Unpacking the EU’s new fiscal rules

Unpacking the EU’s new fiscal rules

Monday, 26 February 2024

Funcas Europe

Following a long negotiation period, the EU has reached an agreement on new fiscal rules. The revised framework represents a compromise between the more hawkish positions which advocate a rapid return to fiscal balance and the need for a gradual approach that preserves growth prospects.  What will be the impact of the new framework for Europe’s economy in the medium and long term?

To understand the broad implications of the new framework, we’ve recently released a new Future is Blue podcast with Vinzenz Ziesemer, Director at the Institute voor Publieke Economie and Raymond Torres, Funcas Europe Director. You can access the podcast here.

The new EU fiscal rules mark a significant shift from the previous framework, adjusting the approach to fiscal management within the European Union to address post-pandemic realities, high public debt, and the need for massive public investment, particularly in fighting climate change.

The emphasis has shifted from strict annual deficit and debt limits to monitoring net primary government expenditure, aiming for a more direct control over spending that impacts debt reduction and fiscal sustainability over a four- to seven-year timeframe​​​​ –an important element of flexibility in comparison with the previous system.

Flexible Debt Reduction: The rules offer differentiated debt reduction targets based on a country's debt level, with a more gradual approach for countries with less than 90% debt to GDP. This aims to facilitate fiscal consolidation while allowing for strategic investments​​.

Deficit and safeguards: A new "deficit resilience safeguard" introduces a planning margin below the 3% deficit limit to allow fiscal flexibility, alongside enforcement mechanisms for non-compliance. This includes sanctions for exceeding agreed spending limits​​.

Investment and interest adjustments: Investments, especially in green and digital technologies, can extend debt reduction timelines. Interest payments may be temporarily excluded from deficit calculations for countries with deficits above 3%, providing more fiscal space for necessary investments​​​​.

"The basic idea of having more forward-looking fiscal rules is a good one. But it's unclear how that will turn out in practice, because of the many safeguards that were added during the negotiation process”, explains Vinzenz Ziesemer.

In theory, this reform represents a balance between maintaining fiscal discipline and enabling Member States to invest in crucial areas like climate change, reflecting a compromise between different fiscal policy perspectives within the EU​.

However, “the new fiscal rules do not tackle one of the main weaknesses of EU economic policy, namely the lack of a common budget intended to boost investment and competitiveness”, according to Raymond Torres.

The new rules address country-specific imbalances. And, while they allow for a special treatment of green and digital investment, “they are not designed to boost the provision of common public goods, such as green energy or new technology”, says Torres.

“There may be an under-provision of such goods, in stark contrast with the approach followed by the US IRA programme. Member countries that have fiscal space may also be tempted to multiply State aid interventions, thereby distorting competition in the single market with doubtful benefits for competitiveness of the EU as a whole.”

On a similar note, Vinzenz Ziesemer argues that "the rules do not take into account commitments member states have made in areas such as climate and defence. What looks prudent under these fiscal rules, may turn out to be expensive at a later stage."

The issue is whether the new fiscal rules strike the right balance between the need for fiscal prudence on the one hand, and tackling green and digital transitions on the other. If strictly enforced, it is unclear whether sufficient resources will be invested in those transitions, thereby threatening European competitiveness.

The risk is especially acute in the most heavily indebted Member States. This could exacerbate disparities within the European Union and lead to insufficient investment in essential public goods at EU level.

It is obvious that that the European Union requires fiscal regulations. However, it is equally imperative for the EU to fund its long-term investment objectives, including the transition to green and digital economies, fostering an agile and competitive industrial sector that can stand up against other regions with assertive industrial strategies, and developing a defence mechanism to address increasing global challenges.

Carlos Carnicero Urabayen


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