Are we Living in a Fiscal Federation … and Haven’t Noticed?

https://doi.org/10.63189/YDLR1692

Jean Monnet, one of the EU’s ‘founding fathers’, believed that “Europe would be built through crises, and that it would be the sum of their solutions”.^[i] Since the Central European countries joined the EU in 2004, the Union has been confronted with several crises having significant impact on its functioning. I will argue here that the Euro area crisis, following the global financial crisis of 2007–2009, together with the economic response to the COVID-19 crisis, has fundamentally changed the architecture of the Economic and Monetary Union (EMU) and has pushed us on a trajectory to a fiscal union, sometimes referred to as ‘fiscal federation’.^[ii] I will not discuss the economic consequences of these changes or question their economic rationale. Conversely, from a legal point of view, I would like to point out that it is questionable whether such changes could have been carried out without a change of the Treaties.

The original rules governing the EMU, enshrined already in the Treaty of Maastricht, were based on a clear division of competences. Whereas monetary policy should belong to the exclusive competence of the EU,^[iii] economic policy should remain predominantly in the sphere of Member States, with the EU institutions only taking a coordinating role.^[iv] The Treaties thus foresee a “single monetary policy”^[v] and “close coordination of Member States’ economic policies”.^[vi] The stability of the Euro was to be guaranteed by a requirement on Member States to keep sound budgetary policies, ie the prohibition of “excessive deficits”,^[vii] together with a principle that the Member States themselves are ultimately responsible for their finances – the possibility of a ‘bailout’, either by another Member State or by the EU, was explicitly ruled out.^[viii]

Below I will describe three measures that have, in my opinion, permanently altered the functioning of the EMU.

The new ‘bailout clause’

As underlined above, the EMU was originally based on the ‘no-bailout clause’. Yet when several Member States were severely hit by the financial crisis, financial assistance was provided to them, nonetheless. Ultimately, a permanent rescue facility, the European Stability Mechanism (ESM), was established in 2012.

The legal basis for the creation of the ESM is now contained in Article 136 (3) TFEU, newly added to the Treaties by a decision of the European Council in March 2011. This amendment however entered into force only in May 2013, after being ratified by the last of the Member States. The ESM itself was not established by any measure of EU law, but by an international treaty, the Treaty Establishing the European Stability Mechanism (TESM), which entered into force in September 2012, ie almost a year before the TFEU was amended.

This gave rise to serious speculations concerning the legality of the ESM itself. The legal issues may be divided into three broad categories: first, the compatibility of such a rescue mechanism with the EU law and in particular its ‘no-bailout’ clause, second, the establishment of the ESM itself ‘outside’ the EU law, and third, the fact that it was established months before the amendment of the TFEU, which was meant to enable its creation, entered into force. Even though these questions were discussed by the Court of Justice of the European Union (CJEU) in the Pringle^[ix] case and the Court ultimately concluded that the creation of the ESM was not conflicting with EU law, concerns regarding the persuasiveness of this judgment still remain.^[x]

For practical purposes, however, the EMU now disposes with a rescue mechanism, capable of de facto ‘bailing out’ the Member States in financial difficulties.

Coordination or management of national economic policies?

Whereas monetary policy belongs to the EU’s exclusive competences, economic policies should have remained in the hands of Member States, only coordinated to a necessary extent by “broad economic policy guidelines”.^[xi] This was changed by far-reaching modifications of the EMU rules, included in the so-called ‘Six-Pack’ in 2011 and the ‘Two-Pack’ with the ‘Fiscal Compact’ in 2013.^[xii] One of the regulations contained in the ‘Six-Pack’ introduced the European Semester.^[xiii] Put simply, the European Semester is “nothing more than a period of about nine months in which all EU socio-economic coordination activities occur”.^[xiv] At the same time, it is a major step in the development of the architecture of EU governance. It incorporates into a single procedure employment and social policy coordination, including the European Employment Strategy and the Social Open Method of Coordination, with the fiscal and economic procedures of coordination, in particular the Broad Economic Policy Guidelines, the Stability and Growth Pact and the Macroeconomic Imbalance Procedure.^[xv]

As a result, the fiscal autonomy of Member States has been significantly reduced. The national medium-term fiscal-structural plans are proposed by the Member States but are finally adopted by the Council on the Commission’s recommendation.^[xvi] The plans’ implementation is monitored by the Commission.^[xvii] This significantly limits the space within which the Member States’ economic policies may manoeuvre, because the national budgets need to be ex ante reviewed by the EU institutions. Ultimately, the role of national parliaments in budgetary affairs is marginalised.^[xviii]

At the same time, the reverse qualified majority voting was introduced, meaning in essence that the Commission’s proposal is adopted unless a qualified majority of Member States votes against it in the Council, which significantly shifts the institutional balance in favour of the executive.^[xix] As a result, major economic reforms and budgetary decisions of the Member States are to be executed under the auspices of the Commission, with pre-set ‘austerity’ limits that the Member States cannot exceed (or even question), while the possibility to vote against the Commission’s recommendations is limited.

Financial redistribution

The last tectonic shift in the EMU’s architecture is connected to the EU Recovery Instrument (EURI),^[xx] a fund of EUR 750 billion situated outside of the Multiannual Financial Framework. The disbursement of money on national level is subject to ex ante approval by the Council and monitored by the Commission, in a procedure integrated into the European Semester.^[xxi]

The EURI was set up on the basis of the existing primary law, even though until 2020, there had been a consensus among EU institutions that any deeper fiscal integration, in particular involving issuance of EU debt, would require an amendment of the Treaties.^[xxii] The EURI itself, ie the debt-financed EU fund, was established on the basis of Article 122 TFEU, designed to help Member States in unexpected difficulties. The distribution of the money thus accumulated is realised through different instruments. The most significant one is the Recovery and Resilience Facility (RRF),^[xxiii] based on Article 175 (3) TFEU, ie as a part of cohesion policy.

These two legal bases are difficult to reconcile.^[xxiv] The transfer of funds through RRF to Member States is no longer designed as crisis management. It is a redistribution of money from Member States with high GDP and low unemployment to those with low GDP and high unemployment.^[xxv] Crucially, it abandons the condition of strict conditionality of aid to Member States, required by the CJEU in the Pringle case, discussed above. It is therefore doubtful to what extent Article 122 TFEU may provide a legal basis for financing that is not related to an emergency, but to the criteria of cohesion, based on Article 175 TFEU.^[xxvi]

It also needs to be underlined that the EURI’s funding model is based on empowering the EU to incur debt to cover its expenditures. At the same time, Article 310 (1) TFEU clearly requires that the revenue and expenditure shown in the budget be in balance. This provision has been consistently interpreted as prohibiting the EU from issuing public debt for the purposes of filling the gap between revenue and expenditure.^[xxvii]

These two observations are in line with my reservations presented in the two previous sections concerning the compatibility of the newly adopted measures with the primary law.

Conclusions

Over the last ten years, the functioning of the EMU has significantly changed. The Eurozone now has practically unlimited funds to help its members in financial difficulties (ESM). The EU is empowered to create vast debt-financed funds and use them for redistributive purposes (EURI). Additionally, the fiscal and economic policies of Member States are to a large extent controlled by EU institutions, including national budgets (the European Semester). Indeed, this does resemble the concept of a fiscal federation.

It is not my intention to question the merits of these changes. It may well be that from an economic point of view, they are beneficial or even necessary for the effective functioning of the EMU. My concern is that they are not in line with the Treaties. Financial aid is being provided to states in difficulties, despite the clear message of the ‘no-bailout’ clause. The EU is incurring debt on an unprecedented scale, despite the requirement of its budget being balanced. And the Member States are no longer free to decide their economic policies. The EMU is thus on a course to a fiscal federation, but the rules contained in the Lisbon Treaty arguably do not support it.

I am by no means arguing against these changes to the EMU themselves. I simply put forward that the Treaties need to be changed in order to accommodate them, and the Member States thus need to be given a chance to express their consensus clearly.

^[i] Monnet (1978), p. 430.

^[ii] Hinajeros (2013).

^[iii] Art. 3 (1) (a) TFEU.

^[iv] Art. 5 (1) TFEU.

^[v] Art. 119 (2) TFEU.

^[vi] Art. 119 (1) TFEU.

^[vii] Art. 126 TFEU.

^[viii] Art. 125 TFEU. As underlined by Van Malleghem (2013), p. 161: “Through the ‘no bailout’ clause the Member States were thought to have irrevocably committed themselves to not helping other members of the monetary union, thereby reinforcing the fiscal discipline of all of its members. That prohibition was at the core of the design of the monetary constitution implemented in the Maastricht Treaty”.

^[ix] CJEU, C-370/12, 27 November 2012.

^[x] Tomkin (2013) refers to the CJEU’s reasoning as “conceptual gymnastics”.

^[xi] Art. 121 TFEU.

^[xii] Hinajeros (2013).

^[xiii] Regulation (EU) No 1175/2011 of the European Parliament and of the Council of 16 November 2011 amending Council Regulation (EC) No 1466/97 on the strengthening of the surveillance of budgetary positions and the surveillance and coordination of economic policies, Section 1-A. These provisions on the European Semester were redrafted in 2024 by Regulation (EU) 2024/1263 of the European Parliament and of the Council of 29 April 2024 on the effective coordination of economic policies and on multilateral budgetary surveillance and repealing Council Regulation (EC) No 1466/97.

^[xiv] Bekker (2020), p. 67

^[xv] Verdun and Zeitlin (2018), p. 138.

^[xvi] Regulation (EU) 2024/1263, Chapter IV.

^[xvii] Regulation (EU) 2024/1263, Chapter V.

^[xviii] Papadopoulos and Piattoni (2019), p. 63.

^[xix] van Aken and Artige (2013)

^[xx] Council Regulation (EU) 2020/2094 of 14 December 2020 establishing a European Union Recovery Instrument to support the recovery in the aftermath of the COVID-19 crisis.

^[xxi] Vanhercke and Verdun (2022)

^[xxii] Leino-Sandberg and Ruffert (2022), p. 434.

^[xxiii] Regulation (EU) 2021/241 of the European Parliament and of the Council of 12 February 2021 establishing the Recovery and Resilience Facility.

^[xxiv] Porras-Gómez (2023), p. 14.

^[xxv] Regulation 2021/241, Art. 11.

^[xxvi] Leino-Sandberg and Ruffert (2022), p. 444

^[xxvii] Ibid, p. 451.

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