Establishing a budgetary capacity in the Eurozone. Recent proposals and legal challenges

A. The original features of the European economic union and its insufficient reform

The project of additional budgetary capacity for the Eurozone was born in the context of the wider debate surrounding the reform of the EMU. The Euro is not the currency of one state, but it belongs to a group of sovereign countries. The refusal to relinquish fiscal power along with the monetary competence has necessitated the use of alternative instruments in order to curtail economic divergences within the Eurozone area. In this regard, the Maastricht Treaty introduced common surveillance mechanisms on national budgets focusing on the containment of public deficit and debt. At the same time, the prohibition of bailouts between countries endorsed the principle of national responsibility for sovereign debt and entrusted financial markets with a regulatory role in relation to public finances. In this legal framework, the stabilization of economic shocks and the redistribution of welfare clearly falls on the shoulders of national governments alone. ²

Ten years after the introduction of the Euro, the outbreak of the sovereign debt crisis caused the decentralized model of economic union a large degree of distress. First, the surveillance procedures proved unable to prevent the increase of excessive debt and macroeconomic imbalances in most Member States, as the application of European rules was fully delegated to political intergovernmental bodies, such as the Council and the European Council. At the same time, financial markets also failed to play an efficient regulatory role on domestic public finances: due to the strong interdependence within the Eurozone, even the most indebted countries were granted cheap interest rates on their sovereign debt, as investors knew that the other Member States would come to their aid, if necessary. ³ The fiscal collapse in Greece and the banking crisis in Ireland, immediately jeopardized the stability of the entire monetary union, due to the strong interdependence between countries and the emergence of a toxic loop between sovereign debts and the banking sector.

As the Eurozone was not endowed with any crisis management instruments, Member States decided to set up some measures in order to deal with the emergency. They did this, however, without questioning the fundamental structure of the EMU.

The first group of reforms aimed at fostering fiscal discipline. European institutions strengthened supervision on the adoption of national fiscal policies ⁴ and Member States introduced a balanced budget rule in their constitutional system to limit the ability of national spending ex ante. ⁵ Even if the containment of public indebtedness was definitely a priority, European institutions tried to adopt a wider approach to economic supervision by taking into consideration the rise of macroeconomic imbalances, which could undermine the financial stability of Member States. ⁶

The second group of reforms consisted of creating emergency management tools to intervene in those situations, where the financial collapse of one country could trigger a series of multiple defaults within the Eurozone. In this regard, the governments of the Euro area created the European Stability Mechanism (ESM), ⁷ which is designed to provide the Member States that are experiencing financial difficulties with economic support, when the stability of the Euro area as a whole is at stake. ⁸ Such support is conditional upon the Member State’s compliance with several measures that are defined in a Memorandum of Understanding (MoU) to be agreed with the creditor countries. Evidently, the introduction of a rescue mechanism has significantly weakened the application of the no-bailout clause. ⁹ Despite the efforts of the European Court of Justice (CJEU) to prove its compatibility with the EU Treaties, ¹⁰ the exact purpose of the ESM is to emancipate Member States from their dependence on financial markets in cases of necessity.

The final group of reforms introduced a Banking Union within the Eurozone. The latter is composed of a Single Supervisory Mechanism that is coordinated by the European Central Bank (ECB), a Single Resolution Mechanism and a Single Rule Book; however, at the time of writing, it does not include a common insurance scheme for deposits. The purpose of the Banking Union is to end the vicious loop between the debt crisis and the banking crisis and to strengthen the resilience of the European financial system as a whole.

B. Structural limits of the decentralised model of economic union

Even if the consolidation of the ‘surveillance model’ ¹¹ and the creation of crisis management tools prevented the collapse of the monetary union, they did not succeed in ensuring the durable stability of the Eurozone. Several Member States are in fact still struggling with the difficult process of fiscal consolidation, while economic recovery is slowing down and structural imbalances are re-emerging. ¹² The reason why the crisis cannot be left behind is because of the limits on the decentralized model of economic union, where Member States are excessively charged with responsibilities that they have become either unable or unwilling to bear. It is possible to identify two underlying deficits, which structurally characterize this model.

First, a decentralized economic union is unable to ensure fiscal responsibility in an efficient manner. Member States are notably tempted by moral hazard because in a monetary union, the costs of economic mismanagement and excessive national spending are shared with other countries. This happens in different ways: on the one hand, high public indebtedness in one country increases the inflation level in the others; on the other hand, Member States on the precipice of a bankruptcy are obliged to request financial support from the other countries. Unfortunately, there is not much the existing economic governance mechanisms can do to eradicate moral hazard. Excluding the option of allowing ‘naughty’ Member States to default, due to the unpredictable economic and political consequences, the only option available to them is to strengthen European surveillance on national budgets. This has progressively become ineffective because the threats on which the economic supervision is based, such as the imposition of sanctions from intergovernmental institutions and the cessation of financial support, are not regarded as credible. ¹³ The collective commitment of national governments to pursuing fiscal consolidation ¹⁴ and implementing structural reforms rapidly declined, once they realized that the most acute phase of the crisis was over and the positive results of these measures were too late to materialize. ¹⁵ Even considering the conditionality policy requested by the ESM, the substantial inability of the Greek government to comply with the MoU did not discourage creditor countries from continuing to provide financial support, fearing the consequences of a sovereign default on the rest of the Eurozone.

The second structural deficit of the decentralized economic union is the inability to efficiently react to economic shocks. The latter are events, which can negatively affect the economy of a single Member States (asymmetric shocks) or the entire Union (symmetric shocks). While sovereign countries can normally react to economic shocks by recourse to a number of stabilisers, the Member States of the monetary union lack most of them, as they are obviously deprived of the national exchange rate mechanism, while labour mobility and price flexibility are still weak in the EU. ¹⁶ As a result, the only available instrument to effectively absorb economic shocks remains the fiscal policy.

The national exclusive on this stabilisation tool, however, raises several problems. Experience has clearly proved that national fiscal buffers are unable to stabilize multiple economic shocks. This happened at the outbreak of the sovereign debt crisis, when the public finances of several Member States were overwhelmed by the size and the severity of the shocks. Further to this, several governments are still struggling to fully recover from the crisis, essentially due to the difficulty of investing fiscal resources to re-launch their national economy, while at the same time consolidating their public finances and implementing structural reforms. Even considering the possible intervention of the ESM, the way it is conceived today does not allow it to play any useful role in the absorption of cyclical or systemic economic shocks. The ESM is indeed an emergency mechanism, which can be activated only in specific situations of extreme danger, when one country’s financial difficulties may undermine the stability of the Eurozone as a whole. Finally, the Banking Union also has a limited margin of action: it has enough resources to support the restructuring of single financial institutions, but it does not have enough resources to manage systemic crises in the banking sector, such as those which began in Europe in 2007.

The structural limits of fiscal decentralization and the surveillance model are therefore the primary reasons why the project of the additional budgetary capacity has recently gained fresh support.

A. The proposals for a budgetary capacity of the Euro area

The idea of introducing a common budgetary capacity between the Member States of the monetary union was not something that was completely foreign to the European political debate before the outbreak of the sovereign debt crisis. In 1970, the Werner report on the creation of the Economic and Monetary Union ¹⁷ already envisaged increasing the Community budget after the Member States introduced a common currency. In 1977, the MacDougall report ¹⁸ explained that the establishment of a monetary union would require a European budget of 2-2.5% of GDP in a pre-federal stage, 5-7% at a middle stage and 20- 25% if the Union were ever to become a federation. However, once the Maastricht Treaty adopted the decentralized model of economic integration, the idea of establishing an additional budgetary capacity was completely shelved.

It was only when the sovereign debt crisis hit the European Union, did the idea of centralizing some fiscal functions at the continental level gain fresh support. A number of proposals expressly supported the project of a budgetary capacity in the Eurozone in the context of an overall reform of the EMU.

In June 2012, the (then) President of the European Council Hermann Van Rompuy published a report entitled ‘Towards a genuine economic and monetary union’, which expressly recalled the idea of a fiscal union in the Eurozone, characterized not only by a stronger supervision of national budgets, but also by different forms of fiscal solidarity. ¹⁹ These ideas were better developed by the European Commission in the ‘Blueprint for a deep and genuine Economic and Monetary Union’ that was published in November 2012, ²⁰ and which suggested the introduction of conditional incentives for structural reforms in the short term and the creation of a proper budgetary capacity for the Eurozone in the longer term.

In June 2015, the President of the European Commission, Jean-Claude Juncker, in cooperation with the Presidents of the other major institutions, published another report that emphasized the need for a fiscal stabilization function for the Euro area. ²¹

In December 2016, the High Level Group chaired by Mario Monti published a report on the ‘Future Financing of the EU’ that identified set of new own resources to better finance the European budget. ²² Even if these revenues were primarily conceived to reduce the relevance of GNI-based contributions without automatically increasing the size of the EU budget as such, the report expressly accepted the possibility that the new own resources may finance an additional capacity for the Euro area. ²³

Finally, in February 2017, the European Parliament adopted an ad hoc resolution on the set up of budgetary capacity for the Euro area and two more general proposals on the reform of the EU, both within the current legal framework and through a Treaty amendment, which also mentioned the project. ²⁴

B. General features of the budgetary capacity

The different proposals that have been put forward hitherto essentially describe the budgetary capacity as an instrument aimed at collecting and spending resources across Member States through a centralized mechanism adopted at the European level.

It is important to immediately highlight some of the defining features of the mechanism, which distinguish it from other economic policy instruments that are already available. First, unlike the ESM, the budgetary capacity should not provide reimbursable loans, ²⁵ but should concern transfers from contributors to recipients. ²⁶ While this property will clearly create a stronger solidarity between European citizens and Member States, ²⁷ it will also raise the need for more effective instruments in order to avoid moral hazard. Second, resources pooled by the budgetary capacity should be immediately mutualized in order to share the ownership of the transfers and make the mechanism more compact and solid. This feature would distinguish the Eurozone budgetary capacity from the Single Resolution Fund of the Banking Union, whose resources are divided into national compartments until the end of the eight-year transitional phase. Finally, unlike the current cohesion policy within the EU budget, the Eurozone budgetary capacity should be able to count on a conspicuous amount of resources. ²⁸ Most of the studies on the matter agree that in the initial stage, a transfer mechanism should dispose between 1% to 3% of European GDP, depending on the stabilization tasks that it will manage in concrete terms. ²⁹

Turning now to the functioning of the budgetary capacity, the different proposals advanced so far identify four main sources of financing: national conferrals, new genuine own resources, European taxes and European joint bonds.

National conferrals would consist of periodic fees or contributions that Member States should transfer from their national budgets to the Eurozone capacity on the model of the GNI-based resources of the EU budget. In order to ensure the solidity of the mechanism, contributions should be proportional to national GDP and compulsory for all countries.

Considering the destination of resources, the budgetary capacity should pursue a stabilization function, by facilitating convergence between the Member States and ensuring that the Eurozone is more resilient. The existing weakness of European solidarity prevents the development of other typical functions of fiscal federations, such as income redistribution and social protection. Considering the pursuit of the stability of the Eurozone as a whole, the additional budgetary capacity should have at least one of the following objectives:

Support structural reforms in the Member States that are under stress. By financing the implementation of structural reforms, the transfer mechanism would help to increase the economic resilience of individual Member States and of the Euro area, by reducing the risks of both country-specific shocks and subsequent systemic crisis.

C. Possible concretizations of the Eurozone budgetary capacity

After having analysed the general functioning of the Eurozone budgetary capacity, it is possible to identify some possible implementations in the light of the official proposals that have been put forward hitherto.

A first concretization of the project would be the introduction of conditional financial incentives to national structural reforms. The Van Rompuy report and the Blueprint of the European Commission initially formalized this proposal in 2012 ³⁷ and the European Parliament recently re-launched it in its resolution of 16 February 2017. ³⁸ The purpose of these conditional incentives is to trigger a virtuous circle between transfers and reforms. For this reason, the additional budgetary capacity would be able to provide resources ³⁹ only to those countries that comply with a new ‘convergence code’. ⁴⁰ The latter should identify several measures that aim to modernize economies and improve the competitiveness of each Member State and the resilience of the Euro area as a whole. It should, in particular, focus on a five-year period on convergence criteria regarding taxation, labour market, investment, productivity, social cohesion, public administration and good governance capacities. ⁴¹ By implementing structural reforms, the Member States should become more capable of absorbing asymmetric and symmetric shocks and be able to reduce their refinancing costs. This stabilization function is substantially shaped on the model of the conditional economic assistance granted by the ESM to Member States that are suffering financial difficulties. Evidently, instead of conditional loans, the mechanism would provide conditional transfers. The incentives would be granted only following a Member State’s request and after the conditions agreed with the transfer mechanism are fulfilled.

A more advanced implementation of the budgetary capacity consists of a counter cyclical scheme that is in charge of absorbing asymmetric shocks within the Eurozone. ⁴² Unlike conditional incentives, this stabilization scheme would be automatic, meaning that it can immediately intervene once a negative shock has struck the economy of a Member State. Transfers can be granted via two alternative approaches. Following a macroeconomic approach, the budgetary capacity should work as a ‘rainy-day’ fund, meaning that resources will be collected in times of economic prosperity and transferred back to Member States only when they experience an economic shock. Following a microeconomic approach instead, the budgetary capacity would finance a common European unemployment insurance for all citizens or residents living in the Eurozone. The insurance could be conceived either as an EMU-wide basic unemployment benefit scheme or as a re-insurance system for national unemployment schemes. ⁴³ It is important to stress that the absorption of economic shocks will be automatic only for those countries that are compliant with the aforementioned ‘convergence code’. Furthermore, the provision of resources should respect clear rules on timeframe-possible payments and repayments and being neutral over a longer cycle. ⁴⁴

A future implementation of the fiscal capacity could be a European treasury that is in charge of managing symmetric shocks that have the potential to destabilize the Eurozone as a whole. ⁴⁵ With such a scenario, the Eurozone capacity would be able to fund investment aimed at aggregating demand and full employment in line with Article 3 TEU. ⁴⁶ In order to fulfil these tasks, the European treasury would have to be managed by the European Commission or a new European Minister of Finances. ⁴⁷

A. Limits of the legal basis

The process of fiscal centralization for the Eurozone does not just represent a practical challenge, but it also raises several legal problems that Member States and European institutions should carefully take into consideration. A preliminary issue that needs to be resolved is the identification of a solid legal basis for the implementation of the aforementioned proposals.

The introduction of the convergence code does not pose significant difficulties in this regard, as it could be easily based on the provisions regarding economic coordination, such as Article 121 TFEU or Article 136 TFEU, or on the enhanced cooperation legal basis in Article 20 TEU. ⁴⁸

The setup of a budgetary capacity counting on its own revenues and having its own spending targets would, by way of comparison, be more problematic. In this regard, it is important to acknowledge two important premises.

First, there are no provisions in the existing treaties that expressly forbid the establishment of a Eurozone budgetary capacity. Article 310(1) TFEU on the unity of the budget is not an absolute principle, as there are several EU bodies counting on their own separate resources, notably the European Investment Bank, the European Central Bank and the European Development Fund. ⁴⁹ Moreover, Article 125 TFEU on the prohibition of bailouts does not exclude the transfer of resources between countries, when it aims to ensure a stabilization function. ⁵⁰ On the contrary, the setup of the additional budgetary capacity would comply with the objective of the stability of the Eurozone as a whole, as was defined by the CJEU in its Pringle judgment. ⁵¹

Second, the EU Treaties do not allow for the development of an independent power of taxation at the European level. ⁵² Even interpreting Article 113 TFEU on fiscal harmonisation in the widest sense possible, perhaps in conjunction with Article 136 TFEU or the flexibility clause as per Article 352 TFEU, ⁵³ the setup of genuine European taxes would clash with the principle of conferral and national constitutional law, according to which the Budgethoheit belongs exclusively to the Member States. ⁵⁴

In the light of these observations, the creation of an additional budgetary capacity for the Eurozone should follow a different path, especially when one considers the margin of action that is offered by the EU Treaties.

An important legal basis to take into consideration is Article 311 TFEU on the Union’s own resources and Article 312 TFEU on the Multiannual Financial Framework (MFF). These two provisions might be helpful if Member States were to decide to create the budgetary capacity for the Eurozone in the framework of the EU budget. ⁵⁵ The existing Union’s own resources system and the MFF should be amended in such a way so as to create a new budgetary line, whose financing and access would involve only the participating Member States. In this regard, it would be necessary to identify both new revenues to capitalize on the additional budgetary capacity, like national contributions or own resources, as well as new expenditure targets, notably conditional incentives, a ‘rainy-day’ fund or an insurance scheme against unemployment. The introduction of new own resources, like a common financial transaction tax or a consolidated corporate tax base, could also count on the legal basis offered by Article 113 TFEU regarding the harmonization of national tax legislation. ⁵⁶ It is important to note, however, that the activation of these legal provisions requires the unanimity of national governments in the Council.

In the event that reforming the EU budget is politically impossible, the Eurozone countries might create a separate fund within the EU legal framework as a derogation to the principle of unity of the EU budget as per Article 310(1) TFEU. Some scholars identified a possible legal basis in Article 136(1) TFEU on the enhanced economic coordination within the Eurozone in connection with Article 122 TFEU on the solidarity clause and the flexibility clause that is located in Article 352 TFEU. ⁵⁷ Another possible way may be to use Article 20 TEU on enhanced cooperation. ⁵⁸ The creation of a separate budgetary capacity through this procedure might be eased by the fact that Article 332 TFEU acknowledges that an enhanced cooperation may require its own expenditures and these shall be normally borne by the participating Member States. In this regard, it should be noted that Article 20 TEU has already been used to try and introduce a financial transaction tax (FTT) directive. ⁵⁹

Considering other available legal bases, the reform of the ESM might appear at first glance as a possible option to grant conditional financings to those Member States willing to implement structural reforms. This solution, however, is not practicable: first, the ESM provides loans and not transfers; second, Article 136(3) TFEU clearly conceives the ESM as an emergency tool, which can only work when the stability of the Euro area as a whole is at stake and not as stabilization function for non-crisis times. Furthermore, recent proposals suggested a different kind of development for the ESM. Rather than turning it into an additional budgetary capacity of the Eurozone, ⁶⁰ the ESM should evolve into a European Monetary Fund (EMF) that is in charge of granting credits in case of unsustainable debt and allowing for structured insolvency. ⁶¹ It is self-evident, however, that every transformation of the ESM would require a Treaty amendment.

Looking at other possible legal bases, the EU Treaties do not offer much room for manoeuvre. An extreme option remains the conclusion of a separate agreement, similar to the Fiscal Compact model. Such a perspective should be avoided as much as possible because it would deprive the process of fiscal integration of the guarantees and checks and balances that are offered by the EU legal order and it would oblige it to conceive the additional budgetary capacity primarily in an intergovernmental context.

B. Impact on the principle of conferral

Another important legal issue to consider when establishing a budgetary capacity for the Eurozone is the impact of any reforms on the principle of conferral that is laid down in Article 5 TEU. The latter says that competences that are not conferred upon the Union by the EU Treaties must remain with the Member States and the Union cannot directly or indirectly decide in their regard.

Although consistency with the principle of conferral is formally ensured by the identification of a legal basis within the EU Treaties, the establishment of a Eurozone budgetary capacity might still challenge it in concrete terms. ⁶² On the one hand, the mechanism will have an impact on how many resources will be available at the national level to develop domestic policies. Independently from its concrete implementation, either as a ‘rainy-day’ fund, an unemployment insurance or via conditional incentives, participation in the additional budgetary capacity will temporarily make countries or citizens, either net contributors or recipients. This means that at a specific period in time, each country will either have more or less resources to develop domestic policies. On the other hand, the ‘converge code’ would require Member States to shape their national policies in light of specific targets and objectives defined at the European level. The promise of resources coming from the additional budgetary capacity would be more effective than any threat of unrealistic sanctions in order to encourage compliance with the convergence code. In this regard, it must also be noted that, as the additional budgetary capacity is not an emergency mechanism, it can immediately stop providing resources to non-complying Member States without automatically undermining the stability of the Eurozone. ⁶³ In conclusion, the EU will not only be able to determine how many resources will be allocated to the national level, but it will also be able to determine how they will be used.

In light of this analysis, it will come as no surprise that the initiation of a process of fiscal integration at the European level might engender significant concerns from national constitutional courts, which are the guardians of the Member State’s legal orders. ⁶⁴ The most vocal court on this issue has been the German Bundesverfassungsgericht, which has already clarified in several judgments that the revenue and expenditure competence is part of the German constitutional identity ⁶⁵ and its national allocation is unmodifiable due to the eternity clause found in Article 79(3) of the Grundgesetz. ⁶⁶ According to the German constitutional court, the German parliament must maintain full control over budgetary policies, which cannot, under any circumstances, be transferred to the European level. ⁶⁷ In light of this position, the development of European fiscal sovereignty can be ruled out, at least for the moment. ⁶⁸

The natural dissatisfaction shown by the Bundesverfassungsgericht and possibly of other Constitutional Courts ⁶⁹ to the erosion of national fiscal competence does not mean, however, that any implementation of the Eurozone budgetary capacity should automatically be shelved. Much will depend on how it will be set up in practice. Focusing on the existing proposals, notably the conditional incentives, the common unemployment insurance and the ‘rainy-day’ fund, their creation does not necessarily require a genuine transfer of fiscal sovereignty to the European level. Indeed, as long as the financing and the activation of the additional budgetary capacity respects the following conditions, national fiscal sovereignty will remain unimpeded.

First, the budgetary capacity would be financed through national contributions or a new system of own resources. The latter are particularly suitable for the current proposal because they can provide a stable and potentially significant source of revenues which bypass the need for proper European taxes. ⁷⁰ Therefore, as long as national parliaments agree on the payment of contributions to the budgetary capacity or the setup of new own resources, their fiscal sovereignty will remain intact.

Second, the activation of the transfer mechanism would comply with technical standards. This means that the budgetary capacity should provide resources only once some pre-identified conditions have come into existence, proving the need for stabilization. Such conditions might regard, for example, the unemployment rate, economic downturns, difficulties with the balance of payments or low competitiveness. ⁷¹ In this case an independent authority, such as a newly established European fiscal board, should monitor the effective existence of these conditions and the correct functioning of the transfer mechanism. ⁷² The technical assessment would represent a precondition of the activation of the additional budgetary capacity. ⁷³

Third, the decision to take part in the project of additional budgetary capacity must be voluntary. Although the activation of a ‘rainy-day fund’, a European unemployment insurance or conditional incentives will depend on compliance with the convergence code, the inclusion of a Member State in these mechanisms will require autonomous and unbiased decision in the first place. This means that European institutions cannot oblige a country to participate, but only make sure that it respects the rules of participation.

C. Restraining moral hazard

The introduction of a Eurozone budgetary capacity will pose new challenges to the containment of moral hazard. ⁷⁴ This is a longstanding problem that is inherent in the EMU, which is essentially due to the contradiction of having a strong economic interdependence between Member States without an effective European authority in charge of stopping and sanctioning individual misbehaviours.

On the one hand, the setup of a transfer mechanism will increase the temptation towards moral hazard. Member States might try to abuse the budgetary capacity by putting themselves in the position to permanently receive resources from the other countries that are financing the mechanism. Furthermore, some national governments might feel they can slow down the process of fiscal consolidation and structural reform by counting on the intervention of the common budgetary capacity in the event that symmetric or asymmetric shocks hit their economy. Evidently, such an attitude would undermine the correct functioning of the transfer mechanism and shake the mutual trust on which the process of fiscal integration is premised.

On the other hand, the introduction of a Eurozone budgetary capacity might under certain conditions, reduce the economic misbehaviour of national governments, in turn making European surveillance less necessary. In accordance with the paradox of centralization that was highlighted by Fabbrini, ⁷⁵ the shift of stabilization competences at the European level might relieve Member States from these tasks and automatically reduce the need for public spending at the national level. In such a situation it would be easier for national governments to comply with the European rules on financial stability and focus on structural reforms.

As the provision of resources and the stiffening of surveillance will not alone be able to ensure good fiscal practices of Member States, it is necessary to excogitate better ways to balance both responsibility and solidarity. The establishment of a Eurozone budgetary capacity might serve this purpose, if certain conditions are respected.

First, the transfer mechanism should not aim at equalizing income and correcting structural disparities between the Member States, ⁷⁶ but it should only encourage national reforms and stabilizing economic shocks within the Eurozone. For this reason, transfers cannot be permanent and unidirectional, but they must be designed in such a way so as to avoid that, ‘over a too long period of time, any country is a net loser or gainer from the scheme’. ⁷⁷

Second, the budgetary capacity must count on the strict application of the conditionality policy. Member States will receive resources only if they comply with the convergence code that has been agreed upon at European level. ⁷⁸ The real challenge is clearly to make conditionality credible, meaning that once a Member State fails to execute its obligations, transfers must effectively cease. In this regard, it is important that transfers are temporary, so that no Member State can count on a permanent flow of resources from the budgetary capacity. ⁷⁹ At the same time, resources should be provided in instalments, so that concerned countries are encouraged to comply with European rules for the entire period that they are benefitting from the transfers. Recipient Member States should also agree on a clawback clause, according to which transfers must be paid back in case of certified non-compliance with the convergence code. ⁸⁰ As was already mentioned, the strict application of the conditionality policy would be easier for the Eurozone budgetary capacity than it would be for the ESM. While the latter is an emergency mechanism, which provides financial assistance in situations of extreme distress, when the stability of the Eurozone is at stake, ⁸¹ the budgetary capacity will operate normally along the economic cycle by absorbing the economic shocks, which are temporarily affecting a Member State. For this reason, it would be easier for the budgetary capacity to interrupt the flow of resources without immediately incurring recoils on the financial gear of the monetary union.

Third, the application of the convergence code and the supervision of Member State’s fiscal policies should be based on the judgement of technical authorities. Despite the efforts to constitutionalize the balanced budget rule ⁸² and the introduction of semi-automatic sanctions, the Council has always been unable to effectively apply fiscal rules, as its decisions are substantially based on political considerations. For this reason, some official proposals foresee the creation of a European fiscal board, ⁸³ which should cooperate with political institutions in the management of the additional budgetary capacity. This new authority should be composed of independent experts and monitor the effective compliance with the convergence code. Such independent assessment would help the Eurozone budgetary capacity to fulfil its stabilization mandate and avoid any undue income redistribution between the Member States.

D. Democratic control

Another important challenge that the process of fiscal centralization will have to deal with is the creation of an effective mechanism of democratic control.

The European economic governance is notably affected by some structural democratic deficits, as its functioning is essentially intergovernmental and the European and national parliaments do not take any part in the decision-making process. Even if the EU Treaties provide for a dialogue between institutions in order to increase the transparency of political decisions, European citizens and their direct representatives are essentially excluded from the functioning of economic governance. The recent reforms adopted in reaction to the sovereign debt crisis have exacerbated this situation by reducing the margin of action for domestic parliaments on the definition of national fiscal policies and excluding the European Parliament from the new procedures of supervision and financial assistance. ⁸⁴ In this context, if the establishment of a Eurozone budgetary capacity does not involve parliamentary institutions, the democratic deficit of the EMU would definitely become unsustainable.

In order to understand the importance of democratic accountability in the process of fiscal centralization, it is worth remembering that the competence to collect and redistribute resources in Member States has always been a parliamentary prerogative. Notably, modern democracies were born to give the people control over the government’s management of taxation. The motto of the American revolution, ‘no taxation without representation’, succinctly synthetizes the relationship between the citizens and the fiscal authority in a democratic state. This is the reason why the creation of a European fiscal authority would definitely pose a challenge to the genuine functioning of national parliamentary democracy and create the need for an effective source of democratic legitimation at the level where the new fiscal power has arisen.

For this reason, some proposals envisage upgrading the role of the European Parliament vis-a-vis economic governance so that it shall replace national parliaments in controlling the new budgetary capacity. Unfortunately, even if this solution is regarded as the most reasonable and effective, it cannot be easily implemented for two main reasons. First, national constitutional law sets clear limits on the transfer of national parliamentary prerogatives to the European level. In this regard, the German Constitutional Court has been very clear in explaining that democratic control over budgetary policy must essentially occur at national level and it has highlighted the fact that the national parliament is the holder of core sovereign rights, including fiscal powers. ⁸⁵ Second the European Parliament as it is structured today struggles to effectively represent the popular will in the Eurozone. On the one hand, due to the ‘regressive proportionally rule’, EU citizens are not equally represented in the European Parliament, but people living in smaller Member States have proportionally more representatives than those living in larger Member States. ⁸⁶ On the other hand, the European Parliament is composed of representatives that are elected in all Member States, including those not taking part in the budgetary capacity. If the European Parliament as a whole was involved in the management of the budgetary capacity, almost one fourth of MEPs would be elected by citizens, who are not affected by their decisions in these matters. ⁸⁷

In the light of these observations it looks reasonable that that the functioning of a budgetary capacity for the Eurozone will have to involve national parliaments. This should happen in such a way so as to grant them a key role in the definition of the budgetary capacity, without, however, creating a permanent national veto power on its ordinary functioning. Such a balance can be found in the following manner. First, national parliaments should decide by unanimity how the budgetary capacity must be financed ⁸⁸ and what mandate it shall pursue. This would be possible, for example, if the new budgetary capacity was established through a reform of the own resources system as per Article 311 TFEU and the MFF as per Article 312 TFEU. Before expressing its own decision in the Council, each government should evidently request authorization from their national parliament. ⁸⁹ Evidently, if Member States opted for enhanced cooperation pursuant to Article 20 TEU or via the conclusion of a separate international agreement, national parliaments should also grant their approval thereto. Second, as was already envisaged, the functioning of the budgetary capacity should be based on the independent judgement of technical bodies, such as a European fiscal board. The latter should be able to assess whether Member States respect the convergence code and therefore allow access to the additional budgetary capacity. In this way, national parliaments will not need to decide on the ordinary functioning of the mechanism, because the European fiscal board will verify that the initial mandate established is being respected. ⁹⁰

Granting the fundamental prerogatives of national parliaments does not mean that the European institutions should not play any role in the functioning of the Eurozone’s budgetary capacity. Some proposals suggest merging the positions of the President of the Eurogroup and the Commissioner for Economic and Financial Affairs in a new European Minister of Economic Affairs. ⁹¹ The European Commission should set up a treasury, ⁹² meaning a permanent management in charge of applying and enforcing the existing economic governance and optimizing the development of the Euro area. Evidently, the European Parliament should play a major role in granting democratic accountability. On the one hand, it should check whether the budgetary capacity operates accordingly and that the European minister of Economic Affairs complies with its mandate. ⁹³ This can be easily done by establishing an inter-institutional dialogue based on periodical audits and reports. On the other hand, the European Parliament should also be involved in the actual functioning of the additional budgetary capacity. First, it should approve the decision initially taken by national parliaments with regard to the revenues and the mandate of the additional budgetary capacity. ⁹⁴ Second, it should adopt and amend the convergence code in accordance with the ordinary legislative procedure that is contained in Article 289 TFEU. ⁹⁵

In order to ensure a more genuine democratic representation, some proposals envisage reforming the internal functioning of the European Parliament in such a way to involve only the MEPs from the Eurozone countries in the functioning of the budgetary capacity. ⁹⁶