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Introduction

The process of European integration requires financial resources for its activities, and the EU budget is a tool through which money is collected and allocated for EU policies and objectives as well as for the tasks transferred to it from the national level.

The EU budget is modest in size. As agreed by the Member States, in the Own Resources Decision (ORD), the maximum ceiling of the EU budget financing is set at 1.24 per cent of the EU GNI (or 1.27 per cent of EU GNP). In practice, however, the EU budget has always remained well below that ceiling. As public finances of the EU Member states are typically between 40 and 45 per cent of their respective GNI, the EU budget is equivalent to just over 2 per cent of the total public finances of the Member States. The EU budget does not represent a significant factor in almost any consolidated national public finance category. Three key segments of public finance expenditures in practically any country – defence, security and public order expenditure – as well as healthcare, are not even included in the EU budget, while the presence of certain other expenditure items, such as education and housing, is minimal. There is another fundamental characteristic which distinguishes the EU budget from national public finances. In contrast to national public finances, which can run deficits, the EU budget is legally required to be in balance each year.

Even though the EU budget is small in size, it is of a tremendous political importance for the overall EU integration process. This can be illustrated by the highly complex procedure that is required for the adoption and implementation of the annual budget, which involves practically all important EU institutions, as well as by the strongly politicized multi-annual financial framework (MAFF) negotiations that set the ceiling costs on major expenditure items of the EU budget over a five to seven year period.

Evolution of the EU Budget

The evolution of the EU budget can be roughly classified into two periods: the first, between 1951 and 1987, was characterised by a move towards the unification of budgetary instruments and the crisis of Community finances in the 1980s; the second, from 1988 until today, has been characterised by features introduced by the 1988 EU budgetary reform.

1951–1987

The public finance system of the EC began to develop in the early 1950s, when in 1951 the European Coal and Steel Community (ECSC) Treaty was signed. It was followed by the 1957 European Atomic Energy Community (EURATOM) and European Economic Community (EEC) Treaties. Each of these treaties envisaged different budgets for a particular Community, which led to the co-existence of budgets. The ECSC Treaty provided for two budgets – an administrative and an operating budget. The EURATOM Treaty also set up two budgets: an administrative budget and a research and investment budget. The EEC Treaty, on the other hand, established only one, a so-called ‘single budget’.

The 1965 merger treaty incorporated the ECSC and EURATOM administrative budgets into the EEC budget, and five years later, in 1970, the Luxembourg Treaty incorporated the EURATOM research and investment budget into the general budget. The outcome of these developments was the formation of two budgets – the general budget and the ECSC operating budget – and the system was in place until 2002. The ECSC Treaty expired in 2002 and therefore the ECSC operating budget ceased to exist. Since then the EU has operated with a single EU budget.

During the first 20 years of the Community’s financial system, there were two important developments for the integration of budgetary instruments. The first was the development of common policies. The most notable events, with considerable financial consequences, were probably the creation of the European Agricultural Guidance and Guarantee Fund (EAGGF) in 1962 as an instrument for implementation of the common agricultural policy (CAP), as well as the establishment of two funds for implementation of the cohesion policy: the European Social Fund (ESF) in 1971 and the European Regional Development Fund (ERDF) in 1975. These two policies still constitute about 80 per cent of current EU budget expenditures. The second development was that the initial system, through which the budgets of all the three Communities were financed through a special system of contributions by the Member States, soon proved to be insufficient and unsatisfactory. The need for a better and more efficient system, which would provide sufficient resources, gradually led to a reform of budget financing. Through the 1970 Luxembourg Treaty, a system of so-called ‘own resources’ was introduced.

The processes of unification of the budgetary instruments, development of common policies and progress towards financial autonomy were inevitably connected with difficult negotiations. The majority of disagreements had been associated with responsibilities and powers that each of the institutions had in budgetary matters. Although decisions in budgetary matters were in theory primarily the exclusive prerogative of the Council, in practice other institutions were involved at various stages of the budgetary procedure. The 1970 Luxembourg Treaty partly formalised such a practice by giving more power to the Parliament. Since the 1975 Brussels Treaty, powers on budgetary matters have been shared between the Council and the Parliament.

The legal, political and institutional structure for governing the Community’s finances established in the early 1970s soon proved to be unsustainable over a longer period of time. Relations between Member States, as well as among the European institutions involved in the budgetary adoption procedure, gradually worsened and finally turned into open conflict. An increasing number of incidents made adoption and management of a budget almost impossible. Between 1980 and 1988, approval of four annual budgets was delayed long enough that provisional arrangements in the form of so-called ‘twelfths’ had to be applied for several months.

Since 1988

The 1986 enlargement to include Spain and Portugal and the conclusion of the Single Act injected new optimism into the Community and provided a sound political base for a thorough reform of the Community’s financial system. In 1987, the Commission presented comprehensive reform proposals and in the following year the European Council adopted the broad lines of these proposals. The main political orientation and operational features of each of these orientations were as follows:

  • The Community should be given sufficient resources to enable it to operate properly. In operational terms, this meant a revision of the ORD whereby a new (fourth) resource was introduced based on Member States’ GNP. From that period on, GNP and later on GNI source, represents the balancing item, i.e. it provides the necessary funding for the Community and, from 1992, for the EU budget.

  • Strict supervision of the expenditures financed by these additional resources should be exercised. This orientation, aimed at making an effective brake on rising agricultural expenditures, was operationalized through an inter-institutional arrangement for budgetary discipline in procedures, of which a multi-annual financial framework instrument was an integral part.

  • The political orientation of linking the budget contributions of Member States more closely to their levels of relative prosperity was operationalised through a significant reform of the cohesion policy and especially the instrument for its implementation.

    Since 1988, the Community/EU budgetary system has remained more or less unchanged in terms of its size expressed as percentage of EU GNP/GNI as well as in terms of the magnitude of its expenditure and its distribution, with agriculture and cohesion spending consuming the majority of the GNI source.

    The EU budgetary system continues to be based on two major elements. First, the strategic course of the EU public finances and financial framework for the medium-term period is determined in a multi-annual financial perspective (MAFF). The MAFF is basically an agreement among the institutions on budgetary priorities facilitating the budgetary procedure and the management of various programmes. The MAFF allows financial predictability in the development of EU expenditure. Within the framework of the MAFF, the maximum volume and the composition of the foreseeable EU expenditure are indicated. The MAFF fixes the ceilings for particular expenditure headings as well as for the budget as a whole; the cap on spending levels must be set below the own resources ceiling. The MAFF is a product of an inter-institutional agreement between the Commission, Council and Parliament. Although it is not a multi-annual budget, and the annual budgetary procedure remains necessary to decide the next year’s budget, the MAFF is not just indicative, as it sets the maximum ceilings for each year and each category of expenditure (heading). Until now, Community/EU institutions have adopted four MAFFs. The first, called ‘Delors I’, had duration of five years (1988–1992) while all three of the subsequent ones covered seven-year periods: ‘Delors II’ (1993–1999), ‘Agenda 2000’ (2000–2006) and the current MAFF (2007–2013). Second, the implementation and operational details of the EU budgetary system are elaborated in the annual budget, which must be consistent with the MAFF.

Principles and Procedures for the Annual Budget and for the MAFF Principles

The EU budget is regulated by six principles that are enshrined either in the Treaty or in the secondary financial legislation.

The principle of unity states that all expenditures and revenues of the EU must be included in the EU budget. The European development fund (international development aid) and the financial activities of the European Investment Bank constitute exceptions to this principle.

The principle of universality says that revenues cannot be appropriated for specific spending purposes.

The principle of annuality requires that budgetary appropriations must refer to a specific year. Due to the multi-annual nature of some programs, two categories of appropriation are entered into the EU budget: appropriations for commitments, i.e. the expenditure committed by the EU in a given year with respect to operations that can be carried out over a longer period of time, and appropriations for payments, i.e. the expenditure effectively incurred by the EU in a given year in meeting the commitments of that and/or of previous years.

The principle of equilibrium provides that the EU budget cannot be in deficit or surplus. Practical enforcement of the principle is through automatic adjustment of the GNI revenue source to expenditures.

The principle of specification states that no commitment can be entered in the EU budget without a definite scope and purpose. The only exception is the budgetary reserve.

Finally, the principle of the unit of account states that the EU budget is expressed in EUR.

Procedure for the Annual Budget Adoption and Implementation

The procedures are comparable in many respects to procedures at the national level. The EU budgetary procedure consists of five main phases. Preparation of the budget for the year N starts with the proposal of the Commission submitted by the end of April of year N – 1. In the second phase, Council and Parliament discuss the proposal and adopt the budget with the required majority by the end of December of year N – 1. The next stage consists of the Commission’s execution of the budget throughout year N. Technical control of the budgetary execution, which is in the hands of the European Court of Auditors, represents the fourth stage of the EU budgetary procedure and is usually completed around November of year N + 1 for the budget of year N. The fifth phase – political clearance – is given by the Parliament usually in March of year N + 2 for year N.

Procedures for the MAFF Adoption

The boundaries for the annual budget are set by the MAFF on the expenditure side and by the ORD on the revenue side, with both of them required to be adopted unanimously in the Council. This prerequisite of unanimity is one of the main reasons why MAFF negotiations usually turn into one of the most complex negotiations among the EU Member States, even at the European Council level, where political clearance has to be achieved. On the other hand, the unanimity rule of the Council de facto transfers the decision-making power to this institution. The negotiations about the MAFF 2007–2013 clearly confirm this fact, as the Council agreement was significantly changed by the Commission’s proposal, and the Parliament’s role in the decision-making process was rather symbolic. With the Lisbon Treaty in place, the importance of the Parliament in the MAFF decision-making process has strengthened substantially.

Structure of Expenditures

In the early decades of the Community, CAP absolutely dominated EU expenditure. More recently, due to several enlargements of the Community/EU and through the introduction of the MAFF instrument, CAP expenditures have been capped, allowing funding for some other items, especially cohesion policy expenditures. As shown in Fig. 1, approximately 80 per cent of all EU budget funds was earmarked for these two policies over the last two decades. The remaining share of the budget was allocated for external EU activities and internal policies aimed at boosting competitiveness and the implementation of other objectives.

European Union Budget, Fig. 1
figure 577figure 577

Evolution of EU budget expenditures 1962–2006 (as a percentage of EU GNP/GNI) (Source: European Commission)

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In the MAFF 2007–2013, the total volume of finally agreed expenditures will amount to h864 bn in commitment appropriations and h821 bn in payment appropriations. As shown in Table 1, these amounts are significantly lower than the comparable figures proposed by the Commission.

European Union Budget, Table 1 EU budget expenditures under the MFAA 2007–2013 (Source: European Commission and author’s own calculations)
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The MAFF 2007–2013 classifies expenditures under six headings:

  1. 1.

    Sustainable growth, subdivided into competitiveness for growth and employment (research and innovation, education and training, trans-European networks, social policy, economic integration and accompanying policies) and cohesion for growth and employment (convergence of the least developed EU countries and regions, EU strategy for sustainable development outside the least prosperous regions, inter-regional cooperation);

  2. 2.

    Preservation and management of natural resources (common agricultural policy, common fisheries policy, rural development and environmental measures);

  3. 3.

    Citizenship, freedom, security and justice, subdivided into freedom, security and justice (justice and home affairs, border protection, immigration and asylum policy) and citizenship (public health, consumer protection, culture, youth, information and dialogue with citizens);

  4. 4.

    EU as global player (covers all external actions by the EU);

  5. 5.

    Administration (covers the administrative expenditure of all the European institutions); and

  6. 6.

    Compensations (includes compensatory payments relating to the latest expansion of the EU).

Structure of Revenues

The evolution of the revenue side of the EU budget has been driven by the continuous attempt to strike a compromise between the financial autonomy of the EU budget and sufficiency of resources for its financing. The budget of the ECSC in the early 1950s was financed through a tax-based ‘own’ resource (a levy on steel production) while, in contrast, the Rome Treaty stipulated that the EEC budget was financed in a totally intergovernmental way, i.e. through direct contributions from Member States. At that time, the EEC budget had no ‘own resources’ and thus had no financial autonomy from its Member States.

It was in 1970, with the Luxembourg Treaty, that the EEC budget started to move towards an own resources model. At that time, own resources included traditional own resources, i.e. customs duties and agricultural levies, and VAT-based revenues from Member States. This structure remained unchanged until 1984, when the Fontainebleau Council introduced the UK correction, which in fact means a reduction of the UK contribution to the Community budget. The last major change to the EU budget revenue side occurred in 1988 with the Delors I package, which introduced the fourth resource, known today as the GNP/GNI resource. Figure 2 provides a historical overview of how the EU budget has been financed since 1958.

European Union Budget, Fig. 2
figure 578figure 578

Evolution of EU budget expenditures, 1958–2011 (as percentage of EU GNI) (Source: European Commission 2011)

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Since its last major reform in 1988 and thus also in the MAFF 2007–2013, EU budget revenue has been made up of four major resources:

  1. 1.

    Traditional own resources (TOR), which include customs duties and agriculture levies. In the 2011 EU budget, this source contributes around 14 per cent of total EU budget needs and is on a downward path.

  2. 2.

    Funds levied on the basis of value-added tax (VAT-based resource), defined on the basis of a statistically adjusted VAT base of the Member States. Its share of the EU budget is also small and accounts for around 11 per cent in 2011.

  3. 3.

    Funds levied on the basis of the Gross National Income of the Member States (the GNI-based resource), i.e. funds earmarked for balancing the budget measured in proportion to the GNI of every Member State. In 2011, this funding source participates with around 70 per cent in total funding needs of the EU budget.

  4. 4.

    The UK correction, as formally the fourth EU budget own resource but in substance terms a zero sum mechanism. It amounts to an annual level of around h3.8 bn in the years 2010 and 2011.

    In addition to the four own resources described above, there are some other revenues that may also finance the EU budget. It should be underlined that they are small in size and of a non-foreseeable character. In the 2011 budget, the major source of these other revenues is a budgetary surplus from the previous year. An existence of other revenues reduces the volume of GNI contributions to be provided by Member States.

Correction Mechanisms and Net Balances Issue

An integral part of the own resources system is formally also the ‘UK correction’ as well as a set of ‘corrections on this correction’. Introduction of this instrument dates back into early 1970s when the UK joined the EEC. At that time the UK was among the poorest Member States, but due to the EU budget expenditure bias toward the CAP the country had a negative net financial balance towards the EU budget. As this was considered unfair by the UK authorities, after intense negotiations with other Member States the issue was resolved at the 1984 Fontainebleau European Council through the so-called ‘UK correction’ arrangement, whereby the UK became entitled to a refund financed by all other Member States. The economic logic of the arrangement was that the UK position vis-à-vis the EU budget was excessively negative in relation to its level of development, and that the country is eligible for a rebate on its contribution to the EU budget.

Even though the UK position in terms of its economic development has improved substantially since 1984, eliminating (or at least substantially reducing) the justification for the ‘UK correction’, the system remains in place with only minor changes. This can be explained by the fact that the ‘UK correction’ is an integral part of the ORD, which requires unanimity for changes. The correction mechanism system in place in the MAFF 2007–2013 contains, in addition to the ‘UK correction’ corrections to four other large net payers to the EU budget, whereby Germany, Austria, the Netherlands and Sweden pay only 25 per cent of their normal ‘UK correction’ funding share.

There are also three other ‘corrections on corrections’. First, Germany, the Netherlands, Sweden and Austria have an arrangement whereby their share in financing the ‘UK correction’ has been reduced via a reduction in the call rates for the VAT-based own resource.

Second, the Netherlands and Sweden receive a fixed lump sum reduction of their annual GNI contributions.

Third, Member States retain a fixed percentage of all traditional own resources collected. Since 2000 this percentage has been set at 25 per cent.

The Main Deficiencies of the EU Budget

The EU budget is dominated by a small number of highly redistributive policies, with CAP providing funds for European farmers and cohesion policy redistributing funds towards less wealthy regions. Poor representation of broader EU-wide policies on the expenditure side of the EU budget associated with the domination of national contributions on the revenue side have resulted in a system particularly prone to bargaining and supporting the obsession of Member States to demand juste retour for their contributions to the EU budget. The two most recent MAFF negotiations have confirmed this pork barrel mentality, where achieving an acceptable net balance position has de facto become a more important objective than agreeing the size and structure of the spending.

Despite significant changes within and around the EU over the last two decades, the structural characteristics of the EU budget have remained largely unchanged since 1988. In addition to its strong pro-status quo bias, the EU budget has become less and less transparent. The 2007–2013 MAFF negotiations are a clear confirmation of these problems. In order to achieve acceptable net balances Member States were ready to sacrifice Lisbon-type expenditures as one of the top EU policy priorities at that time, and they also insisted on the continuation of the current corrections and rebates as well as the introduction of new ones.

Structural rigidities in the EU budget reflect the current institutional set-up of the EU and its decision-making system. The MAFF adoption procedure combines elements of an intergovernmental and a supranational approach. According to the Lisbon Treaty, an agreement on a proposal prepared by the European Commission has to be reached in the European Council by consensus, and in the European Parliament by majority. The two institutions have different incentives in these negotiations. While the European Council aims to reduce EU budget expenditures in order to reduce the Member States’ contributions from their national budgets, the European Parliament has an incentive to increase the expenditures as the required funds will be provided automatically by the Member States up to the ceiling determined by the ORD.

There have been several attempts to address the net balances problem and the highly complex and non-transparent system of EU budget corrections, but to date none have been successful. The most serious attempt was the 2004 Commission’s proposal for a generalized correction mechanism that would be open to all Member States and would replace the ‘UK correction’. There have been other ideas to address this subject: One was to modify the calculation of net balances so as to take into account a broader concept of costs and benefits apart from pure budget. There are proposals from academic circles (see, for example, De la Fuente and Domenech 2001; Heinemann 2007; Rant and Mrak 2010) proposing that EU budget negotiations would be divided into two stages. In the first one, net budgetary positions should be fixed followed by the negotiations on the content of the EU budget in the second stage.

Before the 2014–2020 MAFF Negotiations

EU budget has remained conceptually unchanged since the 1988 reform in spite of the fact that the EU has undergone significant changes, including its enlargement from 12 to 27 Member States, completion of the internal market and introduction of new priorities in the areas of internal and external policies. Under the dominant influence of the juste retour logic, the main victim of the 2007–2013 MAFF negotiations was the Lisbon strategy itself, even though all Member States had explicitly supported international competitiveness as the top substantive priority of the EU in the forthcoming period. Being aware that the MAFF deal struck under these negotiations was not only unsuitable in its substance but also highly non-transparent in its financial terms, the December 2005 European Council authorized the Commission to prepare a thorough review of the EU budget and report back in 2008 or 2009.

Due to numerous political considerations, including complications with the Lisbon Treaty ratification process and the 2009 European Parliament elections followed by the appointment of the new Commission, the review was published only in late 2010. This delay has in fact prevented the review from serving its original purpose, i.e. to provide a basis for a thorough discussion about the possible reform of the EU budget. In fact, the review, which was published less than a year before the onset of the negotiations about the 2014–2020 MAFF, has turned into nothing more than a good issue paper for the forthcoming negotiations. Unfortunately, a prime opportunity for a thorough reform of the EU budget has been lost and the negotiations seem to be burdened again with the juste retour logic and the dominance of net national budgetary positions.

During the 2014–2020 MAFF negotiations, the Member States and the EU institutions will have to address numerous challenges, including the relatively weak international competitiveness of the European economy, negative consequences of the ongoing financial and economic crisis, incompleteness of the internal market, continued social and economic disparities, import energy dependence and climate change. On the institutional side, this will be the first MAFF to be negotiated under the Lisbon Treaty, with a formally substantially stronger role of the Parliament in the process.

The official proposal of the Commission for the 2014–2020 MAFF negotiations issued in June 2011 has the following main characteristics:

  1. 1.

    The size of the EU budget is to be kept at a similar level as before, i.e. at a level of around 1.05 per cent of EU GNI in payment appropriations.

  2. 2.

    CAP and cohesion policy remain the two largest spending items in the EU budget, although the former will have a significantly reduced share in total expenditure compared with the 2007–2013 MAFF period.

  3. 3.

    On the revenue side, VAT-based resource is proposed to be abandoned while two new EU taxes – a financial transactions tax and a VAT tax – are proposed to be introduced as of 2018.

  4. 4.

    The existing ‘UK correction’ and ‘corrections on corrections’ mechanism is proposed to be simplified and exchanged by lump sum gross reduction of GNI payments for four large net payers into the EU budget, namely the UK, Germany, the Netherlands and Sweden.

See Also