Why the United Kingdom must say 'No'
By Rt Hon. David Heathcoat-Amory, MP E-mail: david@wells.tory.org.uk

TAX POLICY and the EUROPEAN BUDGET

When monetary policy has been eliminated as a nationalresponse, what is left is fiscal policy; that is changes in taxation and expenditure.

Attempts by governments since the war to 'fine tune' demand in the economy through changes in taxation and expenditure have generally been unsuccessful. The result has been inflation, and very often unemployment too. The present government therefore believes that fiscal policy should be focused on achieving sound public finances, while interest rates are the main instrument for influencing demand and the inflation rate.

If national interest rates were abolished, governments wishing to manage demand in their economies would be obliged to make greater use of fiscal policy. Even if they rejected the use of an active fiscal policy, they would want the normal stabiliser mechanism to work. In a recession, tax receipts drop and government expenditure on, for example, unemployment benefit rises. Thus there is a cyclical rise in the budget deficit which tends to counter the recession. The opposite happens in a period of excessive demand when tax receipts increase and benefit expenditure falls. This helps to moderate the peaks and troughs of the economic cycle, without the need for governments to act.

Unfortunately this mechanism would be put at risk by monetary union. The Maastricht Treaty lays down strict rules on government deficits and debt ratios, and sets up an 'excessive deficit' procedure whereby errant governments are identified and brought into line. In stage two of monetary union, at present, these are no more than recommendations. From the start of stage three they are binding and may be backed up by penalties and fines. (Note 9)

The reason for strict rules governing national deficits is because over-borrowing by one country affects the whole single currency area. With national currencies, governments which run up large debts have to live with the consequences of high inflation. In a single currency area the consequences are 'exported' and all participants share the cost. The penalties against excessive deficits laid down in the Treaty are not thought tough enough by Germany, the country with the most to lose from inflationary behaviour by others. The German Minister of Finance, Theo Waigel, has proposed a 'stability pact' under which the Member States must limit their budget deficits to 1% of GDP, not 3% as proposed in the Treaty. Moreover, he has proposed that the financial penalties for running an excessive deficit would be automatic and draconian. For example, under this stability pact, the UK would have been fined over £10 billion in respect of the 1992-94 deficits. These ideas are still being discussed at the Council of Ministers and it is not clear how they fit in with the legal requirements of the Treaty but they indicate that the eventual controls over the tax and spending policies of participating states are likely to be stricter than originally envisaged.

These controls would prevent a government from boosting its economy in a recession by cutting taxes and raising expenditure. Unfortunately they would go further. As already described, in a recession the budget deficit rises automatically. If this was near the permitted borrowing limit, a government facing a local recession might well have to raise taxation and cut public expenditure. So instead of acting as an in-built stabiliser, fiscal policy could actually accentuate the problem.

Also the democratic question arises again: if loss of an autonomous monetary policy is followed by loss of an autonomous fiscal policy, what is the function of nationally-elected politicians? These powers go to the root of what a parliament is for and their loss must call into question whether such a country is in any real sense self-governing.

Faced with the uncomfortable point that tax and spending powers would not only be tightly controlled but might actually make matters worse, advocates of a single currency sometimes take refuge in the example of the US Dollar. Surely economic disturbances, different rates of development and different tax rates exist in the USA but no one argues for separate state currencies there.

The states and regions of the USA do indeed diverge economically from time to time. Sometimes it may be the financial services and computer sciences of New England that are in relative demand. The oil states could be doing well; or the steel and car making states that may be experiencing changes in demand whether up or down; or the states dependant on military orders or world food prices could be relatively affected.

These states or regions cannot, of course, use the exchange rate to adjust, but other mechanisms do work. Labour mobility is far higher than in Europe, helped by a common language and a historical background of labour migration. The price mechanism, of goods, services and labour is more responsive and the financial sector treats the country as a genuine unit.

There is another very important ingredient. The US fiscal system works as an automatic stabiliser on a federal scale. People in a state experiencing an economic downturn send fewer dollars to the Federal government and receive back more in transfers as unemployment rises. A state experiencing a relative boom does the opposite. It is estimated that about 40% of the relative changes between two states or regions will be evened out in this way. (Note 10) Nothing comparable to America's fiscal system exists in the EU, where virtually all taxes are paid to national and local government. The EU budget is far smaller and half of it is still spent on agriculture. Most of the rest goes on 'structural' support which is supposed to correct economic imbalances but which is not responsive to changes in output and employment - and certainly not quickly or automatically.

Comparisons between the proposed European and the actual US single currency must therefore recognise the important structural and historic differences, and the fact that the US is a federal state with a large central budget and powers of direct taxation.

Something similar to this federal budget would be required in Europe. In 1977 the Commission published the report of a Study Group under the chairmanship of the British economist Sir Donald MacDougall. This estimated that as a minimum a budget of 5 - 7% of Community GDP would be required (as against 1.2% today). The Report envisaged a scheme in which national unemployment schemes would be taken over by the federal budget and financed by a Community-wide tax.

Later, writing in 1992, Sir Donald spelt out his belief that the loss of exchange rate adjustment would make essential larger transfers between Member States. He concluded: 'I fear that an attempt to introduce monetary union without a much larger Community budget than at present would run the risk of setting back, rather than promoting, progress towards closer integration in Europe'. (Note 11) Any such increase would be extremely controversial. It is a big step for a national parliament permanently to hand over a proportion of its tax revenue to an outside body beyond its control. The agreement to increase the size of the Community budget from 1.2% to 1.27% of GDP by 1999 was very reluctantly accepted by the House of Commons. The UK's net contributions to the budget since 1973 already total £38 billion at today's prices and are continuing at some £3 billion per annum.

It is not surprising that advocates of a single currency ignore the findings of the MacDougall Report and the logic which would require a further very large increase in budgetary transfers.

The Delors Report of 1989 recognised that a central budget of this size was not at present politically feasible and referred instead to the need for 'solidarity' to iron out 'the economic difficulties or the surges in prosperity of individual states'.

In other words, the absence of a large enough EU budget would be compensated for by co-ordinating the use of national budgets. For this to have any chance of working the control would have to be swift, automatic and compulsory. Federal powers would initially replace the need for a federal budget. The Delors Report was understandably reticent about drawing the necessary conclusions from its own analysis.