Reforming EU Fiscal Rules: Why Strict Limits and High Penalties Don't Work

The EU Commission wants to comprehensively revise the debt rules for the member states.

According to this, highly indebted countries are to be given more flexibility in debt reduction in the future.

But Federal Finance Minister Christian Lindner (FDP) rejects the plans as insufficient.

The ideas from Brussels are a "wise compromise proposal", writes the economics professor Achim Truger in the guest article.

The reasons.

Since the introduction of the EU fiscal rules in 1992 in the Maastricht Treaty, the well-known limits of three percent of gross domestic product for the state budget deficit and 60 percent for the debt level have been exceeded very often in many member states.

Theoretically, there are strict adjustment regulations and in the end there is a risk of high penalties for non-compliance.

But no one has been sanctioned so far.

Since the corona crisis, the average debt ratio in the euro area has risen to 91.6 percent by 2022.

Germany was 66 percent, Spain, Portugal and France over 110 percent and Italy even 144 percent.

Due to the crisis, the fiscal rules are suspended until 2023;

In 2024, however, they are to be applied again in a reformed form.

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The EU Commission recently presented its reform proposal.

On the one hand, the rules should become more transparent and binding, but on the other hand they should also give more time for adjustments.

The exact adjustment paths are to be determined country-specifically after a risk analysis between the Commission and the Member States.

The amount of possible penalties should be reduced.

A fight is already brewing.

Federal Finance Minister Christian Lindner does not think the reform is strict enough, he insists on uniform numerical targets for all countries and binding annual targets for reducing the debt ratio.

His French colleague Bruno Le Maire then accused Lindner of "introducing old and inefficient ideas through the back door".

New EU Debt Rules: Clash of Economic Worldviews

In the debate, economic worldviews collide.

Proponents of strict rules and harsh penalties assume that consolidation is ultimately a question of political will.

When targets are not being met, they conclude that tougher rules or penalties must force politicians to do so.

Advocates of more flexibility, on the other hand, point out that austerity policies imposed by tough rules weaken the economy and create unemployment, thereby reducing tax revenues and increasing social spending.

This in turn prevents successful consolidation and is even more likely to increase the debt ratio in the short term.

High penalties would add to the misery.

New EU debt rules: Wise compromise proposal

Ultimately, both positions are not entirely wrong: On the one hand, debt reduction will not succeed without political will and commitment.

On the other hand, strict consolidation can lead to a deep crisis, as the experiences of southern European countries in the euro crisis show.

Against this background, the Commission's proposal proves to be downright wise, because on the one hand it gives the states more time to reduce their debts, but on the other hand it makes the adjustment more transparent and binding.

It should now refer to variables that, unlike the budget deficit or the debt ratio, can be verified and actually adhered to by the states themselves: the states would have to comply with strict upper limits for government spending for four to seven years according to a plan agreed with the Commission.

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New EU debt rules promise easier monitoring

This would gradually reduce the budget deficit in an economically viable manner to a level at which the debt-to-GDP ratio would automatically shift to a sustainable path towards the unchanged target value of 60 percent.

Exceeding the spending limits would be punished with an excessive deficit procedure.

Compliance with the spending limits would be much easier to monitor and therefore more binding than the previous complicated and unsuccessful rules.

The basic dispute has actually long since been skilfully bridged by the Commission's proposal.

A constructive solution should be found for the final technical details if politicians in the member states verbally disarm and do not succumb to the temptation, as has been the case up to now, to fan the dispute for transparent domestic political motives.

About the author: Professor Achim Truger is a member of the Advisory Council for the Assessment of Macroeconomic Developments and Professor of Government Activities and Public Finances at the University of Duisburg-Essen.