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«Summer 2014 Review of the Balance of Competences between the United Kingdom and the European Union EU Budget © Crown copyright 2013 You may re-use ...»

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10 Review of the Balance of Competences between the United Kingdom and the European Union: EU Budget For the purposes of this review, we are using a broad definition of competence. Put simply, competence in this context is about everything deriving from EU law that affects what happens in the UK. That means examining all the areas where the Treaties give the EU competence to act, including the provisions in the Treaties giving the EU institutions the power to legislate, to adopt non-legislative acts, or to take any other sort of action. Ultimately, respondents focussed less on the balance of competence in the strictest sense and more on the application of competence in the area of the EU Budget. One area discussed by a small number of respondents, which does have a more direct impact on the balance of competences in its classic sense is the question of introducing new revenue-raising powers for the EU institutions, which would represent a shift in an area of competence that is currently exclusively held by Member States.

Definition of EU competence The EU’s competences are set out in the EU Treaties, which provide the basis for any actions the EU institutions take. The EU can only act within the limits of the competences conferred on it by the Treaties, and where the Treaties do not confer competences on the EU they remain with the Member States.

There are different types of competence: exclusive, shared and supporting. Only the EU can act in areas where it has exclusive competence, such as the customs union and common commercial policy. In areas of shared competence, such as the Single Market, environment and energy, either the EU or the Member States may act, but the Member States may be prevented from acting once the EU has done so. In areas of supporting competence, such as culture, tourism and education, both the EU and the Member States may act, but action by the EU does not prevent the Member States from taking action of their own.

The EU must act in accordance with fundamental rights as set out in the Charter of Fundamental Rights, such as freedom of expression and non-discrimination, and with the principles of subsidiarity and proportionality. Under the principle of subsidiarity, where the EU does not have exclusive competence, it can only act if it is better placed than the Member States to do so because of the scale or effects of the proposed action. Under the principle of proportionality, the content and form of EU action must not exceed what is necessary to achieve the objectives of the EU Treaties.

For the budget in particular, this means examining the areas where the legislation around the EU Budget, and the negotiations and decisions which flow from that legislation, have an impact on the UK national interest. This report, particularly Chapter Three, Impact on the National Interest, will consider the debate which exists around what constitutes the national interest in the context of the EU Budget, before setting out views from gathered evidence on whether the existing EU Budget system operates in a manner that is favourable to the national interest.

The report will first present, building on the detail published as part of the original Call for Evidence, the development of competence in the area of the EU Budget – considering the history of the EU Budget as a system and the development of the legal framework which underpins it. The report will then consider the current state of competence as it affects the UK today. Chapter Three, as noted above, presents views on the impact the budget has on the UK national interest. The final chapter, Future Options and Challenges, will consider the further questions coming from this evidence and the debates around the budget as it develops further.

Introduction 11

In reading this report, it is important to note the key principles of the Balance of Competences Review. This is intended to gather and summarise evidence from a variety of sources, to act as a reference in the future.

Chapter 1: Development of EU Competence

1.1 The EU Budget has been, and remains, an evolving system. From the first European Communities’ budgets to the multi-annual structure employed today, this evolution reflects the changing structure, priorities and challenges in the European Union over its history.

The competences of the European Union with respect to the EU Budget are set out in Treaties. This section provides the historic background on the evolution of the EU Budget system and the development of its treaty framework. In doing so, the chapter covers the broader relationship between the UK, the EU and the EU Budget.

The Development of the Treaty Framework of the European Union (TFEU)

1.2 The Treaty of Rome, ultimately superseded by the Treaty on European Union (TEU) and the TFEU, was agreed on 25 March 1957 and entered into force on 1 January 1958.

It established the European Economic Community (EEC) and had a number of economic objectives, including establishing a European common market. Since 1957 a series of Treaties have extended the objectives of what is now the European Union beyond the economic sphere. The amending Treaties, with the dates on which they came into force, are: the Treaty of Brussels (1 July 1967) which provided for the merger of the institutions of the three Communities; the Single European Act (1 July 1987), which provided for the completion of the Single Market by 1992; the TEU – the Maastricht Treaty (1 November 1993), which covered matters such as justice and home affairs, foreign and security policy, and economic and monetary union; the Treaty of Amsterdam (1 May 1999), the Treaty of Nice (1 February 2003) and the Treaty of Lisbon (1 December 2009), which made a number of changes to the institutional structure of the EU.

1.3 Following these changes, there are now two main Treaties which together set out the competences of the European Union: the TEU and the TFEU.

The Original EU Budget System Pre-UK Entry (1951-1973)

1.4 The European Coal and Steel Community (ECSC), under the Treaty of Paris (1951), was established to maintain peace in Europe following World War Two and to drive the economic growth of its members: Belgium; France; Italy; Luxembourg; the Netherlands;

and West Germany, primarily within the energy sector. In pursuing these objectives it began the development of a European system of budgets for the separate policies of the new Communities. This system expanded with the Treaty of Rome (1957) and the creation of the EEC and the European Atomic Energy Community (EURATOM), sharing institutions with the ECSC.

14 Review of the Balance of Competences between the United Kingdom and the European Union: EU Budget

1.5 Separate budgets existed for the Communities, covering administrative costs, operations, and research and investment in each area. By 1965, these budgets were unified into the first European budget system – the ‘General Budget of the European Communities’, with the ECSC and Euratom budgets incorporated into the EEC budget. Until 1970, this budget was funded solely through national contributions by Member States.

Own Resources The Own Resources system refers to revenue collected from Member States to fund the EU

Budget. This system has developed into a complex structure of four parts seen today:

Traditional Own Resources (TOR), which are mainly import duties on goods brought into any given Member State from outside the European Customs Union. Member States retain 25 per cent of import duties collected in order to cover collection costs, and pass 75 per cent on to the European Commission;*

• Value Added Tax (VAT)-based resource, calculated by applying a set call rate to a hypothetical harmonised VAT base;

• Gross National Income (GNI)-based resource, which reflects the residual EU Budget expenditure to be financed once TOR VAT-based contributions and ‘Other’ revenue (see below) are taken into account. The Commission estimates residual financing needs of the budget as the percentage of EU GNI, which is then applied uniformly to individual Member States’ GNI. The GNI-based resource currently accounts for the largest share of own resources (68 per cent of total EU revenue in 2011); and • ‘Other’ revenue, which includes income from EU staff, unspent money from previous years and any other income, for example, from fines levied by the European Commission.

* The 25 per cent retained to cover collection costs is applicable under the current Own Resources Decision (that is, the 2007 Own Resources Decision) relating to the 2007–13 financial framework. Under the MFF deal achieved at the February 2013 European Council, this has been revised downwards to 20 per cent, but will need to be agreed by Member States under a new Own Resources Decision.

1.6 The first system of Own Resources, the revenue side of the EU Budget – see text box below, was introduced in the Own Resources Decision of 1970, which included what are still the primary ‘traditional’ Own Resources of the budget: customs duties and agricultural levies, along with a VAT-based contribution originally capped at one per cent of a VAT base and applied gradually as progress was made in harmonising the VAT bases.

1.7 As a unified resource system was developed, the first common, unified expenditure policies were also being introduced. These included the European Agricultural Guidance and Guarantee Fund (EAGGF), greater expansion of research policy, a new European Social Fund (ESF) and European Regional Development Fund (ERDF). The ERDF was set up in 1975, championed particularly by the UK and Italy to ensure that EU membership could show tangible economic benefits at home. It has become the main way that the EU has implemented its regional policy.

Chapter 1: Development of EU Competence 15

Budgets Before Financial Perspectives (1973-88)

1.8 The first enlargement of the Communities in 1973 saw the accession of the United Kingdom along with Denmark and Ireland, with the new Member States gradually implementing the resources system which had been negotiated by the original six Member States.

Early Correction Mechanisms The Fontainebleau European Council of June 1984 agreed the basis of what is now the UK’s permanent ‘abatement’. This set a reduction to the UK’s contribution of 66 per cent of the difference between the UK’s share in the EU VAT base and its share of total allocated expenditure. The UK had argued that a permanent correction was needed as a result of a particularly unusual budgetary balance – at the time of the European Council in 1984, the UK was by far the second largest net contributor to the budget, while also being the third poorest Member State of the ten (see data Chart 1.1 below).

This 1984 correction, the UK’s abatement, was financed by other Member States through their usual financing shares. Germany, however, was able to argue that this created a separate imbalance and was allowed a correction of its own at Fontainebleau – a 33 per cent reduction on its share of financing the UK’s abatement.

Today, as the 2014-2020 MFF period begins, several more Member States will receive corrections to their contributions (see text box).

1.9 The introduction of the UK correction, or abatement, was seen as a necessary rectification of a budgetary imbalance, as demonstrated in Chart 1.1.1 At the time of the 1984 European Council in Fontainebleau, the UK was the third-poorest Member State, in terms of GNI per capita, while also making the second-largest net contribution to the budget.

As a result, the June 1984 European Council agreed the following text (the Fontainebleau Principle), which remains the guiding principle behind budgetary corrections today. The

Conclusions said that:

Expenditure policy is ultimately the essential means of resolving the question of budgetary imbalances. However, it has been decided that any Member State sustaining a budgetary burden which is excessive in relation to its relative prosperity may benefit from a correction at the appropriate time.2

1.10 This high UK net contribution was primarily borne out of relatively low UK receipts from the budget, particularly in the area of agricultural spending, which dominated the EU Budget at this time. This was largely the result of an agricultural sector which was relatively small as a proportion of the overall UK economy, when compared to that of other Member States.

A term describing the disproportionate balance between a Member State’s contribution to the EU Budget and the receipts that it receives. In some cases, a Member State may claim that its net balance is unfairly disproportionate to its economic size (as has been the case for the UK). In these cases, the Member State may request the introduction of a ‘correction’ to moderate their contribution to the budget.

Council of the European Union, European Council Meeting at Fontainebleau, Conclusions of the Presidency (1984).

16 Review of the Balance of Competences between the United Kingdom and the European Union: EU Budget

–  –  –

2,000 1,000 3 –1,000

–  –  –

Source: Information derived from European Commission, EU Budget 2008, Financial Report (2009), pp 91-105. GNI at current market prices per head of population.

1.11 As further Member States joined the Community (Greece in 1981 and Spain and Portugal in 1986), the policies undertaken in the budget also grew, with growth in the ESF and ERDF, new policies in fisheries and research and rapid growth in agricultural spend under the EAGGF. New efforts to match increased expenditure with new resources saw the expansion of the VAT resource. The Fontainebleau European Council in 1984 agreed new expanded powers of budgetary discipline, controlling the growth of the EAGGF, with the Council aiming to reduce the rapid increase in the size of the budget as a whole.

1.12 The Brussels Merger Treaty (1967) made several significant changes to the structure of the budget, establishing much of the procedure which we recognise in the budget today. By 1977, the European Court of Auditors (ECA) had been established, by a UK-driven initiative intended to secure effective auditing of EU finances, and the European Parliament had been given powers of ‘discharge’ of the budget, the ability to reject the budget agreed by the Council and the ability to propose its own amendments to the Council’s agreed budget.

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