, ie custom duties, agricultural and sugar levies, VAT resources and those related to GNP. In recent years, GNP resources have increased in importance, while VAT resources and the other sources have declined (Graph 27). With the new Own Resources Decision, which will come into force on 1 January, 2002, this trend will be further reinforced.

Unlike in the case of national budgets, where progressive taxation plays an important redistributive role, in the EU budget, contributions are proportional to the capacity to pay measured by nominal GNP at current exchange rates. Redistributive objectives, as noted above, are, therefore, pursued through expenditure alone.

The importance of VAT resources to revenue, however, is liable to produce regressive effects. To correct for this, the 1988 Own Resources Decision capped the VAT base of all Member States to 55% of GNP, while the 1994 Decision limited it for Member States with GNP per head below 90% of the EU average (the cohesion countries) to 50% and reduced it progressively for others to 50% by 1999. The 1994 Decision also progressively reduced the maximum call rate of VAT from 1.4% in 1995 to 1% by 1999. The March 1999 Berlin European Council and the new Own Resources Decision further reduced the maximum VAT call rate to 0.75% in 2002 and 2003 and to 0.5% from 2004 on.

The increased importance given to GNP resources in future years will reduce the regressive nature of the system substantially, so effectively nullifying an issue which could have become potentially contentious with enlargement and the very low levels of GNP per head in many of the acceding countries.

Cohesion and Budgetary Balances

The balance between contributions to the EU Budget and receipts from it is not a policy objective in itself. Nevertheless, with contributions to the Budget being largely proportional to GNP, expenditure is crucial to determining the configuration of balances. Indeed, whatever their limitations, the latter largely mirror the policy priorities of the Union. The data are consistent with cohesion expenditure being inversely related to regional GDP per head and with the cohesion countries being net beneficiaries of the EU Budget. However, a proper analysis of the contribution of the EU budget to fostering economic and social cohesion needs to take account of the diverse and heterogeneous nature of EU expenditure.

  1. Economic literature is nearly unanimous on the positive and direct relationship between income inequality and social policy. For the most recent findings in Europe see, for example, K. Caminada and K. Goudswaard (2000).
  2. This can be measured in a number of ways none of which is superior to others, see Financing the European Union, Report on the Operation of the Own Resources System, Bulletin of the European Union, Supplement 2/98, especially Annex 3.
  3. The data on EU-15 and enlargement-related structural expenditure are from the "Interinstitutional Agreement between the European Parliament, the Council and the Commission of 6 May 1999 on Budgetary Discipline and Improvement of the Budgetary Procedure", Annex I and Annex II.

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