THE EUROPEAN COMMUNITY: COPING WITH THE BUDGET CRISIS

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP86S00588R000200200003-3
• Release Decision: RIPPUB
• Original Classification: C
• Document Page Count: 20
• Document Creation Date: December 22, 2016
• Document Release Date: January 11, 2010
• Sequence Number: 3
• Publication Date: June 1, 1985
• Content Type: REPORT

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Directorate of Confidential
Intelligence
The European Community:
Coping With the Budget Crisis
Confidential
EUR 85-10103
June 1985
Copy 3 8 3
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 Directorate of Confidential
Intelligence
The European Community:
Coping With the Budget Crisis
the Office of European Analysis. Comments and
queries are welcome and may be directed to the
This paper was prepared by
Chief, European Issues Division, EURA,
Confidential
EUR 85-10103
June 1985
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The European Community:
Coping With the Budget Crisis 25X1
Key Judgments The EC faced a severe budget crisis in 1983 and 1984, largely because its
Information available spending commitments have progressively outpaced its revenue. The crisis,
as of 1 May 1985 which nearly paralyzed the Community, has abated temporarily, but it
was used in this report.
will, in our view, soon resurface.
Last year, the EC was spared insolvency only through emergency loans
from member states. We believe that this year the EC will again
successfully raise emergency funds to cover a projected revenue shortfall.
We also expect the Community to receive a new infusion of cash in 1986
when a mid-1984 agreement to boost Community revenues some 20
percent comes into effect. In our view, however, these new funds will be ex-
hausted by late 1987 because of continuing increases in agricultural
spending and additional expenditures associated with EC enlargement.
The Common Agricultural Policy remains the primary cause of the EC's
budget problems. The Community adopted a series of reforms in 1984 to
curb soaring agricultural spending and take greater account of available
revenues when setting farm support prices. In our judgment, these reforms
will at best slow the drain on the EC budget; the EC will continue to be
plagued with the fundamental problem that its agricultural policy is too
expensive.
When EC revenues again run short in 1986 or 1987, we expect the 25X1
Community to repeat the debilitating battle it fought in 1984 over budget
rebates.
The continuing budget squeeze will, in our judgment, lead the Community
to seek external scapegoats for its problems; as a result, the United States
is likely to face increased EC protectionism in agriculture, and perhaps in
other fields as well. The EC has already proposed restricting imports of US
corn gluten feed to alleviate some of the overproduction in EC dairy and
grain sectors. Following EC entry of Spain and Portugal, now scheduled
for 1 January 1986, the Community may try to impose a domestic tax on
vegetable oils and fats-other than olive oil-that would hurt US soybean
exports to the EC. The extent of EC agricultural protectionism probably
will be limited, however, by internal EC squabbling that will hamper the
Twelve's ability to agree on forceful policies.
Confidential
EUR 85-10103
June 1985
25X1
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In the long run, we believe the budget crisis will impede the institutional
development of the EC. It is likely to cause recurrent squabbling among
Community members and constrain vital EC programs, forcing members
to turn frequently to unilateral solutions to their problems. The budget
crisis has, for example, hampered the Community's ability to initiate
programs in new areas like high technology. In our view, the budget
imbroglio casts doubt on the ability of the EC to proceed substantially
further with European integration. Although the EC will survive its many
problems and crises, the budget crisis demonstrates that EC members
presently lack the political will to push ahead with the kinds of far-
reaching joint economic and political policies necessary to transform the
Community into a "United States of Europe."
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Key Judgments
iii
Recent Budgetary Reforms
3
Limiting Dairy Surpluses
Containing Agricultural Prices
7
New Agricultural Monetary Measures
7
Boosting VAT Revenues
8
Covering the 1984 Budget Shortfall
9
New Regime for "Budgetary Discipline"
9
Prospects
10
Quick Fixes
10
Implications
12
The Budget Crisis and US-EC Relations
13
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The European Community:
Coping With the Budget Crisis
During late 1983 and much of 1984, EC decisionmak-
ing was nearly paralyzed by a budget crisis largely
due to agricultural overspending. The impasse riveted
the attention of both the EC Commission and the
Council-the representatives of the 10 member
states-and resulted in a series of embarrassing sum-
mit deadlocks. The EC's preoccupation with its bud-
get morass stymied Community efforts to restructure
dying industries and promote new high-technology
ventures, pushed issues of West European political
cooperation onto the back burner, and complicated
EC enlargement negotiations. Commentators mused
about the emergence of a "two-speed" Europe divided
between those countries committed to West European
integration and those not. Former Commission Presi-
dent Roy Jenkins expressed the frustration of many
when he admonished the Community to "get its head
out of the groceries." F__1
Figure 1
EC Budget: Spending Versus
Resources, 1979-84
I I I I I I
0 1979 80 81 82 83 841
The EC budget crisis also contributed to US-EC trade
frictions. As the budget problem grew, the Ten at
times tried to vent the strains on the Common Agri-
cultural Policy (CAP) by increasing agricultural pro-
tectionism and seeking external scapegoats for unpop-
ular CAP spending cutbacks. The EC sought, for
example, to restrict imports of US-produced feed
grain substitutes. The Commission also pushed pro-
posals for a domestic tax on vegetable oils-other
than olive oil-to increase EC butter consumption
and displace imports of US soybeans.F_~
The EC's budget crisis erupted in 1983 because three
interrelated problems came to a head at the same
time:
? How to fund EC programs over the short term until
new revenues are available.
? How to distribute the budget burden fairly among
the Ten.
? How to solve the longer term, structural budgetary
problem.F__-]
a 1984 revenue shorftfall was covered by emergency loans from
member states.
The short-term problem arose because in recent years
EC spending in European Currency Units (ECUs),
which largely took the form of open-ended agricultur-
al payments, outpaced the growth of revenue (see
figure 1).' In 1983, for example, overall EC spending
rose nearly 14 percent while revenue grew 10 percent.
Farm spending that year shot up almost 28 percent,
spurred by surplus milk and grain production pur-
chased by Community intervention agencies. Farm
spending and overall spending continued to rise in
' The European Currency Unit, the EC's unit of account, is a
currency "basket" that represents the average value of the Com-
munity's 10 national currencies, weighted roughly according to the
size of the national economies. The average value of the ECU in
1984 was 79 cents.n
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1984. Community revenues come largely from tap- Figure 2
ping member countries' value-added taxes (VAT), but EC Members: Net Budget Contributions, 19838
only up to 1 percent of the total take. This ceiling was
reached in 1984. The Treaty of Rome, which estab-
lished the Community, prohibits EC budget deficits, Note scale change
so the Community faced insolvency. The Ten finally Total Contributions
agreed last October to temporary loans from member Billion Us S
states to cover the 1984 shortfall, and to a higher, 1.4- -2
percent VAT ceiling effective 1 January 1986. The
EC almost certainly will have cost overruns again this
25X1 year, however, so the Ten are confronting the issue of United Kingdom
funding another budget gap in 1985.0 West Germany
France
Luxembourg
Denmark
Netherlands
Belgium
Ireland
Greece
Italy
Contributions Per Capita
US $ per capita
West Germany
United Kingdom
France
Italy
Netherlands
Belgium
Denmark
Greece
Ireland
Luxembourg
negotiations among agricultural ministers, and until a Negative balance indicates a net receipt.
recently without any consideration of available funds.
The political pressures on agricultural ministers, who
are naturally responsive to their farm constituencies, Unclassified
The EC's longer term, structural budget problem
results from strong pressures to continue boosting
farm spending, coupled with a cumbersome and re-
strictive method for meeting financial commitments.
More than 70 percent of Community spending is
devoted to farmers, who enjoy considerable political
clout and who are accustomed to generous subsidies
(see figure 4) Farm prices are set each year by
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Figure 3
EC: Common Agricultural Policy
Payments by Country, 1983
Belgium/
Luxembourg 3.9-\ Ireland 3.9
have led to artificially high support prices that have
ratcheted EC agricultural spending upward. Under
the CAP, the Community stands ready to buy unlim-
ited amounts of most agricultural products at a
predetermined price, regardless of the prevailing mar-
ket price. Since production fluctuates, it is impossible
to predict the exact level of CAP payments required
in a given year. Moreover, because CAP subsidies
have stimulated overproduction in many products, the
Community has tried to dispose of some surpluses
through export subsidies. EC spending on export
subsidies also varies according to world market prices
for commodities.
EC revenues, on the other hand, are more limited and
usually rise slowly (see figure 5). During periods of
economic growth, increased domestic spending gener-
ates higher VAT revenues. Similarly, increased Com-
munity imports from third countries brings the EC
more money from customs duties. The only provision
for a dramatic leap in EC revenues is an increase in
the ceiling on the amount of VAT that EC members
agree to make available to the Community. Raising
Figure 4
EC: Budget Expenditures, 1984
Social spending 6.0
Research, energy,
industry, and
transport 6.4
the VAT ceiling requires the Ten's unanimous con-
sent, and gaining approval can prove difficult if one
member withholds consent to gain concessions on
other issues. The EC did not squarely confront the
problem of raising the VAT ceiling until 1984, when
the original 1-percent limit proved insufficient to
cover expenses.F__1
Recent Budgetary Reforms
In June 1983 at Stuttgart, EC leaders pledged to
undertake fundamental reforms aimed at solving the
Community's mounting financial problems, but we
believe that after two years their accomplishments,
while important symbolic first steps, have been limit-
ed. During 1984, the Ten agreed to a series of reforms
that they publicly touted as major victories to help
end the EC's budget problems. In our view, these
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The EC's Common Agricultural Policy was launched
in 1962 and has become the centerpiece of the EC.
From 1973 to 1984 annual EC spending on CAP
supports averaged 69.3 percent of the EC budget. The
CAP relies on five types of market intervention, all of
which have budgetary implications.F__1
Price supports. Each spring EC agricultural minis-
ters set support prices for milk, cereals, beef, veal,
pork, sugar, wine, and most fruits and vegetables.
The key figure for each commodity is the intervention
price, the price at which Community agents stand
ready to support the market by buying unlimited
quantities of products meeting EC quality standards.
Intervention prices effectively set the floor for the EC
market and for most products largely determine the
final prices received by farmers. By world market
standards, EC prices are extremely high; in 1981, for
example, Community butter prices were 53 percent
higher than world prices and beef prices were 52
percent higher. The most visible result of high inter-
vention prices has been huge agricultural surpluses
that the Community has stockpiled. The EC s butter
"mountain" now stands at nearly 1 million metric
tons, and the wine "lake" now contains almost 3
billion gallons. F-1
lowest price is charged a levy that is calculated daily
and pushes the import price above the domestic price.
Export refunds. Export refunds enable ECfarmers to
sell their higher priced goods on world markets
without suffering a loss. They have increasingly been
used by the Community to dispose of part of the
stockpiles. In 1984, nearly 37 percent of CAP spend-
ing was earmarked for export refunds. In 1984, the
Community provided export subsidies of $1.7 billion
for milk products, $909 million for cereals, and $545
million for beef and veal.
Supplementary and fixed-rate aids. These represent a
small percentage of CAP spending on direct price
supports, often paid in proportion to output or on the
basis of the amount of land tilled. Unlike the support
price mechanism, which guarantees high prices
through market intervention, these aids provide di-
rect subsidies to farmers.
Structural aids. These are aids used for modernizing
the farm sector. They are referred to in the EC
budget as the CAP guidance section. In 1984 they
represented about 3 percent of CAP spending.F_~
Import levies. Most products-cereals, sugar, milk
products, and olive oil-are protected from foreign
competition by a series of variable levies. The partic-
ular commodity entering the Community at the
reforms contain important flaws and represent typical
EC compromises on the lowest common denominator
of agreement. Some of the reforms-such as a new
regime to cut milk production-hold promise, but EC
members have managed to weaken them in their
implementation. Others-such as a new system to
impose mandatory spending controls-contain poten-
tial loopholes and are too vague to be effective. In
addition, although the 1984 reforms may help push
budgetary issues onto the back burner for a while, we
believe the horsetrading that took place in the reform
negotiations may have established precedents that will
set the scene for renewed budgetary squabbling a few
years hence.F__1
Limiting Dairy Surpluses
At the Agricultural Council meeting on 30-31 March
1984, farm ministers approved a five-year program-
dubbed the "super levy"-that imposes quotas on
milk production and stiff tax penalties on overproduc-
tion. The primary objective of the new dairy regime is
to terminate the Community's open-ended guarantee
to buy milk production. The dairy sector is the main
culprit in CAP overspending; in 1984 over 32 percent
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There are three main types of independent EC reve-
nue sources. Collectively they are known in Commu-
nity jargon as "own resources," to distinguish current
methods of ECfundingfrom the Community's early
days when it had to depend on national contributions.
Figure 5
EC: Sources of Revenue, 1984
Ordinary agricultural Sugar and isoglucose
levies 4.8 1 levies 4.4
Value-added tax (VAT) payments. This is the most
important source of EC revenue. The VAT is a
method of indirect taxation on the use of goods and
services by final consumers. Standard VAT rates
vary from EC country to country, from 13 percent in
West Germany to 25 percent in Ireland. Since 1975
EC members have paid up to 1 percent of their VAT
proceeds to the Community annually. When the
mechanism was first instituted, the EC used less than
half of the VAT pool at its disposal; in 1982 it used
92 percent, and in 1983 it claimed 99.8 percent. In
1984 the VAT pool was exhausted. An increase in the
VAT ceiling, or percentage of national VAT proceeds
available to the Community, requires an amendment
to the Treaty of Rome, and thus the approval of all
10 parliaments.F_~
Customs duties. The Community receives the duties
collected through the Common External Tariff on
nonagricultural goods imported from third countries.
In theory, these are the purest form of "own re-
sources" since they are simply collected by member
states on behalf of the Community. The Commission
even reimburses member states their collection costs.
Agricultural levies. The Community also reaps the
proceeds of the CAP levies that close the differential
between world market prices for agricultural goods
and EC threshold prices. In addition, the EC collects
levies on the production and storage of sugar and
isoglucose to help defray the costs of market support
for those products.
Value-added
tax payments
of CAP guarantees went to milk products, compared
with 11 percent for beef and veal, the next-highest
category (see figure 6).F
Although the new dairy regime will slow the growth
of milk surpluses, it will not eliminate them. If
anything, it is likely to ratify the existing state of
persistent overproduction. The super levy's lowest
annual quota, 98.4 million tons, is still well above
current EC consumption of about 87 million tons. In
our judgment, the program simply does not address
the heart of the problem: unduly high support prices
that have provided irresistible incentives for farmers
to expand production. By the Commission's own
conservative estimates, dairy support prices would
have to be cut 12 percent to bring production into line
with consumption.F_~
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The goal of the new regime was to cut marketing year
(MY) a 1984 production to 99.2 million tons, down
from an estimated MY 1983 production of 108
million tons. In MYs 1985-88, production will be cut
further, to 98.4 million tons annually. The quota will
be shared among EC members based on 101 percent
of their 1981 production. Ireland-whose dairy sec-
tor accounts for 9 percent of GNP-has been granted
an exception and will base its quota on its output in
1983, a more productive year. Each EC member will
be allowed to determine just how its quota will be
apportioned among farmers.
EC members will also be allowed to decide whether
individual farmers or dairies will be subject to the
quotas and held responsible for paying the penalty
taxes. If a country chooses to hold farmers responsi-
ble, the farmers will be charged a tax equal to 75
percent of the value of all milk exceeding their quotas
when they deliver it to dairies-in other words, they
will be paid only 25 percent of the value of the milk
over their quotas. The Netherlands, West Germany,
and Northern Ireland have chosen this method of
implementing the quotas at the level of individual
farms. Most other EC countries will impose the
quotas on dairies delivering excess milk to interven-
tion agencies. The dairies will have to pay a super
levy of 100 percent of the target price, a crippling
disincentive since the dairies will receive nothing for
the surplus milk they sell into intervention.F_~
a The marketing year begins on 1 A ril of the stated year and ends
on 31 March of the following year.
Preliminary production estimates for marketing year
(MY) 1984 indicate that, in the first year of the super
levy's operation, EC milk production was held roughly
within the new quotas, although this was accom-
plished largely through distress slaughtering, which
worsened the EC beef surplus. The Community's
Figure 6
EC: Common Agricultural Policy
Support Payments by Crop, 1984$
initial experience in implementing the super levy
raises questions about the commitment of EC mem-
bers to tough CAP reforms, however. Despite their
earlier approval of the super levy, the Ten at first
delayed collection of the levy, blaming administrative
problems. In early December 1984, all members
except Denmark voted in favor of a Council resolution
asking the Commission to push the due date for the
first payment back to March 1985, the end of the
1984 milk marketing year. Only West Germany made
the original deadline for the first payment, 15 Decem-
ber 1984, and Bonn announced it would not make
future payments unless other members do. F__1
Press reports also indicate that Italy apparently at-
tempted an especially ingenious method for sparing its
farmers from the super levy. Instead of applying the
quotas to farms or dairies, Italy claimed that because
of its special circumstances it would implement quotas
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only at the national level, in effect treating the entire
country as one large dairy. The Commission suspected
that Rome would then pay the tax penalty on overall
Italian overproduction out of general government
revenues, thus effectively destroying the practical
impact of the new system on individual farmers. The
Commission maintained that this would be an illegal
national aid to agriculture, and it opened infringe-
ment proceedings against Italy that could have result-
ed in the case's being heard by the European Court of
Justice. Under pressure from the Commission, Rome
finally abandoned its attempt to nationalize its quota
in February 1985. Although the Commission in return
dropped its infringement proceedings, it did agree to
allow EC members to transfer quotas among dairies
in MY 1984, which may establish a precedent for
future implementation of the super levy at the nation-
al level.
Containing Agricultural Prices
The ministers also agreed at the March 1984 Agricul-
tural Council to a package of MY 1984 farm prices
that included an average price decrease of 0.5 percent,
calculated in ECUs. Prices for meat, wine, olive oil,
and most cereals were cut by 1 percent; milk and
sugar prices were frozen at their MY 1983 levels. In
addition, several aids and premiums were decreased.
The ministers portrayed the unprecedented overall cut
in ECU-denominated prices as especially tough.
When translated into national currency terms, howev-
er, prices were actually boosted in seven countries
and, for the Community as a whole, rose 3.3 percent.
Despite the Community's attempt to hold the line on
prices, the package remained costly by preserving
strong price incentives for farmers to overproduce
goods that must be purchased by EC intervention
agencies. F_~
Thus far in 1985 the Community has again tried to
whittle down farm prices, but without success. In
January the Commission proposed a controversial
MY 1985 price package with a 2-percent price rise for
milk, cheese, and olive oil; a price freeze for meat,
sugar, and wine; and a 3.6-percent price cut for
wheat, barley, and rapeseed. West Germany has
blocked final agreement on the package, however,
rejecting it outright because Bonn maintains that the
grain price.cut is excessive. Since 31 March 1985, the
beginning of the new marketing year, the MY 1984
price structure has been continued on an ad hoc basis
while agricultural ministers have met periodically to
try to break the deadlock. F__]
New Agricultural Monetary Measures
At the March Council meeting, EC foreign ministers
also agreed to dismantle the most expensive elements
of the Community's system of monetary compensa-
tory amounts (MCAs)-an elaborate structure of
cross-border taxes and subsidies aimed at neutralizing
the effects of exchange rate fluctuations on CAP
payments. So-called positive MCAs that recompensed
West German and Dutch agricultural exporters for
the higher price of their product-in foreign currency
terms-caused by the strength of the West German
mark and the Dutch guilder are being eliminated in
three stages, beginning in April 1984 and ending in
MY 1987. In addition, most negative MCAs will be
eliminated beginning in MY 1984, and eventually
only France will have a small negative MCA. Hence-
forth, CAP intervention prices will be linked to the
Community's strongest currency, now the mark. The
mark has tended to be the strongest EC currency
since the inception of the European Monetary System
because of low West German inflation and the
strength of the West German economy. F_~
To ease the burden on West German farmers losing
positive MCAs, Bonn has been authorized through 31
December 1988 to add up to 5 percent to its domestic
value-added tax on agricultural products. By using
this extra revenue to compensate its farmers for the
loss of positive MCAs, West Germany is in effect
creating a new national aid to agriculture. Another
result is a partial shift of the financial burden of West
Germany's agricultural support from the EC to West
German consumers, who will pay higher food costs.
Although billed as a significant moneysaving reform,
the new monetary mechanism will give the EC little
budgetary relief. The MCAs being phased out cost
the Community $300 million in 1983. Moreover, the
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The CAP was originally designed in a period of fixed
exchange rates. With the onset of floating rates in
1971, the Community had to design a system to
insulate the intervention price structure-which
farmers insisted should provide stable and predict-
able price support from fluctuating exchange rates.
The EC sets agricultural support prices based on a
currency average, or basket-currently European
Currency Units (ECUs)-and uses a special set of
exchange rates-called green rates-to convert com-
mon ECU-denominated farm prices into national
currencies. Green rates are fixed and do not reflect
currency movements unless they are formally deval-
ued or revalued.F__1
This system holds domestic farm prices steady but
puts farmers in countries with appreciating currencies
at a competitive disadvantage when selling their
products elsewhere in the Community. To counter the
effects of currency fluctuations, the EC invented
monetary compensatory amounts (MCAs). "Positive"
MCAs apply to currencies that are strong relative to
their green rates. They are applied as border subsi-
dies on food exports and border taxes on food
imports. Conversely, "negative" MCAs tax food
exports and subsidize food imports to nullify the
price advantages enjoyed by farmers in weak curren-
cy countries. MCAs are considered `:fixed"for West
Germany, Belgium, the Netherlands, Denmark, Ire-
land, and France, which narrowly limit their currency
movements under the European Monetary System.
Because their currencies fluctuate more widely, Italy,
Greece, and the United Kingdom have variable MCAs
recalculated weekly. As of 1 January 1985, only West
Germany and the Netherlands had small positive
MCAs. France, the United Kingdom, and Greece had
negative MCAs, and no compensatory amounts were
applied to other EC members, indicating that the
Community felt that their green and market ex-
change rates were near parity.
The subsidy element of the MCA system cost the
Community about $300 million in 1983. The system
is also inefficient insofar as it encourages smuggling.
Farmers with positive MCAs can collect an export
subsidy when driving their goods across the border
into a weak currency country, then smuggle the goods
back home and reexport them for a second subsidy.
saving will be reduced in 1985 and 1986 because the
Council also approved in March a special two-year
compensation of $170 million for West German farm-
ers to cushion them from the abrupt loss of positive
MCAs. This EC compensation will be on top of any
25X1 money paid to farmers through national aids.~
Boosting VAT Revenues
At the Fontainebleau Summit in June 1984, EC
leaders made an important breakthrough on the bud-
get by agreeing to raise the VAT ceiling from 1
percent to 1.4 percent. The agreement calls for EC
members to submit the enabling legislation to their
parliaments at the same time they submit the legisla-
tion permitting Spanish and Portuguese accession to
the Community. Under present arrangements, the
agreement will thus have no impact on the 1985 EC
budget. At Fontainebleau, the leaders envisioned the
new VAT ceiling taking effect on 1 January 1986,
with a further increase tentatively scheduled for 1
January 1987, the Commission's best guess as to
when the 1.4-yercent ceiling will be reached.
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Covering the 1984 Budget Shortfall
After much argument, and with the prospect of a
suspension in CAP support payments looming, the
Ten agreed in early October 1984 to a $760 million
supplementary budget to tide the Community over
until 1985. The stopgap measure consists of advances
from member states to the Community, which are to
be repaid once new VAT revenues are available. Since
technically these are one-time loans to be reimbursed
in full after a specified period, they do not violate the
Community's balanced budget requirement. Although
the sum involved is considerably less than the $1.4
billion requested by the Commission, it was enough to
cover essential expenses. The scheme may set a
precedent for future emergency EC funding.)
New Regime for "Budgetary Discipline"
An agreement on new budgetary discipline, reached
by EC foreign ministers in November 1984, was the
precondition the United Kingdom and West Germany
set before they paid out their contributions to the
supplementary budget. The new regime covers the
entire EC budget, not just the CAP, and stipulates
that the rate of spending growth over any three-year
period must be kept below the rate of increase in
Community revenues. F__1
Under the new procedures, EC finance ministers-
who until now have had little direct involvement in the
budget process-will meet each year to agree on a
"reference framework" for spending that will be
based on the average growth of EC revenues in the
previous three years. The Council agreed that the
Community will strive to keep spending below the
ceiling set in the reference framework. Should a
particular EC policy threaten to violate the finance
ministers' guidelines, the Commission-but not indi-
vidual member states-can insist on its suspension. If
spending on individual programs rises excessively
despite the new budgeting procedures, the Ten have
pledged to try to "claw back" spending in the succeed-
ing two years. The new system is to begin in 1985, and
thus will have its first impact on the 1986 budget. The
Ten have agreed to review it one year before the
Community reaches the 1.4-percent VAT ceiling,
which means it may have to be scrutinized as early as
1986.
Enough loopholes exist in the agreement to suggest
that it will have only a limited impact. Most impor-
tant, the new procedures make wide allowances for
exceptional circumstances that can permit higher
spending. EC officials have indicated that these ex-
ceptional circumstances might include enlargement,
the implementation of earlier Council resolutions on
the disposal of surplus agricultural stocks, and aid for
the least economically developed EC members. In
addition, the new procedures carry little legal force.
The United Kingdom had at first demanded an
amendment to the Treaty of Rome to enforce budget-
ary discipline, but the new directive is simply a set of
procedures that have been ratified by the Council but
which can be ignoredF--]
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tia,
The EC Commission prepares the draft Community
budget each year. The draft budget then goes to the
Council-which represents the 10 member states-
and on for final approval to the European Parlia-
ment, which sits in Strasbourg, France, and consists
of 434 directly elected members. The Parliament's
budgetary discretion-one of its few powers-is two-
fold:
? Within certain constraints, it can add spending to
the Commission and the Council's budget
proposals.
? It can reject the entire draft budget and require the
Commission to submit a new one.)
The Parliament can add only to noncompulsory EC
spending. The Treaty of Rome defines compulsory
spending-over which the Parliament has no con-
trol-as spending required by the Treaty or by acts
adopted in accordance with the Treaty. The Commu-
nity has not developed an ironclad working definition
of compulsory spending, but CAP price support and
foreign aid stemming from treaty obligations are
generally considered to fall in this category. Because
the distinction between compulsory and noncompul-
sory spending mainly affects the extent of the Parlia-
ment's budgetary power, defining the two is more a
political than a legal issue. Roughly speaking, only
about one-fourth of EC spending is categorized as
noncompulsory. F_~
In accordance with the Treaty of Rome, each spring
the Commission fixes the maximum rate of noncom-
pulsory spending growth, which further limits the
amount the Parliament may add to the following
year's budget. The Treaty specifies the formula for
deriving the maximum rate, which is based on the
average increase in the previous year of the budgets of
member states and the average increase in Communi-
ty GDP. F_~
If the Parliament seriously objects to the draft
budget and is unable to work out compromises with
the other institutions, it can reject the coming year's
budget outright. This has happened twice, with the
1979 and 1985 budgets. The Treaty of Rome stipu-
lates that, if the Parliament exercises its veto, the
Community can spend in the new fiscal year accord-
ing to a system of `provisional twelfths." Under this
arrangement EC spending each month cannot exceed
one-twelfth of the previous year's total budget. In
effect, this freezes the level of overall EC spending
until the Parliament adopts the new budget. In 1979
the EC operated on provisional twelfths until April.
On top of the new regime's weaknesses, it has also
helped cause a dispute between the Council and the
European Parliament. The Parliament objects to a
Council-imposed ceiling on the budget, over which it
exercises some legal control. In December 1984 the
Parliament rejected the draft 1985 EC budget, in part
to express its displeasure over the new budget disci-
pline guidelines. The Treaty of Rome stipulates that
until the Parliament approves the 1985 budget, the
Community must spend on the basis of 1984 alloca-
tions.
In our judgment, the EC will continue to be plagued
by budgetary problems for years to come. Although
we consider it unlikely, budget difficulties may resur-
face as early as this fall. The Ten must grapple with
two budgetary issues this year: gaining parliamentary
approval for the 1985 budget and ensuring that the
EC fills the revenue gap that the Community will
almost certainly face until the 1.4-percent VAT ceil-
ing takes effect.)
Quick Fixes
The Community should be able to win parliamentary
approval of the 1985 budget by this summer, but the
Council probably will have to yield some discretionary
power to the Parliament under the new budget disci-
pline regime. In addition, the Parliament almost
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certainly will insist on a firm Council program for
covering the 1985 revenue gap. Based on the 1985
draft budget and expected VAT revenues, the Com-
mission estimates that the EC will fall some $2.1
billion short this year. The Parliament has charged
that the Council was irresponsible in adopting a 1985
draft budget without providing sufficient funding, and
this was another important reason for the Parlia-
ment's rejection vote.)
During a Council meeting in late March 1985, the
Ten agreed in principle to additional emergency fi-
nancing for the rest of the year, which should satisfy
the Parliament. The plan provides that, once the
Council and the Commission agree on the exact size
of the 1985 cost overrun, the gap will be filled by
nonrefundable national payments. The Council made
implementation of the plan contingent on the ratifica-
tion by all 10 national parliaments of the 1.4-percent
VAT ceiling, however. Significantly, the British re-
bate agreed to at Fontainebleau will be funded
through these national payments. Should approval of
the 1.4-percent VAT ceiling bog down in one of the
national parliaments and the deal sour, the United
Kingdom will almost certainly respond by cutting off
all EC payments, which would plunge the Community
even deeper into crisis.
In our view, the Ten probably will ratify the 1.4-
percent VAT ceiling in time to avert another budget
crisis this year and bring the new revenues on stream
next January. The heads of government gave the new
VAT ceiling a clear political endorsement at Fon-
tainebleau, and, barring technical delays, the 10
national parliaments should not have difficulty ratify-
ing the measure. With new revenues imminent, we
doubt that the Ten will risk unraveling the budget and
CAP reforms agreed to last year-which they have
portrayed publicly as important victories for the Com-
munity-by allowing budget problems to regenerate
this year. F__1
Unresolved Problems
Once the 1.4-percent VAT ceiling is in place, the fate
of the EC budget in the medium term will rest on the
spending side, especially on the CAP. In our view, the
new budgetary discipline regime is largely cosmetic
and intended to placate the United Kingdom and
West Germany, which, because of their outspoken
public stands in favor of budgetary stringency, were
politically committed to installing new measures. Giv-
en the centrality of the CAP to EC affairs, and the
Community's past difficulty in reforming individual
agricultural sectors such as dairy, wine, and grains,
we doubt that the intentionally vague new budgetary
discipline regime will place an effective lid on spend-
ing. Moreover, the inclusion of finance ministers in
the budget process may further complicate and politi-
cize the annual farm price negotiations. F 25X1
Ironically, the new budget discipline regime may have
the perverse effect of freezing-not lowering-the
percentage of EC spending devoted to agriculture.
The new regime is aimed at holding down the growth
of the entire budget, not just the CAP. In the stiff
competition for EC resources, Community farmers-
who wield considerable political clout-will strongly
resist reductions in their share of the budget. Indeed,
we believe the Community will be tempted to cut less
politically sensitive programs such as high-technology
research and environmental programs to free money
for CAP price supports. The only politically accept-
able way for the Community to orient itself away
from agriculture would be to increase the relative size
of spending in other sectors by boosting the overall
size of the budget, but this would violate the new
budgetary regime.F_-]
Spanish and Portuguese entry into the Community is
likely to place a further strain on EC finances.'
According to Commission figures, full membership
for the Iberian states will increase the number of EC
farmers by 37 percent, raise Community production
of fresh fruits and vegetables by 44 percent, and
expand olive oil and wine production by 66 percent
and 32 percent, respectively. The Community has
tried to spread the costs out by calling for long
transition periods and pressing tough terms on Spain
and Portugal in the enlargement negotiations. Be-
cause some of the final details of Spain and Portugal's
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entry terms must still be ironed out, it is difficult to
assess the budgetary implications of enlargement. The
Although the cumulative effect of the recent CAP
and budget reforms may relieve the financial hemor-
rhaging the Community experienced in 1983 and
1984, we expect that spending pressures will lead the
EC to raise the VAT ceiling periodically. Fiscally
conservative members such as the United Kingdom
and West Germany, however, will probably resist
large VAT increases to maintain leverage over the
budget. We thus believe that the VAT ceiling will be
pushed up in small increments-on the order of 0.2 to
0.4 percentage point-every two or three years.
high-technology ventures are poor.
The EC budget crisis, and the CAP's continued drain
on Community resources, bode ill for EC spending on
nonagricultural programs. Many prominent Commu-
nity spokesmen, led by President Mitterrand when
France held the EC presidency in the first half of
1984, have urged the Ten to put more emphasis on the
development of high technology. Unless the EC's
budget picture changes dramatically, however, the
prospects for significant EC expenditures on new
Lacking Community-wide in-
The EC's continuing fixation on its budget problems
may weaken the Community and encourage an even
more elaborate crazy quilt of national and regional
policies. The agreement on the abolition of positive
MCAs, which was billed as a budgetary measure, is
an example of the EC's drift toward reliance on
national rather than Community programs to support
centives to develop high technology, EC firms may
have trouble raising capital, and they are likely to
have difficulty competing with more technically ad-
vanced US and Japanese companies. F__1
In our view, the EC budget crisis is symptomatic of
deeper problems that will impede the long-term insti-
tutional development of the Community. We believe
that the budget imbroglio demonstrates that EC
members lack the political will to move the Communi-
ty substantially toward greater integration.
EC members have generally adopted a cautious ap-
proach to Community programs, sidetracking bold
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new initiatives. Among these have been recent propos-
als to abolish the veto and move to a system of
majority voting, attempts at CAP reform to reorient
the EC away from agriculture, proposals for beefing
up the European Monetary System and expanding the
international use of the European Currency Unit, and
attempts at reaching joint foreign policy positions.
The Budget Crisis and US-EC Relations
Continuing EC budgetary problems will tempt the
Community to try to externalize its financial troubles,
and, in our view, the United States is likely to be a
primary target. The EC may try both to shift the
financial burden of CAP reform onto third countries
and to find outside scapegoats for domestically unpop-
ular decisions. The Community's early 1984 proposal
to restrict imports of US-produced corn gluten feed,
now the subject of US-EC GATT consultations, is a
prime example of such a policy. It is aimed both at
increasing EC consumption of domestically produced
grain and discouraging dairy production by driving up
feed costs. The proposal, however, serves an even
more important political purpose. Recent remarks by
a highly placed Commission official indicate that the
proposal is intended to appease EC dairy and grain
farmers who must bear the brunt of CAP reforms. EC
farmers have grumbled that US feedstuff producers
have continued to profit from corn gluten sales while
EC farmers face restrictions on production. Budget
problems may also lead the EC to resurrect proposals
for a tax on vegetable oils other than olive oil. This
would hit US soybean sales to the Community ($2.2
billion in 1983), encouraging domestic EC butter and
olive oil consumption and raising new agricultural
revenues.
We believe that, on balance, the EC's preoccupation
with its domestic problems will be detrimental to US
interests. Beyond encouraging further EC agricultural
protectionism, continued EC agricultural overproduc-
tion is likely to lead the Community to try to export
aggressively to third markets. At the same time, the
United States probably will find it more difficult to
deal with the Community. Bickering among the Ten
will make it more difficult for them to take strong and
united stands on trade, monetary, and foreign policy
issues.
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