Without a revision to the rules, national governments may face having to choose between funding social or green policies
POPULAR SUPPORT
Reform of pact to exempt green investment from thresholds is gaining momentum
RECOVERY TEMPLATE
The pandemic recovery fund offers a suggested programme to appease all member states
KEY QUOTE
Getting the fiscal reform right doesn’t mean the Green Deal will then be easy to achieve. However, getting it wrong will make its implementation much more difficult
EU member states have to stick to a fiscal playbook known as the Stability and Growth Pact (SGP), which stipulates that budget deficits must not exceed 3% of Gross domestic product (GDP) and debt limits must stay under 60% of GDP. The aim of these thresholds is to make sure government spending and finances are as aligned as possible so the EU’s single market is not disrupted and governments are not lured down the path of bankruptcy. However, the rules are widely considered to be out of date and not fit for purpose, as many countries were in breach of the limits even before the pandemic hit. A review process was underway before the pandemic struck but the political will to update the rules has been galvanised by Covid-19 lockdowns, which has caused a long period of increased government spending to protect economies. During this period the pact was temporarily suspended. Southern European countries are generally in favour of less strict fiscal constraints so that their economies can continue to recover and grow, while more frugal Northern states do not want to sign off on a new system that allows unfettered public spending. A compromise will have to be found and there is growing support in Brussels for an agreement to be brokered around so-called “green exemptions” or “green gold standards”. These would in theory allow governments to continue pumping money into projects that help the EU progress towards its climate and digital goals, without fear of bumping up against the thresholds and incurring the wrath of the European Commission and other governments. Talks are already ongoing about how best to go about this and the Commission has been gathering stakeholder feedback about the process. Member state leaders are due to meet in early March for a summit to try and outline the broad brushstrokes of what they would like to see from the review before the Commission publishes its plan in the summer. This will trigger the usual horse-trading and bartering between government officials and members of the European Parliament before the new rulebook can become law but the clock is ticking. The current pact is suspended until the end of 2022. Economic recovery and promising signs of growth mean that there will likely be no extension of the fiscal amnesty period. High-ranking EU officials, such as Commission Vice-President Valdis Dombrovskis, doubt that a compromise will be reached before the end of the year, so the Commission will publish transitional guidelines in March.
DIVISIVE SOLUTIONS There is general consensus between countries that changes need to be made but currently little agreement on what those changes should look like. France, Spain and Italy are among the big players that want major reform, while the usual suspects of Germany, Austria and the Netherlands want to return largely to the pre-pandemic status quo. Austrian finance minister Magnus Brunner said that an increasing number of EU countries want budget policies that are more stable, insisting, “It’s not just the frugal ones, it’s more than that. It’s the responsible ones.” But there has been a shift in Europe’s political spectrum since the pandemic struck. Germany’s new government appointed liberal party head Christian Lindner as finance chief, who has signalled that positions have softened since Angela Merkel’s conservatives were ousted at the end of 2021. Lindner has even referred to himself as a “friendly hawk” on economic policy. However, one of German Chancellor Olaf Scholz’s closest financial advisors, Jörg Kukies, said in February 2022 that he is “very sceptical” about the idea of fiscal exemptions for green projects. Kukies, who is state secretary for EU policy, insists that it would be “impossible to agree on privileging certain expenditures over others” and labelled the idea “a Pandora’s Box”. In the Netherlands, the government may look very similar even after many months of coalition-building but a new finance minister in the shape of the social liberal party D66’s Sigrid Kaag suggests that the Dutch leadership will be open to a rethink of fiscal policy. Talks are also well underway in the European Parliament, which in July 2021 backed a report calling for a reform of the “outdated” rules that take into account special consideration of sustainable public investments. “The EU needs a permanent fiscal capacity and a golden rule on public investments such as education, health, infrastructure and the fight against the climate emergency,” says Jonás Fernández, a socialist MEP. Rasmus Andresen, a Green Party MEP, insists, “This is just the opening of the debate. The quality of spending should be good and the definition of what counts as green is very important.” Andresen also agrees that social spending must be linked to green investments to prevent a return to the austerity measures of the previous decade. Yet many economists see a danger. If the rules are redeployed without changes or if the reform process is botched, governments will be forced to choose between social and green policies in order to adhere to the thresholds. It is a situation that EU officials want to avoid at all costs, as flagship policies such as the Green Deal would be severely jeopardised if governments were unable to make the necessary investments. But revamping the architecture of the SGP is a Herculean task, which in its most ambitious form would involve changing treaties that underpin EU law. This requires unanimous voting, which brings its own special set of problems. “Getting the fiscal reform right doesn’t mean the Green Deal will then be easy to achieve. However, getting it wrong will make its implementation much more difficult,” says Ciarán Humphreys at E3G, the green European think tank. Instead, the Commission is looking to draft a plan that will give maximum flexibility to governments, coupled with some regulation changes that are easier to push through. This is where the idea of a green gold standard comes into play.
CHECKS AND BALANCES Investing in climate policies is widely supported across the EU. However, the scope of the funding, which technologies should be prioritised and whether the lion’s share should be public or private money are divisive issues. Humphreys points out that if EU countries are going to meet shorter-term targets set for 2030 and longer-term net-zero goals, more budgetary room will be needed. “You need more fiscal space within Europe because a lot of countries will not be able to make that extra investment that is required. An extra 1% of GDP in public spending is needed every year until 2030 to get us on track. That is a lot of extra money,” he says. The Commission estimates that annual investments will have to increase by around €360 billion in order to meet the 2030 target of slashing greenhouse gas emissions by 55% compared with 1990 levels. An extra two percentage points of GDP will be required to meet the 2050 climate neutrality goal. How much of that money should be public investment varies depending on who you ask, but Humphreys says that up to a third of the costs need to be met by governments otherwise the rest of the spending will not be targeted enough. Moreover, the European Commission estimates that about a third of additional investments up to 2030 will need to be made in the transport sector, much of which is made up of infrastructure that is financed and maintained by public bodies.
DEFINING GREEN One obvious issue arises when considering the idea of fiscal exemptions: what would count as green? Definitions and priorities differ wildly across the member states. France may be a champion of reform but its wider policy wishlist might undermine matters. Its government has suggested that it wants defence spending to be given fiscal leeway, insisting that its weapons industries benefit EU-wide GDP and security. The current climate and energy debate in Brussels also complicates matters quite significantly. The EU’s sustainable investment rulebook, known as the taxonomy—the latest draft of which was published on New Year’s Eve 2021—is the centre of a dispute between member states, who disagree over the Commission’s decision to grant gas and nuclear power a green label. A six-month-long scrutiny period is ongoing, during which time the EU Council and Parliament will have to decide whether to veto the decision. The fact the taxonomy is so divisive, coupled with the threat of legal action from staunchly anti-nuclear Austria and Luxembourg, suggests the taxonomy will not be considered in the fiscal debate. Instead, there are calls for the EU’s recovery fund (RRF) to be used as a template. Under this system, governments have to submit in-depth plans applying for their share of an €800 billion investment budget, made up of grants and loans. The Commission is scrutinising those plans and the EU Council gets a say over whether the money should be released. It was the main condition that won over sceptical countries such as Denmark and the Netherlands when the fund was devised in 2020. It is early days for the recovery fund, which will be in place until 2026, but the first results look promising. Governments have put together well-devised plans that target investments in medium- to long-term projects. If green fiscal exemptions are deployed, the same system could be replicated to check if governments are only investing in projects that are considered to be climate-friendly or making progress towards digitalisation principles.
GOLD STANDARD Zsolt Darvas from Bruegel, a think tank, also suggested in a paper discussed by EU finance ministers in September 2021 that a form of green golden-standard should exempt any net increase in green public investment from the fiscal rules. “It will be impossible to increase green public investment while consolidating budget deficits when EU fiscal rules are reintroduced from 2023,” Darvas says, adding that an RRF-inspired scrutiny process could weed out greenwashing. According to his proposal on how the standard would actually work, the Council of the EU would agree on a list of eligible climate investments and then each country would specify which items they want to be excluded, as part of annual stocktakes they are obliged to compile anyway. Advocates of this idea insist that it would keep the fiscal hawks happy, as the sacrosanct 60% and 3% thresholds would be left in place, while the fiscal doves would be satisfied with having an outlet for public spending and the likely bump in voter-pleasing growth that it would deliver. Deploying the green standard would still require consensus among member states and a nod of approval from the European Parliament, again making it difficult to push through. Governments like Italy and Spain could also upset the applecart if they pursue even more ambitious reform. Darvas suggests that the EU could also set up a form of climate investment fund instead, which would imitate the recovery fund to an extent and give interested governments the opportunity to get grants and loans to fund green projects. This money would very likely also be exempted from fiscal rules, according to Darvas. One of the main obstacles to the idea is again prudent member states were assured the pandemic recovery fund was a one-time deal. The conversation about whether to allow the Commission to borrow billions of euros on behalf of governments is quickly advancing, with EU economy chief Paolo Gentiloni quietly but forcefully championing the idea. The former Italian prime minister recently said that if the RRF is a success, “We will have created a blueprint for similar initiatives in the future and for this method to be used for other strategic missions of the Union.”
CLIMATE IMPACT Fiscal policies and reform involve a lot of accounting and number-massaging on paper, but would a change to the rules have an actual impact on the energy transition? It is hard to predict with certainty but indications are that it is likely. E3G’s Humphreys insists that all aspects of the energy transition would be boosted by extra fiscal leeway, adding, “Anything to do with infrastructure, charging stations, renewables, district heating, would benefit as they are intrinsically linked to public spending.” “Clean technology innovations will also benefit greatly as they often need public money to get started. With more space on offer, there will be more opportunities,” Humphreys adds. Renewable energy is an area where green fiscal exemptions would help build capacity, especially in the public procurement sector, where clean power contracts are a promising source of greenhouse gas emission reductions. “In economies where governments have more fiscal space and are able to borrow at low rates, recovery strategies offer a major opportunity to boost investment in infrastructure, efficiency and clean energy technologies,” the International Energy Agency reported in 2021. More public investment in renewables would be a boon to decarbonisation targets but perhaps not essential, given that a lot of private investment is already flowing into the clean energy domain. Instead, building renovations—which sit at the crossroads of climate and infrastructure policies—are emerging as an ideal candidate for extra investment, which would be more likely if fiscal rules are tailored to green objectives. Renovate Europe, an EU-wide campaign, says improving the bloc’s building stock is a prerequisite for meeting climate targets. Forty per cent of the EU’s annual power consumption and 36% of emissions are generated by buildings. “Allowing governments more flexibility to support renovations, rather than throwing money away through subsidising energy bills or handing out cheques to help pay high bills, would be the right move,” insists Caroline Simpson from the campaign group. “[It] would send a positive signal also to private investors that this is a sector that can—and therefore will—be supported with more public investment,” Simpson adds. Brook Riley, from Danish insulating giant Rockwool, adds that, “Given how opposed some of the EU’s most progressive countries are on what constitutes green energy, it’s hard not to see energy efficiency and building renovations as a unifying solution.” Renovation projects have already been granted special status under the recovery fund, as an incentive for governments to allocate their shares of the €800 billion to building refurbishments. This stands the sector in good stead to get similar treatment for green fiscal criteria if the reform process goes in that direction. A potential heavy influx of investment might yet come with a sting in the tail, though, given the sector faces a shortage of qualified renovators and manufacturing capacity would need time to adjust to demand.•
TEXT Sam Morgan