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.

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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. 

Growth in UK economy to increase EU 'stealth tax'

It's that time of year again. Chancellor George Osborne has delivered his latest budget. The EU geeks that we are, we have one question in mind: what does it say about the UK's contributions to the EU budget?

Well, as ever, this is complicated because there are lots of ways of measuring these contributions. The table below shows the main figures and how they compare to the OBR's previous estimates in December 2013 (click to enlarge):

It shows that the UK's total net and gross contributions to the EU budget are now expected to be around £2.3bn and £1.7bn higher over the next six years than previously forecast. However, the impact of this on the OBR's figures for the Government's Total Managed Expenditure (TME) and Public Sector Net Borrowing (PSNB) as shown in the Budget is neutral or even slightly positive over the same period, compared to the December forecast.

One of the reasons for this is that the OBR effectively treats the contributions that the UK makes to the EU via a share of VAT receipts, customs duties and sugar levies as a direct "EU tax" and the money therefore doesn't show up in the national accounts. UK contributions are also affected by the complex rebate calculations and how much the UK receives from the budget.

As the UK economy is now growing faster than others in the EU, the overall UK contribution increases. But because the rebate is calculated on the basis of the UK's VAT contributions and the UK gets a refund on some of the customs duties it collects, that will help reduce direct contributions from the UK Government's budget and balance out this figure over the six years.

Relative to GDP the increase is tiny and the good news is that it's due to a faster growing economy.  Nevertheless, UK plc still ends up contributing more due to the growth in the 'EU's tax base'...

Economic downturn pushes up UK contribution to the EU budget, according to OBR

Yesterday's Autumn statement revealed that, under the latest OBR forecast, the UK’s net contribution to the EU budget is set to increase by a cumulative £10 billion between 2013-14 and 2017-18.

However, it is not quite as bad as it seems. According to the OBR, £4.9bn of the increase is “spending neutral” due to a change in how EU aid contributions are accounted for.

Nevertheless, the OBR does expect a real increase of around £5bn. This is due to lower than expected VAT revenues and customs duties (known as Traditional Own Resources) across the EU due to the economic downturn. The effect is that this will increase direct national contributions from the net contributors, including the UK's.

See the table below from the OBR's report (click to enlarge):

As we have noted before, it was always possible that the UK's net contribution to the EU budget could increase, despite the long-term EU budget real terms cut agreed in early 2013, due to a variety of factors (such as more more money flowing to the EU's poorer countries, which isn't covered by the UK rebate, fluctuations due to exchange rates, and the fluctuating revenues from VAT and customs duties cited by the OBR.)

Although much of the EU budget remains wasteful and irrational, these figures illustrate why it was so important to secure the cut in overall EU spending levels up to 2020. The deal brokered in February does at least mean that over the long term gross and net contributions will be limited in a way that they were not before. In addition greater pressure on overall spending might (we can hope) finally focus minds on reforming how the money is actually spent.

What does the EU budget deal mean for the UK and Europe?

We've just published a new Flash Analysis outlining our thoughts on the final deal on the long term EU budget. See below for the key points:

Key points

 - For the first time, the EU’s long-term budget will be cut in real terms. The UK government and its allies should be given credit for securing this - especially since this budget will be for 28 rather than 27 countries.

 - The final deal shows that compared to the current long-term EU budget (2007-2013), so-called ‘commitments’ will be cut by €34bn and ‘payments’ will be cut by €35bn. This represents a 3.4% cut and a 3.7% cut respectively (in real terms). The unusually large gap between these two amounts – needed to secure a deal – could potentially cause issues down the line.

- The UK’s gross contribution is likely to fall (as a share of UK GNI) but the net contribution could still increase as more money will be channelled towards the new EU member states – such spending isn’t covered by the UK rebate. However, it’s in the new member states that regeneration cash in particular can have the most comparative impact, so the UK government has done the right thing and this should not be seen as a “defeat”.

- The European Parliament could still scupper the deal and, in a very odd move, some MEPs have called for a “secret” ballot, although they can only approve or reject the deal, not amend it.

 - In the final proposal, direct payments under the CAP have fallen €62.5bn in real terms - a positive development. However, just under 40% of the budget will still be spent on farm subsidies, and as a whole, the EU budget will remain largely inefficient and out of date.

Also for a idea of the difference between the this budget and the current one see this handy table (click to enlarge):

Would the UK's contributions still increase under a new long-term EU budget?

Aside from the headline figure, where it looks as though David Cameron will get his cut, in terms of domestic politics, the next most important aspect of all of this is how the UK's contributions to the budget will be affected. In other words, will the UK still be forced to send more cash to Brussels?

As we predicted back in October, the net contribution was always set to go up - so that isn't really news (though we appreciate that not everyone follows this issue on a daily basis...)

Here are the details:

Net contribution:

Despite securing a real terms cut to the EU budget, the UK’s net contribution (what it pays in to the EU after the cash it gets back and rebate are taken into account) is still likely to go up under this proposal (see our earlier detailed explanation of this effect, which was with an earlier budget proposal in mind, but the broad dynamic still applies).

Essentially, because the share of the EU budget going to the new member states – the ones that have joined the EU since 2004 – will increase, and since the UK gets no rebate on this spending, the UK's net contribution will go up. As we've argued, this isn't a bad thing as it's in the new member states that this cash can make a difference. Still, this could prove politically sticky for the UK Government when explaining the figures to MPs and the Opposition in the months to come – though David Cameron is likely to heap the blame on Tony Blair (with some justification) for giving up part of the rebate in 2005.

Gross contribution:

This is rather more complicated. Under the deal that looks set to be agreed, the budget is falling in real terms, hence the UK gross contribution should fall in real terms. However, there are two potential issues to be aware of:

Firstly, the likely new payments ceiling of €908bn is higher than the actual payments that have been made under the current budget (i.e. the UK's base-line of €886bn based on an extrapolation of 2011 payments, which we explain here). Historically, 'actual payments' fall short of the 'payments ceiling'. But if, under the new budget, the actual payments hit the ceiling, it is possible that the UK's actual gross contribution could top the ones seen under this budget framework (€908bn is higher than €886bn) - it seems unlikely but is possible. Again, this is nothing new, but a function of the Government's starting position.

Secondly, because this would be the first time the budget has been cut, and because of the way the budget (MFF) is structured into 'commitments' and 'payments', there could be unexpected effects.

As we explained here, actual payments 'trail' commitments (or promises to pay). In the context of an ever-increasing budget, this doesn't present a practical problem, because extra funds can always be pledged to meet previous commitments. But now we have a situation where payments are falling well below the level of the commitments that the EU is able to make under the current budget, potentially creating a deficit. The current compromise is also predicated on deeper cuts to payments than to commitments.

But, as the Commission is always at pains to point out, the EU's bills need to be paid - under the current budget this has already led to so-called 'amending budgets' (albeit within the MFF ceilings) to increase payments to match previous commitments. How much of an issue this might be in the next budget period, remains an uncertain question as it depends on the 'commitment profile' (i.e. what/when has the EU promised to pay for specific projects).

In theory, the MFF payment ceilings that are being agreed now cannot be altered unless there is unanimous agreement, as it essentially means re-opening the MFF. For example, in 2011, funds were 'redeployed' to fund a shortfall for the International Thermonuclear Experimental Reactor (ITER), although, in this case, this didn't mean increasing the payment ceiling. The current rules say that ceilings can be revised by 0.03% of EU GNI for 'unforeseen' expenditure. More than this would seem to require unanimity.

Therefore, this second tension between commitments and payments described above, could potentially lead to immense pressure to increase the payment ceiling further down the road. In this hypothetical, albeit not implausible scenario, the UK's ability to block this could be one for the EU and FCO lawyers to thrash out.

The OBR's new forecast and the EU budget: What's in there?

On the same day as George Osborne's Autumn Statement, the Office for Budget Responsibility (OBR) published its new Economic and Fiscal Outlook. As usual, the first section we looked at was the one about how much the UK pays into the EU budget. Here is a reader-friendly table we put together, comparing the UK's net contributions to the EU budget in the latest outlook published yesterday with those in the March 2012 outlook (click to enlarge).  

So, the numbers tell us that the UK's net contribution for 2011-12 turned out to be £1.3 billion lower than expected, but the net contribution for 2012-13 is going to be £2.1 billion higher than the previous forecasts indicated. Why?

The OBR is not exactly forthcoming with a clear explanation, but the report (on page 148) notes:  

The largest change [in expenditure transfers to the EU institutions] is in 2012-13, where we have increased our forecast by £1.5 billion [N.B.: Expenditure transfers to EU institutions are something slightly different from EU budget contributions as a whole]. This mainly reflects revised estimates of GNI and VAT bases for all EU countries in 2012 and 2013. Partly because of exchange rate changes these revisions increased the UK’s relative share in both the GNI and VAT bases, particularly for 2012, and thus increased our GNI contribution. 

This increases our expenditure contributions in all future years, but the effects are partially offset by increases in the abatement [the UK rebate] after 2012-13. The expenditure transfers [to the EU institutions] have also been increased in 2012-13 because of lower than expected surpluses carried forward in the EU budget from the outturn for 2011, and to reflect increases in amending budgets in 2012.

Therefore, essentially the OBR suggests that because the UK economy has done relatively well compared to other EU countries, its share of contributions in terms of Gross National Income (GNI) and VAT base have increased. This is natural given the way the budget is calculated, although it once again highlights the fallibility of economic forecasts at the national and international level - clearly the OBR's early forecast of how the UK economy would develop relative to the rest of the EU was some way off.

The OBR also notes the impact of exchange rate changes which have also increased the UK's contributions in sterling terms. Again this is hard to avoid, although the assumption that this will hold in the longer term is far from certain - and paves the way for future forecast revisions. All this is offset to some extent by the automatic adjustments in the UK rebate (designed to account for these sorts of changes), although as we have noted recently the UK rebate could decrease in the next budget period, hampering this offsetting process.

Finally, though, as the OBR warns, much of this is rather academic given the ongoing EU budget negotiations:

The forecast is subject to risks depending on the outcome of the negotiations for the EU budget for 2013, where we have assumed an increase of 2.8%, and for the new EU budget envelope for 2014 to 2020, where we have assumed a small real terms increase.

The first assumption sounds about right - given that MEPs now seem more willing to accept a 2.9% increase in payments in next year's EU budget, as opposed to the inflation-busting 6.8% increase proposed (twice!) by the European Commission. The second assumption is perhaps a bit pessimistic, given that David Cameron has said that he will veto anything different from, at worst, a 'real terms freeze' in the next seven-year EU budget - and Germany, Sweden and the Netherlands are also pushing for a similar freeze.

This is all clearly but another round in the series of forecasts of UK contributions to the EU budget, and far from the last since the negotiations on the next long term budget are under way. But if you are still confused by all these numbers and wondering how it could all end up, we would recommend reviewing our analysis of what could come out of the negotiations on the next long-term EU budget, and how much the UK would have to pay under each scenario.