Academic journal article Public Finance and Management

Eu Budget Reform Options and the Common Pool Problem

Academic journal article Public Finance and Management

Eu Budget Reform Options and the Common Pool Problem

Article excerpt

ABSTRACT

There is a consensus in the literature that the expenditure structure of the EU budget is not in line with normative criteria based e.g. on the theory of fiscal federalism. While transfer policies have a large weight, policies of a European public good type are neglected. Our contribution explains this inefficient outcome within the framework of a political-economic two-country model adapted from Besley and Coate (2003). The model's modifications integrate crucial features of the EU setting such as income heterogeneity of countries, a GNI dependent revenue formula and the existence of transfer policies in the EU budget besides both local and European public goods. We show that the common pool problem in combination with a budget cap is at the heart of overspending on transfers and under-spending on European public goods. On the base of this model we assess different reform options related to the revenue side. We show that the effects of an EU tax depend crucially on the deviation of the specific tax base's redistributive effects from income proportionality. Furthermore, our results point to the advantages of a general but limited correction mechanism.

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1. INTRODUCTION

Although the current reform debate on the future of the EU budget is characterized by a variety of views there is a wide consensus that the current expenditure structure of the budget is not optimal. In particular, the overweight of transfer policies and the neglect of policies of a European public good type are regularly criticized (a wellknown example is the Sapir report; Sapir et al., 2004).

In our contribution we offer a theoretical explanation for these deficiencies. For this purpose we adapt the seminal political-economic model by Besley and Coate (2003) who point to the possible coordination failures in centralized decision making. We extend this model by integrating important features of the European Union such as income heterogeneity, a GNI dependent revenue formula and the existence of transfer policies in the EU budget besides local and European public goods. In this model, the common pool problem is at the heart of inefficiencies in centralized decision making, as locally elected representatives decide on the allocation of spending at the central level which is financed out of a common pool, so that it is largely borne by other jurisdictions. As a consequence, local representatives face incentives to use their influence in central decision processes for promoting those transfers with an advantageous distributive effect from their country's position.

In the light of this model we do not only analyze how certain characteristics of the status quo such as a cap on revenues influence the incentives of local representatives. We also scrutinize the effects of several reform options which are debated. In brief, it is shown that the introduction of a tax directly payable to the European level might even increase the relative attractiveness of transfers over public goods. By introducing a generalized correction mechanism a more efficient allocation of expenditures can be reached, shifting resources to the provision of EU-wide public goods. However, at the same time, this mechanism has a distorting effect for the ratio of local and European public good. Finally, the concept of a generalized but limited correction mechanism as proposed by Heinemann et al. (2008) is demonstrated to have advantageous properties if an appropriate differentiation of policies included in the correction formula can be achieved.

The remainder of this paper is organized as follows. Section 2 briefly surveys the literature on explanations given for the current neglect of European public goods in the budget. In section 3, we describe the theoretical literature which is our model's starting point. In section 4, the model is specified. In section 5, results referring to the status quo of the EU budget are depicted. …

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