The FTT is dying a death of a thousand cuts – this could be the final one

The EU’s Financial Transaction Tax has taken another big blow today – possibly a fatal one.

A leaked legal opinion by the European Council’s legal service has warned that the current set up of the FTT pursued by 11 member states “infringes” on and “is not compatible” with the current EU treaties (the FT’s Brussels blog has posted the full text and done a good round up of the issues at play).

The legal service was asked to look specifically into whether the FTT’s counterparty principle (taxation based on where the counterparty of the transaction is based) infringed on the right of member states which are not taking part in enhanced cooperation policy not to be affected by said policy (Article 327 TFEU).

The criticism is very much in line with complaints raised by the UK as well as by previous leaked documents (which we exclusively published) which showed growing concerns over the extraterritoriality of the FTT and that it may be discriminatory against non-participating members:

“Concerning the deemed establishment based on the counterparty principle, raises issues of extraterritorial exercise of jurisdiction, disrespect of non-participating Member States' rights under the Treaty, and compatibility with the principles of free movement of capital and non-discrimination.”

“[The counterparty principle] would constitute the exercise of jurisdiction over entities located outside the geographical area concerned by the legislation adopted under the enhanced cooperation.”

“The FTT proposed will be levied not only on risky activities but to a large extent also on activities with a genuine economic substance that are not liable to contribute to systemic risk and which are indispensable for the activities of non-financial business entities. Where activities are covered that can indeed be considered to be liable to contribute to financial markets' risk, it has not been demonstrated that the interests of Member States' are endangered to a point that the Union should divert from its attitude in principle of restraint as to extraterritorial exercise of jurisdiction.”

Those are just a few of the very clear and strongly worded arguments put forth by the legal service. Given the clarity and depth of the arguments presented it is hard not to see this as the final nail in the coffin for this (much maligned) proposal for the FTT.

Given the politics of this, there will have to be some form of 'financial transaction tax'. But, this is now likely to amount to a significantly watered down tax, possibly focused solely on equities and levied at a much lower rate only on those specifically trading the products (similar to the UK's stamp duty).

In any case, this is a big win for the UK – although how much credit it can take for it is unclear. In the end the combination of legal overstretch as well as the potential to inflict significant financial damage on fragile eurozone states has undermined the FTT. Equally this is a blow to the Commission and the European Parliament which have pushed hard and invested a lot of time resources into getting this version of the FTT through.

That said, the Commission has remained unsurprisingly steadfast, suggesting that it rejects the legal opinion and believes the current set up is compatible with the EU treaties. The German government has also suggested it will continue to pursue the FTT, but has said that it will seek to iron out all legal uncertainties first (though some in Germany have previously raised concerns about the substance of tax).

Ultimately, this may have to be decided in court. But the case for the FTT has certainly taken another hefty blow.

Has Germany really gone off the idea of an EU treaty change?

Usually technical meetings behind closed doors in Brussels are pretty dull. However, judging by some of the reports floating around, yesterday’s meeting of the EU Committee of Permanent Representatives (COREPER) may have bucked the trend somewhat. This is the negotiation forum for member states' EU ambassadors - the key guys involved in talks over EU policy. This is where a lot of decisions, de facto, are being made.

As we noted in today’s press summary the UK was outright outvoted on the plans for capital requirements for banks (CRD IV), which entail the controversial caps on bankers' bonuses. 

However, though it was already clear that the UK had lost that particular battle, it was the talks over the EU's proposed, and in part agreed, banking union which caught our eye. EU ambassadors failed to reach agreement amid continued North-South divisions, but the reason why is interesting.

Most media failed to pick up on this, but the WSJ Real Time Brussels blog rightly notes that Germany was strongly pushing for a clearer separation between the ECB's monetary duties and supervisory responsibilities, to avoid a running conflict of interest (see here). The only way this can really happen is to give the supervisory board the final say over supervisory decisions (as opposed to now when it rests with the ECB's Governing Council). This, in turn, requires EU treaty change. The Germans wanted a clear commitment from other member states that this would happen.

According to the WSJ, Berlin also insisted on giving national parliaments (not just the European Parliament) the right to ask questions and get answers on supervisory policy, and giving states under the single supervisor along with the EP the power to remove the Vice Chairman of the supervisory body.

A couple of interesting points there. This is an incredibly fluid target but those who say that Germany has 'gone off the idea' of Treaty change - in light of David Cameron's speech where he mentioned EU treaty change as an avenue for reform - clearly haven't quite appreciated the nature of the proposals floating around. Of course, Berlin won't be shouting it from the rooftops ahead of a national elections and with the relationship with France at an all time low (well almost), but in many of the Germans demand on eurozone governance is an implicit acknowledgement that something has to change in the EU's institutional framework (see our table here of the broad proposals being discussed [p.9]).

The scope (limited or full treaty change), nature (EU treaty or inter-governmental) and timing will be discussed, but it will likely happen sooner or later.

Would EU law introduce border controls with Scotland?

The last time there was a formal English border with Scotland was under the Romans, although for some parts of the middle ages both England and Scotland may have wished for one. Since then, it's pretty much been come and go as you wish. Well, that may - at least hypothetically - soon change.

This week saw the debate over Scottish independence heating up again, in turn throwing up a number of questions about whether Scotland would have to negotiate new membership terms with the EU, and if so, how this would work. Most discussions have focussed on the euro - which all EU members that don't have an opt-out (which only the UK and Denmark have at the moment) - are required to join.

But there's another interesting twist. You might assume that if Scotland again became independent, the current open border would continue. Well, you could be wrong. This is because while the UK has a specific opt-out from the EU's common travel area (the Schengen agreement) under, the Amsterdam Treaty incorporated the Schengen agreement into EU law (Article 77, previously it was a stand alone agreement), meaning that whoever signs up to the full body of EU law, also signs up to Schengen. In other words, similarly to the euro, Scotland would not automatically have an opt out.

The EU considers that all states should join the borderless EU. This would pose a problem for an independent Scotland as the UK and Ireland have their own Common Travel Area and external borders - to help facilitate travel over the Northern Irish Border. If Scotland was in Schengen, England (and the rump UK and Ireland) would need to apply an external border and passport checks on the new frontier.

That is if Scotland was in the EU at all. The UK's membership does not extend to former members. Scotland would therefore have to negotiate for itself an opt-out from Schengen as a part of its accession process from outside the EU.

In addition to a Schengen opt-put, an independent Scotland would also have to negotiate:

• Opt out from the Euro - so it could keep the English (or Scottish?) pound (the SNP says it want this option until the time is right to join the euro).
• Possibly its own budget rebate so it is not unfairly penalised
• A fair deal on fishing.

Plenty to play for in Europe, in other words, should Scotland wish to go down that path...

The Euro Fiscal Pact: The saga continues, now with better news for Cameron

Following last Friday's meeting of negotiators from EU member states (including the UK), a third draft of the new European fiscal pact is now out. As with the version of the draft out last week, Open Europe has got hold of a copy of the revised draft (available here) and, yet again, we're the first in the Anglosphere to publish the draft.

From the UK's point of view, there are some significant changes, at this stage marking a victory for Cameron and Clegg. The controversial reference to the single market in Article 1 is no longer there - the UK has consistently said there should be no overlap between the euro fiscal compact and single market rules - and the role of EU institutions has been narrowed substantially.

From the eurozone's point of view, the draft may actually be worse news than the previous version, as the markets could judge the watering down of the enforcement mechanisms through the EU institutions as a weakness similar to those haunting the original Stability & Growth Pact. Looks as if the Germans have caved in a bit on an extensive role of the ECJ (which the French never were entirely happy about).

After a first glance, the following are the most significant changes from the previous version:

• The reference to the single market which reportedly infuriated UK negotiators has gone;

• A sentence in Article 2 establishing that "In accordance with the case law of the Court of Justice of the European Union, EU law has precedence over the provisions of this treaty" has also disappeared (this could be both good and bad news for the UK and other non-euro members - we'll return to that);

• The expression "structural deficit" has been replaced by "structural balance", but details on what it means in practice are still lacking;

• Article 6 on the coordination of debt issuance has been tweaked and now reads, "With a view to better coordinating the planning of their national debt issuance, the Contracting Parties shall report ex-ante on their public debt issuance plans to the European Commission and to the Council";

• Under the revised draft, the Commission would not be allowed to submit proposals/recommendations to countries with an excessive public debt (something Italy is particularly concerned about, due to its large debt), but only to those running excessive deficits;

• There seems to be a major backtrack on the role of the ECJ, as its jurisdiction is now again restricted to overseeing whether member states properly transpose the balanced budget rule into national legislation;

• In addition, the European Commission no longer has the power to take governments to the ECJ. Under the revised draft, the Commission can be "invited" by member states to issue a report on a country which is thought to be in breach of Article 3(2) - the one on the balanced budget rule. If the Commission supports the breach, the concerned government can be taken to the ECJ, but only by another government;

• The Economic and Monetary Affairs Commissioner would be excluded from the meetings of eurozone leaders, along with the Chairman of the Eurogroup (but Jean-Claude Juncker should not worry too much about this, given that he will attend as Luxembourg's Prime Minister);

• The latest draft includes a specific date for the entry into force of the fiscal pact, 1 January 2013. The number of countries that need to ratify the treaty before it enters into force is now twelve (down from fifteen, which was probably too ambitious, given the problems that could potentially arise in Ireland, Slovakia and Finland);

• A brand-new Article 15 has been added, which reads very much as an invitation to the UK and other non-euro members, "This Treaty shall be open to accession by Member States of the European Union other than the Contracting Parties upon application...The Contracting Parties shall approve the application by common agreement";

• As regards the transposition of the fiscal pact into the EU Treaties, the wording has been slightly toughened up. The expression "an initiative shall be launched" has been replaced with "the necessary steps shall be taken...with the aim of incorporating the substance of this Treaty into the legal framework of the EU."
  

We doubt this is the last word though...

How will the UK judge the role of the ECJ?

A draft of the new European treaty proposed by France and Germany has been leaked and attention has immediately turned to the thorny issue of the role of the EU institutions in enforcing or policing the new deal – remember the UK's line is broadly that they can't, a key source of potential leverage in future talks.

The proposed document would see a role for the European Court of Justice in judging whether national governments have transposed a new “balanced budget” obligation and, if this is breached, an automatic “correction mechanism” into national law. The new treaty states:

NOTING that compliance with the obligation to transpose the "Balanced Budget Rule" into national legal systems at constitutional or equivalent level should be subject to the jurisdiction of the Court of Justice of the European Union, in accordance with Article 273 of the Treaty on the Functioning of the European Union.

The question is whether this is allowed under EU law, can the ECJ be used for this? (NB, the draft foresees no role for the ECJ in enforcing any sanctions but simply judging whether the new rules have been adequately transposed into national law.)

Article 273 of the EU Treaties, cited by the new treaty, states that:

The Court of Justice shall have jurisdiction in any dispute between Member States which relates to the subject matter of the Treaties if the dispute is submitted to it under a special agreement between the parties.

So this EU Treaty article clearly provides the new group with a hook on which to try and hang the new arrangement and get the ECJ involved. Article 273 would allow the ECJ to be used to judge a dispute (in this case whether the “balanced budget” rule has been adequately transposed), as long as the subject of the dispute is “related” to the EU Treaties. The question is whether this 0.5% rule can reasonably be seen as “related” to the Treaties. This is where the legal grey area begins and where it seems that the justification for ECJ involvement is iffy to say the least.

The existing EU Treaties contain obligations for governments to remain within a 3% deficit limit and a 60% debt to GDP limit. But there is no mention of the new 0.5% “structural deficit” limit proposed by the new treaty.

The 0.5% limit is a new obligation. It is therefore a legal stretch to say that this falls under the category of things to which the EU Treaty “relates”. Using the ECJ to judge whether this new obligation has been transposed properly is therefore also a huge legal stretch and one that the UK would be well advised to investigate and possibly challenge. If Cameron does wave the proposal through it will certainly raise political questions about what his veto actually achieved.

The summit to end all summits

At least that was how it was being seen beforehand. Unfortunately, in the aftermath it seems to have fallen short of expectations (although admittedly the dust is yet to fully settle). Nevertheless, it was an interesting summit, especially for the UK. Below we outline the key outcomes of the summit giving our assessment of the economic, political and legal impact which the decisions may have (read our full press release here).

1) Treaty change

Summary: Failed to agree to a treaty change involving all 27 member states. Eurozone members will push ahead with a new treaty for the 17, plus a possible 9 other EU states, pending consultation with national parliaments. Aim to incorporate the measures into the EU Treaties as soon as possible.

Open Europe’s take: The legal basis for the new intergovernmental treaty is still not clear. It will be very legally complex for the new group to use EU institutions to enforce the new treaty without the consent of the UK. As such, the negotiations are far from over, particularly since eurozone leaders are still keen to incorporate the measures into the Treaties and push further in the future in terms of integration.

Was Cameron right to use his veto? How might it impact on UK – EU relations in the future?

- Cameron had little choice but to exercise his veto given the importance of financial services to the UK economy and his need to balance domestic party concerns. His demands were not excessive, particularly given that other EU members have issued similar national demands during this crisis, e.g. Germany over Eurobonds and the ECB’s role, France over using the European Court of Justice (ECJ) to enforce fiscal sanctions and now Finland over the use of QMV in the ESM.

- There was never any discussion of the UK taking part in the new ‘fiscal compact’ but merely whether it would approve the treaty change or not. As such, the UK’s position has not changed within the EU itself. The political dynamics may have changed but whether this will turn out to be better or worse for the UK remains to be seen.

- There is still a huge legal mess to sort out. Whether the new treaty will be enforced by EU institutions or not remains unclear, as is the UK’s role in future proceedings, but it looks likely to be a massive legal stretch to use the existing EU institutions for this new treaty.

- There are valid concerns that Cameron received no clear safeguards while spending a lot of political capital. In order for this to be a sound investment, it needs to be followed up with a concerted push for a more flexible, adaptable and competitive EU in which the UK can feel at home. In the wake of the eurozone crisis, Europe will need a new grand political settlement, which can take years and in which the UK, like all other EU countries, will push their interests.

2) Fiscal compact

Summary: Commitment to balanced budgets, with an annual structural deficit limit of 0.5% enshrined in law and a clear, automatic correction mechanism for when this is broken. Legal enforcement judged by the European Court of Justice (ECJ). The Excessive Deficit Procedure will be strengthened; any country which breaks the 3% threshold will be subject to Commission sanctions unless a qualified majority of eurozone states oppose them. Examine new Commission rules on economic governance and increase surveillance.

Open Europe’s take: Only difference from the stability and growth pact is that qualified majority voting is reversed. Not a particularly credible or strong fiscal compact. There are significant concerns that if countries such as Germany and France struggle to meet the requirements, they will be watered down. Missing out on strong ECJ enforcement and European level automatic sanctions reduces the impact of these measures, unlikely to be enough to convince markets or the ECB that fiscal discipline will be maintained in the long term. Not clear what a national automatic mechanism for correcting budget deficits would be. This seems to be the start of a process, installing fiscal straight jackets on struggling eurozone countries if they wish to stay in the eurozone long term – not clear where their growth and competitiveness will come from.

3) European Stability Mechanism (ESM)

Summary: Move up entry into force to July 2012 or as soon as members representing 90% of capital commitments have ratified it. EFSF will run until mid-2013 as expected, although deciding how the two will run at the same time (given current restrictions in the ESM treaty) will be delayed until March 2012. ESM wording on private sector involvement in future bailouts will be watered down, highlighting that Greece is “unique and exceptional”. An emergency procedure will be added to ESM voting rules, which states that 85% QMV threshold can be used to make decisions if the Commission and the ECB believe the financial and economic sustainability of the euro is threatened.

Open Europe’s take: Moving up the ESM is broadly positive from a market perspective, although the key issues about its implementation have been delayed. One concern is that the sped up timeline for paying in capital resulting from this move will increase pressure on the funding needs for eurozone states. Removing private sector involvement may calm markets in the short term but could be a mistake in the long term. Takes us back to where we were with EFSF bailouts, simply recycling debt around the eurozone with no clear goal for tackling solvency. Although the QMV rule has to be approved by the Finnish parliament, the “emergency procedure” seems misleading – in what instance would giving a bailout not be seen as an emergency?

4) IMF

Summary: Decide within 10 days whether to provide €200bn in bilateral loans to the IMF general resources fund, via national central banks.

Open Europe’s take: The IMF can apply more conditionality on lending, so it is preferable to the central banks doing it themselves. Still only offers a short term liquidity boost to countries, unless IMF is able to enforce broader economic restructuring which the eurozone looks set dead against. Raises questions over the independence of central banks, since they are giving up money to a general fund to be controlled by an institution with completely separate aims. May be opposed by the ECB and/or Germany depending on format. Even with this additional funding the IMF capacity for bailing out Italy and/or Spain still falls well short.

Enhanced cooperation and the EFSF

We came across an interesting proposal today on Business Insider - that EFSF members could use the process of 'enhanced cooperation' to overcome their difficulties agreeing on the second Greek bailout (Finnish collateral demands) and ratifying the expanded role of the EFSF. We've sent a response through to Business Insider, suggesting that this isn't possible becasue the EFSF falls outside the EU treaties, to which enhanced cooperation applies. Unfortunately, there are no easy ways out of this situation.

(Enhanced cooperation - a procedure which allows at least 9 EU member states to push ahead with integration even if others decline to be involved.)

See below for our full response (we'd recommend reading the BI article as well):

The EFSF is not part of the EU Treaties and is a separate special purpose vehicle; therefore enhanced cooperation cannot apply to it. Since it is not technically an EU institution it does not fall into the jurisdiction of rules or procedures such as enhanced cooperation. The articles of incorporation for the EFSF highlight that it is a “public limited liability company” based in Luxembourg, not a formal EU body or institution.

This was an intentional move by eurozone countries to avoid a treaty renegotiation when setting up the EFSF, which would have been massively time consuming and may have failed to be approved. The EFSF grew from the intergovernmental loans given to Greece under the first bailout (although the two are still separate), therefore its basis has always been intergovernmental and not part of the EU Treaties.

The first part of the preamble to the EFSF Framework distinguishes between the change to EU Treaties required to establish the EFSM (the other €60bn temporary fund) and the setup of the EFSF, which did not require EU treaty change.

In addition, the UK didn’t have to approve the creation of the EFSF, since it was not inside the EU treaties. However, the European Stability Mechanism (ESM), the permanent bailout fund, is inside the Treaties and its creation does require UK approval (see here) and the UK also had a vote on the EFSM. It is clearly confusing since both the EFSM and the ESM are part of EU Treaties but the EFSF is not; but the distinction is clear.

It also seems fairly clear in the framework of the EFSF (Article 10, part 5, page 17) that any decisions on disbursing funds or adjusting the mechanism must be made unanimously. The only way around this would be for all the members of the EFSF to unanimously agree to allow Finland to step out of its share of guarantees but, as the current debate shows, the likes of Austria, the Netherlands and Germany would not let Finland excuse itself while they have to take on a new burden for political reasons.

All in all it seems clear that this enhanced cooperation way out is not plausible for the expansion of the EFSF or for the release of the second Greek bailout.

Power to the Parliament

Open Europe has just hosted a debate on the Coalition Government's proposed 'referendum lock' with Europe Minister David Lidington. A write-up and recording of the event will be put on our events page shortly. But in the meantime, two thoughts:

A point raised - echoing what was argued in the Economist's Bagehot column last week - is that the referendum lock amounts to an effective "UK Veto Bill" over new EU treaties. This, so the reasoning goes, is de facto locking in a two-speed Europe, with Britain in the 'slow lane', as it would never be able to sign up to new Treaties under the Bill (assuming that any referendum on a new EU Treaty in the UK would result in a No vote).

This logic contains some truth but is also dated. In today's more fluid, interesting but also more perilous, Europe what matters is one thing: the health of your economy.

Europe is already a multi-speed beast, fuelled by the ongoing eurozone crisis. The slow lane is reserved for the countries which don't have enough cash to carry them over until tomorrow - not those which choose to stay out of the European Public Prosecutor (for example). Which lane the UK occupies in the future will depend on its economic fundamentals - not the referendum lock.

Secondly, some commentators really should read the actual Bill before ranting. Philip Stephens, who every week recycles columns in the FT, for instance. Today he argues,

It is likewise curious that a Tory party so wedded to parliamentary sovereignty should be so keen to subordinate its authority to a plebiscite. Margaret Thatcher got it right when she criticised the last popular vote on Europe in 1975. The referendum, the then Tory leader observed, sacrificed parliamentary sovereignty to political expediency.

This is wide of the mark. In fact, the biggest winner from this Bill is not the British people - a referendum is unlikely to be called for a long-time (which Stephens also acknowledges) - but the UK Parliament. Every decision outlined in the referendum lock will ultimately rest with Parliament, including whether a power shift is significant enough to warrant a referendum under the so-called significance criteria in the Bill.

In this sense, the proposal is actually more of a Parliamentary lock, than a referendum lock. What the Bill will do is restore some control to Parliament - which has been handed over to the government (and then onto MEPs, EU judges and eurocrats) through various EU treaties.

Now it's up to Parliament to decide what to do with these powers.

Ps. Stephens also argues that the EU Bill is "a piece of legislation so dense and unintelligible that it makes the Maastricht treaty seem like an easy read." He clearly has limited experience with EU treaties and texts. In fact, the EU Bill is a Stieg Larsson novel compared to much coming out of Brussels, such as the unconsolidated version of the Lisbon Treaty for example (which we were the first to decodify).

Two vetoes for the price of one

In Parliament this afternoon, David Cameron gave his statement on last week's EU summit, followed by questions from MPs. The debate was a bit all over the place if we're to be perfectly honest, with the 2.9% increase to the EU's 2011 budget dominating.

The most talked about intervention came from Ed Miliband who said in response to Cameron's alleged cave-in on the EU budget freeze for 2011: “He wished he could come back and say No, No No, but in his case it's a bit more like No, Maybe, Oh go on then.” (apparently a phrase Miliband didn't quite come up with himself).

On actual substance, Chris Heaton-Harris made the most astute observation. He noted that the PM now has two separate vetoes at his disposal: one over Treaty change and one over the EU budget post-2013. Heaton-Harris asked whether Cameron would use the two vetoes independently to achieve EU reform. As we’ve argued before, a twin-track approach to EU negotiations is by far the smartest way to achieve reform in Europe and the restoration of some democratic control over key EU powers.

If the two vetoes are used in parallel but for seperate issues - one for repatriation of powers and the other for concessions on the CAP for instance - we bet anyone (eurosceptics and federalists alike) that the Coalition government will get at least one game-changing concession in return.

The Coalition could even get other member states along for the ride if it's confident and strategic enough. After all, Merkel has given us a great example for how to do it.

Unfortunately, in response to Heaton-Harris and also earlier in the debate, Cameron hinted he would pass up his veto over the treaty change, effectively giving EU partners a two-vetoes-for-the-price-of-one deal.

Hopefully this isn't the end of the story though, as there's still much to play for before Treaty changes are agreed. But MPs need to get their line of argument in order or the Coalition might well go for the do-nothing option.

For Cameron to use the twin-vetoes separately but in parallel, is surely what backbenchers in favour of EU refom should be pushing for?

Has Cameron underplayed the UK's hand in Europe?

Over at Conservative Home, we examine how David Cameron is getting on in Brussels - the performance so far is a mixed bag, but there's a clear risk that he has underplayed the UK's hand in the negotiations.

Meanwhile, German media praises Angela Merkel's "poker skills". She has now achieved backing from EU leaders, in principle at least, for changing the Treaty in order to introduce a permanent crisis mechanism for the eurozone.

How Cameron should play his cards in Europe

Over at the Spectator's Coffee House blog, we take a look at how David Cameron should approach today and tomorrow's EU summit - and how he should play his cards in negotiations in Europe moving forward.

We argue,

The British media woke up this week, realising that Europe still exists. As David Cameron travels to Brussels, questions loom over what, exactly, he can achieve in Europe – at this summit, and more importantly, moving forward.

Much of the commentary surrounding the summit has focussed on the increase to the EU’s 2011 budget, which Cameron is fighting. And for good reason. It’s insane that Britain – or any other net contributing state – should be forced to accept any increase to the EU budget, at a time of tough austerity at home.

Cameron has spent considerable time talking up the negotiations on the budget increase, so he may have an ace up his sleeve to achieve a cash freeze tomorrow or in the coming weeks. But a 2.9% hike is not unlikely, meaning that an extra £430 million would be added to UK taxpayers EU bill – or even more once the European Parliament has had its greedy hands on it.

However, as outrageous as it is, the annual budget increase is only a side show in a far bigger act.

Even if he were to achieve a freeze to the EU budget, there’s nothing stopping MEPs and other member states from pushing through a substantial increase in 2012 or 2013 to make up for it. The EU budget is negotiated in seven-year periods (though that can vary), with minor adjustments being made on an annual basis. Sadly, negotiations over this budget period have already been lost – courtesy of Tony Blair in 2005.

So the bigger prize – which may or may not be discussed in corridors at the summit – is clearly a reduction in the size of the budget from 2014 onwards. Cameron has rightly stated that this is his priority moving forward.

But here Cameron could be committing a strategic mistake. The temptation is to try to ask for concessions on the post-21014 EU budget, in return for supporting Merkel’s repeated calls for a Treaty change to fix the eurozone.

Thing is, the UK already has a veto over the negotiations on the post-2014 budget. If the UK refuses to agree, an effective cash freeze will be achieved anyway as the previous budget will be carried over. Secondly, member states are desperate to get rid of the UK’s rebate from the EU budget – in itself a powerful bargaining chip.

So if Cameron trades budget concessions for Treaty change, he will effectively be giving his EU partners two for the price of one.

A better way forward for Cameron is to horse trade on the EU budget and possible Treaty change separately.

Despite strong opposition from EU leaders, German Chancellor Angela Merkel continues to push for a Treaty change to fix the eurozone. And she won’t cave in easily.

As we’ve argued before, Cameron should back Merkel’s calls for Treaty change in return for repatriating powers to Britain. It Treaty change actually materialises, the whole package can then be put to a public vote in a genuine referendum on EU reform. Many Tory backbenchers are now picking up on this idea as well.

Cameron and Merkel will meet on Saturday night over dinner to discuss the way forward for the EU. The Prime Minister must think carefully about how to use the unusually fluid European situation to put Britain’s relationship with the EU on a more sustainable path.

The scope for a new Anglo-German grand bargain is greater than in a long-time. But for Cameron to give away his hand this early would be a serious mistake.

Merkel refuses to fold

German Chancellor Angela Merkel is a tough cookie.

Sandwiched between Deauville and tomorrow's EU Summit, Dr. Merkel took to the podium today to defend the controversial pact with President Sarkozy on economic governance in the eurozone that has left both German politicans and EU leaders incensed (but in different ways).

Addressing the Bundestag this afternoon, a firm Merkel said both President Sarkozy and herself will relentlessly insist on a "culture of stability" at tomorrow's European Council summit. She stressed the necessity of taking "precautions today for dealing with future crises" in the eurozone.

Such precautions, she said, will simply have to include a Treaty change. Merkel stated that the measures taken earlier in the year to bail out Greece were "unavoidable" but did not provide long-term solutions. She insisted on a new, robust and legally unassailable "crisis management framework" anchored firmly in a new EU treaty; a move that she admitted is "ambitious". But she confidently asserted that, for the EU

success will only come with a change to the treaty...improvement is always possible, even if the road is rocky.

Presumably responding to Luxembourgish Foreign Minister Asselborn's and others' sneer that Europe does not work with only a "two-stroke engine", the German chancellor said, "the Franco-German union is not everything in the EU, but, without a German and French union, it is not much."

Tomorrow's summit could be really interesting...

A one-year cash freeze to EU budget won't cut it Mr. Cameron

The news in today's Guardian and Mail is that David Cameron is thinking of doing a deal on the proposed new EU treaty. The reports suggest that Cameron will back the new treaty in return for his demands for a cash freeze to the 2011 budget.

We're not convinced that Treaty-change-for-less-cash is a line that the Government will pursue in the end. But if true, Cameron and his Government risk a mutiny not only from the Tory backbenches but the public at large. And it would be completely justified.

The prospect of a new treaty is rightly seen (and not just by us) as a once in a generation opportunity to renegotiate the UK's relationship with the EU and actually repatriate some of the powers the Conservatives promised they would less than a year ago, or pursue a number of other reforms - for example giving real powers over EU policy to national parliaments.

A one-year cash freeze on the EU budget simply doesn't cut it. Sure, the European Parliament's demands for a 6 percent increase are outrageous and have understandably attracted the headlines recently. But what about 2012 and 2013? There is nothing stopping MEPs, the Commission or even other member states demanding similar increases in these years and there would be little the UK could do about it.

And even the next EU budget period, the the one that starts in 2014, is best negotiated seperately. The UK already has its rebate as leverage in those negotiations. Making horse-trades involving Treaty changes is giving EU partners a 'two for the price of one' deal.

But besides this practical reason, the prospect of yet another 'behind closed doors' EU deal could be politically disastrous. After promising to repatriate powers, Cameron cannot shirk the first, and possibly only, realistic opportunity to do so.

It would certainly make his accusations of "betrayal", levelled at Labour and the Lib Dems for their backtracking on a referendum on Lisbon, look pretty hypocritical.

How should the UK government respond to EU Treaty change?

We take another look at this question over on the Spectator's coffee house blog. With the risk of sounding repetitive, we argue,

Rather than instinctively reaching for the veto, David Cameron should back Merkel’s demands, in return for the repatriation of powers to the UK, along the lines of the original Tory election manifesto. This package could then, possibly, be put to a public vote, and be turned into a genuine referendum on EU reform. The net effect of a new EU treaty would then be fewer powers for Brussels and more for Westminster.

On his blog, the ever-insightful Charles Crawford also has some very interesting things to say about German calls for EU treaty change and the nature of EU diplomacy more generally. He argues,

Do Germany's leaders really think that they can force through this time round a "narrow" Treaty change which gives them enough of what they want by way of financial protection and does not open up all sorts of other clamorous demands?

Or do they know that that is more or less impossible, hence they are pushing for Treaty changes as part of a wider agenda aimed at deliberately prompting a manageable (they hope) mini-crisis which will allow them to redefine the way the European Union works, but on (mainly) German terms? If that means wielding a fierce Teutonic axe on many beloved EU schemes and letting other countries squeal, so be it.

What, I wonder, is the government in London making all this?

In principle this situation represents a huge opportunity for cynical but pragmatic British influence aimed at forcing out great quantities of EU rubbish -- and cutting the bill to British taxpayers.

Question is, have the Coalition folks put on their thinking caps?

Do watch this space...

Germany wins French backing for EU Treaty change

As we anticipated in our previous post, it appears as if Germany has won French backing for a change to the EU treaties in return for greater flexibility on sanctions for eurozone countries which run excessive deficits.

France and Germany have agreed that the Lisbon Treaty should be changed by 2013 in order to:

• Set up a "robust crisis resolution mechanism" for the eurozone, which presumably includes a mechanism for an orderly default procedure for countries that go bust;
• Introduce political sanctions for rule-breakers, including the temporary withdrawal of voting rights within the Council.

The taboo of another round of Treaty change negotiations has now officially been broken. This is potentially huge - and throws up a number of interesting questions for eurozone and non-eurozone countries alike, not least the UK.

Round 2 kicks off

While EU leaders meet today to discuss how to best pretend that they are going to present a different Treaty to the Irish a second time around, Open Europe held an event at The Centre in Brussels, in collaboration with the Bertelsmann Foundation.

We will write more tomorrow about exactly what is being cooked up by EU leaders, and what it all means, but in the meantime, here is a summary of what went on at the event.

Newly elected MEP Joe Higgins, for the Irish Socialist Party, kicked off by pointing out that the debate about what Ireland will do next is not about whether the people want to leave the EU, but rather about what direction the EU was heading. He said, “There are many red-herrings on both sides of the debate”, and described the process going on behind closed doors today at the European Council as “an elaborate charade” to make people think they will be voting on a different text a second time around. He noted that, according to the draft conclusions of the Council, the Treaty itself will not be changed prior to the second referendum, saying the agreement "doesn't advance the issue one iota." He noted, “It is exactly the same text, word by word, not even a comma has been changed”, and noting that none of the Irish people's real concerns are addressed.

When questioned by a Commission official in the audience about why we should bother referendums, when "nobody votes on the question asked", Mr. Higgins said it was "highly arrogant" for someone from the Commission, or indeed anyone else, to stand up and claim that the Irish people had no idea what they were voting for. He said that the results of the vote were barely through before people started calling for a re-vote, and noted: "The right of Irish people to disagree was being questioned." He noted that ahead of the second referendum, the establishment would "terrorise the Irish because of the Irish crash" in the economy. He said this would be "the biggest red-herring of all" in the debate, and challenged proponents of the Treaty to clarify what exactly in the Treaty would help to stop people in Ireland losing their jobs.

Elmar Brok, veteran German MEP for the CDU Christian Democratic Party, kciked off by issuing a series of morbid veiled threats :

1) the Irish people were responsible for the fate of 500 million EU citizens (no pressure, then)

2) “You get this, or you get nothing", there is “no chance of negotiating a new Treaty”

3) If Ireland votes no, the Union would see a “break up into first and second class Member States”, which would distort proper functioning of the EU.

He said: “United we can be stronger, together we can maintain peace and prosperity” and said the guarantees Ireland have been promised would be carried out in a similar way to those awarded to Denmark at the Maastricht ratification process in 1992. “These types of declarations have worked before, and there is no reason to believe they wouldn’t work again. They are legally binding declarations and have been a big success”.

Jens-Peter Bonde reacted from the audience, stating that “EU Member States cannot enter into international agreements”. He said: “These declarations are politically binding, but they have no legal value. All of the Danish ‘guarantees’ have been breached, every single one of them, so they are not legally binding guarantees”. Brok's pretty feeble response was: "This decision will become a protocol and then it will become legally-binding."

Paddy Smyth, Brussels correspondent for the Irish Times said, “it is not undemocratic to ask the people to vote again. I would agree with Joe; nothing has changed in relation to the declarations. It is a question of clarifications entirely, apart from the guarantee of an Irish commissioner”.

For an unswerving advocate of the Treaty, this is quite candid stuff. He said: “Nothing in the declarations materially affects the treaty text. If there was a material difference, then the Treaty would have to be re-ratified in all the other member states” and said that “the difference to the Danish case is that Denmark got an opt-out, which was a material change in effect”.

Smyth pointed out the differences between the yes and no campaigns for the Lisbon Treaty, stating that “the yes-campaign was a defensive campaign addressing those issues raised by the opposition to the treaty, such as abortion or workers’ rights. Many of the proponents of the Treaty had not read it and didn’t understand it to properly defend it”. The no campaign, he claims, will “gain much steadier ground through the debate around the guarantees”.

The Daily Telegraph Brussels correspondent Bruno Waterfield said that in one sense, it was “great to have a second chance for a debate, especially when other countries haven’t had the chance for even one”. He argued that the “EU is a club of leaders and administrators that are running away from debate, and rely on legal forms and arguments. But no one really understands them, and they don’t really mean anything”.

He said: “now is the time for an open and honest debate, an open debate about Europe, but it should not be governed by legal nonsense. The sad thing is that the EU, which is supposed to be about the rule of law, is tying itself in knots to obfuscate politics. The guarantees say more about what the Irish people want, in a kind of a cartoon depiction of what the leaders think the Irish referendum was about”. Waterfield concluded by saying it was indeed necessary to have this debate, particularly in a time of economic crisis.

Adjusting to a non-European world

Anand Menon has an excellent essay in European Voice dismissing the "preposterous argument" that the Lisbon Treaty would have helped Europe deal with the credit crunch or the Georgia crisis. This is his conclusion:

"...the brutal truth exposed by both crises is that the EU's soft power relies for its effectiveness on a permissive hard-power environment, on real rather than confected common purpose. The EU can bring about change, but only if no powerful state opposes it. The Europeans, quite simply, lack the power to deter, let alone coerce Russia.

Claims that Europe is one institutional reform away from global power feed into a profound sense of denial afflicting many in the ‘Old Continent'. How long is it, really, since the states of Europe, either individually or collectively, could decisively shape global politics?

The open contempt Moscow has shown for European attempts to secure its withdrawal from Georgia underscores a stark, painful truth.

Now more than ever, Europeans inhabit a non-European world. There is no choice but to adjust to that and safeguard, as quickly and soberly as we can, what is left of Europe's role in global politics and economics."

Menon touches on a key failing in the thinking of much of the European political class - the idea that Europe's rapidly declining power can be remedied by closer institutional centralisation.

Surely this notion has been tested to destruction by now?

In the broad sweep of history, Europe's period of dominance was short - 200 years at most. This ascendance was achieved as a result of complex factors that are hotly debated amongst historians. But there are two key points to note. First, Europe may be weak now, but it was relatively much weaker in the past (as recently as 1700, Qing China and Mughal India each represented a little less than 25 per cent of world GDP). Second, Europe's meteoric rise was achieved not through the centralisation of power, but through technical, fiscal, political and cultural innovation amongst diverse nation states.

Is European decline innevitable? Can it be reversed? If so, how? This subject won't be resolved in a blog post - but recent events should certainly provoke some serious thought on the issue.

The EU's crisis PR - update

Some more developments on Ethan Winner, the PR hit-man hired by the Commission to set up a "crisis communications" unit to promote the EU. His firm specialises in helping large organisations get round 'problems' - click here for more on his past record.

There been much debate on the US blogosphere in recent days on Winner's activities in the US Presidential election. See here, here, here and here.

Responding to original accusations made on the Jawa Report, Winner has admitted to distributing a video designed to smear Republican Vice Presidential nominee Sarah Palin (the video was behind the row over Palin's alleged support for Alaskan independence).

According to Jawa, Winner's company has a past record of producing fake 'grassroot style' messages designed to look like they did not originate from an organized campaign, a practice know as “astroturfing”.

Will we see similar tactics being adopted by the pro-Treaty camp in the second Irish referendum on Lisbon? The stakes are high and they will not be pulling their punches...

There is still uncertainty (and some scepticism) over whether the Democrats were complicit in Winner's video. But whoever initiated the action, we can be certain that it was not funded by American taxpayers.

The same cannot be said for Winner's new campaign to promote the EU - you will be footing the bill whether you like it or not.

Barroso on EU empire

Barroso's comments describing the EU as an "empire" are up on You Tube. Link here.