Juncker's investment plan gets cool reception

This is the name which has been given to the long touted €315bn investment fund which European Commission President Jean-Claude Juncker has put front and centre of his programme to deliver jobs and growth. The key points of the proposal (EC press release, Juncker speech, Katainen speech) are:

• €315bn investment from 2015 – 2017. This is made up of a €16bn guarantee from the EU budget (a 50% guarantee from €8bn of the budget) and €5bn from the European Investment Bank (EIB). This money will be used as a guarantee to raise the targeted €315bn from private financing on the market.**
• Of the total spend €240bn will go towards long term investments and €75bn to SMEs/mid-cap companies.
• The EFSI will be under the umbrella of the EIB but will have different goals and do a different type of lending.
• In conjunction with the EFSI the Commission will create a “project pipeline” along with technical assistance to help identify viable projects for investment at EU level.
• The investment plan will also contain a road map to remove sector specific regulations that hamper investment, with a focus on the financial sector to tie in with the push towards a Capital Markets Union.

This is the opening salvo of a plan which has long been muted. Judging by the initial reactions, the plan leaves something to be desired. Some thoughts below:

• As an opening salvo, the plan has already been watered down from what many had expected it to be – a real attempt at fiscal stimulus. Whether or not you agree with that prospect, it’s clear this plan does not constitute such an attempt. As it now enters the negotiation phase with approval from the member states and European parliament needed it could still be restricted and fudged further.

• This process seems very similar to previous attempts to create such a fund in 2012 (discussed by us here) and the failed attempt to leverage the European Financial Stability Facility from 2011 (which fell down on the reluctance of the ECB to be involved and the level of public guarantees were not sufficient and too highly correlated with potential risks). History suggests pinning significant hopes on these sorts of plans is not usually a good approach.

• It’s not clear that this buffer will be enough to encourage private investors to take on greater risk. There are numerous factors which are leading to a lack of private investment, risk (at these levels) is only part of it.

• Furthermore, to the point above, reports now suggest that the €21bn will actually be used by the EIB to borrow €63bn in bonds and cash which will then be used as a first loss buffer for the private investors – however, this does not seem to be mentioned in the press release, factsheets or Q&A. Additionally, we’re not sure what rating these bonds issued solely as loss protection would get or who would want to invest in them (seems akin to the lower riskier mezzanine tranches of asset backed securities).

• The promise to review the regulatory issues and create a central system of projects could actually prove to be more important than the funds themselves. That said, we have often heard the first point and the Commission has never followed through. The latter project has potential but the focus will be around “EU value added” and “EU objectives”. We’re not sure why the EU thinks it has a better idea of the returns and benefits on private investment than the market more broadly. Furthermore, these objectives already cloud what should be a simple idea – promote economic growth.

• More generally, questions can be asked about how these funds will be targeted. The focus seems heavily on pan-European infrastructure. While there are sectors where this could be useful – energy and high-tech – such a rigid focus is not needed for a general fund. Many parts of Europe (notably Spain) loaded up on infrastructure in the boom years; they do not really need more of it. What is really needed across Europe is investment in human capital, (re)training and R&D.

• All this once again highlights the huge amount of waste inside the EU budget, which could of course fill some of these roles. It also raises questions about whether the EIB should rethink its investment priorities.

Overall, the response from all sides has been very lukewarm. The plan seems very similar to previous iterations and, for better or worse, does not involve new money. Negotiations are likely to further impact the structure, while questions can be raised about the target and agenda included in the fund. The accompanying proposals for a project pipeline and improving regulation could be useful and tie in with plans for a single market in capital. That said, the EU’s track record on these fronts is not good and will likely take some time for any real impact to be seen.

**Correction: A previous version of this blog post said €294bn would be raised from private finance. However, the aim will actually be to use the €21bn as a guarantee on issuing €315bn worth of bonds on the market, meaning the entire €315bn will be private financing.

The £1.7bn question (Part II) - What are other EU finance ministers saying?

Here's a round-up of comments from other EU finance ministers about the UK's £1.7bn EU budget surcharge and the deal struck at today's meeting. This being EU budget negotiations, everyone is claiming either 'nothing to see here' or victory. Apart from the Dutch, who are getting a pretty raw deal.

We've given our take on the deal in this blog post: when all is said and done, the UK will pay £850 million. The question is whether the rebate the UK gets from the EU budget always applied to the £1.7 billion, and whether, therefore, George Osborne is basically engaging in accounting manoeuvres.

Remember, due to the way the UK's rebate from the EU budget is structured, everyone is basically paying for it, so it's not in anyone else's interest to ever talk it up.

Irish Finance Minister Michael Noonan said,

“My understanding is that the UK will pay the whole amount but there will be no penalties attached or interest rate on that.”

Spain's Luis de Guindos argued,

“No-one has put into question the [European] Commission’s figures…as perfectly valid. Basically, what we agreed on is the possibility of a delay in payments.” 

Dutch Finance Minister Jeroen Dijsselbloem stressed,

“The UK has...a rebate, which they have had for a very long time and of course this mechanism of rebate will also apply on the new contribution. So it's not as if the British have been given a discount today. The old mechanism of the rebate will also apply on the UK contribution, which will increase.”  

According to Austria's Hans-Jörg Schelling,

“Whether the money is to be paid in instalments or as a lump sum is a discussion we can have. But the amount cannot be put in question.” 

Sweden's Magdalena Andersson stroke a more positive note,

“Compared to a situation where the Commission was not going to table a new proposal, of course this is a victory for the UK…Given the amounts, I can understand that one wants to discuss both transparency and the calculations.”  

As regards German Finance Minister Wolfgang Schäuble, he avoided taking a clear stance despite several attempts from journalists at his post-ECOFIN presser. All he said was,

“We have discussed instalments…but we haven't discussed the British rebate...which doesn't mean that the Brits do not raise these questions…I don’t have opinion on that.”

So all clear then...

The most depressing part of this episode is that an enormous amount of energy has been spent, and the UK has been pitted against natural allies, not least the Dutch. Secondly, absolutely nothing on the substance of the EU's wasteful budget has changed.

The £1.7bn question - who's right: Osborne, Farage or the European Commission?

Below we give a blow by blow breakdown of what George Osborne did or did not secure at today’s EU finance ministers meeting. This basically comes down to the UK’s rebate and how it’s applied - and whether it was always going to apply to the £1.7bn.  Osborne claimed that:

As PM said EU bill unacceptable. Now we've halved the bill, delayed the bill & pay no interest on the bill. Result for Britain
— George Osborne (@George_Osborne) November 7, 2014

Whilst Ukip leader Nigel Farage has claimed that:

Osborne trying to spin his way out of disaster. UK still paying full £1.7bn, his credibility is about to nose dive.
— Nigel Farage (@Nigel_Farage) November 7, 2014

This is what EU Budget Commissioner Georgieva said at a press conference just now:

“As we all know the UK receives a rebate on their contribution, but in years when the UK has to pay additional because of GNI corrections, normally this payment would be on 31 December and it would be in the full amount. With the proposal [under discussion]…in exceptional years this period of time would be stretched into the next year, and when this happens, and it would be in these exceptional circumstances, then the payment and the rebate on the payment could converge. In a normal year, they would not. In a normal year, you have a payment on 31 December and then next year, in the spring, we have the calculation of the rebate on this payment.” 

So who’s right?

Well, Osborne is right that the UK will pay half of the initial £1.7bn demand, since the UK’s rebate will now knock off the difference. So in that sense, Farage is wrong. Britain “will not pay the full £1.7bn”. However, the Government’s position isn’t’ entirely what it seems either, since it’s possible (though still not clear) that the rebate was always going to apply to the £1.7bn.
 
Confused? Don’t worry. Few people know how the rebate actually works. Below is our attempt to clarify the issue.

What has actually been agreed?

• The UK secured a delay on its payments and will now have until September 2015 to pay. It will probably pay in July and September 2015.
• It was also agreed that the UK’s £1.7bn bill will have the UK’s rebate applied to it (in the same way all annual contributions do). The Government claims that it wasn’t ever clear whether the rebate would apply, however, Commissioner Georgieva’s suggest that it always would. Usually  the rebate operates on a one year time lag, but now it will be netted off at the same time when the payment is made. The UK government also claims that the rebate applied to the specific amount is above and beyond that which applies normally, due to the way different facets of the rebate are applied and the time period over which it was calculated (we're still looking into this one). 
• This accounts for the reduced the bill from £1.7bn to £850m.

So, Osborne has effectively achieved an ‘interest free’ payment plan for the surcharge, which will see it coincide with the rebate on said surcharge.

Would this always have happened?

• It has been unclear for some time how the rebate would factor in here. Either people were purposefully trying to obscure the question or it was genuinely unclear.
• However, now that it has been settled that the rebate would be applied, it can be said that this reduction would always have happened. The main change is that the rebate has been moved forwarded allowing the initial payment to be reduced.
• On net the UK will pay £850m, but this should always have been the case thanks to the rebate.

Does this impact other countries?

• Since other countries essentially pay for the UK rebate, they will on net be hit.
• Our understanding is that the countries will still get the full amount expected from the GNI calculations – i.e. France should still get €1bn.
• That said, since the rebate is being paid and also a year early, it is likely that their annual EU budget contributions will increase in 2015. On net then, the gains for certain countries (such as France) could actually be less than expected.

So are we looking at a cash flow problem for the EU budget?

• One outstanding question is how this will all work in practical terms. Judging from the European Council conclusions, countries who are getting a pay-out from the GNI calculations can still claim the money on 1 December.
• However, countries who are paying in large amounts can delay their payments until September 2015. It is not clear whether there is enough spare cash in the budget to smooth over this gap.
• Furthermore, the UK is using its rebate to offset its payment. This will not be covered until all countries have paid in their (higher) annual EU budget contributions next year. This further worsens the cash flow problem.

A political conspiracy or genuine uncertainty?

• Questions will now swirl around when all this was known. Surely, if the rebate applies, that was always known to be the case? Logically, since all UK contributions are subject to the rebate, it always was going to be. The only thing that wasn’t entirely clear was when and how it would be factored in. While this is tricky to work out, it’s not clear why the HM Treasury and the European Commission let the dispute run for two weeks. If this was a “set up” by the UK government to claim success, then the Commission was in on it.
• Maybe the handover in Commission has helped breed uncertainty.

So what’s the verdict? Who’s right, Farage, Osborne and Georgieva? Well, Farage is wrong, Osborne right on the amount but may be exaggerated the extent of the concession. The most right is probably Georgieva - though, we still don't have evidence that the rebate was always going to apply.

And of course, the UK will still pay an additional £850 million.

We will update this as events unfold, but what a mess.

Court of Auditors highlights errors in EU spending again

Each year the EU's Court of Auditors issues its opinion on the EU's spending and each year it is the same - "material errors" amounting to billions of euros probably misspent.

First of all, let's get the usual caveats out of the way - the auditors have signed off the accounts, which means that they are a reliable picture of EU revenue and spending. However, there remain significant errors in how the money was spent.

This is from the ECA press release:

The ECA’s estimate of the error rate is not a measure of fraud, inefficiency or waste. It is an estimate of the money that should not have been paid from the EU budget because it was not used in accordance with EU rules.

The other defence that the European Commission will make is that much of this spending is a shared responsibility between national governments and the EU institutions. But that does not excuse the fact that the errors keep rolling in year after year with little improvement and that much of this results from the complexity and Byzantine nature of EU spending programmes.

So how bad was it this year? 

Well here are some of the main findings for 2013:

•  93% of the EU Budget is affected by "material errors"
•  The error rate was 4.7%, amounting to c.€7bn euros "that should not have been paid out from EU budget"

Illustrative examples of waste highlighted by the EU's Auditors:

• Claims under the CAP for grassland that was actually forest.
• Claims for four Spanish border control helicopters that spent little time controlling borders.
• The salary of a private school director in Portugal charged to an EU project.
• €150 million of pre-accession exenditure validated by the Commission on the basis of estimates rather than for incurred, paid and accepted costs.

Is control of spending getting better?

Rate at which EU funding is misspent

One of the more depressing aspects of the EU budget is that the rate at which money is misspent remains consistently high. As we can see over time, it has gone down and then back up leading to the conclusion that the problem is persistent. This year it was 4.7%, which is lower than some previous years but still higher than others pointing to the fact there has been no "solution" to poor financial control.

Same old suspects?

Although there are a number of examples of misspending in Southern Europe, examples are also catalogued across the EU including in regional funding within richer states such as Germany. This begs the question as to why the EU is funding poorly controlled programmes in states that are net contributors and able to pay for their own, probably better quality programmes.

A solution - reform the budget?

Cutting regional funding in rich EU states would cut the EU error total, the EU budget and give states more autonomy all in one go as Open Europe has consistently argued.. Likewise Open Europe has also proposed radical CAP reform moving spending back to national governments. This would allow for more scrutiny of spending as well as well as remove some of the incentives to national governments to spend the money as fast as possible whatever the quality of projects.

Other Court of Auditor suggestions:

The Auditor's make a number of sensible recommendations and observations, including the following which are particularly interesting: 

• A better harmonisation of how GNI is calculated: The Court of Auditors has found that there are inconsistencies as to how different states calculate their "unofficial" economies. Given that the EU budget contributions are based on relative sizes of member states GNI and that recent statistical revisions have led to the UK receiving a large £1.7 surcharge any inconsistencies will no doubt be looked at very closely in HM Treasury.
 

• EU value added often difficult to discern: The EU's globalisation fund was picked out as an example of funding that has a low rate of EU "value added." That begs a question as to why it exists.

Verdict: Good report but, unfortunately, we will no doubt be returning to the subject of misspending when next year's report comes out... 

When it comes to the EU budget, the bad news just keeps on coming

David Cameron and George Osborne might be forgiven for thinking that when it comes the EU budget, it never rains, it pours. Fresh on the heels of the Commission's explosive demand for an extra £1.7bn for this year's EU budget, the ONS' annual Pink Book published this morning has revealed that the UK's contribution last year stood at a whopping £11.27bn - much higher than the £8.6bn the Treasury had forecast (see page 14 of this HMT document) and a 32% increase on 2012.

There are a number of reasons why there is such a large discrepancy:

• Partly this can be accounted for by the €11.2bn that was retroactively added onto the EU budget late last year (one of the European Parliament's conditions for swallowing the cut to the EU's long-term budget for 2014-2020). In addition, the growth of the UK's economy resulted in an adjustment and increase of £781m to the UK's contribution (-£190m via a separate VAT adjustment) - the same mechanism partially responsible for the £1.7bn demand. 
• Due to its strong economic growth relative to other EU member states, a situation which looks set to continue in the near future, we also warned that the UK faced an 'EU stealth tax' via higher GNI, VAT and customs contributions.
• We warned last year following the landmark budget cut that the UK might yet end up paying more in net terms due to Tony Blair's rebate cut and a larger share of EU funding going to new member states but the latest developments (the surcharge + stronger relative economic performance) risk pushing this up even higher.

Needless to say, this will only crank up the pressure on the government which is already in a difficult position vis-a-vis the EU budget, EU free movement and the European Arrest Warrant and will make it even harder for David Cameron to give any ground on the £1.7bn surcharge. 

Britain's £1.7bn budget bill: Who is to blame and what happens next?

Cameron has promised to invoke the spirit
of Thatcher over the EU budget

As EU leaders were agreeing the final details of the EU's new energy and climate change policies on Thursday evening, the FT's Alex Barker dropped the bombshell that the UK had been asked by the Commission to pay an extra £1.7bn surcharge into this year's EU budget. It was clear Cameron had not been expecting this and he angrily accused the Commission of a stitch-up, and refused to pay by the December 1 deadline.

By now, several explanation pieces have been published but there is still some confusion so here is one more try from us to clarify the situation:

Where did the demand come from?

There are effectively two things going on here, lumped together: the standard, annual revision of national contributions to the EU budget, and a one-off recalibration of the way in which national statistics authorities measure the size of their economies, going back several years. It is the combination of the two that have created a “perfect storm” for the UK:

1) Annual adjustment: Every year the EU member states and Commission work out respective national contributions to the following year's EU budget, once the actual economic data for the year in question is available. Member states' contributions can be revised upwards or downwards based on the performance of their economies. EU rules state that:

"The Commission shall inform the Member States of these adjustments in time for them to enter them in the account... on the first working day of December of the same year."

As David Cameron has rightly pointed out, these revisions are usually minor and therefore uncontroversial.

2) Changing the way the size of the economy is measured: Eurostat – the EU’s statistical body – recently reviewed the way in which member states auditing the way in which EU member states assess the size of their economies, concluding that under agreed EU rules (ESA95), several countries haven’t estimated their economies properly dating all the way back to 2002 (1995 in the case of Greece). In 2012, Eurostat instructed member states’ authorities to re-assess the figures – and to do so before 2014 . The ONS published its revised figures in May 2014, which among other re-valued the size and contribution of the UK's charity sector, which meant that overall. the UK economy was larger than previously thought, and had therefore been underpaying towards the EU.

The large UK bill is therefore primarily due to the one-off revision applied retroactively over 12 years, though effectively rolled in with the far less controversial annual adjustment. This is where a lot of the confusion comes from.

Who knew what when – and who is at fault?

This is what the debate has now shifted to, and there is a fair amount of blame to go around; no one really had their political radar switched on.

The European Commission: People within DG Budget (the Commission’s budget department) were briefing media on Thursday and well into Friday that the changes was due to the introduction of ESA10 – basically drugs and prostitution, something which left most people perplexed, and helped to fuel confusion and outrage.

It was also clear that the politics of the hefty bill would be lethal. Of course, Commission officials can claim the robot defense that “we are only following the rules”, but the Commission has always been a hybrid between an executive and a bureaucracy – so it should have handled this with far more care (the December 1 deadline was an over-kill), although some of this can be forgiven given that we’re between two Commissions.

The UK government: The exact figures were presented on Friday a week and half ago, a week before the EU summit. But it’s been clear since May this year that the UK economy was larger than expected following the ONS' revisions – indeed, the UK government itself triumphantly pointed this out. It’s also been clear for some time that other key countries were going to revise their figures. So while no one knew the full picture until 1 ½ week ago, different parts of the Government, including the Treasury, knew earlier a higher bill would be coming, albeit not the exact size. Perhaps the Government hoped this could have been snuck through somehow.

David Cameron: Probably hadn't been briefed until just before the EU summit but chose to adopt a very tough position, leaving himself limited room for manoeuvre. Some say this is a manufactured row to distract from other pressing EU issues like the European Arrest Warrant and EU free movement – a convenient row in which Cameron can ‘stand up to Brussels’ and claim some sort of success. We very much doubt it however,

What are Cameron’s options?

Cameron has effectively promised not to pay by 1 December and not to pay a bill “anywhere near” the £1.7bn mark – he restated that position yesterday in the Commons. So it’ll be hard for him to climb down. At the same time, the annual adjustment is supposed to be automatic – not subject to a separate vote – and the new calculations have already effectively been signed off by the ONS, so Cameron’s practical options are limited:

Rally a coalition to block the change: As a result of the extra €9.528bn that the EU will get due to the revisions, it is cutting the budget by €9.948bn - a net cut of €420m, and the Commission has tabled a draft amending budget to implement these changes. This budget will be subject to a vote among member states and as we set out here, the UK and other net losers have a blocking minority. However, rejecting the amending budget would mean the UK actually paying more (€3.6bn as opposed to €2.1bn), but the flipside would be that almost every member state would pay more too - rather than a €1bn rebate for France and a €779m one for Germany, they would face bills of €562bn and €1.4bn respectively - this could give the UK some leverage, although it could also backfire.

Seek revision of figures: Cameron has said he will launch an "exhaustive" review into the methodology that was used, effectively challenging the basis for the calculations. The figures aren't exactly transparent – and maybe this process will expose something they can run with and muster political support around. It's complicated by the fact that the ONS itself signed off on the underlying figures.  

Unilaterally revise the figures: The UK could check if the ONS went further then it needed to in revising past economic performance under ESA95, and if so, revise its figures again.

Go to court: It is not clear whether the UK would have any grounds for taking the Commission to the ECJ but one potential avenue would be to challenge the retroactive aspect of the bill as well as its unprecedented nature. Either way, it could bog down the process and buy Cameron some much needed breathing space in which to work on alternatives.

Refuse to pay: That could well trigger a crisis However, and the worst-case scenario is that the UK will face potential fines and infraction (see here for the figures).

Veto unrelated EU measures: It has been suggested that the UK could play hardball by vetoing other EU measures such as changes needed for the Eurozone to integrate further- but there are no such measures imminent over which the UK has a veto.

Ultimately, because the money is not needed for the 2014 budget per se, the issue could be kicked into the long grass, allowing for a face-saving compromise to be agreed. Speaking in the Commons yesterday Cameron sounded pretty confident that something can be done. We hope he’s right.

EU budget surcharge: how much support does the UK have around Europe?

David Cameron has taken a very tough position on the EU budget surcharge, claiming that he "won't pay" the £1.7bn the Commission has demanded from the UK by December 1 after concluding the UK had been underpaying into the budget relative to the size of its economy. Other countries have also been hit - so how much support does Cameron have around Europe?

These changes which again are due to recalibration in the way the size of economies are calculated (more on this later) are being tagged on to the annual "adjustment" to the EU budget, which is basically normal procedure.

However, this also means that EU leaders will have to agree to an "amending budget" via a decision taken by Qualified Majority Voting. This also means that the UK might have some chance of "blocking" the change if it can get other allies on board.

Below is the voting balance, if all "net losers" are clubbed together under QMV. 

EU member states' voting weights: 93 votes needed for a blocking minority

However, not all the other member states affected have been as firm as Cameron. The Dutch have appeared to soften their stance with Dutch Finance Minister Jeroen Dijsselbloem stating on Dutch TV yesterday that the Netherlands would pay its €642m surcharge "if the facts and figures are correct". Irish Taoiseach Enda Kenny said his Government will pay the additional bill, adding that “we have always abided by the rules”, while Maltese Prime Minister Joseph Muscat claimed that:

“Malta is not surprised that the EU has asked for this top-up… but we are still seeking clarifications on how the [Commission] calculated this figure”. 

Italian Europe Minister Sandro Gozi said that:

“An in-depth examination is needed… we will see whether it will be really necessary to apply the new method to calculate [national] contributions. In any case, this doesn’t imply an immediate payment.”

So hardly an endorsement of the UK's tough position, but there may be enough support for a delay or some alternative arrangement such as paying the surcharges in installments. Meanwhile, Cameron did at least get some support from an unexpected source... France (which has received a €1bn rebate). The Telegraph cites former French Europe Minister Pierre Lellouche as saying that:

"I think it's ludicrous to actually go and punish the one country that has suffered the reform. The results are showing up now - the unemployment rate has gone down to half what it is in France. The growth rate is four times what it is in France - and we go and punish the British? It's madness". 

Sadly for Cameron, Lellouche won't have a vote.

EU and Tory madness – but what has changed?

In Britain, “Europe” as a political issue has pretty much gone mad over the last few weeks. There has been a lot of rhetoric, but where are we in terms of substance?

Free movement: When asked about reports in UK media that David Cameron is considering proposing quotas for EU migrants, Angela Merkel told the Sunday Times: “Germany will not tamper with the fundamental principles of free movement in the EU”. This has always been the German position (Wolfgang Schäuble today echoed those comments). She added, “I spoke to David Cameron and we agreed to assess the [the upcoming ECJ verdict on EU migrants’ access to benefits] together. These are controversial issues that are debated also in our country. I am of the opinion that they need to be resolved in a way that tackles abuse.”

Hot potato factor: Medium to high. As we’ve always said, changes to the EU’s “fairness” regime – who can access what benefits and when – is fully possible. Caps will be much trickier. Yes, the politics around EU free movement have become massively complicated, with Tory politicians seemingly talking up the need to cap numbers – even though we may sense a bit of back-peddling on the more aggressive rhetoric (Michael Fallon’s comments notwithstanding). Remember, we have not yet seen a concrete proposal from No 10 and in terms of the basic positions in Europe, Cameron’s chances of achieving reform in this area are very much unchanged. This remains a moving target though and much can happen.

European Arrest Warrant and the “block” opt-in: This is the decision by the Coalition government to take advantage of a quirk in the Lisbon Treaty which allows the UK top opt out of around 130 EU police and crime measures, and then choose to opt back in to all, some or none of these measures, which means accepting ECJ jurisdiction over these laws. The opt out will take effect on 1 December – but the Coalition wants the Commons to vote to opt back into a package of 33 laws, including the controversial European Arrest Warrant.

Hot potato factor: Medium. Up to 100 Tory MPs have said they want to rebel and vote against opting in to the EAW. This is a debate that has been going on for some time and the big question was always how many MPs would vote against opting back in to the EAW. Theresa May and Michael Gove are now trying to minimise the rebellion and Lib Dem and Labour MPs will vote with the Tory leadership so the measure will almost certainly pass.

The £1.7bn cash demand: Due to changes to the way the size of the economy is calculated (ESA 95 NOT ESA 10), the European Commission has asked the UK to cough up another £1.7bn by 1 December – freakily coinciding with the bloc opt-in deadline. Cameron has vowed not to pay the money by then.

Hot potato factor: Off the charts. This is simply shocking. From the DG Budget people within the Commission not being able to explain where the changes come from – in fact briefing media the wrong information (out of ignorance not spin) – to officials in Brussels, London and elsewhere not getting the political explosiveness of the issue to Cameron seemingly being taken completely by surprise. Depending on how this ends, it has the potential to go down in history as one of the most mismanaged episodes in the EU, ever. Cameron can hardly pay up by December 1, but it’s also not clear whether he can block it (the decision will be taken by a qualified majority vote – see upcoming blog post), meaning that without a face-saving gesture - which, given the stakes, is still fully possible - the stage is set for a proper political crisis.

This is a new development, and in the short-term, far more unpredictable than the block opt-in or free movement debate.

Cameron will update the House of Commons today – it could be a long afternoon.

Updated: Commission silent as foundation for increased EU budget contributions remains unclear

Update 24/10/14 17.05:
Outgoing Commission President Jose Manuel Barroso has just given his press conference which frankly did not clear much up. Barroso insisted, as the Dutch position below does, that this payment demand is part of an annual adjustment which is based off of the revised figures for annual GNI (which are produced by national statistics agencies and then verified by eurostat).

Essentially, he is suggesting that the final figures for the UK in 2013 proved to be so far ahead  of expectations that they altered the UK's share of the budget significantly.

This is not a completely implausible scenario but it leaves some glaring gaps. Firstly, its hard to imagine the economy outperformed so much and other EU economies underperfomed so significantly that the UK has to stump up another €2.1bn. Secondly, this doesn't fit with the leaked doc from the FT. As discussed below, the figures clearly seem to relate to a longer term assessment based off the ESA changes to the way GNI is calculated.

All that said, its becoming increasingly clear that the positions of the Commission, UK and others are not quite compatible so something will have to give in a negotiation.

***********************************************************

Currently, there is still no clear explanation for where the demand for increased contributions to the EU budget came from or exactly how it was calculated - see our comprehensive analysis here. While the Dutch and the Brits are both concerned about being asked to contribute more, they are actually putting slightly different versions of events forward. These two split the prevailing theories about how this has come about.

The first version of events, pushed by the Dutch, suggests that this is not as surprising has been made out since it is actually down to the regular assessment of the four cycle of VAT receipts and tax returns related to GDP of countries. When asked by Dutch BNR radio ‘Does this revision have anything to do with the new accounting method?’, Dutch Finance Minister Jeroen Dijsselbloem responded,

“No, this seems to come from a [annual] source revision which is something different from the statistical method that is used to calculate [the GDP].” 

The point that surprised the Dutch was that the demand came out at almost double what they had forecast and there is no clear explanation of why this is.

The other version of events ties into the document leaked by the FT. Judging by this document it is hard not to see this cost as a result of a calculation based off the introduction of the new European System of Accounts 2010. The UK is suggesting it was unaware of such a significant overhaul to the EU budget calculations and has not been included in the discussion around the changes. The document clearly looks to alter the budget contributions over the period between the introduction of the previous system of accounts and the end of 2013. The total figures also line up with the reports and are yet to be rejected or even disputed by anyone. The fact the figures are so large also fits more with this version of events than the regular adjustment - in this sense something will have to give (size of demand primarily) for the first version of events to be true.

What do they agree on?

• There is clear agreement that this has been handled poorly by the Commission, who is still yet to provide any clarity into the debate or explain exactly how much they are asking for and why.
• Furthermore, the demand for payment immediately also seems to be a miscalculation by the Commission which caught some unawares at least in terms of the size, if not the timing.

While this may seem trivial it is vitally important that the Commission makes clear and gets to the bottom of what is going on here. Ultimately, Cameron’s options will be very different depending on whether the demand is driven by a unique one off event (such as long terms GDP changes) or part of a regular assessment of the EU budget. In any case, whatever the source serious questions need to be asked about how a bill of €2.1bn can materialise with little or no political discussion.

Why is the UK being asked to pay in more to the EU budget and what can it do about it?

There are a number of headlines today around the EU’s request for a further €2.1bn from the UK in terms of its contribution to the EU’s budget.

Below we breakdown exactly how and why this has happened and what options the UK has now.

How has this happened?

• The European Commission has launched a review of EU budget shares (based of VAT receipts and Gross National Income [GNI]) going back to 1995.
• This is tied in with the introduction of the new European System of Accounts (ESA) 2010 which came into force in September. This is a new approach to assess the true value of a country’s economy (its GDP) by counting some activities which are often missed. Many of you will have read the countless headlines about how GDP will now try to quantify the value of prostitution and the drug trade. However, the new calculations also give more weight to research & development and other softer types of investment. The Commission has estimated that these adjustments will push most member states GDP up, albeit by varying degrees.
• Essentially, since 1995 the UK has performed better than expected and better than many of the other EU member states. As such its economy is larger than originally thought. Under the review this means that its share of the EU budget – which is calculated off the back of GDP and population as a share of overall EU GDP and population – has increased.
• The EU is also in the process of producing an amendment to the annual budget which we discussed here. At some point, very recently, the EU has decided to almost combine the two issues possibly causing a speed up in the payment date for this €2.1bn lump sum.

Why has everyone been caught off guard?

• While the annual amendments to the budget are expected and usual (though often unnecessary and far too high as we have pointed out numerous times) this adjustment on GDP terms is unprecedented and seems to be largely a one off – as such it has caught most people off guard.
• It also seems that the release has been kept under wraps for some time. While the amending budget has been known and discussed for some time, with the final details circulated to member states a week ago in preparation for the current EU summit, the details of this were only released to member states a day ago. Essentially it was somewhat sprung on them ahead of the summit.
• This is exacerbated by the fact that this is clearly an extensive long term process and that the ESA 2010 adjustment has been running for years. To say the release and interaction with member states on this issue has been poorly handled would be a massive understatement.

What are the UK’s options now?

• First, it’s clear the UK is not alone in its outrage. The Netherlands has been asked to pay in a further €640m, while Italy has been asked for €340m. Dutch Prime Minister Mark Rutte has called this “an unpleasant surprise which raises a lot of questions”, adding, “when I say go to the bottom of this, it means to look at all aspects, including legal ones. It is still too early to run ahead on this.”
• The first option is to get an agreement to deduct any payments from future budget contributions. This would avoid having to pay in a lump sum now and also mean that it on net the UK does not pay any extra.
• The second option would be to secure a political or legal agree to ignore these uprated GDP shares and stick with the originals. This should be doable through a vote in the European Council. That said, because some members are getting a rebate – France and Germany in particular – this could prove a very tricky agreement to strike.
• As Rutte has already pointed out, countries may have legal recourse. Exactly what form this could take is unknown but the retroactive nature of the cost and its lack of discussion and warning could provide some grounds.
• Lastly, the UK (and the Netherlands) could simply refuse to pay. As large net contributors to the EU budget, there is little that others can do to force them to pay. Obviously the EU could launch its own legal action in terms of infraction proceedings; however, the maximum fine for the UK is around €225m on an annual basis – much less than it is being asked to stump up here. This could also be combined with the point above, with the UK refusing to pay until the legal proceedings have run their course. ***see update below***

Open Europe’s take
While this does not necessarily seem to be a political stitch up from the EU there is no doubt that it is unreasonable and politically irresponsible. Retroactively taxing someone over 20 years is fundamentally unfair. The fact that the UK and Netherlands are being punished for doing better than expected and better than others almost encapsulates everything that is wrong with the EU’s approach – particularly when the Eurozone economy is struggling to find any growth.

Once again the EU has failed to learn any lessons from the previous budget negotiations and has helped to feed those who want to leave the EU, possibly ultimately shooting itself in the foot. Still, what's interesting is that in a debate marred by splits, the UK political class is almost entirely united in its outrage against this move. It is ironic that in the week when one poll found British support for EU membership at its highest since 1991, the Commission has managed to unite everyone from Lib Dem MEPs to UKIP in outrage. If Cameron manages to resist the demand somehow, he would be able to score a massive victory.

Update 24/10/14 12:05:
One point to add regarding the refusing to pay option and the potential fines. On top of the potential fine from infraction proceedings mentioned above, the amount of €2.1bn will be charged 2.5% interest (standard 2% above the Bank of England base rate currently 0.5%), which increases by 0.25% for every additional month which the outstanding amount is not paid off. Such interest could clearly mount up very quickly and become very expensive. If the UK is eventually forced to accept £2.1bn figure, then it could clearly turn out to be very costly. Ultimately, though, if the UK is prepared to play hard ball, it would lead to a stand-off that will would need to be resolved by a political negotiation. Such disputes rarely reach such escalated levels and resolutions are normally found before costs mount up. 

When is money not "real money"? Let's ask the European Commission...

There is a select group of masochists out there (us included) who devote their time to studying the inner workings of the EU budget. Its a very dry and technical process but at the end of the day the numbers matter - the UK's gross annual contribution (post rebate) this year is around €14.7bn, which easily exceeds the £7bn in fresh tax cuts David Cameron pledged at the Tory party conference yesterday.

Today, Commission President Barroso urged member states to sign off on a €4.7bn 'top up' to this year's budget, an issue we covered back in June. What struck us however was some of the language in a separate Q&A put out by the Commission, which contains gems like:

"The EU budget consists of commitment appropriations and payment appropriations. Broadly speaking, commitments are usually higher than payment appropriations and do not constitute "real money"; they could be compared to the amount mentioned in a contract any household or private company commits itself to pay at the completion of any given work. Payments, on the other hand, are "real money"; they are what the EU budget has to pay, again, just like any household or private company has to pay the builders once any contracted work is completed."

However, it is highly disingenuous to describe new spending commitments in the budget as not "real money" given that they are inextricably linked with payments: as the Commission itself is fond of saying, today's commitments are tomorrow's payments while today's payments are yesterday's commitments. 

It might however explain why the Commission is so frivolous when it comes to making new spending promises before then pressuring national governments to stump up extra cash i.e. "real money" to make up the difference.

Attention new European Commission! This is how to save £200bn, kick-start growth and re-connect the EU with voters

This morning, Open Europe published a 'mandate' for the new European Commission - in short a series of proposals setting out what the Commission should - and shouldn't - be doing over its five year term of office. Our mandate idea was inspired by the reformist Dutch Foreign Minister Frans Timmermans, who last year proposed a 'European Governance Manifesto' in which national governments would identify a series of priorities for the Commission.

Our mandate, which we call on David Cameron and other EU leaders to adopt, contains a number of detailed proposals spanning a wide range of policy areas - from reforming the EU budget, increasing transparency and accountability to liberalising the single market in services - but its overarching theme is boosting the EU's capacity to create jobs and generate economic growth while ensuring the EU stays well clear of areas better handled nationally or locally. Our mandate would:

• Save European taxpayers £200bn (€252bn) over a seven-year EU budget period by re-targeting and slimming down flawed spending programmes,
• Cut the wages and perks of EU officials and scrap a number of EU quangos that add no value, saving taxpayers a total of £819m (€1bn) per year,
• Boost the EU economy by £236bn (€294bn) by making it easier to export services to other EU member states,
• Introduce a series of new checks on EU laws to ensure they boost jobs and growth whilst ending unnecessary EU meddling. 

With David Cameron's EU reform agenda often being accused of vagueness, having the Commission adopt such a mandate would be a big win. Of course this is not the limit of the reforms the UK ought to push for - our priorities relate to what falls within the Commission’s remit; many key issues will be debated between national governments with a limited role for the Commission. Although in the longer term we think EU Treaty change will be needed, all our proposals can be accommodated within the existing EU Treaties, so there is no excuse for foot-dragging.

We have commissioned George Roberts – an independent illustrator and animator – to draw a series of cartoons to accompany some of our key proposals. Over the next couple of days, we will be posting these cartoons on our blog along with a more detailed description of what the policy proposal entails and a discussion of why it is important.

In the meantime, you can read the press release here, the full mandate here and join the conversation on Twitter by using the hashtag #EUpriorities.

Balance of Competences round-up: Part II

Further to our previous post on the Government's Balance of Competences report on free movement, below we pick out some of the key points from the other reports published today:

The report on the services stated that:

“Incomplete and ineffective implementation of existing services legislation has hindered the development of the free movement of services, but full implementation of existing legislation within the current level of EU competence may have implications for Member States’ ability to make decisions in this area.”

The report also echoes Open Europe's recommendation that if further liberalisation cannot be achieved at the EU28 level, a group of like-minded member states should push ahead using the so-called 'enchanced co-operation' mechanism.

“There is scope to go further on services liberalisation, extending the application of the country of origin principle, either within specific sectors or across the piece, and either at EU-level or within a smaller group of Member States through enhanced co-operation. Further liberalisation could also be achieved through a sectoral approach, focusing firstly on those sectors of greatest economic importance.”

The report on financial services noted the risks to non-euro member states from deeper eurozone integration - something Open Europe warned about back in December 2011 in our Continental Shift report:

“There were significant concerns that the advent of the banking union could have an unfair or damaging effect on Member States outside the euro area [such as] EU-wide regulation that is appropriate for the euro area but is not suitable for all Member States; the practice of caucusing and the development of a common euro area position on financial services issues which are at odds with a single market that is open internationally, dynamic, innovative and globally competitive; the fragmentation of the Single Market with barriers erected between its euro area and non-euro area constituents; the undermining of economic benefits associated with liberalised capital markets; and the marginalisation of non-euro area interests.”

The report warned that:

“The risk of discrimination against non-euro area Member States has already crystallised with the ECB location policy that euro-denominated financial instruments should be cleared only by a clearing house physically located in a euro area Member State.”

And recommended that:

“The creation of the banking union underlines the fact that the EU has become so large and diverse that ‘variable geometry’ is necessary.”

The report on the EU budget noted that:

"The value of expenditure in the budget, where in particular... on research and innovation, was seen as a priority for a greater share of the budget, although views were also heard in support of structural and cohesion funds, particularly in poorer Member States. The value for money of the Common Agricultural Policy (CAP) was questioned by a large proportion of respondents, with particular concerns about the value of Pillar One of the CAP."

The report on cohesion (regional) policy picked up on many of the points raised by Open Europe's seminal 'Off Target' report - which recommended limiting the structural funds to less developed member states - arguing that:

"support for the general principles of cohesion policy and the need to provide support particularly for poorer Member States, was shared by many respondents... The evidence as a whole is inconclusive but where significant positive impacts have been identified, they tend to have been in the poorer regions or Member States."

But adding that:

"A key question is whether structural funds should be used in richer regions of Member States, given the alternative sources of funding available, the more limited additionality and the goal of reducing disparities. This was sometimes expressed in terms of concerns about paying money into the EU only to get it back with conditions attached. Many respondents recognised that the UK might be better off financially if it did not contribute to cohesion policy in rich Member States or regions."

"Finally, it is important that funds available for cohesion policy are well managed. However, the complexity of rules and the perceived burdens of applying for, reporting on and auditing projects are potential barriers to the effectiveness of the structural and cohesion funds."

The report on agriculture also picked up on Open Europe's criticisms of the CAP, noting that:

“respondents put forward evidence that, notwithstanding the reforms, the CAP’s objectives remained unclear and that the criteria for allocation of funding were irrational and disconnected from what the policy should be aiming to achieve. The majority of respondents argued that the CAP remains misdirected, cumbersome, costly and bureaucratic.”

The report on fundamental rights noted that:

"There was mixed evidence on the case law of the ECJ; while some considered that the ECJ has simply upheld fundamental rights, others considered that some of its judgments have undermined national sovereignty and the EU’s legislative institutions... in comparison to other human rights protections in domestic law, fundamental rights can have a wider scope and can result in the disapplication of primary legislation. Therefore, with an increasing domestic awareness of EU fundamental rights, the evidence suggests that their impact will increase."

Compared to the first two stages of the BoC which were rather underwhelming, this third tranche of reports has at least been more explicit in identifying some of the most pressing challenges that need to be addressed while - for the most part - steering clear of setting out solutions.