Report on public finances in EMU 2012.
Date: 2012-09-13
Institutions: Directorate-General for Economic and Financial Affairs
Subjects: EU Member State, Economic and Monetary Union, budgetary control, economic analysis, fiscal policy, monetary crisis, public expenditure, public finance, report

European Commission

Directorate-General for Economic and Financial Affairs

Public finances in EMU - 2012

EUROPEAN ECONOMY

4/2012

ACKNOWLEDGEMENTS

This  report  was  prepared  in  the  Directorate-General  of  Economic  and  Financial  Affairs  under  the 
direction of Marco Buti, Director-General, Servaas Deroose, Deputy Director-General, and Lucio Pench, 
Director for Fiscal Policy.

Matteo Salto was the coordinator of the report. Lucia Piana co-ordinated Part II. The main contributors 
were Paolo Biroli (Part II), Jocelyn Boussard (Part III), Francisco de Castro (Part III), Roland Eisenberg 
(Part  I),  Christine  Frayne  (Part  I  and  II),  Matteo  Governatori  (Part  IV),  Ombeline  Gras (Part  II), Veli 
Laine (Part I), Lucia Piana (Part I and II), Stephanie Riso (Part I and II), Matteo Salto (Part III), Salvatore 
Serravalle (Part I and II), Barbara Stearns-Blasing (Part I), Georges Tournemire (Part II). 

The  country  fiches  in  Part  IV  and  some  boxes  were  prepared  under  the  coordination  of  Matteo 
Governatori and Matteo Salto by Narcissa Balta, Paolo Battaglia, Barbara Bernardi, Peghe Braila, Nicolas 
Carnot,  Francisco  de  Castro,  Ioana  Diaconescu,  Roland  Eisenberg, Miroslav  Florian,  Pierre  Gaudillat, 
Ombeline Gras, Oskar Greveshmul, Peter Harvan, Alexandra Hild, Renata Hruzova, Anna Iara, George-
Marian  Isbasoiu,  Jonas  Jensen,  Julda  Kielyte,  Mitija  Kosmrl,  Milan  Lisicky,  Natalie  Lubenets,  Janis 
Malzubris,  Anton  Mangov,  Balazs  Parkanyi,  Nicolas  Philiponnet,  Wolfgang  Pointner,  Savina Princen, 
Bartosz Przywara, Karl Scerri, Monika Sherwood, Jaroslav Snajdr, Peter Soidla, Vladimir Solanic, Ingrid 
Toming, Thomas  Usher,  Henk  van  Noten,  Samuel  Whittaker,  Pavlina  Zakova,  Andreas  Zenthofer and 
benefitted  from  comments  by  Stefan  Ciobanu, Bozhil  Kostov,  Carl  Emmerson (Institute  of  Fiscal 
Studies), Angeliki Stergiatou (Greek Ministry of Finance) and William Roos (French Treasury).

Tamas Gabor Szin was responsible for layout and IT support. David Yim provided statistical support for 
Part IV. Davide Osti provided assistance for Part III. Secretarial support was provided by Maja Trevisan.

The  report  benefitted  from  comments  and  suggestions  by  colleagues  in  the  Directorate-General  for 
Economic and Financial Affairs, in particular by Jan in't Veld, Julia Lendvai, Nicolas Carnot, Peer Ritter, 
as  well  as  by  other  services  of  the  Commission  and  by  Anke  Weber  and  Luc  Eyraud (International 
Monetary Fund, Fiscal Affairs Department) and Sandro Momigliano (Banca d'Italia). Data provision by 
Hansjörg Blöchliger (OECD), Bernhard Manzke and Joern Tenhofen (Deutsche Bundesbank) and Sandro 
Momigliano is gratefully acknowledged.

Comments on the report would be gratefully received and should be sent, by mail or e-mail to the editors:

Lucio Pench

European Commission
Directorate-General for Economic and Financial Affairs
Directorate for the macro economy of the euro area and the EU
Office BU-1 00-191
B-1049 Brussels
e-mail: lucio.pench@ec.europa.eu

or

Matteo Salto

European Commission
Directorate-General for Economic and Financial Affairs
Directorate for the macro economy of the euro area and the EU
Office BU-1 00-188
B-1049 Brussels
e-mail: matteo.salto@ec.europa.eu

ii

CONTENTS

Summary

Part I:

Current developments and prospects

Summary
1. Current developments and prospects

1.1.

1.2.

A stalling and differentiated recovery

Short-Term developments and prospects for the budget balance

1.3. Consolidation continues in the eu

1.4.

Short-term developments and prospects for public debt

1.5. Government revenue and expenditure: a WELL balanced consolidation
Implementation of the Stability and Growth Pact
2.1.

Introduction

The Excessive Deficit Procedure (EDP)
2.2.
Stability and convergence programmes
3.1. Macroeconomic scenarios

3.2.

3.3.

Fiscal consolidation

Debt implications

2.

3.

Part II:

Evolving budgetary surveillance

Summary
1.
2.

Introduction
The 2011 reform of the Stability and Growth Pact
2.1.

The reform of the preventive arm of the SGP

2.2.

The reform of the corrective arm of the SGP

3. National budgetary frameworks: minimum requirements and peer 

reviews
3.1.

A binding instrument: the Directive on national budgetary frameworks

3.2.

The peer review of national fiscal frameworks

4.

5.

Evidence from the Fiscal Governance database

3.3.
Proposal introducing enhanced monitoring and ensuring the 
correction of excessive deficit of the Member States in the euro 
area
The Stability Treaty and the fiscal compact
5.1.

The Treaty on Stability, Coordination and Governance : An intergovernmental 

initiative to strengthen budgetary discipline and economic policy 
coordination

5.2. Operationalising the Treaty - Ratification process and anchoring into EU law

1

9

11
14
14

15

17

18

20
22
22

23
29
29

32

41

59

61
64
68
68

72

83
83

85

88

92
105

105

107

Part III: Consolidation and dynamics of the multipliers. Are there 

counter-intuitive effects?

Summary

1.
2.

Introduction
Review of existing estimates of fiscal multipliers

111

113
115
117

iii

2.1.

2.2.

2.3.

2.4.

2.5.

A review of the literature on fiscal multipliers estimated by new Keynesian 
DSGE models

VAR-based fiscal multipliers in the literature

VAR estimates of output multipliers to government spending shocks

Fiscal multipliers in crisis periods

Effects of debt and deficit on government yield

2.6. Conclusion on review of value of multipliers

3.  Debt dynamics and effects from consolidations
Short-run effects of fiscal consolidations

3.1.

3.2. Medium-run effects of consolidation

3.3.

Introducing changes to government yields into the analysis

3.4. Country analysis 2011-2020

4. Conclusions
Annex 1. Assumptions underlying the baseline scenario in section III.5

Part IV:

Fiscal decentralisation in the EU - main characteristics and 

implications for fiscal outcomes

Summary
1. Main trends of fiscal decentralisation in the EU

1.1.

1.2.

1.3.

1.4.

1.5.

Introduction

Decentralisation of expenditures

Decentralisation of revenue sources

Expenditure vs. tax decentralisation, vertical fiscal imbalances

Deficit and debt of subnational governments in the EU

1.6. Conclusions

2. National fiscal decentralisation arrangements - a description 

based on country-specific analysis
2.1.

The content of country-specific analysis on fiscal decentralisation 
arrangements

2.2.

A summary of main patterns of fiscal decentralisation in the EU based on 

country-specific analysis

3.

2.3. Conclusions
Fiscal decentralisation and fiscal outcomes
3.1.

Introduction

3.2.

3.3.

3.4.

3.5.

Fiscal decentralisation and fiscal outcomes: theoretical considerations

Stylised facts on decentralisation and fiscal outcomes

Regression analysis of the impact of decentralisation on fiscal balance

Fiscal rules, decentralisation and fiscal outcomes

3.6. Conclusions

Annex 1. National fiscal decentralisation arrangements in the EU -

country fiche
A1.1. Belgium

A1.2. Bulgaria

A1.3. Czech Republic

A1.4. Denmark

A1.5. Germany

A1.6. Estonia

A1.7.

Ireland

iv

117

121

125

129

131

133
136
136

139

142

150
158
160

161

163
165
165

165

173

176

179

181

183

183

183

191
192
192

192

194

199

204

207

209
209

211

215

218

222

232

235

A1.8. Greece

A1.9. Spain

A1.10. France

A1.11. Italy

A1.12. Cyprus

A1.13. Latvia

A1.14. Lithuania

A1.15. Luxembourg

A1.16. Hungary

A1.17. Malta

A1.18. The Netherlands

A1.19. Austria

A1.20. Poland

A1.21. Portugal

A1.22. Romania

A1.23. Slovenia

A1.24. Slovak Republic

A1.25. Finland

A1.26. Sweden

A1.27. United Kingdom

Annex 2. Results of regressions on the impact of fiscal decentralisation 

on government expenditures and revenues

Part V:

Resources

1. Abbreviations and symbols used
2. Glossary
3.
4.

References
Useful Internet Links

LIST OF TABLES

237

240

246

251

255

257

260

264

265

269

270

272

276

279

283

284

286

288

292

294

300

301

302
307
315
324

I.1.1.
I.1.2.
I.1.3.

I.1.4.
I.1.5.
I.2.1.
I.2.2.
I.2.3.
I.3.1.

I.3.2.
I.3.3.

I.3.4.

II.2.1.

Budget balances in EU Member States (% of GDP)
Euro area - General government budget balance (% of GDP)
Composition of changes in the government debt ratio in EU Member States (% 
of GDP)
Euro area - Government revenue and expenditures (% of GDP)
Government revenue and expenditure (% of GDP)
Overview EDP steps - Euro area Member States
Overview EDP steps - Non-euro area Member States
Overview EDP steps - Greece
Budgetary developments in the Member States up to 2014 according to the 
SCPs
Fiscal adjustment for EU 27: 2012 SCPs vs. Spring 2012 EC Forecasts
Debt-stabilizing primary balance for Member States whose debt-to-GDP ratio is 
projected to exceed the 60% threshold in 2015
Minimum adjustments over the transition period for Member States whose debt-
to-GDP ratio exceeds the 60% threshold in 2011
Expenditure benchmark in relation to MTO achievement

16
17

20
21
21
26
27
28

38
42

44

45
70

v

II.4.1.

III.2.1.
III.2.2.
III.2.3.
III.2.4.
III.3.1.
III.3.2.
III.3.3.
III.3.4.

III.3.5.

III.3.6.
IV.1.1.
IV.1.2.

IV.1.3.

IV.1.4.
IV.1.5.
IV.1.6.
IV.3.1.

IV.3.2.

IV.3.3.

IV.3.4.

IV.3.5.

IV.3.6.

IV.3.7.

IV.A1.1.

Reporting obligations for euro area Member States subject to the excessive 
deficit procedure
Expenditure VAR-based multipliers
Tax VAR-based multipliers (To an increase in net taxes)
Cumulative output multipliers to spending shocks
Resuming the strand of literature on fiscal consolidation and the cost of debt
Critical first year multipliers in EU Member States at constant interest rates in 2011
Range of parameters used to assess the sensitivity of the critical year n*
Potential impact of parameter changes on n*
Potential impact of a 1% of baseline GDP consolidation on the critical year and 
return to 2011 debt levels - LP
Potential impact of a 1% of baseline GDP consolidation on the critical year and 
return to 2011 debt levels - HP
Parameter values assumed for the simulation
Share of subnational government expenditure in the EU (in %)
Percentage of subnational government expenditure by function (% of total 
general government expenditure by cofog) - 2009
Percentage of subnational government expenditure by economic function -
2010
Share of subnational government revenues in the EU
Coverage of subnational government expenditure by subnational tax revenues
Subnational government deficit vs. deficit of general government (% of GDP)
Fiscal outcomes of general government (% of GDP), averages for observations 
with low and high values of different indicators of fiscal decentralisation (EU27 
Member States, 1995-2010 period)
Conditional means of selected indicators of fiscal decentralisation for high vs. 
low expenditure and revenue decentralisation
Conditional means of fiscal outcomes of general government (% of GDP) for 
low vs. high expenditure decentralisation, controlling for low vs. high values of 
other decentralisation indicators (by column) - EU-27 Member States, 1995-2010
Regressions on the effect of fiscal decentralisation on the primary balance of 
general government (LSDVC estimator, EU27, 1995-2010)
Results of regressions with the primary balance of general government as 
dependent variable and decentralisation by government function and by 
economic function included among regressors (LSDVC estimator, EU27, 1995-
2010)
Strictness of fiscal rules applying to subnational governments, averages for 
observations with low and high values of different indicators of fiscal 
decentralisation (EU27 Member States, 1995-2010 period)
Results of regressions on the effect of fiscal decentralisation and fiscal rules on 
primary balance and expenditures of the general government (EU27, 1995-
2010, LSDVC estimator)
Subnational government competencies in Italy following the 2001 constitutional 
reform
Local government in England - Functions and powers

IV.A1.2.
IV.A2.1. Results of regressions with primary expenditure of general government as 

dependent variable (LSDVC estimator, EU27, 1995-2010)

IV.A2.2. Results of regressions with total revenues and tax burden of general government 

as dependent variable (LSDVC estimator, EU27, 1995-2010)

vi

102
123
124
128
133
138
149
150

150

151
152
166

170

172
174
177
177

195

196

197

202

203

205

206

253
296

300

300

LIST OF GRAPHS

I.1.1.
I.1.2.
I.3.1.
I.3.2.
I.3.3.
I.3.4.
I.3.5.
I.3.6.

I.3.7.

I.3.8.
I.3.9.
I.3.10.

I.3.11.

I.3.12.

II.2.1.
II.2.2.

II.2.3.
II.2.4.
II.3.3.
II.4.1.
III.2.1.
III.3.1.
III.3.2.
III.3.3.
III.3.4.

III.3.5.

III.3.6.

III.3.7.
III.3.8.
III.3.9.

III.3.10.
IV.1.1.

IV.1.2.

IV.1.3.

IV.1.4.

Real GDP growth developments
Short-term fiscal impact of the crisis - general government debt
Growth assumptions (EU)
Growth assumptions (euro area)
Sectoral net lending and relative ULC changes in the SCPs (2011–2015)
Sectoral net lending and relative ULC changes in the COM forecast (2011-2013)
Planned changes in government deficits over 2011–2015 in the SCPs
Planned changes in the structural government deficits over 2011–2015 in the 
SCPs and the MTOs
General government deficit for 2013: decomposition of the gap between the 
SCP projections and the COM forecasts
Envisaged variation in expenditure and revenue ratio 2011-2015*
2011-2015 planned changes in general government debt
Comparing average 2005-2008 interest-growth differential and debt ratio in 
2004 in Euro Area Member States
Comparing average 2010-2013 interest-growth differential and debt ratio in 
2009 in Euro Area Member States
General government debt for 2013: decomposition of the gap between the 
SCP projections and the COM forecasts
Legal steps under the preventive arm of the SGP as of 13 December 2011
Steps preceding the preparation of a Report under Article 126(3) assessing a 
possible breach of the debt criterion
The legal steps of the corrective arm of the SGP as of 13 December 2011
The legal steps of the corrective arm of the SGP as of 13 December 2011
The MTBF index in the EU27, 2009 and 2010
The new fiscal governance framework in the euro area
VAR responses to a government spending shock
Debt ratio and critical multipliers
Critical year and underlying debt trend
Stylised paths of GDP impulse responses used in the simulations
Debt dynamics (baseline steady state, b0 = 100%), no effect on interest rates –
with low persistence
Debt dynamics (baseline steady state, b0 = 100%), no effect on interest rates –
with high persistence
Confidence effects on debt dynamics - a) low persistence , b) high persistence 
- first-year m=1,5
Debt evolution with myopic financial markets (h=1) – low persistence
Debt evolution with myopic financial markets (h=1) – high persistence
Debt evolution as a function of market horizon- a) low persistence , b) high 
persistence - first year m=1,5
The effect of myopia on debt projections
Subnational government expenditure (% of general government expenditure in 
2010)
Change in subnational government expenditure between 1995 and 2010 
(percentage points of general government expenditure)
Subnational government expenditure as a percentage of general government 
expenditure and government expenditure as a percentage of GDP (2010)
Subnational government expenditure by function (% of general government 
expenditure by cofog) - EU average for 2002 and 2009 and minimum and 
maximum for 2009

15
19
30
30
31
31
33

34

39
40
42

43

43

44
71

74
82
83
90
101
127
138
140
141

141

142

143
146
147

148
148

167

167

168

169

vii

IV.1.5.

IV.1.6.
IV.1.8.
IV.1.7.
IV.1.9.

Subnational government percentage of investment expenditure by the general 
government (1995 and 2010)
Subnational government revenues (% of general government revenues - 2010)
Decomposition of tax revenues of subnational governments (2010)
Sources of subnational government revenue (2010)
Coverage of subnational governments' expenditure by subnational tax 
revenues (1995 and 2010)

IV.1.12. Coverage of subnational government expenditures by transfers (1995, 2007 and 

2010)
Subnational government deficits (% of GDP), 1999 vs. 2010
Subnational government debt (% of GDP), 2007 vs. 2010

IV.1.10.
IV.1.11.
IV.1.12. Coverage of subnational government expenditures by transfers (1995, 2007 and 

2010)

LIST OF BOXES

I.3.1.
I.3.2.
II.2.1.
II.2.2.
II.4.1.
II.4.2.

II.4.3.

The expenditure benchmark
Overview of Council recommendations relating to fiscal policy
The transition period
Computing the "adjusted fiscal effort"
Stability Bonds
Extract from Article 5 of the proposed Regulation on enhanced monitoring: 
Information to be presented by Member States in their draft budgetary plan
The proposed Regulation on enhanced surveillance for Member States 
experiencing severe difficulties with regard to their financial stability or for those 
in receipt of financial assistance
Common principles for national fiscal correction
Debt evolution as a function of consolidation

II.5.1.
III.3.1.
IV.A1.1. Equalisation mechanisms across subnational entities in France*
IV.A1.2.

Subnational governments' institutional reform under the Economic Adjustment 
Programme of Portugal

172
174
175
175

178

179
179
180

180

35
46
75
82
93

99

103
109
153
249

282

viii

EDITORIAL

Four years on from the onset of the crisis, we still find ourselves in very challenging economic times. The 
economic recovery has not lived up to the expectations that existed at the time of the publication of last 
year's report. The EU is entering recession again and concerns over debt sustainability in some Member 
States,  signalled  by  persistently  high  spreads  in  their  sovereign  bond  yields  continue  to  dominate  the 
policy agenda. The vicious circle between sovereign debt and a still fragile banking sector added to the 
vulnerability. 

Member  States  remain  committed  to  the  consolidation  of  their  public  budgets,  both  in  this  and  coming 
years, as is evident from their medium-term plans. These show that despite the worsened macroeconomic 
outlook, Member States are sticking with their consolidation plans and will continue closing their deficits 
this year and next. The composition of consolidation in terms of the expenditure/revenue split and types 
of measures that are being implemented is broadly consistent with a credible consolidation supportive to 
medium-term growth.  This is discussed in Part I of the Report. It shows that the significant increase in 
debt  ratios  seen  since  the  start  of  the  crisis  alongside  the  still  sizeable  deficits  mean  that  there  is  little 
scope for many Member States to ease off the fiscal tightening, despite the extra pressure that this might 
put  on  already  faltering  growth.  Amid  the  debate  about  how  best  to  continue  to  respond  to  the crisis, 
concerns  have been raised that further fiscal consolidation amid  weak  growth prospects  may  have self-
defeating effects on debt ratios. Part III presents a detailed analysis that highlights how such effects may 
arise  but  concludes  that  such  cases  are  rather  theoretical  and  anyhow  short-lived  under  reasonable 
economic assumptions. The analysis shows that for a large negative response of growth to consolidation –
as captured by a high value of the fiscal multipliers – such undesired effects would be quickly reversed
unless these multipliers have a high persistence. This happens in cases where the fiscal adjustments are 
repeatedly non-credible or if effects on interest rates are large and negative, contrary to what is normally 
expected  in  consolidations. So,  in  order  for  the  consolidation  driven  increase  in  debt  to  persist,  a high 
degree  of  financial  market  myopia alongside  an  implausible  negative  reaction  of  interest  rates  to 
consolidation  are required.  Such  a  situation  would  happen  if  factors  that  cannot  be  modelled  influence 
heavily  the  reaction  of  financial  markets,  for  example  if  financial  markets  come  to  believe  that 
consolidation will be reversed based on the consideration that the short-term negative impact on growth 
will  make  consolidation  too  unpopular. Simulations  based  on  projections  for  the  EU  Member  States
confirm the expectation that any negative response of debt to consolidation will be quickly reversed, even 
for high debt countries.

As  part  of  the  response  to  the  crisis,  the  EU  has  introduced  a  major  overhaul  of  the  EU  system  of 
economic governance. Economic and budgetary surveillance in the EU – and especially in euro area – has 
been  largely  reformed  with  the  adoption  of  the  legislative  package  known  as  the  "Six  Pack",  which 
entered into force at the end of 2011. The new provisions that now apply put conditions on the debt level 
at the heart of the Stability and Growth Pact and will ensure that reducing the high public indebtedness 
that the crisis will have left behind is a key priority in Member States' fiscal policy setting. In addition, 
the introduction of an expenditure benchmark and the possibility of financial sanctions in the preventive 
arm of the Stability and Growth Pact will provide a framework that supports better fiscal policy-making 
when better economic times return, to ensure that the Member States public finances return to a position 
of  underlying  health.  Despite  these  changes,  increasing  evidence  of  the  scale  of  the  spillovers  between 
euro area countries has given impetus to the drive to further strengthen euro area economic governance. 
In November 2011, the Commission took a first step in this direction, proposing enhanced monitoring of 
budgetary  policies  of  all  euro  area  Member  States  as  well  as  specific  surveillance  procedures  for  those 
experiencing financial stability risks. The Commission's proposals were followed by the signature of an 
intergovernmental Treaty by 25 Member States in March this year, committing the contracting parties to 
ambitious fiscal discipline including an appropriate mirroring of the core EU budgetary rule – namely, the 
requirement that each country's structural balance should be at its Medium-Term Budgetary Objective –
in national legislation. The new architecture is not that of a perpetual fiscal austerity: after an initial effort 
to put their fiscal house in order, Member States have to ensure that their expenditure is financed. This 
should be normal practice to ensure sustainability of public finances but poses no constraints on the size 
or type of expenditure that governments undertake. All that is required is that there are sufficient revenues 

ix

to fund the spending programmes. The Report describes developments in budgetary surveillance in Part 
II. 

In  a  phase  of  consolidation,  there  are  concerns  that  the  increasing  devolution  of  tasks  from  central  to 
subnational  tiers  of  government  may  jeopardise  aggregate  fiscal  discipline.  Part  IV  of  the  Report 
characterises fiscal decentralisation arrangements in the EU from both the expenditure and revenue side, 
based  on  Eurostat  data  and  country-specific  descriptions.  It  shows  through  econometric  analysis  that 
fiscal  decentralisation  is  not  in  itself  harmful  for  fiscal  discipline,  as  long  as  subnational  governments 
predominantly finance their expenditures with their own taxes and fees rather than with transfers from the 
central  government.  Policy  concerns  should  therefore  not  focus  on  decentralisation  as  such  but  on 
decentralisations that are not accompanied by subnational responsibility on the revenue side. It is not who 
undertakes the spending that is important, but whether those spending are also those who are accountable 
to taxpayers.

The reforms of  fiscal  governance adopted and proposed make the  necessary budgetary consolidation at 
Member States' level more credible and equip the EU with much better tools to appropriately respond to 
future  crises.  Moreover  financial  backstops  have  been  put  in  place  since  2010  and  progressively 
strengthened to guarantee the stability of the euro area, culminating in the adoption of a permanent crisis 
resolution  mechanism, the European Stability Mechanism,  in February of this  year. While far-reaching, 
these  measures  still  cannot  solve  all  the  current  difficulties  of  the  EU  economies.  While  sound  public 
finances  are  and  will  remain a  cornerstone  of  the  European  Union's  policy  response  to  the  crisis, 
complementary action on the fragile financial system is necessary. In this regard, the Euro Area Summit 
of 29 June affirmed that it is imperative to break the vicious circle between banks and sovereigns. These 
are all steps towards the achievement of a genuine economic and  monetary union,  for which a  specific 
and time-bound road map is being prepared.

Marco Buti

Director-General
Economic and Financial Affairs   

x

SUMMARY

Recent economic 
developments have 
been worse than 
expected…

Following  the  deep  contraction  the  EU  economy  went  through  in  2009 
modest growth had returned in the third quarter of 2009 and with it came an 
expectation that albeit-slow return to normality had begun. While this seemed 
to be the case in 2010, by the end of 2011, the outlook had taken a downward 
turn. The expectation  now is  that real GDP  will stagnate or go into  slightly 
negative  territory  this  year  before  picking  up  again  in  2013 based  on  an 
appeasement  of  uncertainties  linked  to  the  situation  in  Greece  and  Spain. 
While there are some encouraging signs on the  global stage in terms of  the 
outlook  for  the  world  economy,  the  continued  need  for  profound  macro-
economic adjustment as a consequence of the imbalances that have built up 
during the last decade in the  public and private sector  weigh  heavily on the 
growth outlook.

…and the differences 
across countries are 
particularly marked

The  macroeconomic  environment  is  thus  characterized  by  considerable
variation  within  the  European  Union. In  2011,  economic  growth  exceeded 
3%  in  several  Member  States,  but  was  negative  in  others  like  Greece, 
Portugal and Slovenia. 

Despite disappointing 
growth developments, 
deficits have been 
reduced thanks to 
decisive expenditure-
based fiscal 
consolidation plans….

Despite  weaker  growth  in  2011  than  forecast  a  year  ago,  overall  public 
deficits were reduced thanks to strong consolidation efforts. In the euro area, 
the  average  general  government  deficit  fell  from  6.2%  of  GDP in  2010  to 
4.1% of GDP in 2011, and a similar improvement also occurred in the EU27. 
Around half of this improvement was structural, indicating that consolidation 
measures and economic  growth played a roughly equal role in reducing the 
deficit.  The  improvements  in  budgetary  positions  in  the  euro  area  were
primarily expenditure-based.

…and are expected 
to shrink further in 2012 
and 2013

The budgetary plans 
submitted by Member 
States show continued 
structural tightening 
over 2012 and 2013…

In  the  European  Union,  budget  balances  vary  widely.  While  the  highest 
deficit amounted to 13% of GDP (Ireland), two countries were able to bring 
their  deficit  below  the  3%-of-GDP  Treaty  limit  in  a  sustainable  manner 
(Bulgaria  and  Germany).  Yet,  twenty  one  Member  States  remain  subject  to 
the Excessive Deficit Procedure. 

Overall,  the  reduction  in  deficits  is  forecast  to  continue  in  2012  and  2013. 
According to the Commission services' Spring 2012 forecast, public deficit is 
set to shrink to 3.8% of GDP in 2012 and then to fall further to 3.4% in 2013 
for  the  EU  as  a  whole.  The  combination  of  continued  falling  deficits 
alongside a widening output gap for 2012 means that overall the fiscal stance 
is  expected  to  turn  pro-cyclical  this  year,  before  turning  counter-cyclical 
again in 2013 with the anticipated return of stronger growth, although in an 
environment of large and negative output gap. 

In  view  of  the  substantial  debt  increase  induced  by  the  crisis,  the  Member 
States plan for pursuing ambitious fiscal consolidation plans. Their Stability 
and  Convergence  Programmes  (SCPs),  which  were  submitted  to  the 
Commission and Council in  Spring as part of the European Semester, show 
that 
they  have  broadly  the  same  expectations  on  growth  than  the 
Commission.  They  broadly  maintain  their  nominal  fiscal  targets in  spite  of 
the  foreseen  protraction  of  the  cyclical  slowdown  currently  underway.  On 
aggregate,  both  the  EU27  and  the  euro  area  are  projecting  that  they  will
significantly  improve  their  fiscal  positions  every  year  between  2011  and 
2015, with the time profile of the consolidation being relatively front-loaded.

1

European Commission

Public finances in EMU - 2012

…with the 
composition of the 
consolidations being 
broadly supportive of 
medium-term growth. 
This is in line with the 
overall long-term 
European growth 
strategy.

Growth affects deficits 
– but consolidations 
also affect growth –
these two 
countervailing effects 
need to be balanced 
through an adequate 
design for 
consolidation.

The crisis years have 
driven debt up in the 
EU…

2

This  overall  pattern  conceals  considerable  variation  across  Member  States, 
with  Ireland,  Spain,  Italy,  Slovenia,  Bulgaria,  Latvia,  Lithuania,  Poland, 
Romania, and the United Kingdom showing the largest deficit reductions in 
their 2012 budgets.

The  consolidation  plans  set  out  in  the  SCPs  rely  on  large  structural 
tightening.  The  average  structural  balance  in  both  the  EU27  and  euro  area 
should fall by over 3 percentage points of GDP over the four years from 2011 
to 2015. For a number of Member States, the pace of consolidation tends to 
be more moderate as they move out of excessive deficits and embark on the 
adjustment  path  towards  their  medium-term  objective  (MTO).  The  marked 
structural improvement of around 1½ percentage points of GDP expected for 
2012,  as  opposed  to  the  planned  structural  tightening  close  to  1  percentage 
point in  last  year's  SCPs,  indicates  that  the  Member  States  have  generally 
undertaken
structural  adjustments,  while  macroeconomic 
conditions are less favourable. 

additional 

in 

that  plays  a  role 

It is evident that economic growth is a key concern: this is the reason why the 
EU, in line with its Europe 2020 growth strategy, proposed in the context of 
the  European  Semester,  country-specific  recommendations  for  the  reforms 
that need to be undertaken to deliver stability, growth and jobs. However, the 
weak  growth  environment  poses  a  challenge  to  fiscal  consolidation.  One 
element 
the  relationship  between  growth  and 
consolidation  is  the  composition  of  the  consolidation.  Consolidations  based 
on  expenditure  rather  than  revenues  tend  in  general  to  be  more  lasting  and 
more growth-supporting in the medium-term, but more recessive in the short-
term.  Indeed,  the  improvements  in  the  budgetary  positions  in  the  euro  area 
between  2010  and  2011  have  been  primarily  engineered  via  expenditure 
restraint.  However,  this  has  been  also  achieved  through  phasing  out  the 
stimulus  programmes  of  2009,  including  reductions  in  public  investment.  
According to plans set out in the SCPs, Member States project to base further 
fiscal consolidation on expenditure cuts, thus aiming at making it as durable 
as possible.

The need to restore the credibility in the public finances and the danger posed 
by  large  deficits  and  debts  are  obvious  and  even  more  so  now  that  growth 
prospects are looking weak again. However, while weak growth causes larger 
deficits,  the  effect  of  consolidation  on  growth  must also  be  taken  into 
account. As a country consolidates, in the short-term aggregate demand falls 
and  this  has  a  negative  impact  on  growth  before  the  positive  impacts  from 
reduced interest payments and reduced taxation kicks in. 

However, consolidation remains a must in view of the effect of several years 
of  the  worst  economic  and  financial  crisis  since  World  War  II  on  overall 
government debt figures. Deficits may be falling on average, but they remain 
significant, and public  support to the  financial  system continues to drive  up 
public debt. In 2011, the average debt-to-GDP ratio in the euro area reached 
88% of GDP – some 20 percentage points higher than at the start of the crisis 
in  2007.  Portugal,  Spain,  Greece  and  Ireland  saw  the  highest  increases  in 
2011.  Further  expected  increases  in  debt  in  2012  and  2013  point  to  a  euro 

area debt to GDP ratio of 92.6% of GDP by 2013, with a possibility of higher 
levels resulting from any further public interventions in the financial sector.

…to a point where 
some countries have 
faced market censure 
over their perceived 
ability to repay their 
debt.

A number of countries have faced strong pressure from financial markets, as 
doubts  about  their  ability  to  finance  their  increased  debt  have  led  to 
unprecedented  spreads  on  the  interest  rates  on  their  sovereign  debt.  Within 
the  euro  area,  Greece,  Ireland  and  Portugal  have  been  granted  financial 
assistance, enabling them to access funds from outside the markets, subject to 
strict conditionality requirements. The case for strong and sustainable public 
finances  no  longer  needs  to  be  made  – the  events  of  recent  times  make  the 
case for it evident.

The difficulty some 
countries have faced 
in accessing liquidity 
has led to the creation 
of financial 
backstops…

…together with 
regulation for financial 
markets and more is in 
the pipeline

The  aggravation  of  market  tensions  for  some  euro  area  countries  led  to  the 
creation of financial backstops of last resort in order to safeguard stability of 
the euro area. The temporary firewalls that  were gradually developed in the 
course  of  2010 are  currently  providing  financial  support  to  Greece,  Ireland 
and Portugal. At the end of 2010, the European Council decided to establish a 
permanent  crisis  resolution  mechanism.  Following  technical  and  political 
decisions  to  enhance  the  mechanism's  flexibility,  euro  area  Member  States 
signed  a  Treaty  establishing  the  European  Stability  Mechanism  (ESM)  in 
February  2012.  The  strict  conditionality  attached  to  the  financial  support 
provided  by  all  these  mechanisms  implied  a  significant  strengthening  of 
economic and fiscal surveillance on the Member States concerned.

The  supervisory  and  regulatory  framework  of  the  banking  system  also 
underwent  significant  reforms.  A  new  EU  financial  supervisory  framework 
became  operational  in  January  2011.  In  response  to  G20  commitments,  the 
EU continues  its  financial  regulation  programme  notably  by  strengthening 
the capital requirements for banks and by presenting a European framework
for  bank  recovery  and  resolution.  The  proposed  framework  sets  out  the 
necessary  steps  and  powers  to  ensure  that  bank  failures  across  the  EU  are 
managed in a way which avoids financial instability and minimises costs for 
taxpayers.  Moving  towards  a genuine  banking  union  based  on  a  single 
banking  supervision  mechanism,  the  June  29  Euro  Area  Summit  confirmed 
that the Commission would present proposals to that effect.

The crisis led to major 
overhaul of EU 
economic and 
budgetary 
governance 

A major overhaul of the EU economic governance framework was proposed 
by the Commission in September 2010 and adopted by European Parliament 
and  Council  in  the  second  half  of  2011  (the  so-called  'Six  Pack').  With  its 
entry  into  force  in  December  2011,  the  EU  is  now  equipped  with much 
stronger rules than before the start of the economic and financial crisis.

The "Six Pack" sets up 
a new 
macroeconomic 
imbalances 
procedure… 

The Six Pack legislation has strengthened a wide range of existing aspects of 
economic  governance  and  introduced new  ones.  A  new  Macroeconomic 
Imbalances Procedure has been set  up to prevent or correct  macroeconomic 
imbalances to reduce the risks of their unwinding resulting in sudden rises of 
government  deficits  and  debt.  In  addition,  the  Six  Pack  introduced  wide 
reforms to the Stability and Growth Pact (SGP) which sets out the provisions 
according  to  which  the  Treaty  requirements  to  ensure  fiscal  discipline  are 
implemented. The SGP contains two arms – the preventive and the corrective 
– with  the  former  setting  the  requirements  for  policy-making  under  normal 
circumstances and the latter dealing with the consequences of gross errors in 
fiscal policy making.

Summary

3

European Commission

Public finances in EMU - 2012

… reforms both the 
preventive and 
corrective arms of the 
Stability and Growth 
Pact…

As a result of the Six Pack legislation, the adjustment towards the medium-
term budgetary objective, which is the core concept of the preventive arm of 
the  SGP,  has  a  new  dimension,  easier  to  monitor.  While  compliance  was 
previously assessed by looking at a country's structural balance adjustment, a 
new  expenditure  benchmark  has  been  added,  which  will  allow  an  early 
detection  and  correction  of  unsustainable  expenditure  developments.  In  the 
years  prior  to  the  onset  of  the  crisis,    increases  in  expenditure  were  a  key 
reason for a persistence of weak underlying public finances, which then left 
Member States with insufficient fiscal space to support their economies when 
the  crisis  hit.    As  for  the  corrective  arm,  in  line  with  the  Treaty  envisaging 
both  a  deficit  and  a  debt  criterion  to  examine  compliance  with  budgetary 
discipline,  a  debt-reduction  benchmark  has  been  established  to  allow  the 
opening  of  an  excessive  deficit  procedure  (EDP)  on  the  basis  of  an 
insufficiently  diminishing  debt-to-GDP  ratio.  Preceded  by  an  assessment  of 
the relevant factors, an EDP can now be launched for Member States whose 
debt  exceeds  60%  of  GDP  and  does  not  comply  with  the  numerical  debt 
benchmark, even if they show a deficit below 3% of GDP.

….including a new 
toolbox of early and 
gradual enforcement 
mechanism…

The  Six  Pack  also  changed  the  provisions  for  enforcement  of  the  SGP.  For 
the euro area, enforcement is now ensured by an early and gradual system of 
financial  sanctions,  which  can  already  be  invoked  in  the  preventive  arm,  in 
the  case  of  inadequate  measures  to  correct  a  significant  deviation  from  the 
appropriate  adjustment  towards  the  MTO.  Previously,  the  possibility  of 
financial sanctions was limited to a very late stage of the corrective arm. 

…and introduced 
minimum 
requirements for 
national budgetary 
frameworks.

Since the euro area 
shares enhanced 
spillovers new 
proposals for 
additional surveillance 
requirements for euro 
area countries and a 
new procedure for 
countries 
experiencing severe 
difficulties, are 
underway.

The  Six  Pack  also  includes  a  new  Directive  on  national  budgetary 
frameworks  aiming  at  promoting  compliance  with  the  SGP  by  introducing 
minimum  standards  for  Member  States'  fiscal  frameworks.  Different 
frameworks  can  be  compatible  with  EU  budgetary  framework,  as  long  as 
their  quality  and  the  consistency  of  their  rules  is  conducive  to  the 
achievement  of  the  EU  obligations.  For  this  reason,  the  Directive  requires 
only  minimum  standards,  in  particular  with  regard  to  accounting  and 
statistics,  forecasting,  numerical  fiscal  rules,  medium-term  budgetary 
frameworks and transparency. But further initiatives have also been taken: in 
order to help countries that wish to go beyond the minimum requirements set 
out  in  the  Directive,  Member  States  also  participate  in  an  exchange  of 
information in order to help identify best practices and provide examples of 
how  to  build  stronger  frameworks  and  institutions.  The  first  meetings  took 
place in November 2011.  

With  the  sovereign  debt  crisis  intensifying  over  the  course  of  2011,  the 
consensus  in  favour  of  deeper  reforms,  both  at  national  and  EU  level,  to 
support  the  euro  area  gained  in  strength  and  momentum.  On  23  November 
2011,  the  Commission  proposed  two  regulations  further  strengthening  the 
budgetary  and  economic  policy  surveillance  requirements  and  processes  for 
the euro area. The first proposal aims at enhancing monitoring of budgetary 
policies  of  euro  area  Member  States,  including  provisions  specific  to  euro 
area  Member  States  subject  to  the  Excessive  Deficit  Procedure,  to  which 
stricter  monitoring  requirements  apply.  The  second  proposal  concerns  euro 
area  Member  States  experiencing  severe  difficulties  with  regard  to  their 
financial stability or receiving a financial assistance on a precautionary basis. 

The  consensus  for  mirroring  EU  rules  at  national  level  is also  behind  the 

4

signature  of  the  Treaty  on  Stability  Coordination  and  Governance  (TSCG) 
that  was  signed  by  25  Member  States  (all  EU  countries  except  the  United 
Kingdom  and  Czech  Republic)  on  2  March  2012  and  that  is  currently 
undergoing the process of ratification. The TSCG commits participating euro 
area countries to the Fiscal Compact which reinforces the obligation to reach 
the  MTO  already  envisaged  by  the  preventive  arm  of  the  SGP  through 
national rules and automatic corrective mechanisms.

The  adoption of  these  initiatives,  has  not,  of  course, solved  the  debt  crisis. 
Whatever  the  extent  of  the  improvement,  a  reform  of  the  economic 
governance framework cannot suddenly solve a crisis which is fundamentally 
a  (private  and  government)  balance sheet  problem. Overcoming  the  current 
crisis  requires  deleveraging  in  both  the  public  and  private  sectors.  The 
reforms  adopted  and  proposed  enhance  the  credibility  of  the  planned  fiscal 
adjustment  and  thus  reduce  its  negative  short  term  impact  on  real  GDP 
growth and set up the framework for better policy-making in the years when 
growth has returned. 

It has been however claimed in some corners that there are circumstances in 
which  consolidation  can  lead  to  dynamics  where  consolidating  may  lead  to  
increase rather than reduce debt-to-GDP ratios, at least in the short-term. In 
particular, such counter-intuitive dynamics would play out when the effect of 
a consolidation has such a negative impact on the economy, that government 
debt  as  a  share  of  GDP  increases  significantly  due  to  the  shrinking  of  its 
denominator (other things being equal, as GDP falls, debt as a share of GDP 
increases).  This  then  has  the  effect  of  increasing  the  interest  payments  in 
GDP  and  requires  further  consolidation  which  further  increases  the  debt 
burden. Part III shows that this would be the case only under very restrictive 
assumptions.

The main factors driving the success of a consolidation in reducing the debt 
ratio are the value of the fiscal multiplier (which measures the reaction of the 
economic  output  to  a  budgetary  expansion  or  consolidation  by  the 
government)  and  the  reaction  of  sovereign  yields  to  consolidation.  The  size 
of  first-year  multipliers  is  larger  if  the  fiscal  consolidation  is  based  on 
government expenditures – and government investment in particular – if the 
measures  taken  are  not credible  and  temporary,  if  agents  are  financially 
constrained and if the monetary policy stance is such as unable or unwilling 
to reduce real interest rates along with the fiscal shock. The negative output 
effects  of  consolidations  are  larger  if  consolidations  are  implemented  at  the 
same  time  worldwide.  The  composition  of  consolidation  has  an  impact  on 
long-term output with tax-based consolidations  less supportive of  long-term 
growth.

In the current juncture 
consolidation is 
inescapable in many 
EU Member States.

The success or failure 
of a consolidation 
depends on the 
reaction of the 
economy and on the 
nature of the 
consolidation pursued.

Estimating the 
parameters for the EU 
economies shows that 
counterintuitive 
effects of 
consolidation on debt 
dynamics are 
unlikely….

However,  there  is  a  growing  understanding  that  fiscal  multipliers  are  non-
linear and become larger in crisis periods due to uncertainty about aggregate 
demand  and  credit  conditions,  the  presence  of  slack  in  the  economy,  the 
larger  share  of  consumers  that  are  liquidity  constrained,  and  to  the  more 
accommodative  stance  of  monetary  policy.  Given  these  findings,  it  is 
reasonable  to  suspect
that  in  the  present  juncture  the  multipliers  for 
composition-balanced permanent consolidations are higher than normal. The 
simulations conducted show that it cannot be excluded that counter-intuitive 
effects  on  the  debt  ratio may arise  under certain,  very  specific,  strong 

Summary

5

European Commission

Public finances in EMU - 2012

…and even so, they 
would be short-lived

Consolidation efforts 
concern all the 
different levels of the 
general 
government…

…and the recent 
increases in the 
decentralisation of 
government functions 
can make this more 
difficult, depending 
on the exact set-up of 
the relationship 
between central and 
subnational 
government.

assumptions. Such short-term effects are countered if the immediate reaction 
of interest rates to consolidation is very large.

These effects, however, can only arise, if several factors play out at the same 
time: the effects of consolidation on GDP would last various years, the deficit 
reduction  would  induce  a  large  increase  on  average  effective  interest  rates 
(contrary  to  what  is  normally  expected  and  estimated  in  consolidations)  the 
increase in risk premia induced by a higher observed debt ratio are ten times
the average estimates and, finally, financial markets would suffer from a high 
degree  of  myopia.  Simulations  based  on  projections  for  the  EU  Member 
States  yield  the  result  that  given  these  extreme  assumptions,  such  debt-
increasing effect of consolidations would in general be short-lived. 

Consolidation  needs  within  the  European  fiscal  framework  are based  on 
general  government  balance,  which  is  the  appropriate  level  as  overall debt 
sustainability is the key element of the Stability and Growth Pact.  This is the 
reason why budgetary targets set within the EU fiscal surveillance framework 
apply  to  the  whole  of  general  government.  However,  the  responsibility  for 
their  achievement  rests  on  central  government  only. In  recent  years,  EU 
policymakers  have  increasingly  raised  the  concern  that  the  behaviour  of 
the 
subnational  governments  may  be  one  of 
achievement of budgetary targets at general government level. The necessity 
of  consolidation  and  the  implementation  of  minimum  requirements  for 
national  budgetary  framework  have  given  prominence  to  the  necessity  of 
designing carefully fiscal rules for subnational authorities within EU Member 
States, especially against the trend towards increasing fiscal decentralisation 
across most of the EU from both the expenditure and revenue sides.

the  factors  hindering 

Part  IV  documents that,  albeit  with  some  cross-country  heterogeneity,  this 
trend concerns also traditionally centralised countries, with common patterns 
emerging with respects to the functions that are more frequently devolved to 
subnational tiers. In  many cases, functions that  used to be centralized along 
with expenditures that have a markedly local dimension have been devolved 
– fully  or  in  part  – to  subnational  tiers  of  government.  However  fiscal 
responsibility  has  not  always  followed,  as  transfers  from  the  central 
government  tend  to  predominate  over  taxes  as  the  main  revenue  source  of 
subnational  governments  across  the  EU  and  truly  autonomous  subnational 
taxes are quantitatively important mainly in the more decentralised Member 
States.  However  subnational  governments  are  often  subject  to  fiscal  rules, 
but,  generally,  default  of  subnational  entities  in  fiscal  distress  is  de  facto
ruled  out,  although  central  government  'bailout'  often  comes  at  the  price  of 
much tighter central control on subnational policies.

6

Fiscal decentralisation 
can adversely affect 
fiscal balances if 
financed 
predominantly 
through transfers from 
the central 
government and if not 
matched by 
subnational 
responsibility on the 
revenue side.

Part IV also investigates the relationship between fiscal decentralisation and 
fiscal  outcomes  of  general  government  in  the  EU  through  econometric 
analysis.  It  appears  that  fiscal  decentralisation  is  not  harmful  for  budgetary 
discipline at the general government level per se, although it is likely to have 
an  adverse  effect  if  predominantly  financed  by  transfers  from  the  central 
government  and  if  not  matched  by  subnational  governments  having  the 
responsibility  for  financing  the  expenditures  through their  own  taxes  and 
fees. This is in line with theoretical predictions underlining the risk of a 'soft-
budget constraint' associated with a high reliance on transfers. Therefore, the 
policy  concerns  over  possible  adverse  implications  on  budget  balances 
should  not  focus  on  decentralisation  as  such  but  on  a  'bad'  design  of 
decentralisation, i.e. one  which is  not accompanied by  subnational  financial 
to  subnational 
responsibility.  With  respect 
governments, borrowing rules appear to partly counteract the adverse effect 
of transfers on fiscal balances.

to  fiscal  rules  applying 

Summary

7

Part I
Current developments and prospects

SUMMARY

The  recovery  which  had followed  the  worst 
economic crisis since World War II is now stalling 
with  the  euro  area  and  the  whole  EU  economy 
being  estimated  to  have  been  in  a  mild  recession 
over the last few months. After the deep recession 
in  2009  and  the  temporary  rebound  in  2010
followed  by  a  still  favourable  beginning  of  2011, 
GDP growth started to slow again in the course of 
2011.  In  particular,  the  final  weeks  of  the  year 
brought  about  sluggish  growth,  tensions  in  many 
sovereign  debt  markets  and  banking  sector 
fragility,  which  spread  over  the  first  months  of 
2012. GDP is expected to slightly decrease in 2012
in the euro area and to remain flat in the EU, with
higher growth of the rest of the world leading to a 
slow  recovery  as  of the  second  half  of  the  year, 
assuming the resolution of present uncertainties in 
the  sovereign  and  banking  markets.  Against  this 
background,  the  euro  area  summit  of  June  29 
stressed  the  necessity  to  break  the  vicious  circle 
between  banks  and  sovereigns  and  supported  a 
proposal  for  an  effective  single  supervisory 
mechanism for banks in the euro area allowing the 
European  Stability  Mechanism  (see  box  I.1.1)  the 
possibility to recapitalise banks directly relying on 
appropriate  conditionality.  The  introduction  of 
such  a  novelty  and  the  financial  support  to  Spain 
will help the return to financial stability.

However, growth developments in the EU are now 
diverging  more  strongly  across  Member  States 
than  in  previous  years.  In  2011,  GDP  growth 
ranged  from  high  positive  rates  of  over  3%  in 
several  Member  States  to  negative  growth  in 
others. GDP  growth  is  expected  to  be  widely 
differentiated  also  in  2012,  with  a  certain  number 
of countries going back to negative growth.

The public finances continue to be heavily affected 
by  adverse GDP  and  labour  market  developments
and  the  majority  of  EU  countries  posted  a  2011 
government  deficit  above  3%  of  GDP,  although 
Member  States  reduced deficits  substantially  in 
2011. The euro area headline deficit decreased by 
two  points  to  4.1%  of  GDP,  with  a  similar 
improvement  registered  in  the  EU  as  a  whole.
Within  the  euro  area,  all  Member  States  posted 
improvements,  with  the  exception  of  Cyprus  and 
Slovenia but  with  highly  differentiated  budgetary 
positions.  The  stronger budgetary  positions  in  the 
euro  area  were primarily  due 
lower 
expenditure-to-GDP ratio. 

to  a

risks 

According  to  the Commission  services'  Spring 
2012 forecasts, the improvements in the budgetary 
positions are  expected 
to  continue,  although 
remain  and  country-specific 
downside 
developments differ widely. The aggregate general 
government deficit for the euro area and the EU is 
expected  to  shrink by  0.9  percentage  points  to 
reach 3.1% of GDP (3.6% of GDP for the EU) in 
2012 with a further improvement in 2013, despite 
the  fact  that  the  additional  effect  of  high  interest 
expenditures  kicks 
in.  As  a  consequence  of 
continued structural fiscal tightening coupled with 
widening  negative  output  gaps,  in  several  EU 
Member  States  the  fiscal  stance  is  forecast  to  be 
pro-cyclical  in  2012,  albeit  to  a  very  different 
degree.

High budget deficits and overall modest real GDP 
growth  with public  interventions  in  the financial 
system continued to drive up public debt. In 2011 
the  debt-to-GDP  for  the  euro  area  amounted  to
88% (83.0% for  the  EU) 2.4 (2.8  for  the  EU) 
percentage points up on 2010. A further increase in 
debt  in  2012  to  92.6% of  GDP in  the  euro  area 
(87.3%  in  the  EU)  by  2013  is  projected in 
Commission  services'  Spring  2012 
forecast. 
Moreover  a  high  risk  remains  of  further  public 
intervention  in  the  financial  sector  in  certain 
finance  developments  and 
countries.  Public 
outlook in the euro area and in the EU are analysed 
in  Chapter  I.1. Consolidation  can  have  a  negative 
short-term 
impact  on  aggregate  demand,  as 
discussed  in  more  detail  in  Part  III.  However, 
consolidation  is  necessary  in  many  EU  Member 
States,  especially  those  under  a  macroeconomic-
adjustment  programme  or  those  under  heavy 
pressure  from  the  financial  markets  in  order  to 
avoid  dangerously  spiralling  interest  rates.  It  is 
therefore important that consolidation is done in a 
way 
the 
medium-term  and  accompanied  by  appropriate 
structural reforms. 

that  preserves  growth  prospects 

in 

Chapter  I.2  focusses on  the  excessive  deficit 
procedure  (EDP)  and  describes  the  developments 
in the application of the Stability and Growth Pact 
(SGP) in the first year following the major reform 
strengthening  EU  fiscal  governance  which  was 
approved  by
late  2011. 
Developments  in  this  area  reflect  the  fact  that  in 
2011  the  government  deficit  exceeded  the  3%  of 
GDP reference value in seventeen Member States.

legislator, 

the 

in 

11

European Commission

Public finances in EMU - 2012

The  Council  abrogated  the  Finnish  EDP  in  2011 
and the Bulgarian and the German EDPs in 2012.  

euro area and the EU27 should fall by over 3pps of 
GDP over the four years from 2011 to 2015. 

It is worth stressing that in the case of Hungary the 
Council took recourse in 2012, for the first time, to 
the  possibility  of  suspending  cohesion  fund 
commitments 
non-
compliance with its EDP recommendation. Such a 
decision  was  lifted  by  the  Council  upon  the 
that  Hungary  had  made  adequate 
conclusion 
progress 
the 
excessive deficit.

timely  correction  of 

towards  a 

Hungary's 

following 

Chapter  I.3  provides  an  overview  of  the  2012 
updates  of 
the  Stability  and  Convergence
Programmes  (SCPs)  submitted  by  Member  States 
in  the  context  of  the  European  Semester.  As  this 
round  of  SCPs  and  the  related  assessment  is  the 
first one based on the new provisions of the  SGP,
the  Chapter  provides,  besides  the  examination  of 
budgetary 
assumptions 
macroeconomic 
objectives, an analysis of the SCPs also relative to 
the expenditure benchmark and the debt reduction 
benchmark. 

and 

reaffirmed 

In view of the persistent pressure on the euro area 
sovereign debt markets but also the less favourable 
growth  assumptions,  the  February  2012  ECOFIN 
the  principle  of 
Council  had 
differentiated  fiscal  exit  strategies  taking  into 
macro-financial 
account 
situations. 
EDP 
recommendations,  these  principles  represent  the 
basis  for  the  assessments  of  the  programmes.  In 
the context of the European Semester, the Council 
recommendations  are  expected  to  feed  into  the 
national budgets for 2013.

country-specific 

Together 

with 

the 

The overall picture emerging from the SCPs is one 
of stagnation of GDP growth in 2012, followed by 
some  recovery  in  2013,  in  line  with  the 2012 
large
Commission  Spring  forecast.  Relatively 
differences  are  found  only  for  Bulgaria  and 
Sweden. 

Member  States  plan  to  continue  consolidating in 
spite  of  the  foreseen  protraction  of  the  cyclical 
slowdown.  On  aggregate,  both  the  euro  area  and 
the EU27 plan to improve significantly their fiscal 
positions every year between 2011 and 2015, with 
the 
the  consolidation  being 
relatively  front-loaded.  According  to  the  SCP 
plans,  the  average  structural balance  in  both  the 

time  profile  of 

12

towards 

For  a  number  of  Member  States,  the  pace  of 
consolidation  tends  to  be  more  moderate  as  they 
move out of excessive deficits and embark on the 
adjustment  path 
their  medium-term 
objective  (MTO).  The  marked  average  structural 
improvement  of  around  1½  pp  of  GDP  expected 
for  2012,  as  opposed  to  the  planned  structural 
tightening  close  to  1  pp  in  last  year's  SCPs, 
indicates  that  the  Member  States  have  generally 
favourable  macroeconomic 
reacted 
conditions  with  additional  structural  contractions. 
Further structural improvements of similar size are 
projected  for  the  remainder of  the  programme 
period. 

less 

to 

This overall pattern conceals however considerable 
variation  across  Member  States,  with  Ireland, 
Spain, Italy, Slovenia, Bulgaria, Latvia, Lithuania, 
Poland,  Romania,  and 
the  United  Kingdom
showing  the  largest  deficit  reductions  already  in 
their 2012 budgets. On average, the consolidations 
set out in the SCPs for both the euro area and the 
EU27  are  primarily  expenditure-based. Also  the 
composition in terms of revenues is tilted towards 
indirect 
favouring  medium-term 
growth.

taxes, 

thus 

to 

risks 

related 

The  main 
policy 
are 
implementation  as overall  the  national  budgetary 
projections appear to rely on especially favourable 
assumptions on growth, revenue or expenditure in 
the  cases  of  Belgium,  Spain,  France,  Poland, 
Slovenia,  Bulgaria,  Lithuania,  Sweden  and  the 
Netherlands,  although,  in  the  case  of  the  last  two 
favourable  macroeconomic 
Member  States, 
assumptions and optimistic expenditure projections 
are partially compensated by prudent estimates on 
the revenue side.

The  SCPs  project  that  in  the  euro  area  debt  will 
reach 85% of GDP (80% in the EU) at the end of 
the programme period after having peaked in 2012.
Hence,  as  long  as  the  consolidation  measures  are 
not  reversed  after 2014,  debt  should  be  on  a 
declining  path 
the 
programmes’ horizon. In all Member States except 
Denmark  and Luxembourg,  debt  is  projected to 
peak  before  2015.  However,  in  Spain  and  the 
United  Kingdom,  the  projected  reduction  in  2015 

the  years  beyond 

for 

Current developments and prospects

Part I

is  small  and  reaching  back  the pre-crisis  debt 
levels is likely to take many further years.

According  to  the  new  rules  accompanying  the 
evolution  towards  the  debt  reduction benchmark 
established by the reform of the Pact (and detailed 
in  Part  II),  the  structural  government  balance  in 
Member States whose current debt-to-GDP ratio is 
above  the  60%  threshold  and  that  are  currently  in 
EDP, has to evolve so that it is guaranteed that the 
respect  of  the  debt  benchmark  will  be  respected 
three years after the end of the EDP. According to 
the  plans  set  out  in  the  SCPs  all  Member  State 
concerned  by 
transition  period  would 
implement  structural  adjustments  large  enough  to 
ensure
the  debt 
reduction benchmark by the end of their transition 
period.

sufficient  progress 

towards

this

13

1. CURRENT DEVELOPMENTS AND PROSPECTS

1.1.  A STALLING AND DIFFERENTIATED 

RECOVERY

framework 

institutional 

The  recovery  which  has  followed  the  worst 
economic  crisis  since  World  War  II  is  now 
stalling,  with the  euro  area  and  the  EU  economy 
being  estimated  to  have  been  in  a  mild  recession 
over the last  few months. In early 2012, thanks to 
determined policy responses and a strengthening of 
the 
underpinning 
economic  policy  in  the  EU,  tensions  in  financial 
markets  receded  and  private  sector  confidence 
returned.  These  developments  are  now  subject  to 
the  effects  of  the  persisting  concerns  about  the 
situation  in  the sovereign  market  and  in  the 
banking  sector.  Following  an  assumption  that 
confidence  will  strengthen  over  time,  as  the 
challenges  raised  by  the  crisis  are  successfully 
strong 
addressed, 
implementation  of  the  agreed  determined  policy 
actions,  an  expected  higher  growth  of  the  world
economy is  set  to  lead  to  a  slow  recovery  taking
off  in  the  second  half  of  the  current  year,  and 
further  accelerating in  2013. In  other  words,  the 
recovery  might be  stalling  only  temporarily  and 
would  resume,  under  the  condition  that  funding 
costs  in  vulnerable  Member  States  and  risks 
related  to  the  overall  policy  environment  can  be 
kept  in  check. Forthcoming  proposals  towards  a 
banking union should mitigate financial instability.

including 

through 

the 

Graph  I.1.1 shows  the  GDP  growth  projections 
according  to  the  Commission  services'  Spring 
2012  forecast. (1) For  the  euro  area  the  graph 
shows  a  deep  recession  in  2009  with  GDP 
shrinking by 4.3% followed by a recovery in 2010  
and  2011  when  GDP  grew  by  1.9%  and  1.5% 
respectively before being expected to stall in 2012
with  a  growth  of  just 0.3%.  For  the  EU27,  the 
pattern of GDP developments looks similar, output 
shrunk  by  4.3%  in  2009,  grew  by  2.0%  in  2010 
and by 1.5% in 2011 and is expected to stagnate in 
2012.  For  both  the  euro  area and  the  EU27,  the 
outlook  for  2013  is  for  a  rebound  of  growth  of 
1.3%  and  1.0%  respectively,  driven  by  external 
demand.  However,  in  spite  of  encouraging  signs 
pertaining  to  the  overall  situation  of  the  world 
economy,  concerns  about  fiscal  sustainability  in 
several  EU  Member  States  weigh  heavily  on  the 

(1) See Europen Commission (2012a).

14

growth  outlook,  by  adding  uncertainty  and 
presenting downside risks.

Correspondingly, output gaps in the euro area and 
the  EU are  expected  to  widen  again  to  reach  the 
negative  levels  of  –2.6 and  –2.7  respectively;  in 
both cases this is slightly worse than in 2010 when 
the corresponding gaps  were –2.4 and –2.5. More 
details are given in Section I.1.3 below.

in 

competitiveness

Growth developments in the EU are now diverging 
more  strongly  across  Member  States  than  in 
previous  years.  These wide  disparities depend,
inter  alia, on  different  structural  challenges  and 
further  domestic  and  external  imbalances,  with
being 
developments 
particularly important. While some Member States 
are  growing,  others still  remain  in  –or  are  re-
entering – recession. In 2011, GDP growth ranged 
from  high  positive  rates  of  over  3%  of  GDP  in 
several Member States (Estonia, Lithuania, Latvia, 
Poland,  Sweden,  Slovakia,  Austria  and  Germany) 
to  negative  growth 
in  Greece,  Portugal  and 
Slovenia. Within each of these two categories there 
was  again  considerable  variation,  with 
the 
extremes  being  growth  of  7.6% in  Estonia  and  –
6.9% in  Greece.  In  the  large  Member  States,  real 
GDP  is  expected  to  grow by  between  2.7% in 
Poland  and  -1.8% in  Spain  this  year.  In  Greece, 
Portugal,  Spain,  Italy,  Slovenia,  the  Netherlands, 
Cyprus,  Hungary,  Belgium  and 
the  Czech 
Republic the output change  is forecast to stagnate 
or  to  be  in  the  negative territory, sometimes 
markedly.

(7.1% 

in  2008), 

The economic crisis has also had visible effects on 
the  labour  market.  From  the  low  of  7.6%  in  the 
euro  area 
the  euro  area 
unemployment  rate  has  risen  rapidly,  although 
reacting  with  a  lag  to  real  GDP  developments.  In 
it  stood  at  10.1%  in  2010,  before
the  euro  area 
increasing marginally to 10.2% in 2011: in EU27 it 
stood  at  9.7% in  both  years).  Unemployment  is 
expected  to  remain  at  the  higher  level  of  11%  in 
the  euro  area  (10.3%  in  EU27)  in  both  2012  and 
2013. 

However, 
labour  market  developments  differ 
markedly across  countries,  with  weaker  Member 
States  hit  by  rapid  deterioration  of  labour  market 
and  Member  States  with  better  growth  observing 
levels. A  very 
an 

in  employment 

increase 

order.  Adverse 

considerable  deterioration  in  the  labour  market  is 
expected 
large-scale 
in  countries  undergoing 
economic adjustments, while some others are set to 
experience some improvements, albeit of a mostly 
limited 
labour  market 
developments affect the sustainability of the public 
the  usual  revenue  and 
finances  directly  via 
the  current 
expenditure  channels.  Moreover,
malfunctioning of credit markets in some Member 
States such as Spain further compounds the major 
policy  challenge  for  the  euro  area  and  the  EU 
economy to reduce unemployment.

Graph I.1.1:

Real GDP growth developments

4

3

2

1

0

-1

-2

-3

-4

-5

EA-17

EU-27

2007

2008

2009

2010

2011

2012

2013

Source: Commission services.

1.2. 

SHORT-TERM DEVELOPMENTS AND 
PROSPECTS FOR THE BUDGET BALANCE

In  2011,  the  budgetary  positions  in  the  euro  area 
and  the  EU  improved  significantly  in  comparison 
to 2010, when they had broadly stalled, and to the 
two  preceding  years  where  they  had  dramatically 
deteriorated. Table I.1.1 shows the budget balances 
for  all  EU27  countries  from  2009  to  2013  on  the 
basis  of  the  Commission  services'  Spring  2012 
forecast, while Table I.1.2 breaks down the general 
government  balance  for  the  euro  area  into  its 
constituent  parts  over  the  years  2008  to  2013.  As 
Table  I.1.1  shows,  the  euro  area  average  headline 
deficit  came  in  at  4.1%  of  GDP in  2011,  down 
from  the  6.2%  in  2010.  This  is  still  far  above  the
historical  low  of  0.7%  posted  in  2007  before  the 
outbreak of the crisis. As shown in Table I.1.2, the 
average  general  government  deficit
in  the  EU
decreased by 2 percentage points reaching 4.5% of 
GDP in 2011. In both the euro area and the EU, the 
decrease in the headline deficit  was  matched by a 
decrease about half this size in the structural deficit
– which equals the headline deficit net of cyclical 

Current developments and prospects

Part I

factors and one-off and other temporary  measures
– by  1.0%  and  1.1% 
This
strengthening  of  the  structural  balance suggests 
that the improvement in the headline deficit was of 
both  a  structural  and  a  cyclical  nature,  in  roughly 
equal proportions. 

respectively. 

also 

States 

Within  the  euro  area,  all  Member  States  posted 
improvements in  2011,  with  the  exception  of 
Cyprus  and  Slovenia.  The  deficit  was  highest  at 
13.0%  of  GDP  in  Ireland,  which  had  however 
experienced  an  unprecedented  deterioration  in  the 
budget  balance  the  year  before.  Several  other 
Member 
significant 
improvements.  Among 
these  are  Germany, 
Portugal and Slovakia. Improvements of between 1 
and 2 percentage points of GDP  were recorded in 
Greece, France, Malta and Austria. In all euro area 
countries  except  Germany,  Luxembourg,  Austria, 
Malta,  Finland and  Estonia,  the  deficit  in  2011 
exceeded  the  3%  of  GDP  reference  value  of  the 
Treaty. Estonia is the only euro area Member State 
to have posted a surplus, of 1.0% of GDP.

posted 

in 

risks 

further 

forecast, 

improvements 

According  to  the  Commission  services'  Spring 
2012 
the 
budgetary  positions are  expected  in  2012  and 
2013,  although  downside 
remain  and 
country-specific  developments  differ  widely. 
Against  the  current  growth  outlook,  the  aggregate 
general  government  deficit  of 
the  euro  area
Member States is expected to reach 3.2% of GDP 
in 2012, 0.9 percentage points lower than the year 
before. A further improvement to 2.9% of GDP is 
projected  for 2013.  Broadly  the  same  profile  is 
expected  for  the  EU  as  a  whole.  The  aggregate 
deficit  is  forecast  to  decline  to  3.8%  of  GDP  in 
2012,  from  4.5%  in  2011,  and  to  continue to 
decrease to 3.4% of GDP in 2013.

15

European Commission

Public finances in EMU - 2012

Table I.1.1:

Budget balances in EU Member States (% of GDP)

BE
DE
EE
IE
EL
ES
FR
IT
LU
NL
AT
PT
SI
FI
MT
CY
SK
EA-17
BG
CZ
DK
LV
LT
HU
PL
RO
SE
UK
EU-27

2009
-5.6
-3.2
-2.0
-14.0
-15.6
-11.2
-7.6
-5.4
-0.8
-5.6
-4.1
-10.2
-6.1
-2.7
-3.8
-6.1
-8.0
-6.4
-4.3
-5.8
-2.7
-9.7
-9.4
-4.5
-7.4
-9.0
-1.0
-11.4
-6.9

Budget balance
2011
-3.9
-1.0
1.0
-13.0
-9.2
-8.5
-5.2
-3.8
-0.6
-4.6
-2.6
-4.2
-6.4
-0.9
-2.7
-6.3
-4.8
-4.1
-2.1
-3.1
-1.9
-3.5
-5.5
4.2
-5.1
-5.2
0.1
-8.3
-4.5

2012*
-3.1
-0.9
-2.4
-8.3
-7.3
-6.4
-4.5
-1.9
-1.8
-4.4
-3.0
-4.7
-4.3
-1.0
-2.6
-3.4
-4.8
-3.2
-1.9
-2.9
-4.2
-2.1
-3.2
-2.6
-3.0
-2.8
-0.5
-8.0
-3.8

2010
-3.9
-4.3
0.3
-31.2
-10.5
-9.3
-7.1
-4.5
-0.9
-5.0
-4.5
-9.8
-6.0
-2.8
-3.7
-5.3
-7.7
-6.2
-3.1
-4.8
-2.7
-8.1
-7.3
-4.3
-7.9
-6.8
-0.1
-10.2
-6.5

2013*
-3.3
-0.7
-1.3
-7.5
-8.4
-6.3
-4.2
-1.0
-2.2
-4.6
-1.9
-3.1
-3.8
-0.6
-2.9
-2.5
-5.1
-2.9
-1.7
-2.6
-2.1
-2.1
-2.8
-3.0
-2.5
-2.2
-0.1
-6.9
-3.4

2009
-3.7
-1.3
-0.9
-9.7
-14.7
-8.7
-6.2
-4.0
1.3
-4.1
-2.7
-8.6
-4.4
0.8
-3.5
-5.9
-7.7
-4.6
-3.1
-5.6
0.6
-6.6
-7.2
-2.2
-7.4
-9.6
2.5
-9.4
-5.1

Structural balance
2011
-3.4
-0.8
-0.2
-8.4
-5.7
-7.3
-4.1
-3.6
0.4
-3.5
-2.4
-6.2
-3.9
0.6
-3.3
-5.5
-5.1
-3.4
-1.0
-2.6
0.2
-3.2
-4.6
-4.3
-5.0
-3.3
0.1
-6.9
-3.8

2012*
-2.7
-0.4
-0.8
-8.1
-2.9
-4.8
-3.2
-0.7
-0.6
-2.4
-2.2
-3.0
-2.2
0.3
-3.5
-2.7
-4.4
-2.1
-0.7
-1.8
-1.7
-2.2
-2.9
-2.1
-2.8
-1.8
0.3
-6.9
-2.7

2010
-3.2
-2.3
-0.5
-9.6
-9.0
-7.4
-5.7
-3.6
0.5
-3.8
-3.3
-8.4
-4.5
-0.5
-4.4
-5.0
-7.3
-4.4
-1.5
-4.6
0.1
-5.0
-5.1
-3.6
-7.5
-6.1
1.1
-8.8
-4.9

2013*
-2.6
-0.3
-0.5
-7.9
-4.5
-4.8
-2.9
-0.1
-1.4
-2.5
-1.8
-1.3
-1.9
0.3
-3.3
-1.7
-4.6
-1.9
-0.8
-1.8
-1.0
-1.7
-2.1
-2.0
-1.9
-1.2
0.4
-5.1
-2.2

2009
-0.1
1.4
-0.7
-7.6
-9.6
-6.9
-3.7
0.7
1.6
-1.9
0.0
-5.8
-3.0
1.9
-0.4
-3.3
-6.3
-1.7
-2.3
-4.3
2.4
-5.1
-5.9
2.5
-4.8
-8.1
3.5
-7.4
-2.4

Structural primary balance
2011
-0.1
1.8
-0.1
-4.9
1.2
-4.9
-1.5
1.3
0.9
-1.4
0.2
-2.3
-2.0
1.7
-0.2
-3.1
-3.5
-0.4
-0.3
-1.2
1.9
-1.7
-2.8
-0.2
-2.3
-1.7
1.1
-3.7
-0.8

2012*
0.7
2.1
-0.6
-4.1
3.4
-1.6
-0.6
4.7
0.0
-0.3
0.5
1.8
0.3
1.5
-0.2
0.5
-2.5
1.1
0.1
-0.4
-0.1
-0.6
-0.8
2.0
-0.1
0.0
1.4
-3.5
0.4

2010
0.2
0.2
-0.4
-6.5
-3.4
-5.4
-3.3
1.0
0.9
-1.8
-0.6
-5.6
-2.9
0.5
-1.3
-2.7
-5.9
-1.6
-0.9
-3.2
1.8
-3.5
-3.3
0.4
-4.8
-4.6
1.9
-5.9
-2.2

2013*
0.7
2.0
-0.3
-2.4
1.9
-1.5
-0.2
5.5
-0.8
-0.3
0.9
3.7
0.7
1.6
0.1
1.6
-2.5
1.4
0.2
-0.3
0.4
0.1
0.0
2.1
0.9
0.6
1.5
-1.6
0.9

Note:  The  structural  budget  balance  is  calculated  on  the  basis  of  the  commonly agreed  production function method  (see  European  Commission 
(2004)).
*Figure from Commission services' Spring 2012 forecast.
Source: Commission services.

Outside the euro area, the general picture conveyed
by the Commission services' Spring 2012 forecast
is  one  of  continued  deficit  reduction.  The  Czech
Republic, Denmark, Poland, Lithuania, Latvia and
Romania  are  expected  to  bring down the  general
government net borrowing to 3% of GDP or below
in  either  2012  or  2013.  Bulgaria  is  expected  to 
continue  running  deficits  below  the  3%  threshold 
over the  forecast  horizon,  while  in  Sweden close-
to-balance  headline  budgetary  positions  are 
projected for both 2012 and 2013. While a further
substantial budgetary  improvement of  1.6pp.  is
forecast  for  the  United  Kingdom  in  2012,  the
deficit is  expected  to  fall  only  by  0.2pp. in 2013.
Due  in  part  to  the  one-off  accounting  impact  of
pension reforms, the deficit in Hungary is forecast
to  revert  to  2.6%  of  GDP  in  2012,  following  a
surplus in 2011.

The  structural  balance  is  estimated  to  improve  in 
2012 by 1.3pp. of GDP in the euro area and 1.1pp
in  the  EU  as  a whole.  For  2013,  further  limited
improvements of the order of 0.2pp. of GDP in the
euro  area  and  of  0.5pp. in  the  EU  as  a  whole  are
projected. The more limited reduction expected for

in sufficient  detail.

2013  is  linked  to  the no- policy-change  scenario
underlying  Commission  services' forecasts,  which
only  takes  into  account measures  that have  been
specified 
In several  EU
Member  States,  namely  Bulgaria,  Belgium,  the
Czech Republic,  Greece,  Spain,  Italy,  Cyprus,
Poland, Portugal,  Romania,  Slovenia,  Slovakia,
Sweden  and  the United  Kingdom, fiscal  policy  is
forecast to be tighten pro-cyclically in 2012, albeit
to a very variable degree.

None of  the euro  area  countries  that  had attained
their  medium-term  budgetary  objective  (MTO) in 
2008 managed to meet their MTO in 2010. In 2011
Finland was  the  only  euro  area  Member  State
which  had  achieved  its  objective.  Section  I.1.3
considers the MTOs, which are set to be updated in
2012, in more detail. Structural fiscal positions are
forecast to remain weak over the forecast horizon,
and  despite  some  improvements, very  few  EU
countries will  be near  to attaining their  MTOs  in
either 2012 or 2013.

16

Current developments and prospects

Part I

Table I.1.2:

Euro area - General government budget balance (% of GDP)

Total revenue (1)
Total expenditure (2)
Actual balance (3) = (1) - (2)
Interest (4)
Primary balance (5) = (3) + (4)
One-offs (6)
Cyclically adjusted  balance (7)
Cyclically adj. prim. balance = (7) + (4)
Structural budget balance = (7) -(6)
Change in actual balance:
              - Cycle 
              - Interest
              - Cycl.adj.prim.balance
                    - One-offs
                   - Structural budget balance

2008
45.0
47.1
-2.1
3.0
0.9
-0.1
-2.9
0.2
-2.8
-1.4
-0.6
0.1
-0.9
-0.1
-0.8

2009
44.8
51.2
-6.4
2.9
-3.5
0.0
-4.6
-1.8
-4.6
-4.3
-2.4
-0.2
-2.0
0.0
-1.8

2010
44.7
51.0
-6.2
2.8
-3.4
-0.7
-5.1
-2.3
-4.4
0.2
-0.1
-0.1
-0.5
-0.6
0.2

2011
45.3
49.4
-4.1
3.1
-1.1
0.1
-3.3
-0.2
-3.4
2.1
1.1
0.2
2.0
0.8
1.0

2012*
46.2
49.4
-3.2
3.2
0.0
0.1
-2.0
1.2
-2.1
0.9
-0.4
0.2
1.5
0.0
1.3

2013*
46.1
49.0
-2.9
3.2
0.3
0.0
-1.8
1.4
-1.9
0.3
0.1
0.0
0.2
-0.1
0.2

Note: Differences between totals and sum of individual items are due to rounding.
*Figure from Commission services' Spring 2012 forecast.
Source: Commission services.

1.3.  CONSOLIDATION CONTINUES IN THE EU  

balance

average

showing  on 

The  previous  figures  are  completed  by 
the
observation  that  the  euro  area  primary  balance  is
expected to be balanced in 2012 with the structural
primary
an 
improvement  of roughly two  and  half  points  of
GDP in only two years – the corresponding figure
for  the  EU  is  of  the  same order  of  magnitude.
While  in  some  Member  States  fiscal  exit had
already  started  in  2010,  in  2011  all EU  Member
States begun  to  withdraw  the fiscal  stimulus
measures which  they had  put  into  operation  in 
2009–2010 to support their economies. As a result,
the  structural  balance  improved  and  is  set  to
continue to do so in 2012, despite the inertia linked
to the level of non-cyclical expenditure. Similarly,
in 2011 the average headline deficit has decreased
along with  the shrinking  of  the  negative  output
gap, and is also set to continue to do so in 2012.

historical  perspective after  the  beginning  of  the
financial crisis. Indeed the budgetary legacy of the
economic  and  financial  crisis  of  2009–2010  has
compounded  already  existing  high  debt  levels in
the EU. In some countries this has seriously put at
risk fiscal  sustainability.  Thus  overall,  despite  the
short-term adverse effect on growth, consolidating 
in  line with  SGP  requirements  is  the  only  option
for many EU countries.(2)

In particular, as stipulated in the conclusions of the
ECOFIN Council from February 2012,(3)  Member
States  benefiting from  a financial  assistance
programme should stick to the targets as agreed in
the programme  and  should  fully  and  in  a timely
manner implement  the  policy  measures, including
structural 
respective 
of  Understanding.  Similarly,
Memorandum 
Member States facing close market scrutiny should
continue to meet the agreed budgetary targets and
stand 
further  consolidation 
ready 
measures if needed.

reforms,  agreed 

to  pursue 

the 

in 

These  achievements  are  remarkable,  since while
the  output  gap was  narrowing  by more  than  one
percentage  point  between  2010  and  2011,
it  is
expected  to  widen  in  2012  to  return  to  its 2010
levels – as noted  in Section  I.1.1.  Therefore the
fiscal stance is expected to be pro-cyclical in 2012.
However,  according  to  the  Commission  services
Spring 2012 forecast, the expected growth rebound
in  2013  would  narrow  output gaps, 
thereby 
entailing a countercyclical fiscal stance. 

Notwithstanding  large  differences  across  Member
States,  a  restrictive  fiscal  stance  stems  from  the
fact  that  consolidation  has become  a  necessity
given  the  peak  levels  reached  by  debt from an

The  strain  that  the  crisis  left  on  government
finances (4)  is  explained  by  three factors:  the  role
of the automatic stabilisers in reaction to the crisis, 
the 
introduction  of  discretionary measures
including  the  large-scale support  to the  financial

(2) Successfully tackling the debt crisis as set out in the five-
point plan of the Council of October 2011 requires further 
bold consolidation efforts along these lines.

(3) The  conclusions  of  the  ECOFIN  Council  are  available  at

http://www.consilium.europa.eu/press/press-
releases/economic-and-financial-affairs?BID=93&lang=en
(4) During the first phase of the crisis, between 2007 and 2009,
the budget  balance  deteriorated  from  a deficit  of 0.7%  of
GDP  to  6.4% in  the  euro  area  and  from  0.9%  of  GDP  to 
6.9% in the EU.

17

European Commission

Public finances in EMU - 2012

sector, and,  in  some  Member  States, the  fall  in 
revenues  due  to  the  bursting  of  housing  and/or 
credit  bubbles.  This  latter  effect  is  significant  in 
countries where,  before  the  crisis,  real  estate 
bubbles  temporarily  masked  an  underlying  fiscal 
weakness  because  the  buoyancy  of  tax  receipts 
depended  heavily  on  real  estate  transactions. As 
the  underlying 
these 
weaknesses of fiscal positions showed up.

revenues  plummeted

Automatic stabilisers (5) represented around half of 
the  deterioration  in  2009,  and  various  types  of 
support  measures  explain  the  other  half.  Many  of 
these  support  measures  then  remained  in  place  in 
2010,  when  average  headline  deficits  persisted  at 
levels above 6% of GDP in the euro area and EU.
The  increases  in  deficits  led  to  corresponding 
increases in debt. In addition, the debt ratios have 
risen  substantially  on  the  back  of  below-the-line 
operations  in  the  context  of  the  support  to  the 
financial  sector.  While  this  extra  effect  on  debt 
measured  as  capital  injections  to  banks  accounted 
for less than 2% of GDP in 2009 in both the euro 
area  and  the  EU,  it  has  been  rising  continuously
and reached around 3% of GDP at the end of 2011 
in  both  the  euro  area  and  the  EU (6)  with  a  very 
differentiated impact by country.

1.4. 

SHORT-TERM DEVELOPMENTS AND 
PROSPECTS FOR PUBLIC DEBT

Graph I.1.2 displays the increases in debt projected 
between  2007  and  2013. It  shows  that  debt  in  the 
euro area is projected to rise from 66.3% of GDP 
in  2007  to  92.7%  in  2013  and  from  59.0%  to 
87.3%  in  the  EU.  Within  these  totals,  there  is 
considerable variation in both the starting levels of 
debt, which ranged from 3.7% of GDP in Estonia 
to 107.4% in Greece, and in the overall increases. 
By  contrast,  a  decrease  in  public  debt  is  forecast
for Sweden. At the EU level, debt will not start to 
decrease before 2014.

Table  I.1.3  shows  that  despite  the  impressive 
performance  of  the  euro  area  and  the  EU  in 
reducing  government  deficits,  the  contribution  of 
the  deficit  to  the  increase  in  the  debt  ratio  is  still 
the largest, larger than the snowball effect. (7)

At  a  country  level,  Member  States  with  higher 
starting levels of debt are more likely to face both 
a  snowball  effect of  debt  and  an  increase  in  the 
interest  rate  as  markets  may  doubt  countries' 
ability to service their debt over the medium term.
In  the  most  difficult  cases  the  country  concerned 
might even be precluded from refinancing itself in 
the  markets.  For  this  reason,  high  levels  of  debt 
can  increase  the  urgency  to  consolidate,  even  in 
spite of an unfavourable economic environment, if 
there is a realistic fear of a sovereign debt crisis. In 
these  cases,  there  is  no  overall  benefit  from 
providing  more  support  for  the  economy  in  the 
short-term,  given  the  price  that  will  be  paid  in 
terms of servicing the resulting debt. .

But high debt is  not the only reason  why  markets 
may  doubt  a  country's  likelihood  of  repaying  its 
debt. Other factors such as the outlook for growth 
in  the  medium  term,  the  presence  of  macro-
financial  imbalance  risks  related  to  the  overall 
policy  environment  are  also  key  determinants  of 
the reaction of financial markets.

The  continually  rising  debt-to-GDP  ratios  reflect 
the  still  high  budget  deficits  in  certain  countries, 
but  also  public  interventions  in  the  financial 
system.  In  2011  the  average debt  rose  by 2.4
percentage points relative to 2010 to 88% of GDP
in  the  euro  area,  and by  2.8  percentage  points  to 
83.0% in  the  EU27.  Debt  increases  in  Portugal, 
Spain,  Greece  and  Ireland  were  particularly 
notable,  with  Greek  debt 
to  an 
unprecedented 165.3% of GDP, resulting in private 
sector involvement in its containment.

increasing 

(5) The automatic stabilisers vary across countries in their size 
and  composition.  Overall,  in  bad  times,  governments 
receive less revenue from taxes while spending levels tend 
to  rise  due  to  an  increased  burden  on  the  social  security 
system.  However,  automatic  stabilisation  mainly  works 
through  the  inertia  of  expenditure with  respect  to  cyclical 
increases 
their  share 
swings 
‘automatically’ in downturns and declines in upturns. 
(6) These  are  Commission  services  (DG  ECFIN) elaborations 
based  on  a survey  made  by  Member  States  within  the 
context of the Economic and Financial Committee.

in  output: 

in  GDP 

(7) The  snowball  effect  of  debt  stems  from  the  interaction 
between  the  interest-growth  rate  differential  and  the  debt 
level:  if  the  difference  between  the  interest  paid  on  debt 
and  the  growth  rate  is  positive  – and  it  will  in  general 
increase with debt – the dynamics of debt are explosive and 
an increase in primary balances is required to escape from 
the resulting cycle.

18

Current developments and prospects

Part I

Graph I.1.2:

Short-term fiscal impact of the crisis - general government debt

% of GDP

2007

2013

180

160

140

120

100

80

60

40

20

0

EE BG LU SE RO LT DK LV CZ FI SK PL SI NL AT MT HU CY DE ES EU FR EA UK BE PT IE

IT EL

Notes:  2012 and 2013 are forecast data. Differences between the sum and the total of individual items are due to rounding.
Source: Commission services.

A  further  increase  in  debt  to  92.7%  of  GDP  by
2013 is projected in the euro area and to 87.3% in
the  EU,  as  primary  deficits  are  coupled  with  a
weak contribution  from economic growth  in 2012 
and 
interest
expenditure, in some Member States in particular.
There  also  remains  the  risk  of
further  debt
increases  from  further  public  intervention  in  the
financial sector.

the  additional  effect  of  high 

Part of the heterogeneity in the rise in debt is also
due to  sizeable  differences  across  countries  in
public interventions  in the  financial  sector.  In  the
case  of Ireland, government debt was  among  the 
lowest in the EU before the crisis, but is projected
to reach 120.2%  of  GDP  in  2013. Countries  with
large  public  interventions  in  the financial  sector
typically have  large  debt-increasing stock-flow
adjustments in Table I.1.3.

On  the  whole,  as new  regulatory  requirements
strengthening  the  resilience  of  financial  sector
institutions  are  bearing  fruit,  the  total  current
effective  support  level in  the  EU - measured  as
total  aid  to  banks including guarantees - has  been 
declining from  a  peak  of  13%  of  GDP in  the
Autumn of 2009 to 8% of GDP in early 2012. (8)
That could  signal financial sector  recovery  and
reduced exposure  of  Member  States  to  potential

(8) See footnote (5).

losses  on the support  provided.  Nonetheless
significant  downside  risks 
to  public  finances
emanating from the financial  sector  do  persist  in 
some Member States.

figures 

Aggregate
to mask  diverging
tend 
developments  at  the  country  level.  There  are 
several  Member  States with low  or  very  low  pre-
crisis debt levels, which however have been rising
sharply  until 2012.  This  group  of  countries
includes  Ireland,  Spain  and  the  United  Kingdom,
and,  starting  from  lower  levels,  Latvia,  Lithuania
and  Slovenia.  Moreover,  five  euro  area  countries
are expected to have debt above 100% of GDP by
2012. Italy already had a public debt-to-GDP ratio
above  100%  of  GDP  before  the  crisis.  In  Greece
the extremely high debt ratio of 165.3% of GDP is
also  expected  to  remain  at  such  high  levels  over
the  forecast  horizon,  reaching 168.0%  of GDP  in 
no-policy-change
2013
assumption).  In  Ireland  and Portugal  the  debt-to-
GDP ratio exceeded 100% of GDP in 2011 and is
set  to  continue  growing, while  in  Belgium it  is
forecast  to stand  again  at  triple-digit  levels  from
2012  onwards  (again  under  the no-policy-change
assumption).

(under 

usual 

the

19

European Commission

Public finances in EMU - 2012

Table I.1.3:

Composition of changes in the government debt ratio in EU Member States (% of GDP)

Gross debt ratio

Change in 
debt ratio

Change in the debt ratio in 
2008-13 due to:

2008

2009

2010

2011

2012*

2013*

2008-3*

Primary
balance

Interest &growth 
contribution

Stock-flow
adjustment

BE
DE
EE
IE
EL
ES
FR
IT
LU
NL
AT
PT
SI
FI
MT
CY
SK
EA-17
BG
CZ
DK
LV
LT
HU
PL
RO
SE
UK
EU-27

89.3
66.7
4.5
44.2
113.0
40.2
68.2
105.7
13.7
58.5
63.8
71.6
21.9
33.9
62.3
48.9
27.9
70.1
13.7
28.7
33.4
19.8
15.5
73.0
47.1
13.4
38.8
54.8
62.5

95.8
74.4
7.2
65.1
129.4
53.9
79.2
116.0
14.8
60.8
69.5
83.1
35.3
43.5
68.1
58.5
35.6
79.9
14.6
34.4
40.6
36.7
29.4
79.8
50.9
23.6
42.6
69.6
74.8

96.0
83.0
6.7
92.5
145.0
61.2
82.3
118.6
19.1
62.9
71.9
93.3
38.8
48.4
69.4
61.5
41.1
85.6
16.3
38.1
42.9
44.7
38.0
81.4
54.8
30.5
39.4
79.6
80.2

98.0
81.2
6.0
108.2
165.3
68.5
85.8
120.1
18.2
65.2
72.4
107.8
47.6
48.6
72.0
71.6
43.3
88.0
16.3
41.2
46.5
42.6
38.5
80.6
56.3
33.3
38.4
85.7
83.0

100.5
82.2
10.4
116.1
160.6
80.9
90.5
123.5
20.3
70.1
74.4
113.9
54.7
50.5
74.8
76.5
49.7
91.8
17.6
43.9
40.9
43.5
40.4
78.5
55.0
34.6
35.6
91.2
86.2

100.8
80.7
11.7
120.2
168.0
87.0
92.5
121.8
21.6
73.0
74.5
117.1
58.1
51.7
75.2
78.1
53.5
92.7
18.5
44.9
42.1
44.7
40.9
78.0
53.7
34.6
34.2
94.6
87.3

11.5
14.0
7.1
75.9
55.0
46.9
24.3
16.1
7.9
14.5
10.7
45.5
36.1
17.7
12.9
29.2
25.6
22.5
4.8
16.2
8.7
25.0
25.4
5.1
6.6
21.2
-4.6
39.8
24.8

Notes:  Differences between the sum and the total of individual items are due to rounding.
*Figure from Commission services' Spring 2012 forecast.
Source: Commission services.

2.4
-2.6
3.7
56.0
20.2
29.3
15.9
-8.0
3.8
13.9
2.7
12.6
16.5
1.0
-0.4
9.9
21.8
7.7
9.3
12.2
4.9
17.7
19.4
-11.1
12.4
18.0
-4.6
28.1
10.3

5.5
4.8
-0.4
19.7
51.9
13.0
5.2
20.6
-0.5
7.6
4.7
20.9
10.4
0.1
4.6
8.7
2.5
9.7
1.1
5.3
4.5
5.0
3.2
9.5
-1.2
0.8
-0.2
4.7
8.2

6.8
14.4
-3.8
14.5
4.7
1.7
2.0
3.2
13.9
8.4
6.3
5.9
2.7
20.3
2.4
-3.5
-3.3
7.0
-4.7
-4.0
14.2
10.5
1.8
5.1
-2.4
0.2
3.0
9.5
5.6

Germany,  France,  Cyprus,  Hungary,  Malta,  the
Netherlands and Austria also had debt ratios above
the 60% threshold in 2011 and further increases of
these  ratios are  projected  in  all  these  countries
except  Germany  and  Hungary.  The  debt  ratio  is
projected  to  start  declining in Italy,  Poland  and 
Sweden in 2013.

1.5.  GOVERNMENT REVENUE AND

EXPENDITURE: A WELL BALANCED
CONSOLIDATION

by 

broadly 

and 
diminishing 

The  consolidation  between 2009  and  2012  was
reached  via  a  relatively  balanced  composition  of
revenue measures,  with
expenditure 
expenditures 
1.8 
percentage points of GDP and revenues increasing
by  1.5  percentage  points.  In  2010 and  2011,  the 
improvement  in  budgetary  positions  in  the  euro
area was the result of a lower expenditure-to-GDP
ratio rather  than  tax  increases;  the  reduction  in
spending was also due to lower public investment.
Table  I.1.4 shows 
the main  components  of
government  revenue  and  spending  for  the  euro

area  from  2008  to  2013.  It  shows  that that  the
revenue  ratio  remained  stable  overall  between
2009 and 2010, while expenditure fell. Despite the
expectation  of  lower  growth  in  2012,  a  marked
increase in revenues with stable expenditure ratios
is being forecast.

Moreover,the  composition  of  revenue  increases is
not  likely  to  weigh  on  labour  and  production –
social  contributions  and  current  taxes  on  income
and wealth  are  broadly  stable  over  the  period, 
while  indirect  taxes  increase,  a  change  in  the
revenue  mix  which  is  found  to  be  growth-
supportive in the medium term.

Table  I.1.5  shows  the  expenditure  and  revenue
ratios  for  all  EU  countries  and shows,  that,
according  to  the  Commission  services'  Spring
2012 forecast,  the  expenditure  ratio  in  the  euro
area  is  expected  to continue  to  decrease  over  the
forecast horizon,  while  the  revenue  ratio is  set  to
remain stable.

20

Current developments and prospects

Part I

Table I.1.4:

Euro area - Government revenue and expenditures (% of GDP)

Total revenue

Taxes on imports and production (indirect)

Current taxes on income and wealth

Social contributions

of which actual social contributions

Other revenue

Total expenditure

Collective consumption

Social benefits in kind

Social transfers other than in kind

Interest

Subsidies

Gross fixed capital formation

Other expenditures

2008
45.0

12.5

12.5

15.3

14.2

4.7

47.1

8.0

12.6

16.0

3.0

1.2

2.6

3.7

2009
44.8

12.5

11.6

15.8

14.6

4.9

51.2

8.6

13.6

17.6

2.9

1.2

2.8

4.4

2010
44.7

12.7

11.6

15.6

14.4

4.8

51.0

8.4

13.6

17.6

2.8

1.4

2.5

4.7

2011
45.3

12.8

11.8

15.7

14.5

5.0

49.4

8.2

13.3

17.4

3.1

1.4

2.3

3.7

2012*
46.2

2013*
46.1

13.1

12.4

15.7

14.5

4.9

49.4

8.1

13.3

17.5

3.2

1.3

2.2

3.7

13.3

12.4

15.5

14.3

4.9

49.0

7.9

13.2

17.5

3.2

1.3

2.1

3.8

Note:  Differences between the sum and the total of individual items are due to rounding.
Expenditure  figures  are  corrected for  the  difference  between  the  definition  of  expenditures  according  to ESA95  and  according to  EDP  rules.  This
mainly reflects the interest expenditures related to swap transactions.
*Figure from Commission services' Spring 2012 forecast.
Source: Commission services.

Table I.1.5:

Government revenue and expenditure (% of GDP)

2009

2010

2011

2012*

2013*

2009

2010

2011

2012*

2013*

Revenue

Expenditure

DK

EE

IE

EL

ES

FR

LT

MT

NL

PL

RO

SK

HU

IT

SI

UK

BE

BG

CZ

DE

CY

LV

LU

AT

PT

FI

SE

EA-17

EU-27

55.2

43.2

34.8

38.2

35.1

49.2

34.3

39.7

46.0

37.2

32.1

33.5

46.9

46.5

43.2

40.1

48.1

36.3

39.1

44.9

40.1

34.7

42.2

48.7

39.6

53.4

54.0

44.8

44.2

55.1

40.9

35.6

39.7

36.3

49.5

33.7

39.5

46.2

37.5

33.4

32.4

45.2

46.0

44.2

40.2

48.9

34.3

39.3

43.6

41.1

35.7

41.6

48.1

41.4

52.7

52.4

44.7

44.1

56.0

39.2

35.7

40.9

35.1

50.7

32.0

40.2

45.5

38.5

32.5

32.6

52.9

46.1

44.5

40.8

49.4

33.1

40.3

44.7

41.0

35.6

41.4

47.9

44.7

53.2

51.4

45.3

44.6

54.5

38.9

35.8

42.4

36.0

51.8

33.5

41.9

46.3

40.1

33.4

33.0

46.1

48.4

44.4

40.8

50.9

33.3

40.4

44.7

42.6

36.0

41.9

48.4

43.0

53.6

51.8

46.2

45.2

54.7

38.1

35.5

42.2

35.7

52.0

33.1

40.8

46.1

39.8

33.2

32.5

44.6

48.4

44.0

40.8

50.4

33.6

40.5

44.4

42.8

34.9

41.8

48.6

43.1

54.3

51.8

46.1

45.2

57.8

45.2

48.8

53.8

46.3

56.8

43.8

43.5

51.6

44.5

41.1

41.5

51.5

52.0

49.3

46.3

53.7

40.7

44.9

48.1

46.2

44.5

43.0

52.9

49.7

55.9

54.7

51.2

51.1

57.6

40.6

66.8

50.0

45.6

56.5

40.9

43.3

51.3

45.4

40.2

40.0

49.4

50.6

50.3

47.3

52.7

37.4

44.2

47.9

46.4

43.9

42.4

52.6

51.2

55.2

52.2

51.0

50.6

57.8

38.2

48.8

50.0

43.6

55.9

37.5

43.0

50.2

43.6

37.7

37.4

48.6

50.0

50.9

48.3

53.2

35.2

43.4

45.7

47.3

39.1

42.0

50.5

48.9

53.7

51.1

49.4

49.1

58.6

41.2

44.1

49.7

42.4

56.3

36.8

44.4

50.8

43.1

36.2

37.7

48.6

50.4

48.7

49.3

53.9

35.2

43.3

45.6

46.0

38.1

43.6

51.4

47.7

54.3

52.1

49.4

48.9

56.6

39.3

43.1

50.6

42.0

56.2

36.1

43.8

50.8

42.4

35.4

37.3

47.6

49.5

47.9

50.3

53.7

35.3

43.1

45.2

45.3

37.0

44.0

50.6

46.1

54.7

51.8

49.0

48.4

*Figure from Commission services' Spring 2012 forecast.
Source: Commission services.

21

2.

IMPLEMENTATION OF THE STABILITY AND GROWTH PACT

2.1. 

INTRODUCTION

focussing,  in  particular,  on  the  excessive  deficit 
procedure (EDP).

through 

discipline 

The  EU  fiscal  framework,  as  laid  down  by  the 
Stability and Growth Pact (SGP), aims at ensuring 
budgetary 
two  main 
requirements.  Firstly,  Member  States  are  required 
by  the  Treaty  to  avoid  excessive  government 
deficit  and  debt  positions,  measured  against 
reference  values  of  respectively  3%  and  60%  of 
GDP (9). Secondly,  they  are  required  by  the 
preventive  part  of  the  SGP (10) to  achieve  and 
maintain  medium-term  budgetary  objectives 
(MTO),  which  are  given  as  cyclically  adjusted 
targets  for  the  budget  balance,  net  of  one-off  and 
temporary measures. Compliance with the MTO is 
meant 
the  sustainability  of  public 
finances  and  to  allow  the  automatic  stabilizers  to 
work  without  breaching  the  3%  of  GDP  deficit 
threshold set by the Treaty. 

to  secure 

The  EU  legislator,  in  late  2011,  adopted a  major 
framework  of  EU 
reform  strengthening 
the 
fiscal 
economic  governance, 
surveillance,  as  presented  in  Part  II.  Steps  in  EU 
budgetary surveillance launched after this date are 
subject  to  the  new  rules  including  transition 
provisions.

including  EU 

This  section  reviews 
surveillance 
budgetary 

the 

implementation  of 
January  2011, 

since 

(9) Article  126  of  the  Treaty  lays  down  an  excessive  deficit 
procedure  (EDP)  which  is  further  specified  in  Council 
Regulation  (EC)  No.  1467/97 
'on  speeding  up  and 
clarifying  the  implementation  of  the  excessive  deficit 
procedure',  amended  in  2005  and  2011,  which  represents 
the  corrective  arm  of  the  SGP.  The  Code  of  Conduct 
provides  specifications  on  the  implementation  of  the 
Stability and Growth Pact and guidelines on the format and 
content of stability and convergence programmes, and has 
been updated on 24 January 2012. Relevant legal texts and 
guidelines 
at: 
http://ec.europa.eu/economy_finance/sgp/legal_texts/index
_en.htm

found 

can 

be 

(10) The  preventive  arm  of  the  SGP  is  contained  in  Council 
Regulation  (EC)  No.  1466/97  'on  the  strengthening  of  the 
surveillance  of  budgetary  positions  and  the  surveillance 
and  coordination  of  economic  policies',  which  was 
amended  in  2005  and  2011.  This  Regulation  specifies  the 
obligation  for  the  Member  States  to  achieve  and  maintain 
their  MTO.  Together  with  Regulation  (EC)  No.1467/97 
and  the  new  Directive  on  requirements  for  budgetary 
frameworks  of  the  Member  States  (Directive  (EC)  No. 
2011/85)  and  Regulation  (EU)  No  1173/2011  on  the 
effective enforcement of budgetary surveillance in the euro 
area, it forms the SGP.

22

Following  the  marked  deterioration  of  public 
finances in EU Member  States in the  wake of the 
severe economic recession of 2009, many Member 
States  started fiscal  consolidation  efforts in  2010, 
including  in  particular  efforts  to  correct  excessive 
government  deficits  under 
the  Stability  and 
Growth Pact. The efforts  were intensified in 2011 
and  led  to  a  significant  improvement  of  public 
finances in  both  the  euro  area  and  in  the  EU  as  a 
whole.  Based  on  data  notified  by  Member  States 
and validated by Eurostat, in 2011 the government 
deficit exceeded the 3% of GDP reference value in 
seventeen  EU  Member  States.  This  is somewhat 
better 
the 
Commission  services'  Autumn  2011  forecast,
nineteen  countries  were  projected  to  exceed  this
the 
3%  of  GDP  reference  value.  However, 
budgetary correction cannot be considered durable 
at  this  stage  for  all  Member  States that  reduced 
their deficit-to-GDP  ratio 
the  3% 
threshold in 2011; based on Commission services' 
( 11),
in some  of  these
Spring  2012  forecast
countries  the  deficit-to-GDP  ratio  is  expected  to 
increase  again  above  the  3%  of  GDP  reference 
value  in  2012  or  2013.  As  a  result,  the  EDP 
abrogation  cannot  yet  be  considered  for  these 
countries. 

previously 

to  below 

expected: 

than 

in 

forecast,( 12)

the  process  of 

As  shown  in  Chapter  I.1,  according  to  the  2012 
fiscal 
Spring 
consolidation is expected to continue in 2012 with 
an estimated improvement of the structural budget 
balance in 2012 expected to be above 1% of GDP 
both  in  the  EU  and  the  euro  area.  The  projected 
improvement of the budgetary situation in the EU 
is  broad  based  across  Member  States.  Only  a 
limited  number  of  countries  would  register  an 
increasing headline deficit in the years covered by 
the  Commission  services'  2012  Spring  forecasts, 
2012 and 2013. 

At  the  beginning  of  2011,  a  number  of  Member 
States were assessed to have taken effective action 
in response to the recommendations to correct their 
excessive deficit recently addressed to them by the 
Council.  In  the  case  of  Greece,  which  is  the  only 

(11) See European Commission (2012a). 
(12) See footnote 9.

Member  State  currently  subject  to  a  notice  under 
Article  126(9)  to  take  (specific)  measures  to 
remedy  the  situation  of  excessive  deficit,  the 
review  of  the  notices  and  the  assessment  of 
compliance  with 
in 
parallel  with the  review  of  the  macroeconomic 
adjustment programme. 

them  occurred  regularly, 

of 

2011, 

in  Autumn 

In 
the 
the  Summer,  on  recommendation  by 
Commission,  the  Council  abrogated  the  Finnish 
the 
EDP. However, 
comprehensive 
budgetary 
assessment 
developments in all EU countries undertaken in the 
context of the Commission services’ Autumn 2011 
forecast  revealed  that  a  timely  and  sustainable 
correction  was  clearly  at  risk  in  some  Member 
States with  an  imminent  or  close  deadline  for 
correcting of 2011 or 2012. This  was the case  for
Belgium,  Cyprus,  Hungary,  Malta  and  Poland. 
These five Member States were called to treat the 
adoption  of  a  budget  for  2012  and/or  additional 
measures 
timely  and  sustainable 
correction  of  the  excessive  deficit as  a  matter  of 
urgency.

that  ensure 

As  stated  in  the  Communication  issued  on 11 
January  2012,  the  Commission  considered  that  
four  of  the  Member  States  concerned  (Belgium, 
Cyprus,  Malta  and  Poland)  had  taken  effective 
action towards a timely and sustainable correction 
of the excessive deficit.

At  the  same  time,  on  recommendation  by  the 
Commission,  the  Council  stepped  up  the  EDP  for 
Hungary  in March 2012 and set a new deadline –
2012  – for  bringing  the  general  government 
balance  below  the  3%  of  GDP  reference  value  of 
the  Treaty. As a  follow-up  to  this new  Council 
recommendation under Article 126(7), on 30 May 
2012,  the  Commission  adopted  a  Communication 
on the assessment action taken. 

In  June  2012,  on the  basis  of  a  Commission 
recommendation, 
the 
decision  on  the  existence  of  an  excessive  deficit 
for Germany and Bulgaria (see below). 

the  Council  abrogated 

Finally,  also  following  a  recommendation  by  the 
Commission,  the  Council  addressed  a  revised 
recommendation under Article 126(7) to Spain on 
10 July 2012. Spain is recommended to correct its 
excessive deficit by 2014. The Council established 
the  Spanish 
the  deadline  of  3  months  for 

Current developments and prospects

Part I

to 

take  effective  action  and, 

government 
in 
accordance  with  Article  3(4a)  of  Council 
Regulation (EC) No 1467/97, to report in detail the 
consolidation strategy that is envisaged to achieve 
the targets.

Currently, all EU Member States are subject to the 
EDP,  except  for  Bulgaria,  Estonia,  Finland, 
Germany,  Luxembourg  and  Sweden. For  all 
countries  under 
the 
procedure is now in abeyance. (13)

the  EDP,  except  Spain, 

to 

the  EDP, 
Among  Member  States  subject 
Greece,  Portugal, 
Ireland  and  Romania  are 
benefiting  from  financial  assistance,  while  Spain, 
Cyprus  and  Hungary  have  recently  requested 
financial  assistance.  Meanwhile,  the  Balance  of 
Payment  (BoP)  programme  for  Latvia  ended  in 
January 2012. 

2.2. 

THE EXCESSIVE DEFICIT PROCEDURE (EDP)

This section focuses on the implementation of the 
EDP  since  January  2011.  The  historical  country-
specific  developments  are  summarised  in  Tables 
I.2.1.-I.2.3. (14)

2.2.1. EDP in euro-area member states

Table  I.2.1. shows  the  EDP  steps  taken  for  all 
euro-area countries except Greece, which is shown 
in Table I.2.2. 

Proceeding in a chronological order, on 6 January 
2011, the Commission assessed the action taken by 
Malta in  compliance  with  the  February  2010 
Council  recommendation  to  bring  the    excessive 
deficit  situation  to  an  end  and  concluded  that 
effective 
taken. While 
acknowledging  that  the Maltese  authorities  had 
taken  fiscal  consolidation  measures  to  correct  the 
excessive deficit by 2011, the Council noted that in 
spite of a better macroeconomic environment than 
expected  in  the  Council  recommendations,  there 
had  been  no  acceleration  in  the reduction  of  the 

action 

been 

had 

(13) Greece is subject to a notice by the  Council under  Article 

126(9). See subsequent paragraphs. 

(14) All 

the  country-specific  developments  regarding 
the 
excessive  deficit  procedure  (EDP)  can  be  followed  at: 
http://ec.europa.eu/economy_finance/economic_governanc
e/sgp/deficit/index_en.htm.

23

European Commission

Public finances in EMU - 2012

deficit  in  2010,  and  that  considerable  downside 
risks existed to the achievement of the 2011 deficit 
target.

Malta notified a deficit of 2.7% of GDP for 2011. 
The  Commission  services' Spring  2012  forecast 
projected  the  government  deficit at  2.6%  of  GDP 
in 2012 and 2.9% of GDP in 2013. The deficit was 
thus  projected  to  remain  below  the  3%  of  GDP 
threshold over the forecast horizon, but with a very 
small  margin.  The  Commission  has  not  yet 
recommended  to  the  Council  to  abrogate  the 
decision  on  the  existence  of  an  excessive  deficit, 
but  the situation  will  be  re-evaluated  later  in  the 
year,  subject 
information, 
to  complementary 
including  the  results  of  the  EDP  dialogue  visit  to 
Malta conducted by Eurostat in May 2012. (15) 

In  late  January  2011, the  Commission  concluded 
that effective action had been taken by Cyprus and 
Finland in compliance with the July 2010 Council 
recommendations  to  correct  the  excessive  deficit. 
On  this  basis,  in  mid-February  2011,  the  Council 
concluded  positively  on  action  taken  by  the  two 
countries. 

Finland's  first  notification  of  government  deficit 
and  debt  data  showed  reported  that  the  general 
government  deficit  had  remained  below  3%  of 
GDP  in  2010.  The  Commission  forecast  that  the 
deficit  ratio  would  remain  below  3%  in  the  two 
next  two  years.  On  this  basis,  the  Commission 
recommended  to  the  Council  to  abrogate  the 
existence  of  an  excessive  deficit.  The  Council 
closed  the  Finnish  EDP  procedure  on  12  July 
2011. 

On  24  August  2011,  the  Commission  concluded 
that Ireland had made adequate progress towards a 
timely  correction  of  the  excessive  deficit,  in 
response 
the  December  2010  Council 
recommendation  to  correct  the  excessive  deficit 
situation,  and  that  no  further  EDP  steps  were 
needed. Based on the Summer 2011 review of the 

to 

(15) In accordance with Council Regulation (EC) No 479/2009 
on  the  application  of  the  Protocol  on  the  EDP  annexed  to 
the Treaty establishing the European Community.

(16) The excessive deficit procedure for Ireland runs in parallel 
to the macroeconomic adjustment program agreed between 
Ireland  and  the  Commission  on  behalf  of  the  lenders,  in 
liaison with the ECB and the  IMF. See the 'Memorandum 
of  Understanding 
Economic  Policy 
on  Specific
Conditionality'  between  the  Commission  and  the  Irish 
authorities that was signed on 16 December 2010.

24

financial  assistance  programme  for  Ireland,  the 
government  deficit  in  2011  is  expected  to  remain 
below the target outlined for that year in the EDP 
decision, and to reach the target for 2012. (16) 

In  the  case  of  Greece,  the  excessive  deficit 
procedure  runs  in  parallel  to  the  macroeconomic 
adjustment programme agreed between Greece and 
the Commission on behalf of the lenders, in liaison 
with  the  ECB  and  the  IMF.  (17)  In  the  EDP 
context,  the  Commission  has  further  assessed 
action taken in compliance with the February 2010 
Council  decision  to  give  notice to  Greece  in
(18)  Based  on  Commission 
February 2011. 
recommendations,  the  Council  adopted  further 
amendments to its February 2010 decision to give 
notice (recast in July 2011) to the Greek authorities 
under  Article  126(9)  TFEU,  in  March,  July  and 
November  2011.  Further  amendments  of  this 
decision in March 2012 included a revision of the 
fiscal  adjustment  path,  in  particular  in  light  of 
worse 
economic 
performance  and  newly  announced  government 
measures  for  the  reduction  of  the  primary  deficit, 
while leaving the deadline for the correction of the 
excessive deficit in 2014. 

than  previously 

expected 

that,  according 

On  30  May  2012,  following  Germany's first 
notification of government deficit and debt data for 
2011  which  reported  that  the  deficit-to-GDP  ratio 
returned  well  below  the  3%  of  GDP  reference 
value,  and  given 
the 
Commission  services'  2012  Spring  forecast ( 19), 
further 
the 
forecast  horizon, 
the  Commission  adopted a 
recommendation for a Council decision abrogating 
the  decision  on  the  existence  of  excessive  deficit
for  Germany.  On  19  June  2012,  the  Council 
decided to abrogate the excessive deficit procedure 
for Germany. 

improvements  are  expected  over 

to 

the 

case  of  Spain, 

the  Commission 
In 
recommended  on  6  July 2012  to  the  Council  to 
adopt a new recommendation for correction of the 

(17) See Memorandum on Economic and Financial Policies and 
Memorandum  of  Understanding  on  Specific  Economic 
Policy  Conditionality  (both  3  May  2010).  All 
the 
documents related to the implementation of the EDP in the 
case 
at: 
http://ec.europa.eu/economy_finance/sgp/deficit/countries/
greece_en.htm

Greece 

found 

can 

be 

of 

(18) The noticed was revised in July, October 2011 and again in 

March 2012.
(19) See footnote 9. 

excessive  deficit  adopted  by  the  Council  in  2009. 
In  particular,  it  was  recommended  to  extend 
Spain’s  deadline  for  correction  of  the  excessive 
deficit  by  one  year,  to  2014.  To  this  end,  the 
Spanish  authorities  shall  deliver  an  improvement 
of the structural balance of 2.7pp. of GDP in 2012, 
2.5pp. of GDP in 2013 and 1.9pp. of GDP in 2014. 
The  headline  deficit  targets  should  be  6.3%  of 
GDP for 2012, 4.5% of GDP for 2013 and 2.8% of 
GDP  in  2014. This  recommendation  was  made  in 
view of the fiscal effort undertaken by the Spanish 
authorities  and,  in  line  with  Article  3(5)  of 
to  a 
Regulation  (EC)  1467/97, 
substantial deterioration of the country’s economic 
situation  and  outlook,  compounded  by  a  less  tax-
rich  growth  composition, compared  with 
the 
the  earlier  Council 
projection  underpinning 
recommendation.  The  Council  adopted 
this 
recommendation on 10 July 2012.

in  response 

2.2.2. EDP in non-euro area Member States

In 

their

July 

compliance  with 

Table I.2.1. shows the EDP steps taken for the non 
euro-area countries. Proceeding in a chronological 
order, in February 2011 the Council concluded that 
Bulgaria and  Denmark had  taken  effective  action 
in 
2010 
recommendation  to  end  their excessive  deficits, 
and that no further EDP steps were needed at that 
the 
time. 
its  January  2011  assessment, 
Commission  had  concluded,  based  on 
the 
Commission  services'  2010  Autumn  forecast,  that 
both countries had taken the necessary measures to 
correct the excessive deficit by the deadlines set by 
the Council. On 30 May 2012, on the basis of the 
Bulgaria's  first  notification  of  government  deficit 
and  debt  data  for  2011  stating  that  the  deficit-to-
GDP ratio returned below the 3% threshold and of 
the  Commission  services'  2012 spring  forecast 
showing  a  further  improvement  of  the  budgetary 
the 
the 
situation 
Commission  adopted 
for  a 
Council  decision  to  abrogate  the  decision  on  the 
existence of an excessive deficit. On 19 June 2012, 
the  Council  abrogated 
the  excessive  deficit 
procedure for Bulgaria. 

forecast 
recommendation 

horizon, 

over 

In the case of Hungary, in its assessment of action 
taken  of  11  January  2012, 
the  Commission 
concluded  that  Hungary  had  not  taken  effective 
action  in  response  to  the  July  2009  Council 
recommendation.  While  the  general  government 
the  Hungarian 
expected  by 
balance  was 

Current developments and prospects

Part I

authorities,  based  on  the  2011  Autumn  EDP 
notification, and by the Commission services' 2011 
Autumn  forecast,  to  turn  into  surplus  (of  4.2%  of 
GDP) in 2011, this was exclusively due to one-off 
revenues  of  almost  10%  of  GDP,  linked  to  the 
transfer of pension assets from the private pension 
schemes to the state pillar. Moreover, according to 
the  Commission  services'  2011  Autumn  forecast, 
in  2012  the  3  %  of  GDP  reference  value  of  the 
Treaty would have again been respected thanks to 
one-off measures of close to 1 % of GDP, while in
2013 the deficit was expected to exceed the 3 % of 
the 
GDP  reference  value. On 
Commission's 
the  Council 
recommendation, 
decided  on  24  January  2012  that the  country  had 
not  taken  effective  action  in  response  to  its 
recommendation  to  correct  the  excessive  deficit 
situation of 7 July 2009.

the  basis  of 

On 13 March 2012, on a recommendation from the 
the  Council  adopted  a  new 
Commission, 
recommendation  addressed  to  Hungary  to  end  the 
excessive deficit situation by 2012, by requiring an 
additional  fiscal  effort,  i.e.  additional  measures  of 
a structural nature, of at least 0.5% in 2012, on top 
of the 1.9% of GDP already expected.

On  the  same  date,  the  Council  also  adopted  a 
decision  suspending  almost  a  third  of  scheduled 
commitments  for  Hungary  from  the  EU  Cohesion 
Fund in 2013, taking recourse, for the first time, to 
the  possibility  of  suspending  Cohesion  Fund 
commitments  in  case  of  non-compliance  with  its 
EDP  recommendation under  Article  126(7)  of  the 
Treaty,  according  to  Article  4(1)  of  Regulation 
(EC) No 1084/2006.

to 

to 

On 30 May 2012, the Commission concluded that 
Hungary had  made  adequate  progress  towards  a 
timely  correction  of  the  excessive  deficit,  in 
2012  Council 
the  March 
response 
the 
to  bringing  an  end 
recommendation 
excessive deficit situation, and that no further EDP 
steps  were  needed.  On the  same  date, 
the 
Commission also adopted a proposal for a Council 
decision to lift the suspension of the commitments 
from  the Cohesion  Fund,  in  accordance  with
Article  4(2)  of  Regulation  (EC)  No  1084/2006 
establishing 
the 
suspension  for  the  Cohesion  Fund  commitments, 
which the Council adopted on 19 June 2012.

the  conditions 

lifting 

for 

25

European Commission

Public finances in EMU - 2012

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S

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Current developments and prospects

Part I

Table I.2.2:

Overview EDP steps - Non-euro area Member States

Steps in EDP procedure

Treaty Art.

HU

UK

LV

PL

Country
LT

RO

CZ

BG

DK

126(3)
126(4)

12.05.2004 11.6.2008 18.02.2009 13.05.2009 13.05.2009 13.05.2009 07.10.2009 12.05.2010 12.05.2010
24.05.2004 25.6.2008 27.02.2009 29.05.2009 29.05.2009 29.05.2009 27.10.2009 27.05.2010 27.05.2010

126(5)
126(6)
126(7)

126(6)
126(7)

24.06.2004 02.07.2008 02.07.2009 24.06.2009 24.06.2009 24.06.2009 11.11.2009 06.07.2010 15.06.2010
24.06.2004 02.07.2008 02.07.2009 24.06.2009 24.06.2009 24.06.2009 11.11.2009 06.07.2010 15.06.2010
24.06.2004 02.07.2008 02.07.2009 24.06.2009 24.06.2009 24.06.2009 11.11.2009 06.07.2010 15.06.2010

05.07.2004 08.07.2008 07.07.2009 07.07.2009 07.07.2009 07.07.2009 02.12.2009 13.07.2010 13.07.2010
05.07.2004 08.07.2008 07.07.2009 07.07.2009 07.07.2009 07.07.2009 02.12.2009 13.07.2010 13.07.2010
05.11.2004 08.01.2009 07.01.2010 07.01.2010 07.01.2010 07.01.2010 02.06.2010 13.01.2011 13.01.2011
at least
1½% of
GDP in
2009-2011
2011

at least
2¾% of
GDP in
2010-2012
2012

at least
1¼% of
GDP in
2010-2012
2012

at least
1½% of
GDP in
2010-2011
2011

at least
0.5% of
GDP in
2011-2013
2013

1% of GDP 
in 2010-
2013

at least ¾%
of GDP in
2011

2011

2013

2008

-

at least
0.5% of
GDP in
2009/10
fin. year
 2009/10

Starting phase

Commission adopts EDP-report = start of the procedure
Economic and Financial Committee adopts opinion
Commission adopts:
     opinion on existence of excessive deficit
     recommendation for Council decision on existence of excessive deficit
recommendation for Council recommendation to end this situation
Council adopts:
     decision on existence of excessive deficit
     recommendation to end this situation
          deadline for taking effective action

          fiscal effort recommended by the Council*

          deadline for correction of excessive deficit

Follow-up of the Council recommendation under Art. 126(7)

Commission adopts communication on action taken
Council adopts conclusions thereon
Commission adopts recommendations for Council decision establishing
inadequate action
Council adopts decision establishing inadequate action
Commission adopts recommendation for NEW Council recommendation to 
end excessive deficit situation
Council adopts NEW recommendation to end excessive deficit situation
          deadline for taking effective action

          fiscal effort recommended by the Council*

          new deadline for correction of excessive deficit

Follow-up of the NEW Council recommendation under Art. 126(7)

Commission adopts communication on action taken
Council adopts conclusions thereon
Commission adopts recommendations for Council decision establishing
inadequate action
Council adopts decision establishing inadequate action
Commission adopts recommendation for NEW Council recommendation to 
end excessive deficit situation
Council adopts NEW recommendation to end excessive deficit situation
          deadline for taking effective action

          fiscal effort recommended by the Council*

          new deadline for correction of excessive deficit

Follow-up of the NEW Council recommendation under Art. 126(7)

Commission adopts communication on action taken
Council adopts conclusions thereon
Commission adopts recommendations for Council decision establishing
inadequate action
Council adopts decision establishing inadequate action
Commission adopts recommendation for NEW Council recommendation to 
end excessive deficit situation
Council adopts NEW recommendation to end excessive deficit situation
          deadline for taking effective action

          fiscal effort recommended by the Council*

          new deadline for correction of excessive deficit

Follow-up of the NEW Council recommendation under Art. 126(7)

Commission adopts communication on action taken
Council adopts conclusions thereon
Commission adopts recommendations for Council decision establishing
inadequate action
Council adopts decision establishing inadequate action
Commission adopts recommendation for NEW Council recommendation to 
Council adopts NEW recommendation to end excessive deficit situation
          deadline for taking effective action

          fiscal effort recommended by the Council

          new deadline for correction of excessive deficit

Follow-up of the NEW Council recommendation under Art. 126(7)

Commission adopts communication on action taken
Council adopts conclusions thereon

Abrogation

Commission adopts recommendation for Council decision abrogating
existence of excessive deficit
Council

 existence of excessive deficit

s decision abr

ati

Notes: * Average annual fiscal effort, unless indicated otherwise.
Source: Commission sources.

-
-

-
-

27.01.2010 03.02.2010
16.02.2010 16.02.2010

126(8)

22.12.2004 24.03.2009

126(8)
126(7)

18.01.2005 27.04.2009
16.02.2005 24.03.2009

126(7)

08.03.2005 27.04.2009
08.07.2005 27.10.2009
beyond 1%
of GDP in
2010/11-
2013/14
fin. year
 2013/14

2008

-

13.07.2005
-
20.10.2005

-
-
-

126(8)

126(8)
126(7)

08.11.2005
26.09.2006 11.11.2009

-

126(7)

10.10.2006 02.12.2009
10.04.2007 02.06.2010

-

2009

1¾% of
GDP in
2010/11-
2014/15
fin. year
2014/15

13.06.2007 06.07.2010
10.07.2007 13.07.2010

126(8)

-

126(8)
126(7)

-
24.06.2009

07.07.2009
07.01.2010
0.5% of
GDP in
cumulative 
terms in 
2010-2011
2011

27.01.2010
16.02.2010

11.01.2012
24.01.2012
06.03.2012
13.03.2012
13.09.2012

at least
0.5% of
GDP on top 
of the 1.9%
of GDP  
foreseen 

2012

30.05.2012
19.06.2012

126(7)

126(8)

126(8)
126(7)
126(7)

126(12)

15.06.2010 27.01.2011 27.01.2011
13.07.2010 15.02.2011 15.02.2011

-
-
-

-

-
-
-

-

27.01.2010 08.02.2010

16.02.2010 16.02.2010
16.08.2010 16.08.2010

at least
2¼% of
GDP in
2010-2012
2012

1¾% of
GDP in
2010-2012

2012

21.09.2010 21.09.2010
19.10.2010 19.10.2010

30.05.2012
19.06.2012

27

European Commission

Public finances in EMU - 2012

Table I.2.3:

Overview EDP steps - Greece

Steps in EDP procedure

Starting phase

Commission adopts EDP-report = start of the procedure
Economic and Financial Committee adopts opinion
Commission adopts:
    opinion on existence of excessive deficit
    recommendation for Council decision on existence of excessive deficit
    recommendation for Council recommendation to end this situation
Council adopts:
    decision on existence of excessive deficit
    recommendation to end this situation
         deadline for taking effective action
         fiscal effort recommended by the Council
         deadline for correction of excessive deficit

Follow-up of the Council recommendation under Art. 126(7)

Commission adopts recommendations for Council decision establishing inadequate action
Council adopts decision establishing inadequate action
Commission adopts recommendation for Council decision to give notice
Council decision to give notice
         deadline for taking effective action
         fiscal effort recommended by the Council
         new deadline for correction of the excessive deficit

Follow-up of the Council decision

Commission adopts communication on action taken
Council adopts conclusions thereon
Commission adopts recommendation for NEW Council decision to give notice
Council decision to give notice
         fiscal effort recommended by the Council
         new deadline for correction of the excessive deficit

Follow-up - 1st review

Commission adopts communication on action taken
Council adopts conclusions thereon
Commission adopts recommendation for Council decision amending the Council decision 
          to give notice
Council decision amending the Council decision to give notice
         new deadline for correction of the excessive deficit

Follow-up - 2nd review

Commission adopts communication on action taken
Council adopts conclusions thereon
Commission adopts recommendation for Council decision amending the Council decision 
          to give notice
Council decision amending the Council decision to give notice
         deadline for correction of the excessive deficit

Follow-up - 3rd review

Commission adopts communication on action taken
Council adopts conclusions thereon
Commission adopts recommendation for Council decision amending the Council decision
          to give notice
Council decision amending the Council decision to give notice
         deadline for correction of the excessive deficit

Follow-up - 4th review

Commission adopts communication on action taken
Council adopts conclusions thereon
Commission adopts recommendation for Council decision amending the Council decision
          to give notice
Council decision amending the Council decision to give notice
          deadline for correction of the excessive deficit

Follow-up - 5th review

Commission adopts communication on action taken
Council adopts conclusions thereon
Commission adopts recommendation for Council decision amending the Council decision 
          to give notice
Council decision amending the Council decision to give notice
          deadline for correction of the excessive deficit

Follow-up - Second Adjustment Programme

Source: Commission services.

Treaty
Art.

126(3)
126(4)

126(5)
126(6)
126(7)

126(6)
126(7)

126(8)
126(8)
126(9)
126(9)

126(9)
126(9)

126(9)

126(9)

126(9)

126(9)

126(9)

126(9)

126(9)

126(9)

126(9)

126(9)

EL

18.02.2009
27.02.2009

24.03.2009
24.03.2009
24.03.2009

27.04.2009
27.04.2009
27.10.2009
-
2010

11.11.2009
02.12.2009
03.02.2010
16.02.2010
15.05.2010
at least 3½% of GDP annualy in 2010 and 
2012

09.03.2010
16.03.2010
04.05.2010
10.05.2010
at least 10% in cumulative terms over 2009-
2014

19.08.2010
07.09.2010
19.08.2010

07.09.2010
2014

09.12.2010
20.12.2010
09.12.2010

20.12.2010
2014

24.02.2011
07.03.2011
24.02.2011

07.03.2011
2014

01.07.2011
12.07.2011
05.07.2011

12.07.2011
2014

26.10.2011
08.11.2011
26.10.2011

08.11.2011
2014

28

3.

STABILITY AND CONVERGENCE PROGRAMMES

and 

(SCPs) 

besides 

examination 

This Chapter provides an overview of the Stability 
and  Convergence  Programmes 
that 
Member States submitted in April-May 2012. This 
round  of  SCPs  and  the  related  assessment  is  the 
first  one  based  on  the  new  provisions  of  the 
Stability and Growth Pact which entered into force 
in December 2011. Therefore, the present Chapter 
of 
the 
provides, 
macroeconomic 
budgetary 
assumptions 
objectives,  an  analysis  of  the  SCPs  against the 
expenditure  benchmark  and  the  debt  reduction 
benchmark  (see  Part  II on  Evolving  budgetary 
surveillance). Recommendations  based  on 
the 
SCPs were adopted by the Council in July 2012 on 
the basis of a Commission recommendation. Prior 
to  this,  in  view  of  the  persistent  pressure  on  the 
euro  area  sovereign  debt  markets  but  also of the 
less  favourable  growth  assumptions,  the  February 
2012  ECOFIN  Council  had 
the 
principle  of  differentiated  fiscal  exit  strategies 
into  account  country-specific  macro-
taking 
financial  situations.  Together  with 
the  EDP 
recommendations,  these  principles  represent  the 
basis  for  the  assessments  of  the  programmes.  In 
the context of the European Semester, the Council 
recommendations  are  expected  to  feed  into  the 
national  budgets  for  2013.  For  this  reason,  this 
Chapter gives special attention to 2013, examining 
the  deficit  targets  set  out  in  the  SCPs  against  the 
background  of  the  Commission  services'  Spring 
2012 forecasts.  It  then  presents  the  adjustment 
paths,  the  time  profile  and  the  composition  of  the 
consolidation  over  the  whole  horizon  of  the 
programmes.  The  Chapter  finally  outlines  the 
implications of the fiscal plans for the debt path.

reaffirmed 

the 

their 

2  highlights 

The  Chapter  consists of  four  sections.  Section 1 
the  macroeconomic  scenarios  with 
examines 
particular  attention  given 
sectoral 
to 
implications. A decomposition of the gap between 
SCP  projections  and  the  Commission  forecasts  is 
presented.  Section
fiscal 
consolidation  strategy  (pace,  time  profile  and 
composition  of  the  fiscal  adjustment)  and  also 
assesses expenditure plans for 2013 and for 2014–
2015. In addition, it presents the convergence path 
towards  Member  States'  medium-term  budgetary 
objectives (MTOs), including an assessment of the 
respect  of  expenditure  benchmark.  Section 3 
assesses 
the 
term 
macroeconomic  scenarios  and  the  consolidation 
plans  on  debt.  This  part  also  considers – where 

implications  of 

the  short 

appropriate  – whether  sufficient  progress  towards 
compliance  with  the debt  reduction  benchmark is 
ensured  according  to  the  SCPs  plans.  Section 4 
assesses  the  longer  term  implications  of  the  plans 
for  fiscal  sustainability,  notably 
into 
account 
in  age-related 
expenditure.  SCP  data  are  taken  from  the  SCP 
tables  submitted  by  Member  States.  SCP  data  for 
Greece  are  not  reported  as  Greece  did  not  submit 
the relevant tables. ( (20)

the  projected  changes 

taking 

3.1.  MACROECONOMIC SCENARIOS

On  average,  macroeconomic  scenarios  for  2012-
2013  are  similar  between  SCPs  and  Commission 
forecasts,  albeit  slightly  less  favourable  for  the 
latter.  The  overall  picture  is  one  of  stagnation  in 
2012,  followed  by  some  recovery 
in  2013. 
According  to  SCPs,  EU27  growth  would  average 
0.2pp  in  2012  (Commission:  0.0pp)  and  1.5pp in 
2013  (Commission:  1.3pp).  Forecasts  are  slightly 
lower for the euro area (Graphs I.3.1-I.3.2). 

According to SCPs, except in a few countries, the 
slowdown implies a widening output gap in 2012, 
contrasting  with  projections  made  last  year  of  a 
gradual pick-up in growth and a narrowing output 
gap  already  in  2012.  With  nominal  budgetary 
projections for 2012 often remaining close to those 
of  a  year  ago,  this  implies  a  tightening  of  the 
average  fiscal  stance.  For  2013,  some  moderate 
reduction  in  the  output  gap  is  generally  expected. 
At  the  EU  27  and  euro  area  level,  the  output  gap 
would  remain  large  and  negative  over  2012-2013 
(above  2%  in  2013),  with  some  further  closing 
expected by 2015 (up to about ¾ %). Output gaps 
are  deemed  to  be  largest  (and  remain  so) in 
countries  currently  experiencing  recessions  (such 
as Portugal, Spain and Slovenia), with moderately 
large  output  gaps  also  in  a  number  of  other 
countries. 

In  some  countries  there  are  notable  differences 
between SCPs and Commission's growth forecasts. 
Some  SCPs  pencil  in  markedly more  favourable 
assumptions  (for  either  2012  or  2013,  or  both), 

(20) Since  Greece  did  not  present  a  Stability  Programme  in 
2012,  it
is  not  taken  into  account  in  SCPs  weighted 
averages  for  the  euro  area  and/or  the  EU27  presented in 
this  note,  as  opposed  to  Commission  services'  Forecasts 
which cover all EU27 Member States.

29

European Commission

Public finances in EMU - 2012

Graph I.3.1:

Growth assumptions (EU)

4.0

3.0

2.0

1.0

0.0

-1.0

-2.0

-3.0

-4.0

-5.0

Output Gap - COM
GDP growth - COM
GDP growth - SCP

Output Gap - SCP
Potential growth - COM
Potential growth - SCP

07
06
Source: SCPs, Commission services.

08

09

10

11

12

13

extent

for  Slovenia,  Hungary, 

especially  so for  Bulgaria  and  Sweden,  and to
some 
the
Netherlands,  France  and Spain.  A few  countries
the Commission
project  weaker  growth 
forecast over 2012-2013 (Estonia and Slovakia).

than 

The  counterpart  of  improvement  in government
balances foreseen  in  the  SCPs  is,  for  nearly  all
Member  States,  an  expected  dissaving  by  the

Graph I.3.2: Growth assumptions (euro area)

domestic  private  sector, which  is  particularly
sizeable in Ireland, Lithuania, the United Kindom, 
the Netherlands,  Romania,  France,  Poland  and
Belgium (Graph I.3.3).

External balances also are expected to improve in
the  majority of cases. The bisector in Graph I.3.3.
delineates the  boundary  between  those  countries
where  an  improvement  is  expected  vis-à-vis  the

Output Gap - COM
GDP growth - COM
GDP growth - SCP

Output Gap - SCP
Potential growth - COM
Potential growth - SCP

4.0

3.0

2.0

1.0

0.0

-1.0

-2.0

-3.0

-4.0

-5.0

06

13
09
Note: "Potential growth - COM" refers to Commission's 2012 spring forecasts. "Potential growth - SCP" refers to potential growth based on the
harmonised methodology and the growth assumptions of SCPs. The same conventions hold for "Output Gap – COM" and "Output Gap – SCP"
Source: SCPs, Commission services.

08

07

12

10

11

30

Current developments and prospects

Part I

Graph I.3.3:

Sectoral net lending and relative ULC changes in the SCPs (2011–2015)

6.0

4.0

2.0

0.0

0.0

-2.0

-4.0

-6.0

-8.0

EE

PT

Change in relative ULC (black bubbles
for cost-competitiveness deterioration 
relative to EU 27)

FI

MT

SK

2.0

DE

DK

AT
CZ

HU

4.0

IT

BE

FR

NL

RO

PL

BG

SE

LV

6.0
CY

UK

LT

Deterioration vis-à-
vis rest of the world

10.0

12.0

8.0

ES

Improvement vis-à-vis
rest of the world

IE

Net lending of general government - SCPs (variation 2011-2015, % of GDP)

-2.0

)

P
D
G

f
o
%

,
5
1
0
2

-
1
1
0
2
n
o
i
t
a
i
r
a
v
(

s
P
C
S

-

r
o
t
c
e
s

e
t
a
v
i
r
p
e
h
t

f
o

i

g
n
d
n
e

l

t
e
N

Source: SCPs, Commission services.

rest of the world – countries that lie above the line
are  expected  to  show  an  improvement  in  their
external  balances while  those  below  are  expected
to show a deterioration.

An  improvement  in  the  external balance  takes
place  when  the  sum  of  the  changes in  private  net
lending  and  public net  lending  is  positive.  This  is
the  case in  particular for  Portugal,  Cyprus, Spain
and  Ireland,  with  also significant  changes  in

Graph I.3.4:

Sectoral net lending and relative ULC changes in the COM forecast (2011-2013)

-
1
1
0
2

n
o

i
t

a
i
r
a
v
(

M
O
C

-

r
o
t
c
e
s

e
t
a
v
i
r
p
e
h
t

f
o

)

P
D
G

f
o
%

,
3
1
0
2

-3.0

EE

-2.0

-1.0

i

g
n
d
n
e

l

t
e
N

Change in relative ULC
(black bubbles for cost-
competitiveness deterioration 
relative to EU 27)

Source: SCPs, Commission services.

EL

PT

FR

CZ

1.0

AT

BE

5.0

4.0

3.0

2.0

MT

1.0

0.0

NL

SK

0.0
FI
DE
DK

BG

SE

-1.0

-2.0

-3.0

-4.0

HU

ES

2.0

UK

SI

3.0

IT

LV

PL

LT

4.0

5.0

6.0

Improvement vis-à-vis
rest of the world

IE

RO

CY

-5.0
Net lending of general government - COM (variation 2011-2013, % of GDP)

Deterioration vis-à-
vis rest of the world

31

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
European Commission

Public finances in EMU - 2012

In 

Hungary (21), Malta, Italy, the Netherlands and the 
United  Kingdom. 
some  Member  States 
however, the planned improvement in government 
balances  is  more  than  offset  by  private  sector 
dissaving,  resulting  in  a  deteriorating  external 
position.  This 
includes  Estonia,  Denmark, 
Bulgaria,  Sweden,  Latvia, and  to  a  lesser  extent 
Germany.  Portugal  is  the  only  Member  State 
where  both  the  public  and  the  private  sector  are 
projected  to  deleverage.  Member  States  expecting 
a very large improvement of their external balance 
also 
cost 
competitiveness  as  measured  by  relative  unit 
labour  costs  (ULC).  (22) However,  there  is  no 
systematic  correlation  between  the  evolutions  of 
relative ULC and external balances. 

improvements 

foresee 

large 

in 

trends.  On 

Although not directly comparable in terms of time 
period,  the  Commission  services'  forecast  over 
2011-2013  (Graph  I.3.4)  broadly  confirms these 
however, 
projected 
Commission  services'  forecasts tend  to  show  less 
marked  improvements  in  domestic  private  sector 
balances and a more balanced distribution between 
Member  States  improving  and  those  deteriorating 
in terms of external balance.

average 

3.2. 

FISCAL CONSOLIDATION

The conclusions of the 21 February 2012 ECOFIN 
Council  stressed  that  all  Member  States  should 
continue to respect their commitments in line with 
the  rules  of  the  Stability  and  Growth  Pact  (SGP). 
While these rules allow the automatic stabilisers to 
work  around  the  agreed  path  of  structural  fiscal 
adjustment,  these conclusions  highlight  that  the 
room  for  fiscal  manoeuvre  differs  sharply  across 
Member  States,  with  those  benefiting  from  a 
financial  assistance  programme  or  those  facing 
close  market  scrutiny  being  called  to  exercise 
particular vigilance. Therefore countries benefiting 
from a financial assistance programme should stick 

(21) In  Hungary  net  public  lending  is  adjusted  for  one-off  and 

temporary measures in 2011.

(22) The  size  of  the  a  country's  circle  reflects  the  percentage 
change  of  the  real  effective  exchange  rate  over  the  2011–
2015  horizon  relative  to  the  EU27,  with  white  circles 
indicating  improvements  in  competiveness  and  black 
circles deteriorations. Formally, the indicator represents the 
percentage change in the nominal unit cost of labour over 
2011–2015 relative to the EU27 according to methodology 
in  the  Commission  services'  quarterly  report  on  Price  and 
Cost Competitiveness.

32

to  the  targets  as  agreed  in  the programme  and 
should fully and in a timely manner implement the 
including  structural  reforms, 
policy  measures, 
respective  Memorandum  of 
the 
in 
agreed 
Understanding.  Similarly,  Member  States  facing 
close  market scrutiny should  continue to  meet the 
agreed budgetary targets and stand ready to pursue 
further  consolidation  measures  if  needed.  Finally, 
the 
for 
expenditure-based  consolidations  – calling  for  the 
growth  of  expenditure  (net  of  discretionary 
revenue  measures)  to  remain  below  the  medium-
term rate of potential GDP growth until they have 
reached their MTO – while advocating expenditure 
prioritisation in favour of growth-friendly items.

a  preference 

conclusions 

express 

towards 

the  MTO  against 

Against  this  background,  this  section  reviews  the 
size and time profile of the planned consolidation, 
in  terms  of  both  headline  targets  and  structural 
balances. It contains also an assessment of the rate 
the 
of  progress 
expenditure  benchmark  introduced  by  the  reform 
of  the  Pact  alongside  the  traditional  approach,
based  on 
the  structural 
balance. The main risks to the achievement of the 
targets – both macroeconomic and policy-related –
are  highlighted  on  the  basis  of  a  comparison  with 
the  Commission forecasts  based  on  a  no-policy-
change  scenario.  This is  followed  by  a  more 
detailed analysis of the composition of the planned 
consolidation, including a disaggregation for broad 
categories of expenditure. 

improvement 

the 

in 

3.2.1. Size and time profile of planned 

consolidation

After the sizeable reduction in government deficits 
achieved  in  2011 (23) in  both  the  euro  area  (from 
6.2%  of  GDP  in  2010  to  4.1%)  and  the  EU  as  a 
whole  (from  6.5%  to  4.5%),  Member  States  plan 
overall  to  continue  with  ambitious  consolidation 
against a background of the foreseen protraction of 
the  cyclical  slowdown, evident  since  the  second 
half of last year. 

the  planned  changes 

in 
Graph  I.3.5 shows 
government  deficits  over  the  2011–2015  horizon, 
as set out in the SCPs. It shows that, on aggregate, 
both  the  EU27  and  the  euro  area  are  projected  to 
improve significantly  their  fiscal  positions  every 

(23) This deficit reduction exceeded the plans in the 2011 SCPs 
by 0.4pps of GDP in both the euro area and the EU27.   

Current developments and prospects

Part I

2015

2014

2013

2012

2011

Graph I.3.5:

Planned changes in government deficits over 2011–2015 in the SCPs

14.0

12.0

10.0

8.0

6.0

4.0

2.0

0.0

-2.0

-4.0

-6.0

IE ES UK SI CY LT FR RO PL SK NL EU PT EA IT BE LV CZ MT AT BG DK DE LU FI SE EE HU

Source: SCPs, Commission services.

year  between  2011  and  2015.  Overall,  the  time
profile  of  the  consolidation  is  relatively  front-
loaded,  as  the  largest  reduction  in  the  deficit,  by
about  1pp  of  GDP,  is  planned  for  2012,  while
somewhat  lower  reductions  are  pencilled  in from
2013 on, in particular for the euro area. 

While  the  extent  of  the  planned  deficit  reductions
broadly  reflects starting  positions,  considerable
cross-country variations are observed, including in 
the  profile  of  adjustment.
In  Belgium,  Malta,
Austria, Portugal, Slovakia, Finland, Bulgaria, the
Czech  Republic,  Slovakia  and  Denmark, 
the
comparison  between  the  first years  (2012–2013)
and 
the
programmes  suggests  a  relatively  back-loaded 
adjustment.  For Austria,  Portugal, Finland  and
Denmark,  the  deficit  is  even  projected  to  increase 
before  resuming  a  downward  path  from  2013
onwards.

(2014–2015)  of 

the  outer

years 

The  same  comparison  suggests  a  frontloaded
consolidation  in  Ireland,  Spain,  Italy, Slovenia,
Bulgaria,  Latvia, Lithuania,  Poland,  Romania and
the UK,  which  show  the largest deficit reductions
already 
largest
reductions planned for 2013 are in Spain, Cyprus,
France, Portugal and Denmark. 

their  2012  budgets.  The 

in 

Estonia and Sweden stand out for having achieved
a budget surplus already in 2011, which according 
to  plans would  turn  into  a  deficit  (albeit  of  very
small  proportion  for  Sweden)  in  2012,  before
moving  again  into surplus territory  (already  in
2013  for  Sweden,  a  year  later  for  Estonia).  The 
surplus recorded in 2011 in Hungary reflects large
one-off  operations  and  is  planned  to  be followed
by  declining  deficits.  Finally,  no  apparent  pattern 
of deficit reduction can be detected in the plans of
Luxembourg, where  the  small  deficit  recorded  in
2011  is  planned  to  be  followed  by  deficits
oscillating between 1 and 2% of GDP.

3.2.2. Evolution of structural balances 

The  Member  States generally  foresee  substantial
structural consolidations over the period. This can 
be seen in Graph I.3.6 which shows the level of the
structural balance for the years from 2011 to 2015,
alongside  the respective medium-term  objectives.
According to the SCP plans, the average structural
balance in both the EU27 and euro area should fall
by over 3pp of GDP over the four years from 2011
to 2015. This effort is somewhat frontloaded, with 
a  more  sizeable adjustment  in  the  early years  as
compared  to  the  later years covered  by  the  SCPs. 
For  a  number  of  Member States,  the  pace  of
consolidation  tends  to  be  more  moderate  as  they 

33

European Commission

Public finances in EMU - 2012

Graph I.3.6:

Planned changes in the structural government deficits over 2011–2015 in the SCPs and the MTOs

10.0

8.0

6.0

4.0

2.0

0.0

-2.0

-4.0

2015

2014

2013

2012

2011

MTO

IE UK ES CY SI PT PL LT SK FR HU EU-
27

IT NL EA-
17

RO BE MT CZ LV AT BG DE SE EE DK LU FI

Source: SCPs, Commission services.

move out of excessive deficits and embark on the
adjustment  path 
their medium-term
objective (MTO). 

towards

indicates 

For  2012  a  marked  structural  improvement  of
around  1½pp  of  GDP  is  expected  on average by 
SCPs.  This  compares with  a  structural  tightening
close to 1pp planned for 2012 in last year's SCPs.
the Member  States  have
This 
generally
structural
adjustments,  while  macroeconomic  conditions  are
less favourable. The combination of a wider output
gap and a significant structural adjustment leads to
a pro-cyclical stance in 2012. 

that 
undertaken 

additional 

According to  the  SCPs, a  substantial  policy
in  2013,  with  a
tightening  should  still  occur
structural improvement of about ¾pp for the EU27
and  close  to  1pp  at  the  level  of  the  euro  area. 
Structural  adjustments  should  continue  thereafter
at  a  slower  pace  of  close  to ½pp  for  the  EU27
average, with slightly lower tightening for the euro
area.

Graph I.3.6 also shows that the Member States are
moving towards their MTOs and some of them are
set  to  have  achieved  it  by  2015 or  before. These 
countries  are  Portugal,  Bulgaria, Czech  Republic,

34

Poland and Romania,  while Cyprus,  Hungary,
Italy,  Germany,  Sweden  and  Estonia  expect  tol
overachieve  it.  Spain, Slovenia,  Belgium, Latvia,
and Austria  are  projecting  that  they will  come 
close to their MTO by 2015.

While almost all countries plan some consolidation 
over  the 2011–2015  period,  there  are  notable 
differences  in  terms  of  pace  and  timeline.  The 
cumulated  size  of  the  structural  adjustment  tends
to  be  related  to  the  starting  position  of  the
countries (with a generally larger adjustment when 
the  structural  deficit  is  initially higher).  Moreover
and while there are exceptions, a correlation can be
found  between  large  cumulated  consolidation  and 
frontloaded  adjustment  (in  the  sense  of  taking 
place in 2012-2013 rather than in later years). 

Thus,  over  2011-2015,
substantial  and  rather
frontloaded  structural  improvements  are foreseen 
in Spain, Cyprus, Slovenia, Portugal, France, Italy,
Lithuania,  Hungary,  Poland,  Romania  and  the
United 
structural
improvements  are  also planned  in  most other
countries  but  in  a more  spread  out  manner.  A
loosening  of  the  structural  balance  is  expected  in
Finland, Denmark and Luxembourg.

Significant 

Kingdom. 

Current developments and prospects

Part I

Box I.3.1: The expenditure benchmark

Since the entry into force of the reform of the Stability and Growth Pact (SGP) – the so-called Six-Pack – in 
December 2011, the appropriateness of the adjustment path of  Member States towards their  medium-term 
budgetary objective (MTO) under the preventive arm, is assessed based on two pillars. (1)

The first pillar is the analysis of the annual structural adjustment undertaken by the Member States, which 
should amount to 0.5% of GDP as a benchmark until the MTO is reached. The second pillar compares the 
evolution  of  government  primary  expenditure,  net  of  discretionary  revenue  measures,  to  a  reference  rate, 
based on the medium-term potential GDP growth (see Section II.2.1). Countries that are at their MTO will 
have  a  reference  rate  equal  to  their  medium-term  potential  GDP  growth  rate,  while  those  not  yet  at  their 
MTO  will  have  a  reference  rate  that  is  lower.    The  second  pillar will  be  used  for  the  first  time  to  assess 
adjustment towards the MTO based on the 2012 budgetary plans. (2)

Table 1 presents the real growth rate of government expenditure net of discretionary revenue measures, as 
planned by Member States in their SCPs for 2012 and 2013, in light of the benchmark they should respect 
according  to  the  requirements  of  the  preventive  arm  of  the  SGP  (such  periods  are  flagged  with  grey 
shading).  Bold  figures  warn  that  the  enforcement  of  such  plans  would  not  comply  with  the  current 
benchmark:  out  of  15  Member  States  subject  to  the  preventive  arm  in  2012  and/or  2013,  4  could  be 
concerned (Germany in 2012, Romania in 2013, Estonia and Luxembourg in both years). If this materialises 
with  an  observed  impact  on  government  balance  of  at  least  0.5%  of  GDP  over  one  year  (or  cumulatively 
over two consecutive years), the deviation from the adjustment path towards the MTO might be considered 
to be significant (as defined in Art. 6 of Reg. 1466/97).

Overall,  EU  Member  States'  policy  choices,  in  terms  of  expenditure  growth  and  discretionary  revenue 
measures (3),  as  presented  in  the SCPs,  would,  in the  great  majority  of  cases,  be  consistent  with  medium-
term potential growth. The outliers are Luxembourg, which stands clearly over its benchmark rate in 2012, 
while  Estonia,  Denmark,  Germany  and  Belgium  also  markedly  exceed  it;  as  far  as  the  2013  plans  are 
concerned,  Member  States  are  expected  to  comply,  at  the  exception  of  a  clear  deviation  for  the  UK  and 
Estonia, while Luxembourg stands again above its benchmark rate.

However,  a  majority  of  Member  States  actually  plan  a  larger  adjustment  than  what  is  required  by  the 
preventive  arm  (by  maintaining  real  net  expenditure  growth  well  below  the  benchmark);  this  reflects  the 
undergoing  correction  of  current  excessive  deficits  and  a  large  consolidation  of  public  finances  which  is 
underway in the EU, and more specifically in the euro area.

(1) All results of this first exercise of the assessment of policy plans against the expenditure benchmark, presented in this 
note,  are  only  based  on  plans  as  reported  by  Member  States  in  their  programmes,  at  the  exception  of  corrections 
undertaken after bilateral contacts with the authorities.

(2) Member States subject to the EDP are not formally concerned by this benchmark.
(3)

In  accordance  with  Art.5  of  Reg. 1466/97,  the  change  in  expenditure  is  recalculated  in  order  to  avoid  taking  into 
account  non-discretionary  changes  in  government  expenditure  due either  to unemployment  benefits  or  to EU 
programmes matched by EU funds revenue. To avoid penalizing peaks in investment, corresponding expenditure is 
also  smoothed  over  four years.  Finally,  the  effect  of  measures  taken  by  the  Member  States  on  the  revenue  side  is 
deducted,  to  obtain  a  net  change  in  government  expenditure. As  for  the  benchmark,  the  reference  rate  used  as  a 
ceiling  over  expenditure  growth  corresponds  to  the  10-year  average  growth  rate  of  potential  GDP  (2007-2016). 
Moreover, as long as the Member State is not at its MTO, this expenditure growth should remain below the reference 
rate,  in  order  to  support the  required  structural  adjustment by  0.5%  of  GDP  towards  the  MTO;  this  yields  a  lower 
benchmark  (the  "lower  rate"). Member  States  which  have  overachieved  their  MTO  could  temporarily  exceed  the 
benchmark as  long  as,  taking  into  account  the  possibility  of  significant  revenue  windfalls,  the  MTO  is  respected 
throughout the programme period.

(Continued on the next page)

35

European Commission

Public finances in EMU - 2012

Box (continued)

Table 1:

Growth of government expenditure net of discretionary revenue measures and applicable benchmark

Applicable benchmark for 2012 and 
2013a (%)

Real growth rate of government expenditure net of discretionary revenue measures  presented in SCPs

0.4
1.1 in 2012, 2.6 in 2013
1.2
0.9 in 2012, 0 in 2013
0.0 in 2012, 1.2 in 2013
1
-0.8
-1.4
-0.2
0.3
-0.8
0.3
-0.1
0.8
1.8 in 2012, 0.6 in 2013
-0.6
0.2
0.4
0.5
2.6
-1.1
1.4
0.6
1.8
1.4 in 2012, 0.5 in 2013
1.8
0.1

BE
BG
CZ
DK
DE
EE
IE
EL
ES
FR
IT
CY
LV
LT
LU
HU
MT
NL
AT
PL
PT
RO
SI
SK
FI
SE
UKd
EA17
EU27

2012

1.5
-11
-3.3
2
0.9
2.2
-13.4
n.a.
-12
-1.4
-6.7
-9.1
-3
-6.3
4.9
-9.5
-4.4
-3.6
0.8
1
-2.3
-4.3
-9.2
0.4
0.9
2
-4.3
-3
-2.9

2013

2014

2015

-0.2
-2
-1.7
-2.4
0.6
4.6
-5.3
n.a.
-7.4
-1.2
-3.5
-5.2
-0.5
-0.6
2
-2.5
-1
-0.1
-0.3
1.2
-3.3
1.5
-6.5
0.1
-1
1.5
2.8
-1.7
-0.9

-0.5
-0.4
-2.4
0.4
0.2
2.5
-6.1
n.a.
-2.9
-0.3
-1.2
-3.3
-0.7
0.4
2.2
1.7
-0.5
-0.6
0.5
0.6
-2.4
1.4
-2.6
0.6
0.5
0.3
-2.5
-0.7
-0.9

-0.7
5.2
0.2
0.5
1.4
-0.2
-4.6
n.a.
-2.1
-0.3
0.1
2.6
-1.1
3
2.6
2.2
-0.7
-1.1
0.1
0.5
-0.6
2
-3.1
1.3
1.5
0.8
-1.5
0
-0.1

a: for all Member States but SE (as well as DK, FI and LU in 2012 and BG and DE in 2013), the applicable benchmark is 
a rate below their reference medium-term rate of potential GDP growth to support the adjustment towards the MTO.
b: shaded rows correspond to years to which the requirements of the preventive arm are applicable.
c: bold figures indicate an excess of net expenditure growth over the applicable benchmark (only indicative for
2014 and 2015, also taking into account planned achievement of the MTO). Concerning  SE, the overachievement
of the MTO over the programme period allows a temporary excess over the benchmark..
d: the deadline for UK to correct its excessive deficit corresponds to the fiscal year 2014/2015.
Source: SCPs, Commission services 

Graphs 1 and 2 present  expenditure  plans  for  2012  and  2013  (the net  real  growth  rate  is  shown  on  the
vertical axis) in comparison to their respective benchmark (to be read on the horizontal axis). To respect the
benchmark,  net  expenditure  growth  needs  to  remain  below  the  bisector.  According  to  the  requirements  of
the  preventive  arm,  a few  Member  States would  simply  be  required  to  keep  the  net  growth  of  real 
expenditure at or below their medium-term potential GDP growth rate (depicted with a circle), in order to
remain at their MTO. However, most of the Member States have to maintain it below a lower rate (depicted
with a diamond), as they have to progress towards their MTO.

(Continued on the next page)

36

Current developments and prospects

Part I

Box (continued)

Graph 1:

Real growth of government expenditure net of discretionary revenue measures and applicable 
benchmark as presented in SCPs in 2012

Source: SCPs, Commission services.

Graph 2:

Real growth of government expenditure net of discretionary revenue measures and applicable 
benchmark as presented in SCPs in 2013

Source: SCPs, Commission services.

37

European Commission

Public finances in EMU - 2012

Table I.3.1:

Budgetary developments in the Member States up to 2014 according to the SCPs

Real GDP growth

Government balance

Structural balance

Government gross debt

BE
DE
EE
IE
EL
ES
FR
IT
CY
LU
MT
NL
AT
PT
SI
SK

FI
EA-17 (*)
BG
CZ
DK
LV
LT
HU
PL
RO
SE
UK (1)

EU-27 (*)

2011
1.9
3.0
7.6
0.7
#N/A
0.7
1.7
0.4
0.5
1.6
2.1
1.2
3.1
-1.6
-0.2
3.3

2.9
1.7
1.7
1.7
1.0
5.5
5.9
1.7
4.3
2.5
3.9
0.8

1.7

2012
0.1
0.7
1.7
0.7
#N/A
-1.7
0.7
-1.2
-0.5
1.0
1.5
-¾
0.4
-3.0
-0.9
1.1

0.8
-0.1
1.4
0.2
1.2
2.0
2.5
0.1
2.5
1.7
0.4
0.8

0.2

2013
1.3
1.6
3.0
2.2
#N/A
0.2
1.8
0.5
0.5
2.1
2.0
1¼
1.4
0.6
1.2
2.7

1.5
1.2
2.5
1.3
1.5
3.7
3.7
1.6
2.9
3.1
3.3
2.0

1.5

2014
1.7
1½
3.4
3.0
#N/A
1.4
2.0
1.0
1.0
3.3
2.0
1½
2.0
2.0
2.2
3.6

2.1
1.6
3.5
2.2
1.8
4.0
3.4
2.5
3.2
3.6
3.7
2.7

2.0

2011
-3.7
-1.0
1.0
-13.1
#N/A
-8.5
-5.2
-3.9
6.3
-0.6
-2.7
-4.7
-2.6
-4.2
-6.4
-4.8

-0.5
-4.0
-2.1
-3.1
-1.8
-3.5
-5.5
4.3
-5.1
-5.2
0.3
-8.3

-4.4

2012
-2.8
-1.0
-2.6
-8.3
#N/A
-5.3
-4.4
-1.7
-2.6
-1.5
-2.2
-4.2
-3.0
-4.5
-3.5
-4.6

-1.1
-2.9
-1.6
-3.0
-4.0
-2.1
-3.0
-2.5
-2.9
-2.8
-0.1
-5.9

-3.3

2013
-2.2
-½
-0.7
-7.5
#N/A
-3.0
-3.0
-0.5
-0.6
-1.2
-1.7
-3.0
-2.1
-3.0
-2.5
-4.5

-0.5
-1.9
-1.3
-2.9
-1.8
-1.4
-2.0
-2.2
-2.2
-2.2
0.5
-6.0

-2.4

2014
-1.1
0.0
0.1
-4.8
#N/A
-2.2
-2.0
-0.1
0.0
-0.9
-1.1
n.a.
-1.5
-1.8
-1.5
-4.2

-0.1
-1.2
-0.5
-1.9
-1.9
-0.8
-1.0
-1.9
-1.6
-1.2
1.7
-4.4

-1.7

2011
-2.9
-1.0
-0.2
-8.2
-
-6.9
-4.2
-3.6
6.9
0.4
-2.9
-3.5
-2.4
-6.0
-6.2
-4.3

0.5
-3.3
-1.0
-2.7
0.1
-2.6
-4.7
-4.0
-5.1
-3.1
-0.2
-6.9

-3.7

2012
-2.3
-0.5
-0.8
-7.9
-
-4.4
-3.1
-0.5
-2.0
-0.2
-2.2
-2.3
-2.1
-2.6
-1.6
-4.1

-0.2
-1.9
-0.6
-2.0
-0.9
-1.2
-2.6
-1.9
-2.5
-1.7
1.0
-4.4

-2.2

2013
-1.4
-0.3
0.0
-7.4
-
-2.2
-1.8
0.5
0.2
0.1
-1.8
-1.5
-1.6
-1.0
-0.9
-2.3

0.2
-1.0
-0.6
-2.1
-0.3
-0.9
-2.1
-1.2
-1.7
-1.2
1.6
-4.6

-1.5

2014
-0.6
0.1
0.5
-5.2
-
-0.9
-1.2
0.5
0.8
-0.2
-1.3
-2.8
-1.3
-0.4
-0.6
-2.0

0.1
-0.6
-0.2
-1.3
-0.7
-0.7
-1.5
-1.1
-1.1
-0.5
2.4
-3.5

-1.0

2011
98.0
81.2
6.0
108.2
#N/A
68.5
85.8
120.1
71.6
18.2
72.0
65.2
72.2
107.8
47.6
43.3

48.6
86.1
16.4
41.2
46.5
42.6
38.5
80.6
56.4
33.3
38.4
84.0

81.1

2012
99.4
82.0
8.8
117.5
#N/A
79.8
89.0
123.4
72.1
20.9
70.3
70.2
74.7
113.1
51.9
50.2

50.7
89.7
19.8
44.0
40.5
44.5
40.2
78.4
53.7
34.2
37.7
89.0

84.3

2013
97.8
80.0
11.0
120.3
#N/A
82.3
89.2
121.5
70.2
23.6
68.7
70.7
75.3
115.7
53.1
52.0

51.8
89.3
18.4
45.1
41.4
45.8
38.6
77.0
52.5
33.7
35.4
91.9

84.3

2014
95.5
78.0
10.6
119.5
#N/A
81.5
88.4
118.2
67.8
24.4
67.4
n.a.
74.6
113.4
52.6
53.0

51.9
87.7
18.0
44.8
41.2
46.7
36.7
73.7
50.6
32.8
31.8
92.7

83.0

(1) Convergence programme and autumn forecast: financial years ending in following March.
(*) In case of missing programmes: weighted average of the figures for those countries that have submitted a programme.
Source: SCPs, Commission services.

3.2.3. Risks to the SCPs targets: an assessment

The budgetary targets outlined in SCPs can be seen
less  favourable
as vulnerable  to  three  risks:
macroeconomic  conditions may negatively  affect
the  achievement  of  the  targets  throughout  the
programme period; the impact of the consolidation
measures may have  been  overestimated;  and  the
targets may not  be  supported  by  sufficiently 
detailed  measures,  especially for  the  years not
covered by the current budget.

Graph I.3.7 seeks to highlight these different risks 
by focusing  on  the  gap  between  Member  States' 
targets  and 
the Commission  services'  deficit
forecasts for 2013, in terms of the following three
components:    i)  the  difference  in the  deficits
projected for 2012 (labeled the '2012 base effect'),
reflecting differences in the growth projections for
2012  and/or  the  assessment of  the  impact  of  the
measures  in  the  2012 budget;  the  effect  of
difference  in  the  growth  projections  for  2013 
(labeled  '2013  growth  gap'),  calculated using  the
standard  semi-elasticities  of budgetary  balance  to
growth;    iii)  the  residual  difference,  (labeled  the
'2013  policy  gap'), presumably  mainly  stemming 
the  absence  of  detailed consolidation 
from 

measures for  2013  (and  hence  their  non-inclusion
in the Commission services' forecasts based on the
no-policy change assumption).

The  base  effect,  reflecting  a different  assessment
of  the  budgetary  outcome  for  the  current year,
amounts  to  a  relatively modest  0.3pp  of  GDP  for
both the euro area and the EU as a whole. There is
however  considerable  variation  across  countries:
the 2012 base effect explains 0.8pp of GDP of the
higher deficit projected by Commission services in 
Cyprus and Slovenia while in  Spain  it  attains
1.1pp. Conversely, in Finland and Estonia and to a
lesser  extent  in  Germany  and the Czech  Republic
there are small positive base effects. 

stemming 

The  gap 
from  different  growth
projections  for  2013  is  even  smaller,  at  0.1pp  of
GDP  for  both  the  euro  area  and  the  EU.  While  a
possible favorable bias emerges for Spain, France,
the Netherlands,  Hungary,  Poland,  Bulgaria,
Hungary and Sweden, only in the case of Sweden
where it amounts to 0.6pp of GDP does this appear
to  be  sizeable.  By  contrast,  the  macroeconomic
scenario may impart  a  small  prudent  bias  to  the 
budget  plans  in Austria, Estonia,  the  Czech
Republic and Slovakia. 

38

Current developments and prospects

Part I

Graph I.3.7:

General government deficit for 2013: decomposition of the gap between the SCP projections and the COM forecasts

10.0

8.0

6.0

4.0

2.0

0.0

-2.0

-4.0

2013 policy gap

2013 growth gap

2012 base effect

Deficit 2013 - COM

Deficit 2013 - SCP

IE

UK

ES

SK NL

FR

SI

BE

EU PT

LT MT HU EA CZ

PL CY

LU RO LV DK

AT

BG EE

IT

DE

FI

SE

Source: Commission services.

For the EU27 as a whole, revenue-to-GDP ratios in
the SCPs are 0.5 and 0.3pp of GDP lower in 2012,
and 2013, respectively, than those projected by the
Commission services,  whereas  for  the  euro  area 
revenue  ratios  are  higher  than  envisaged  by  the
Commission services, by 0.1pp and 0.4pp in 2012 
and 2013, respectively. Revenue projections could
be  considered to  be  particularly  cautious in  the
Netherlands,  Denmark,  Poland,  Sweden  and  the
UK.  In  the  cases  of  Latvia  and  Estonia  revenue
projections  appear  somewhat  on  the  high  side  in 
2012, but this possible bias is almost totally offset
by  apparently very  conservative  assumptions  for
2013. By contrast, revenues appear to be projected
on the basis of especially favorable assumptions in
Belgium,  Spain,  Italy,  Malta  and  Bulgaria,  where
in  these  cases  the  revenue  ratios in  SCPs  imply 
revenue growth rates that exceed those of GDP by
more than 3pp in 2012.

Expenditure projections are lower in the SCPs than
in the Commission services' 2012 Spring forecasts.
The  expenditure  ratios
the  SCPs  are on 
aggregate lower  by  1pp  in  2012  and  by  1.2pp  in
2013 for  the  EU27,  whereas  for  the  euro  area 
differences are  narrower  and amount  to 0.2pp  in 
2012  and  of  0.5pp  in  2013. This pattern  is

in 

Lithuania, 

Cyprus,  Luxembourg,

observed  for most  Member  States,  among which
the
Spain,  France,
Poland,
Slovenia,
Netherlands, 
Denmark,  Sweden  and 
the  United  Kingdom 
present in their SCPs the most sizeable differences 
when  compared  with  Commission
services' 
projections. At  least  part  of  the  differences  is
accounted for  by  policy measures  that  are  not
included  in  the Commission  services  2012  Spring 
forecast. 

For  the  remaining  countries,  the  size  of  the
difference  between  the  two  sets  of  forecasts may
be taken as an estimate of the required measures to
meet the targets in the SCPs and hence provide an
indication  of  the magnitude  of  the underlying 
implementation  risks.  By  contrast,  expenditure
projections in Germany, Italy, Malta and especially
in Austria  and  Bulgaria  can  be  considered  to  lean
toward the conservative side. 

In  conclusion, balancing the  different  types  of
risks,  overall  budgetary  projections  appear  to  rely
on  especially  favourable  assumptions  on  growth,
as well as on revenue or expenditure in the cases of
Belgium,  Spain,  France,  Poland,  Slovenia,
Bulgaria,  Lithuania,  Sweden  and the  Netherlands.

39

European Commission

Public finances in EMU - 2012

However,  in  the  case  of  the  last  two  Member
States,  favourable  macroeconomic  assumptions
and optimistic expenditure projections are partially
compensated  by  prudent  estimates  on  the  revenue
side.

The expenditure-to-GDP ratio is set to fall between
2011  and  2015  in  all Member  States  except
Finland  and Luxembourg.  Ireland, Lithuania,
Slovenia,  Spain, Latvia,  the  United  Kingdom,
Portugal  and  Poland  are forecasting  reductions  in 
expenditure of over 5pp of GDP. (24)

3.2.4. Composition of consolidation

On average, the consolidations plans set out in the
SCPs for  both  the  euro  area  and  the  EU27  are 
primarily expenditure-based.  Graph I.3.8 indicates
the 2011 starting level for revenue and expenditure
ratios,  as well  as  the  variation  expected  for  both
variables by 2015, as set out in the SCPs. It shows
that,  on  average, general government  expenditure
is forecast to decrease from 49.4% of GDP in 2011
to 47.2% in 2015 in the euro area, and from 48.5%
to  45.7%  of  GDP  in  the  EU27.  Meanwhile,
revenue  is  forecast  to  increase  from  45.4  %  of
GDP in 2011 to 46.5% in 2015 in the euro area and 
from  44.2%  of GDP  to  44.7%  in  the  EU27.  The
change in expenditure corresponds to nearly 2/3 of
the  overall  change  in  the  deficit  in  the  euro  area 
and  over  4/5 
the
consolidation  plans  broadly  expenditure-based  on 
average.

the EU27,  making 

in 

all 

are 

almost 

countries 

reducing
While 
expenditure,  only 11  Member  States plan an 
increase  in  the  revenue-to-GDP  ratio  over  the
2011-2015 programming period. Belgium and Italy
foresee an  increase  in  revenue  of  over  2½pp  of
GDP, while  France, Cyprus, Spain,  Romania  and
Finland project an increase of over 1pp. In Ireland, 
an increase  in  the  tax  revenue  ratio is  offset  by  a
reduction  in  non-tax  revenues.  In  addition,  13 
forecast  a  reduction  in  their
Member  States
revenue as a share of GDP. The largest reduction is
foreseen in Hungary  (8pp  of  GDP, 
largely 
reflecting one-off  increase  in  revenues  in  2011),
while  Estonia, Latvia,  Denmark,  Portugal  and
Lithuania forecast a decrease of over 2pp.

(24) For IE  and  UK,  the  observed  change  in  expenditure-to-

GDP relies in part on one-off measures.

Graph I.3.8:

Envisaged variation in expenditure and revenue ratio 2011-2015*

P
D
G

f
o
%

5

3

1

-1

-3

-5

-7

-9

-11

-13

var rev 2011-2015

var exp 2011-2015

2011 Revenue ratio (rhs)

2011 Expenditure ratio (rhs)

P
D
G

f
o
%

60

50

40

30

20

10

0

DK FR FI BE SE SI AT NL

IT EA-
17

PT

IE HU EU-
27

CY DE UK ES PL CZ MT LU LV EE RO LT SK BG

* For IE and UK, the observed change in expenditure-to-GDP relies in part on one-off measures.
Source: SCPs, Commission services.

40

 
 
Current developments and prospects

Part I

plans set out in the SCPs, including an analysis of
compliance with  the  new  provisions  concerning 
the debt reduction benchmark.

3.3.1. Evolution of the debt-to-GDP ratio

Graph I.3.9 shows the projected changes in general
government  debt  over  the period  2011–2015.  In
the  euro  area, overall  debt  is  projected  to  reach a 
level  slightly  above  85%  of  GDP  after  having 
peaked  at  almost  89%  of  GDP  in  2012; in  the
EU27 the corresponding figures are 80% and 84%
of  GDP.  The  implication for  the medium  term  is
that as long as the consolidation measures are not
reversed  beyond  2014, debt  should  be  on  a
declining  path 
the
programmes’ horizon. In all Member States except
Denmark  and  Luxembourg,  debt  is  projected to 
peak  before  2015.  However,  in  Spain  and  the
United  Kingdom,  the  projected  reduction  in  2015 
is  small  and  coming  back  to  pre-crisis  levels  is
likely to take many further years.

the  years  beyond 

for 

I.3.9 also  shows 

Graph 
that  consolidations
envisaged by the Member States do not necessarily
ensure  that  debt-to-GDP  ratios  in  2015 will  be
lower  than  in  2011:  Spain,  Ireland,  Slovakia,
Luxembourg, 
the  United  Kingdom,  Estonia,
Slovenia,  Finland,  Czech  Republic  and  Portugal
will  see  their  debt-to-GDP  ratio  increase between
2011 and 2015.

While consolidation is a necessary prerequisite for
the debt to go down in the long-run, debt dynamics
also  depend crucially  on the  interest  rate-growth
differential. ( 26) 
the  differential

larger 

The 

(26) The  change  in  the  gross  debt  ratio can  be  decomposed  as

t

t

−
1

−

follows: 
D
D
D
Y
Y
Y
−
t
t
t
1
ere t is a time subscript; D, PD, Y and SF are the stock of
government debt, the primary deficit, nominal GDP and the 

PD
Y
t

SF
t
Y
t



+







(*

wh

r
t

+

−

=

g

−
1

−
1

)

t

t

t

is 

Latvia, 

Poland, 

Slovenia, 

Denmark, 

consolidation 
in

entirely 
Overall, 
fiscal 
Slovakia, 
expenditure-based 
Estonia, 
the
Lithuania,
Portugal,  Germany,
Netherlands, 
Hungary, Bulgaria, the UK and Sweden. In Spain,
Austria, Cyprus, France, Malta and Romania, it is
relatively  evenly  balanced  between spending  cuts
is  primarily
increases, while 
and  revenue 
revenue-based in Belgium and Italy. (25)

it 

Table I.3.2 displays the yearly fiscal adjustment at
the  aggregate  EU27 level  and  its  expenditure  and
revenue  components  as  foreseen  in  the  SCPs
between 2012 and 2015. Those are compared with 
the  corresponding  adjustment
forecast  by  the
Commission services for the years 2012 and 2013.
the  primary 
improvement 
The  envisaged 
balance  exceeds  Commission  services  forecast
marginally for 2012 (by 0.2pp of GDP) and more
strongly for  2013  (by  0.5pp of  GDP). Therefore,
the SCPs appear to be slightly more optimistic than
Commission  services  forecast  on  the  size  of  the
budgetary improvement at aggregate EU level. 

in 

the

Commission

The  table  also  shows  the  composition  of  the
adjustment.  For  2012,  the  SCP  adjustment  is
evenly balanced between revenue and expenditure, 
while 
forecast
consolidation  only  on  the  revenue side.  For  2013,
2014  and  2015,  SCP  consolidation is  driven  by 
expenditure cuts. Overall, in  2012, the adjustment
appears to be front-loaded on the revenue side, and
more uniform – if not slightly back-loaded – on the
expenditure side.

services 

3.3.  DEBT IMPLICATIONS     

This  section  assesses  debt  implications  of  the
macroeconomic  scenario  and  of  the  consolidation

(25) In Finland the small fiscal adjustment envisaged is entirely

revenue-driven.

Table I.3.2:

Fiscal adjustment for EU 27: 2012 SCPs vs. Spring 2012 EC Forecasts

2012

2013

SCPs
Planned Δ

EC Forecast
Δ 

SCPs
Planned Δ

EC Forecast
Δ 

2014
SCPs
Planned Δ

2015
SCPs
Planned Δ

0,6

-0,5

1,1

0,8

0,0

0,9*

0,1

-0,7

0,8

-0,2

-0,5

0,3

-0,1

-0,9

0,8

0,0

-0,8

0,7

Revenue

Expenditure

Government Balance

* Deviations are due to rounding.
Source: SCPs, Commission services.

41

European Commission

Public finances in EMU - 2012

Graph I.3.9:

2011-2015 planned changes in general government debt

2011-2015 change

Peak level

2011 debt level

120.0

100.0

80.0

60.0

40.0

20.0

0.0

IT

IE PT BE EA-
17

FR UK DE EU-
27

Source: SCPs, Commission services.

HU AT MT CY ES NL PL FI SI DK SK LV CZ LT SE RO LU BG EE

between real interest rate and real GDP growth (r-
g),  the  larger  the  increase  in  the  primary  balance
required to stabilise a given debt ratio. Thus, (r-g)
plays  a  key  role  in  determining  an  appropriate
strategy to achieve a given debt target.

that 

Graph  I.3.10 shows 
the interest-growth
differential  is  positively  correlated with  the  level
of public debt in normal times (2005 to 2008) and
Graph I.3.11 shows that this is also true during the
crisis  (2009  to  2013) – the  larger  the  public  debt 
ratio, the higher the differential tends to be. This is
driven  by  two main  effects.  Firstly,  a  high  debt
ratio  may  trigger  an  increase  in  risk  premia  ( 27), 
thereby  leading  to higher interest  rates.  Secondly,
higher  debt  levels  and  interest  rates might weigh
on economic growth, especially when debt exceeds 
a  certain  threshold level as a  number  of  papers
suggest. (28)  

stock-flow  adjustment  respectively,  and  r and g represent
the average real interest rate and real rate of GDP growth. 
The term in parentheses represents the “snow-ball”  effect, 
measuring the combined effect of interest expenditure and
economic growth on the debt ratio.

(27) See empirical evidence in Part III.
(28) See for example Kumar and Woo (2010).

42

the 

differential 

interest-growth

The consolidation strategies envisaged in the SCPs
have  an  impact  on  long-run  debt-to-GDP  ratios.
The  last  column  of  Table I.3.3 shows  the  debt-
stabilising  primary  balance, under  the  assumption
that 
remains
constant  from  2015  onwards (column  of  the
middle).  If  the  2015  structural  primary  balance
projected  in  the  SCPs (fourth  column) is  higher
than  the debt-stabilizing primary  balance,  this
means  that  the  planned  consolidation  over  2011-
2015  will  ensure  the stabilization  of  the  debt-to-
GDP  ratio  from  2015  onwards. Table  I.3.4  shows
that  it  is  the  case  according  to  all  Member  States' 
consolidation plans.

forecasts?  Graph 

How do the SCP debt projections compare with the
I.3.12
Commission  Spring
presents the projections  for 2013  using  a  similar
methodology as for Graph I.3.7. The figure shows
the  level  of  debt  projected  by  both  the  SCPs  and 
the  Commission services and  decomposes  it  into 
the 
the
'2012  base  effect' which  represents
difference  in  projected  levels  of  debt  in  2012,  the
'2013 growth gap' which quantifies the differences
due  to  different growth  assumptions for 2013  and
the residual '2013 policy gap', which is assumed to 
reflect 
that  policy  changes
included in the SCPs have on the debt projections.

the  contribution 

Current developments and prospects

Part I

Graph I.3.10: Comparing average 2005-2008 interest-growth differential and debt ratio in 2004 in Euro Area Member States

-
5
0
0
2

l

a
i
c
n
e
r
e
f
f
i
d
e
t
a
r
h
t
w
o
r
g
-
e
t
a
r

t
i
c
i
l

p
m

i

e
g
a
r
e
v
A

4

2

0

-2
8
0
0
2

-4

-6

-8

-10

PT

NL

60

DE

FR
AT

80

MT

CY

IT

BE

100

EL

120

0

20

IE

40

SI

FI

ES

SK

LU

EE

Debt-to-GDP ratio in 2004

Source: SCPs, Commission services.

The  figure  shows  that  for  both  the  euro  area  and 
EU27,  the  Commission  services  forecast  slightly 
higher  debt-to-GDP  ratios in  2013.  For  the  euro 
area, the Commission services expect debt to come 
in  at  92.6%  of  GDP,  while  the  SCPs  project 
89.3%. For EU27 the difference between the two is 
similar; while the Commission services expect the
debt  of  87.2%  of  GDP  the  SCPs  forecast  84.3%. 
The  '2013  policy  gap'  accounts  for  0.8pp  of  the 

difference  in  the  euro  area  debt,  and  0.5pp  in  the 
EU27. A significant contributor to the difference is 
also  the  '2012  base  effect'  which  accounts  for 
2.3pp in the euro area and 2.2pp in the EU27.

This  overall  '2012  base  effect'  is  driven  by  a 
number  of  Member  States 
that  show  very 
significant differences in their SCPs relative to the 
largest 
Commission  services'  estimates.  The 

Graph I.3.11: Comparing average 2010-2013 interest-growth differential and debt ratio in 2009 in Euro Area Member States

-
0
1
0
2

l

a
i
c
n
e
r
e
f
f
i
d
e
t
a
r
h
t
w
o
r
g
-
e
t
a
r

t
i
c
i
l

p
m

i

e
g
a
r
e
v
A

8

6

4

2
3
1
0
2

0

-2

-4

-6

0

20

LU

EE

Source: SCPs, Commission services.

SI

ES

IE

PT

EL

IT

CY

NL

SK
40

60

FI

MT
AT

FR

DE

80

BE
100

120

140

Debt-to-GDP ratio in 2009

43

 
 
 
 
 
 
 
 
 
 
European Commission

Public finances in EMU - 2012

Table I.3.3:

Debt-stabilizing primary balance for Member States whose debt-to-GDP ratio is projected to exceed the 60% threshold in
2015

Member State

2015 Debt-to-GDP

2015 Interest- growth
differential (%)

2015 structural primary
balance (% GDP)

Debt-stabilizing primary
balance (% GDP)

BE
DE
ES
FR
IE
IT
CY
HU
MT
AT
PT
UK

92.3
76
80.8
86.4
117.4
114.4
65.4
72.7
65.3
72.8
109.5
91.4

0.2
0.8
-0.4
-0.6
1.5
1.6
0.4
2.7
1.8
0.5
0.2
-0.8

Source: SCPs, Commission services.

differences  in  2012  base  levels  are  found  for
Cyprus (5.1% of GDP), Malta (4.7% of GDP) and 
Slovenia  (3.5%  of  GDP)  but these  small  Member
States  account for  little  in  the  weighted  average.
However, France  and  the  United  Kingdom  also
have  sizeable  differences  of,  respectively,  1.5%
and  2.9%  of  GDP. As with  the  differences  in  the
deficit  projections,  the fact  that many  Member
States have  significant  policy  changes  penciled  in
is  both  a  risk  and  a  challenge,  as  consolidation 
measures must be implemented, to ensure that the
outcomes are not weaker than the plans.

3.5
2.6
2.9
2.2
2.1
6.1
3.6
2.8
3
2
4.5
0.9

0.2
0.6
-0.3
-0.5
1.7
1.7
0.3
1.9
1.1
0.4
0.2
-0.7

3.3.2. Debt benchmark

to 

According 
the  debt  reduction benchmark 
introduced by  the  reform  of  the  Pact,  Member
States whose  current  debt-to-GDP  ratio  is  above
the  60%  threshold have  to  reduce  the  distance  to
60% by an average rate of one twentieth per year
as  a  benchmark,  based  on  changes  over  the  last
three  years for which the  data  is  available.  The
debt reduction benchmark is also considered to be
fulfilled 
the
Commission services indicate  that  the  required
reduction  in the  differential  will  occur  over  the
three-year  period  encompassing  the  two years
following  the final year for which  the  data  is

the  budgetary 

forecasts  of 

if 

Graph I.3.12: General government debt for 2013: decomposition of the gap between the SCP projections and the COM forecasts

10

8

6

4

2

0

-2

-4

2013 policy gap

2013 growth gap

2012 base effect

Debt 2013 - COM (rhs)

Debt 2013 - SCP (rhs)

140.0

120.0

100.0

80.0

60.0

40.0

20.0

0.0

IT

IE

BE EA-
17

UK FR EU-
27

Source: SCPs, Commission services.

DE ES HU CY MT AT NL

PL

SI

FI

SK CZ

LV DK

LT

SE RO LU BG EE

44

Current developments and prospects

Part I

Table I.3.4:

Minimum adjustments over the transition period for Member States whose debt-to-GDP ratio exceeds the 60% threshold in
2011

Member States

Debt Ratio in 2011

Deadline for EDP
correction

Minimum cumulative required structural 
adjustment over the transition period[1]

SCPs/COM Forecasts[2]

SCP Plans[3]

Cumulative planned 
adjustment in the
SCPs

IT

PT

BE

FR

UK

DE[4]

HU

AT

MT

CY

ES

NL

120.1

107.8

98

85.8

85.7

81.2

80.6

72.2

72

71.6

68.5

65.2

2012

2013

2012

2013

2014

2013/2011

2012

2013

2011

2012

2013

2013

0

0

1

0.2

1.5

0

0.7

0

1.7

0.1

0.4

0

0

0

0.9

0.1

1.2

0

0

0

0.7

0.2

0.1

0

0.8

0.7

2.4

2

2.5

0.9

1

1.4

2

2.6

2

n.a[5]

[1] In  both  cases  (SCPs/COM forecasts  and SCPs  plans), fiscal  plans  are  assumed to follow  SCPs  projections until  the  EDP deadline.  Differences
between both scenarios then only stem from growth assumptions.
[2] Growth projections between 2012 and 2020 are the following: in 2012 and 2013, they rely on the 2012 COM Spring forecasts, then from 2014 to
2016,  the  real  GDP growth is  assumed  to  linearly  close  the  output gap  by  2016, finally from  2016  onwards,  projections  are assumed  to  converge
towards the AWG projections.
[3]  Growth projections between 2012 and  2020 are the following: they rely on the SCPs as long as data are available and then, assuming  constant
potential growth, real GDP growth is assumed to close the output gap by 2016 and equal to potential thereafter.
[4]  In case  of  Germany,  the  calculations  are made for  a  2011  EDP  abrogation  and  thus  the  transition  period  is  assumed  to  start in  2012.
[5] Not available since the Netherlands have not reported structural balance beyond 2013.
Source: SCPs, Commission services.

available,  based  on unchanged  policies.  However, 
Member  States  subject  to an  excessive  deficit
procedure at the time of the entry into force of this
new  provision  are granted a  three-year  period
following  the  correction  of  the  excessive  deficit
during which Member States should make progress
towards  compliance with  the  debt  benchmark.  A 
negative assessment of the progress made towards
compliance  with  the  debt  benchmark  should  lead
to  the  preparation  of  a  report  under  Art.  126(3). 
"Sufficient  progress 
is
defined  as  a  continuous  and  realistic  adjustment
needed  to  ensure  meeting  the  debt  benchmark  at
the  end  of  the transitional  period. Specifically, to
ensure continuous and realistic progress during the
transition  period Member  States  should  respect
simultaneously two conditions as laid down in the
Code of Conduct:

towards  compliance" 

− 1)  the annual structural  adjustment should not
deviate  by more  than  0.25% of  GDP  from  the
minimum  linear structural adjustment ensuring
that  the  debt  rule is  met  by the  end  of  the
transitional period.

− 2)  At  any time  during the  transitional  period,
the  remaining  annual structural  adjustment
should not exceed ¾ % of GDP. 

This  ensures  that  the  path  of  deficit  reduction  is
sustained  over  the  three  years  of  the  transitional
period  (first  condition)  and  realistic  (second
room for
condition), while  allowing  some 
manoeuvre during the transition period.

For each Member State concerned by the transition
the minimum
I.3.4 compares 
period,  Table
required adjustments to the structural balances set
out in the SCPs. (29) It shows that, based on plans,
all  Member  States would  implement  structural
adjustments 
the  debt
large  enough 
their
reduction  benchmark  by 
transitional  period.  All  Member  States  also  plan
sufficient  progress  according  to  the  two  criteria
mentioned above.

to  meet 
the  end  of 

(29) The  minimum  required  adjustment 

the  minimum
structural adjustment that ensures that, if followed, the debt
reduction  benchmark  will  be  met  at
the  end  of  the
transition period.

is 

45

European Commission

Public finances in EMU - 2012

Box I.3.2: Overview of Council recommendations relating to fiscal policy

1.     AT

Summary assessment:

The Council is of the opinion that the macroeconomic scenario underpinning the budgetary projections in the programme is cautious for the 

years 2012 and 2013. For 2014-2016 the scenario becomes more optimistic, projecting average GDP growth of 2.1%, consistently above 

the  current  estimates  of  potential  growth. The  objective  of  the  budgetary  strategy  outlined  in  the  programme  is  to  correct  the  excessive 

deficit by 2013 and reach the medium-term budgetary objective (MTO) by 2016. The programme has changed the MTO from the target of 

a balanced budget over the business cycle to a structural deficit of 0.45% of GDP, adequately reflecting the requirements of the Stability 

and Growth Pact. The foreseen correction of the excessive deficit is in line with the deadline set by the Council recommendation issued in 
the  context  of  the  Excessive  Deficit  Procedure  in  December  2009.  However,  based  on  the  (recalculated)  structural  budget  balance*,  the 
average  annual  fiscal  effort  planned  at  0.5%  of  GDP  for  the  period  2011-2013  is  lower  than  the  0.75%  of  GDP  recommended  by  the 

Council. The envisaged structural progress towards the MTO is sufficient in 2015, but lower than 0.5% of GDP per year benchmark of the 

Stability  and  Growth  Pact  in  2014  and  2016.  However,  in  2014-2015  the  projected  growth  rate  of  government  expenditure,  taking  into 

account discretionary revenue measures, respects the expenditure benchmark of the Stability and Growth Pact. Nevertheless, there are risks 

accompanying the fiscal targets both on the revenue and on the expenditure side. For example, the budgetary effect of some measures is 

difficult to quantify because of dependence on individual uptake. Since the legislation has not yet been decided the details of the financial 

transaction tax are not yet known. The envisaged expenditure cuts at the sub-national level are not defined. The programme foresees that 

the debt-to-GDP ratio, which amounted to 72.2% at the end of 2011, is going to peak at 75.3% in 2013 before gradually falling to 70.6% in 

2016. In terms of the debt reduction benchmark of the Stability and Growth Pact, Austria will be in a transition period in the years 2014-

2016 and the plans presented in the programme would ensure sufficient progress towards compliance with the debt reduction benchmark. 

However, there are risks attached to this projection because of the  growing debt of state-owned companies classified outside the general 

government sector and potential further burden due to the banking sector government support.

Recommendation:
•

Implement the 2012 budget as envisaged and reinforce and rigorously implement the budgetary strategy for the year 2013 and beyond; 

sufficiently  specify  measures  (in particular  at  the  sub-national  level),  to  ensure  a  timely  correction  of  the  excessive  deficit  and  the 

achievement of the average annual structural adjustment effort specified in the Council Recommendations under the Excessive Deficit 

Procedure  .  Thereafter,  ensure  an  adequate  structural  adjustment  effort  to  make  sufficient  progress  towards  the  medium-term 

budgetary objective (MTO), including meeting the expenditure benchmark.

•

Take  further steps to strengthen  the  national budgetary  framework by aligning responsibilities across the  federal, regional and  local 

levels of government, in particular by implementing concrete reforms aimed at improving the organisation, financing and efficiency of 

healthcare and education.

2. 

BE

Summary assessment:

The Council is of the opinion that the macroeconomic scenario underpinning the budgetary projections in the programme is plausible for 

the  years 2012 and 2013 and optimistic  for the  years 2014 and 2015 as it  foresees GDP growth to be substantially  higher than the  latest 

estimates of potential growth emerging from the Commission's 2012 spring forecast. The objective of the budgetary strategy outlined in the 

programme is to bring the deficit below 3% of GDP in 2012 (to 2.8% of GDP, down from 3.7% of GDP in 2011) and to zero in 2015. The 

programme  confirms  the  previous  medium-term  budgetary  objective  (MTO)  of  a  surplus  of  0.5%  of  GDP  in  structural  terms,  which 

adequately reflects the requirements of the Stability and Growth Pact The planned 2012 headline deficit complies with the deadline set by 

the Council for the correction of the excessive deficit and the planned fiscal effort complies with the EDP recommendation of a minimal 

average  annual  effort  of  ¾%  of  GDP  in  structural  terms.  The  planned  growth  rate  of  government  expenditure,  taking  into  account 

discretionary  revenue  measures,  complies  with  the  expenditure  benchmark  of  the  Stability  and  Growth  Pact  in  2013  to  2015,  but not  in 
2012. Based on the (recalculated) structural budget balance*, the programme projects the structural balance to improve by 1.1 percentage 
point of GDP in 2012 and by about 0.8% of GDP on average over the period 2013-2015. However, there are risks stemming from the fact 

that the additional measures to be taken from 2013 onwards are not yet specified and that the macroeconomic scenario from 2014 onwards 

is too optimistic. The government debt, which at 98.0% of GDP in 2011 is well above the 60% threshold, is planned by the programme to 

stabilise and then to decline to 92.3% in 2015, which would imply sufficient progress towards meeting the debt reduction benchmark of the 

Stability and Growth Pact. Moreover, implicit liabilities stemming from the guarantees given to the financial sector are particularly large. 

The rules-based, multi-annual framework for general government, particularly with regard to expenditure would benefit from enforcement 

mechanisms and/or commitments from the regions and communities, as well as from the local level, in order to meet their allocated deficit 

targets.

(Continued on the next page)

46

Current developments and prospects

Part I

Box (continued)

Recommendation:
•

Implement the budget for the  year 2012 to make sure the excessive deficit is corrected by 2012. Additionally, specify the measures

necessary to ensure implementation of the budgetary strategy for the year 2013 and beyond, thereby ensuring that the excessive deficit is

corrected in  a  durable  manner  and  that  sufficient progress  is made  towards  the  mediumterm  budgetary  objective  (MTO), including

meeting  the  expenditure  benchmark,  and  ensure  progress  towards  compliance  with  the  debt reduction  benchmark. Adjust  the fiscal

framework to ensure that the budgetary targets are binding at federal and sub-federal levels, and increase transparency of burden-sharing 

and accountability across layers of government.

3. 

BG

Summary assessment:

The Council is of the opinion that compared with the Commission´s 2012 spring forecast the macroeconomic scenario  underpinning the

budgetary projections in the programme is optimistic for the 2012-13 period, when annual growth is expected to reach 1.4% in 2012 and

2.5% in 2013. The Commission's 2012 spring forecast foresees a GDP growth of 0.5% in 2012 and 1.9% in 2013. After the correction of

the excessive deficit in 2011, the objective of the budgetary strategy outlined in the programme is to achieve a budgetary position which is

close  to  balance,  both  in  terms  of  the  structual  and headline  budget balances,  by  the  end of  the programme  period. The medium-term 

budgetary objective (MTO), defined in structural terms, has been marginally revised from a deficit of 0.6% of GDP to a deficit of 0.5% of 
GDP. The new MTO adequately reflects the requirements of the Stability and Growth Pact. Based on the (recalculated) structural deficit*, 
Bulgaria  plans  to  achieve its  MTO  over the  programme  period.  In 2012-2014,  the growth rate  of government  expenditure,  taking into

account discretionary revenue measures, would respect the expenditure benchmark of the Stability and Growth Pact, yet breach it in 2015.

Planned fiscal consolidation faces a number of risks stemming from (i) lower revenue given the optimistic macroeconomic scenario as well

as less tax-rich underlying growth structure of the economy and (ii) inefficiencies in the public sector, particularly with respect to arrears in

healthcare, which may lead to considerable expenditure pressures. The debt ratio is below 60% of GDP and, according to the programme, it

is  expected  to  peak  at  close  to  20%  of  GDP in  2012  and  then  to  decrease  over  the  programme period.  There is    considerable  scope  for

improvement in  tax  compliance  and  advancing  in  this  area  would  allow  Bulgaria  to  support higher growth  enhancing  expenditures. A

requirement to keep the budget deficit below 2 % and limiting government expenditure to 40 % of GDP was adopted as an amendment to

the  Organic Budget Law,  thus  strengthening  the  binding nature of the  fiscal  framework  and  improving  the predictability  of  budgetary 

planning.  However,  challenges  remain  with  respect  to  further improving  the  contents  of  the medium-term  budgetary  framework and

strengthening  the reporting  on  accrual  basis  including  through improving  the  quality  and  timeliness  of  reporting  by State Owned

Enterprises and sub-national governments.

Recommendation:
•

Continue with sound fiscal policies to achieve the medium-term budgetary objective by 2012. To this end, implement the budgetary

strategy as envisaged, ensuring compliance with the expenditure benchmark, and stand ready to take additional measures in case risks to 

the budgetary scenario materialise. Strengthen efforts to enhance the quality of public spending, particularly in the education and health 

sectors  and  implement  a  comprehensive  tax-compliance  strategy  to further improve  tax  revenue  and  address  the  shadow  economy.

Further improve the contents of the medium-term budgetary framework and the quality of the reporting system. 

4.  CY

Summary assessment:

The  Council is  of the  opinion  that  the macroeconomic  scenario  underpinning  the  budgetary projections in  the  programme  appears

optimistic in  2012-2014. Although incorporating  a major  downward  revision  of  the growth  outlook,  the macroeconomic  scenario

underpinning  the  budgetary  projections in  the  programme  remains  subject  to  downside risks,  relating in  particular  to  the  evolution  of

domestic demand  in 2012-2013. The objective of the budgetary strategy outlined in the programme is to correct the excessive deficit by

2012  and  to  reach  the medium-term  budgetary  objective  (MTO)  by  2014,  and  to  stay  at  MTO in  2015.  The  programme  confirms  the

previous MTO of a balanced budget in structural terms, which adequately reflects the requirements of the Stability and Growth Pact. The

planned  correction  of the  excessive  deficit is in line  with  the  deadline  set  by  the  Council  recommendation issued in  the  context  of  the
Excessive  Deficit  Procedure  on  13  July  2010.  Based  on  the  (recalculated)  structural deficit,* the  average  annual fiscal  effort planned  at
1.5% of GDP for the period 2011-2012 is equal to the effort recommended by the Council. The envisaged progress towards the MTO in 

2013 is sufficient as it is higher than the 0.5% of GDP benchmark of the Stability and Growth Pact both according to the Commission's

2012 spring forecast and the programme. The growth rate of government expenditure, taking into account discretionary revenue measures,

is in line with the expenditure benchmark of the Stability and Growth Pact in 2013-2014, but not in 2015. There are risks accompanying the

budgetary targets of the programme linked to the macroeconomic scenario appearing optimistic in 2012-2014 and the planned consolidation 

effort in  2013,  party  relying  on  not fully specified measures.  According to  the  programme,  the  debt-to-GDP ratio,  which  amounted  to

IT

IE

BE EA- UK FR EU- DE ES HU CY MT AT NL

PL

SI

FI

SK CZ

Source: SCPs, Commission services.

LV DK

LT

(Continued on the next page)

SE RO LU BG EE

47

European Commission

Public finances in EMU - 2012

Box (continued)

ensure  sufficient  progress  towards  compliance  with  the  debt  reduction  benchmark.  However,  there  are  risks  attached  to  this  projection 

linked to the possible rescue operations of financial corporations.

Recommendation:
•

Take  additional  measures  to  achieve  a  durable  correction  of  the  excessive  deficit  in  2012.  Rigorously  implement  the  budgetary

strategy, supported by sufficiently specified measures, for the year 2013 and beyond to ensure the achievement of the medium-term 

budgetary  objective  (MTO)  by  2014  and  compliance  with  the  expenditure  benchmark  and  ensure  sufficient  progress  with  the  debt 

reduction benchmark. Accelerate the phasing-in of an enforceable multiannual budgetary framework with a binding statutory basis and 

corrective mechanism. Take measures to keep tight control over expenditure and implement programme and performance budgeting as 

soon as possible. Improve tax compliance and fight against tax evasion.

5.  CZ

Summary assessment:

The  Council  is  of  the  opinion  that the  macroeconomic  scenario  underpinning  the  budgetary  projections  in  the  programme  is  plausible. 

According to the convergence programme, GDP growth is expected to reach 0.2% and 1.3% in 2012 and 2013 respectively, compared to 

0% and 1.5% in 2012 and 2013 respectively in the Commission's 2012 spring forecast. The objective of the budgetary strategy outlined in 

the programme is to reach a balanced budget in 2016. The general government deficit target of 2.9% of GDP in 2013 is in line with the 

deadline for correcting the excessive deficit set out in the Council recommendations of 2 December 2009. The average annual fiscal effort 
of 0.9% of GDP over the period 2010-2013, based on the (recalculated) structural budget balance*, is slightly below  the effort of 1% of 
GDP recommended by the Council. The programme confirms the previous medium-term budgetary objective (MTO) of a deficit of 1% of 

GDP, which adequately reflects the requirements of the Stability and Growth Pact, to be reached in 2015. The progress towards the MTO is 

0.8% and 0.7% of GDP in 2014 and 2015 respectively, based on the (recalculated) structural balance and the rate of growth of government 

expenditure complies with the expenditure benchmark of the Stability and Growth Pact. The budgetary projections of the programme are 

subject  to  several  risks.  The  law  on  financial  compensation  to  churches,  currently  discussed  in  Parliament,  would  increase  the  general 

government deficit by 1.5% of GDP in the year of entry into force. More generally, the nature and extent of the envisaged consolidation 

measures on both the revenue and the expenditure side entails a considerable risk for the sustainability of the fiscal adjustment beyond the 

programme  period.  Budgetary  adjustment  has  so  far  relied  mostly  on  across-the-board  cuts,  which  affect  also  growth-enhancing 

expenditure.  Additional savings in public  administration expenditures amounting  to almost 1% of GDP are planned  for 2013 - 2015, but 

details are not sufficiently specified in the programme. Finally, most of the planned revenue measures are of a temporary nature and should 

expire in 2015. According to the programme, the debt-to-GDP ratio is expected to peak at 45.1% of GDP in 2013 and decline thereafter, 

mainly on account of the projected continuous improvement of the primary balance.

Recommendation:
•

Ensure  planned  progress  towards  the  timely  correction  of  the  excessive  deficit.  To  this  end,  fully  implement  the  2012  budget  and 

specify measures of a durable nature necessary for the year 2013 so as to achieve the annual average structural adjustment specified in 

the  Council  recommendation  under  the  Excessive  Deficit  Procedure.  Thereafter,  ensure  an  adequate  structural  adjustment  effort  to 

make  sufficient  progress  towards  the  medium-term  objective,  including  meeting  the  expenditure  benchmark.  In  this  context,  avoid 

across-the-board  cuts,  safeguard  growth-enhancing  expenditure  and  step  up  efforts  to  improve  the  efficiency  of  public  spending. 

Exploit the available space for increases in taxes least detrimental to growth. Shift the high level of taxation on labour to housing and 

environmental taxation. Reduce the discrepancies in the tax treatment of employees and the self-employed. Take measures to improve 

tax collection, reduce tax evasion and improve tax compliance, including by implementing the Single Collection Point for all taxes. 

6. 

DE

Summary assessment:

The Council is of the opinion that the macroeconomic scenario underpinning the budgetary projections in the programme is plausible. The 

programme's  projections  for  2012-13  are  broadly  in  line  with  the  Commission's  2012  spring  forecast  as  regards  the  pace  and  pattern  of 

economic growth as well as labour market developments. The programme's projections for economic growth in the outer years are broadly 

in line with the Commission's estimate of Germany's medium-term potential growth rate. The objective of the budgetary strategy outlined 

in the programme is to meet the medium-term budgetary objective (MTO) already in 2012 and to reach virtually balanced nominal budgets 

as  from  2014,  starting  from  a  nominal  deficit  of  1.0%  of  GDP  in  2011,  thus  below  the  3%  of  GDP  reference  value  of  the  Treaty 

significantly ahead of the 2013 deadline. The programme specifies the previous MTO of a structural deficit of ½% of GDP, (interpreted as 

a narrow range around 0.5% of GDP), which adequately reflects the requirements of the Stability and Growth Pact, to imply a deficit not 

exceeding 0.5% of GDP. Risks to the deficit and debt targets may arise notably if additional measures to stabilise the financial sector turned 
out  to  be  required.  Based  on  the  (recalculated)  structural  deficit*,  Germany  plans  to  respect  its  MTO  throughout  the  programme  period, 
which should also be the case taking into account the risk assessment. According to the information provided in the programme and also 

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Box (continued)

increase  by  0.8 pp.  to  82.0%  of  GDP  in  2012,  before  falling  to  80%  of  GDP  in  2013  and  remaining  on  a  downward  path  thereafter. 

Following the correction of the excessive deficit, Germany is in a transition period and, according to plans, is making sufficient progress 

towards compliance with the debt reduction benchmark of the Stability and Growth Pact.

Recommendation:
•

Continue  with  sound  fiscal  policies  to  achieve  the  medium-term  budgetary  objective  by  2012.  To  this  end,  implement  the  budgetary 

strategy as envisaged, ensuring compliance with the expenditure benchmark as well as sufficient progress towards compliance with the 

debt reduction benchmark. Continue the  growth-friendly consolidation course through additional efforts to enhance the efficiency of 

public spending on health care and long-term care, and by using  untapped  potential  to improve the efficiency of  the tax system; use 

available scope  for  increased and  more efficient  growth-enhancing spending on education and research at all  levels of  government. 

Complete  the  implementation  of  the  debt  brake  in  a  consistent  manner  across  all  LÄNDER,  ensuring  timely  and  relevant  monitoring 

procedures and correction mechanisms.

7. 

DK

Summary assessment:

The Council is of the opinion that the macroeconomic scenario underpinning the budgetary projections in the programme is plausible. The 

scenario projecting GDP growth at 1.2 and 1.5% in 2012 and 2013 is broadly in line with the Commission's 2012 spring forecast of 1.1 and 

1.4%. Accordingly, the government deficits are slightly smaller in the convergence programme (4.0 and 1.8% of GDP in 2012 and 2013 

respectively,  compared  with  4.1  and  2.0%  of  GDP  in  the  Commission's  2012  spring  forecast).  The  objective  of  the  budgetary  strategy 

outlined  in  the  programme  is  to  correct  the  excessive  deficit  by  2013  and  achieving  the  medium  term  budgetary  objective  (MTO) of  a 

structural deficit of no more than 0.5 percent of GDP. The government's objective is also to reach at least a structurally balanced budget in 

2020. The programme thereby confirms the previous MTO, which adequately reflects the requirements of the Stability and Growth Pact. 

The  planned  headline  deficit  in  2013  is  consistent  with  a  timely  correction  of  the  excessive  government  deficit  and,  based  on the 
(recalculated) structural budget balance*, the planned fiscal effort in that year complies with the Council recommendation issued under the 
Excessive Deficit Procedure in July 2010. Net discretionary measures as presented in the programme are estimated to yield a consolidation 

broadly  in  line  with  the  EDP  recommendation.  The  consolidation  path  has  become  more  back-loaded than  previously  planned  and  a 

sizeable effort is needed in 2013 to ensure the required structural adjustment. Risks of falling short of the 3% of GDP reference value in 

2013 are  limited; the Commission's  2012  spring  forecast sees the  government deficit at 2.0% of GDP. Denmark  is expected  to reach  its 

MTO in 2013. However, based on the (recalculated) structural budget balance, this is not the case from 2013 onwards, and the estimated 

budgetary improvement in the structural budget balance falls short of the 0.5% of GDP required by the Stability and Growth Pact. At the 

same time, the growth rate of government expenditure, taking into account discretionary revenue measures, is expected to be in line with 

the  expenditure  benchmark  of  the  Stability  and  Growth  Pact.  Part  of  the  budget  deficits  will  be  financed  by  reducing  the  government's 

account with Denmark's Nationalbank. Denmark's gross public debt is projected to fall from 46.5% of GDP in 2011 to  42.1% in 2015, well 

below 60% of GDP.

Recommendation:
•

Implement the budgetary strategy as envisaged, to ensure a correction of the excessive deficit by 2013 and achieve the annual average 

structural  adjustment  effort  specified  in  the  Council  recommendations  under  the  Excessive  Deficit  Procedure.  Thereafter,  ensure  an 

adequate  structural  adjustment  effort  to  make  sufficient  progress  towards  the  medium-term  budgetary  objective  (MTO),  including 

meeting the expenditure benchmark.

8. 

EE

Summary assessment:

The Council  is of the opinion that the  macroeconomic scenario  underpinning  the budgetary projections  in the programme  is plausible  in 

2012-13, when GDP growth is expected to average around 2.4%. The Commission's 2012 spring forecast foresees GDP growth of 3.8% in 

2013.  The  objective  of  the  budgetary  strategy  outlined  in  the  programme  is  to  ensure  sustainable  fiscal  policy  that  supports  balanced 

growth, by achieving a structural surplus while ensuring sufficient fiscal buffers and reducing the tax burden on labour. The strategy also 

aims  at  fulfilling  the  requirements  of  the  Stability  and  Growth  Pact.  The  programme  aims  at  overachieving  the  medium-term  budgetary 

objective (MTO) of a structural surplus as of 2013. The MTO adequately reflects the requirements of the Stability and Growth Pact. Based 
on the (recalculated) structural budget balance,*, the rate of growth of government expenditure, taking into account discretionary revenue 
measures,  will  meet  the  expenditure  benchmark  of  the  Stability  and  Growth  Pact  by  2015.  In  parallel,  the  programme  aims  at  reaching 

headline surpluses as of 2014. The debt ratio is well below 60% of GDP and, according to the programme, is likely to decrease after 2013 

to about 10% in 2015.

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Box (continued)

more binding multi-annual expenditure rules within the medium-term budgetary framework, continue enhancing the efficiency of public 

spending and implementing measures to improve tax compliance.

9.

EL

Recommendation: Detailed recommendations are set out in a Memorandum of Understanding.

10.  ES

Summary assessment:

The  Council  is  of  the  opinion  that the  macroeconomic  scenario  underlying  the  programme  is  broadly  plausible  for  2012  and  optimistic 

thereafter.  The Commission's 2012 spring  forecast projected GDP  growth to  reach -1.8%  in 2012 and  -0.3%  in 2013, against  -1.7% and 

0.2%, respectively, in the programme. In compliance with the Excessive Deficit Procedure, the objective of the budgetary strategy outlined 

in the programme is to bring the general government deficit below 3% of the GDP reference value by 2013, based mainly on expenditure 
restraint, but also on some revenue-increasing measures. Based on the (recalculated) structural balance*, the annual average improvement of 
the structural balance planned in the programme is 2.6 % of GDP for 2011-13, above the fiscal effort of over 1.5 % of GDP on average over 

the period 2010-13 recommended under the Excessive Deficit Procedure. Following the correction of the excessive deficit, the programme 

confirms the medium-term objective (MTO) of a balanced budgetary position in structural terms, which would be almost reached by 2015 

with  a  structural  budget  deficit  of  0.2 %  of  GDP.  The  MTO  adequately  reflects  the  requirements  of  the  Stability  and  Growth  Pact.  The 

envisaged  pace  of  adjustment  in  structural  terms  in  2012-13,  represents  sufficient  progress  towards  the  MTO  and  the  growth  rate  of 

government expenditure, taking into account discretionary revenue measures, is in line with the expenditure benchmark of the Stability and 

Growth Pact. The programme projects the government debt ratio to peak in 2013 and to start declining thereafter. In 2014 and 2015 Spain 

will  be  in  transition  period  and  plans  presented  in  the  programme  would  ensure  sufficient  progress  towards  compliance  with  the  debt 

reduction  benchmark  of  the  Stability  and  Growth  Pact.  The  deficit  and  debt adjustment  paths  are  subject  to  important  downside  risks. 

Macroeconomic developments could turn out less favourable than expected. Moreover, measures are not sufficiently specified from 2013 

onwards.  Budgetary  compliance  by  regional  governments,  given  their  recent  poor  track  record,  a  greater  sensitivity  of  revenues  to  the 

ongoing structural adjustment, the uncertain revenue impact of the fiscal amnesty and potential further financial rescue operations also pose 

risks  to  the  budgetary  strategy.  Any  impact  of  these  financial  rescue  operations  on  the  deficit  would  be  of  a  one-off  nature.  Strict 

enforcement of the Budget Stability Law and the adoption of strong fiscal measures at regional level would mitigate the risks of a slippage 

at  regional  level. Given  the  decentralised  nature  of  Spain’s  public  finances,  a  strong  fiscal  and  institutional  framework  is  essential.  The 

Council welcomes the intention of the Commission to present a thorough assessment of the implementation of the Council recommendation 

on correcting the excessive deficit, also taking into consideration the announced multi-annual budget plan for 2013-14 in the coming weeks.

Recommendation:
•

Deliver  an  annual  average  structural  fiscal  effort  of  above  1.5%  of  GDP  over  the  period  2010-13  as  required  by  the  EDP 

recommendation by implementing the measures adopted in the 2012 budget and adopting the announced multi-annual budget plan for 

2013-14 by end July. Adopt and implement measures at regional level in line with the approved rebalancing plans and strictly apply 

the new provisions of the Budgetary Stability Law regarding transparency and control of budget execution and continue improving the 

timeliness  and  accuracy  of  budgetary  reporting  at  all  levels  of  government.  Establish  an  independent  fiscal  institution  to  provide 

analysis,  advice  and  monitor  fiscal  policy.  Implement  reforms  in  the  public  sector  to  improve  the  efficiency  and  quality  of  public 

expenditure at all government levels. 

11.  FI

Summary assessment:

The Council is of the opinion that the macroeconomic scenario underpinning the budgetary projections in the programme is plausible for 

the  2012-13 period, GDP  growth expected in the programme  is  in  line with  the Commission's 2012 spring  forecast. Projections are also 

realistic for the years 2014 and 2015 as they foresee GDP growth to be substantially lower than encountered before the crises and lower 

than  in  the recovery  years 2010-11. The main  budgetary  goal of  Finland's 2012 stability programme  is to reduce the central  government 

deficit by limiting expenditures and increasing revenues. As the central government budget is the main source of the general government 

deficit, improving its position will contribute to balancing of the general government budget. The medium-term budgetary objective (MTO) 

of  a  surplus  of  0.5%  of  GDP  in  structural  terms  reflects  adequately  the  requirements  of  the  Stability  and  Growth  Pact.  Based  on  the 
(recalculated) structural budget balance*, Finland has met the MTO in 2011 but would marginally deviate from it over 2012-15. The rate of 
growth of government expenditure, taking into account discretionary revenue  measures, complies with the expenditure benchmark of the 

Stability and Growth Pact in all years except 2015. The programme aims at balancing the general government budget by 2015 and reaching 

surpluses as from 2016. The debt ratio is well below 60% of GDP and according to the programme, the debt level will peak in 2014 at close 

to  52%  of  GDP  and  then  start  declining.  A  notable  sustainability  gap  still  exists  in  Finland’s  public  finances,  mainly  stemming  from  a 

rapidly  deteriorating  dependency  ratio  caused  by  population  ageing.  The  sustainability  gap  in  public  finances  needs  to  be  continuously 

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Box (continued)

monitored and  measures adjusted accordingly.  Finland’s fiscal  framework  is anchored to  multi-annual expenditure ceilings, but these do 

currently not apply for the municipal sector.

Recommendation:
•

Preserve a sound  fiscal position  in 2012 and beyond by correcting any departure  from the  medium-term budgetary objective (MTO) 

that  ensures  the  long-term  sustainability  of  public  finances.  To  this  end,  reinforce  and  rigorously  implement  the  budgetary  strategy, 

supported by sufficiently specified measures, for the year 2013 and beyond including meeting the expenditure benchmark. Continue to 

carry  out  annual  assessments  of  the  size  of  the  ageing-related  sustainability  gap  and  adjust  public  revenue  and  expenditure  in 

accordance with  the  long-term objectives and needs. Integrate the local government sector better in the system of  multi-annual  fiscal 

framework including through measures to control expenditure. 

12.  FR

Summary assessment:

The Council is of the opinion that the macroeconomic scenario underpinning the budgetary projections in the programme is optimistic. The 

Commission's 2012 spring forecast projected GDP growth to reach 0.5% in 2012 and 1.3% in 2013, against 0.7% and 1.75%, respectively, 

according to the programme. After the deficit came out better than expected at 5.2% of GDP in 2011, the programme plans to bring it down 

to  3%  of  GDP  in  2013,  which  is  the  deadline  set  by  the  Council  for  correcting  the  excessive  deficit,  and  to  continue  consolidation 

thereafter, with a balanced budget to be achieved by 2016. The medium-term budgetary objective (MTO) of a balanced budget in structural 

terms is expected to be reached within the programme period. The MTO adequately reflects the requirements of the Stability and Growth 
Pact.  Based  on  the  (recalculated)  structural  balance*,  the  planned  average  annual  fiscal  effort  in  2010-2013  is  in  line  with  the  Council 
recommendation of 2 December 2009. Annual progress in structural terms equivalent to a further 0.7% of GDP towards achieving the MTO 

is  projected  to  be  made  in  2014–16.  According  to  the  programme,  the  growth  rate  of  government  expenditure,  taking  into  account 

discretionary revenue measures, is in line with the expenditure benchmark of the Stability and Growth Pact. The adjustment path presented 

in the programme is subject to risks. The macroeconomic scenario could turn out to be less favourable as indicated by the Commission's 

2012  spring  forecast.  Measures  are  not  sufficiently  specified  to  reach  the  targets  from  2013  onwards  and  to  achieve  the  recommended 

average annual fiscal effort. Furthermore, France's track record when it comes to meeting expenditure targets is mixed. Therefore, it cannot 

be ensured that the excessive deficit will be corrected by 2013 unless the planned  measures are sufficiently specified and additional ones 

implemented as needed. Starting from 85.8% of GDP in 2011, the debt ratio is expected to reach 89.2% in 2013 and to drop to 83.2% in 

2016. According to the programme, the debt reduction benchmark will be met at the end of the transition period (2016).

Recommendation:
•

Reinforce and implement the budgetary strategy, supported by sufficiently specified measures, notably on the expenditure side, for the 

year 2012 and beyond to ensure a correction of the excessive deficit by 2013 and the achievement of the structural adjustment effort 

specified in the Council recommendations under the Excessive Deficit Procedure. Thereafter, ensure an adequate structural adjustment 

effort  to  make  sufficient  progress  towards  the  medium-term  budgetary  objective  (MTO),  including  meeting  the  expenditure 

benchmark,  and  ensure  sufficient  progress  towards  compliance  with  the  debt  reduction  benchmark.  Continue  to  review  the 

sustainability and adequacy of the pension system and take additional measures if needed.

13.  HU

Summary assessment:

The  Council  is  of  the  opinion  that  the  macroeconomic  scenario  underpinning  the  budgetary  projections  in  the  programme  is  somewhat 

optimistic. The Hungarian authorities’ growth projections for 2012 and 2013 are higher by around half a percentage point compared to the 

Commission's 2012 spring forecast on the account of the more optimistic official assumptions regarding domestic demand, particularly in 

2013. The objective of the budgetary strategy outlined in the programme is to ensure the sustainable correction of the excessive deficit by 

the 2012 deadline set by the Council in line with the Council Recommendation of March 2012. The official deficit targets and the planned 

fiscal  efforts  comply  with  the  March  2012  Council  recommendations  based  on  Article  126(7).  The  programme  confirms  the  previous 

medium-term  budgetary  objective  (MTO)  of  1.5%  of  GDP,  which  it  plans  to  achieve  by  2013.  The  MTO  adequately  reflects  the 
requirements of the Stability and Growth Pact. Based on the (recalculated) structural budget balance*, progress towards the MTO does not 
appear  to  be  adequate  in  2013  against  the  assessment  of  the  Commission's  2012  spring  forecast,  which  takes  into  account  the 

implementation  risks  related  to  selected  saving  measures  and  a  less  optimistic  macroeconomic  scenario.  The  growth  rate  of  government 

expenditure, taking into account discretionary revenue measures, is in line with the expenditure benchmark of the Stability and Growth Pact 

in 2013, but not in 2014 and in 2015. According to government plans, the public debt is continuously reduced throughout the programme 

period to below 73% of GDP in 2015, but will remain above the 60% of GDP reference value. Regarding the debt reduction benchmark, 

Hungary  will  be  in  transition  period  in  2013-2014  and  the  programme  would  ensure  sufficient  progress  towards  compliance  with  the 

benchmark.  According  to  the  programme,  the  debt  reduction  benchmark  would  be  met  at  the  end  of  the  transition  period,  in  2015,  and 

thereby should help to reduce the accumulated external and internal indebtedness.

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Box (continued)

Recommendation:
•

Correct  the  excessive deficit  by  2012  in  a  durable  manner,  by  implementing  the  2012  budget  and  the  subsequently  approved 

consolidation  measures,  while  reducing  the  reliance  on  one-off  measures.  Thereafter,  specify  all  structural  measures  necessary  to 

ensure  a  durable  correction  of  the  excessive  deficit  and  to  make  sufficient  progress  towards  the  medium-term  budgetary  objective 

(MTO),  including  meeting  the  expenditure  benchmark,  and  ensure  sufficient  progress  towards  compliance  with  the  debt  reduction

benchmark. Also to help mitigate the accumulated macroeconomic imbalances, put the public debt ratio on a firm downward path.

•

Revise the cardinal law on economic stability by putting the new numerical rules into a binding medium-term budgetary framework. 

Continue to broaden the analytical remit of the Fiscal Council, with a view to increasing the transparency of public finances.

14. 

IE

Summary assessment:

The  Council  is  of  the  opinion  that the  macroeconomic  scenario  underpinning  the  budgetary  projections  of  the  programme  is  plausible. 

Economic  growth  projections  in  the  programme  are  similar  to  the  Commission's  spring  2012  forecast.  The  objective  of  the  budgetary 

strategy of the programme is to reduce the general government deficit below the 3% of GDP threshold by end 2015, which is in line with 

the deadline set by the Council for correcting the excessive deficit. The programme currently projects a deficit of 8.3% of GDP (below the 

programme target of 8.6% of GDP) in 2012, 7.5% of GDP in 2013, 4.8% of GDP in 2014 and 2.8% of GDP by the end of the programme 

period  in  2015.  This  path  is  underpinned  by  consolidation  measures  of  2.7%  of  GDP  implemented  in  the  budget  for  2012,  and  broad 

consolidation  measures of 3.9 % of  GDP  in 2013-2014 and a  further partly specified consolidation effort of 1.1% of GDP  in  2015. The 

programme restates the medium-term objective (MTO) of a structural general government deficit of 0.5 % of GDP, which is not reached 

within the programme period. The MTO adequately reflects the requirement of the Stability and Growth Pact. General government debt is 

above 60% of GDP and is projected to increase from 108% of GDP in 2011 to 120% in 2013 before starting to decline. For the duration of 

the Excessive Deficit  Procedure  until 2015 and  in the  following three  years, Ireland will be  in transition period and the budgetary plans 

would ensure sufficient progress towards compliance with the debt reduction benchmark of the Stability and Growth Pact.

Recommendation: Detailed recommendations are set out in a Memorandum of Understanding.

15.

IT

Summary assessment:

The Council is of the opinion that the macroeconomic scenario underlying the programme is plausible, under the assumption of no further 

worsening in financial market conditions. In line with the Commission's spring 2012 forecast, it expects real GDP to contract sharply this 

year  and  recover  gradually  in  2013.  In  compliance  with  the  Excessive  Deficit  Procedure  (EDP),  the  objective  of  the  budgetary  strategy 

outlined  in  the  programme  is  to  bring  the  general  government  deficit  below  the  3%  of  GDP  reference  value  by  2012,  based  on  further 

expenditure restraint and additional revenues. Following the correction of the excessive deficit, the programme confirms the medium-term 

budgetary objective (MTO) of a balanced budgetary position in structural terms, which adequately reflects the requirements of the Stability 

and Growth Pact. It plans to achieve it in 2013, i.e. one year earlier than targeted in the previous stability programme, through the measures 
already adopeted  in 2010 - 2011. Based on the  (recalculated) structural deficit*, the  planned average annual  fiscal effort over the period 
2010-2012 is well above the 0.5% of GDP recommended by the Council under EDP. The envisaged pace of adjustment in structural terms

in 2013 allows achieving the MTO in that year and the planned rate of growth of government expenditure, taking into account discretionary 

revenue  measures  would  comply  with  the  expenditure  benchmark  of  the  Stability  and  Growth  Pact.  The  programme  projects  the 

government debt ratio to peak in 2012 and to start declining at an increasing pace thereafter, as the primary surplus increases. In 2013-14 

Italy  will  be  in  transition  period  and  its  budgetary  plans  would  ensure  sufficient  progress  towards  compliance  with  the  debt  reduction 

benchmark, as also confirmed in the Commission's 2012 spring forecast. According to plans, the debt reduction benchmark will be met at 

the end of the transition period (2015). Reaching the above deficit and debt outcomes will require strict and full budgetary implementation 

of the corrective measures adopted in 2010-11.

Recommendation:
•

Implement the budgetary strategy as planned, and ensure that the excessive deficit is corrected in 2012. Ensure the planned structural 

primary surpluses so as to put the debt-to-GDP ratio on a declining path by 2013. Ensure adequate progress towards the medium-term 

budgetary  objective,  while  meeting  the  expenditure  benchmark  and  making  sufficient  progress  towards  compliance  with  the  debt 

reduction benchmark.

•

Ensure that the specification of the key features of the Constitutional balanced budget rule in the implementing legislation, including 

appropriate  coordination  across  levels  of  government,  is  consistent  with  the  EU  framework.  Pursue  a  durable  improvement  of  the 

efficiency  and  quality  of  public  expenditure  through  the  planned  spending  review  and  the  implementation  of  the  2011  Cohesion 

Action Plan leading to improving the absorption and management of EU funds, in particular in the South of Italy. 

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Box (continued)

16. 

LT

Summary assessment:

The Council is of the opinion that the macroeconomic scenario underpinning the budgetary projections in the programme is plausible. It is 

broadly  in  line  with  the  Commission's  2012  spring  forecast  for  2012  and  2013.  The  objective  of  the  budgetary  strategy  outlined  in  the 

programme is to correct the excessive deficit by 2012 as recommended by the Council and progressing towards the medium-term budgetary 

objective (MTO) thereafter. The  programme confirms the previous MTO,  i.e. a structural  general  government surplus of 0.5  % of  GDP, 

which adequately reflects the requirements of the Stability and Growth Pact, and outlines a consolidation of at least 1 percentage point per 

year,  planning  a  balanced  budget  by  2015.  While  the  budgetary  plans  are  in  line  with a  timely  correction  of  the  excessive  deficit,  the 
average  annual  fiscal  effort  in  2010-2012,  based  on  the  (recalculated)  structural  budget  balance*,  is  expected  to  be  lower  than  2.25%  of 
GDP  required  by  the  Council  in  its  recommendation  of  16  February  2010.  The  planned  annual  progress  towards  the  MTO  in  the  years 

following  the  correction  of  the  excessive  deficit  is  slightly  higher  than  0.5%  of  GDP  in  structural  terms,  that  is,  the  benchmark  of  the 

Stability  and  Growth  Pact.  The  planned  rate  of  growth  of  government  expenditure,  taking  into  account  discretionary  revenue  measures, 

complies with the expenditure benchmark of the Stability and Growth Pact in 2013 and 2014, but not in 2015. General government debt is 

projected  to  remain  below  60%  of  GDP  over  the  programme  period,  increasing  to  nearly  41%  of  GDP  in  2013,  according  to  the 

Commission's 2012 spring forecast, while the convergence programme targets the debt to decrease to around 35% by 2015. The reform of 

budget  planning  and  execution  is  progressing  but the  government  has  still  to  approve  the  proposed  laws.  These  laws  would  improve 

accountability within the fiscal framework, by establishing an independent body, and to tighten rules on treasury reserves.

Recommendation:
•

Ensure planned progress towards the timely correction of the excessive deficit. To this end, fully implement the budget for the year 

2012  and  achieve  the  structural  adjustment  effort  specified  in  the  Council  recommendation  under  the  Excessive  Deficit  Procedure. 

Thereafter,  specify  the  measures  necessary  to  ensure  implementation  of  the  budgetary  strategy  for  the  year  2013  and  beyond  as 

envisaged,  ensuring  an  adequate  structural  adjustment  effort  to  make  sufficient  progress  towards  the  medium-term  budgetary 

objective,  including  meeting  the  expenditure  benchmark,  while  minimising  cuts  in  growth-enhancing  expenditure.  In  that  respect, 

review and consider increasing taxes least detrimental to growth, such as housing and environmental taxation, including introducing 

car taxation, while reinforcing tax compliance. Strengthen the fiscal framework, in particular by introducing enforceable and binding 

expenditure ceilings in the medium-term budgetary framework.

17. 

LU

Summary assessment:

The Council is of the opinion that the macroeconomic scenario underpinning the budgetary projections in the programme is plausible. In 

particular,  the  programme  scenario  for  2012  and  2013  is  very  close  to  the  Commission's  2012  spring  forecast.  Medium-term  deficit 

projections are  made under a slightly optimistic growth scenario, above potential growth although still well below average historic rates. 

The objective of the budgetary strategy outlined in the programme is to bring the deficit from 1.5% in 2012 to 0.9% in 2014 with a package 

of consolidation measures of around 1.2% of GDP and provide a wider room for  manoeuvre in case of negative shocks. The programme 

confirms the previous medium term objective (MTO) of a structural surplus of 0.5%. However, this MTO cannot be regarded as appropriate 

under the provisions of the Stability and Growth Pact because, based on current policies and projections, this MTO does not appear to take 

sufficiently into account the implicit liabilities related to ageing, despite the debt being below the Treaty reference value. Moreover, based 

on both the Commission's 2012 spring forecast as well as on the (recalculated) structural budget balance in the programme, Luxembourg 

would significantly depart from its own MTO starting from 2012. The growth rate of government expenditure, net of discretionary revenue 

measures,  is expected to significantly exceed the expenditure benchmark as  defined  in the Stability and Growth  Pact.  At 20  % of GDP, 

gross government debt is below the reference value of the Treaty.

Recommendation:
•

Preserve a sound fiscal position by correcting any departure from a  medium-term budgetary objective (MTO) that ensures the long-

term sustainability of public finances, in particular taking into account implicit liabilities related to ageing. To this end, reinforce and 

rigorously  implement the budgetary strategy, supported by sufficiently specified  measures,  for the  year 2013 and beyond, including 

meeting the expenditure benchmark. 

18. 

LV

Summary assessment:

The  Council  is  of  the  opinion  that  the  macroeconomic  scenario  underpinning  the  budgetary  projections  is  cautious  in  2012,  taking  into 

account the latest available information, and plausible in 2013. While macroeconomic projections for 2012 in the programme scenario are 

very  close  to  those  in  the  Commission's  spring  2012  forecast  (with  GDP  growth  projections  respectively  at  2.0%  and  2.2%),  recent 

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Box (continued)

convergence  programme  has  changed  the  medium-term  objective  from  -1.0%  to  -0.5%  of  GDP;  the  new  MTO  adequately  reflects  the 

requirements  of  the  Stability  and  Growth  Pact.  The  planned  headline  deficit  in  2012  complies  with  the  deadline  for  correction  of  the 

excessive deficit established  in Council Recommendation of  7 July 2009.  For 2013, the programme targets a headline deficit  of 1.4% of 

GDP,  although  the  planned  expenditure  reduction  is  not  yet  fully  supported  by  measures.  Based  on  the  (recalculated)  structural  budget 
balance*, Latvia  will  approach  its  MTO  by  the  end  of  the  programme  period  in  2015.  While  the  recalculated  information  suggests  that 
progress  towards  the  MTO  is  less than  0.5%  of  GDP  in  structural  terms  in  outer  years  of  the  programme,  planned  expenditure  restraint 

would ensure that the growth rate of government expenditure, taking into account discretionary revenue measures, would be in line with the 

expenditure  benchmark  of  the  Stability  and  Growth  Pact.  At  the  same  time,  tax  changes  from  the  second  half  of  2012  as  adopted  by 
Parliament on the 24th of May, which are  not  yet reflected  in the programme scenario but acknowledged  in the  letter accompanying  the 
submission of the 2012 convergence programme represent a risk to the attainment of targets in 2013 and beyond. The general government 

debt  ratio  is  below  60%  of  GDP,  increasing  from  42.6%  of  GDP  in  2011  to  46.7%  of  GDP  in  2014,  as  the  authorities  pre-fund  large 

repayments  related  to the  international  financial assistance programme that are due  in 2014-2015, and  falling  to  38.9%  in 2015 as these 

repayments are made.

Recommendation:
•

Ensure planned progress towards the timely correction of the excessive deficit. To this end, implement the budget for the year 2012 as 

envisaged and achieve  the  fiscal effort specified  in the Council recommendation  under the Excessive Deficit Procedure. Thereafter, 

implement  a  budgetary  strategy,  supported  by  sufficiently  specified  structural  measures,  for  the  year  2013  and  beyond,  to  make 

sufficient progress towards the medium-term budgetary objective (MTO), and to respect the expenditure benchmark. Use better than 

expected cyclical revenue to reduce government debt.

•

Implement  measures  to  shift  taxation  away  from  labour  to  consumption,  property,  and  use  of  natural  and  other  resources  while 

improving the structural balance; ensure adoption of the Fiscal Discipline Law and develop a medium term budgetary framework law to 

support the long-term sustainability of public finances; restore contributions to the mandatory funded private pension scheme at 6% of 

gross wages from 2013.

19.  MT

Summary assessment:

The Council is of the opinion that the macroeconomic scenario underpinning the budgetary projections is optimistic, especially in the outer 

years  of  the  stability  programme  period  when  compared  with  potential  growth  as  estimated  by  the  Commission.  The  objective  of  the 

budgetary strategy outlined in the programme is to gradually reduce the deficit, to 0.3% of GDP in 2015, after the planned correction of the 

excessive  deficit  in  2011.  The  programme  confirms  the  previous  medium-term  budgetary  objective  (MTO)  of  a  balanced  position  in 

structural terms, which is to be achieved beyond the programme period. The MTO adequately reflects the requirements of the Stability and 

Growth Pact. There are risks that the deficit outcomes could be worse than targeted, stemming  from (i)  lower revenue  given the slightly 

optimistic macroeconomic scenario; (ii) possible overruns in current primary expenditure; and (iii) the ongoing restructuring of the national 
airline (Air Malta) and financial situation of the energy provider (Enemalta). Based on the (recalculated) structural budget balance*, annual 
progress  towards  the  MTO  is  planned  to  be  in  line  with  the  0.5%  of  GDP  benchmark  in  the  Stability  and  Growth  Pact.  Using  the 

Commission’s identification of the one-offs included in the budgetary targets, average progress towards the MTO is slightly higher (¾% of 

GDP) but spread very unevenly, with no progress in 2012 followed by an effort of 1¼% in 2013. According to the information provided in 

the programme, the growth rate of government expenditure, taking into account discretionary revenue measures, would be in line with the 

expenditure  benchmark  of  the  Stability  and  Growth  Pact  throughout  the  programme  period.  The  risks  to  the  budgetary  targets  imply, 

however,  that  the  average  adjustment  towards  the  MTO  could  be  slower  than  appropriate.  After  peaking  at  72%  of  GDP  in  2011,  the

general government gross debt ratio is planned in the programme to start decreasing and to reach 65.3% of GDP in 2015 (still above the 

60%  of  GDP  reference  value).  According  to  the  plans  in  the  programme,  Malta  is  making  sufficient  progress  towards  meeting  the  debt 

reduction benchmark of the Stability and Growth Pact at the end of the transition period (2015) but this assessment is subject to risks as the 

debt  ratio  could  turn  out  higher  than  planned  given  the  possibility  of  higher  deficits  and  stock-flow  adjustments.  Malta's  medium-term 

budgetary framework remains non-binding, implying a relatively short fiscal planning horizon. The programme announces that the Maltese 

government is considering reforms to the annual budgetary procedure, including timelines, and introducing a fiscal rule embedded in the 

Constitution, including monitoring and corrective mechanisms, in line with recent changes to the euro area governance framework.

Recommendation:
•

Reinforce the budgetary strategy in 2012 with additional permanent measures so as to ensure adequate progress towards the medium-

term budgetary objective (MTO) and keep the deficit below 3% of GDP without recourse to one-offs. Continue fiscal consolidation at 

an appropriate pace thereafter, so as to make sufficient progress towards the MTO, including meeting the expenditure benchmark, and 

towards compliance with the debt reduction benchmark, by specifying the concrete measures to back up the deficit targets from 2013, 

while  standing  ready  to  take  additional  measures  in case  of  slippages.  Implement,  by  end-2012  at  the  latest,  a  binding,  rule-based 

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Box (continued)

multi-annual fiscal framework. Increase tax compliance and fight tax evasion, and reduce incentives towards indebtedness in corporate 

taxation. 

20.  NL

Summary assessment:

The Council is of the opinion that the macroeconomic scenario underpinning the budgetary projections in the programme is optimistic. For 

2013,  the  stability  programme  projects  economic  growth  of  1¼%  without  taking  into  account  the  negative  impact  of  the  additional 

consolidation measures on growth, whilst, on the basis of the same no-policy change scenario, the Commission's forecast a lower growth 

rate  of  0.7%.  The  stated  objective  of  the  programme  is  to  meet  the  Council  recommendations  on  correcting  the  excessive  deficit  and  to 

strive to further improve the budgetary position towards the medium-term budgetary objective (MTO) by targeting a structural effort of at 

least 0.5% per year. The programme targets a headline general government deficit of 3% of GDP in 2013 and confirms the previous MTO 

of a structural deficit of 0.5% of GDP, which adequately  reflects the requirements of the Stability and Growth Pact. The average annual 
fiscal  effort  of  0.75%  of  GDP  over  the  period  2010-2013,  based  on  the  (recalculated)  structural  budget  balance*,  is  in  line  with  the 
structural  effort  of  ¾%  of  GDP  recommended  by  the  Council.  As  the  programme  does  not  provide  budgetary  targets  beyond  2013,  the 

sustainability  of  the  budgetary  correction  in  2013  and  progress  towards  the  MTO  in the  outer  years,  including  compliance  with  the 

expenditure  benchmark  of  the  Stability  and  Growth  Pact,  cannot  be  assessed.  The  budgetary  projections  over  the  programme  period  are 

subject  to  implementation  risks.  These  are  not  solely  restricted  to  the  newly  announced  consolidation  measures,  but  also  to  the 

implementation  of  some  of  the  measures  agreed  upon  earlier  by  the  outgoing  government.  The  additional  measures  proposed  by  the 

government in April 2012 for 2013 and their budgetary impact have been further specified and quantified on 25 May after the cut-off date 

for  assessment.  Budgetary  adjustment  has  so  far  relied  mostly  on  expenditure  cuts,  which  also  affect  growth-enhancing  expenditure. 

According to the 2012 stability programme, the debt-to-GDP ratio is expected to further rise relatively markedly in 2012, to 70.2% of GDP 

and to increase slightly further to 70.7% of GDP in 2013, taking into account the impact of the additional consolidation measures. The debt 

ratio is thus projected to remain well above the 60% reference value. For 2014 and 2015, the programme does not specify debt targets and 

therefore an assessment of compliance with the debt reduction benchmark of the Stability and Growth Pact beyond 2013 cannot be given.

Recommendation:
•

Ensure  timely  and  durable  correction  of  the  excessive  deficit.  To  this  end,  fully  implement  the  budgetary  strategy  for  2012  as 

envisaged.  Specify  the  measures  necessary  to  ensure  implementation  of  the  2013  budget  with  a  view  to  ensuring  the  structural 

adjustment  effort  specified  in  the  Council  recommendations  under  the  Excessive  Deficit  Procedure.  Thereafter,  ensure  an  adequate 

structural adjustment effort to make sufficient progress towards the medium-term budgetary objective (MTO), including meeting the 

expenditure  benchmark,  and  ensure  sufficient  progress  towards  compliance  with  the  debt  reduction  benchmark  whilst  protecting 

expenditure  in  areas  directly  relevant  for  growth  such  as  research  and  innovation,  education  and  training.  To  this  end,  after the 

formation  of  a new  government,  submit  an  update  of  the  2012  stability  programme  with  substantiated  targets  and  measures  for  the 

period beyond 2013. 

21.  PL

Summary assessment:

The Council is of the opinion that the macroeconomic scenario underpinning the budgetary projections in the programme is plausible and is 

in  line  with  the  Commission's  2012  spring  forecast.  The  objective  of  the  budgetary  strategy  outlined  in  the  programme  is  to  correct  the 

excessive deficit by 2012 and reach medium-term budgetary objective (MTO) by 2015. The programme confirms the MTO of a deficit of 

1% of GDP, which adequately reflects the requirements of the Stability and Growth Pact. The planned correction of the deficit is in line 

with the deadline set by the Council and the planned fiscal effort complies with the recommendation under the Excessive Deficit Procedure. 
Based  on  the  (recalculated)  structural  deficit*,  the  planned  annual  progress  towards  the  MTO  is  higher  than  0.5%  of  GDP  (in  structural 
terms). The growth rate of government expenditure, taking into account discretionary revenue measures, is in line with the benchmark of 

the Stability and Growth Pact over entire programme period, but exceeds the expenditure benchmark by a small margin in 2013, according 

to the Commission's 2012 spring forecast. Sufficient progress towards the MTO may require additional efforts as it predominantly relies on 

sizeable cuts in public investment expenditure and is not sufficiently supported by detailed measures in the outer years of the programme. 

General government debt is projected to remain below 60 % of GDP in Poland over the programme period. The national authorities forecast 

it to decrease gradually from 56.3% of GDP in 2011 to 49.7% of GDP in 2015, whereas the Commission, taking account of possible risks 

to the consolidation plans, expects the improvement to be slower.

Recommendation:

Ensure planned progress towards the correction of the excessive deficit. To this end, fully implement the budget for the year 2012 and 

achieve the structural adjustment effort specified in the Council recommendations under the Excessive Deficit Procedure. Thereafter, 

specify  the  measures  necessary  to  ensure  implementation  of  the  budgetary  strategy  for  the  year  2013  and  beyond  as  envisaged, 

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Box (continued)

•

Speed up the reform of the fiscal framework by enacting legislation with a view to introducing a permanent expenditure rule by 2013. 

This rule should  be consistent with the  European system of accounts. Take  measures to strengthen the  mechanisms of coordination 

among the different levels of government in the medium-term and annual budgetary processes.

22.  PT

Recommendation: Detailed recommendations are set out in a Memorandum of Understanding.

23.  RO

Summary assessment:

The Council is of the opinion that the macroeconomic scenario underpinning the budgetary projections in the programme is plausible. The 

objective  of  the  budgetary  strategy  outlined  in  the  programme  is  to  reach  a  budget  deficit  below  3%  of  GDP  in  2012,  in  line  with  the 

Council  recommendations  given  to  Romania  under  the  Excessive  Deficit  Procedure.  Thereafter,  it  aims  at  achieving  a  medium-term 

budgetary objective (MTO) defined as a deficit of 0.7% of GDP in structural terms. The MTO adequately reflects the requirements of the 

Stability and Growth Pact. Following the planned correction of the excessive deficit in 2012, the deficit is expected to decrease further to 
2.2%  of  GDP  in  2013,  to  1.2%  of  GDP  in  2014  and  0.9%  of  GDP  in  2015.  Based  on  the  (recalculated)  structural  budget  balance*, this 
implies an improvement in the deficit by 1.5% in 2012, 0.5% in 2013 and 0.7% in 2014, in line with the 0.5% of GDP benchmark of the 

Stability  and  Growth  Pact.  The  growth  rate  of  government  expenditure  is  in  line  with  the  expenditure  benchmark  of  the  Stability  and 

Growth Pact over the 2012-2015 period. The programme foresees the achievement of the MTO in 2014. The main risks to the budgetary 

targets are the arrears of state owned enterprises, as well as potential re-accumulation of arrears at local government level and in the health 

sector, even if some measures have been taken in the health sector. As regards public debt, it was below 34% of GDP by end 2011 thus 

remaining substantially below 60% of GDP.

Recommendation: Detailed recommendations are set out in a Memorandum of Understanding.

24.  SE

Summary assessment:

The Council is of the opinion that the macroeconomic scenario underpinning the budgetary projections in the programme is plausible for 

2012 and optimistic in 2013-15, when GDP growth is expected to average around 3.5%. The Commission's 2012 spring forecast foresees 

GDP growth of 2.1% in 2013. The objective of the budgetary strategy outlined in the programme is to ensure long-term sustainability by 

respecting the rules of the Swedish fiscal framework, including the target of having a surplus in general government net lending of 1% of 

GDP over the cycle. The strategy also aims at fulfilling the requirements of the Stability and Growth  Pact, notably  respecting the 3% of 

GDP  reference  value.  The  programme  has  changed  the  medium-term  budgetary  objective  (MTO)  from  a  general  government  surplus  of 

1.0% of GDP to a deficit of 1.0% of GDP. The new MTO adequately reflects the requirements of the Stability and Growth Pact. Due to the 

change, the MTO is, based on the (recalculated) structural budget balance, likely to be met over the programme period, even taking into 

account the likelihood of further expansionary discretionary  measures in 2013 or 2014, . Certain downside risks to budgetary projections 

from 2013 onwards are linked to the optimistic macroeconomic assumptions. The planned growth rate of government expenditure, taking 

into account  discretionary  revenue  measures, would comply  with the expenditure benchmark of the  Stability and Growth Pact. The debt 

ratio is below 60% of GDP and, according to the programme, is projected to continue to decrease over the programme period.

Recommendation: Detailed recommendations are set out in a Memorandum of Understanding.

25.  SI

Summary assessment:

The  Council  is  of  the  opinion  that  the  macroeconomic  scenario  underpinning  the  budgetary  projections  in  the  programme  is  optimistic 

when compared with the Commission’s 2012 spring forecast. The objective of the budgetary strategy outlined in the programme is to bring 

the general government deficit below 3% of GDP in 2013, the deadline set by the Council, and to pursue further deficit reduction thereafter 

so  as  to  broadly  achieve  Slovenia’s  medium-term  budgetary  objective  (MTO)  by  2015.  The  MTO  is  defined  as  a  balanced  position  in 

structural terms, unchanged from the previous programme, but cannot be regarded as appropriate under the provisions of the Stability and 

Growth  Pact  because,  based  on  current  policies  and  projections,  it  does  not  ensure  sufficiently  rapid  progress  towards  long-term 

sustainability.  There  are  risks that  the  deficit  outcomes  could  be  worse  than  targeted,  due  to  (i)  a  lack  of  specification  of  the  measures 

foreseen,  in  particular  for  the  period  2014-15;  (ii)  a  track  record  of  primary  current  expenditure  overruns;  (iii)  lower  revenue  given  the 

relatively  optimistic  macroeconomic  scenario  and  uncertainty  about  the  impact  of  the  recently  decided tax  measures;  and  (iv)  possible 
additional  capital  support  operations  and  calling  of  guarantees.  Based  on  the  (recalculated)  structural  balance*,  the  average  annual  fiscal 
effort over the period 2010-2013, is planned to be almost 1% of GDP, slighty above the one recommended by the Council. However, the 

Commission's 2012 spring forecast implies that an additional effort will have to be made in 2013 to respect the recommendation over the 

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Box (continued)

growth of government expenditure, taking into account discretionary revenue  measures, is in line with the expenditure benchmark of the 

Stability and Growth Pact in both years, so overall the programme plans a broadly appropriate adjustment path towards the MTO. Taking 

account of the risks mentioned above, the progress towards the MTO could be slower than appropriate in both years. From around 48% of 

GDP  in 2011,  general  government  gross debt  is projected  in the programme to  peak by  2013 at 53%  (thus remaining below the 60% of 

GDP reference value) before falling slightly by the end of the programme period. The debt projections are subject to upward risks from the 

possibility  of  higher  deficits  mentioned  above  and  higher  stock-flow  adjustments.  Slovenia’s  medium-term  budgetary  framework  and 

expenditure rule remain insufficiently binding and insufficiently focussed on achieving the MTO and securing long-term sustainability.

Recommendation:
•

Implement  the  2012  budget,  and  reinforce  the  budgetary  strategy  for  2013  with  sufficiently  specified  structural  measures,  standing 

ready  to  take  additional  measures  so  as  to  ensure  a  correction  of  the  excessive  deficit  in  a  sustainable  manner  by  2013  and  the 

achievement  of  the  structural  adjustment  effort  specified  in  the  Council  recommendations  under  the  Excessive  Deficit  Procedure. 

Thereafter, ensure an adequate structural adjustment effort to make sufficient progress towards an appropriate medium-term objective 

for  the  budgetary  position,  including  meeting  the  expenditure  benchmark.  Strengthen  the  medium-term  budgetary  framework, 

including the expenditure rule, by making it more binding and transparent.

26.  SK

Summary assessment:

The Council is of the opinion that the macroeconomic scenario underpinning the budgetary projections in the programme is plausible. It is 

broadly in line with the Commission's 2012 spring forecast, although the latter assumes somewhat higher real GDP growth in 2012. The 

stated  objective  of  the  budgetary  strategy  outlined  in  the  programme  is  to  ensure  the  long-term  sustainability  of  public  finances.  The 

intermediary steps defined to reach this are a rigorous implementation of the 2012 budget and a reduction of the headline deficit below 3% 

of GDP in 2013, the deadline for correction of the excessive deficit set by the Council. The achievement of the headline deficit target in 

2013,  however,  may  fall  short  of  plans.  The  programme  has  changed  the  medium-term  budgetary  objective  (MTO)  from  a  close-to-

balanced budget to a structural deficit of 0.5% of GDP, which is not foreseen to be achieved within the programme period. The new MTO 
adequately reflects the requirements of the Stability and Growth Pact. Based on the (recalculated) structural budget balance*, the average 
annual  fiscal  effort  in  2010-2013  amounts  to  1.3%  of  GDP,  well  above  the  required  value  recommended  by  the  Council,  whereby  the 

residual fiscal effort is somewhat back loaded to 2013. The target for 2013 is subject to risks, as suggested revenue measures may fall short 

of the objective; simultaneous implementation of all small-scale measures can be difficult to implement, and in light of upwards revisions 

of the deficit targets that took place in the past. In addition, further across-board expenditure cuts may prove unsustainable in the medium 

term. In 2014 and 2015, the average fiscal effort stands at 0.3% of GDP annually, which is below the required adjustment of 0.5% of GDP 

for countries which have not yet reached the MTO. Nevertheless, according to the programme the growth rate of government expenditure, 

taking into account discretionary revenue measures, is in line with the expenditure benchmark of the Stability and Growth Pact in the outer 

years of the programme. Government debt would remain well below 60% of GDP. While Slovakia passed legislation establishing the Fiscal 

Council, so far it has not been set up and the legislation on expenditure ceilings has not yet been adopted.

Recommendation:
•

Take additional measures in 2012 and specify the necessary measures in 2013, to correct the excessive deficit in a sustainable manner 

and  ensure  the  structural  adjustment  effort  specified  in  the  Council  recommendations  under  the  Excessive  Deficit  Procedure. 

Implement targeted spending cuts, while safeguarding growth-enhancing expenditure, and step up efforts to improve the efficiency of 

public  spending.  Thereafter,  ensure  an  adequate  structural  adjustment  effort  to  make  sufficient  progress  towards  the  medium-term 

objective,  including  meeting  the  expenditure  benchmark.  Accelerate  the  setting  up  of  the  Fiscal  Council  and  adopt  rules  on 

expenditure ceilings.

•

Increase tax compliance, in particular by improving the efficiency of VAT collection; reduce distortions in taxation of labour across 

different employment types, also by limiting tax deductions; link real estate taxation to the market value of property; make greater use 

of environmental taxation

27.  UK

Summary assessment:

The Council is of the opinion that the macroeconomic scenario underpinning the budgetary projections in the programme is plausible. The 

objective  of  the  budgetary  strategy  outlined  in  the  programme  is  to  implement  the  necessary  fiscal  consolidation to  achieve  the 

government's fiscal targets on net debt and cyclically-adjusted current balance. The convergence programme does not include a medium-

term  objective  (MTO)  as  foreseen  by  the  Stability  and  Growth  Pact.  According  to  programme  projections,  the  deadline  to  correct  the 

excessive  deficit  set  by  the  Council  in  its  recommendation  of  2  December  2009  is  expected  to  be  missed  by  one  year.  The  government 

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Box (continued)

deficit in 2014-15, the deadline set by the Council, is estimated at 4.4% of GDP, implying, based on the (recalculated) structural deficit*, an 
average fiscal effort of 1.25% of GDP between 2010-11 and 2014-15 which is below the 1¾% effort set out in the Council recommendation 

under  the  Excessive  Deficit  Procedure.  Although  the  government  has  not  deviated  from  its  fiscal  consolidation  strategy  which  initially, 

based on previous  macroeconomic projections, appeared sufficient to comply with  EDP targets, the  fiscal performance and outlook have 

been affected by a deterioration of economic growth prospects. Revenue measures have been significantly front-loaded in the adjustment 

path of the fiscal consolidation. Almost 40% of the total annual fiscal consolidation planned for the 2010-11 to 2014-15 period has been 

achieved  by  the  end  of  2011-12,  including  30%  of  the  spending  cuts  and  two-thirds  of  the  net  tax  increases.  The  potential  revenue 

contribution  from  an  increased  efficiency  of  the  tax  system,  stemming  from  a  review  of  the  VAT  rate  structure,  remains  relatively 

underexploited. According to the convergence programme, the general government deficit is expected to be 8.3% of GDP in 2011-12, 5.9% 

in 2012-13, 6.0% of GDP in 2013-14, 4.4% of GDP in 2014-15, 2.9% of GDP in 2015-16 and 1.2% of GDP in 2016-17. These estimates 

are somewhat lower than those by Commission services, who in its 2012 spring forecast expect a deficit of 6.1% of GDP in 2012-13 (which 

would  be  7.9%  without  an  upcoming  one-off  pension  fund  transfer)  and  6.5%  of  GDP  in  2013-14.  The  differences  stem  from  a  lower 

growth forecast and amendments made by Eurostat to UK data. Some adjustments were made to the government’s fiscal plans in the 2011 

Autumn  Statement  to  prioritise  growth-enhancing  expenditure,  but  public  sector  investment  is  still  set  to  fall  sharply  by  2014-15. 

Government debt, forecast at 94.7% in 2013-14, is expected to peak in 2014-15.

Recommendation:
•

Fully  implement the budgetary strategy  for the  financial  year 2012-13 and  beyond,  supported by sufficiently specified  measures, to 

ensure  a  timely  correction  of  the  excessive  deficit  in  a  sustainable  manner  and  the  achievement  of  the  structural  adjustment  effort 

specified in the Council recommendations under the Excessive Deficit Procedure and to set the high public debt ratio on a sustained 

downward path. Subject to reinforcing the budgetary strategy for the financial year 2013-14 and beyond, prioritise growth-enhancing 

expenditure to avoid the risk that a further weakening of the medium-term outlook for growth will negatively impact on the long-term 

sustainability of public finances

* Cyclically  adjusted  balance  net  of  one-off  and  temporary  measures,  recalculated  by  the  Commission  services  on  the  basis  of  the 

information provided in the programme, using the commonly agreed methodology.

58

Part II
Evolving budgetary surveillance

SUMMARY

The deepening of the sovereign debt crisis in 2011 
and 2012 marked a turning point in the debate on 
the EU economy and its governance framework, in 
particular in relation to the euro area. The move to 
stricter  budgetary  and  economic  surveillance 
intensified,  building  on 
the  recently  adopted 
reforms.

in 

space 

Despite 
sustained 
the  preceding  period  of 
economic  growth,  many  Member  States  entered 
the  recession  in  2009  with  little  or  no  room  for 
fiscal  manoeuvre  to  reduce  its  impact  on  the 
economy.  In  some  Member  States,  the  apparent 
as  macroeconomic 
fiscal 
vanished 
imbalances  and  strains 
financial  markets 
unwound.  The dramatic  social  implications  of 
shrinking  economic  output  and  rising  government 
deficits and debt in those Member States that were 
most strongly affected, along with the first signs of 
spillovers to other euro area countries, triggered a 
the  EU 
consensus  on 
governance  framework.  As  a  result  the  economic 
and  fiscal  surveillance  framework  in  the  EU  as  a 
whole  was  reformed,  and  a  crisis  resolution 
mechanism for the euro area was introduced. 

to  change 

the  need 

to 

tackle 

(CRA3) 

is  meant 

system  also  underwent 
financial 

The  supervisory  and  regulatory  framework  of  the 
significant 
banking 
supervisory 
reforms.  A  new  EU 
framework became operational in January 2011. In 
response  to  G20  commitments,  the  EU  continues 
its  financial  regulation  programme.  The  latest 
Commission's legislative proposal on credit rating 
agencies 
the 
overreliance  of  financial  markets  on  ratings, 
concentration  in  the  credit  rating  sector,  CRAs 
civil  liability  and  remuneration  models.  Other 
major  on-going  projects  include  revisions  of  the 
capital  requirements  for  banks  (CRD4  directive) 
and  the  markets  in  financial  instruments  directive 
(MIFID),  both  currently  being  discussed  in  the 
the  Council.  Most 
European  Parliament  and 
recently, on 6 June 2012, the Commission adopted 
a  legislative  proposal  for  bank  recovery  and 
resolution.  The  proposed  framework  sets  out  the 
necessary  steps  and  powers  to  ensure  that  bank 
failures across the EU are managed in a way which 
avoids financial instability and minimises costs for 
taxpayers.  The  May  2012  informal  European 
Council  summit  resolved that  Economic  and 
Monetary  Union  needed  to  be  deepened  and  a 
potential 'banking union' could be established with 
and 
banking 
more 

supervision 

integrated 

for 

resolution,  and  a  common  deposit 
insurance 
scheme.  The  June  2012  Euro  Area  summit 
confirmed  that  the  Commission  would  present 
supervisory 
plans 
mechanism  along  with  a  framework  for  the 
potential direct recapitalisation of euro area banks 
through  the  ESM,  paving  the  way  for  a  banking 
union.

a  European 

single 

With  a  number  of  euro  area  members  facing 
insolvency/illiquidity, backstops of last resort were
set  up as  early  as  May  2010  (see  Box  I.2) to 
guarantee  the  stability  of  the  euro  area.  The 
temporary  firewalls  were  developed  gradually.  In 
February  2012,  Member  States  signed  a  Treaty 
establishing  the  European  Stability  Mechanism
(ESM).  The  strict  conditionality  attached  to  the 
financial  support  provided  by  all  the  different 
backstops  implied  a  significant  strengthening  of 
economic  and  fiscal  surveillance  on  the  Member 
States concerned.  

The  lack  of  fiscal  space  for  some  countries  to 
support  their  economies  during  the  early  days  of 
the  crisis,  and  the  more  recent  evolution  of  the 
crisis  from  a  banking  crisis  to  a  sovereign  debt 
one,  highlighted  the  extent  of  the  implications  of 
inadequate  national  economic  and  budgetary 
policy  during  the  boom  years.  With  the  risks  to 
spillovers  to  other  Member  States  also  becoming 
evident, 
strengthening  of  EU 
surveillance  has  been  undertaken.  A  major 
the  EU  economic  governance 
overhaul  of 
framework  was  proposed  by  the  Commission  in 
September  2010  and  adopted  by  European 
Parliament and Council in the second half of 2011 
(the so-called 'Six Pack'). With its entry into force 
in  December  2011,  the  EU  has  now  thus  much 
stronger rules than before the start of the economic 
and financial crisis.

an  overall 

The  Six  Pack  legislation  has  strengthened  a  wide 
range of existing aspects of economic  governance 
and  introduced  new  ones.  A  new  Macroeconomic 
Imbalances Procedure has been set up to prevent or 
Early 
correct  macroeconomic 
detection of such imbalances  will reduce the risks 
of  their  unwinding  resulting  in  sudden  rises  of 
government  deficits  and  debt  in  Member  States 
with apparently sound public finances.

imbalances.

A  move towards a  more integrated framework  for 
assessing  economic  reforms  and  public  finance 

61

European Commission

Public finances in EMU - 2012

the  submission  of 

plans had already started in Spring 2011, when, in 
the  context  of  the  Europe  2020  strategy,  the 
European  Semester  was  implemented  for  the  first 
time.  The  European  Semester  coordinates  and 
aligns 
the  Stability  and 
Convergence  Programmes  (SCPs),  which  contain 
Member  States'  budgetary  plans,  with  that  of 
National  Reform  Programmes  (NRPs),  which 
contain  the  elements  necessary  for  monitoring
progress towards the Europe 2020 national targets 
for  sustainable  and  inclusive  growth.  Both  these 
documents are now submitted by mid-April so that 
they  can  be  analysed  and  country-specific 
recommendations  under  Article  121(2)  – on  the 
Broad Economic Policy Guidelines – and 148(4) –
on Employment Guidelines – can be issued before 
the  summer  – in  time  to  feed  into  the  preparation 
of the national policies for the following year.

to  which 

to  ensure 

The  Stability  and  Growth  Pact  (SGP)  sets  out  the 
the  Treaty 
provisions  according 
requirements 
fiscal  discipline  are 
implemented.  In  light  of  the  heated  debate  on  the 
need  to  adapt
the  fiscal  policy  reaction  to  a 
deteriorating  economic  environment, Chapter  II.2 
explains 
to 
Excessive Deficit Procedures (EDPs) in the case of 
worsening  economic  conditions  as  well  as  the 
methods used to assess whether an extension of the 
timeline for correcting an excessive deficit can be 
granted. 

the  SGP  provisions 

that  apply 

and 

correction

Chapter  II.2  also  presents  the  main  new  features 
introduced  in  the  SGP by  three  of  the  regulations 
contained in the Six Pack. The adjustment towards 
the  medium-term  budgetary  objective  (MTO) 
which is the core of the preventive arm of the SGP 
will  now  be  assessed  on  the  basis  of  a  new 
allows
expenditure  benchmark,  which
early 
detection
unsustainable 
of 
expenditure  developments,  as  well  as  on  the 
structural  balance.  As  for  the  corrective  arm,  in 
line with the Treaty envisaging both a deficit and a 
debt  criterion 
to  examine  compliance  with 
budgetary  discipline,  a  debt-reduction  benchmark 
has  been  established  to  allow  the opening  of  an 
EDP on  the  basis  of  an  insufficiently  diminishing 
debt-to-GDP ratio. For the euro area, enforcement 
is  now  ensured  by  a  gradual  system  of  financial 
sanctions,  which  can  already  be  invoked  in  the 
preventive arm, in the case of inadequate measures 
to  correct  a  significant  deviation 
the 
appropriate adjustment towards the MTO. 

from 

62

Compliance  with  the  SGP will  also  be  promoted 
by the minimum standards introduced for Member 
States' fiscal frameworks. Chapter II.3 presents the 
the  Directive  on  national 
main  elements  of 
budgetary  frameworks  which  was  also  part  of  the 
Six  Pack.  As  is  the  case  for  most  other  national 
institutions, national budgetary frameworks are far 
from  homogeneous within  the  EU.  Such  diversity 
is documented by a database created as a result of 
the  Ecofin  Council's  2006  decision  to  ask  the 
Commission  to  conduct  a  comprehensive  analysis 
of the existing national fiscal rules and institutions 
in  the  EU  Member  States.  Based  on  a  recent 
update  of  this  database,  Chapter  II.3  outlines  the 
main  changes  in  national  fiscal  frameworks  that 
took place in 2010.

and 

political 

different 

The  variety  across  national  fiscal  frameworks 
reflects 
economic 
environments and traditions. Different frameworks 
can be compatible  with EU budgetary framework, 
as long as their quality and the consistency of their 
rules  is  conducive  to  the  achievement  of  the  EU 
obligations. For this reason, the Directive requires 
only minimum standards, in particular with regard 
to accounting and statistics, forecasting, numerical 
fiscal  rules,  medium-term  budgetary  frameworks 
and  transparency.  However,  best  practices  going 
beyond  these  minimum  requirements  are  also 
discussed amongst Member  States, in peer review 
exercises,  in  order  to  help  countries  achieve  the 
best  outcomes  they  can.  Chapter  II.3  briefly 
outlines  the  outcome  of  the November  2011 
session of this exercise.

With the sovereign debt crisis intensifying over the 
it  has  become  widely 
course  of  2011, 
the 
the  postponement  of 
that 
acknowledged 
adoption  of  even  deeper  reforms,  both  at  national 
and  EU  level,  could  put  the  Economic  and 
Monetary  Union  (EMU)  at  serious  risk,  with 
dramatic implications for all Member States.

The  most  recent  initiatives  of  reforms  to the 
budgetary  surveillance  framework  have  focussed 
on  the  euro  area,  where  spillovers  are  particularly 
high.  Chapter  II.4  presents  the  two  regulations 
proposed  by  the  Commission  on  23  November 
2011, focussing in particular  on the  main  features 
the  draft  regulation  aimed  at  enhancing 
of 
monitoring  of  budgetary  policies  on  euro  area 
Member  States.  The  same  regulation  includes 
provisions  specific  to  euro  area  Member  States 

Evolving budgetary surveillance

Part II

subject  to  EDP,  to  which  stricter  monitoring 
requirements  apply.  The 
regulation 
concerns  only 
area  Member  States 
experiencing severe difficulties with regard to their 
financial  stability  or  receiving  financial  assistance 
on a precautionary basis. 

second 

euro 

National  governments  have  also  spurred  a  further 
strengthening  of  the  adopted  reforms  for  the 
national level. Chapter II.5 presents the content of 
the  Treaty  on  Stability, Coordination  and 
Governance  (TSCG)
that  was  signed  by  25 
Member  States  (30) on  2  March  2012  and  that  is 
currently undergoing the process of ratification. In 
particular, the Fiscal Compact which is part of the 
TSCG reinforces the obligation to reach the MTO 
already  envisaged  by  the  preventive  arm  of  the 
SGP through  national 
rules  and  automatic 
corrective mechanisms.

Finally,  a  vision  for  the  future  of  a  deeper  and 
integrated  EMU  has  been  presented  on  26  June 
2012 in the Report "Towards a Genuine Economic 
and Monetary Union" prepared by the President of 
the  European  Council,  in  cooperation  with  the 
Presidents  of  the  Commission,  of  the  Eurogroup 
and of the European Central Bank. (31) The Report 
sets  out  four  building  blocks  for  the  future  EMU: 
an  integrated  financial  framework,  an  integrated 
budgetary  framework,  an  integrated  economic 
policy  framework  and  strengthened  democratic 
legitimacy  and  accountability.  In  its  June  2012 
its 
meeting, 
President, again in cooperation with the Presidents 
of  the  Commission,  of  the  Eurogroup  and  of  the 
ECB,  to  develop  a  specific  and  time-bound  road 
map  for  the  achievement  of  a  genuine  Economic 
and Monetary Union.  

the  European  Council 

invited 

(30) The United Kingdom and the Czech Republic did not sign 

the TSCG.

(31) See European Council (2012).

63

1.

INTRODUCTION

Budgetary  frameworks  are  set  up  to  guide  policy 
making  over  time.  In  order  to  be  effective,  they 
need to be stable enough to facilitate planning over 
the years, but they must also be flexible enough to 
adapt  as  any  weaknesses  become  apparent  and  as 
the  environment  in  which  they  operate  changes. 
The need for stability is a key reason why changes 
are  not  usually  introduced  as  a  result  of  small 
weaknesses  being  identified.  However,  lack  of 
timely adaptations of  frameworks to the emerging 
policy challenges is also explained by institutional 
improvements  proves 
inertia.  Consensus  on 
particularly difficult to achieve when they concern 
introducing more binding rules. Major changes are 
thus  often  adopted  only  as  a  result  of  dramatic
events,  which  disclose  the  unsustainability  of  the 
status quo. 

Although  there  has  been  an  increase  in  research 
into  budgetary  institutions  and  rules  in  recent 
years,  the  available  empirical  work  is  still  limited 
(see  for  instance  Fabrizio,  2008).  The  existing 
work  does  seem  to  confirm,  though,  that  one 
determinant  that  typically  brings  about  change  to 
budgetary 
institutions  and  rules  are  negative 
economic  shocks.  Sufficiently  large  economic 
shocks not accommodated by markets help build a 
constituency  for  improving  budget  institutions. 
The  fiscal  framework  of  the  European  Union  has 
proven to be no exception to these findings.

The overall favourable  macroeconomic conditions 
that characterised the first decade of the Economic 
and  Monetary  Union  (EMU)  had  masked  the 
extent of the potential consequences of the pitfalls 
of the EU governance framework. A first reform to 
the  Stability  and  Growth  Pact  (SGP)  (32)  – the 
framework  for  budgetary  surveillance  at  EU  level 
– was  carried  out  in  2005.  This  reform  was  also 
linked  to  the  effects  of  a  – more  moderate  –
negative  shock.  Deficits  rising  above  the  3%  of 
GDP  threshold  during  an  economic  downturn 
clearly  showed that government balances that  had 
not  improved  in  structural  terms  in  the  late  1990s 

(32) Member  States  are  required  by 

the  Treaty  on 

the 
Functioning  of  the  European  Union  to  avoid  excessive 
deficits  (Article  126)  and  to  ensure  coordination  of  their 
economic  policies  and  sustained  convergence  of  their 
economic  performance  (Article  121).  The  Stability  and 
Growth Pact (SGP) provides the secondary legislation that 
defines these obligations in greater detail and thus sets out 
the  framework  within  which  fiscal  policy  making  is  to  be 
set and monitored at European level.

64

and early 2000s (Buti, 2006). However, the reform 
was  essentially  triggered  by  the  difficult  debate
between  EU  institutions  and  Member  States  that 
ensued  from  the  November  2003  decision  by  the 
Council 
the  Commission 
follow 
recommendations concerning  the excessive deficit 
procedures for France and Germany. 

not 

to 

linked 

all 
In 

problems, 

The  reform  that  followed  in  2005  was  a  positive 
step forward, as it enhanced the economic rationale 
of  the  SGP.  It  introduced  provisions  on  how  to 
deal  with  special  circumstances  and  country-
above 
specific 
to 
macroeconomic 
particular, 
downturns. 
following the 2005 reform, the adjustment required 
to  correct  the  excessive  deficit  was  formulated  in 
structural  terms to  allow  the  automatic  stabilisers
to  operate  freely around  the  fiscal  consolidation 
path,  unless  there  are  specific  risks  to  financial 
remains  particularly 
stability.  This  provision 
relevant in the current economic situation (Chapter 
II.2  includes  an  explanation  of  how  effective 
action to correct an excessive deficit is assessed). 

prepared 

However,  several  problematic  aspects  of  the  SGP 
that  had  already  been  identified  at  that  time  were 
not effectively addressed by that reform, including 
the definition  of  the  satisfactory  pace  of  debt 
reduction,  the  poor  enforcement  mechanisms  and 
too  optimistic  macroeconomic  and 
the  often 
budgetary 
national 
forecasts 
authorities.  The  experience  of  the  2005  reform  
brought  forward  the  importance  of  seizing  the 
window  of  opportunity  given  by  the  call  for 
reforms  in  bad  economic  times  to  also  address 
imprudent fiscal policies in good times. Changes to 
budgetary  frameworks  should  not  just  focus  on 
contingent  situations 
to  be 
exceptional,  but  should  carefully  consider  the 
incentives inherent in the emerging framework for 
the medium and longer term. 

that  are 

likely 

by 

While  a  number  of  weaknesses  had  already  been 
identified before the start of the current economic 
in  2008  (see  European 
and  financial  crisis 
Commission,  2008b),  the  momentum  for  reforms 
to  the  EU  governance  framework  only  really 
gained  pace  when  the  possibility  of  the  illiquidity 
or  insolvency  of  both  EU  and  euro  area  Member 
States  arose  for  the first  time  since  the  launch  of 
the euro.

The  impact  of  financial  crises  on  the  public 
finances  is  typically  very  large  and  long  lasting 
(see  the  analysis  of  the  fiscal  cost  of  financial 
crises  in  European  Commission,  2009a).  The 
consequences of a crisis are, however, even worse 
in countries where they come on top of underlying 
public 
in  some 
instances, are revealed by the crisis itself. This has 
been the case for a number of EU Member States. 

fragilities,  which, 

finances 

Lack  of  room  for  budgetary  manoeuvre  with  the 
onset  of  the  crisis  and  the  subsequent  risks  to 
financial  stability  spurred  acknowledgement  that 
the  SGP  had  not  provided  sufficient  incentive  to 
pursue prudent fiscal policies in good times. Also, 
the  SGP's  effectiveness  in  correcting  government 
deficits below 3% of GDP was not enough to curb 
government 
unsustainable 
expenditure 
(European 
Commission, 2010a).

developments 
and 

of 
ratios 

debt 

On  12  May (33)  and  30  June  2010 (34),  the 
Commission issued two communications outlining 
that  were 
a  comprehensive  set  of  measures 
economic 
reinforce 
to 
considered 
governance in  the  EU,  drawing  on  the  lessons  of 
the  first  ten  years  of  EMU. (35)  Since  then,  a 
number of initiatives have followed.

urgent 

A  first  package  of  legislative  proposals  reforming 
economic  governance  – the  so-called  Six  Pack  –
was  presented  by 
the  Commission  on  29 
September  2010.  This  package  is  addressed  to  all 
Member States although certain aspects of it apply 
only  to  the  euro  area.  Thanks  to  changes  in 
legislative  procedures  introduced  by  the  Lisbon 
Treaty  (36),  the  European  Parliament  was,  for  the 
first time, deeply involved in the design of the EU 
fiscal  framework.  Rapid  but  intense  negotiations 

(33) COM(2010) 

final
http://ec.europa.eu/economy_finance/articles/euro/docume
nts/2010-05-12-com(2010)250_final.pdf

250 

(34) COM(2010) 

367/2 

http://ec.europa.eu/economy_finance/articles/euro/docume
nts/com_2010_367_en.pdf 

to 

(36) According 

(35) The  Report  EMU@10  (European  Commission,  2008b)
taking stock of the experience of the first ten years of EMU 
had already highlighted some of the challenges ahead. 
the  Lisbon  Treaty, 

legislation  on  the 
coordination of economic policy has to be adopted by both 
through  ordinary 
European  Parliament  and  Council, 
legislative  procedure.  A  special  legislative  procedure 
envisaging  only  Council  adoption  remains  for  legislation 
that concerns  the  Excessive  Deficit  Procedure  (EDP)  and 
the related EDP protocol. 

Evolving budgetary surveillance

Part II

the 

legislation 

the  same 

texts  agreed  by 

between the European Parliament and the Council 
led  to  the  adoption  of  all  six  proposed  pieces  of 
legislation at the first reading. Parliament gave its 
position  in  September  2011  and  the  Council 
in  November, 
decided  on 
confirming 
the 
Parliament. While the legislative process entailed a 
number  of  changes with  respect  to  the  proposals
presented  by  the  Commission,  in  particular  with 
regard  to  the  formulation  of  the  principle  of 
prudent  fiscal  policy  making,  the  thrust  of the 
Commission's proposals was broadly retained. The 
legislation  entered  into  force  on  13  December 
2011. 

surveillance. 

These  six  pieces  of  legislations  include  a  major 
reform of the SGP, but also new legislation, with a 
the  boundaries  of  EU 
wider  scope.  First, 
to 
surveillance  have  been  extended 
include 
Previously, 
macroeconomic 
the 
macroeconomic  surveillance  came  under 
recommendations  stemming 
the  Broad 
Economic  Policy  Guidelines  – the  Six  Pact 
sharpens 
the  definition  of  macroeconomic 
surveillance  and  adds  enforcement  mechanisms. 
Second, the legislation revamps fiscal frameworks 
not only at EU level, but also at national level.

from 

regulation  on 

the  prevention  and 
The new 
correction  of  macroeconomic  imbalances also  has 
important 
to  fiscal 
implications  with  regard 
surveillance.  ( 37)  It  addresses  cases  like  those  of 
Ireland  and  Spain,  where  government  deficit  and 
debt figures were not a source of concern ahead of 
the  crisis.  In  these  Member  States,  government 
deficits and debt, however, increased suddenly and
dramatically  once  the  crisis  hit,  as  a  result  of  the 
unravelling of imbalances that were not essentially 
of  a  fiscal  nature,  although  they  contributed  to 
mask  unsustainable  expenditure  trends.  The  new 
regulation  aims  to  ensure  the  timely  assessment 
and correction of risks as they emerge. 

the  need 

The  new  directive  on  national  budgetary 
frameworks  addresses 
to  ensure
consistency  between  national  fiscal  governance 
and the EU budgetary discipline provisions. It also 
promotes  stronger  frameworks  to  support  national 
economic  policy-making  in  those  Member  States 

(37) Regulation  (EU)  1176/2011  of  the  European  Parliament 
and of the Council of 16 November 2011 on the prevention 
and correction of macroeconomic imbalances.

65

European Commission

Public finances in EMU - 2012

that  have  still  to  make  progress  in  this  respect.  In 
line  with  subsidiarity  concerns  and  a  history  of 
very  different  budgetary 
frameworks  across 
Member  States,  the  directive  sets  only  minimum 
requirements.  However,  with  a  view  to  exceeding 
these  minimum  requirements,  best  practice  is 
discussed  between  Member  States  through  a  peer 
review process. The directive and the peer review 
process are presented in Chapter II.3.

excessive  deficit repeatedly.  Unlike  the  sanctions 
foreseen  by  the  Treaty,  enforcement  mechanisms 
the  new  regulation  are  deemed 
foreseen  by 
the  basis  of  a  Commission 
on 
adopted,
recommendation,  unless  a  majority  of  euro  area 
Member  States 
this 
recommendation (the so-called "reversed qualified 
majority").   

the  Council 

rejects 

in 

The  reformed  SGP  is  presented  in  Chapter  II.2. 
The reform included two regulations amending the 
existing  legislation  on:  (i)    the  preventive  arm  of 
the  SGP (38)  – the  part  of  the  SGP  which  aims  to 
ensure  that  Member  States  are  at  their  Medium-
Term  budgetary  Objective  (MTO)  – and  (ii)  the 
corrective arm of the SGP – the Excessive Deficit 
(EDP). (39)  The  main 
revisions 
Procedure 
concerned  the  introduction  of  benchmarks  for 
revenue 
expenditure 
discretionary 
the 
in 
measures)  and  debt  developments, 
preventive  and  corrective  arm, 
respectively. 
Further  provisions  have  also  been  added,  in 
particular  as  regards  severe  economic  downturns 
for the EU or the euro area as a whole, as well as 
for  the  launch  of  EDPs  for  Member  States  with 
government  debt-to-GDP  ratios  below  60%  of 
GDP. 

(net 

of 

The pieces of legislation mentioned above apply to 
all Member States. ( 40) The only specific euro area 
aspect  of  the  legislation  on  economic  governance 
that  entered  into  force  in  December  2011  are  the 
two  regulations  on  enforcement  mechanisms  (one 
regulation related to the SGP and one regulation on 
macroeconomic imbalances) which do not concern 
Member States outside the euro area. In particular, 
the regulation on enforcement mechanisms for the 
SGP  envisages  a  gradual  system  of  financial 
sanctions  for  euro  area  Member  States  that  can 
already be invoked in the preventive arm – this is 
well  before  the  sanctions  envisaged  by  the  Treaty 
(Article  126)  in  the  case  where  a  euro  area 
Member 
comply  with 
recommendations  by  the  Council  to  correct  its 

State 

does 

not 

A distinction between provisions for euro area and 
non-euro  area  Member  States  is  warranted  by  the 
different  implications  of  fiscal  misbehaviour  by 
euro  area  or  non-euro  area  countries  on  other 
Member States. As demonstrated by the sovereign 
debt crisis – and in particular by the need to put in 
place  common  financial  backstops  – spillovers 
from  fiscal  policies  are  high within  a  currency 
union.  More  integrated  economic  and  financial 
systems  mean  that  other countries  bear  a  higher 
share  of  the  cost  of  one  country's  profligacy  than 
would  otherwise  be  the  case.  The  increased 
awareness  of  the  cost  of  not  preventing  these 
negative  spillovers  has  led  the  Commission  to 
present two further legislative proposals, known as 
the Two Pack,  for regulations specific to the euro 
area on 23 November 2011. On the same day, the 
Commission  also  presented  a  Green  Paper  on  the 
feasibility  of  common  euro  area  debt  issuance, in
particular  on Stability  Bonds that could  over  the 
medium 
the 
institutional setup of EMU (see Box II.4.1). One of 
the 
the 
aforementioned  financial  backstops.  It  seeks  to 
strengthen 
budgetary 
economic 
surveillance  of  Member  States  experiencing  or 
threatened  with  severe  difficulties  with  regard to 
their  financial  stability or  receiving  a  financial 
assistance on a precautionary basis. (41) 

legislative  proposal 

term  contribute 

to  completing 

linked 

and 

the 

to 

is 

The  other 
legislative  proposal,  on  enhanced 
budgetary  monitoring,  is  more  directly  linked  to 
the SGP and will complement existing texts, when 
adopted. (42) It aims to reinforce the coordination, 
surveillance  and  discipline  of  euro  area  Member 

(38) Council  regulation  (EC)  1466/97  of  7  July  1997  on  the 
strengthening  of  the  surveillance  of  budgetary  positions 
and the surveillance and coordination of economic policies.
(39) Council  Regulation  (EC)  1467/97  of  7  July  1997  on 
speeding  up  and  clarifying  the  implementation  of  the 
excessive deficit procedure.

(40) Only  provisions  on  national  numerical  fiscal  rules  do  not 
apply to the UK, in view of its specific Protocol annexed to 
the Treaties. 

(41) Proposal for a Regulation of the European Parliament and 
of  the  Council  on  the strengthening  of  economic  and 
budgetary  surveillance  of  Member  States  experiencing  or 
threatened  with  serious  difficulties  with  respect  to  their 
financial stability in the euro area (COM/2011/0819 final).
(42) Proposal for a Regulation of the European Parliament and 
of  the  Council  on  common  provisions  for  monitoring  and 
assessing draft budgetary plans and ensuring the correction 
of excessive deficit of the Member States in the euro area 
(COM/2011/0821 final).

66

States'  public  finances.  It sets  common  budgetary 
rules  and  a  timeline  for all  euro  area  Member 
States.  Above  all,  it  envisages an assessment  of 
governments'  draft budgetary  plans  each  autumn 
by  the  Commission,  so  as  to  feed  into  national 
Parliaments'  examination  of  the  draft  budget. 
Stricter provisions should apply to Member States 
the  proposed  regulation
in  EDP,  for  which 
envisages a closer monitoring.

On  21  February  2012, 
the  Council  reached 
agreement  on  a  general  approach  to  the  proposed 
Regulation  for  negotiations  with  Parliament.  The 
European  Parliament's  negotiation  position  was 
adopted in plenary meeting on 13 June 2012. 

At  the  date  of  publication  of  this  report,  the 
negotiations  between  the  co-legislators  have  just 
started.  Accordingly,  Chapter  II.4  presents  the 
Commission  proposals  of  23  November  2011.
These  Commission  proposals  were  followed  by 
another  important  initiative  aimed  at  enhancing 
economic governance, including fiscal surveillance 
and budgetary frameworks. On 9 December 2011, 
the  Heads  of  State  and  Government  of  the  euro 
area  as  well  as  almost  all  non-euro  area  Member 
States  put  forward  proposed  changes to  economic 
governance  of  the  euro  area  by  way  of  a  'fiscal 
rules, 
compact'  based  on  stricter  budgetary 
completed by closer economic policy coordination, 
and a strengthening of stabilisation instruments. 

On  30  January  2012,  the  Heads  of  State  and 
Government  of  25  Member  States  (the  only  non-
signatories  were  the  United  Kingdom  and  the 
Czech  Republic)  agreed  on  the  draft  of  an 
intergovernmental 
Stability, 
Treaty 
Coordination and Governance in the Economic and 
Monetary Union (TSCG),  which they signed on 2
March  2012.  The  content  of  the  TSCG,  including 
provisions  going  beyond  the  fiscal  compact,  is 
described in Chapter II.5.

on 

Participating  Member  States  essentially  undertake 
intensified  commitments  through  the  TSCG,  in 
particular to reflect the SGP rules in their national 
legislation.  The  Article  on  the  fiscal  compact 
contains a provision to enshrine a balanced budget 
rule  at  national  level  through  binding,  permanent 
and  preferably  constitutional  provisions.  The 
TSCG explicitly refers to the respect of the MTOs
of  the  SGP.  The  rule  should  also  contain  an 
automatic  correction  mechanism  that  shall  be 

Evolving budgetary surveillance

Part II

triggered in the event of significant deviation from 
the MTO or the adjustment path towards it, and be 
monitored  at  the  national  level  by  independent 
institutions.

principles  concerning 

The  TSCG  tasks  the  Commission  to  propose:  (i) 
common
the  national 
automatic correction mechanisms and the role and 
independence  of  the  institutions  responsible  at 
national  level  for monitoring  compliance  with  the 
rules;  (ii)  a  time  frame  for  convergence  towards 
the country-specific MTOs. 

The  TSCG  will  enter
into  force  following 
ratification  by  at  least  twelve  euro  area  countries.
(43)  Along  with  the  transposition  into  national 
legislation  of  the  directive  on  national  budgetary 
frameworks,  to  be  completed  by  December  2013, 
the TSCG entail the adoption of important reforms 
of  national  fiscal  governance  in  many  Member 
States.

In  its  Communication  of  20  June  2012,  the 
Commission  has  already  put  forward  seven 
common  principles  for  designing  the  national 
correction  mechanisms.  The  principles  cover  the 
legal status of a national correction mechanism, its 
consistency  with  the  EU  framework,  activation, 
nature  of  the  correction  in  terms  of  size  and 
timeline,  operational  instruments,  escape  clauses, 
and  the  role  and  independence  of  monitoring 
institutions. (44)

(43) At  the  cut-off  date  of  this  document  Greece, Portugal, 
Slovenia  and  Latvia have deposited  their  instrument  of 
ratification of the TSCG.

(44) COM(2012) 342 final
http://eur-

lex.europa.eu/LexUriServ/LexUriServ.do?uri=COM:2012:
0342:FIN:EN:PDF

67

2.

THE 2011 REFORM OF THE STABILITY AND GROWTH PACT

2011 reform of the SGP 

As part of the EU response to the crisis, a reform 
of  the  European  common  fiscal  framework  – the 
Stability  and  Growth  Pact  (SGP) – entered  into 
force  on  13  December  2011.  The  new  framework 
has two main components:

Stronger  preventive  action  and  deeper  fiscal 
coordination: A new expenditure benchmark  will 
now be used alongside the change in the structural 
budget  balance ( 45) to  assess  adjustments  towards 
the  country  specific  medium-term  budgetary 
objective  (MTO).  Inadequate  action  to  correct 
significant  deviations 
the  appropriate 
adjustment  path  towards  the  MTO  can  lead  to  an 
interest-bearing deposit (of 0.2% of GDP as a rule) 
to be lodged by non-compliant euro area countries.

from 

Stronger corrective action through a reinforced 
SGP:  The 
launch  of  an  Excessive  Deficit 
Procedure (EDP) can now result from government 
debt  developments  as  well  as  from  government 
deficit. Member States with debt in excess of 60% 
of  GDP  should  reduce  it  in  line  with  a  numerical 
benchmark. Furthermore, regardless of whether an 
EDP  is  launched  on  the  basis  of  deficit  or  debt 
developments,  progressive  financial  sanctions  on 
euro area Member States kick in at an earlier stage 
of  the  EDP. In  cases  of  particularly  serious  non-
compliance,  including  those  evidenced  by  the 
existence  of  an  interest  bearing  deposit,  a non-
interest bearing deposit (of 0.2% of GDP as a rule) 
will be requested from a euro area country when it 
is placed in EDP. Failure by a euro area country to 
comply  with  a  Council  recommendation  under 
Article  126(7)  to  correct  its  excessive  deficit  will 
result  in  a  fine  (of  0.2%  of  GDP  as  a  rule).  The 
fine imposed can rise up to 0.5% of GDP per year 
in the case of non-compliance with a notice to take 
measures  for  the  deficit  reduction  in  accordance 
with Article 126(9).

2.1. 

THE REFORM OF THE PREVENTIVE ARM OF 
THE SGP 

The  provisions  of  the  preventive  arm  of  the  SGP 
should  provide  the  main  guidelines  for  budget 

(45) The structural balance is defined as the cyclically adjusted 

balance net of one-off and temporary measures

68

planning  and  execution  of  the  Member  States 
when  they  are  not  subject  to  the  more  stringent 
requirements  of an  EDP.  Countries  currently  in 
this  situation  are  Bulgaria,  Estonia,  Germany, 
Finland, Luxembourg and Sweden. The preventive 
arm  is  implemented  through  Council  Regulation 
(EC)  No  1466/97  of  7  July  1997  on 
the 
strengthening  of  the  surveillance  of  budgetary 
positions and the  surveillance and coordination of 
economic policies.

The expenditure benchmark

the 

towards 

the  MTO, 

financing  of 

judging  progress 

Under  the  preventive  arm  of  the  SGP,  Member 
States aim at a specific fiscal target – the so-called 
medium-term  budgetary  objective  (MTO)  – to 
ensure  the  sustainability  of  their  public  finances. 
The new rules define an "expenditure benchmark"
for 
to 
complement the assessment based on the structural 
balance.  The  aim  is  to  improve  the  planning  and 
the  Member  States  by 
the  fiscal  record  of 
guaranteeing 
expenditure 
revenues  of  an 
programmes  by  permanent 
equivalent  level.  This  should help  avoid  the 
repetition  of  mistakes  made  ahead  of  the  crisis, 
when  unsustainable  expenditure 
trends  were 
temporarily  funded  through  windfall  revenues  or 
additional  borrowing.  The  expenditure  benchmark 
does  not  constrain  governments  in  terms  of  their 
level  of  government  expenditure  – it  simply 
requires 
to  expenditure  are 
financed  through  additional  revenues.  The  actual 
size  of 
is  not 
constrained. 

that  all  changes 

to  GDP  ratio 

the  spending 

For Member States that have achieved their MTO, 
the expenditure benchmark is complied with when 
the annual growth of government expenditure, net 
of  discretionary  measures  taken  on  the  revenue 
side,  does not  exceed  a  reference  medium-term 
rate of potential GDP growth. 

the 

For Member States that have not yet reached their 
MTO, the expenditure benchmark is complied with
when 
annual  growth  of  government 
expenditure,  net  of  discretionary  measures  taken 
on the revenue side, does not exceed a rate below 
reference  medium-term  rate of  potential  GDP 
growth. 

Evolving budgetary surveillance

Part II

these 

The  government  expenditure  aggregate  to  be 
assessed  excludes  interest  expenditure,  since  it  is
to  a  large  extent  not  under  the  control  of  the
government,  and  non-discretionary  changes  in
unemployment benefit expenditure, so as to allow
for 
to  vary  counter-cyclically.  It  also
excludes  expenditure  on  EU  programmes  fully
matched  by  EU  fund  revenue  and  increases  in
revenue  mandated by  law.  Due  to  the  potentially
very high  variability  of  investment  expenditure,
especially in the case of small Member States, the
government  expenditure  aggregate 
to  be
adjusted by averaging investment expenditure over
4 years.

is 

The notion of “significant deviation” and the 
enforcement provisions

In  the  preventive  arm,  the  enhanced Stability  and
Growth  Pact  allows  a  stronger  action  in  the  event
of “significant deviation” of a Member State from 
the MTO or from the appropriate adjustment path
towards it.

To  enforce  this  rule,  the  concept  of “significant
deviation” has  been  defined  in  the  amended
Regulation  1466/97  and  has been  detailed  in  the
Code  of  Conduct. (47) The identification  of  a
the
significant  deviation  from 
appropriate  adjustment  path  towards  it  is  to  be
based  on  outcomes  (i.e.,  ex-post data) as  opposed
to  plans.  In  substance, 
the
'significant deviation' consists of an assessment of
both  the  deviation  of  the  structural  balance  from
the appropriate adjustment path towards the MTO

the  analysis  of 

the  MTO  or 

(47) Specifications  on  the  implementation  of  the  Stability  and
Growth  Pact  and  guidelines  on  the  format  and  content  of
Stability and Convergence Programmes:

http://ec.europa.eu/economy_finance/economic_governanc
e/sgp/pdf/coc/code_of_conduct_en.pdf

in  order 

to  ensure 

The  difference  between the  reference  rate  and  the 
rate  below  the  reference rate – referred  to  as  "the 
convergence  margin"
is  country-specific, 
–
depending  on the  size of government spending  in 
the  economy ( 46), 
that
complying with  this  lower  rate yields  an  annual
improvement of the government balance. Applying 
a  lower  reference  rate  for Member  States not  at
their  MTO means  letting  revenues grow more 
this  should help 
rapidly 
the
than  spending:
the  required  structural
Member  State  to meet
adjustment  of  0.5pp  of  GDP. Table 
II.2.1
summarises  the  different  requirements  and  their
effects for  Member  States  both  at  and not yet  at
their MTOs.

the 

projections 
taking 

and 
into  account 

The reference medium-term rate of potential GDP
growth is based  on  regularly updated  forward-
backward-looking 
looking 
estimates, 
relevant
calculation method  provided  by  the  Economic
Policy  Committee (EPC).  The  reference  medium-
term  rate  of  potential  GDP  growth will  be  the
average  of  the  estimates  of  the  previous  5 years, 
the
the  estimate 
projections for the following 4 years. The aim is to
have  a measure  which  is  sufficiently  stable  over
time  to  provide  a  reference,  but  is  also  regularly
updated so as to avoid that the reference provided
to guide policy is out of touch with the economic
situation.

the  current year  and 

for 

(46) The convergence margin is set so that the lower increase in
net  expenditure  relative  to GDP  is  consistent  with  a
tightening  of  the  budget  balance  of 0.5pp  of GDP, when 
GDP  grows  at  its  potential  rate. It  is  calculated based  on
the  assumption  that  any  decrease  in  the  share  of  public
expenditure  in  the  economy  (which  would  occur
if
expenditure  grows  slower  than  potential GDP) would  be
translated into an exactly proportional improvement of the
structural  balance  (the  coefficient  being  equal  to  the  base 
value of the share of public expenditure in GDP times the
convergence margin of expenditure growth).

Table II.2.1:

Expenditure benchmark in relation to MTO achievement

Member State at its MTO

Net expenditure growth in line with the reference rate

% government expenditure in GDP constant

Member State not at its MTO
Net expenditure growth in line with a rate below the
reference rate
% government expenditure in GDP decreases

Structural balance constant over time

Structural balance strengthens

Remains at MTO

Source: Commission services.

Gap with the MTO closes over time

69

European Commission

Public finances in EMU - 2012

and  of  the  impact  of  an  excess  of  expenditure 
growth over the expenditure benchmark. 

For a Member State that has not reached the MTO, 
the deviation will be considered significant if both: 
(i) the deviation of the structural balance from the 
appropriate adjustment path corresponds to at least 
0.5% of GDP in one single year or at least 0.25% 
of  GDP  on  average  per  year  in  two  consecutive 
years  ;  and  (ii)  an  excess  of  expenditure  growth 
has  had  a  negative  impact  on  the  government 
balance  of  at  least  or  0.5%  of  GDP  in  one  single 
year or cumulatively over two  years. In case only 
one  of  the  two  conditions  above  is  verified,  the 
deviation  will  be  considered  significant  if the 
overall 
limited 
also 
compliance with respect to the other condition. 

assessment 

evidences

In  the  event  of  a  significant  observed  deviation  a 
warning  under  Article  121(4)  is  issued  by  the 
Commission.  Within  one  month  from  the  date  of 
adoption of this warning, the Council will examine 
the  situation  and,  on  the  basis  of  a  Commission 
recommendation,  adopt  a  recommendation  under 
Article  121(4)  for  the  necessary  policy  measures 
within  the  established  deadline,  normally  of  five 
months. (48) The  recommendation  under  Article 
121(4)  is  adopted  by  the  Council  by  qualified 
majority. 

The  Member  State  concerned  has  to  report  to  the 
Council  on  action  taken  in  response  to  the 
recommendation  within  the  deadline  established 
by  the  Council.  If the  Member  State  fails  to  take 
appropriate  action  in  response  to  the  Council 
recommendation
the 
Commission  recommends  immediately  to  adopt  a 
decision  establishing  that  no  effective  action  has 
been  taken. This  decision  is  also  adopted  by  the 
Council  by  qualified  majority.  At  the  same  time, 
the Commission may recommend to the Council to 
adopt  a  revised  recommendation  under  Article 
121(4) on necessary policy measures.

under  Article  121(4), 

However, if the Council does not take the decision 
that no effective action has been taken and failure 
to comply with the recommendation under Article 
121(4) persists, after one  month  from  its previous 
recommendation,  the  Commission  adopts  a  new 

(48) The deadline is reduced to three months if the Commission, 
in  its  warning,  considered  the  situation  to  be  particularly 
serious and warranting urgent action. 

70

recommendation to the  Council to take a decision 
that  no  effective  action  has  been  taken.  In  this 
case,  the  decision  is  adopted  by  the  Council  by 
“reversed  simple  majority”.(49) At the  same  time 
the Commission may recommend to the Council to 
adopt  a  revised  recommendation  under  Article 
121(4) on necessary policy measures.

In the case of euro area Member States, a financial 
sanction  (an  interest-bearing  deposit  of  0.2%  of 
GDP  as  a  rule)  may  be  imposed  if  the  Council 
decides  that  no  action  has  been  taken  to  address 
the Council recommendation under Article 121(4). 
This sanction is recommended by the Commission 
and  adopted  by  the  Council  according  to  the 
“reversed qualified majority” vote. (50)

In order to deal with exceptional circumstances, an 
escape clause has been inserted. This foresees that 
the  deviation  may  be  left  out  of  consideration 
when  it  results  from  an  unusual  event  outside  of 
the  control  of  the  Member  State  concerned  which 
has a major impact on the financial position of the 
general government or in case of severe economic 
downturn  for the euro area or the EU as a  whole, 
provided 
this  does  not  endanger  fiscal 
sustainability in the medium-term.

that 

The operational entry into force

The  new  provisions  of  the  preventive  arm  are 
immediately  operational,  in  particular  with  regard 
to  the  content  of  the  Stability  or  Convergence 
Programmes (SCP). If a Member State submits an 
SCP  which  presents  plans  that  do  not  comply  ex-
ante with the provisions of the preventive arm, the 
Council should invite the Member State to submit 
a new programme. 

Programmes  of  Member  States  which  are  still 
subject  to  an  EDP  need  to  demonstrate  that  they 
meet  the  obligations  deriving  from  the  preventive 
arm after correcting their excessive deficit.

(49) This  means  that  the  Commission’s  recommendation  is 
adopted  unless  a  simple  majority  within  the  Council 
decides  to  reject  it,  within  ten  days  or  its  adoption  by  the 
Commission.

(50) This  means  that  the  Commission’s  recommendation  is 
adopted  unless  a  qualified  majority  within  the  Council 
decides to reject it.

Evolving budgetary surveillance

Part II

Graph II.2.1:

Legal steps under the preventive arm of the SGP as of 13 December 2011

Member States concerned:  Member States not already bound by the more stringent requirements of the corrective arm.
For all Council decisions: no account of the vote of the MS concerned.
Qualified majority voting (QMV) rules (Lisbon Treaty): 55% of MS participating in the decisions (i.e., in the context of the SGP, 16 countries if EA, 
26 otherwise, as the concerned country does not vote), comprising at least 65% of population of these States. 
Until the end of the Lisbon Treaty transitional period (as defined by the Protocol 36 to the Treaty): 2/3 of EA MS (excepted concerned country), with 
weights computed according to that Protocol, are needed to reach a QM.
Reversed voting rules (RQMV/RSMV): the qualified/simple majority rules need to be fulfilled to reject the Council decision.
Source: Commission services.

71

European Commission

Public finances in EMU - 2012

While the ex-ante compliance with the expenditure 
benchmark in the SCPs has already been examined 
in  Spring  2012  (see  Section  I.3),  the  ex-post
compliance  with  the  expenditure  benchmark  and 
possible existence of a significant deviation will be 
evaluated for  the  first  time  in  Spring  2013,  when 
the  outturn  of  2012  budget  formulated  under  the 
new rules will be assessed.

three  years  period  encompassing  the  two  years 
following  the  final  year  for  which  the  data  is 
available."

The compliance with the debt criterion will then be 
checked  in  three  steps  and  an  excessive  deficit 
procedure could be launched when:

• First  step:  the  government  debt  ratio  is  above 

the reference value of 60% of GDP 

2.2. 

THE REFORM OF THE CORRECTIVE ARM OF 
THE SGP 

and 

in 

The  corrective  arm  of  the  Stability  and  Growth 
Pact  (SGP)  is  concerned  with  the  procedure  to be 
followed if a country's public finances fall outside 
the  requirements  of  the  Treaty.  It  is  based  on 
Article  126  of  the  Treaty  which  specifies  that 
Member  States  shall  avoid  excessive  government 
deficits.  It  defines  the  criteria  according  to  which 
compliance  with  budgetary  discipline  should  be 
examined 
the  general 
terms  of  whether 
government  deficit  exceeds  3%  of  GDP  or  the 
debt-to-GDP  ratio  exceeds  60%  and 
is  not 
sufficiently  diminishing  towards  this  reference 
ratio.  Hence,  an  Excessive  Deficit  Procedure 
(EDP) can be launched not only on the basis of the 
deficit  criterion  but  also  on  the  basis  of  the  debt 
criterion.  The  corrective  arm  is  implemented 
through Council Regulation (EC) No 1467/97 of 7 
July  1997  on  speeding  up  and  clarifying  the 
implementation of the EDP. 

The debt reduction benchmark

Following  the  amendments  to  the  corrective  arm 
that  entered  into  force  on  13  December  2011,
Member States with debt in excess of 60% of GDP 
should  reduce  their  debt  in  line  with  a  numerical 
benchmark. 

In  particular,  according  to  Article  2  (1a)  of 
Regulation  1467/97,  a  government  debt  ratio 
above  60%  of  GDP  should  be  considered  in 
compliance  with  the  debt  criterion  if  its  excess 
over  60%  "has  decreased  over  the  previous  three 
years at an average rate of one twentieth per  year 
as  a  benchmark,  based  on  changes  over  the  last 
three  years  for  which  the  data  is  available.  The 
requirement under the debt criterion should also be 
considered  fulfilled  if  the  budgetary  forecasts  of 
the  Commission 
required
indicates 
reduction  in  the  differential  will  occur  over  the 

that 

the 

• Second step: 

bt > bbt = 60% + 0.95/3 (bt-1 - 60%) + 0.952/3 
(bt-2 - 60%) + 0.953/3 (bt-3 - 60%)

where 

bt stands for the debt-to-GDP ratio in year t; 

bbt stands for the backward-looking benchmark 
debt ratio in year t; 

and

• Third step:

•

(a)  bt+2  >  bbt+2 =  60%  +  0.95/3  (bt+1  - 60%)  + 
0.952/3 (bt - 60%) + 0.953/3 (bt-1 - 60%)

where

bbt+2 stands for the forward-looking benchmark 
debt ratio;

bt+1  and  bt+2  stand  for  the  debt  forecast  in  year 
t+1  and  t+2  as  estimated  by  the  Commission 
under the 'no-policy-change' assumption on the 
basis  of  the  fiscal  outcome  of  year  t;and,  in 
parallel 

•

(b)  the  breach  of  the  benchmark  cannot  be 
attributed to the influence of the cycle.

The  proposed  formula  for  the  benchmark  debt 
level  and  the  long  time  horizon  over  which  it  is 
computed is meant to avoid the pitfalls of a simple 
benchmark  requiring  a  1/20th annual  reduction  of 
the  excess  of  the  debt  ratio  over  60%  of  GDP, 

72

Evolving budgetary surveillance

Part II

specifically the volatility of the benchmark and its 
vulnerability to manipulation. (51)

has been enlarged by the amendments to regulation 
1467/97. (52)

Graph  II.2.2 illustrates  the  procedure  for  judging 
whether  a  country's  debt 
in 
compliance with the debt benchmark.

trajectory 

is 

to  excessive  deficit 
Member  States  subject 
procedures opened before the adoption of the debt 
reduction  benchmark  have 
to  comply  with 
recommendations  and  notices  focussing  only  on 
the  only  requirement  to  bring  their  deficit  below 
3% of GDP in a durable manner. 

introduced.  Compliance  with 

However,  a  deficit  of  3%  of  GDP  does  not, 
however,  ensure  that  debt-to-GDP  ratios  diminish 
sufficiently toward 60% of GDP. In fact, this was 
the reason why a debt-reduction benchmark had to 
be 
the  existing 
recommendation  to  correct  the  excessive  deficit
does not thus ensure that the debt benchmark will 
be  also  complied  with  in  the  year  following  the 
correction.  On  the  contrary,  lacking  a  sizeable 
additional correction, a breach would be likely. In 
order  to  avoid  having  to  launch  an  excessive 
deficit procedure on the basis of the debt criterion 
at the same time of the abrogation of the procedure 
three-year 
based  on 
the  deficit  criterion,  a 
In 
transitional  period  has  been  envisaged. 
particular,  as  specified  by  the  same  Article  2  (1a) 
of  Regulation  1467/97, "For  a  Member  State  that 
is  subject  to  an  excessive  deficit  procedure  on  8 
November  2011  and  for  a  period  of  three  years 
from  the  correction  of  the  excessive  deficit,  the 
requirement  under  the  debt  criterion  shall  be 
considered fulfilled if the Member State concerned 
makes  sufficient  progress  towards  compliance  as 
assessed in the opinion adopted by the Council on 
its stability or convergence programme."

Extension of the list of the other relevant factors 

Before establishing that an excessive deficit exists,
the  Commission  prepares  a  report  under  Article 
126(3) TFEU if a Member State does not fulfil the 
requirements  specified  under  either  the  deficit  or 
debt  criteria.  The  Commission  report  should  take 
into  account  the  other  relevant  factors  whose  list

(51) The  properties  of  the  formula  were  presented  in  last  year 

edition of the Report (European Commission, 2011).

However,  as  regards  relevant  factors,  the  deficit 
criterion and the debt criterion are not on an equal 
footing.  Before  establishing  that  an  excessive 
deficit exists on the basis of the debt criterion, the 
whole  range  of  relevant  factors  covered  by  the 
Commission  report  should  be  taken  into  account, 
which  is  not  always  the  case  for  the  launch  of 
excessive  deficit  procedures  based  on  the  deficit 
criterion.

(52) According  to  Article  2(3)  of  regulation  1467/97,  "The 

report shall reflect, as appropriate:

(a) the developments in the medium-term economic position, in 
the  various 
particular  potential  growth, 
contributions provided by labour, capital accumulation and 
total  factor  productivity,  cyclical  developments,  and  the 
private sector net savings position;

including 

(b) the developments in the medium-term budgetary positions, 
including,  in  particular,  the  record  of  adjustment  towards 
the  medium-term  budgetary  objective,  the  level  of  the 
primary balance and developments in primary expenditure, 
both current and capital, the implementation of policies in 
the  context  of  the  prevention  and  correction  of  excessive 
macroeconomic imbalances, the implementation of policies 
in the context of the common growth strategy of the Union, 
and the overall quality of public finances, in particular the 
effectiveness of national budgetary frameworks;

(c)  the  developments  in  the  medium-term  government  debt 
position,  its  dynamics  and  sustainability,  including,  in 
particular, risk factors including the maturity structure and 
currency  denomination  of  the  debt,  stock-flow  adjustment 
and  its  composition,  accumulated  reserves and  other 
financial assets, guarantees, in particular those linked to the 
financial  sector,  and  any  implicit  liabilities  related  to 
ageing and private debt, to the extent that it may represent 
a contingent implicit liability for the government.

The  Commission  shall  give  due  and  express  consideration  to 
any other factors which, in the opinion of the Member State 
concerned, are relevant in order to comprehensively assess 
compliance  with  deficit  and  debt  criteria  and  which  the 
Member  State  has  put  forward  to the  Council  and  the 
Commission. In that context, particular consideration shall 
be given to financial contributions to fostering international 
solidarity and achieving the policy goals of the Union, the 
debt  incurred  in  the  form  of  bilateral  and  multilateral 
support  between  Member  States 
the  context  of 
safeguarding  financial  stability,  and  the  debt  related  to 
financial  stabilisation  operations  during  major  financial 
disturbances."

in 

73

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Public finances in EMU - 2012

Graph II.2.2:

Steps preceding the preparation of a Report under Article 126(3) assessing a possible breach of the debt criterion

Source: Commission services.

In  particular,  with  regard  to  the  deficit  criterion, 
the  2011  reform  introduced  a  distinction  between 
Member  States  with  the  debt-to-GDP  ratio  above 
or  below  60%  of  GDP.  The  whole  range  of  other 
relevant factors has to the taken into account when 
evaluating the existence of an excessive deficit on 
the basis of the deficit criterion in Member States 
with  debt-to-GDP  ratios  below  60%  of  GDP. 
Moreover, where the excess of the deficit over 3% 
of  GDP  reflects  the  implementation  of  a  pension 
reform  introducing  a  multi-pillar  system  that 
includes  a  mandatory  fully  funded  pillar,  the 
Commission and the Council will also consider the 
net  cost  of  the  reform  to  the  publicly  managed 
pillar when assessing developments in EDP deficit 
figures  for  Member  States,  as  long  as  the  general 
government deficit does not significantly exceed a 
level  that  can  be  considered  close  to  3%  of  GDP 

and the a debt-to-GDP ratio remains below 60% of 
GDP, on condition that overall fiscal sustainability 
is maintained. (53)

However, if the Member State's debt ratio exceeds 
60%  of  GDP,  when  evaluating  compliance  with 
the deficit criterion, the relevant factors assessed in 
the  Commission  report  will  be  taken  into  account 
in the steps leading to the decision on the existence 
of  an  excessive  deficit  only 
the  general 
government  deficit  remains  close  to  the  reference 
value  and  its  excess  over  the  reference  value  is 
temporary (this  is  the  so-called  "double  condition 
of the overarching principle"). 

if 

(53) The net cost of the pension reform is measured as its direct 
impact  on  the  general  government  deficit  (as  defined  in 
Article 1 of Regulation 479/2009).

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Evolving budgetary surveillance

Part II

Box II.2.1: The transition period

In  order  to  assess  the  debt  path  during  the  transition  period,  a  definition  of  "sufficient 
progress towards compliance" is necessary. It is defined as the minimum linear structural 
adjustment ensuring that – if followed – Member States will comply with the debt rule by
the end of the transition period. This minimum linear structural adjustment path will be 
built taking into account both the influence of the cycle and the forward-looking nature of 
the  debt  benchmark.  Also,  in  order  to  ensure  continuous  and  realistic  progress  towards 
compliance  during  the  transition  period,  Member  States  should  simultaneously  respect 
the following two conditions:

− First,  the  annual  structural  adjustment  should  not  deviate  by  more  than  ¼%  of 
GDP from the minimum linear structural adjustment ensuring that the debt rule is 
met by the end of the transitional period;

− Second, at any time during the transition period, the remaining annual structural 

adjustment should not exceed ¾ % of GDP.

This  should  ensure  that  the  path  of  deficit  reduction  chosen  by  the  Member  State  is 
sustained  over  the  three  years  of  the  transitional  period  (first  condition)  and  realistic 
(second  condition),  while  allowing  some  room  for  manoeuvre  during  the  transition 
period. 

A  negative  assessment  of  the  progress  made  towards  compliance  with  the  debt 
benchmark during the transition period should lead to the preparation of a report of the 
Commission, based on Article 126(3).

Enforcement provisions 

Beyond improvement of the  corrective arm of the 
SGP,  a  new  Regulation  on  the  enforcement  of 
budgetary  surveillance  in  the  euro  area  also 
entered  into  force  on  13  December  2011.  This 
Regulation  sets  progressive  financial  sanctions 
which  kick  in  at  an  earlier  stage  of  the  EDP  than 
was  previously  the  case. A non-interest  bearing 
deposit of 0.2% of GDP may be requested from a 
euro area country already when it is placed in EDP 
(either  on  the  basis  of  its  government  deficit  or 
debt).  Failure  of  a  euro  area  country  to  comply 
with  recommendations  for  corrective  action  will 
result in a fine.

Assessment  of  effective  action:  which 
implications? 

The  2005  reform  of  the  SGP  introduced  rules  to 
in  spite  of  an
take  into  account  the  fact  that,

occurs  with  major 

adequate  response  to  the  recommendations,  the 
deadline  for  correction  might  not  be  achieved 
because  of  unexpected  unfavourable  economic 
developments. In  case  an  unexpected  economic 
event 
unfavourable 
consequences  for  the  Member  State  concerned  by 
the  excessive  deficit  procedure,    the  possibility 
extending  the  deadline  for  correction  without 
stepping up the procedure is, however, considered 
only  if  the  Member  State  has  taken  "effective 
action"  to  comply  with  the  recommendation  or 
notice addressed to it by the Council. 

The  2011  reform  of  the  SGP  did  not  change 
dramatically  the  provisions  on  assessment  of 
effective  action,  but  provided  some  important 
elements  of  clarity.  First,  the  recommendations 
issued after the entry into force of the amendments 
will include annual  nominal targets,  which  should 
be consistent  with a  minimum annual  fiscal effort 

75

European Commission

Public finances in EMU - 2012

in 

to 

taken 

of at least 0.5pp. of GDP as a benchmark. ( 54) This 
novelty just aims at transparency; it does not imply 
a repeal of the important changes introduced by the 
2005 reform to return to an obligation of delivering 
a  nominal  adjustment. Second,  Member  State 
under an EDP will have to prepare a report on the 
action 
the  Council’s 
response 
recommendation  under  Article  126(7)  or  a  notice 
under  Article 126(9). (55) The report shall include 
the 
for  government  expenditure  and 
revenue and for the discretionary measures on both 
the  expenditure  and  the  revenue  side  consistent 
with  the  Council’s  recommendation,  as  well  as 
information  on  the  measures  taken  and  the  nature 
of  those  envisaged  to  achieve  the  targets.  Reports 
of Member States subject to a notice under Article 
126(9)  should  also  include  the  information  on  the 
actions  being  taken  in  response  to  the  specific 
Council recommendations. ( 56)

targets 

not 

apply 

provisions 

to 
did 
These 
recommendations  that  were  issued  before  13 
December  2011,  which  is  the  case  for  almost  the 
totality  of  recommendations 
that  characterise 
ongoing EDPs. Their implementation will however 
not  entail  major  changes  to  the  methodology 
developed  to  assess  effective  action  for  existing 
EDPs, which is described below.

The initial assessment of effective action

The  Council 
recommendations  under  Article 
126(7)  establish  a  maximum  deadline  of  six 
months for effective action to be taken. The 2011 
reform  has  explicitly  envisaged 
that,  when 
warranted  by  the  seriousness  of  the  situation,  the 
deadline may be three months. (57)

The  Code  of  Conduct  of  the  SGP  specifies  the 
modalities  of  the  initial  assessment  of  effective 
action.  Following  the  expiry  of  the  deadline,  the 
Commission  assesses  whether  the  Member  State 
concerned  has  acted  in  compliance  with  the 
( 58) This  assessment  should 
recommendation.

(54) Articles 3(4) and 5(1) of Regulation 1467/97.
(55) Articles 4(2) and 6(1) of Regulations 1467/97.
(56) The reporting requirements of Member States in EDP will 
increase  with  the  entry  into  force  of  the  two-pack,  which 
foresees  bi-annual  and  quarterly  reporting  for  126(7) 
recommendations  and  126(9)  notice  respectively  (see 
Section II.4).

(57) Articles 3(4) of Regulation 1467/97.
(58) As indicated in the Code of Conduct, in the case of a notice 
under  Article  126(9),  the  initial  assessment  of  effective 

76

consider whether the Member State concerned has 
publicly  announced  or  taken  measures  that  seem 
sufficient to ensure adequate progress towards the 
correction  of  the  excessive  deficit  within  the  time 
limits set by the Council.

This is a preliminary assessment in most cases and 
in  cases  of  a  multi-annual 
particularly  so 
correction  framework.
In  the  specific  case  of 
recommendations  or  notices  which  have  set  a 
deadline for the correction of the excessive deficit 
more  than  one  year  after  its  identification,  the 
assessment  should  mainly  focus  on  the  measures 
taken  for  the  year  following  the  identification  of 
the excessive deficit.

The assessment of effective action when the 
procedure is held in abeyance 

If  the  Commission  considers  that  the  Member 
the 
State  has  acted 
recommendation  or  notice,  it  informs  the  Council 
accordingly and the procedure is held in abeyance. 

in  compliance  with 

After  the  first  and  only  systematic  assessment  of 
effective  action  required  by  the  SGP,  Member 
States'  compliance  with  the  recommendation  is 
subject to a continuous monitoring which does not 
embed fixed/defined occasions to take stock of the 
situation. 

According  to  the  Code  of  Conduct,  during  the 
period of abeyance the Commission should assess 
whether the  measures already announced or taken 
are  being  adequately  implemented  and  whether 
additional  measures 
and 
implemented in order to ensure adequate progress 
toward  the  correction  of  the  excessive  deficit 
within the time limits set by the Council.

announced 

are 

Lack of effective action: case for stepping up 
the EDP and imposing sanctions  

The Code of Conduct also specifies what should be 
done in  case  it  appears  that  the  Member  States 
concerned  has  not  acted  in  compliance  with  the 
recommendation or notice. Specifically, it requires 
the  following  step  of  the  EDP  procedure  to  be 
activated.

action takes place after the four month period following the 
notice.

that 

the  Commission  has 

This  means 
to 
recommend  to  the  Council  to  adopt a  decision 
under Article 126(8) in case the Member State was 
subject to a recommendation under Article 126(7). 
For  euro  area  Member  States,  the  decision  under 
Article  126(8)  is  followed  by a  notice  under 
Article 126(9). In case the Member State does not 
even comply with the notice, the Treaty envisages 
enforcement measures under Article 126(11).

2011 

reform 

The 
additional 
enforcement  mechanisms  of euro  area  Member 
States, all already entered into force. (59)

introduced 

is 

launched. 

In  particular, 

The imposition of a non-interest bearing deposit is 
now  possible  already  when  the  excessive  deficit 
the 
procedure 
Commission  will  recommend  to  the  Council  to 
require  a  non-interest  bearing  deposit:  (i)  in  case 
the  Member  State  was  already  subject  to  an 
interest-bearing  deposit  for  inadequate  action  to 
correct a significant deviation from the adjustment 
in  case  of 
path 
the  MTO;  or  (ii)
particularly  serious  non-compliance  with 
the 
obligations laid down in the SGP. 

towards 

is  now 

A Council  decision  on  non-effective  action  under 
Article  126(8)  addressed  to  a  euro  area  Member 
followed  by  a  Commission 
State 
recommendation  to  the  Council  to  impose  a fine 
corresponding  to  0.2%  of  GDP  as  a  rule.  In  the 
case  of  Cohesion  Fund  beneficiaries, 
the 
possibility  to  suspend  a  part  of  the  commitments 
under  the  Cohesion  Fund in  view  of  a  Council 
decision  126(8)  exists  both  for  euro  area  and  for 
non-euro area Member States. (60)

A  decision  under  Article  126(11)  includes,  as  a 
rule,  fines  up  to  0.5%  of  GDP  per  year  (a  fixed 
component  of  0.2%  of  GDP  plus  a  variable 
component linked to the size of the deficit). 

Evolving budgetary surveillance

Part II

The case for postponing the deadline

consequences 

for 
the  adoption  of 

According  to  Article  3(5)  of  Regulation  1467/97 
(and analogous Article 5(2) in case of notices): "If 
effective action has been taken in compliance with 
a recommendation under Article 126(7) TFEU and 
unexpected  adverse  economic  events  with  major 
unfavourable 
government 
that 
finances  occur  after 
recommendation,  the  Council  may  decide,  on  a 
recommendation from the Commission, to adopt a 
revised  recommendation  under  Article  126(7) 
TFEU.  The  revised  recommendation,  taking  into 
account  the  relevant  factors  referred  to  in  Article 
2(3)  of  this  Regulation  may,  in  particular,  extend 
the  deadline  for  the  correction of  the  excessive 
deficit  by  one  year  as  a  rule.  The  Council  shall 
the  existence  of  unexpected  adverse 
assess 
economic 
events  with  major  unfavourable 
consequences for government finances against the 
economic  forecasts  in  its  recommendation.  In  the 
case  of  a  severe  economic  downturn  in  the  euro 
area or in the Union as a whole, the Council may 
also  decide,  on  a  recommendation  from  the 
Commission,  to  adopt  a  revised  recommendation 
under Article 126(7) TFEU provided that this does 
not  endanger  fiscal  sustainability  in  the  medium 
term."

for 

consequences 

the  deadline 
events 

Therefore, the Regulation allows for the possibility 
of  postponing  the  deadline  for  correction  when  a 
Member State has taken effective action but cannot 
for  correction  because 
meet 
with  major 
occurred
unexpected 
unfavourable 
government 
finances.  While this provision  was already part of 
the  2011 
the  SGP  since 
the 
introduced 
postponement of the deadline not only on the basis 
of  unexpected  adverse  economic  events  for  the 
Member  State  concerned  but  also  in  case  of  a 
severe  economic  downturn  in  the  euro  area  as  a 
whole or in the Union as a whole, provided that the 
revision  does  not  endanger  fiscal  sustainability  in 
the  medium  term.  ( 61) In  this  latter  event,  the 
postponement is not conditional on action taken.

the  2005  reform, 
the  possibility  of  considering 

(59) Enforcement mechanisms for euro area Member States are 
included  both  in  Regulation  1173/11  on  the  effective 
enforcement of budgetary surveillance in the euro area and 
in  Regulation  1697/97  on  speeding  up  and  clarifying  the 
implementation of the excessive deficit procedure. 

.
(60) Council  Regulation  (EC)  No  1084/2006  of  11  July  2006, 
establishing  a  Cohesion  Fund  and  repealing  Regulation 
(EC) No 1164/94.

(61) Regulation  1467/97  does  not  provide  a  specific  definition 
of  severe  economic  downturn  for  the  Union  or  the  euro 
area  as  a  whole that  could  lead  to  a  postponement  of  the 
deadline  for  correction.  Only  indicatively,  a  reference  is 
provided by the provision specifying whether an excess of 
the  deficit  over  the  reference  value  resulting  from  an 
economic  downturn  could  be  considered  as  exceptional.  

77

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Public finances in EMU - 2012

Abrogation of the procedure in case of a 
durable correction 

Some  important  clarifications  on  conditions  for 
abrogating  the  excessive  deficit  procedure  have 
been included in the  latest version of the  Code of 
Conduct.  In  particular,  the  Code  of  Conduct 
foresees  that  a  decision  on  abrogation  should  be 
based  on  notified  (i.e.  observed)  data  and  that 
abrogation  should  only  occur  if  the  Commission 
services' forecast indicates that the deficit will not 
exceed  the  3%  of  GDP  reference  value  over  the 
forecast horizon. (62)

Irrespective of the structural effort implemented, a 
"durable correction" is deemed achieved if:

•

(i) 
the  notified  data  for  the  previous  year 
show  a  deficit  below  3%  of  GDP  or  a  deficit 
close to  3%  of  GDP 
that  has  declined 
substantially  and  continuously  and  where  the 
excess over the 3% threshold is fully explained 
by  the  net  cost  of  the  implementation  of  a 
multi-pillar  system  that  includes  a  mandatory, 
fully funded pillar; 

and

•

(ii) the Commission services' forecast indicates
that the deficit will not exceed the 3% of GDP 
reference  value  over  the  forecast  horizon  or 
where the excess over the 3% threshold is fully 
explained by the net cost of the implementation 
includes  a 
of  a  multi-pillar  system 
mandatory, fully funded pillar.

that 

If  the  deadline  has  expired  but  one  or  both  of  the 
above  conditions  are  not  respected,  the  procedure 
should be stepped up.

According  to  article  2(2),  this  would  be  the  case  "if  the 
excess  over  the  reference  value  results  from  a  negative 
annual  GDP  volume  growth  rate  or  from  an  accumulated 
loss of output during a protracted period of very low annual 
GDP volume growth relative to its potential". 

(62) Reflecting the operationalization of the debt criterion in the 
EDP allowed by the 2011 reform, the Code of Conduct also 
specifies  that  the  abrogation  requires  the  debt  ratio  to 
comply  with  the  forward-looking  element  of  the  debt 
benchmark. However, the envisaged transitional period for 
the  debt  benchmark  implies  that  this  provision  does  not 
apply for current EDPs. 

78

How to assess effective action?  

According  to  the  Code  of  Conduct,  a  Member 
State should be considered to have taken effective 
action  if  it  has  acted  in  compliance  with  the 
recommendation  or  notice,  regarding  both  the 
implementation  of  the  measures  required  therein 
and budgetary execution. The assessment should in 
particular  take  into  account  whether  the  Member 
State concerned has achieved the annual budgetary 
targets  initially  recommended  by  the  Council  (63) 
and  the  underlying  improvement  in  the  cyclically 
adjusted  balance  net  of  one  off  and  other 
temporary  measures.  In  case  the  observed  budget 
balance proves to be lower than recommended or if 
the improvement of the cyclically adjusted balance 
net  of  one  off  and  other  temporary  measures  falls 
significantly short of the adjustment underlying the 
target,  a  careful  analysis  of  the  reasons  for  the 
shortfall would be made. In particular, the analysis 
should  take  into  account  whether  expenditure 
targets  have  been  met  and 
the  planned 
discretionary  measures  on  the  revenue  side  have 
been implemented.

on  Regulation 

the 
Based 
specifications  provided  in  the  Code  of  Conduct, 
the  Commission  assessment  of  effective  action 
reflects the comparison of three different variables:

1467/97 

and 

• The recommended effort (R); 

• The  apparent  fiscal  effort  (S)  measured  by  the 
change  in  the  structural  balance  computed 
according 
agreed 
methodology;

commonly 

the 

to 

• The  "adjusted  structural  balance"  (S*),  where 

the adjustment takes into account: 

− the  impact  of  revisions  of  potential  output 
growth compared to that assumed at the time of 
the recommendations (α) (See Box II.2.2), 

− the  impact  of  the  composition  of  economic 
growth  or  of  other  windfalls/shortfalls on 
revenue (β), (See Box II.2.2),

− the  impact  of  other  unexpected  events  on  the 

general government balance (γ).  

(63) The  provision  on  the  annual  budgetary  targets  is  fully 
relevant  only  for  recommendations  and  notices  adopted 
after the entry into force of the 2011 reform.

The comparison of R with S*, to assess the extent 
the 
taken  with 
of 
the  effort 
recommended  one, 
a 
is 
comparison  of  S  and  S*,  which  provides  an 
approximation  of  unexpected  events  with  an 
impact on public finances.  

respect 
compounded  by 

to 

in 

For  current EDP  recommendations  entailing  a 
multi-annual  correction defined 
terms  of 
average  structural  effort,  the  comparison  should 
focus on the period since the start of the correction 
period  until  the  year  for  which  the  budget  should 
normally  already  have  been  adopted.  Admittedly, 
the  formulation  of  recommendations  in  terms  of 
average  structural  effort suggests  that  a  lower 
effort 
that 
recommended  should  be  taken  into account  as  an 
aggravating  factor  in  case  the  correction of  the 
deficit by  the deadline  is  at  risk  in  the  later  years 
even  if  due  to  a  deteriorated  macroeconomic 
scenario in those years.

initial  years  compared 

the 

to 

in 

How to interpret the results?

•

•

If the implemented effort, as measured both by 
S  and  S*,  is  in  line  with  that  recommended, 
then  the conclusion is that effective action  has 
been taken;

than 

indicates  a 

lower  effort 

If  S* 
that 
recommended  there  is  a  strong  presumption
that  no  effective  action  has  been  taken.  With 
requiring  an 
recommendation 
the  current 
annual  average  fiscal  effort,  consideration 
should be given to the existence of a margin for 
manoeuvre for reaching the deadline through a 
higher effort in the later years. This margin for 
manoeuvre  is  subject  to  some  constraints.  In 
particular,  it  should  be  such  that
the  effort 
postponed  to  later  years  remains realistic, 
especially  given 
less 
favourable  macroeconomic  scenario.  If  S  is 
below the recommended effort but S* indicates 
an  effort  in  line  with  that  recommended,  then 
there  is  evidence  that  some  economic  events 
impact  on public  finances  have 
with  an 
materialised.  However,  a  small difference 
would  mean 
unfavourable 
consequences  for  government  finances of  the
unexpected adverse economic events where not 
major.

the  possibility  of  a 

that 

the 

Evolving budgetary surveillance

Part II

How to proceed with the careful analysis? 

The Code of Conduct requires a careful analysis of 
why  the  fiscal  effort  fell  short  of  that  underlying 
the  recommended  targets.  In  particular,  since  the 
2011  reform  of  the  SGP,  the  Code  of  Conduct 
specifies that the careful analysis should take into 
account whether:

•

•

the expenditure plans have been achieved, 

the  discretionary  revenue  measures  planned 
have been implemented.

The composition of growth and its effect on the tax 
base have  already  been  taken  into  account  in  the 
computation of S* and in particular of β. However, 
a  more  detailed  analysis  should  be  carried  out, 
including  highlighting  possible 
for 
divergences between the fiscal effort measured by 
the  change  in  the  structural  balance  and  the 
budgetary  impact  of  the  measures  effectively 
implemented  by  the  Member  State  concerned,  i.e. 
divergences between the top-down and the bottom-
up approach. 

reasons 

When is extending the deadline permissible? 

In  the  case  of  effective  action  and  an  unexpected 
adverse  economic  event  with  major  unfavourable 
consequences 
the
for  government 
deadline  may  be  extended,  by  one  year  as  a  rule. 
However,  there  is  no  obligation  to  postpone  the 
include 
deadline.  Such  a  decision 
supplementary considerations on: 

finances, 

should 

•

•

•

•

the size of the gap to the 3% of GDP threshold, 

the macro-financial vulnerability,

the overall fiscal stance,

and any other relevant country-specific factors. 

A  large  amount  of  uncertainty  surrounding  the 
forecast might  also  require  caution  in  proceeding 
with  an  immediate  postponement  of  the  deadline. 
For  example,  this  could  be  the  case  if  such  a 
decision is to be considered in the early years of a 
multi-annual  correction.  In  case  of  non-effective 
action,  which 
the 
procedure, a decision to extend the deadline in the 
new  recommendation  or  the  notice  can  also  be 

implies  a  stepping  up  of 

79

European Commission

Public finances in EMU - 2012

Graph II.2.3:

The legal steps of the corrective arm of the SGP as of 13 December 2011

Definitions
Required fiscal effort = R
Change in the structural budget balance = S
Change in the adjusted structural budget balance = S*
S*=S-(α+ß+γ)
Effect of revision of potential output growth on S = α
Effect of revision of windfall/shortfall on S = ß
Other effects on S (e.g. natural disaster) = γ
Careful analysis: analysis of expenditure and revenue developments compared to national plans in line with recommendation, bottom-up approach.
Source: Commission services.

taken.  This  decision  should  essentially  rest  on  an 
assessment  of  the  plausibility  of  meeting  the  old 
deadline. If the size of the gap to the 3% of GDP is 
too  large,  then  an  extension  of  the  deadline  could 
be considered. 

•

•

and 

(2)  What  does  a  careful  analysis  reveal  about 
the  expenditure  and  revenue  developments 
compared to original plans in case of doubts? 

To  summarize, following  consideration  whether 
the  general  government  deficit  be  durably  below 
the  3%  of  GDP 
the 
recommended deadline, the assessment of effective 
action  should  address  the  following  sequence 
which is set out in the decision tree in Graph II.2.3: 

reference  value  by 

•

(1)  Has  the  recommended  fiscal  effort  been 
achieved  once 
all  possible  unexpected 
economic  events  with  major  consequences  for 
government finances are taken into account? 

As  mentioned  above,  the  application  of  this 
framework needs particular caution when effective 
action is assessed in response to recommendations 
envisaging  an average  structural  effort  to  be 
carried  over  a  multi-annual  correction period, 
given the existence of a margin for manoeuvre for 
delivering the required effort in future budgets.

80

Evolving budgetary surveillance

Part II

Graph II.2.4:

The legal steps of the corrective arm of the SGP as of 13 December 2011

Source: Commission services.

81

European Commission

Public finances in EMU - 2012

Box II.2.2: Computing the “adjusted fiscal effort”

1/ The impact of revisions of potential output growth

When comparing recommended and estimated changes in the structural budget balance at different moments
in time, differences can result from variations in the estimation of the potential output growth.

Specifically,  the  effect  of  revisions  of  potential  growth  surprises  on  the  change  in  the  structural  budget

balance between t-1 and t is computed as:

S
G
−
t
1
*
GDP
−
t
1






*

 ∆



GDP
t
*
GDP
−
t
1

rec


−


*

∆

GDP
t
*
GDP
−
t
1

, where 

G

S
−
nt
*
GDP
1−
t






is the expenditure 

to GDP ratio net of cyclical factors in year t-1 – that is the year in which the Council recommendation under

126.7 (or 126.9) TFEU was issued - and

rec

 ∆




*
GDP
t
*
GDP
−
1
t






−

∆

*
GDP
t
*
GDP
−
1
t

GDP in year t.

is the revision of the growth rate of potential

Most of  the  current  EDP  recommendations  formulate  adjustment  requirements  as  annual average
improvement. In this case the correction terms involves the revision of average potential growth rates over
the adjustment period.

2/ The revenue gap

The idea is to compute the windfall/shortfall on revenues as expected when the recommendation was issued 
and  to  compare  it  to the  actual windfall/shortfall  on  revenues. Formally,  the  “revenue  gap”  (RG)  can  be 
written as follows:

RG

t







t

−∆=
R
DM

actual

t

−

*
ε

GDP
t



 ∆



∆−
R








 windfall
 / 



−

1



GDP
t

shortfall

−
1

t

R

rec
t

−

DM

rec
t

−

*
ε


windfall


underlying

shortfall

 / 

rec


 ∆
GDP


t
−
1


GDP

−

t
1


recommenda
tion






 the

R

t

where 

*ε is  the  conventional overall  tax  elasticity  on  GDP  (usually  close  to  1), 

tDM the actual discretionary revenue measures in t relative to t-1 and
rec
tR

being the level of revenues in year t, 

tR is  the  actual  level  of
tGDP the actual
tDM the discretionary revenue measures in

revenues in year t, 

level of GDP in t (

rec

t relative  to t-1 and 

rec

tGDP

the  level  of GDP  in t,  as  forecast - under  the  unchanged  policy scenario  -

when the recommendation was issued). If this expression is negative, it means that the windfall (resp. the
shortfall)  turned out lower  (resp.  higher)  than  expected  when  the  recommendation  was  issued.  It  is  worth 
noting  that  the  accuracy  of  this  calculation  mainly  relies  on  the  accuracy  of  the  discretionary revenue
measures estimated by the ECFIN country-desks.

Finally, in order to compute the adjusted fiscal effort, the “revenue gap”, expressed at current prices, needs
to be converted into a ratio where the denominator takes the form of a nominal potential output. β then can
be written as follows:

β

=

GDP
t

*




GDP
t

and 

RG
t
nom

GDP
t

where 

*

tGDP stands for the potential output (at constant prices)

real

GDP
t





nom

real

GDP
t

is the ratio of GDP at current prices over the GDP at constant prices (this ratio being

precisely the price deflator of the GDP).

nom

GDP
t

GDP *
t









real

GDP
t

can then be seen as a nominal potential

output.

82

3.

NATIONAL BUDGETARY FRAMEWORKS: MINIMUM 

REQUIREMENTS AND PEER REVIEWS

In  the  context  of  the  recent  overhaul  of European 
economic  governance  undertaken  in response  to 
the  crisis  in  2010-2011,  the  role  of  national  fiscal 
frameworks has been given new prominence: most 
visibly,  through  the  adoption  of  a  binding  legal 
text  on  minimum  requirements;  but  also  through 
the  sharing  of  best  practices between  Member 
States 
through  a  peer  review  process.  The 
monitoring  of  progress  at  the  EU  level  is  also 
robust  dataset 
supported  by  an  extensive, 
maintained  by 
(Directorate 
General for Economic and Financial Affairs – DG 
ECFIN).

the  Commission

3.1.  A BINDING INSTRUMENT: THE DIRECTIVE 

ON NATIONAL BUDGETARY FRAMEWORKS

The  Directive  on  requirements  for  budgetary 
frameworks of the Member States (64) was adopted
as  part  of  the  Six-Pack  economic  governance 
package  and  will  be 
transposed  by  end  of 
December 2013. It sets out minimum requirements 
for  Member  States'  fiscal  frameworks  in  five  key 
areas  outlined below, with  a  view  to  ensuring 
consistency  between  national  fiscal  governance 
and  budgetary  discipline  provisions  from  the  EU 
Treaties and the Stability and Growth Pact (SGP). 
The  legal  instrument  chosen  was  a  Directive,  to 
ensure the most appropriate association of uniform 
EU-level requirements with the variety of Member 
States' budgetary structures. Contrary to voluntary 
standards,  a  Directive  is  binding,  but  unlike  a 
Regulation – through which most of the SGP rules 
are  established  – it  leaves  Member  States  the 
flexibility  to choose the  means  they  will  use  to 
comply with  its  requirements.  In  particular,  the 
Directive  on  budgetary
allows 
Member States to adapt their existing frameworks 
to  the  new  EU  rules,  and  leaves  open  the 
possibility  of  enacting  – or  maintaining  – more 
stringent 
its  minimum 
requirements.  This  is  crucial  not  only  to  respect 
existing  institutional  settings,  but  also  to  anchor 
national ownership of EU rules.

frameworks

provisions 

than 

(64) Council  Directive  2011/85/EU  of  8  November  2011  on 
requirements  for  budgetary  frameworks  of  the  Member 
States which entered into force on 13 December 2011.

Key requirements in five areas of budgetary 
policy-making

requires 

accruals-based

framework.  Building  on 

− 1)  Accounting  and  statistics:  Sound  fiscal 
statistics  are  not  only  necessary  to  support 
national  budgetary  processes  from  budget 
preparation  to  execution,  they  are  also  crucial 
for  a  proper  functioning  of  the  EU  fiscal 
surveillance 
the 
proven methodological framework provided by 
the 
the  European  System  of  Accounts, 
Directive 
data 
compliant with ESA95 covering all the general 
government subsectors, and also regular audits, 
both  internal  and  external,  of  public  accounts. 
Member  States  are  required  to  publish  cash-
based  fiscal  data,  at  a  monthly  frequency  for 
each  of  the  central  and  regional  government 
and  social  security  subsectors,  while  local 
to  report  on  a 
governments  are  required 
quarterly 
tables 
explaining  how  ESA95  data  is  derived  from 
primary  sources  should  also  be  made  publicly 
available.

Reconciliation 

basis. 

− 2) Forecasting: Macroeconomic and budgetary 
forecasts  are  an  essential  component  of  the 
budget  process,  as  fiscal  planning  based  on 
biased  or  unrealistic  forecasts  may  hamper 
budgetary  discipline in  a  significant  manner. 
The  Directive  mandates  the  public  availability 
of  official  macroeconomic  and  budgetary 
forecasts prepared for fiscal planning, and also 
of 
and 
parameters on which these forecasts are based; 
alternative  scenarios  (e.g.  lower-than-expected
growth) shall also be considered. Furthermore, 
the reliability of the forecasts can be improved 
through comparisons with forecasts from other 
institutions  – such  as the  Commission  – and 
independent economic institutes; other relevant 
stakeholders should contribute to strengthening 
the robustness of forecasts.

the  methodologies, 

assumptions 

− 3)  Numerical  fiscal  rules: Well-designed 
national  rules-based  frameworks  are  known  to 
significantly  enhance  budgetary  discipline; 
numerical  fiscal  rules  can  therefore  provide 
effective domestic  leverage for the SGP (itself 
a  rule-based  system  defined  on  quantitative 
increased  domestic 
fiscal 

through 

targets) 

83

European Commission

Public finances in EMU - 2012

ownership  of  fiscal  goals.  While  discretion  is 
left  in  the  definition  of  the  numerical  fiscal 
rules – which  may  target  not  just  the  debt  or 
deficit  but  also expenditure  and/or revenues  –
basic  features  are  mandated  in  the  Directive. 
These  features  include  the  requirements  that 
the  targets  and  scope  of  the  rules  be well 
defined,  that effective  and  timely  independent 
monitoring be  put 
strict 
compliance  mechanisms must  exist  and  that
well-circumscribed  escape  clauses should  be 
defined. This  can  be  relevant  not  only  at  the 
general  government  level,  but  also  at  the  sub-
national level, as shown in Part IV.

in  place, 

that

− 4)  Medium-term  budgetary 

are 

frameworks
(MTBFs):  Although  the  annual  budget  law  is 
the  pivotal  element  of  fiscal  policy  in  all 
Member  States,  most  fiscal  measures  have 
budgetary 
the  yearly 
implications  beyond 
cycle; a  multiannual  perspective  can  greatly 
improve  fiscal  planning.  While  Stability  and 
Convergence 
already 
Programmes
presented from a multi-annual perspective, they 
impact  on  domestic 
could  have  a  greater
budgetary  debates,  notably  given that  annual 
budgets  are  supposed  to  be  in  line  with  SCP 
commitments.  The  Directive  therefore  sets  out 
minimum  requirements  for  domestic  MTBFs 
which  include  a  fiscal  planning  horizon  of  at 
least three years, the embedding the MTBF into 
the  EU  fiscal  framework  (including  reference 
  the  medium-term 
to  the  achievement  of 
objective), revenue and expenditure projections 
on  the  basis  of  unchanged  policy  and  an 
explicit link to annual budgets.  

− 5) 

(which,

according 

Transparency: 

fiscal 
Increasing 
decentralisation 
in  most  Member  States 
strengthens  the  need  for  coordination  between 
central  government 
to 
Protocol 12 of the Treaty, is the level at which
compliance  with  Treaty  provisions  on  fiscal 
matters  is  judged),  and  regional  and  local 
governments,  which  manage  an  increasing 
share  of  public  expenditure.  The  Directive 
promotes accountability by calling for national 
fiscal  frameworks  to  appropriately  cover  all
general  government  tiers  and  requires  that 
coordination 
Member 
mechanisms 
including 
numerical  fiscal  rules.  The  Directive  also 

subsectors, 

establish 

across 

States 

84

requires  more  clarity  on  specific  items  which 
may have an impact on budgets, namely extra-
budgetary 
and 
tax 
contingent liabilities.

expenditures 

funds, 

Recent progress on adoption and monitoring

the given 

All Member States must fulfil the requirements of 
the  Directive  within 
transposition 
deadline, that is the end of 2013. By then, Member 
States  must  have  taken  all  the  necessary  legal, 
institutional and procedural measures to ensure full 
compliance.

Euro  Plus  Pact  partners  aim  for  an  early 
implementation. If  they  so  wish,  Member  States 
can choose to exceed the requirements imposed by 
the  Directive.  They  can  also ensure  that  these  are 
transposed  into  national  legislation  in  advance  of 
the deadline. This is the case for participants to the 
Euro  Plus  Pact  (members  of  the  euro  area  plus 
Bulgaria,  Denmark,  Latvia,  Lithuania,  Poland  and 
Romania),  who  pledged  in  mid-2011  to  transpose 
the Directive by the end of 2012.

countries.

Spurred  on  by 

in  most 
Sweeping  reforms  are  underway 
European 
the 
impending  deadline  for  the  transposition  of  the 
Directive, and supported in parallel by the sharing 
of  best  practice at  European  level
through  the 
Economic  Policy  Committee  (EPC)  Peer  Review 
process  which  is  described  below,  most  Member 
States  have recently committed to a strengthening 
of  their  national  fiscal  framework.  In  spite  of 
different national traditions in the conduct of fiscal 
policy,  and  of  different 
starting  positions, 
significant  reforms  were undertaken  in  a  majority 
of  Member  States  in  2011  in  the  pursuit  of  better 
fiscal governance.

Taking  stock  of  this  progress,  the  Commission 
will prepare an Interim Progress Report for the 
Directive by the end of 2012. As provided for by 
the  adopted  Directive, 
the  Commission  will 
prepare a  report  on  the  measures  in  place  across 
countries implementing the main provisions of the 
Directive  by  mid-December,  on  the  basis  of 
information  to  be  provided  by  the Member  States
in the second half of 2012.

Evolving budgetary surveillance

Part II

3.2. 

THE PEER REVIEW OF NATIONAL FISCAL 
FRAMEWORKS

EU.  The  Commission  services  contributed  to  the 
peer review by preparing country factsheets. (66)

this 

The  Directive  on  budgetary  frameworks  ( 65)
constitutes one of two pillars of the Commission's 
strategy to reinforce fiscal-structural settings in the 
European  Union.  The  second  pillar  has  been 
developed  as  a  forum  for  discussion  among 
Member  States  which  should  lead  to  tangible 
developments in the area. Together with legislative 
initiatives, 
approach  was 
two-pronged
approved  in  the  final  report  of  the  Van  Rompuy 
task force on economic governance. It foresaw the 
organisation  of  a  regular  assessment  and  peer 
review  of  domestic  fiscal  frameworks,  alongside 
the  requirements  set  in  the  Directive.  Its purpose 
was to  seek  policy  advice  and  evaluate  other 
desirable  but  non-binding  features  of  domestic 
fiscal  frameworks  which  support good  policy 
making. The  Van  Rompuy  Task  force  concurred 
with  the  earlier  Council  conclusions  of  18  May 
2010, which invited the Commission and the EPC 
to  promote  the  exchange  of  best  practices,  in 
particular in view of the elements that have proven 
to  be  most  successful  in  underpinning  fiscal 
consolidation  efforts  and 
to 
building up sustainable public finances.

in  contributing 

Consequently,  the  peer  review  was  carried  out  in 
2011  under  the  aegis  of  the  Economic  Policy 
Committee (EPC) in two sessions. The first session 
in  May  2011  reviewed  the  frameworks  of  14 
Member  States  (Estonia,  Ireland,  Greece,  Italy, 
Cyprus,  Latvia,  Lithuania,  Hungary,  Malta, 
Poland,  Portugal,  Romania,  Slovakia  and  the 
United Kingdom). The second session covered the 
remaining  13  Member  States  in  November  2011 
(Belgium,  Bulgaria,  Czech  Republic,  Denmark, 
Germany, 
Luxembourg, 
Netherlands,  Austria,  Slovenia,  Finland  and 
Sweden).

France, 

Spain, 

The  output  of  the  peer  review  took  the  form  of 
EPC policy advice to the reviewed Member States. 
This  non-binding  guidance  consisted  of  elements 
that were deemed to improve each country's fiscal 
framework,  while 
taking  account  of  national 
specificities  and  respecting  the  wide  spectrum  of 
institutional  and  administrative  traditions  in  the 

(65) Council  Directive  2011/85/EU  of  8  November  2011  on 
requirements  for  budgetary  frameworks  of  the  Member 
States which entered into force on 13 December 2011.

in 

the  case 

is  particularly 

the  country-specific  elements  usually 
While 
prevailed  over  common  factors,  the  2011  peer 
review  revealed  a  number  of  general  trends.  It 
confirmed  that  there  was  strong  momentum  for 
fiscal  framework  reform  in  most  Member  States. 
This 
those with 
previously  weak  frameworks,  including  a  lack  of 
any  independent  fiscal  institution  supporting  the 
preparation,  execution  and  assessment  of  annual 
budgets,  as  well  as  limited numerical  fiscal  rules 
and poor medium-term planning. The peer review 
identified  important  gaps  in  these  areas  and 
provided policy advice to specify the relevant key 
building blocks that would need to be put in place. 
Particular attention has also been paid to the need 
for  comprehensive  and  timely  fiscal  statistics. 
Pressing  ahead  the  implementation  of the  agreed 
commitments will prove critical for these countries
which are often undertaking major macroeconomic 
reforms  in  parallel,  as  structural  improvements  in 
fiscal  policymaking  should  support  and  go  hand-
in-hand with fiscal consolidation efforts.

Another  feature emerging from the peer review  is
that  reforms  are  not  only  taking  place  in  Member 
States  with  the  weakest  frameworks.  Member 
States with relatively stronger frameworks are also 
taking  steps  to  refine  existing  structures  and  add 
new building blocks. While some of the best fiscal 
performers  in  the  EU  have  been  able  to  rely  on  a 
relatively  light  fiscal  framework, based  on  a 
combination  of  mutual 
trust,  strong  political 
commitment  and  popular  support,  those  Member 
States have  recently  felt  the  need  to  cement the
informal  arrangements they  were  used  to into 
legislation,  further  reinforcing  the  link  between 
political  commitment  and  policy  deliverables.
Some Member States took further steps to enshrine 
national 
key 
constitution,  with  the  intention  of  providing  a 
stronger legal base to enforce the reforms.

principles 

fiscal 

their 

into 

From a thematic point of view, cross-cutting issues 
identified  in  the  2011  peer  review  included: 
(i) fiscal  rules;  (ii) fiscal  councils;  (iii) medium-
term budgetary frameworks (MTBFs) and (iv) sub-
national  governments slippages  (on  the  relevance 
of it, see Part IV).

(66) See European Commission (2012b). 

85

European Commission

Public finances in EMU - 2012

As part of the advice delivered in the course of the 
peer  review,  the  introduction  of  fiscal  rules  was 
suggested for a number of countries, especially on 
the  expenditure  side.  While  these  rules  share  the 
same general objectives and features (as target and 
scope  definition,  enforcement  and  compliance 
mechanisms,  and  escape  clauses),  different 
approaches were discussed, including the treatment 
of  cyclical  expenditure,  tax  expenditure  and/or 
expenditure not considered to be directly under the 
control of public authorities.

The  introduction  or  the  strengthening  of  fiscal 
councils  has  also  been  advocated  for  several 
countries,  though  some  differences  among  EPC 
Members  remained  in  the  assessment  of  their 
performance  and  suitability.  In  smaller  countries, 
resource  constraints  are  more  often  considered  to 
be  a  hindrance 
their  establishment  and 
development.  An  alternative  could  be  to  facilitate 
cooperation  between  resources  scattered  across 
existing institutions.

to 

The  introduction  or  strengthening  of  MTBFs  was 
recommended  for  some  Member  States,  mostly 
through the insertion of more binding features. The 
discussion  of  specific  design  features  addressed 
several items, for example the proper mix of fixed 
and flexible elements or methodologies to account 
for multi-year price and cost developments.

their  place 

Another  promising  topic  concerned  sub-national 
in  budgetary 
governments  and 
frameworks.  While  the  construction  of  a  fiscal 
framework  usually  begins  with  the  resolution  of 
issues  at  the  central  government  level,  it  should 
also  encompass  sub-national  governments  as  they 
may  be  an  important  source  of  fiscal  slippages, 
especially if expenditures at sub-national level are 
not  matched  with  the  adequate  level  of  funding 
responsibilities  as  indicated  in  Part  IV.  A  number 
of  Member  States  received  policy  advice  in  this 
field,  especially  countries  with  a  federal  or  a 
heavily-decentralised administrative structure. The 
peer  review  also  highlighted  the  need  for  further 
work  to  better  assess  how  expenditure  in  sub-
national  governments 
effectively 
monitored  and  controlled.  Avenues  for  further 
research  include  stricter  internal  funding  and 
borrowing  arrangements,  tasking  fiscal  councils 
with  the  monitoring  of  sub-national  governments 
(in  countries  with  stronger  fiscal  decentralisation) 

could  be 

86

or  enhancing 
increased transparency.

reputational  sanctions 

through 

Overall,  the  2011  peer  review  process  provided  a 
unique  opportunity  for  Member  States  to  brief 
each other and the Commission on progress made. 
It  gave  impetus  to  these  reforms  by  providing 
‘good/best  practices’  amongst 
examples  of 
Member  States.  Where  appropriate,  elements  of 
the  resulting  policy  advice  were  incorporated  into 
the country-specific recommendations in the 2011 
European semester exercise. A monitoring process 
has  been  agreed  upon  by  the  EPC,  whereby 
Member  States'  progress  towards  the  measures 
advised would be discussed in 2012 and 2013.

Leaving  aside  common  features,  the  following 
section presents country-specific information about 
the  most  visible  recent  reforms  introduced  in  the 
Member  States  examined  in  the  November  2011 
session of the peer review. ( 67)

the 

In  Austria,  the  fiscal  framework  consists  of  the 
Fiscal Equalisation Law and the Austrian Stability 
Pact  encompassing  all  levels  of  government  as 
well  as  the  medium-term  expenditure  framework 
(MTEF),  which  concerns  only 
federal 
government.  On  15  November  2011,  the  Austrian 
federal government adopted a proposal for a ‘debt 
brake’,  with  the  transition  to  a  structural general 
government deficit of 0.35% of GDP by 2017. The 
reform  package  foresees  the  extension  of  the 
level.  Subsequently, 
MTEF 
following negotiations on the debt brake with sub-
national authorities, the proposed deficit limit was 
raised from 0.35% to 0.45% of GDP.

the  Länder 

to 

In  Belgium,  the  budget  process  has  gradually 
taken  the  form  of  a  series  of  agreements  or 
conventions  not  only  between  the  political  parties 
of  the  governing  coalition  but  also  between  the 
different government layers. The framework relies 
on  the  two  existing  independent  bodies  (the 
Federal Planning Bureau and the High  Council of 
Finance),  which  continue  to  positively  influence 
contrast, 
finance  developments.  By 
public 
numerical fiscal rules and medium-term budgetary 
frameworks appear to be less developed, which has 
contributed  to  frequent  slippages  in  the  past. It  is 
framework  will  undergo 
expected 

that 

the 

(67) For  Member  States  examined  in May  2011,  see  European 

Commission (2011a), pp.107-108.

significant changes  as  a  result  of 
the  new 
agreement  on  institutional  reforms  which  was 
concluded in October 2011. This calls for adequate 
fiscal 
measures 
framework  with a view to tackling the rising debt 
challenge.

the  domestic 

reinforce 

to 

In  the  Czech  Republic,  the  government  has 
launched a review of the existing fiscal framework 
(dating  from  2004)  with  the  aim  of  improving  its 
functioning.  As  a  first  step,  an  internal  expert 
group  at  the  Ministry  of  Finance is  identifying 
weaknesses  in  the  current  framework.  In  the 
second  phase,  the  government  will  propose  draft 
legislation  which  will  also  aim  at  complying  with 
the  new  requirements  on  fiscal  frameworks 
stemming from EU legislation. Proposals currently 
under  consideration  include:  possible  ways  of 
improving coordination between different levels of 
government, a  new  fiscal  rule  for  local  and 
enforcement
regional  governments,
mechanisms  for  the  existing  fiscal  rules, better 
monitoring  and  ex  post  evaluation  of  budgetary 
performance, and  the  introduction sustainability 
considerations in the fiscal targeting. Furthermore, 
the possibility of establishing an advisory body on 
fiscal  and  budgetary  matters 
is  also  under 
discussion.

stronger 

for 

led 

period 

federal 

finances 

In  Germany a  wide  political  debate  on  the 
sustainability  of  public 
to  an 
amendment  of  the  Constitution  in  2009,  replacing 
the  golden  rule  by  the  debt  brake  stipulating 
balanced  budgets 
and  Länder 
governments.  For  the  federal  budget,  the  debt 
brake has been in effect from 2011 and applies to 
the cyclically adjusted budget. It sets a ceiling for 
the  federal  structural  deficit  in  normal  times  of 
0.35 % of GDP which will apply from 2016 with a 
transition 
2011.  The 
starting 
implementation  of  the  debt  brake  for  the  federal 
(virtual)  control  account 
budget 
registering deviations in budget execution from the 
defined  level  of  authorised  new  borrowing,  with 
overruns entering as debits, and savings as credits. 
Debits  on  the  control  account  need  to  be  reduced 
once  they  exceed  1  %  of  GDP,  but  only  in  an 
economic upswing and by no more than 0.35% of 
GDP per annum. Länder budgets must be balanced 
as  of  2020.  The  constitutional  amendment  also 
included  the  establishment  of  a  Stability  Council 
with  a  view  to  enhancing  the  monitoring  of 
budgetary developments at the federal and Länder 

includes  a 

in 

Evolving budgetary surveillance

Part II

level  and  introducing  a  federation-wide  early 
warning  system.  In  2010,  it  replaced  the  former 
Financial  Planning  Council  and  consists  of  the 
federal  ministers  of  finance  and  economic  affairs 
as well as the state ministers of finance.

In Denmark,  given the important role of regional 
and  local  authorities  in  administrating  public 
expenditure, 
forward  a 
the  government put 
proposal  for  multi-annual  expenditure  ceilings 
covering  all  levels  of  government  to  tighten 
spending  control  and  to  prepare  for  the  effects  of 
demographic  ageing  in  spring  2011.  The  ceilings 
are  to  be  underpinned  by  sanctions,  including 
reductions  in  appropriations  and  grants,  and  to  be 
controlled  by  the  Danish  Economic  Councils 
the 
(DORS),  which  are  currently  monitoring 
implementation  of 
the  general  government’s 
budget plans and quantifying short-term and long-
term  budgetary  effects  of  envisaged  policy 
measures and reforms.

amendment,  which 

In September  2011, 

In Spain, in response to perceived weaknesses, the 
fiscal  framework  was  strengthened  in  2010  with 
the  obligation  for  autonomous  regions  to  publish 
standardised  economic  and  budgetary  execution 
data on a quarterly basis. In addition, in July 2011, 
the  government  introduced  an  expenditure  rule,
to  which  central  government  and 
according 
municipalities  cannot  set  an  expenditure  growth 
rate  greater  than  the  medium-term  nominal  GDP 
growth  rate  in  the  setting  of  their  budgetary 
the 
stability  objectives.
parliament  approved  a  constitutional  balanced 
budget 
should  prohibit 
structural deficits in excess of targets set at the EU 
level and limit the size of the aggregate debt of all 
levels  of  administration to the  reference  value  set 
in the Treaty on European Union; it also enshrines 
the 
and  prioritises  debt 
repayments  over  other  expenditure.  Crucial 
parameters  of  the  constitutional  rule  have  been 
defined  in  an  organic  act  on  budgetary stability 
specifying,  in  particular, 
the  definition  of  the 
structural  deficit  and  the  deficit  ceilings at  the 
general government level (which is 0 as a general 
rule  but  can  reach  0.4%  of  GDP  in  case  it 
accompanies  structural  reforms),    the  distribution 
of  deficit  and  debt  limits  between  the  different 
levels  of  administration and the  responsibility  of 
each government in case of breach, the exceptional 
circumstances that can justify exceeding the limits, 
and  the  corrective  mechanisms for  non-compliant 

expenditure 

rule 

87

European Commission

Public finances in EMU - 2012

administrations. The  act  entered  into  force  on  1 
May  2012,  but  the  main  binding  provisions  will 
only take effect from 2020 onwards.

3.3. 

EVIDENCE FROM THE FISCAL 
GOVERNANCE DATABASE

In France, in line with the constitutional reform of 
July  2008,  a  second  multi-annual  public  finance 
planning act was passed for the 2011–14 period in 
December  2010.  On  the  expenditure  side,  the 
target  now  covers  the  whole  general  government 
sector,  including  local  authorities.  A  maximum 
increase  in  expenditure  compared  to  that  of  2010
has  been  set  and  central  government  expenditure
excluding  interest  payments  and  civil  servants’ 
pensions  is  now  to  remain  unchanged  in  nominal 
terms.  An  annual  ceiling  exists  for  healthcare 
spending  and  for  the  main  mandatory  funds  of 
social  security.  Transfers  to  local  governments 
have been frozen in nominal terms.

to 

for 

relative 

In the Netherlands, the September 2010 Coalition 
Agreement  endorsed  new  rules,  following  the 
advice  of  the  Budgeting  Framework  Commission. 
These  include  (i)  the  adoption  of  a  signalling 
margin:  a  downward  deviation  of  one  percentage 
the  general 
the  path 
point 
government  deficit  would 
trigger  additional 
consolidation measures; (ii) expenditures sensitive 
to  cyclical  trends  (unemployment  benefits,  social 
assistance benefits and movements in the terms of 
interest  expenditure  have  been 
trade)  and 
reintroduced  within 
the  expenditure  ceiling 
frameworks;  (iii)  the  rule  that  spending  overruns 
should be compensated in a ‘specific’ manner was 
broadened;  (iv)  a  windfall  formula  for  tax  relief 
was  introduced,  but  subject  to  strict  eligibility 
conditions.

In  Slovenia, the budget  for 2010/11  was prepared 
using  performance-based  budgeting,  whereby  the 
budgetary  lines are translated into 16 policy areas
for  the  first  time.  A  new  expenditure  rule  for  the 
general  government  (in  cash  terms) was  applied 
for  the  2011–14 period.  It  lays  down  expenditure 
ceilings on a rolling basis by limiting expenditure 
growth to potential GDP growth (both in  nominal 
terms)  and  restraining  it  further  as  long  as  the 
primary  deficit  and  the  general  government  debt 
(as % of GDP) exceed their target values. Ceilings 
are  fixed  for  the  first  two  years  and  indicative 
ceilings for the following two years.

88

With  a  view  to  supporting  the  EU  reflection  and 
decision-making  process,  the  Fiscal  Governance 
database  maintained  by  DG  ECFIN  collects 
information  on  the main  elements  of  national 
budgetary frameworks that underlie the conduct of 
budgetary  policies  of  general  government  at  all 
stages (68),  such  as national  fiscal  rules,  medium-
term  budgetary  frameworks,  and 
independent 
fiscal institutions.

The  fiscal  governance  database  was  created  as  a 
result  of  the  Ecofin  Council's  January  2006 
decision  to  ask  the  Commission  to  conduct  a 
comprehensive  analysis  of  the  existing  national 
fiscal rules  and  institutions  in  the  EU  Member 
States.  In  April  2009, the  Ecofin  Council invited 
Member  States 
the 
Commission's  questionnaire  on  changes  to their 
fiscal governance.

annually 

update 

to 

The  most  recent  update  of  the  fiscal  governance 
database focused on changes in fiscal frameworks 
that took place in 2010. 

Numerical fiscal rules

index  measuring 

services  have  defined  a 
The  Commission 
composite 
the  strength  of 
numerical fiscal rules based on five dimensions, on 
which  information  has  been  collected  through  the 
annual  survey.  These  are the rules'  statutory  base, 
the  room  for  setting  or  revising  objectives,  the 
nature  of  the  bodies  monitoring  compliance  and 
fostering 
their
enforcement  mechanisms,  and  media  visibility.
The index also takes into account the coverage of 
general  government  finances  by  the  numerical 
fiscal rules. 

enforcement 

rule,

the 

of 

In  2010,  the  number  of  numerical  fiscal  rules  in 
force increased by two compared to 2009. Thus 24 
Member  States were  operating  a  total  of  70 
numerical rules in 2010 (Cyprus, Malta and Greece
did  not  have  any  numerical  fiscal  rules,  as  in 
previous years). This increase is a result of new 

(68) The fiscal governance dataset is accessible on DG ECFIN's 
at 

website 
http://ec.europa.eu/economy_finance/db_indicators/fiscal_
governance/index_en.htm.

Evolving budgetary surveillance

Part II

Graph II.3.1:

The fiscal rule index (FRI) in the EU27 and selected groups of Member States, 1990 to 2010

1

0.8

0.6

0.4

0.2

0

-0.2

-0.4

-0.6

-0.8

x
e
d
n
i

s
e
l
u
r

l
a
c
s
i
f

l
a
c
i
r
e
m
u
N

-1

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

EU 27

EU 15

EU 12

Source: Commission services.

rules  introduced  in  2010, of which  two  were
implemented  in  the  United Kingdom,  one  in 
Slovenia and  one  in  Estonia, while  at  the same
time,  Slovenia
and Germany  abolished  one
existing rule each. 

By type, budget balance rules continued to be the
most widely used, making up around 40 per cent of
the  rules.  Debt  rules  and  expenditure  rules
correspond  to  27  and  24 per  cent of  the  rules,
respectively.  About  25  per  cent  applied  to  both

central and general government while the majority
– over 30 per cent – applied to local governments.

The  fiscal  rule  index  (FRI)  summarising  the
average  strength of numerical fiscal rules in force 
in  the  EU27  countries  along  five  dimensions  has
recovered from its first ever drop in 2009. (69) This

(69)  Note  that  the  fiscal  rule  index  calculated  from  the
2009  data 
is  obtained  from  slightly modified 
calculations as compared with earlier releases of the

Graph II.3.2:

The fiscal rule index (FRI) in the EU-27 by country, 2009 and 2010

12

10

8

6

4

2

0

x
e
d
n
i

s
e
l
u
r

l
a
c
s
i
f

l
a
c
i
r
e
m
u
N

2009

2010

EU27 UK DK BG LT SE NL ES PL EE FR LU DE AT SI

FI SK CZ HU BE LV PT RO IT

IE CY EL MT

Source: Commission services.

89

 
 
 
 
European Commission

Public finances in EMU - 2012

the 

from 

two  new 

results mainly
rules
implemented in the United Kingdom that replaced
previously suspended rules. Graph II.3.1 shows the
FRI over time, for the EU27 and for the pre-2004
members (EU15) and more recent entrants (EU12). 
It  shows  that the  average strength  of numerical
fiscal rules has increased more significantly in the
EU15  than  it  has amongst  the EU12. In  terms  of 
individual  Member  States Graph  II.3.2  shows the
value  for  the  FRI  by  Member  State  for  2009  and
2010. It highlights the significant improvement of
the  United Kingdom and minor  changes  taking
place in other countries. 

Medium-term budgetary frameworks

Medium-term budgetary frameworks (MTBFs) are
defined  as  institutional  policy  instruments  that
allow the extension of the horizon for fiscal policy
making beyond the annual budgetary calendar. (70)
Similarly  to fiscal  rule  index,  the  MTBF  index
captures the quality of these devices based on five
dimensions: (1) the existence of a domestic MTBF, 
(2)  the  connectedness  between  the  multi-annual

index. Still, figure 3 is based on a recalculated series
of the fiscal rule index for the whole period covered
by the dataset, therefore comparability in time is not 
impaired by the change in methodology.

(70) See  European  Commission,  Directorate-General 

for 
Economic  and  Financial  Affairs  (2007)  for  this  definition
and details.

Graph II.3.3:

The MTBF index in the EU27, 2009 and 2010

(3) 

the 

budgetary targets and the preparation of the annual
budget, 
involvement  of  national
parliaments in the preparation of the medium-term 
budgetary  plans,  (4)  the  existence  of  coordination
mechanisms  between
general
government  prior  to  setting  the medium-term 
budgetary  targets,  and  (5)  the monitoring  of
of  multi-annual
enforcement  mechanisms
budgetary targets. 

subsectors  of

2010  saw  several  changes  to  MTBFs  in  the  EU
Member  States.  A major  novelty was  the  new
budgetary framework  in  Greece  which aims  to
include  fiscal  targets for  the  general  government
and its sectors as well as measures to achieve these
targets,  as  a  minimum.  In  Poland,  a  Multi-Year
Financial Plan of the State is prepared as of 2010.
It  comprises  a  statement of  the  government
medium-term 
medium-term 
projections  of  expenditure  and  revenue  and
together  with
fiscal
aggregate 
macroeconomic assumptions. 

projections 

policy,

fiscal 

Graph  II.3.3 shows  the  MTBF  index  for  all
Member States for 2009 and 2010. It shows that in 
2010 
the  quality  of medium-term  budgetary 
frameworks  as measured  by  the  MTBF  index
experienced  an  improvement  compared  to  2009.
This results from the considerably higher score of
Greece that had no MTBF before, as well as minor 
improvements in  several other countries including
Poland, Italy and Slovenia.

2009

2010

2.0

1.8

1.6

1.4

1.2

1.0

0.8

0.6

0.4

0.2

0.0

x
e
d
n
i
F
B
T
M

2
U
E

R
7 F

S
E

I

L S
N

T

I

K
U

O
R

T
M

L
E

I

T F
A

Z
C

E
E

E
D

E
B

K
S

E
S

U
H

K
D

V
L

G
B

L
P

T
L

E

I

T
P

*
Y
C

U
L

* The MTBF index for Cyprus is considered the same as in 2009 since no new information was submitted in 2010.
Source: Commission services.

90

 
Evolving budgetary surveillance

Part II

Even  with  the  increase  in  the  number  of  fiscal 
councils, among the new EU Members only 5 have 
such  institutions  (Estonia,  Hungary,  Lithuania, 
Slovenia  and  Romania).  This  might  be  due  to  the 
fact  that  independent  fiscal  institutions  require  a 
certain  investment  in  terms  of  adequate  financing 
and  skilled  human  resources,  in  contrast  to  other 
areas  of  fiscal  governance  where  changes  can  be 
achieved  by  legal  instruments.  Some  of  the  new 
EU  members  may  therefore have  preferred  to 
concentrate  their  human  resources  for  monitoring 
fiscal policy making in the central bank, ministries 
of finance, and academia.

Independent fiscal institutions 

fiscal 

institutions  are  a 

Independent 
further 
institutional  mechanism  to  improve  budgetary 
performance  and  help  foster  a  medium-term 
orientation for  budgetary  policy.  Their  role  is  to 
provide  independent  input,  analysis,  assessment 
and/or  recommendations  in  the  area  of  fiscal 
policy.  In  a  number  of  EU  Member  States  these 
institutions  (also  called  fiscal  councils)  have 
proved  to  be  instrumental  in  improving  fiscal 
policy  making  by  providing  positive  and/or 
and 
normative 
recommendations.

assessments, 

analysis, 

independent 

there  were  29 

In  2009, 
fiscal 
institutions located in 17 EU Member States. Such 
institutions  were  far  more  common  in  the  former 
EU15, often having a long history. In new Member 
States some tasks of independent fiscal institutions 
are  often  assumed  by  central  banks  that  are  not 
covered under the definition used in the survey. 

is 

responsible 

for  monitoring 

In  2010  three  new  independent  fiscal  institutions 
were established (Greece, Romania and the United 
Kingdom),  two  were  reformed  (Sweden  and  the 
United Kingdom) and one closed (Italy). The new 
Greek fiscal council, the Parliament (State) Budget 
Office, 
the 
implementation  of  the  state  budget,  the  analysis 
and  evaluation  of  the  state  budget's  data  and 
forecasts,  and  of  the  sustainability  of  long  term 
fiscal  figures.  The  Romanian  Fiscal  Council  is 
composed  of  five  members  who  will  support  the 
work of government and parliament in the process 
of elaboration  and  development  of  fiscal  and 
budgetary  policies.  Finally,  the  Office  for  Budget 
Responsibility, new fiscal institution in the United 
examining and 
Kingdom,
reporting on  the  sustainability  of 
the  public 
finances and  for assessing the extent to  which the 
fiscal  mandate  has  been,  or  is  likely  to  be 
achieved.

is  responsible  for

In Italy, on the other hand, the Italian Institute for 
Studies and Economic  Analyses (ISAE) ceased to 
exist  at  the  end  of  2010.  The  closure  of  the 
Institute  was  part  of  a  general  rationalisation  of 
public  bodies.  The  new  Constitutional  law  on  a 
balanced  budget  rule  envisages  the  creation  of  a 
fiscal council within the Italian Parliament.

91

4.

PROPOSAL INTRODUCING ENHANCED MONITORING 

AND ENSURING THE CORRECTION OF EXCESSIVE DEFICIT 
OF THE MEMBER STATES IN THE EURO AREA

A clear need for an enhanced monitoring of 
budgetary policies in the euro area

Member  States  experience  strong  interlinkages 
between  both  their  economic  situations  and 
their budgetary policies. The management of the 
public  finances  in  each  of  the  euro  area  Member 
States becomes a matter of common concern given 
that it may affect all other participant countries. In 
good  times,  this  interdependence  brings  increased 
prosperity.  But  it  also  means  that  the  sharing  of 
risk  should  be  accompanied  by  a  sharing  of 
responsibility  and  a  seamless  procedure  covering 
all  eventualities,  including  the  use  of  financial 
backstops, is needed.

The  Stability  and  Growth  Pact  (SGP)  contained 
stronger  provisions  for  the  euro  area  Member 
States  since  its  inception  and  the  Six  Pack 
enhanced  and  added  to  these.  In  this  way,  the 
imposition of financial sanctions in case euro area 
Member States do not comply with the rules of the 
SGP  has  been  intensified.  In  addition,  it  was 
necessary  to  adapt  the  surveillance  framework  to 
the  exceptional  situations  of  euro  area  Member 
States  under  financial  assistance,  and  for  those 
experiencing financial difficulties. 

led 

The  increasing  awareness  of  the  interlinkages  of 
to  an 
the  euro  area  economies  has 
acknowledgement  of  the  need  to  further  reinforce 
the  framework  for  budgetary  coordination  and 
governance  for  euro  area  Member  States.  In  the 
light  of  this,  the  Commission  put  forward  two 
additional proposals for legislation and a Green 
Paper on Stability Bonds on 23 November 2011 
(the Green Paper is described in Box II.4.I). 

1)  A proposal  for  a  Regulation  on  common 
provisions  for  monitoring  and  assessing  draft 
budgetary  plans  and  ensuring  the  correction  of 
excessive deficits of the Member States in the euro 
area. 

for  a  Regulation  on 

the 
2)  A proposal 
strengthening  of 
and  budgetary 
economic 
surveillance  of  Member  States  experiencing  or 
threatened  with serious difficulties  with respect to 
their financial stability in the euro area. 

This second  proposed  Regulation  sets  out  explicit 
rules for enhanced surveillance for those euro area 
Member  States  facing  severe  difficulties  with 
regard  to  their  financial  stability;  those  in  receipt 
of  financial  assistance  on  either  a  precautionary 
basis  or  as  part  of  a 
full-scale  assistance 
programme;  and  those  in  the  process  of  exiting 
such  assistance.  For  the  first  time,  there  will  be  a 
common and graduated framework that will set out 
the surveillance requirements made in such cases.

Taken  together,  these  proposals  put  in  place  an 
enhanced monitoring procedure that builds on and 
complements  the  SGP  for  the  euro  area  Member 
States,  ensuring  a  seamless  continuity  of  policy 
monitoring in all budgetary situations.

in 

Following the usual process for the adoption of 
legislative  proposals,  both  texts  have  since  been 
discussed 
the  European 
the  Council  and 
Parliament.  The  Council  reached  agreement  on  a 
general  approach  to  the  proposed Regulations, 
which was endorsed by the 21 February ECOFIN. 
The  European  Parliament's  negotiation  position 
was adopted in plenary meeting on 13 June 2012. 

budgetary 

Both  proposals  are  based  on  Article  136  of  the 
Treaty  on  the  Functioning  of  the  European  Union 
(TFUE), which allows specific legislation aimed at 
and 
reinforcing 
surveillance in the euro are to go beyond the legal 
framework  applicable  to  the  Union  as  a  whole 
(corresponding  to  Regulations  No  1466/97  and 
1467/97 in the context of fiscal surveillance). This 
so-called Two Pack comprises:

coordination 

the  date  of  publication, 

At 
between 
Accordingly, 
Commission proposals of 23 November 2011. 

the  negotiations 
just  started. 
the 

the  co-legislators  have 

this  Chapter 

presents 

92

Evolving budgetary surveillance

Part II

Box II.4.1: Stability Bonds

The  recent  discussion  about  possible  common  euro  area  debt  issuance  ignited  again  in particular  after  the 
Report  of  the  President  of  the  European  Council  of  26  June  2012  (see  European  Council  (2012)) which
presents  a  vision  for  the  consolidation  of  the  Economic  and  Monetary  Union.  The  report  states  that  "In  a 
medium term perspective, the issuance of common debt could be explored as an element of.a fiscal union". 
A large  number  of  proposals  for  Eurobonds  have  been  put  forward,  including  the  issuance  of  mutualised 
bonds combined with a debt redemption fund as suggested by the German Council of Economic Advisers(1), 
different options of Stability Bonds as outlined in the Commission's Green Paper or the common issuance of 
short-term debt securities (E-Bills). These various Eurobond schemes differ remarkably related to the aims, 
the structure and the time pattern of the new instrument. To further frame the intensified public debate on 
common  debt  issuance  in  the  euro  area,  the  European  Commission  published  a  Green  Paper  on  the 
feasibility of introducing Stability Bonds on 23 November 2011. It identified significant potential benefits of 
introducing  Stability  Bonds.  Creating  a  new  sovereign  bond  market  segment  would  accommodate  the 
shortage of stable, deep and liquid assets in the euro area. Although common issuance of government bonds 
is unlikely to play any decisive role in overcoming the current sovereign debt crisis, Stability Bonds could 
over  the  medium  term  contribute  to  completing  the  institutional  setup  of  EMU.  Stability  Bonds  would 
thereby (i) facilitate the transmission of monetary policy, (ii) deepen the internal market and render capital 
markets more efficient, (iii) increase the stability and shock resilience of the financial sector, (iv) raise the 
attractiveness  of  euro-area  financial  markets  and  the  euro  at  global  level,  and  (v) reduce  the  impact  of 
excessive  market  fluctuations  on  sovereign  borrowing  costs  and  hereby  strengthen  the  stability  and 
robustness of government financing. The European Commission considers that the main feature of common 
issuance should be overall enhanced financial stability. To emphasize this aim the term "Stability Bonds" is 
used instead of "Eurobonds". 

The Green Paper outlines three generic options for common issuance, by combining two main features: the 
guarantee structure (joint and several vs. several) and the degree of substitution of national by joint issuance 
(partial vs. complete):

–

–

–

Option 1, based on joint and several guarantees, full substitution of national bonds;

Option 2, based on joint and several guarantees, partial substitution of national bonds;

Option 3, based on several guarantees, partial substitution of national bonds.

The three options are characterized by different trade-offs between expected benefits on the one hand and 
the fulfilment of preconditions as well as the difficulty of implementation on the other hand. Option 1 seems 
to be the most likely to provide a high credit quality of commonly issued bonds, as well as major positive 
effects  on  financial  integration,  on  financial  stability  and  on  the  global  attractiveness  of  EU  financial 
markets. At the same time, this approach would however imply the greatest risk of moral hazard, as it would 
completely  suppress financial markets  and  market  interest  rates  as  signals  and  incentives  for  individual 
Member States' fiscal policy. The third approach addresses this latter concern, while, at least in the absence 
of further credit enhancement, it does not provide the best credit quality or not the best rating. Consequently, 
the  expected  level  of  liquidity  of  the  Stability  Bonds  would  be  more  limited.  The  impact  on  financial 
integration, on financial stability and on the global attractiveness of EU financial markets would overall be 
rather medium to low. The second option is commonly referred to as the "blue-red approach"2 and balances 
the different previous arguments. It implies a relatively high credit quality for common bonds ("blue bonds") 
and addresses at the same time the risk of moral hazard through the remaining national-guaranteed bonds (or 
"red bonds"). Member States with higher debt would not be able to refinance them through common bonds, 
but  beyond  a  threshold  rely  on  financing  all  additional  debt  through  national  bonds.  As  they  would  be 
obliged to serve the common bonds first (seniority principle), the national bonds would be issued at higher 
costs.  The  three  approaches  also  differ  in  terms  of  required  adjustment  of  the  regulatory  framework.  As 

1

2

See German Council of Economic Experts (2011). 
See Delpa et al.(2010).

(Continued on the next page)

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Public finances in EMU - 2012

Box (continued)

option 3  would  not  call  for  changes  of  the  Treaty  on  the  Functioning  of  the  European  Union  (TFEU),  it 
could  be  used  as  short-term  immediate  crisis  management  tool.  In  contrast  to  this,  options 1  and 2  would 
need Treaty changes and are therefore more suitable as medium to long-term instruments. Hereby Stability 
Bonds  option  2  could  be  launched  as  medium-term  tool  to  repair  financial  markets  after  the  crisis,  while 
option 1 would rather be an instrument to complete the EMU architecture in the long run by contributing to 
a more advanced economic and financial architecture.

While  Stability  Bonds  would  provide  substantial  benefits  in  terms  of  financial  stability  and  economic 
efficiency,  it  is  essential  to  meet  important  economic,  legal  and  technical  preconditions.  The  positive  net 
effects of common issuance of bonds depend on managing the potential disincentives for financial discipline 
and the therefrom resulting consequences. Budgetary discipline must be guaranteed in order to limit moral 
hazard.  While  the  EU's  governance  framework  has  been  considerably  reinforced  over  recent  years,  it 
remains to be seen whether such a framework would provide sufficient safeguards also in a framework of 
more advanced or ambitious forms of common issuance.  In such a case, additional criteria or conditions for 
the participation in common issuance might be warranted.  Second, Stability Bonds would need to have high 
credit quality to be accepted by investors. The successful implementation of the new economic governance 
framework  already  in  force  and  in  the  process  of  being  put  in  place  may  be  a  significant  step  towards 
fulfilling the preconditions for common issuances. Furthermore, consistency with the EU Treaty would be 
essential to ensure the successful introduction of Stability Bonds. Common bonds must not be in breach with 
the Treaty prohibition on the "bailing out" of Member States (Art. 125 TFEU). This would be particularly 
relevant within Bond issuance under joint and several guarantees. While some options would require Treaty 
changes,  others  would  not.  Issuance  under  several  but  not  joint  guarantee  would  be  possible  within  the 
existing  Treaty  provisions.  Overall,  the  technical  design  of  Stability  Bonds  impacts  all above  mentioned 
issues.  It  is  therefore  most  important  to  consider  various  design  options  and  to  analyse  the  resulting 
consequences.  The  Commission's  Green  Paper  elaborated  on  the  various  parameters  and  options  and 
provided a first tentative analysis of their advantages and disadvantages. 

In  winter  2011/2012  the  Commission  invited  all  citizens  and  organisations  to  contribute  to  the  public 
consultation on its Green Paper on the Feasibility of introducing Stability Bonds. The results of the public 
consultation,  published  in  May  2012,  showed  significant  differences  in  views  between  supporters  of  and 
opponents  to  Stability  Bonds.  However,  the  majority  of  respondents  were  in  favour  of  implementing  a 
common debt issuance instrument. Most of the supporters expressed a preference for Stability Bonds option 
2.  Overall,  several  issues  were  raised:  Respondents  voiced  their  concerns  about  moral  hazard  and 
emphasised  on  the  fact  that  sufficient  fiscal  discipline  should  be  ensured  before  implementing  Stability 
Bonds. Therefore a stable legal and governance framework should be put in place. Furthermore participants 
stressed  that  Stability  Bonds under  joint  and  several  guarantees  should involve  a  tight  control on national 
budgets  possibly  including  a  restriction  of  sovereignty.  Especially  market  stakeholders  called  for  a  stable 
and  definite  instrument,  rather  than  a  transitory  one  and  emphasized  simplicity  and  transparency.  They 
objected  to  hybrid  or  over-collateralised  structures,  with  or  without  credit  enhancement,  and  favoured  a 
simple  issuance  structure,  ideally  via  a  central  debt  management office.  Fears  of  an  unjustified burden on 
citizens and an increase of financing costs for sub-national entities have also been put forward. Finally, legal 
concerns were addressed as well. 

Even if the number of replies is relatively low and cannot be interpreted as representative, they offer a useful 
snapshot  of  relevant  concerns  and  preconditions  of  political  and  technical  nature.  The  public  consultation 
was  a  useful  process  for  further  reflection  on  Stability  Bonds,  as  it  revealed  several  additional  issues  not 
addressed  in  the  Green  Paper.  The  issues  raised  in  the  responses  are  being  studied  by  the  Commission 
services and further reflection is taking place on possible implementation schemes of Stability Bonds.

Due to the existence of trade-offs between the political scope of a new instrument and the legal, political and 
technical feasibility of introducing such an instrument in the short term, more limited options for common 
issuance are under discussion. Especially if the main objective was to design common issuance as a crisis 
management took, an instrument that differs in design and phasing compared to the Green Paper approaches 

(Continued on the next page)

94

Evolving budgetary surveillance

Part II

Box (continued)

time and/or maturity of such common issuance. Main examples of such more limited approaches include (1) 
common  issuance  based  on  several  guarantee  only;  (2) time-limited  common  issuance  based  on  joint  and 
several guarantees in the form of a debt redemption fund as proposed by the German Council of Economic 
Experts,  or  (3) common  issuance  only  of  short-term  debt  with  a  maturity  of  up  to  1  to  2  years,  so-
called"Eurobills" / "E-bills".

The latter proposal has attracted the most significant attention.  As all other proposed instruments, E-bills 
involve  specific  advantages  and  disadvantages.  However,  while aiming  for  a  crisis  management  tool  the 
benefits of  common issuance of  short-term debt seem to exceed the negative consequences. E-bills  would 
contribute to financial market  completion by providing a larger supply of short-term securities  markets of 
sufficiently high credit quality. Until now markets for T-bills, commercial paper and certificates of deposit 
are  relatively  underdeveloped  in  most  Member  States.  Eurobills  could  moreover  strengthen  financial 
stability insofar as they would assure a ready supply of short-term liquidity for all euro area Member States. 
Compared  to  long-term  bonds,  the  potential  exposure of  Member  States  to  E-bills  under  joint  and  several 
guarantees would be reduced in volume and time. This is mainly due to the smaller size of the government 
bill markets and the lower average  maturity of bills. The common issuance of short-term securities would 
also seem beneficial for the conduct of monetary policy in the euro area, as the transmission channels would 
be  strengthened  and  harmonised.  Finally,  some  of  the  more  technical  issues  to  be  solved  for  commonly 
issuing long-term bonds (i.e. trading venues or maturity profiles), would be smaller  for issuing short-term 
paper  only.  Nevertheless  the  limits  of  Eurobills  need  to  be  considered.  Unlike  for  long-term  bonds, 
collective gains in liquidity premia would be extremely limited, as bills are typically not traded, but purely 
bought  and  held.  Effects  on  market  integration  and  efficiency  would  equally  be  restrained.  Furthermore, 
euro  area  Member  States'  current  reliance  on  T-bills  in  overall  issuance  differs  widely.  This  would 
complicate the introduction of Eurobills, including an agreement on aggregate limits. In addition, it should 
be  avoided  that,  by  creating  a  particularly  attractive  short-term instrument,  a  bias  towards  short-term 
issuance  appears,  particularly  in  vulnerable  Member  States.  This  could  lead  to  very  serious  rollover  risks 
over the medium term. As is the case for the issuance of common bonds, care would also need to be taken to 
ensure  that  an  introduction  of  Eurobills  does  not  breach  the  no  bailout  condition  enshrined  in  the  TFEU
under Article 125.

Still, E-bills should be considered as a possible crisis management tool, as they are more flexible and more 
easily manageable. As they are of short-term nature their issuance can relatively easily been phased out in 
the  event  they  lead  to  unwarranted  consequences.  While,  when  successful  they  could  become  a  stepping 
stone for other forms of common issuance.

MAIN FEATURES OF THE PROPOSED REGULATION 
ON ENHANCED MONITORING

The  proposal  for  a Regulation on monitoring  and 
assessing  draft  budgetary  plans  and  ensuring  the 
correction  of  excessive  deficits of  the  Member 
States in the euro area sets out graduated steps and 
conditions that reinforce the monitoring of national 
budgetary  policies.  The  main  features  of  the 
Commission  proposal  are 
this 
Subsection. 

set  out 

in 

regarding  their  budgetary  procedures.  These  new 
requirements  aim to  complement  the  European 
Semester so as to ensure a good integration of the 
European  Union  policy  guidance  in  the  national 
budgetary  process  and  to  allow  taking  a  view  of 
the  euro  area  as  a  whole  (see  Graph  II.4.1). 
Experience has shown that effective planning plays 
a  key  role  in  ensuring  sound  public  finances,  in 
particular when it allows the ex ante identification 
of any risk of gross errors and thus prevents them 
from occurring.

A  Common  Budgetary  Timeline  for  the  euro 
area

All  Member  States  of  the  euro  area  will  follow  a 
common  timeline,  as  well  as  common  rules, 

In addition, euro area Member States need to take 
into account the fact that their budgetary plans may 
potentially  trigger  spillover  effects  on  the  other 
countries  sharing  the  same  currency.  Therefore,  a 
first  step  in  reinforcing  the  preventive  aspect  of 

95

European Commission

Public finances in EMU - 2012

European  surveillance 
to  ensure  a  better 
is 
synchronisation  of  the  key  steps  of  the  budgetary 
procedure.  Sharing  a  common  budgetary  timeline 
should  help  Member  States  exchange  relevant 
information  and  follow  the  budgetary  procedures 
of  their  counterparts  in  a  transparent  manner,  and 
so  facilitate  synergies.  This  will  reinforce  the 
effectiveness of the European Semester, organised 
for the first time in 2011, and which is premised on 
the  same  rationale  which  is  that  the  EU  Member 
States  need  to  coordinate  better  their  budgetary 
and  economic  processes  in  line  with  common 
objectives, building  on  Commission  and  Council 
recommendations. 

This  common  budgetary  timeline  is  organised 
around three milestones:

By 15April: the fiscal plans in accordance with the 
national  medium-term  budgetary  frameworks  are 
made public. 

Each  Member  State  must  prepare  a  national 
medium-term  budgetary  framework  and  publish  it 
alongside its Stability Programme that is submitted 
to the Commission and the Council, in accordance 
with the preventive arm of the SGP. 

As a starting point, the information to be presented 
in the national medium-term budgetary framework 
should encompass  all  the  data  required  in  the 
Stability  Programme;  however,  the  Member  State 
may  decide  that  this  national  document  might  go 
further  either  in  the  horizon  or  in  the  coverage  of 
the  medium-term  budgetary  strategy  that  it  sets 
out.

By  15  October: The  draft  budget  is  made  public, 
together  with  the  macroeconomic  forecasts  on 
which it is based;

the  general 
The  draft  budgetary  plans 
governments are made public and submitted to the 
Commission and the Eurogroup.

for 

is 
The  submission  of  draft  budgetary  plans 
intended  to  mirror the  procedure  of  the  Stability 
Programmes, but with focus on the following year. 
This  new  milestone  will  be  specific  to  the  euro 
area,  acknowledging  the  need  for  an  enhanced 
synchronisation  of 
the  budgetary  policies  of 
Member States sharing the same currency.

96

By  31  December:  Budget  Laws  are  adopted  and 
made public.

Finalising  all  countries'  budgetary  processes  in  a 
synchronised  manner 
should  eliminate  any 
uncertainty  possibly  linked  to  the  forthcoming 
budgetary plans of the euro are Member States and 
enhance the transparency both across countries and 
towards external observers.

Common  Budgetary  Rules 
Member States

for  euro  area 

Building on the same rationale as the Directive on 
national  budgetary  frameworks  adopted  in  2011 
presented  in  Section  II.3,  the  proposal  for  a 
Regulation on enhanced budgetary monitoring sets 
out  more  precise  requirements  for  euro  area 
Member  States.  The  new  rules  are  therefore 
additional  to  the  provisions of  the  Directive  on 
national  budgetary frameworks  which should  be 
transposed in all Member States by end-2013. 

sustainable 

There is strong evidence showing the effectiveness 
of  rules-based  fiscal  frameworks  in  supporting 
sound  and 
fiscal  policies.  The 
introduction  of  national  fiscal  rules  which  are 
consistent  with 
is 
the  European 
to  ensure  that  Member  States  are 
important 
equipped  to  abide  by  their  obligations  under  the 
SGP. 

framework 

in 

in  place 

fiscal  rules 

the  directive  on  national  budgetary 
While 
frameworks  requires  EU  Member  States  to  have 
numerical 
to  promote 
compliance with EU obligations (71), the proposed 
regulation  explicitly  requires  euro-area  Member 
States  to  enshrine  the  medium-term  budgetary 
objective  (MTO) 
their  national  budgetary 
process. At least for euro area Member States, the 
approval of this provision would allow transposing 
in  secondary  legislation  the  core  commitment  of 
the  Contracting  Parties  of  the  intergovernmental 
Treaty on  Stability, Coordination and Governance 
in  the  Economic  and  Monetary  Union  (TSCG), 
signed  on  2  March  2012  (see  Chapter  II.5).  The 
binding  nature  of  such  national  rules  would 
demonstrate the strongest commitment of national 
authorities to  meet their obligations deriving  from 

(71) The  UK  is  exempted  from  this  provision, in  view  of  its 

special Protocol annexed to the Treaties.

Evolving budgetary surveillance

Part II

the preventive arm of the SGP, too often neglected 
in the past.

parliaments  and  stakeholders  in  the  EU-level 
perspective.

is 

rules 

Ensuring  that  all  Member  States  of  the  euro  area 
have  high-quality  budgetary  processes  is  another 
safeguard  to  help  them  meet  the  strengthened 
requirements  and  ensure  a  sound  management  of 
their  public  finances. The  first  area  concerned  by 
these  new  common  budgetary 
the 
reliability of the forecasts on which Member States 
base  their  budgetary  plans,  be  they  the  national 
medium-term fiscal plan or the draft budget for the 
forthcoming  year.  Indeed,  in  the  absence  of 
realistic  and  unbiased  forecasts,  the  link  between 
budgetary planning and execution is weakened and 
Member  States  are  likely  to  miss  the  targets 
foreseen in the plans. In particular, as the revenue 
projections are based on the level and composition 
of  economic  growth,  overly  optimistic  GDP 
forecasts  will  leave  the  government  unable  to 
respect  its  budgetary  targets  for  revenues  and 
hence,  for 
the  overall  budget  balance.  The 
directive  asks  the  macroeconomic  and  budgetary 
forecasts  to  be  realistic  and  subject  to  a  regular 
evaluation. The proposed regulation requires fiscal 
plans  of  euro  area  Member  States  to  be  based  on 
independent macroeconomic forecasts.

In addition, according to the Commission proposal 
euro  area  Member  States  should 
rely  on 
independent  fiscal  bodies  for  the  monitoring  and 
implementation  of  national  rules,  in  particular,  of 
rules ensuring compliance  with  the  MTO.  The 
require  national 
directive  does  not  strictly 
fiscal 
independent  bodies 
rules. 
However, 
that  monitoring  of 
numerical  rules  should  be  based  on  analysis 
carried out by independent bodies

it  envisages 

to  monitor 

New  reporting  requirements 
to 
improve  the  monitoring  of  Member  States' 
budgetary policies

in  order 

An  enhanced  monitoring  of  budgetary  policies  in 
the  euro  area  exerted  at  the  European  level  and 
based on a reinforcement of existing processes for 
budgetary  and  economic  surveillance,  has  been 
deemed  necessary  to  take  account  of  the  fact  that 
national economic policies of Member States are a 
matter  of  common  concern  – particularly  in  the 
case  of  countries  sharing  a  single  currency.  This 
implies greater awareness and interest by national 

The  new  Regulation,  builds  upon  the  European 
Semester  by  introducing  a  new  exercise  to  be 
conducted  in  the  autumn,  when  the  budgetary 
plans  of  Member  States  of  the  euro  area  will  be 
assessed.  This  new  exercise  would  involve  only 
the forthcoming budgetary year, as opposed to the 
European  Semester,  which  considers  budgetary 
plans and policies over the medium run. By taking 
into account one budgetary year only, just ahead of 
the  adoption  of  the  Budget  by  the  National 
Parliament,  this  new  milestone  should  allow  a 
more  targeted  and  more  relevant  intervention  into 
national  budgetary  processes,  thus  reinforcing 
substantially the preventive function of the SGP.

enables 

By requiring the submission by Member States of 
their  draft  budgetary  plans  by  15  October,  the 
the 
Regulation 
Commission to examine the national draft budgets 
of  all  euro  area  Member States,  both  individually 
and with an overall view on the forthcoming fiscal 
stance in the euro area. 

the  Council 

and 

In  addition,  the  Eurogroup  will  hold  a  discussion 
on  the  fiscal  prospects  for  the  euro  area  for  the 
forthcoming year, on the basis of the assessment of 
the  draft  budgetary  plans  undertaken  by  the 
Commission.

The Regulation lays down the required information 
which  is  expected  to  be  provided  by  Member 
States  in  their  draft  budgetary  plan  (see  Box 
II.3.2).  This  information,  provided  following  the 
common European accounting standards (ESA 95), 
in  order  to  be  fully  comparable  across  Member 
States,  will  ensure  horizontal  consistency  in  the 
assessment  and  to  allow  the  framing  of  a  euro 
area-wide  picture  of  fiscal  positions.  Indeed,  the 
information required has been selected in order to 
provide  a  comprehensive  overview  of  the  fiscal 
position  of  each  Member  State  over 
the 
forthcoming  year.  The  proposal  presented  on  23 
November  envisages  that  the  specific  content  and 
the  format  of  the  draft  budgetary  plans  is  to  be 
established by the Commission. 

There are two potential steps that the Commission 
might decide to undertake on the basis of the draft 
budgetary  plans.  First,  in  exceptional  cases  of 
serious non-compliance of the budgetary plan with 

97

European Commission

Public finances in EMU - 2012

the obligations of the Member States deriving from 
the SGP, the Commission will be able, within two 
weeks  from  the  date  the  Member  State  submitted 
its programme, to request a revised draft budgetary 
plan.  In  particular,  this  would  be  the  case  where 
the  implementation  of  the  initial  budgetary  plan 
would  put  at  risk  the  financial  stability  of  the 
risk 
concerned 
Member  State 
jeopardising the good functioning of the EMU, or 
where  the  implementation  of  the  initial  budgetary 
plan  would  entail  an  obvious  significant  violation 
of the recommendations formulated by the Council 
under the SGP. 

or  would 

In addition, the Commission may adopt an opinion 
on  a  Member  State's  draft  budgetary  plan,  after 
having  properly  assessed  it. This  opinion  will  be 
given as  soon  as  possible,  with  a  maximum 
deadline established in the Commission proposal at 
30  November.  The  objective  is  to  transmit  this 
information to the Member State concerned before 
the  plan  is  adopted  by  the  National  Parliament, 
inviting  the  budgetary  authorities  to  take  it  into 
account in the process of the budget law adoption. 
The  Commission  would  then  stand  ready  to 
present its opinion to the national Parliament at its 
request.

This  new  role  of  the  Commission  is  one  of 
information  and  monitoring,  and  there  is  no 
transfer  of  sovereignty  away  from  the  Member 
States,  which  remain  fully  competent  on  deciding 
on their budgets. The final budget Law is adopted 
by  the  National  Parliament  in  full  respect  of  its 
prerogatives. It is clear that countries  will need to 
respect  European  requirements  on  their public 
finances when setting their budgetary plans if they 
want to avoid that the Commission requests a new 
budgetary plan; but these requirements are already 
set in the Treaty and the SGP and this new exercise 
is only meant to enhance the dialogue between the 
Member  States  and  the  European  institutions  and 
among  themselves.  The  Regulation  on  enhanced 
monitoring therefore adds to the national rules and 
scrutiny of Member States' policy making but does 
not  place  additional  requirements  on  the  policies 
themselves that  should  have  anyway  been  in 
compliance of the requirements recalled in Chapter 
II.2.

In  addition,  any  Commission  Opinion  issued  on 
the  draft  budgetary  plan  of  a  Member  State  may 
inform  any  subsequent  decisions  about 
help 

98

whether this Member State should be placed in an 
Excessive  Deficit  Procedure;  the  Opinion  will  be 
formally taken into account in the steps leading the 
opening  of  the  procedure. More  precisely,  the 
extent  to  which  this  opinion  has  influenced  the 
final  budget  should  be  part  of  the  assessment, 
where no follow-up to the early guidance from the 
an 
Commission 
aggravating factor.

should  be 

considered 

as 

Finally, The Treaty on Stability, Coordination and 
Governance in the Economic and Monetary Union 
(TSCG)  described  in  Chapter  II.5  acknowledges 
the  necessity  to  enhance  coordination  on  the 
budgetary side by also increasing the exchange of 
information  concerning  debt  management.  The 
objective  is  to  ensure  that  each  national  debt 
manager  benefits  from  useful  information  about 
broad  parameters  of  debt  issuance  by  other  debt 
managers  in  the  euro  area.  The  Commission 
proposal  for  this  Regulation  could  be  amended 
accordingly  to  foresee  a  regular  reporting  by 
Member  States  on  their  ex  ante debt  issuance 
plans. 

Of course, possible gains, deriving from increased 
transparency and predictability of funding plans to 
all sovereign debt issuers in the euro area, have to 
be  weighed  against  the  imperative  and  justified 
needs  of  flexibility  and  confidentiality  of  issuing 
policies and procedures.

(ESDM), 

reporting  could  be  built  on  existing 
This 
mechanisms  and  frameworks  for 
information 
sharing  across  Member  States  on  their  debt 
issuance. For instance, the Economic and Financial 
Committee's Sub-Committee on EU sovereign debt 
of 
markets 
debt 
representatives 
management 
an
appropriate  forum  for  such  consultation  and 
cooperation. The ESDM has been established for a 
number of  years and  has  started to implement ad-
hoc  codes  on  monthly  reporting  of  national debt 
issuance. Existing processes could therefore allow 
Member States to comply with what is now set as a 
legislative requirement.

primarily 
of  Member 
could 

composed 
States' 
constitute 

offices, 

Evolving budgetary surveillance

Part II

Box II.4.2: Extract from Article 5 of the proposed Regulation on enhanced monitoring: 
Information to be presented by Member States in their draft budgetary plan

The draft budgetary plan shall contain the following information for the forthcoming year:

(a)  the  targeted  budget  balance  for  the  general  government  as  a  percentage  of  Gross  Domestic  Product 
(GDP), broken down by sub-sector of general government;

(b) the projections at unchanged policies for expenditure and revenue as a percentage of GDP for the general 
government and their main components;

(c) the targeted expenditure and revenue as a percentage of GDP for the general government and their main 
components,  taking  into  account  the  conditions  and  criteria  to  establish  the  growth  path  of  government 
expenditure net of discretionary revenue measures under Article 5(1) of Regulation (EC) No 1466/97;

(d) a detailed description and a well-documented quantification of the measures to be included in the budget 
for the year to come in order to bridge the gap between the targets referred to in point (c) and the projections 
at  unchanged  policies  provided  in  accordance  with  point  (b).  The  description  may  be  less  detailed  for 
measures with a budgetary impact estimated to be lower than 0.1% of GDP. Particular attention shall be paid 
to major fiscal policy reform plans with potential spillover effects for other Member States whose currency 
is the euro;

(e) the main assumptions about expected economic developments and important economic variables which 
are relevant to the achievement of the budgetary targets. These assumptions shall be based on independent 
macroeconomic growth forecast;

(f) where applicable, additional indications on how the current recommendations addressed to the Member 
State concerned in accordance with Article 121 of the Treaty in the budgetary area will be met.

A  closer  monitoring  of  progress  by  euro  area 
Member  States  under  the  Excessive  Deficit 
Procedure (EDP)

the 

new 

surveillance, 

While  the  enhancement  of  the  monitoring  of 
national  budgetary  policies  for  all Member  States 
of the euro area reinforces the preventive aspect of 
proposed 
European 
Regulation also includes provisions to increase the 
effectiveness  of  its  corrective  part.  The  corrective 
arm  only  concerns  Member  States  which  have 
already  breached  the  rules  governing  either  the 
deficit  level  or  the  pace  for  debt  reduction,  and 
which,  as  a  consequence,  are  subject  to  an 
Excessive  Deficit  Procedure  (EDP).  The  fiscal 
position of such Member States being particularly 
fragile,  it  becomes  a  matter of  common  concern 
for  the  euro  area  as  a  whole.  It  is  therefore  the 
responsibility  of  the  EU  to  put  in  place  tighter 
requirements to ring-fence the budgetary fragilities 
and  ensure  an  effective  and  durable  correction  of 
budgetary slippages.

Enhancing  the  effectiveness  of  the  monitoring 
exerted  at  the  EU  level  in  the  framework  of  the 
EDP  means  ensuring 
that  Member  States 
concerned  take  sufficient  and  effective  action, so 
that  their  excessive  deficit  is  corrected  within  the 
specific  deadline  set  by  the  Council.  The  SGP 
already  foresees that  concerned  Member  States 
would submit a progress report to the Commission 
and  the  Council.  This  report  presents  the  action 
taken by the Member State to correct the excessive 
deficit  (Article  3(4a)  of  Regulation  1467/97) 
within  the  six  months  (at  the  latest)  following 
Council  recommendations  issued  in  accordance 
with  Article  126(7)  TFUE  (see  Table  II.4.1).  It  is 
on  the  basis  of  the  information  provided  in  that 
report 
a 
recommendation  by  the  Commission,  whether 
effective action has been taken.  

the  Council 

decides, 

that 

on 

However,  experience  has  shown  that  a  closer 
monitoring  of  budgetary  developments  and  of  the 
corrective  action  undertaken,  over  and  above  this 
existing report,  would be instrumental in ensuring 

99

heightened  to  every  three  months  if  the  Member 
State is subject to a Council notice (in accordance 
with  Article  126(9)  TFUE).  Indeed,  such  Council 
notice is issued after the  Council  has decided that 
the Member State has not taken effective action to 
correct  its  excessive  deficit;  this  more  critical 
situation  deserves  a  closer  and  more  frequent 
monitoring  of  budgetary  developments  for  the 
Member State concerned.

In this way, more frequent information sharing will 
be the basis for the identification of the risks that a 
Member  State  might  not  correct  its  excessive 
deficit  within  its  deadline.  In  the  event  of  such 
risks being identified, the Commission will issue a 
recommendation to the Member State for measures 
to  be  taken  within  a  given  timeframe.  This 
recommendation  will  be  presented 
the 
Parliament  of  the  Member  State  concerned  at  its 
request.  Compliance  with  this  recommendation 
should  allow  for  a  rapid  correction  of  any 
developments  putting  at  risk  the  correction  of  the 
excessive deficit within the established deadline. 

to 

of 

such 

compliance  with 

a 
Assessment 
Commission recommendation should be part of the 
continuous  assessment  made  by  the  Commission, 
of  the  effective  action  to  correct  the  excessive 
in  particular  when  deciding  whether 
deficit, 
effective action to correct the excessive deficit has 
been taken.

European Commission

Public finances in EMU - 2012

increases 

an  early  correction  of  any  deviations  from  the 
Council recommendations on the correction of the 
excessive  deficit.  Building  on  this  rationale,  this 
the 
proposed  Regulation 
requirements  placed  on  euro  area  Member  States 
in  terms  of  the  scope  of  the  information  to  be 
shared  and  the  frequency  of  the  reports  to  be 
submitted  to  the  Commission  and  to  the  Council. 
This  will  allow  an  early  identification  of  risks  to 
the  compliance  with  the  Member  State's  deadline 
to correct its excessive deficit.  

both 

When an EDP is opened, the Member State has to 
present a comprehensive overview of its budgetary 
situations  and  of  the  actions  it  plans  to  take  to 
correct  the  excessive  deficit.  In  this  way  the 
initial 
proposed  Regulation  complements 
report  on  action  taken  with  a  comprehensive 
assessment  of  in-year  budgetary  execution  for  the 
general  government  and  its  sub-sectors,  including 
financial  risks  associated  to  contingent  liabilities 
with potentially large impacts on public budgets, to 
the extent that they may contribute to the existence 
of an excessive deficit.

the 

Second,  besides  this  initial  overview  of  situation 
and  the  elaboration  of  the  plans  drawn  up  by  the 
Member  State  after  entering  the  excessive  deficit 
procedure,  the  proposed  Regulation  foresees  a 
regular  exchange  of  information,  following  the 
initial report, until the excessive deficit is actually 
corrected.  Accordingly,  euro  area  Member  States 
in  EDP  are  required  to  report  regularly  to  the 
Commission  and  to  the  Economic  and  Financial 
Committee, 
bodies  with 
information  on  the  in-year  budgetary  execution, 
the  budgetary  impact  of  discretionary  measures 
taken  on  both  the  expenditure  and  the  revenue 
side,  targets  for  the  government  expenditure  and 
revenues,  as  well  as  information  on  the  measures 
adopted  and  the  nature  of  those  envisaged  to 
achieve the targets for the general government and 
its sub-sectors. The report shall be made public.

providing 

these 

As  provided  for  in  Article  126  of  the  Treaty,  the 
modalities  of  such  closer  monitoring  have  to  be 
graduated depending on the stage of the procedure 
the Member State is subject to. Therefore, after the 
initial  report  on  action  taken  to  be  submitted  in 
accordance  with  Regulation  1467/97,  the  new 
regular  reporting  introduced  by  the  proposed 
Regulation  on  enhanced  monitoring  is  to  be 
submitted  every  six  months,  but  the  frequency  is 

100

Evolving budgetary surveillance

Part II

Graph II.4.1:

The new fiscal governance framework in the euro area

the  Member  State  concerned  by  a  Commission 
recommendation issued in the context of the closer 
monitoring to participate in an exchange of views.

Source: Commission services.

As described in Chapter II.5, the TSCG introduces 
the  concept  of  'economic  partnership  programme' 
for  countries  in  EDP,  i.e.,  a programme  including 
structural reforms to ensure a durable correction of 
the  excessive  deficit.  Also  progress  with  the 
the  economic  partnership 
implementation  of 
programme  could  be 
the closer 
in 
monitoring envisaged by this proposed regulation. 

included 

Attention  has  been  paid  to  avoid  over-burdening 
national  administrations:  reports  and  monitoring 
already envisaged throughout the excessive deficit 
procedure,  as  described  in  the  corresponding 
Regulation of the SGP, are included and combined 
with the requirements set out in the new proposed 
text (see Table II.4.I). In addition, countries which 
are  subject 
to  a  macroeconomic  adjustment 
programme  are  also  exempt  from  the  reporting 
requirements  of 
this  proposed  Regulation  on 
monitoring and assessment.

Finally,  in  order  to  enhance  the  dialogue  between 
the  Union  institutions  – in  particular  between  the 
European  Parliament, 
the 
Commission  –and  to  ensure  greater  transparency 
and accountability, the competent committee of the 
European Parliament  may offer the opportunity to 

the  Council  and 

101

European Commission

Public finances in EMU - 2012

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Evolving budgetary surveillance

Part II

Box II.4.3: The proposed Regulation on enhanced surveillance for Member States 
experiencing severe difficulties with regard to their financial stability or for those in receipt 
of financial assistance

The second proposal for a Regulation of the so-called Two-Pack makes Member States experiencing severe 
difficulties with regard to their financial stability or receiving a financial assistance on a precautionary basis 
subject  to  enhanced  surveillance.  The  proposal  dovetails  the  financial  assistance  granted  outside  the 
framework of the Union with the Treaty, by setting out a clear procedure for preparing and adopting macro-
economic  adjustment  programmes.  It  also  sets  out  the  procedure  for  post-programme  surveillance  for 
countries which have received loans or have drawn a precautionary assistance.

The main components of the proposed regulation are:

(a) enhanced surveillance

The  Commission  can,  in  close  cooperation  with  the  EFC,  decide  to  make  a  Member  State  subject  to 
enhanced surveillance, with such a decision being automatic for countries receiving precautionary financial 
assistance. This surveillance involves (a) an obligation on the Member State to adopt measures to address 
the sources of instability, (b) regular review missions, and (c) quarterly reporting by the Commission to the 
Eurogroup Working Group (EWG). This will give the Commission significant powers: beyond full access to 
fiscal data, the Commission would have the capacity to force a stress test exercise or to access disaggregated 
data of financial institutions. 

If  monitoring  shows  that  further  measures  are  needed  and  the  financial  situation  of  the  Member  State 
concerned has a significant impact on the financial stability of the euro area, the Commission can propose to 
the Council to recommend that this Member State take precautionary measures or prepare a macroeconomic 
adjustment programme (de facto, seek financial assistance). 

(b) procedure for deciding and monitoring a macroeconomic adjustment programme 

The programme is prepared by the country and the Commission (in liaison with the ECB) and is submitted 
for approval to the Council via a Commission proposal.   The Commission, in liaison with the ECB, will 
ensure the monitoring  of  the  programme.  The  two  main  novelties  are  (a)  an  obligation  on  the  MS  facing 
insufficient  administrative  capacities  to  seek  technical  assistance  from  the  Commission  and  (b)  the 
possibility  for  the  Council  to  decide  that  a  beneficiary  is  not  complying  with  the  policy  requirements 
contained in the adjustment programme. The latter decision would have very significant effects; it would de 
facto  trigger  the  interruption  of  the  disbursements  of  the  financial  assistance  of  the  European  Financial 
Stability Fund (EFSF)/European Stability Mechanism (ESM) and a suspension of payments or commitments 
under the structural funds. 

(c) simplification of the monitoring of programme countries

Macroeconomic adjustment programmes go beyond fiscal issues and have a wide scope, covering all policy 
areas  that  could  improve  the  economic  and  financial  situation.  All  attention  naturally  focuses  on  the 
monitoring  of  the  programme,  if  only  because  it  conditions  the  disbursements.    For  this  reason,  it  is 
proposed  to  avoid  duplication  and  overburdening  by  suspending  the  monitoring  under  the  SGP and  the 
implementation  of  the  Excessive  Imbalance  Procedure (EIP),  European  Semester  and  the  proposed 
Regulation on enhanced budgetary monitoring. 

(d) post-programme surveillance

Post-programme  surveillance  inadvertently  offers  lenders  extra  protection  by  ensuring  that  the beneficiary 
remains  on  the  right  fiscal  track,  thus  protecting  its  capacity  to  repay  its  debt.  Under  the  proposed
Regulation, a country would be subject to the post-programme surveillance conditions as long as it has not 

(Continued on the next page)

103

European Commission

Public finances in EMU - 2012

Box (continued)

repaid 75%  of  its  debt.  This  could  lead  to  a  very  long  surveillance  period,  which  explains  why  post-
programme  surveillance  is  not  described  in  detail.  The  Commission  would  have  monitoring  powers  and 
report twice a year. Where appropriate, it can propose to the Council to recommend to the MS concerned to 
adopt  corrective  measures.  The  wording  allows  enough  flexibility  to  fine  tune  the  level  of  surveillance 
according to specific needs; it can be either intrusive or very light, depending on the economic and financial 
situation of the Member State concerned. 

It  should be  noted  that  the  Commission  will  implement  post-programme  surveillance  only  if  the  financial 
support is financed by the EU (EFSM) or its Member States (ESM, EFSF), but not if it comes from the IMF 
or third countries.

104

5.

THE STABILITY TREATY AND THE FISCAL COMPACT

to 

an 

(TSCG), 

further  strengthen and 

The  Treaty  on  Stability,  Coordination  and 
Governance 
intergovernmental 
initiative,
is  the  latest  stage  of  the European
economic  governance  reform. As  part  of  the
multidimensional  response  to  the  economic  and 
financial crisis, it is a reflection of Member States' 
willingness 
fully 
implement the  provisions  of  the  revised  Stability 
and  Growth  Pact
(SGP).  Indeed,  Contracting 
Parties  have  decided  to  incorporate  key  concepts 
of the SGP within their national legislation, and to 
go  beyond  in  some  cases.  Even  if  the  preference 
would have been the adoption of similar provision 
within  the  framework  of  EU  law,  the  TSCG 
nevertheless runs  alongside  and  complements  the 
new  legislation  on  fiscal  and  macroeconomic
surveillance  – the  so-called  "Six-Pack"  – which 
entered into force on 13 December 2011. 

5.1. 

THE TREATY ON STABILITY, 
COORDINATION AND GOVERNANCE : 
AN INTERGOVERNMENTAL INITIATIVE TO 
STRENGTHEN BUDGETARY DISCIPLINE 
AND ECONOMIC POLICY 
COORDINATION  

5.1.1. An intergovernmental initiative 

and 

fiscal 

At  the  European  Council  of  8-9  December  2011, 
most EU Member States decided to open the  way 
to  an  intergovernmental  treaty  designed  to  ensure 
economic 
surveillance 
greater 
coordination  within 
the  European  Union. 
Following a period of negotiations which involved 
all 27 Member States, as well as consultations with 
the European Parliament, the Commission and the 
European Central Bank, the  Treaty  was signed on 
2  March  2012  by  25  Heads  of  State  or 
Government. (72)

to 

The option of an international treaty allowed those 
Member  States  willing 
proceed  with 
commitments  going  beyond  what  is  currently 
envisaged  by  the European Treaties,  to  do  so 
despite other States  wishing to remain outside the 
process.  While  not  being  part  of  EU  law  as  such, 
the  Treaty  on  Stability,  Coordination  and 

(72) The  TSCG  was  signed  by  all  euro  area  Member  States,  
and  by  Bulgaria,  Denmark,  Hungary,  Latvia,  Lithuania, 
Poland,  Romania,  and  Sweden. The  United  Kingdom  and 
the Czech Republic did not sign the TSGC.

Governance  is  however  consistent  with  EU  law
and  shall  be  applied  in  conformity  therewith.  The 
Treaty  therefore  appears  as  a  demonstration  of 
Member  States'  willingness  to  go for  a  closer 
economic union.

and 

Governance 

The  25  signatories  of  the  Treaty  on  Stability, 
(TSCG), 
Coordination 
concentrated their commitments to achieve greater 
budgetary  and  economic  coordination  on  three 
main  dimensions: 
(ii) 
economic  policy  convergence  and  (iii)  enhanced 
governance of the euro area.

fiscal  discipline, 

(i) 

5.1.2. Building on the Stability and Growth 

Pact, a fiscal compact to improve 
Member States' budgetary discipline

On the budgetary side, the fiscal compact (Articles 
3 to 8 of the TSCG), which covers the fiscal rules 
of  the  TSCG,  gathers  elements  of  a reinforced 
coordination 
stages  of  budgetary 
surveillance, which is governed at the level of the 
Union  by  the  SGP  – with  some  reinforced 
provisions specific to the euro area. 

all 

for

The fiscal compact follows the two-fold approach 
of the SGP, where a preventive arm is designed to 
maintain or guide Member States towards medium 
and  long-term  fiscal  sustainability;  coming  at  a 
later  stage,  in  cases  that  the  preventive  arm  is 
supposed to avoid, corrective mechanisms, namely 
the  excessive  deficit  procedure  (EDP),  ensure  the 
correction of gross policy errors.

The  fiscal  compact  intends  to  complement  both 
stages of fiscal surveillance, through:

− at  a  preventive  stage:  implementation  of  a 
balanced-budget rule into national law; ex-ante 
reporting on debt issuance plans;

− ensuring  the  correction  of  gross  policy  errors: 
greater  deterrence  of  the  corrective  procedure; 
new  focus  on  structural  reform  necessary  to 
accompany correction of fiscal imbalances. 

− As main commitments consist in enshrining in 
national  law,  and  with  the  support  of  national 
mechanisms,  core  principles  of  the  SGP,  the 
fiscal  compact  demonstrates  an 
increased 
ownership  of  European  rules.  This  can  only 

105

European Commission

Public finances in EMU - 2012

reinforce  adherence  and  compliance  with  a 
common  commitment  towards  sounder  fiscal 
policy-making in Europe. 

Accordingly, and building directly on the concepts
of  the  European  Stability  and  Growth  Pact,  the 
fiscal compact sets the following rules:

level 

the  core  concept of 

• Contracting  Parties  commit  to  translate  at  the 
national 
the 
'preventive  arm'  of  the  SGP:  their  budget  will 
'balanced  or  in  surplus'
have  to  reach  a 
the  annual 
if 
position,  deemed  respected 
structural balance of the general government is 
at  the  country-specific  medium-term  objective 
(MTO).  In  most  cases,  this  MTO  will  have  a 
lower limit amounting to a structural deficit of 
-0.5%  of  GDP  (see  section  5.2.2  below). 
Following  the  same  rules  as  in  the  SGP,  a 
temporary  deviation  from  the  medium-term 
objective or the adjustment path towards it will 
only  be  possible  in  exceptional  circumstances. 
In case of significant observed deviations from 
the  MTO  or  the  adjustment  path  towards  it, 
also assessed in accordance with SGP concepts, 
correction  mechanisms  will  be 
triggered 
automatically at the national level.

• To  ensure  compliance,  the  Contracting  Parties 
will  have  to  enshrine  those  rules  in  their 
national  law  through  provisions  of  binding 
force and permanent character. Failure to do so 
may  result  in  the  CJEU imposing a  financial 
sanction  of  up  to  0.1%  of  the  Member  State's 
GDP. In addition, independent bodies will be in 
charge,  at  the  national  level,  of  monitoring 
compliance with the balanced-budget rule.

•

If  deficits  need  to  be  contained,  the  crisis 
showed that debt also requires to be monitored 
closely.  A  major  innovation  of  the  six-pack 
was  to  give  to  the  government  debt  as  much 
importance  as  to  the  deficit,  by  allowing  the 
opening of an EDP if any of the two criteria is 
not  respected.  Recalling  their  commitment  to 
comply  with  what  has  been  translated  into  a 
new  debt  reduction  benchmark  (see  Chapter 
II.2),  the  Contracting  Parties  re-state  in  the 
TSCG  that,  in  case  their  general  government 
debt exceeds  60%  of  GDP,  they  will  have  to 
reduce  the  difference  between  their  debt-to-

106

GDP ratio and the 60% threshold at an average 
rate of one twentieth per year as a benchmark.

• Confirming the greater focus on debt and with 
a view to better coordinate the planning of their 
national  debt  issuance,  the  Contracting  Parties 
will report ex ante on their issuance plans to the 
Council  of  the  EU and  to  the  European 
Commission.

for 

these  new 

• Enforcement of the rules of the SGP was one of 
the challenges to be addressed by the reform of 
the  SGP.  In  that  vein,  the  six-pack  reinforced 
disincentives for non-compliant Member States 
of the euro area, through the creation of quasi-
automatic  financial  sanctions  attached  to  the 
different  steps  under  the  preventive  arm  and 
under the EDP. Indeed, sanctions are triggered 
under  a  recommendation  of  the  Commission, 
unless  a  qualified  majority  of  Member  States 
opposes  them:  this  is  the  so-called  reversed 
qualified  majority  voting.  If  such  voting  rules 
were  possible
sanctions 
introduced  by  secondary  law,  the  steps  of  the 
EDP  itself  are  set  by  the  Treaty  on  the 
Functioning  of  the  European  Union  (TFEU), 
together with the corresponding voting rules in 
the  Council  of  the  EU:  they  could  not  be 
modified by one of the Regulations of the six-
pack.  As  a  consequence,  to  strengthen  the 
deterrence  of  the  procedure  by  introducing 
more  automaticity  in  the  different  steps  of  the 
EDP, the  only  alternative  to  a  Treaty  change 
was  an  intergovernmental  agreement.  Hence 
the 
the 
Contracting  Parties  of  the  TSCG  to  support 
Commission  recommendations  in  the  context 
of  the  EDP  unless  a  qualified  majority  of 
Member  States  is  against  – mimicking  the  so-
called reversed qualified majority voting. Even 
though  this  provision  is  restricted  to  cases 
when  the  procedure  is  opened  on  the  basis  of 
an  excessive  deficit,  leaving  aside  debt-based 
EDPs, this provision, coming on top of the new 
financial  sanctions  of 
the  six-pack,  will 
enhance  the  dissuasive  dimension  of the  EDP 
for euro area Member States. 

commitment" 

"behavioural 

of 

• To support the correction of excessive deficits, 
and  ensure  its  effectiveness  and  durability, 
Contracting  Parties  add  a  complement 
to 
the excessive 
existing  requirements  under 

deficit procedure. Contracting Parties subject to
an  EDP will  have  to  present an economic 
partnership  programme  detailing the  structural 
reforms  that  are  deemed  necessary  to  support 
an  effective  and  durable  correction  of  the 
excessive deficit.

5.1.3. An agreement aimed at reinforcing 
economic coordination and 
governance of the euro area.

Economic  policies  are  a  matter  of  common 
concern  for  all  Member  States  of  the  Union,  as 
stated by  Article 121 of the  TFUE. Commitments 
are made in that direction in the framework of the 
TSCG, to  deepen  economic  policy coordination 
and  convergence  (Title  IV  of  the  TSCG).  These 
include 
enhanced 
cooperation  on  matters  essential  for  the  smooth 
functioning of the euro area, as well as greater ex-
ante coordination  of  the  major  economic  policy 
reforms  planned  by 
signatories.  Such 
coordination  will  involve  the  institutions  of  the 
European Union.

increased 

recourse 

the 

to 

in  order 

introduced 

Provisions were  also 
to 
reinforce  the  governance  of  the  euro  area  (title  V 
of  the  TSCG).  The  Treaty  makes  provision  for 
regular  informal  meetings  to  take  place  between 
the  Heads  of  State  or  Government  of  euro  area 
Member States, together  with the President of the 
European  Commission.  The  objective of  those 
Euro  Summit  meetings,  which  shall  take  place  at 
least  twice  a  year,  will  be  to  discuss  issues 
concerning  the  governance  of  the  Economic  and 
Monetary  Union,  as  well  as  strategic  orientations 
to  increase  economic  convergence  among  euro-
area  Member  States. A  President  of  the  Euro 
Summit, appointed by the euro-area Heads of State 
or  Government  will ensure  the  preparation  and 
continuity  of  the  meetings  in  close  cooperation 
with  the  President  of  the  European  Commission. 
Herman  Van  Rompuy  was  designated  to  embody 
this  function,  with  the  same  term  of  office  as  for 
the  presidency of  the  European  Council that  he 
holds  in  parallel  until  30  November  2014.  The 
President of the Euro Summit,  will keep non-euro 
area  Member  States  informed  of  the  preparation 
and outcome of those  meetings and  will present a 
report  to  the  European  Parliament  after  each  of 
them.

Evolving budgetary surveillance

Part II

5.2.  OPERATIONALISING THE TREATY -

RATIFICATION PROCESS AND 
ANCHORING INTO EU LAW

5.2.1. The ratification process of the TSCG

Before  it  becomes  operational,  the  Treaty  on 
Stability,  Coordination  and  Governance  will  have 
to  go  first  through  a  ratification  process  by  the 
Member States’ national parliaments. 

The  Treaty  shall  enter  into  force  on  1  January 
2013,  provided  that  twelve  euro-area  signatories 
have ratified it. The national parliaments of several 
euro area Member States have already approved it: 
Greece  was  the  first  signatory  to  notify  the 
ratification the  TSCG  on  10  May 2012,  followed 
by Slovenia, Portugal and Latvia.

While  euro-area  Member  States  are  bound  by  the 
Treaty  from  the  first  day  of  the  month  following 
the deposit of their instrument of ratification, other 
Contracting Parties whose currency is not the euro 
may  decide  to  be  bound  by  certain  provisions 
related to the  fiscal compact  and economic policy 
coordination, on a voluntary basis.

In  parallel,  the  European  institutions  are  working 
towards  the  integration  of  some  provisions  of  the 
Treaty into EU law.

5.2.2. Anchoring provisions into EU law: 

possible Commission initiatives and 
connection with the Two-Pack

the 

treaty 

indicated 

of 
the  EU 

provisions 
into 

Contracting  Parties  of  the  TSCG  pledged  to
incorporate
the 
legal 
intergovernmental 
framework within five years of its entry into force. 
The  European  Commission  has 
its 
intention  to  operationalize  relevant  parts  of  the 
treaty, such as key elements of the fiscal compact, 
through secondary legislation. The objective of the 
European  Commission  is  to  ensure  that  novelties,
and  elements  needed  for  their  operationalization,
are  entrenched  into  law  via  the Community 
method, in full compatibility with the Stability and 
Growth  Pact. Relying  on EU 
law,  when 
appropriate,  will ensure  a quick  and  smooth 
implementation.

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European Commission

Public finances in EMU - 2012

5.2.2.1. Calendar for convergence towards 

the MTO

in 

is  maintained  at 

While  Member  States  commit 
the  fiscal 
compact to set up a constraining framework at the 
national  level  to  ensure  that  their  budgetary 
position 
the  medium-term 
budgetary  objective,  most  of  the  Contracting 
Parties  are  currently  not  yet  at  their  MTO. 
Therefore,  a  horizon  needs  to  be  set  for  their 
adjustment towards the objective. Accordingly, the 
Commission  will  define  a  timeframe  for  the 
convergence  towards  Member  States'  respective 
MTOs.

This calendar will be presented by the Commission 
following  the  imminent  revision  of  the  MTOs, 
which  occurs  every  three  years  and  is  due  this 
year. It will be based on common principles, and in 
full accordance with the spirit and the principles of 
the SGP.

According to the fiscal compact, MTOs in the euro 
area,  which  are  country-specific  values,  could  not
go below a structural deficit of 0.5% of GDP: this 
is  slightly  more  stringent  than  what exists  in  the 
current  legislation,  i.e.  -1%  for  Member  States 
participating in the Economic and Monetary Union 
or  in  the  European  Exchange  Rate  Mechanism  II. 
The fiscal compact however maintains this limit of
-1%  of  GDP  for  Member  States  with  a  debt-to-
GDP  ratio  significantly  below  60%  and  low  risks 
for the sustainability of public finances.

5.2.2.2. Common principles for the national 

set-ups ensuring compliance with the 
balanced-budget rule

principles  underlying 
the  national  correction 
mechanisms was issued by the Commission on 20 
June 2012. (see Box II.5.1).

5.2.2.3. Strengthening ex ante economic 

coordination

The  TSCG  envisages  a  reinforced  economic 
coordination,  stipulating 
the  Contracting 
Parties  should  ensure  that  all  major  economic 
reforms  that  they  plan  to  undertake  will  be 
discussed  ex  ante,  and  where  appropriate, 
coordinated among themselves. 

that 

to  present 

information  on 

According to these provisions, Contracting Parties 
will  have 
those 
economic  reform  plans  - which  could  have  spill 
over  effects  on  other  Member  States  - ahead  of 
their adoption, so that they may be discussed at the 
level  of  the  Eurogroup.  Countries  that  do  not 
participate  in  the  Economic  and  Monetary  Union 
may also opt in the process and present their own 
economic  reform  plans  to  other  Member  States. 
This  mechanism  will  allow 
identifying  best 
practice  and  benchmarking  future  reforms.  This 
will  also  be  an  occasion  to  look  systematically  at 
likely  cross-border  spill  over  effects  as  well  as 
implications  for  the  euro  area's  overall  macro-
economic policy stance.

compact

In order  to  ensure  compliance  with  the  new  rules 
the 
implementing  MTOs  at  the  national  level,
fiscal 
correction 
foresees 
mechanism will  be  triggered  automatically  in  the 
event of a significant deviation from the  medium-
term objective or the adjustment path towards it. 

that 

a 

According  to  the  TSCG,  this  national mechanism 
is to  be  put  in  place  on  the  basis  of  common 
principles  to  be  proposed  by  the  Commission  on 
the  nature,  size  and  timeframe  of  the  corrective 
action to be undertaken, as well as on the role and 
independence 
institutions 
responsible  for  monitoring  compliance  with  the 
rule.  A  Communication  putting  forward  common 

national 

the 

of 

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Evolving budgetary surveillance

Part II

Box II.5.1: Common principles for national fiscal correction

The common principles for national fiscal correction mechanisms as expressed in the Communication form 
the Commission COM(2012) 342 of 20 June 2012 are the following.

(1)  [Legal  status]  The  correction  mechanism  shall  be  enshrined  in  national  law  through  provisions  of 
binding  force  and  permanent  character,  preferably  constitutional,  or  otherwise  guaranteed  to  be  fully 
respected and adhered to throughout the national budgetary processes. The mechanism shall fully respect the 
prerogatives of national Parliaments. 

(2) [Consistency with EU framework] National correction mechanisms shall rely closely on the concepts and 
rules of the European fiscal  framework. This  applies in particular to the notion of a 'significant deviation' 
and the definition of possible escape clauses.  The correction, in terms of size and timeline, shall  be made 
consistent with possible recommendations addressed to the concerned Member State under the Stability and 
Growth Pact. 

(3) [Activation]  The  activation  of  the  correction  mechanism  shall  occur  in  well-defined  circumstances 
characterising  a  significant  deviation  from  the  medium-term  objective  (MTO)  or  the  adjustment  path 
towards  it.  The  activation  triggers  may  comprise  EU-driven or  country-specific  criteria,  to  the  extent  that 
they meet the above condition. Subject to the same condition, both ex ante mechanisms that set budgetary 
objectives  preventing  the  materialisation  of  deviations  and  ex  post  mechanisms  that  trigger  corrections  in 
reaction to prior deviations, may fulfil the requirements. 

(4)  [Nature  of  the  correction]  The  size  and  timeline  of  the  correction  shall  be  framed  by  pre-determined 
rules.  Larger  deviations  from  the  medium-term  objective  or  the  adjustment  path  towards  it  shall  lead  to 
larger corrections. Restoring the structural balance at or above the MTO  within the planned deadline, and 
maintaining  it  there  afterwards,  shall  provide  the  reference  point  for  the  correction  mechanism.  The 
correction  mechanism  shall  ensure  adherence  to  critical  fiscal  targets  as  set  before  the  occurrence  of  the 
significant  deviation,  thereby  preventing  any  lasting  departure  from  overall  fiscal  objectives  as  planned 
before the occurrence of the significant deviation. At the onset of the correction Member States shall adopt a 
corrective plan that shall be binding over the budgets covered by the correction period. 

(5) [Operational instruments] The correction mechanism may give a prominent operational role to rules on 
public expenditure and discretionary tax measures, including in activating the mechanism and implementing 
the correction, to the extent that these rules are consistent with attainment of the MTO and the adjustment 
path towards it. The design of the correction mechanism shall consider provisions as regards, in the event of 
activation, the coordination of fiscal adjustments across some or all sub-sectors of general government. 

(6)  [Escape  clauses]  The  definition  of  possible  escape  clauses  shall  adhere  to  the  notion  of  'exceptional
circumstances' as agreed in the Stability and Growth Pact. This would include an unusual event outside the 
control  of  the  concerned  Member  State  with  a  major  impact  on  the  financial  position  of  the  general 
government, or periods of severe economic downturn as defined in the Stability and Growth Pact, including 
at the level of the euro area. The suspension of the correction mechanism in the event of an escape clause 
shall  be  on  a  temporary  basis.  The  correction  mechanism  shall  foresee  a  minimum  pace  of  structural 
adjustment once out of the escape clause, with the requirement from the Stability and Growth Pact a lower 
limit. When exiting the escape clause, Member States shall adopt a corrective plan that shall be binding over 
the budgets covered by the correction period.

(7)  [Role  and  independence  of  monitoring  institutions]  Independent  bodies  or  bodies  with  functional 
autonomy  acting as  monitoring institutions shall support the credibility and transparency of the correction 
mechanism.  These  institutions  would provide  public  assessments  over:  the  occurrence  of  circumstances 
warranting  the  activation  of  the  correction  mechanism;  of  whether  the  correction  is  proceeding  in 
accordance with national rules and plans; and over the occurrence of circumstances for triggering, extending 
and exiting escape clauses. The concerned Member State shall be obliged to comply with, or alternatively 

(Continued on the next page)

109

European Commission

Public finances in EMU - 2012

Box (continued)

explain publicly why they are not following the assessments of these bodies. The design of the above bodies 
shall  take  into  account  the  already  existing  institutional  setting  and  the  country-specific  administrative 
structure. National legal provisions ensuring a high degree of functional autonomy shall underpin the above 
bodies, including: i) a statutory regime grounded in law; ii) freedom from interference, whereby the above 
bodies shall not take instructions, and shall be in a capacity to communicate publicly in a timely manner; iii) 
nomination  procedures  based  on  experience  and  competence;  iv)  adequacy  of  resources  and  appropriate 
access to information to carry out the given mandate.

5.2.2.4. Connections with the Two-Pack 

Regulation on enhanced monitoring 

The rationale of the TSCG shares some traits (see 
Part II.4)  with the proposed Two Pack Regulation 
for  monitoring  and 
on  common  provisions 
assessing  draft  budgetary  plans  and  ensuring  the 
correction  of  excessive  deficit  of  the  Member 
States in the euro area. 

Both  initiatives  have  the  same  objective  to  secure 
sound  fiscal  policy-making  in  the  euro  area,  by 
provisions  complementing  at  the  same  time  the 
preventive  and  the  corrective  arms  of  the  SGP. 
Both intend to articulate better budgetary practices 
at  Member  State 
strengthened 
provisions for euro area fiscal surveillance.

level  with 

is  why 

inter-institutional 
the  current 
This 
negotiations on the Two-Pack offer an appropriate 
context to reflect on how to enshrine into EU law 
some  of  the  provisions  of  the  intergovernmental 
treaty. The  proposed  Regulation  on  enhanced 
monitoring could provide a suitable legal space to
enshrine  into  EU  law  some  of  the  key  elements 
operationalising  the  TSCG,  and  more  specifically 
the fiscal compact.

110

Part III
Consolidation and dynamics of the multipliers. 
Are there counter-intuitive effects?

SUMMARY

the 

started 

process 

necessary 

One  of  the  main  consequences  of  the  economic 
and  financial  crisis  has  been  sharp  increases  in 
government  debt.  As  a  result,  the  EU  Member 
of
States 
consolidating their  government  finances in  2010.  
In  the  face  of  growing  signs of  a  weakening 
economy,  a  public  debate  is  taking  place  on  the 
government 
effectiveness 
finances.  The  tone  of  the  debate  has  mounted  in 
the  claim  that "austerity can  be self-defeating". 
The  aim  of  this  Chapter  is  to  provide  simulations 
on the  short- and  long-term  effects  of  fiscal 
consolidations under various scenarios. 

consolidating 

of 

the

the 

the 

i.e. 

fiscal  multiplier, 

The  main  factors driving 
impact  of  a 
consolidation on the debt-to-GDP ratio are the size 
impact  of 
of 
consolidation  on  growth,  and  the  reaction  of 
sovereign  yields  to  such  a  consolidation.    While 
there  is  a  large  body  of  research  concerning  the 
former  (with  an  equally  large  variance  in  the 
results), 
is  currently  available 
concerning the latter. 

less  evidence 

if 

iii) 

the 

larger 

The size of the fiscal multipliers depends on many 
factors,  the  most  relevant  of  which  are  i)  the 
composition  of  the  adjustment  and  whether  it  is 
perceived  to  be  permanent  or  temporary,  ii)  the 
absence  or  presence  of  financial  constraints  for 
economic  agents, 
the  size  of  automatic 
stabilizers, iv) the initial level of public debt, v) the 
stance of monetary policy and vi) the international 
economic  environment.  Moreover  the  size  of  the 
fiscal  multipliers  evolves  with  time.  The  size  of 
first-year  multipliers 
fiscal 
is 
consolidation is based on government expenditures 
– and government investment in particular – if the 
measures  taken  are  not  credible  and  temporary,  if 
agents  are  financially  constrained  and  if  the 
monetary  policy 
to 
accommodate the effect on real interest rates along 
with  the  fiscal  shock.  The  negative  output  effects 
of  consolidations  in  one  country  are  reinforced  if 
consolidations  are  implemented  at  the  same  time 
by  all  its  trade  partners.  The  composition  has  an 
tax-based 
long-term  output,  as 
impact  on 
consolidations  have  a  long-term  negative  impact 
on  output  which  is  not  present  in  expenditure-
based  consolidations  unless  these  are  based  on 
government investment.

is  unable  or  unwilling 

in  crisis  periods because  of  the  increase  in 
aggregate uncertainty about aggregate demand and 
credit  conditions,  which 
therefore  cannot  be 
insured by any economic agent, of the presence of 
slack  in  the  economy,  of  the  larger  share  of 
consumers that are liquidity constrained, and of the 
more  accommodative  stance  of  monetary  policy. 
Recent empirical works on US, Italy, Germany and 
France confirm this finding. It is thus reasonable to 
assume  that  in  the  present  juncture,  with  most  of 
the 
undergoing 
consolidations,  and  in  the  presence  of  tensions  in 
the  financial  markets  and  high  uncertainty,  the 
multipliers  for  composition-balanced  permanent 
consolidations are higher than normal. 

economies 

developed 

For the counter-intuitive debt dynamics to happen 
multipliers  should  be 
to 
significant  slack  in  the  economy  or  lack  of 
credibility  of  the  consolidation  programme,  very 
persistent and financial markets very short-sighted. 

large,  either  due 

However, even  when  these  factors come together, 
the  analysis  also  shows  that  even  for  high  but 
plausible  values  of  the  first-year  fiscal  multipliers 
such counterintuitive scenario would be short-lived 
unless 
the  effects  of  consolidation  on  GDP 
remained  large  for  two-three  years  or  if  deficit 
reduction induces  a  rapid  and  large  increase  on 
average effective interest rates - contrary to what is 
normally expected and estimated in consolidations 
- and  the  increase  in  risk  premia  induced  by  a 
higher  observed  debt  ratio  are  ten  times  the 
average  estimates.  In  the  latter  and  improbable 
case  only,  somewhat 
longer-lasting  counter-
intuitive  dynamics  could  not  be  excluded.  Once 
again, a high degree of financial market myopia is 
further  required  for  these  effects  to  happen:  if,  to 
the  contrary,  after  consolidation  measures  have 
been  implemented  financial  markets  do  not  only 
look  at  the  debt  ratio  of  the  first  year  (and  attach 
implausibly high risk premia to the observed short-
term  change  in  the  debt  ratio,  while  ignoring  any 
longer-term  debt-reducing  effect)  but 
instead 
consider  those  three  or  four  years  ahead,  the  debt 
dynamics  would  evolve  as  one  would  expect: 
consolidation reduces the debt-to-GDP ratio. Thus, 
under  reasonable  assumptions,  counter-intuitive 
debt dynamics become practically impossible.

In  addition,  there  is  a  growing  understanding  that 
fiscal multipliers are non-linear and become larger 

Finally, some calculations are performed taking as 
a  baseline  current  economic  projections  for  EU 
Member  States.  They  first  show  that  the  reverse 

113

it 

the 

that 

is  possible 

effects on the economy tend to cumulate along the 
line  and  can,  in  presence  of  continued  myopic 
behaviour  of  financial  markets,  induce  counter-
intuitive  dynamics.  This  could  be  the  case,  for 
example, if the target of fiscal policy is exclusively 
set  in  terms  of  headline  variables,  like  headline 
debt  or  deficit  ratios  and  not  in  structural.  In  this 
scenario 
situation 
consolidation-debt 
increase-consolidation-further 
debt  increase  takes  place  as  long  as  the  current 
multiplier  is  high  enough.  The  same  spiral  can 
happen with deficits, but for sensibly higher values 
of  the  multipliers.  As  a  high  degree  of  financial 
market myopia is necessary for this to happen, this 
underlines that  the credibility of the adjustment is 
crucial in providing financial markets with a long-
if  policy 
term  view.  It 
recommendations  are  formulated  in  terms  of  a 
(path of) structural balances so that, once sufficient 
measures  are  taken,  time  is  left  for  the  effects  of 
the consolidation measures to deploy fully, in line 
with current EU legislation.

therefore  better 

is 

European Commission

Public finances in EMU - 2012

if 

fiscal 

tightening  only 

effect  of  consolidations  would  end  within  three 
years or less even if the impact of consolidation on 
GDP growth is long lasting, provided that financial 
markets  do  not  require  substantially  higher  risk 
premia  when  the  country  consolidates  – even 
though  the  required  interest  rates  increase  with 
debt levels. High debt countries would experience 
a  scenario  in  which  the  debt  ratio increased 
following 
financial 
markets  were  myopic  and  induced  a  very  high 
increase  of  average  effective  interest  rates  when 
the country consolidates. Second, it is also shown 
– in line with the analysis provided in Chapter I.3 -
that  in  view  of  the  debt  dynamics  in  a  number  of 
EU Member States, sizeable fiscal efforts of some 
points  of  GDP  would  be  needed  to  bring  debt 
ratios  back  to  current  levels  within  the  next 
decade.  Given  the  high  level  of  debt  reached  in 
many  of 
is  a 
necessity. The analysis shows that, in these cases, 
high multipliers do not play a decisive role in debt 
dynamics, but may, under adverse scenarios delay 
the fall in the debt ratio by one year at most.

these  countries,  consolidation 

The  simulation-based  analysis in  this  Section 
assumes  that  the  relation  between  the  risk  premia 
paid on sovereign debt and the fiscal multipliers is 
relatively  small. However, fiscal consolidations in 
the  presence  of  large  multipliers  could  lead  to 
increases  in  the  debt  ratio,  thereby entailing  rises 
in  the  government  real  interest  rates.  This  would 
imply that a consolidation would take a long time 
to bring debt below baseline. The case for interest 
rates  increasing  with  a  consolidation can  reflect 
factors  affecting  financial  markets  that  cannot  be 
modelled, for example if financial markets come to 
believe  that  consolidation  will  be  reversed  based 
on political economy reasons. This could entail an 
increase  in  risk  premia  offsetting the  action  of 
monetary policy. This simplifying assumption is a 
useful  first  approximation.  In  any  case  it  is  to  be 
noted  that,  in  presence  of  a  myopic  reaction  of 
financial  markets 
to  consolidations,  such  an 
assumption 
is  could  more  easily  generate  a 
scenario displaying the counter-intuitive dynamics. 
So by making such an assumption the results found 
here  constitute  a  limit  to  the  possibility  of  having 
unexpected debt dynamics.

A  final  issue  that  is  not  included  in  the  scenario 
analysis is the effect of consecutive consolidations. 
If consolidations are repeated, especially in periods 
where  multipliers  are  large  and  persistent,  the 

114

1.

INTRODUCTION

EU countries  have  seen large debt increases  since 
the onset of the crisis. In most EU countries debt is 
now at an unprecedented level. In some cases, the 
increases since 2007 have exceeded 20 percentage 
points of GDP starting from an already high level. 
The  impact  of  the  crisis  has,  for  a  number  of 
countries,  compounded 
the  dynamics  of  a 
structural  deficit.  As  shown  in  Part  I,  the  EU 
Member  States  have  now  started  consolidating 
their government finances. The increased levels of 
debt have led to pressure being placed on a number 
of countries by the financial markets especially in 
absence  of 
interventions  from  central  banks. 
Moreover, the realisation that inadequate attention 
to  debt  levels  during  the  "good"  economic  times 
that  preceded  the  crisis  led  to  amendment  of  the 
Stability and Growth Pact (SGP) to put debt on an 
equal  footing  with  the  deficit.  New  provisions  in 
the  SGP  foresee  that  EU  members  with  a  debt  to 
GDP ratio higher than 60% have to act to put it on 
a  downward  path  such  that  the  excess  of  the  debt 
ratio  over  this  60%  value  decreases  by  1/20th  per 
year on average over three years.  

A  public  debate  is  taking  place  both  in  the  press 
and  within  the  economics  profession  on  the 
effectiveness  of  consolidation 
in  government 
finances  in  the  current  situation,  mounting  in  the 
question whether "austerity can be self-defeating". 
In this context, "self-defeating" would mean that "a 
reduction in government expenditure leads to such 
a  strong  fall  in  activity  that  fiscal  performance 
indicators  actually  get  worse"  This  formulation 
stems from Gros (2011), who refutes such a claim 
for the longer term.  (For further contributions, see 
for  example 
taking  place  on 
www.voxEU.org:  among  many  Buti  and  Pench 
(2012), Cafiso and Cellini (2011), Corsetti (2011), 
Gros (2011), and Krugman (2012)). The debate is 
reflected  also  in  more  academic  literature  (see 
Section  III.2  below)  where  there  has  been  a  large 
increase  in  the  amount  of  new  research  on  the 
effects of fiscal consolidations.

the  debate 

Given  the  renewed  relevance  of  the  debt,  both  in 
the  financial  markets  and  in  the  context  of  the 
fiscal governance in the EU, the public discussion 
has  centred  on  the  debt-to-GDP  ratio  as  the  key 
fiscal policy indicator. The present Chapter aims to 
discuss  the  consolidation  dynamics and  to  define 
precisely  the  conditions  under  which  counter-
intuitive dynamics can happen. The main result in 

this respect is that such a possibility exists, but it is 
mainly  short-lived and  its occurrence  depends  on 
the effects on sovereign yields.  

the 

The success of a consolidation in reducing the debt 
ratio  depends  crucially  on  the  value  of  the 
multiplier,  which  measures 
impact  of 
consolidation  on  growth,  and  on  the  reaction  of 
sovereign  yields  to  such  a  consolidation.  Even  a 
cursory  literature  review  shows  that  estimates  or 
assessments  of  the  value  of  the  multipliers  vary 
enormously depending on the type of model used, 
the 
economic 
conditions assumed for the estimate, the conduct of 
monetary  policy  and  other  factors  influencing  the 
interest  rates,  the  composition  of  the  adjustment 
and  various 
the 
(from 
exchange 
labour  market 
rate 
arrangements).

to  credit  and 

econometric 

institutional 

technique, 

factors 

the 

the 

impact  of 

The  present  Part finds  a  general  condition  that 
describes
the  adoption  of 
consolidation measures – compared to the situation 
without consolidation considered as the baseline –
on the final debt ratio as a function of starting debt 
ratio, cyclical budgetary semi-elasticities and fiscal 
multipliers.  Quite  intuitively  the  basic  condition 
shows that in presence of a high starting debt ratio 
and  of  a  high cyclical  semi-elasticity,  relatively 
high  fiscal  multipliers  more  likely  to  be  observed 
in crisis times are needed to have undesired effects 
of  consolidations  in  the  short  term.  The  Part then 
shows  how  such  a  conclusion changes  when 
account  is  taken  of  the  effect  on  yields,  a 
particularly  relevant  condition 
the  current 
sovereign crisis. 

in 

Chapter III.2  discusses  the  factors  that  influence 
multipliers according to theory and presents a vast 
review  of  the  empirical  literature  assessing  the 
value  of  multipliers.  The  review  covers  DSGE 
calibration-based estimates, model-based estimates 
of different nature, VAR-based estimates and other 
estimates 
econometric 
techniques.  It  also  provides  a  review  of  existing 
estimates of effects of government debt and deficit 
on government yields.

different 

based 

on 

Chapter III.2  also presents  VAR-based  estimates 
of  multipliers  for  some  large  euro  area  countries 
and  for the  euro  area  as  a  whole.  The  analysis  is 
conducted  using  quarterly  data  and  using  a 

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traditional  structural  VAR  approach.  The  main 
novelty  of  the  analysis  is  to  take  the  effects  of 
confidence directly into account which should help 
reduce  the  downward  bias  on  the  fiscal  multiplier 
induced by the fact that the date at which measures 
are implemented does not correspond with the date 
at  which  measures  are announced  or  become 
known  to  the  economic  actors (for  the  potential 
relevance  of  this  point  see  Romer  and  Romer 
(2010),  Ramey  (2011)  and  Corsetti  et  al.  (2011) 
The  results  of  the  exercise are  in  line  with 
literature results, with fist-year multipliers between 
0.4 and 1.4 depending on the country, an increased 
second-year  multiplier  and  values  for  third  year 
multipliers  still  in  line  with  first-year  multipliers, 
before a relative quick decrease.

in 

taken  by 

term,  since

the  government  balance 

the  consolidation  measures 

If 
the 
government  are  of  a permanent  nature,  such  an 
effect  can  only  be  short 
the 
is 
improvement 
permanent  – and  cumulates  its  effects  on  debt 
compared  to  baseline  – the  effects  on  growth  of 
such  a  consolidation  vanish  in  time.  Section  III.3
analyses the conditions influencing the number of 
years  that,  in  case  of  a  short-term  consolidation-
induced  debt-increase, 
a
consolidation to show its effects on the debt ratio. 
for  a 
It 
consolidation to improve debt is relatively short –
under  the  situation  in  which  debt  increases  from 
the  beginning. 
factors 
influencing the length of the reverse effect are the 
multipliers  at  the  different  years  and  the  initial 
level of debt and deficit.

typical  horizon 

are  needed 

Intuitively, 

the  main 

shows 

that 

the 

for 

Also in Chapter III.3 estimated cyclical elasticities 
and  actual  debt  figures  for  EU  countries  are  used 
to  have  a  back-of-the-envelope  representation  of 
the  situation  of  the  various  EU  countries  with 
respect to the values of multipliers estimated in the 
literature,  given  the  current  crisis  situation  and 
tight credit markets.

Finally, Chapter III.4 presents a set of conclusions 
based on the analysis conducted along Part III.

116

2.

REVIEW OF EXISTING ESTIMATES OF FISCAL MULTIPLIERS

temporary  nature and 

This  Chapter aims  at  providing  an  overview  of 
existing  estimates  of  fiscal  multipliers.  It  is  now 
acknowledged that it is more correct to talk about 
the  multipliers  rather  than  about  the  multiplier, 
given that the value of fiscal multipliers, as it will 
be seen in more detail in the next Section, depends 
on  many  factors  relative  to  the  fiscal  shock  itself 
its 
(its  permanent  or 
composition), to  the  economic  environment  (the 
economic  situation,  the  economic  situation  of  the 
partner countries, the stress in the financial market) 
and  to  economic  policy regime (monetary  and 
exchange rate policy). It is therefore very difficult 
to compare correctly different estimates and every 
comparison  has 
taken  with  care.  For 
example,  empirical  estimates  made  using  Vector 
Auto-Regression  techniques  (VAR)  concern  most 
of the times very specific fiscal shocks in terms of 
composition, and always consider temporary fiscal 
shocks  – which  are  not  purely  temporary  in  that 
fiscal variables have an autoregressive component, 
while  model-based  evaluations  like  evaluations 
based on Dynamic Stochastic General Equilibrium 
(DSGE)  models  can  vary  in  this  respect  from 
purely  temporary  measures  to  fully  permanent  so 
that comparisons are not always correct.

to  be 

Given  the  relevance  of  fiscal multipliers  in  the 
discussion  concerning  consolidation  it  is  however 
useful  to  provide  an  overview  of  existing  results, 
in particular in the two main areas of the literature 
which study effects of fiscal shocks.

2.1.  A REVIEW OF THE LITERATURE ON FISCAL 
MULTIPLIERS ESTIMATED BY NEW 
KEYNESIAN DSGE MODELS 

is  due 

The  concept  of  fiscal  multiplier 
to 
traditional  Keynesian  macroeconomic  analysis, 
where  it  indicates  the  reaction  of  output  to  a 
change  in  government  spending.  More  precisely, 
the  output  multiplier  is  defined  as  the  ratio 
between the change in the level of output and the 
exogenous  change  in  the  relevant  fiscal  variable. 
However,  in  practice  fiscal  shocks  have  some 
degree  of  persistence,  which  affects  the  response 
of  output  to  such  shocks.  Therefore,  the  literature 

often  refers 
multiplier", especially with VARs. (73) 

the  concept  of  "cumulative 

to 

in  government 

In  this  framework,  consumption  and  investment 
depend on current income. In presence of nominal 
rigidities  and a  low rate  of  resource  utilisation  an 
increase 
increases 
aggregate  demand  and  output.  In  basic  Keynesian 
economics  the  key  parameter  in  estimating  the 
fiscal  multiplier  is  the  "marginal  propensity  to 
consume"  which  measures  the  fraction  of  current 
income that is consumed rather than saved.

spending 

its  Mundell-Flemig  extension 

Subsequent  developments  in  economic  theory, 
from the Hicksian IS/LM version of the multipliers 
to  open 
via 
economies,  the  re-discovery  by  Barro  of  the  so-
called  Ricardian  effects  and  through  to  the  most 
recent  New  Keynesian  developments  have  shown 
that  the  marginal  propensity  to  consume  is  only 
one  of  the  relevant  parameters  affecting  the  value 
of the multipliers. 

According  to  modern  theory  – mainly  modelled 
via DSGE models – there are different factors that 
affect  the  multipliers.  These  can  be  grouped  as 
follows:  i)  factors  that  force  consumers  to  base 
consumption  choices  on  current  revenues  only, 
such  as  financial  frictions;  ii)  factors  concerning 
the  nature  of  the  fiscal  shock,  in  particular  the 
credibility  of  the  shock  and/or  its  permanent  or 
temporary nature; iii) the composition of the fiscal 
shock; iv) structural features  of the economy, like 
the  presence  of  nominal  or  real  rigidities;  v)  the 
size  of  automatic  stabilizers;  vi)  the  type  of 
monetary policy, and vii) the exchange rate regime 
and  the  degree  of  openness  of  the  economy. In 
most  of  these  models  responses  to  shocks  are 
symmetric, for which the discussion of the effects 
of expensionaly  fiscal  shocks is equivalent to that 
of  fiscal  consolidations  with  the  reverse  sign. 
However, it is likely that responses to fiscal shocks 
are  not  symmetric  depending  on  the  economic 
situation  or  the  state  of  public  finances.  In  this 
connection, the size of fiscal multipliers could also 
be  conditioned  by  the  initial  level  of  public  debt. 
Thus,  fiscal  expansions  with  high  public  debt 
levels  could  have  more  limited  effects  (or  even 

(73) The  cumulative  multiplier  is  defined  as  the  cumulative 
response  of  output  at  a  given  point  in  time  relative  to  the 
cumulative fiscal shock at the same point. 

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Public finances in EMU - 2012

negative)  on  output  as  agents  might  discount  a 
fiscal tightening in the future.  

The  first  two  factors  in  the  list  act  on  the  fiscal 
multiplier  with  the  same  economic  mechanism 
based  on  the  influence  that  expectations  of  future 
income have on current consumption decisions.  If 
economic  agents  are  forward-looking  and  make 
their  decisions  on  the  basis  of  permanent  income, 
an  increase  in  the  government  deficit  induces  a 
negative  wealth  effect  on  households,  as 
households  expect  a  corresponding  future  tax 
increases  and  thus  future  surpluses.  This reduces
consumption  and  increases labour  supply,  which
tends  to  reduce  real  wages  and  consumption
further.  This  decline  in  private  demand  offsets 
most  of  the  increased  public  demand,  causing 
output  to  increase  by  less  than  the  increase  in 
government  consumption  (see  Hall  (2009)  and 
Woodford 
the 
In 
investment  multipliers  are 
consumption  and 
negative  and  the  output  spending  multiplier  is 
lower  than  one,  even  if  its  value  depends  on  the 
relative increase in the labour supply relative to the 
fall in consumption. 

framework, 

(2011)).

this 

Baxter  and  King  (1993)  show  that  a  model  in 
which a large (permanent) stimulus causes a large 
wealth effect and a large increase in labour supply 
can  have  a  spending  multiplier  near  to  one  as  the 
consequent  boom  in  the  marginal  product  of 
capital  and  investment  compensates  for  the  effect 
in  general,  Real 
on  consumption.  However, 
Business Cycle (RBC) models in which prices are 
flexible and competition is perfect indicate that the 
effects  of  fiscal  policy  on  output  pass  mainly  via 
supply  effects  and  generate  small  spending 
multipliers which very often are below 0.5.

The  capacity  of  households  to  make  consumption 
choices  on  the  basis  of  their  permanent  income  is 
the divider between Keynesian theory and modern 
theory. This idea, which was introduced in DSGE 
models  in  Galì  et  al.  (2007)  and  dates  back  to 
Campbell and Mankiw (1998) and Mankiw (2000), 
is meant to reintroduce some Keynesian features in 
consumption  behaviour,  in  line  with  observed 
empirical  patterns  of  the  relation  between  current 
income  and  current  consumption  and  of  (at  least 
some)  consumption  increase  in  response  to  an 
increase 
in government  spending.  Consumers 
make choices on the basis of current income either 
because  of  less-than-perfect  rationality  or  because 

118

they  are  financially  constrained  in  the  sense  that 
they  cannot  get  credit 
their  present 
consumption  which  would  be  reimbursed  with 
future incomes.

for 

The  introduction  of  this  type  of  consumers  along 
with  perfectly  rational  consumers,  together  with 
other  features  which  will  be  discussed  below, 
constitute  the  basis  for  the  current  mainstream 
theory,  a  synthesis  between  RBC  and  Keynesian 
models defined as "New Keynesian" models.

According  to  the  meta-analysis  of  Leeper  et  al. 
(2011) the fraction of non-savers is the single most 
relevant  parameter  in  influencing  the  size  of  the 
impact  spending  multipliers  – except  for  the 
monetary  policy  regime.  Such  a  fraction  explains 
19%  of  the  size  of  the  multipliers  on  impact  and 
13%  of  the  first-year  multiplier.  To  give  an  order 
of magnitude, the QUEST model shows increased 
impacts on multipliers for temporary fiscal shocks 
done with measures that concern consumers which 
are  of  this  order  of  magnitude  or  larger.  For 
example  the  multiplier  of  fiscal  transfers  and 
labour tax doubles  from 0.2 to 0.4, while the  first 
year  multiplier  of  increases  in  government  wages 
increases 
(see European 
Commission (2010b) and Roeger et al. (2010)).

from  1.1 

to  1.3 

The  second  factor  that  influences  the  multiplier, 
concerns the temporary (or credible) nature of the 
fiscal  shock.  A  permanent  fiscal  expansion has  a 
much  larger  size  than  a  temporary  shock,  and 
therefore  a 
larger  negative  wealth  effect  on 
consumers  that  are  Ricardian  and/or  base  their 
consumption decisions on their permanent income. 
This  depresses  consumption  more  and,  as  a 
consequence,  decreases  the  fiscal  multiplier.    The 
same  mechanism  holds  if  fiscal  measures  are 
credible:  in  that  case  Ricardian  agents  know  that 
the  measures  taken  by  the  government  have  a 
permanent  effect  and  therefore  the  multiplier  is 
decreased  via  the  mechanism  just  explained  This 
factor  has  a  very  large  impact  on  the  value  of 
multipliers:  for  example  in  QUEST  the  multiplier 
of a balanced (in terms of composition) permanent 
fiscal stimulus is 0.3/0.4 but can increase to 0.7/0.8 
if 
taken  are  non-credible  or 
temporary.

the  measures 

The  composition  of 
it 
consolidation or  stimulus)  is  the  major  factor 
concerning the size of the fiscal multiplier, so that 

the  fiscal  shock (be 

Consolidation and dynamics of the multipliers. Are there counter-intuitive effects?

Part III

they 

assessed 

many economists consider there to not be just one, 
but  a  many 
In  general, 
fiscal  multipliers. 
government  spending  multipliers  are  found  to  be 
different from tax ones. That is the reason why in 
spite of fiscal packages usually target both sides of 
the  budget, 
separately. 
are 
Multipliers vary also when one takes into account 
the  future  ways  of  financing  an  expansion,  which 
becomes  less  relevant  in  the  case  of  a  permanent 
consolidation.  Coenen  et  al.  (2012)  compare 
results  from  the  DSGE  models  used  in  six 
institutions and show that in general larger impact 
and  first-year  multipliers  are  found  with  spending 
measures  (except  for  general  transfers);  this  is
particularly the case with government expenditure, 
which  has  a  first-year  multiplier  above  unity if 
transfer 
measures  are 
multipliers  have  a  smaller  short-term  impact, 
unless 
constrained 
households.  Thus  first-year  multipliers  for  a 
permanent  consolidation  estimated  from  QUEST 
(European  Commission  (2010b) and  Roeger  et  al. 
(2010)
for  government  wages  and 
government 
investments,  0.5  for  government 
purchases and below 0.4 for transfers and taxes.

temporary.  Tax  and 

financially 

targeted 

are  1 

at 

first  year  or 

the  highest  value.  Thus 

Most  analyses propose  values  for  (temporary) 
government  purchases 
impact 
multipliers.  The  multipliers  based  on  government 
purchases  have 
the 
multiplier of 1.6 proposed by Romer and Bernstein 
(2009)  and  the  multipliers  analysed  in the  meta-
analysis by Leeper et al. quoted in this Subsection, 
- which consider environments in which monetary 
policy  is  accommodative (74)  – all  refer  to 
multipliers  for  government  purchases.  This  is  the 
case  for  the  values  below  0.7  proposed  by  Cogan 
et al. (2010) and for the values oscillating between 
0.5 for Germany and 1.1 for the US in Barrel et al. 
(2012).  Tax  and  transfer  multipliers  for  EU 
countries  are  all  below  0.4.  The  corresponding 
multiplier  for  temporary  government  expenditure 
shocks in QUEST is 0.8  which increases to 1.2 if 
monetary policy is at the zero lower bound. ( 75)

It  is  worth  noting,  however,  that  taxes  and 
expenditures  imply  also  very  different  long-term 

(74) Accommodative monetary policy is a monetary policy that 

decreases real interest rates. 

(75) This  range can  be compared  to  values  for  government 
investment  multipliers  presented  in Coenen  et  al.  (2012) 
which  proposes a  range  of  0.9  and  1.3  or  1.1  to  2.2 
depending on the model discussed.

multipliers,  with a  negative and increasing impact 
on output from cuts in government investment, an 
increase  in  corporate  tax  and  long-term  positive 
impact on GDP from cuts in government transfers 
and  purchases,  and  increases  in  housing  taxes 
(European  Commission  (2010b)). QUEST  results 
(76)  show  that  fiscal  consolidations  generally 
involve a fundamental trade-off between short-run 
pain  and  long-run  gain.  The  pain  arises  from  the 
negative  multiplier  effects  of  lower  spending  or 
higher taxes,  while the  gain stems from the lower 
world  interest  rates  and  lower  distortionary  taxes 
associated  with  lower  debt  levels.  The  results  on 
both  pain  and  gain  are  subject  to  important 
qualifications  such  as  the  design  of  a  fiscal 
package;  if  the  tightening  is  well  designed  with 
favourable  long-run  incentives  for  investment  and 
labour supply, then the short-term pain only arises 
in the presence of an initial lack of credibility and 
only lasts for the non-credibility period. If, on the 
other hand, the fiscal tightening is badly designed 
– for  example  sharply  raising  taxes  on  income  or 
cutting essential government investment – the long 
run  gain  could  be  much  lower  or  even  non-
existent,  as  higher  distortions  and/or  productivity 
losses  offset  the  gains  from  lower  real  interest 
rates. 

These  effects  also  depend  on  monetary  policy. 
However  in  general  it  is  preferable  to  use  all 
instruments: Forni, Gerali, Pisani (2010) simulate a 
monetary union DSGE model of the euro area and 
analyse the macroeconomic and welfare effects of 
alternative  fiscal  consolidation  strategies.  They 
show that a significant debt-to-GDP ratio reduction 
obtained  by  reducing  both  expenditure  and  taxes 
can be welfare improving. 

The presence of real frictions like the presence of 
investment  adjustment  costs  and  constraints  to 
adapt  capacity  utilisation,  which  is  common  to 
RBC  and  new  Keynesian  models  and  was 
introduced  by  Burnside  et  al.  (2004),  reduce 
multipliers because the presence of those  frictions 
slows  the  reaction  of  firms  to  changes  in  interest 
rates  because  of  the  costs  they  entail (see  also 
(Monacelli  and  Perotti  (2008)). According  to 
Leeper et al. (2011) the quantitative impact of the 
presence of frictions is reduced. 

(76) This  is  the  case  for  most  DSGE  models  see  for  example 

Clinton et al. (2010).

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Public finances in EMU - 2012

the 

the  presence  of 

On the contrary the presence of nominal rigidities 
like  price (77)  or  wage  rigidities,  characteristic  of 
new  Keynesian  models, allows  them  to  stress  –
financially 
together  with 
constrained  consumers  –
relevance  of 
aggregate  demand.  In  a  model  with  monopolistic 
competition,  Woodford  (2011)  shows  that  the 
presence  of  either  of  these  rigidities  increases 
multipliers.  Price  rigidities  increase  multipliers 
because  firms  respond  to  increases  in  aggregate 
demand  not  by 
increasing  prices  but  rather 
increasing  output.  Leeper  et  al.  (2011)  show  that 
price rigidities increase first-year multipliers by six 
percentage points. This is not a very large amount, 
but the effect remains in the long-term multipliers. 
The  presence  of  wage  stickiness,  which  clearly 
refers to Keynes' traditional argument, has  similar 
effects because the real wage may remain constant, 
or  even  fall,  while  average  labour  productivity 
increases.  It  is  important  to  notice  that  if  fiscal
policy  does  not  raise  inflation  expectations  but 
lowers them, the sticky prices assumption worsens 
the  impact on  output  and  labour,  because  it 
prevents prices from falling and the mark-up from 
rising,  lowering  labour  demand  and  output  (see 
Linnenmann and Schabert (2003)).

The role of monetary policy, via the impact on real 
interest  rates  is,  in  the  context  of  the  new 
Keynesian  models,  the  most  important  factor 
determining  the  size  of  government  spending 
multipliers.  In  the  Hicksian  IS/LM  version  of  the 
Keynesian  approach,  spending  multipliers  are 
smaller  the  stronger  the  reaction  of  interest  rates, 
as  a  strong  increase  in  interest  rates  crowds  out 
investments. Therefore situations in which interest 
rates do not increase with the increase in expected 
inflation  generated  by  fiscal  stimulus,  like  the 
liquidity  trap  characterising  depressed  economic 
environments  show  large  spending  multipliers. 
This  feature  is  very  relevant  in  new  Keynesian 
DSGE  models  such  as  described  in  Woodford 
(2011), as the stance of monetary policy influences 
the 
the  more 
accommodative monetary policy is, the smaller the 
real  interest  rates  and  as  a  consequence  the  larger 
the  multipliers induced  by  the  same  fiscally-
generated increase in demand and inflation. Leeper 
et  al.  (2011)  show  that  the  parameter  which 
represents the reaction of interest rates to expected 

the  multipliers: 

size 

of 

(77) This  assumption  goes  together  with  the  assumption  of  the 
existence of monopolistic power in the product market.

120

in 

rule 

the  Taylor 

inflation 
is  particularly 
important,  accounting  for  about  10  percent  of 
impact  multipliers.  This  effect  is  magnified  in 
situations  which  can  be  described  as  near  to  the 
Keynesian  liquidity  trap,  in  which the nominal 
interest  rate  remains  at  zero  (the  so-called  "zero 
lower  bound"  condition). Christiano,  et  al.  (2011) 
show  that  in  a  fairly  standard  DSGE  model,  the 
multipliers  are  higher  the  larger  the  percentage  of 
spending  implemented  under  this  condition,  with 
peak  multipliers  that  can  be  larger  than  two  if 
fiscal action is taken in periods  w the economy is 
in liquidity trap and such a liquidity trap condition 
holds for three years, with values much above one 
– the  fairly  standard  multiplier  for  temporary 
increase  in  government  expenditures  in  normal 
times.  This  result  is  consistent  with  the  meta-
analysis  in  Leeper  et  al.  (2011)  which  indicates 
that under the regime with passive monetary policy 
and  active 
fiscal  policy  one-year  spending 
multipliers  can  be  high,  at  1.5-1.6. (78)  To  give  a 
further  idea  of  the  order  of  magnitude,  Table 
III.6.1  in  European  Commission  (2010a)  shows 
that,  depending  on  the  composition  of  the  fiscal 
stimulus,  multipliers increase by 30 to 50% under 
monetary  accommodation.  All  six  DSGE  models 
analyzed  in  Coenen  et  al.  (2012)  show  effects  of 
the same size.

The  final  aspect  to  be  considered  concerns  the 
external  side  of  the  economy.  This  has  two 
aspects:  first  the  degree  of  openness  of  the 
economy,  and  second  the  exchange  rate  regime 
coupled with freedom of capital movements. In the 
Mundell-Fleming  extension  to  open  economies, 
the fixed exchange rate regime magnifies the fiscal 
multiplier  in  presence  of  capital  mobility  because 
of the monetary accommodation necessary to keep 
the  exchange  rate  at  parity.  Erceg  and  Lindé
(2012a)  study  the  relative  efficiency  of  spending 
versus  tax  instruments  in  monetary  unions  and 
spending-based 
show 
consolidations  are  smaller  than  multipliers  of  tax-
based  consolidations  if  monetary  policy  is  at  the 
zero lower bound. However, the reverse holds for a 
small  member of a currency  union, or if the other 

that  multipliers 

of

(78) The values of 0.8 for QUEST given above and 1.6 are not 
directly  comparable  because  of  different  assumptions  on 
credibility and on the composition of the consolidation, but 
represent the relevant range of values that can be supported 
by  existing  models.  The comparable  QUEST  multiplier  is 
1.2.

Consolidation and dynamics of the multipliers. Are there counter-intuitive effects?

Part III

members  of  the  currency  union  are  consolidating 
and monetary policy is in a liquidity trap.

Finally, a high degree of openness of the economy 
reduces the  multipliers  in that a fiscal expansion's 
effect on aggregate demand is limited as part of the 
effects  of  the  fiscal  shock  leaks  abroad  via
increased  imports and  reduced  exports.  Thus  an 
open  economy  has  smaller  multipliers. Corsetti 
and Mueller (2012a) stress the existence of cross-
border  effects  of  national  fiscal  policy  on  foreign 
demand via an interest rate channel and show that 
in  presence  of  large  contagion  effects  on  risk 
premia, multipliers can be sizably reduced.

2.2.  VAR-BASED FISCAL MULTIPLIERS IN THE 

LITERATURE

this  restriction  again 

An 
increasing  number  of  empirical  studies 
assessing  the  macroeconomic  effects  of  fiscal 
shocks  was  produced  in  the  last  decade.  The 
studies  are  very  different  in  nature,  sample  and 
techniques used, so that they cannot be compared. 
The main differences concern i) the choice to have 
panel  or  individual  estimates  and  ii)  the  type  of 
technique  used.  The 
first  choice  needs  an 
assumption  on  whether  (at  least  some  of)  the 
crucial  parameter  of  interest  are  equal  across 
countries  composing  the  panel  and  trades  off  the 
disadvantages  from 
the 
advantages coming from the possibility of making 
more  precise  estimates  thanks  to  the  different 
experience  of  the  different  countries  which  can 
reduce  the  problems  raising  from  the  absence  of 
long  enough  data  series.  The  second  choice  is 
based  on  the  evaluation  of  which  methodology  is 
preferable  to  solve  the  identification  issue which 
bias the estimate of the multipliers and is raised by 
the  contemporaneous  reciprocal  effects  of  fiscal 
policy  on  growth  and  of  growth  on  fiscal  policy 
outcomes. The choice of the technique relies upon 
the availability of data and of proper instrumental 
variables. The present Chapter presents  separately 
estimates  based  on 
country  VAR 
techniques.

single 

The effects of government expenditure shocks 
in the VAR literature on individual countries 

The  last  decade  has  seen  a  large  increase  in  the 
number  of  studies  assessing  the  macroeconomic 
effects  of  fiscal  shocks  using  VAR  techniques. 

While the most prominent papers have focused on 
the  U.S.,  there  has  also  been  a  growing  body  of 
evidence  on  other  countries,  especially  European 
Union  ones.  The  literature  typically  finds  short-
term  (usually  1-year)  multipliers  to  be  somewhat 
below  1  in  the  case  of  the  United  States,  whereas 
for European countries cumulative  multipliers (79)
over  the  same  horizon  are  usually  found  to  be 
above unity. ( 80)

From  a  theoretical  point  of  view,  the  sign  and 
magnitude  of  the  impact  of  discretionary  fiscal 
policy  on  aggregate  demand  depends  on  many 
conflicting  factors,  as  shown  above,  which  can 
lead to opposite conclusions.

Government spending multipliers are therefore not 
structural  constants  as  they  depend  heavily  on  a 
number of structural features as well as on cyclical 
factors.  Thus,  as  fiscal  multipliers  depend  on  the 
responses  of  endogenous  economic  variables  to 
fiscal shocks, they are expected to vary over time.    

Empirically,  estimated  multipliers  also  depend  on 
the  methodology  used  to  derive  responses  of 
economic  activity  to  fiscal  shocks.  In  general, 
VAR  multipliers  are  usually  found  to  be  higher 
than RBC or even DSGE models. The response of 
is  key.  While  private 
private  consumption 
consumption  is  usually  found  to  decrease  in  RBC 
models  as  a  result  of  the  negative  wealth  effect, 
empirical  evidence  in  VAR  studies  usually  shows 
positive  responses  of  this  variable  in  response  to 
higher public spending. 

One criticism often levied at the VAR literature, is 
that  VAR  models  cannot  properly  account  for  the 
fact  that  changes  in  government  spending  and 
taxes  can  be  anticipated  due  to  legislative  and 
implementation 
(2008)) 
because in this case the effects of the fiscal shock 
would appear in the economy as from the moment 
agents  anticipate  the  government  decisions.  If 
looking  Structural  VAR 
agents  are  forward 

(Leeper,  et  al. 

lags 

(79) The cumulative multiplier at a given period is obtained as 
the  ratio  of  the  cumulative  response  of  GDP  and  the 
cumulative  response  of  government expenditure.  They  are 
especially  accurate  to  correct  for  the  persistence  of  fiscal 
shocks.

(80) Other  literature  reviews  come  to  the  opposite  conclusion, 
namely that fiscal multipliers in the US are somewhat more 
sizeable than in Europe due to automatic stabilizers playing 
a  larger  role  in  Europe.  This  conclusion  is  affected  by 
studies used in the comparison.

121

European Commission

Public finances in EMU - 2012

and 

their  effects

(SVAR)  models  may  fail  to  correctly  estimate 
fiscal  shocks,  thereby  leading  to  biased  estimates 
of 
in  particular  of  fiscal 
multipliers.  This  is  the  so-called  "fiscal  foresight 
problem". The debate on this issue is open in that 
if  Ramey  (2011)  finds  that  fiscal  foresight  is  a 
relevant issue inducing a bias on estimates of fiscal 
multipliers  contrary to  the  previous  findings  of 
Perotti  (2004,)  Bouakez  et  al.  (2010)  show  that 
Ramey's results are most likely driven by the data 
points relative to the Korean War episode only and 
should  thus  be  not  considered  of  a  general 
relevance. (81)

Four  basic  approaches  to  identify  fiscal  shocks  in 
VARs  can  be  distinguished  (Perotti,  (2004);)  (1) 
the  identification  of  fiscal  policy  shocks  by  using 
dummy  variables  that  capture  specific  episodes 
(event  approach)  such  as  the  military  build-ups 
(Burnside et al., 2000; Ramey and Shapiro, 1998; 
Edelberg et al., (1999)); (2) the imposition of sign 
restrictions  on  the  impulse  response  functions 
(Mountford 
the 
identification of fiscal shocks based on a Cholesky 
ordering  (Fatás  and  Mihov,  (2001));  (4)  and 
finally, the identification of fiscal policy shocks by 
exploiting  decision  lags  in  policy  making  and 
information  about  the  elasticity  of  fiscal  variables 
to  economic  activity  (Blanchard  and  Perotti, 
(2002) and Perotti, (2004)).

and  Uhlig, 

(2009)); 

(3) 

Table  III.2.1  summarizes  some  of  the  available 
empirical  evidence  in  the  literature  on  fiscal 
multipliers  to  government  expenditure  shocks. 
Most of the available empirical estimates of fiscal 
multipliers  refer  to  the  United  States,  with  the 
different  estimates  being  far  from  conclusive  in 
across 
view 
specifications  and  methodologies.  Short-term 
multipliers, 
rank 
between  0.4  and  1;  for  longer  horizons  the 
dispersion  is  even  larger.  Blanchard  and  Perotti 
(2002)  find 
that  expansionary fiscal  shocks 
increase  GDP.  Their  results  imply a  cumulative 

typically  one-year,  usually 

the  marked 

differences 

of 

(81) Technically,  while Ramey  (2011)  provides  evidence  that 
SVAR-based  innovations  in  the  US  as  identified  in 
Blanchard  and  Perotti  (2002)  can  be  anticipated  and 
Granger-caused  by  Ramey  and  Shapiro  (1998)  war 
episodes. However, Perotti (2004) finds little evidence that 
SVAR-based innovations are predictable. In turn, Bouakez 
et al. (2010) show that, the fiscal foresight problem is not 
severe enough to preclude the use of SVAR innovations as 
correct measures of unanticipated fiscal shocks as Ramey's 
results are driven by the Korean War episode.

122

multiplier  to  shocks  to  direct  expenditure  of 
around 0.5 at the 4th and 12th quarters. 

Building  on  this  methodology  Perotti  (2004)  also 
includes 
interest  rate  as 
endogenous  variables and  observes  even  lower 
multipliers for the sample between 1980 and 2001. 

the  GDP  and 

the 

By  contrast  the  results  in Galí  et  al.  (2007) and 
Fatás  and  Mihov  (2001)  imply  a  significantly 
larger  cumulative  multiplier  of  government 
spending,  which  amounts  to  above  one after  one 
year.

that  consists 

Mountford  and  Uhlig  (2009)  use  a  different 
methodology 
imposing  sign 
restrictions to impulse responses. In this case, their 
1-year multiplier also stands close to 0.5, although 
it  decreases  quickly  thereafter  and  eventually 
becomes negative.

in 

the  news  and  consequently 

In  turn,  Ramey  (2011)  criticizes  standard  VAR 
identification  methods  for  not  accounting  for  the 
timing  of 
the 
anticipation  effects  of  economic  agents  to  fiscal 
news.  She  uses  a  narrative  method  to  construct 
richer  government  spending  news  variables  from 
1939  to  2008  and  obtains  short-term  government 
spending  multipliers  ranging  from  0.6  to  1.2, 
within range of previous estimates.

Despite the evidence being scanter than in the case 
of  the  US,  the  last  years  have  witnessed  an 
increasing amount of empirical studies with further 
evidence of multipliers for different countries. For 
Germany,  Perotti  (2004), Heppke-Falk  et  al. 
(2006)  and  Baum  and  Koester  (2011) estimate  1-
year  cumulative  multipliers  ranging  between  and 
0.7.  These  multipliers  are  observed  to  increase 
somewhat  during  the  second  year  after  the  shock, 
although  showing  somewhat  larger  discrepancies. 
However,  the  Threshold  VAR  estimates  in  Baum 
and  Koester  (2011) observe higher  spending 
multipliers in  low  growth  regimes,  whereas  in 
good  times  multipliers  are  lower  and  seem  to 
behave more linearly.

Consolidation and dynamics of the multipliers. Are there counter-intuitive effects?

Part III

Table III.2.1:

Expenditure VAR-based multipliers

Studies

Sample

Short-term multiplier[1]

Medium-term Multiplier [2]

Identification strategy[3]

Blanchard and Perotti (2002)

US (1947:1-1997:4)

-0.69

0.5[4]

Perotti (2004)

Galí et al. (2007)
Ramey (2011)

US (1960:1-1979:4)
US (1980:1-2001:4)
US (1954:1-2003:4)
US (1939:1-2008:4)

1.29
0.36
0.7
0.6 to 1.2

Mountford and Uhlig (2009)

US (1955:1-2000:4)

0.65[5]; 0.46; 0.28[6]

1.4
0.28
1.74
No estimate

-0.22

Fatas and Mihov (2001)
Perotti (2004)

Heppke - Falk et al. (2006)

US (1960:1 - 1996:4)
Germany (1960:1-1974:4)
Germany (1975:1-1989:4)
Germany (1974:1-2004:4)

Baum and Koester (2011)

Germany (1976:1-2009:4)

Benassy-Quere and Cimadomo
(2006)
Biau and Girard (2005)
Giordano et al. (2007)
De Castro (2006)
De Castro and Hernández de 
Cos (2008)
De Castro and Fernández 
(2011)
IMF (2005)
Perotti (2004)

Benassy-Quere and Cimadomo
(2006)
Burriel et al. (2010)

Germany (1971:1-2004:4)

France (1978:1-2003:4)
Italy (1982:1-2004:4)
Spain (1980:1-2001:2)

Spain (1980:1-2004:4)

Spain (1981:1-2008:4)

Portugal (1995:3-2004:4)
UK (1963:1-1979:4)
UK (1980:1-2001:2)

UK (1971:1-2004:4)

Euro Area (1981:1-2007:4)

Similar to Galí et al. (2007) Similar to Galí et al.(2007)

0.36

0.62

0.7

0.23

1.9
1.2
1.14-1.54

1.3

0.94

1.32
0.48
-0.27

0.12

0.87

0.28

1.27

0.69

-0.23

1.5
1.7
0.58-1.04

1

0.55

1.07
0.27
-0.6

-0.3

0.85

Decision lags in policy
making and imposition of
contemporaneous GDP
elasticities

Blanchard-Perotti

Cholesky decomposition
Narrative approach
Sign restrictions on impulse
responses
Cholesky decomposition
Blanchard-Perotti

Blanchard-Perotti
Blanchard-Perotti and
Threshold VAR
FVAR and Blanchard-
Perotti
Blanchard-Perotti
Blanchard-Perotti
Cholesky decomposition

Blanchard-Perotti

Blanchard-Perotti

Blanchard-Perotti
Blanchard-Perotti

FVAR and Blanchard-
Perotti
Blanchard-Perotti

(1) We define "short-term" as a time gap ranging from simultaneous effects to one year distance from the fiscal shock.
(2) By medium-run is broadly intended a period going from 1 to 3 years after the time fiscal shock took place.
(3)  Perotti (2004) distinguished four basic approaches in the literature to identify fiscal shocks in VAR: 1. Setting a dummy variable accounting for
specific episodes such as wars; 2. Imposing sign restrictions on IRFs (pioneered in an "agnostic" way by Uhlig 2005); 3. Exploiting Choleski ordering;
4. Considering decision lags in policy making and fiscal variables' elasticity to economic activity (narrative).
(4) Cumulative multiplier between the 4th and 8th quarter.
(5) Impact multiplier.
(6)  These two numbers are referred to expenditure multiplier respectively at the 4th and 8th quarters.
Source: Commission services.

Much higher multipliers are obtained by Biau and
Girard (2005) in the case of France. Relying on the
Blanchard-Perotti  identifying methodology,  they
gauge
cumulative  multipliers of  government
spending close  to  2  at  the  4th  quarter,  dreceasing
only gradually thereafter and amounting to around 
initial  shock. (82)
1.5 three  years  after 
Significantly higher  than  one multipliers  are  also
observed  by Giordano  et  al.  (2007) for  Italy,
although  they  focus  only  on  purchases  of goods
and services. 

the 

(82) It  is  to  be  noted  however  that  French  quarterly  data  for
fiscal policy  variables  only  have  been computed  recently.
interpolation
Older  data are 
techniques. The replication of the Biau and Girard exercise 
made by the Commission with data until 2010 (but notice
that series used may be different) gives insignificant values
of the multipliers.

thus constructed  using 

direct 

In  the  case  of  Spain,  either with  a  Cholesky
the  Blanchard-Perotti 
decomposition  or with 
government
strategy
identification 
expenditure short-term multipliers are estimated at
around 1 or above after one and two years, while
after  three  years.they  diminish  and  range between
0.6  and  1 (see De  Castro  (2006),  De  Castro  and
Hernández  de  Cos  (2008) or De  Castro  and
Fernández (2011)).

For  Portugal  the  IMF  (2005) also  relies  on  the
Blanchard-Perotti  approach and  also  obtain,  one-
year  spending multipliers above  unity,  remaining 
above  this level for  almost  three  years.  These
estimates are close to those observed for Spain. 

The  existing  evidence for  the  United  Kingdom 
contrasts however with  that  for  other  countries, 

123

European Commission

Public finances in EMU - 2012

Table III.2.2:

Tax VAR-based multipliers (To an increase in net taxes)

Studies

Sample

Short-term multiplier

Medium-term multiplier

Identification strategy

Blanchard and Perotti (2002)

US (1947:1-1997:4)

Within range -0.7 and -1.3 Within range -0.4 and -1.3

Perotti (2004)

Favero and Giavazzi (2007)

US (1960:1-1979:4)
US (1980:1-2001:4)
US (1980:1-2006:4)

Mountford and Uhlig (2009)

US (1955:1-2000:4)

Romer and Romer (2010)

Perotti (2004)

US (1945:1-2007:4)
Germany (1960:1-1974:4)
Germany (1975:1-1989:4)

Baum and Koester (2011)

Germany (1976:1-2009:4)

Benassy-Quere and Cimadomo
(2006)
Biau and Girard (2005)
Giordano et al. (2007)

Germany (1971:1-2004:4)

France (1978:1-2003:4)
Italy (1982:1-2004:4)

De Castro (2006)

Spain (1980:1-2001:2)

Portugal (1979:1-2007:4)
UK (1963:1-1979:4)
UK (1980:1-2001:2)

UK (1971:1-2004:4)

Afonso and Sousa (2009)

Perotti (2004)

Benassy-Quere and Cimadomo
(2006)
Cloyne (2011)
Burriel et al. (2010)

Source: Commission services.

-1.41
0.7
0.29

-0.16

0.29
-0.04

-0.66

-1.17

-0.5
0.16

0.05

+
-0.23
0.43

-0.23

UK (1945-2010)
Euro Area (1981-2007)

Between -0.5 and -1.0
-0.63

Decision lags in policy
making and imposition 
of contemporaneous
GDP elasticities

Blanchard-Perotti

Narrative approach
Sign restrictions on
impulse responses
Narrative approach

Blanchard-Perotti

Blanchard-Perotti and
TVAR
FVAR and Blanchard-
Perotti
Blanchard-Perotti
Blanchard-Perotti

Cholesky decomposition

Blanchard-Perotti

Blanchard-Perotti

FVAR and Blanchard-
Perotti
Narrative approach
Blanchard-Perotti

-23.87
1.55
0.65

-2.35

-3
-0.05
0.59

-0.53

-1.08

-0.8

0.39

+
-0.21
0.7

-0.07

-2.5
-0.49

where spending multipliers are usually found to be
very  low,  usually  non-significant  (see  Bénassy-
Quéré  and  Cimadomo,  (2006))  and  sometimes
even negative (Perotti (2004)).

Also with 
identification
the  Blanchard-Perotti 
methodology, Burriel et al. (2010) for the euro area
as a whole obtain multipliers below, although close
to  unity  in  the short  term,  while after  3 years it
shrinks  to some 0.6.  These  estimates fall  within
range  of  previous  empirical  evidence  for  other
European  countries  as well as  for  the  available
evidence for the US. Burriel et al. (2010) also find
that  fiscal  multipliers  are  higher
for  public
investment shocks and in times of fiscal stress.

The effects of tax shocks in the VAR literature 
on individual countries 

As in the case of government expenditure shocks,
the bulk of the available empirical evidence on tax
multipliers refers to the United States. Results are
not  conclusive  as  even  differences  in  the  sign  of
multipliers  are  observed.  In  any  case,  most  of  the 
empirical  estimates  reveal  that  tax shocks  usually
than  public
entail 

lower  effects  on GDP 

124

expenditure. Table III.2.2 summarizes some of the
available empirical evidence.

The results in Blanchard and Perotti (2002) imply 
tax  multipliers ranging  between -0.7  and  -1.3 for
the first two years and somewhat lower in absolute
value for the third one. It is worth mentioning that
these  are  not  cumulative  multipliers;  they  are
estimated with  respect  to  the  size  of the  initial
shock.

Favero  and  Giavazzi  (2007)  allow for  impose  the
fulfillment of the government borrowing constraint
in the VAR specification and obtain positive (non-
cumulative) multipliers to an increase of taxes for
the  sample  1980-2006. The  increase  of  output  in 
response to a tax increase is rather counterintuitive,
although  this  result  is  also  observed  in  other
studies and for other countries.

and  Uhlig 
consisting

their
Mountford 
methodology 
sign 
restrictions,  obtain (non-cumulative)  multipliers
that  amount  to around  2  or  even  above  after  two
years after a negative revenue shock.

(2009),  with 
imposing 
in 

Consolidation and dynamics of the multipliers. Are there counter-intuitive effects?

Part III

the 

Romer  and  Romer  (2010)  employ  a  narrative 
approach for the US post-World War II period and 
find very high negative tax multipliers, of almost -
3% over the next three years following the shock. 
This  contrasts  significantly  with 
lower 
multipliers  calculated  on  the  basis  of  tax  shocks 
identified within VARs with the Blanchard-Perotti 
methodology.  Favero  and  Giavazzi  (2010)  argue 
that  such  difference 
is  not  explained  by  a 
difference  in  the  shocks  (VAR  versus  narrative) 
but  by  the  different  models  used  to  estimate  their 
effects  on  macro  variables. They  show  that  when 
the  effects  of  shocks  identified  by  the  narrative 
method  are  analysed 
the  context  of  a 
multivariate  VAR  (rather  than  using  a  limited 
information, single-equation approach), multipliers 
with  both  methodologies  turn  out  to  be  rather 
similar and are estimated at about unity. 

in 

For Germany, Perotti (2004) estimates cumulative 
multipliers  to  net  tax  cuts  of  around  -0.6.  As  in 
other cases, the reduction of output in response to a 
tax  cut  after  three  years  is  rather  counterintuitive. 
In  turn,  in  Heppke-Falk  et  al.  (2006)  output  is 
barely  affected  by  net  tax  shocks.  By  contrast, 
Baum  and  Koester  (2011),  with 
linear 
specification,  estimate  a  multiplier  of  -0.66  after 
one  year.  In  their  TVAR  estimates  they  do  not 
obtain significant evidence of non-linearities. 

their 

In the case of France (Biau and Girard (2005) very 
low,  non-significant
tax  multipliers  are  found, 
whereas  for  Italy  (Giordano  et  al.  (2007)),  Spain
(De Castro (2006)) or Portugal (Afonso and Sousa 
(2009)(83) 
are 
observed,  with higher  net  taxes  yielding positive 
short-term output responses.

some  counterintuitive

results

Bénassy-Quéré  and  Cimadomo,  (2006)  for  the 
United  Kingdom  also  obtain very  low  one-year 
multipliers,  of  some  0.2,  whereas  Perotti  (2004) 
also  estimates  negative  multipliers in  response  to 
tax cuts, as observed in other cases. 

(83) They  argue  that  increases  in  taxes  can  raise  private 
consumption in the case of fiscal consolidations if it moves 
the  economy  from  an  unsustainable  fiscal  path  to  a 
sustainable  one  (Giavazzi  et  al.,  (2000)). In  addition, the 
effect  of  a  tax  shock  on  output  depends  on  whether  it  is 
motivated by the government's desire to stabilize the debt, 
or  is  unrelated  to  the  stance  of  fiscal  policy  (Romer  and 
Romer, (2007)).

By contrast, Cloyne (2011) identifies fiscal shocks 
with a narrative approach à la Romer and  Romer. 
He  argues  that  the  estimated  output  elasticities  of 
net  taxes  in  the  Blanchard-Perotti  method,  in 
addition to automatic responses to output changes, 
would also be capturing any  legislated changes in 
policy  which  are  contemporaneously  correlated 
to 
with  output.  He  finds 
negative  tax  shocks  between  0.5  and  1  per  cent, 
depending  on  the  model  specification,  which  rise 
to around 2.5 per cent after 10-12 quarters. 

impact  multipliers 

Regarding  the  euro  area  as  a  whole,  Burriel  et  al. 
(2010) gauge net-tax multipliers between  -0.6 and 
-0.5 for the first three years. 

2.3.  VAR ESTIMATES OF OUTPUT MULTIPLIERS 

TO GOVERNMENT SPENDING SHOCKS 

In order to provide further evidence on the effects 
of  government  spending  shocks  and  output 
multipliers  thereof,  VARs  for  Germany,  Italy  and 
Spain are estimated. The focus on these three euro 
area  cases  is  motivated  by  the  availability  of 
quarterly fiscal data to carry out the estimations. In 
fact,  quarterly  datasets  used  in  previous  empirical 
studies  are  employed:  in  the  case  of  Germany  the 
quarterly dataset in Heppke-Falk et al. (2006); (84) 
for Italy the dataset in Giordano et al. (2007); (85) 
in  the  case  of  Spain  the  new  dataset  recently 
compiled by De Castro et al. (2012). (86) The VAR 
estimations  cover  the  period  from  1985Q1  to 
2010Q4  in  the  cases  of  Germany  and  Italy  and 
from 1986Q1 onwards in the case of Spain. (87)

The  euro  area  as  a  whole  is  also  dealt  with.  To 
estimate the relevant VAR models we made use of 

(84) We  thank  Bernhard  Manzke  and  Joern  Tenhofen  for 

proving us with an updated version of this dataset.

(85) We  thank  Sandro  Momigliano  for  an  updated  version 

thereof.

(86) This quarterly fiscal database for Spain is compiled for the 
period  1986Q1-2010Q4  and  it  is  solely  based  on  intra-
annual information, on the basis of multivariate, state-space 
mixed-frequencies models. The models are  estimated with 
annual  and  quarterly  national  accounts  data  and 
government monthly cash accounts data.

(87) VAR  models  were  also  estimated  for  France  and  the  UK. 
However,  they  are  not  presented  as  responses  were  either 
rather  counterintuitive  or  non-significant. For  France,  this 
can be due to the fact that existing quarterly data for fiscal 
variables 
from 
interpolation until very recently. Negative fiscal multipliers 
for the UK are also found in Perotti (2004).

in  national  accounts  are  derived 

125

European Commission

Public finances in EMU - 2012

the  quarterly  fiscal  database  for  the  euro  area 
compiled  by  Paredes  et  al.  (2009) (88)  and 
employed  in  Burriel  et  al.  (2010)  and  in  Kirchner 
et  al.  (2010)  to  assess  the  macroeconomic  effects 
of fiscal shocks in the EMU. As in previous cases, 
the  VAR  estimations  cover  the  period  from 
1985Q1 to 2010Q4.  

The estimated  models include a  measure of direct 
government  spending  (g)  as  the  relevant  fiscal 
variable.  In  the  cases  of  Germany,  Spain (89)  and 
the euro area as a whole this variable is the sum of 
government  purchases  of  goods  and  services, 
personnel expenditure and public investment made 
the 
by 
government  expenditure  variable  used 
the
estimations is the sum of the two first components 
only,  which  turns  out  to  be  close  to  government 
consumption in the quarterly national accounts. 

the  general  government; 

Italy 
in 

for 

The economic sentiment indicator (ESI) estimated 
by  the  European  Commission  is  included  as 
endogenous  variable  too.  Its  inclusion  aims  to 
address,  at  least  in  part,  the  "fiscal  foresight 
problem"  of  VAR  estimates.  The  remaining 
endogenous  variables  are  GDP (gdp),  the  GDP 
deflator (p) to allow for price changes and a long-
term  interest  rate (r) (10  years). (90)  Government 
spending and GDP enter in real terms in logs. The 
GDP deflator is the price index used to obtain real 
government expenditure. In the case of Germany a 
dummy to capture the effect of the unification has 
been included as an exogenous variable, given that 
government  expenditure  data  show  an  upward 
swift in 1991. This variable turns out to be highly 
significant.  A  dummy  for  the  last  crisis  period, 
since  2008Q1,  has  also  been  included  as  an 
exogenous  variable  when  it  turned  out  to  be 
significant, especially in the case of Spain but also 
in  the  euro  area  as  a  whole.  The  purpose  for  its 
inclusion  is  to  correct  for  a  number  of  elements 
linked  to  the  financial  crisis  that  are  not  properly 

(88) This quarterly fiscal database for the euro area is compiled 
for the period 1980Q1-2010Q4. As in the case of Spain, it 
is solely based on intra-annual information, on the basis of 
multivariate, state-space mixed-frequencies models.

(89) For  the  purpose  of  the  analysis  in  this  Section  the  only 
variable from the quarterly fiscal database by De Castro et 
al. 
investment,  as  government 
consumption  has  been  taken  from  the  quarterly  national 
accounts.

is  public 

(2012) 

(90) Alternative  models  including  public  debt  as  endogenous 
variable  have  been  estimated  to  test  the  robustness  of  the 
results.  The  results  did  not  differ  significantly  from  those 
presented here though.

126

accounted  for by  the endogenous variables. These 
elements include the sharp correction in residential 
investments  after  a  protracted  period  of  buoyant 
housing  markets  in  a  number  of  countries,  the 
credit  crunch  following  the  financial  crisis  and 
sovereign  debt  crisis  as  a  result  of  a  lack  of 
markets  confidence  on  the  ability  by  some  euro 
area  Member  States  to  meet  the  service  of  their 
public debt.    

Government  spending  shocks  are  identified  by 
using 
the 
the  Cholesky  decomposition  with 
ordering (g, esi, gdp, p, r). This ordering assumes 
decisions 
that 
are
expenditure 
public 
predetermined  within 
the  quarter  and  affect 
contemporaneously  the  remaining  variables  in  the 
system. Hence, the identified government spending 
shocks are equivalent to Blanchard-Perotti ones. 

Graph  III.2.1  shows  the  impulse  responses  to  a 
government  spending  shock  of  the  main  variables 
for the countries under consideration. Government 
spending  shocks  display  little  persistence  in  the 
case  of  Germany  and  Italy,  whereas  they  turn  out 
to  be  fairly  persistent  in  Spain  and  in  the  whole 
euro  area  where  it  is  still  significant  after  12 
quarters.  Confidence 
in  all  cases, 
possibly in view of the positive reaction of GDP in 
the  short  term.  However,  confidence  worsens 
around three years after the initial shock, when the 
initial improvement in economic activity has faded 
away. In turn, interest rates rise some quarters after 
the  initial  shock  except  in  Germany,  where  their 
response is broadly non-significant. 

increases 

The  responses  for  the  whole  euro  area  largely 
follow  this  pattern.  However,  in  this  case  the 
increase  in  confidence  in  response  to  the  fiscal 
shock  is  not  significant.  On  the  other  hand, 
although the euro area interest rate also rises, this 
response  is  more  muted  than  in  the  cases  of 
individual  countries.  Hence,  the  interest  response 
loses  significance  and  turns  out  to  be  significant 
only  for  some  quarters  around  the  second  year 
after the shock. 

The  impulse  responses  of  government  spending 
and  GDP  are  used  to  estimate  the  cumulative 
output multipliers shown in Table III.2.3. The left 
panel  presents  the  multipliers  obtained  with  the 
sample  covering  until  2010,  whereas  the  right 
panel  displays  the  multipliers  for  the  pre-crisis 
period.  Estimated  output  multipliers  for  Germany 

Consolidation and dynamics of the multipliers. Are there counter-intuitive effects?

Part III

Graph III.2.1: VAR responses to a government spending shock

Source: Commission services.

evidence.  The 

and  Spain  are  very  similar  and  stand  around  1.2 
after one  year for the sample covering  until 2010. 
These  values  are  broadly  in  line  with  previous 
empirical 
impact 
multiplier  for  Germany  is  somewhat  below  the 
estimate  of  0.62  in  Heppke-Falk  et  al.  (2006), 
whereas the estimated value after one year appears 
largely  comparable  with  their  peak  estimate  of 
1.27  after  6  quarters.  By  contrast,  the  multiplier 
after  one  year  is  larger  than  the  short-term  linear 

estimated 

multiplier  of  0.7  reported  by  Baum  and  Koester 
(2011).  For  Spain  these  estimates  are  broadly  in 
line  with  output  multipliers  around  1.3  in  De 
Castro and Hernández de Cos (2008). By contrast, 
medium-term  multipliers  for  both  Germany  and 
Spain  in  Table  III.2.3 are  higher  than  those 
reported by the aforementioned studies.

Estimated  cumulative  output  multipliers  in  Italy 
are  significantly  lower,  always  below  unity.  The 

127

European Commission

Public finances in EMU - 2012

Table III.2.3: Cumulative output multipliers to spending shocks

Sample until 2010Q4

Quarters

4

1.19

0.34

1.15

1.38

8

1.78

0.75

1.79

1.67

1

0.38

0.1

0.3

0.63

12

1.49

0.22

1.49

1.27

1

0.71

0.11

0.58

0.79

Sample until 2007Q4

Quarters

4

1.99

0.43

1.35

1.23

8

3.08

0.84

1.55

1.57

12

3.4

0.5

0.98

1.06

Germany

Italy

Spain

Euro area

Source: Commission services.

peak is observed in the second year after the shock,
when the cumulative multiplier amounts to 0.75, to
decrease  rapidly  thereafter.  These  values  are  well
below cumulative multipliers reported in Giordano
et  al.  (2007).  However,  they  are  not  directly
comparable as multipliers reported by Giordano et
all focus only on purchases of goods and  services
in that expenditure on wages and salaries does not
lead to significant responses. On the other hand, it
is worth recalling that multipliers for Italy are not
fully comparable with those for Germany or Spain,
as for these two countries public investment is also
embedded in the government expenditure variable
in  the  respective  VAR models.  Public  investment
is  deemed  to  entail  positive spill-overs  on  private
GDP,  for which  shocks  to  this  variable would  be 
expected  to yield higher multipliers  than  other
spending components.

In  the  case  of  the  euro  area,  output  multipliers
amount  to  around  to  1.4  one  year  after  the  shock 
and  remain  comfortably well  above  unity  even
there  years  after  the  initial  shock.  These  contrast
significantly with values obtained in Burriel et al.
(2010),  where  cumulative multipliers  are  lower
than  those  reported  in  Table  III.2.3 regardless  of
the  sample  used.  The  reason  for  such  a  different
could  be  that  the  specification  in  Burriel  et  al.
(2010) includes net taxes, which rise endogenously
to 
thereby
spending 
contributing  to  assuage  the  GDP  response.  By 
contrast,  the  specification  adopted  here  does  not
allow for endogenous net tax responses, which are
replaced by the economic sentiment indicator.   

government 

shocks, 

The  comparison  between  the  estimates with the
whole  sample  and  for  the  pre-crisis  period yields
interesting  results.  In  the  case  of  Spain medium
term multipliers  seem to  have  increased with  the
crisis.  This  evidence would,  in  principle,  be
consistent  with  the  hypothesis  that  insofar  as  the
increase  of
crisis  has 

implied  a 

sizeable 

128

financially-constrained  agents  and  a  reduction  of
it may have
the  used  productive  capacity 
contributed to raise fiscal multipliers. However, in
the  case  of  Germany  the  opposite  seems true,
whereas in Italy however, the crisis does not seem
to  have  had  a  significant  impact  on  government
spending multipliers.  In  the  case  of  Germany,
despite  the  sizeable  fall  of  GDP  in  2009,  the
unemployment  rate  has  stood  at  historical  lows.
Therefore,  the  share  of  constrained  economic
agents,  rather  than  increasing, might  even  have
decreased,  thereby  contributing  to moderate  fiscal
multipliers. While the results here might appear in
some  contradiction with  those  in  Baum  and
Koester  (2011),  it  is worth noticing  that  the
difference  between  the multipliers  in  the  two
panels  in  Table  III.2.3  cannot  be  taken  as  an
indication  of  how multipliers  in  Germany  behave
in  crisis  periods;  the  two  panels  only  reflect  the
influence of the last three years, where no especial
liquidity  constraints seem  to have  been  present  in
Germany.

The  multipliers for  the  euro  area  as  a  whole  are
also higher for the sample covering until 2010 than 
with  the  sample  ending  in  2007.  Arguably,  this
result could be consistent with the hypothesis that
multipliers  tend  to  increase in  times  of  subdued
economic growth or even when GDP contracts due
to  the  rise  in  financially-constrained  agents  and
when  the  economy  approached  to  the  lower  zero
bound. This result is consistent with the findings in
Afonso  et  al.  (2011), who  find  that  the size  of
fiscal multipliers is higher than average in the last
crisis.  However,  this  statement  must  be  qualified
as for government spending multipliers, given their
standard  errors,  the  differences  between  both  sets
of estimations are not significant.

the  evidence  presented 

this
Accordingly, 
Section
to
government expenditure shocks may be sizeable in

that  output  multipliers 

suggests 

in 

Consolidation and dynamics of the multipliers. Are there counter-intuitive effects?

Part III

the  three  country  cases  examined,  especially  in 
Germany and Spain, as well as for the euro area as 
a whole where they stand above 1 in the short and 
medium  term.  This  evidence  appears  broadly 
consistent  with  previous  empirical  evidence 
reported in Section III.2.2.

these  conditions,  the  increased  demand  for  output 
would  bring  an  increase  in  employment  and 
consumption.  The  Keynesian  tradition  is  thus 
inherently  non-linear  in  that  the  effects  of  fiscal 
policy are different depending on the status of the 
economy.

The  range  of  VAR-based  short  and  medium  term 
output  multipliers  to  fiscal  shocks  is  quite  wide, 
with  estimates  depending  on  the  sample  period, 
the  econometric 
country  under  scrutiny  and 
specification  employed.  Notwithstanding 
this, 
some general conclusions can be drawn from both 
the  estimates  presented  here  and 
the 
empirical  literature.  Despite  their  wide  range, 
output  multipliers 
to  government  expenditure 
shocks  are  sizeable,  in  many  cases  estimated  at 
above one. In turn, net taxes appear to imply lower 
multipliers  than  public  spending,  although  their 
effects in the medium term are deemed to be non-
negligible. 

from 

While  a  proper  assessment  of  fiscal  multipliers  is 
of  high  importance  when  adopting  discretionary 
fiscal measures, this issue gains especial relevance 
in  the  coentex  of  the  current  crisis  where  most 
EU27  Member  States  are  implementing  sizeable 
fiscal  consolidation  packages  simultaneously. 
According  to  the  evidence  on  fiscal  multipliers 
presented  in  this  chapter,  fiscal  contractions  are 
expected to weigh heavily on economic activity in 
the  short 
these  effects 
displaying  somewhat  high  degrees  of  persistence. 
These effects must be factored in, especially when 
designing  the consolidation strategies  with a  view 
to minimise these negative effects. 

term,  with  some  of 

2.4. 

FISCAL MULTIPLIERS IN CRISIS PERIODS

One  of  the  main  issues  discussed  within  the 
the  "self-defeating consolidations"
context  of 
debate  is  the  non-linearity  of  the  multipliers  (see, 
among  many,  Parker  (2012)), and  specifically  the 
fact  that  multipliers  are  expected  to  be  larger  in 
crisis periods. 

This  argument  is  enshrined  in  the  Keynesian 
tradition  which  proposes  fiscal  policy  as  an 
effective  instrument  to  manage  aggregate  demand 
there  are  underutilized 
in  periods 
production 
is 
expected  to  avoid  wage  upward  pressure  and,  in 

in  which 
factors:  high  unemployment 

to 

firms  have 

Modern  theory  in  general  does  not  give  this
channel  a  large  weight,  with  the  exception  of 
Thomas (1995), which shows that, in situations in 
which 
invest  under  profits' 
uncertainty  which  they  cannot  hedge  risks  in  the 
financial markets, employment level is sub-optimal 
and  fiscal  policy can  be  used 
increase 
employment  and  welfare.  The  economy  in  a 
financial  crisis,  which 
is  characterized  by 
about 
non-insurable 
aggregate 
expected  aggregate  demand  and  credit  conditions, 
fits  such  a  model  characterized  by  incomplete 
markets. (91) 

uncertainty 

to 

However  DSGE  models  - also  of 
the  new 
Keynesian  type  – follow  a  different  line  of 
argument and provide in general linear multipliers, 
which  are  functions  of  the  various  parameters 
discussed above. Assessing the value of multipliers 
in  crisis  situations,  can  mostly  be  done  in  an 
heuristic  way,  by  assessing 
that 
reasonably can be taken by the crucial parameters 
in crisis  times as opposed to the  values  that those 
parameters can take under normal circumstances. 

the  value 

influencing 

the  value  of 

the 
Three  factors 
multipliers  in  DSGE  models  can  in  principle  be 
related  to  crisis.  First  channel  is  the  traditional 
Keynesian presence of slack in the economy. This 
channel  however,  in  presence  of  agents  that  take 
the  basis  of  their 
consumption  decisions  on 
permanent  income  – and  not  only  their  present 
income as in the Keynesian tradition – has a very 
limited  effect  on  the  multipliers.  More  relevant 
quantitative  impact  on  the  multiplier,  as  shown 
above, comes from the percentage of agents which 
are rationed on the financial markets and from the 
fact  that  monetary  policy  is  at  the  so-called  zero 
lower  bound  i.e.  in  a  situation  akin  to  the 
Keynesian liquidity trap.

(91) The  relevance  of  uninsurable  uncertainty  in  depressing 
investments is corroborated, among many, by the empirical 
studies of Bloom (2009) and Bloom et al. (2007.)

129

European Commission

Public finances in EMU - 2012

are 

that 

that  are 

financially 

Even  if  DSGE  models  do  not  make  endogenous 
the  share  of  consumers 
liquidity 
constrained,  it  is  a  reasonable  assumption  that 
during  crisis,  especially  crisis  originated  in  the 
financial  sector  as  the  present  one,  the  fraction  of 
consumers 
constrained 
increases.  As  indicated  in  the  review  of  the 
literature  above,  QUEST,(92)
in  line with  the 
literature,
indicates  an  increase  of  the  impact 
multiplier  by  20%  on  average  in  presence  of 
financially  constrained  consumers,  with  higher 
value  for  fiscal  measures 
impacting  directly 
current  revenues  – like  transfers  to  households  -
and smaller for other type of measures. ( 93)

A second key factor of key relevance is the stance 
of  monetary  policy:  the  more  accommodative 
monetary policy, the larger the multipliers, via the 
impact on real interest rates. Moreover Christiano, 
et  al.  (2011)  show  that  multipliers  are  higher  the 
larger  the  percentage  of  spending  implemented 
under  a  liquidity  trap,  with  peak  multipliers  that 
can  be  larger  than  two  while  Leeper  et  al.  (2011) 
find one-year spending multipliers at 1.5-1.6. Also 
Table  III.6.1  of  European  Commission  (2010a) 
shows 
of  monetary 
accommodation  increases  multipliers  by  25%  to 
30%.

presence 

that 

the 

to 

The  main  exceptions 
linear  models  are 
constituted by Erceg and Lindé (2010) which build 
a  new-Keynesian  DSGE  model  showing  that  the 
duration  of  a  liquidity  trap  is  endogenous  and  is 
shorter  the  larger  the  fiscal  stimulus  provided  by 
an  increase  in  government  spending.  Given  that 
multipliers  are  larger  the  longer  the  period  in 
which the economy remains in the liquidity tap, in 
Erceg  and  Lindé  the  size  of  the  multiplier  is 
inversely  related  to  spending  levels.  The  second 
exception  is  Canzoneri  et  al.  (2012),  which  build 
on  the  previous  reasoning  and  introduce  costly 
financial 
financial 
frictions to vary counter-cyclically. The model can 
thus  generate  impact  spending  multipliers  which 
are between two and three in recessions and 0.9 in 
expansions.  Yearly  cumulative  multipliers  are 
almost  1  and  roughly  two  thirds  respectively.  It 

intermediation 

allowing 

(92) See European Commission (2010b), pg. 186.
(93) The relevance of financial frictions in crisis period is also
indirectly  confirmed  by  Kollmann  et  al.  (2012)  and  in't 
Veld and Roeger (2012), where it is shown the relevance of 
state  support  to  banks  in  reducing  risk  premia  and  real 
interest rates.

130

features: 

should  be  noticed  that  these  results  are  obtained 
with  persistence  of  government  shock  of  0.97. 
the  model  mimics 
Interestingly 
fully 
two 
the  "theorem  of 
first, 
Keynesian 
multiplier  in  balance"  holds  in  that  multipliers 
during  recessions  remain  greater  than  one  even if
higher spending is financed through taxes; second, 
debt-financed  multipliers  are  even  higher  (in 
recessions).

are 

Recent  empirical  analysis 
tends  to  find  that 
multipliers  are  larger  in  crisis  periods.  Auerbach 
(2010)  using  a  smooth 
and  Gorodnichenko 
transition  structural  VAR  (STVAR)  methodology 
find peak values for spending multipliers of 1 and 
for  tax  multipliers  of  -1  in  the  US.  When  a 
is  made  between  expansions  and 
distinction 
recessions 
found 
spending  multipliers 
respectively  around  0.6  and  up  to  2.5, while  tax 
multipliers  become  smaller  but  still  differentiated 
at  -0.5  and  -0.1  in  recessions  and  expansions,
respectively.  Values  can  become  very  large  in 
recessions depending on the proxies used for fiscal 
variables'  expectations  but  the  difference  between 
expansion  and  recession  remains.  Auerbach  and 
Gorodnichenko  (2011)  use  a  panel  of  semiannual 
yearly  observations  for  OECD  data  since  1985  to 
find the same result – but much lower multipliers –
with  a  linear  multiplier  estimated  at  around  0.2,  a 
recession  multiplier  between  0.4  and  0.7  and  an 
expansion  multiplier  which  is  never  significantly 
different  from  0.  IMF  (2012)  presents  similar 
results  using  a  threshold  VAR for  the  large  EU 
countries.

A  similar  exercise  is  made  in  Caprioli  and 
Momigliano (2011) which use a STVAR technique 
on  a  sample of  quarterly  data  for  Italy  in  1982-
2011. They show that in recession the responses of 
private  GDP  are  much  larger  than  in  expansions,
with  peak  responses  after  six  quarters  of  0.13  in 
the  linear  model,  0.16  in  expansions  and  0.61  in 
recessions.

Afonso et al. (2011) use similar techniques on data 
from  a  quarterly  dataset  for  the  period  1980:4-
2009:4  for  the  U.S.,  the  U.K.,  Germany  and  Italy 
to  estimate  the  differences  in  multipliers  in  high 
financial stress versus low financial stress regimes. 
They find  that  the  responses  of  economic  growth 
to a fiscal shock, defined in terms of changes in the 
debt  ratio.  are  mostly  positive  (though  in  some 
cases  very small) in both financial  stress regimes,

Consolidation and dynamics of the multipliers. Are there counter-intuitive effects?

Part III

but that 3-year multipliers can be twice as large as
in high stress regime (0.7 versus 0.3 in Italy, 0.24 
versus 0.2 in the US, 0.2 versus 0.15 in the UK and 
0.4 versus 0.2 for Germany) so that they conclude 
that the size of the fiscal multipliers is higher than 
average in the last crisis.

As  mentioned  before,  Baum  and  Koester  (2011) 
with  a  Threshold  VAR  show 
that  public 
expenditure multipliers vary depending on the size 
of  the  shock,  its  sign  and  the  level  of  the  output 
gap.  Hence,  in  low  regimes  or  crisis  periods  they 
observe  that  the  higher  the  size  of  the  shock,  the 
higher  the  spending  multiplier  when  government 
increases.  Hence,  a  government 
expenditure 
expenditure 
to  a 
increase  of  5%  may 
multiplier  of  around  1.3,  whereas  when the 
spending 
the 
multiplier  diminishes  to  around  1.  In  good times 
though  multipliers  are  lower  and  seem  to  behave 
more linearly.

increase  only  amounts 

to  2% 

lead 

for 

the 

Bouthevillain  and  Dufrenot  (2011)  estimate  a 
Markov  switching  model  on  quarterly  data  on 
1970:1-2009:4. (94) 
period 
France 
Increasing government expenditures is effective in 
raising GDP in recessions but not in expansions in 
expansions,  and  similarly  for  a  decrease 
in 
government revenues.

2.5. 

EFFECTS OF DEBT AND DEFICIT ON 
GOVERNMENT YIELD

The other relevant factor that shapes the dynamics
of  the  debt  ratio  following  a  consolidation  is  the 
response  of  apparent  interest  rates  on  sovereigns. 
The predictions of economic theory on the effects 
of  fiscal  policy  variables  on  interest  rates  are  not 
univocal.  The  traditional  Keynesian  analysis  well 
represented  by  the  IS/LM  model  stresses  the  role 
of  deficit:  an  increase  in  deficit  tends  to  increase 
government  yields  and  consequently  interest  rates 
via  demand  pressure:  the  consequent  increased 
demand  for  money  pushes  up  interest  rates  –
unless monetary policy reacts by increasing money 
supply as it is the case if the country wants to keep 
its exchange rate unchanged following the change 

(94) True fiscal policy data at quarterly frequency are computed 
in France only for recent years. Data used in Bouthevillain 
and  Dufrenot,  as  those  used  in  the  present  Section  are 
based on yearly time series interpolation by the OECD.

that 

in  deficit.  A  similar  argument  holds  for  New 
Keynesian  DSGE  models, 
incorporate  a 
Taylor rule by which interest rates react positively 
to  future  inflation generated  by  the  increased 
demand  due 
increase  or  a 
devaluation/depreciation  of  the  currency.  These 
models  however  refer  to  short-term  interest  rates, 
while the relevant rate for the economy is probably 
the  long-term  interest  rate,  which  better  reflects 
marginal productivity of capital. 

to  a  deficit 

On top of reacting to short term interest rates and 
inflation  expectations,  long-term  interest  rates  are 
influenced  by  debt  levels  via  different  channels. 
First, as stressed in Engen and Hubbard (2004) and 
Gale and Orszag (2004) growth theory shows that 
the debt level rather than the government deficit is 
the  relevant  fiscal  variable  that  impact  on  long-
term  interest  rates.  A  higher  government  debt 
crowds  out  investments  thus  resulting  in  a  lower 
capital  stock. This  at  equilibrium  implies  higher 
real 
interest  rates  given  decreasing  marginal 
productivity  of  capital.  A  second  channel  which 
relates  higher  debt  to  increased  long-term  interest 
rates  goes  via  risk  premia  (see  Eaton  and 
Fernandez  (1995)). Increased  debt  levels  imply  a 
higher probability of default which in turn implies 
higher  risk  premia  and  thus  sovereign  yields  –
even  though  this  is  necessarily  also  related  to  the 
assumption  of  lower  expected  future  government 
deficits  as  pointed  out  in  Manasse,  Roubini  and
Schimmelpfennig  (2003).  Thus  the  main  question 
to be faced by empirical researches is which fiscal 
variables to use for the analysis, whether deficit or 
debt.

The  existing  empirical  literature  on  the  effects  of 
fiscal  variables  on  sovereign  yields  can  be 
categorized in two groups. A first group of papers 
estimates how fiscal policy variables influence the 
level of long-term interest rates taking into account 
the effects of future inflation and monetary policy 
variables.  A  second  group  of  articles  tries  to 
explain  the  factors  driving  the  behaviour  of 
spreads,  in  general  vis-a-vis  Germany,  among 
which  fiscal  variables  play  a  role.  Many  times  no 
choice is made and both variables are tested.

The main technical problem  facing the first group 
of  papers is  related  to  endogeneity:  the  level  of 
interest  rates  that has  to  be  explained  by  fiscal 
variables  also  influences  the  very  same  variables 
that  are  used  to  explain  it,  both  directly  via 

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Public finances in EMU - 2012

increased  expenditures  and  indirectly,  via  the 
impact  on  the  economy.  In  order  to  solve  this 
problem,  Elmendorf  (1993)  uses  deficit  forecasts 
for  the  US  and  finds  that  an  increase  in  deficit 
projections  of  1%  of  GNP  raises  five-year  bond 
yields  by almost  50  basis  points.  The  use  of 
projected  deficit  to  solve  the  endogeneity  issue 
however  is  not  without  problems,  given  that  the 
business  cycle  affects  at  the  same  time  the  fiscal 
policy variable and sovereign yields. 

Laubach  (2009) and Engen  and  Hubbard  (2004), 
uses  therefore  five-year-horizon  deficit  and  debt 
projections  by  the  Congressional  Budget  Office 
and  finds somewhat  lower  effects  of  around  20 
basis  points  for 
ten-year 
forward  rate  for  each  point  of  GDP  increase  in 
deficit  and  some  3 basis  points  increase  for  the 
five-year-ahead  ten-year  forward  rate  for each 
point  of  GDP  increase  in  debt.  Thomas  and  Wu 
(2009)  control  also  for  risk  indicators  but  find 
results in the same range.

the  five-year-ahead 

As  Gale  and  Orszag  (2004)  show,  this  result 
indicates  a  roughly  similar  effect  of  debt  and 
deficit over a ten year horizon, in that a permanent 
increase  in  deficit  by  one  point  of  GDP  would 
increase the debt to GDP ratio by the same amount 
and have thus a cumulative effect in  interest rates 
of  the  same  order  of  magnitude.  Always  for  the 
US,  Gale  and  Orszag  test  differences  between 
predictions  on  real  and  nominal  interest  rates  and 
find broadly similar results for deficit, in the range 
of 30 to 70 basis points increase for each point of 
deficit  increase,  and  still  small  but  slightly  higher 
for debt up to 6 basis points.  None of these papers 
uses samples containing crisis data.

Similar estimates are found in papers that study the 
impact of fiscal policy on the yield curve: Dai and 
Philippon  (2005)  show  that  in  the  US  a  one 
percentage point increase in government deficit to 
GDP ratio lasting for three years increases the 10-
year  rate  by  40-50  basis  points  and  that  this 
increase  is  due  not  only  to  higher  expected  spot 
rates  – related  to  monetary  policy  – but  also  for 
one third to higher risk premia. 

Another  group  of  paper  uses  evidence  from  other 
advanced  economies  and  applies  panel  data 
estimators  to  assess  the  impact  of  fiscal  variables 
on interest rates. Ardagna et al. (2006) finds lower 
effects of deficits,  whereas for the debt no impact 

is  found  below  the  threshold  of  63%  of  GDP  and 
only  a  small  effect  is  estimated for  higher  values.
Similar  effects  are  obtained  in Ardagna  (2004), 
which finds  that  the  ten-years  government  bond 
interest rate increases by some 160 basis points in 
periods of worsening primary government balance 
and  decreases  by  somewhat  lower  values  in 
consolidation periods.

For a panel of ten of the early members of the euro 
area Faini (2006) detects no significant effect from 
debt  levels  on  ten-year  real  interest  rates  but  a 
small effect (a few basis points) from government 
deficit.  The  article  finds  however  that  there  are 
sizable  spillover  effects  within  the  euro  area:  the 
aggregate  euro  area  deficit and  debt  have  an 
impact  on  ten-year  real  interest  rates  of  some  40 
and 3 to 8 basis points, respectively.

The  second  strand  of  the  literature  uses  infra 
annual  data  at  various  frequencies  to  assess the 
behavior of spreads within the euro area, the main 
advantage of using high-frequency data being that 
the  endogeneity  problem  is  greatly  reduced.    The 
general feature of such analysis is to show that an 
international  risk  factor  explains  the  bulk  of  the 
spreads  behavior,  but  that  fiscal  variables  have 
some  effect  as  well. Codogno  et  al.  (2003), using 
as  independent  variable  differences  in  debt-to-
GDP  ratios  with  respect  to  Germany,  find  that 
fiscal  policy  variables  have  effect  on  relative  ten-
year  government  bond  swap  spreads  except  for 
Austria,  Italy  and  Spain  when  interacting with 
international  risk  variables. In  turn,  Bernoth  et  al. 
(2004), with a sample of emissions by thirteen EU 
countries,  finds  that  each  point  of  difference 
between  the  country's  debt  ratio  and  Germany's 
debt ratio entails an effect on the spread around 3 
basis  points,  jointly  with  some  evidence  of non-
linear  effects  for  large  debt  levels. Barrios  et  al. 
(2009) and  Schucknecht  et  al.  (2010)  find  very 
alike results in similar contexts but with data from 
the  current  crisis  considered  in  the  sample.  In  the 
latter case, as in Codogno et al. (2003), the effects 
of  government  debt  on  spreads  steeply  after  the 
bankruptcy of Lehmann Brothers. Values of 12 to 
18  basis  points  are  also  found  in  European 
Commission  (2011a) 
in  a  study  which  uses 
observations  of  ten  founding  euro  area  countries 
over 1999-2009.

Summing  up,  despite  some  dispersion  in  the 
estimates,  higher  fiscal  deficits  and  public  debt 

132

Consolidation and dynamics of the multipliers. Are there counter-intuitive effects?

Part III

Table III.2.4: Resuming the strand of literature on fiscal consolidation and the cost of debt

Studies

Sample

Short term int. rates
(5 years)

Long term int. rates
(10 years)

Approach

Engen and Hubbard (2004)

US (1976-2003)

Debt  0.28

Debt  0.30

Vector auto regression (VAR)

Gale and Orszag (2004)

US (1956-2000)

Deficit  0.3/0.7

LS and ML estimates

Eaton and Fernandez (1995)

Survey of literature

Manasse, Roubini and
Schimmelpfenning (2003)

47 economies with market
access (1970-2002)

Increased debt levels raise the 
probability of default. Higher
public debt increases risk premia

Increased debt levels raise the 
probability of default. Higher
public debt increases risk premia

Laubach (2010)

US (1976:1-2006:2)

Thomas and Wu (2009)

US (1983-2005)

Deficit  : 0.23
Debt : 0.032
for the 5-year-ahead 5-year
forward rate
Deficit : 0.48-0.60

Deficit : 0.20-0.29;
Debt : 0.022-0.044 
for the 5-year-ahead 10-year
forward rate
Deficit : 0.30-0.46

Dai and Philippon (2005)

US (1970:1-2003:3)

Deficit : 0.4-0.5

Literature review

Logit and binary recursive tree 
analysis

LS and IV regression

LS regression 
VAR that incorporates a no-
arbitrage affine term-structure 
model with a set of structural 
restrictions to identify fiscal 
policy shocks

Ardagna et al. (2004)

16 OECD countries (1960-
2002); (1975-2002)

Ardagna (2006)

16 OECD countries (1960-
2002) yearly data

Faini (2006)

10 EA members (1979-2002)

Debt: 0.53

Codogno et al. (2003)

Bernoth et al. (2004)

Barrios et al. (2009)

9 EMU founding members
(1999-2002)

13 EMU countries (1999-
2002)
7 Euro area countries (2003-
2009)

Schucknecht et al. (2010)

12 countries (1991-2002)

European Commission (2010)

10 founding members (1999-
2009)

1% of GDP increase in primary
deficit:
+10 bp (static specification)
+150 bp (P-VAR)
Non-linear effects of public debt

Deficit : 0.24-0.42 
Debt:  0.04-0.06
interest rate increases by 162 basis
points in periods of worsening
primary government balance and
decreases by 124 basis points on
average in consolidation periods

Debt: Lowest in Netherlands 0.05; 
highest in Portugal 0.08
Debt ratio of 50 points higher than
Germany: +47.5 b.p.
Debt ratio of 25 points higher than
Germany: +30 b.p.;
Government surplus: -0.024 Debt :
0.003
+marginal debt (benchmark
country): 0.09 b.p. before 2008;
1.18 b.p. after.

Debt: 12-18 basis points

Panel and
Panel VAR

Panel

Panel

Time series inspection and
SURE estimates

Panel

LS and IV regression

Panel

Panel

 Iara and Wolf (2001)

11 EA countries (1999-2009)

Debt: 0.93-1.40

Panel (GMM)

Source: Commission services.

ratios seem to lead to higher interest rates too (see 
Table III.2.4.). On average, the available evidence
suggest  that  increases  in  public  deficits  and  debt 
ratios of around 1% of GDP may entail long-term
interest  rate  rises  of around  50  basis  points  and 
about  5  basis  points,  respectively.  Both  estimates
are compatible as a permanent increase in deficits
by  one  point  of GDP would  increase  the  debt  to
GDP  ratio  by  the  same  amount  and have thus  a
cumulative effect in interest rates of the same order
of magnitude. However, these effects may be non-
linear.  The  effects  on government yields  are
expected  to  rise with the  stock  of  public  debt,

the 

risk  premium 

mainly via 
linked with
sustainability  concerns.  Accordingly,  insofar  as
fiscal consolidations succeeded in reducing public
debt,  their  associated  short-term  pain would  be 
lower the larger the initial stock of public debt.

2.6.  CONCLUSION ON REVIEW OF VALUE OF 

MULTIPLIERS 

The review of the literature presented above allows
drawing the  following  conclusions,  despite  the
large  variation  in  estimates and  the  difficulty  in

133

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Public finances in EMU - 2012

comparing  them.  Assessing  the  current  size  of 
fiscal  multipliers  is  complex,  in  that  the  value 
taken  depends  on  its  composition,  its  permanent 
nature, and on the economic environment at large. 

First,  the  large  majority  of  estimates  of  first-year 
spending multipliers in normal times are located in 
the  range  of  0.4  to  1.2.  The  values  are  lower  –
quite  often  below  0.7  -
for  tax  multipliers. 
Therefore, 
the  composition  of  observed 
if 
consolidation  is  taken  as  a  guide,  multipliers  are 
expected  in  general  to  be  lower  than  the  highest 
estimates: using observed changes in revenues and 
expenditures  to  GDP  ratios  as  proxies  for  the 
composition of the adjustment shows that in 2012 
consolidation  is  equally  shared  in  revenue  and 
expenditure  measures  (see  Chapter I.3). In  the 
same  direction  also  go  the  indications  that  comes 
from 
the 
the  mostly  permanent  nature  of 
consolidation in the EU.

in 

However,  it  is  likely  that  in  the  current  juncture 
impact multipliers are higher than normal because 
the  literature  stresses  that  in  situations  of  crisis, 
and  of  financial  crisis  in  particular,  with  many 
agents  constrained 
the  financial  markets, 
multipliers are larger than average. The specificity 
of  the  EU  and  of  the  euro  area,  with  high  trade 
integration  fixed  exchange  rates  and  the  necessity 
of  consolidating  at  the  same  time  and  during  a 
period  in  which  the  rest  of  the  world  is  growing 
well below potential indicate add to the probability 
that first year fiscal multipliers are relatively high.

The European Commission's QUEST model yields 
first-year multipliers of around 0.7 and 0.4 for the 
Euro  Area  for  a  balanced  consolidation  in  normal 
economic times, which is perceived respectively as 
temporary/not  credible or  permanent/credible  by 
consumers 
(2010b)).
(European  Commission 
These  multipliers  can  become  larger  in  a  crisis 
period (by a factor of one half) and even larger in a 
crisis  period  in  which  trade  partners  consolidate 
when they can be multiplied roughly by a factor of 
5/3. 

The  relevance  of  the  fact  that  consolidation  is 
pursued  at 
the  same  time  by  many  partner 
countries  is  stressed  both  in  theoretical  paper  like 
Erceg and Lindé (2012) relatively to the effects via 
international  interest  rates,  and  in  Perotti  (2011) 
where it is shown that the so-called non-Ricardian 
effects – related to the effect of future government 

134

balances  on  permanent  income  - where  most 
probably not the source of the short-run success in 
terms  of  GDP  of  the  main  four  episodes  of 
consolidation  which  were  associated  with  an 
expansion,  rather  the  main  driver  of  growth  was 
exports  rather  than  internal  demand.  This  is 
particularly relevant for euro area countries, which, 
despite  being  relatively  open  economies  if  taken 
individually  and  have as  main  trade  partners  the 
other  countries  of  the  union  (in  general). In  that 
case  there  can  be  magnifying  effect  of  an  area-
wide consolidation on the multipliers. 

Multipliers  in  the  current  juncture  as  assessed  by 
QUEST  are  around  0.7  and  1.2  respectively  for 
permanent/credible  and  temporary/non  credible 
balanced  consolidation  under  an  accommodative 
monetary policy. 

Multipliers will be quite different according to the 
composition of the consolidation, with government 
consumption  multipliers  lying  between  0.5  and 
0.8;  larger  multipliers  correspond  to  cuts  in 
government  wages  and  government  investments 
(above 1) while smaller multipliers (of around 0 in 
normal times and 0.7 in times of crisis) correspond 
to  VAT  and  labour  tax  increases.  The  meta-
analysis  by  Leeper,  Traum  and  Walker  proposes 
similar multipliers for partially permanent/credible 
government  consumption  based  shocks  which  are 
in the order of magnitude of 0.6 to 0.9 for normal 
times  but  larger  multipliers  – around  1.6  – for 
is 
periods 
accommodative 
open 
economies. ( 95) 

in  which  monetary 

relatively 

policy 

and 

for 

The estimates of spending multipliers made by the 
Commission on three large euro area countries and 
aggregate  euro  area  data (96)  are  in  line  with 
literature results, with fist-year multipliers between 
0.4  and  1.4,  an  increased  second-year  multiplier 
and  values  for  third  year  multipliers  still  in  line 

(95) The  values  of  0.7  and  1.6  are  not  directly  comparable 
because of different assumptions on credibility and on the 
composition of the consolidation, but represent the relevant 
range of values that can be supported by existing models. It
is recalled that a comparable QUEST multiplier is slightly 
above one. See Chapter  III.2.

(96) Estimates  for  France  were  made  but  resulting  multipliers 
were  found to  be  null.  This  can  be  related  to  the  fact that 
the  quarterly  series  which  are  used  are  derived 
interpolating  annual  data  and  therefore  are  not  proper 
quarterly data and do not reflect the reality of fiscal shocks. 
Non-significant multipliers were found also for the UK, in 
line with Perotti (2004).

Consolidation and dynamics of the multipliers. Are there counter-intuitive effects?

Part III

the  case 

with  first-year  multipliers,  before  a  relative  quick 
decrease.  This 
if 
is  even  more 
composition  is  taken  into  account,  as  spending 
VAR  multipliers  are  estimated  using  a  composite 
spending variable which is the sum of government 
consumption  and  government  investments,  which 
– according to New Keynesian DSGE models – are 
the  highest 
components  with 
among 
multipliers.

the 

It  should  be  noticed  that,  it  is  not  possible  to 
compare directly VAR-based assessments of fiscal 
multipliers to  model-based ones. The  main reason 
is  that  fiscal  shocks  in  VAR  models  are  typically 
temporary,  while  in  models-based  assessment  the 
nature of the shock can be different.

135

3.

DEBT DYNAMICS AND EFFECTS FROM CONSOLIDATION

at 

the 

looks 

effects 

This  Chapter
that 
consolidations  have  on  the  debt  ratio.  It  looks  at 
the  relationship  between  deficits  and  debts  and 
that 
estimates 
determine  how  government  debt  changes  for 
different levels of deficits. (97)

the  values  of  key  parameters 

In  the  absence  of  any  stock-flow  adjustments, ( 98) 
the  government  debt  to  GDP  ratio  (b)  evolves 
according to the following formula: (99)

where  bal  represents  the  budget  balance  to  GDP 
ratio,  pbal  the  primary  budget  balance,  r  the 
average effective interest rate on government debt  
and  g  nominal  GDP  growth.  The  evolution  of  the 
debt  ratio  can  therefore  be  understood  as  being 
driven  by  the  primary  balance  and  the  snowball 
effect, which is the difference between the average 
effective  interest  rate  and  the  growth  rate  of  the 
economy.  Over  the  medium-term,  the  snowball 
effect  is  of  particular  importance  as  it  drives  the 
magnitude  of  primary  balances  that  are  necessary 
in  order  to  ensure that  government  debt  remains 
sustainable.

The  effects  of  consolidation  on  the  debt  ratio  can 
then be analyzed by looking at the direct effect that 
the consolidation has on balance and its impact on 
the snowball effect. The Chapter starts by looking 
at the short-term impact of consolidations, looking 
at  how  the  fiscal  multipliers  translate  magnitudes 

in  government  debt  and 

(97) This Section Chapter is based on Boussard et al. (2012). 
(98) The  stock-flow  adjustment  is  the  difference  between  the 
the  government 
change 
deficit/surplus  for  a  given  period.  The  main  categories  of 
stock-flow  adjustments  are  net  acquisitions  of  financial 
assets,  items  that  do no  directly  affect  the  Maastricht 
definition of debt and effects of face valuation, comprising 
also 
See 
exchange 
http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/STO
CK_FLOW_2011/EN/STOCK_FLOW_2011-EN.PDF

variation. 

effects 

rate 

of 

(99) This 

is 

formula 

the 
represents 
identity
government  debt  in  cash  terms,  Bal government  balance 
and stock-flow adjustments are assumed to equal zero. The 
formula in the text is derived by expressing all variables as 

derived 
,  where  B

from 

a  ratio  to  GDP  (Y)   

and  simply 

rewriting 

and  approximating 

with 

gives the formula in the text.

136

of  deficits  into  changes  in  economic  growth.  It 
considers  the  impact  of  the  fiscal  multipliers  and 
analyses the magnitude of the multipliers – known 
as  critical  multipliers  – that  might  generate 
undesired effects,  whereby  consolidations  lead  to 
increases  in  the  debt  due  to  the  impact  that  they 
have on the GDP growth. By estimating the value 
of these critical  multipliers  for the EU27 Member 
States and comparing them with the likely range of 
actual  multipliers  according 
the  economic 
literature,  the  Chapter considers  whether  any 
to  face  short-term  debt
countries  are 
increases as  a  result  of  the  current  consolidations, 
due to the effect of consolidations on growth. (100)

likely 

to 

The Chapter then turns to the medium-term, where 
the  impact  of  consolidations  depends  on  how 
various parameters – mainly the impact  multiplier 
and the persistence of consolidation on next years' 
growth but also the starting level of debt, the size 
of  automatic  stabilizers  and  the  baseline  balance 
and  growth  – drive  debt  dynamics.  The  effect  of 
these  parameters  is  analyzed  by looking  at  the 
number  of  years  required  for  debt  to  go  below  a 
baseline  level  following  a  consolidation.  Finally, 
the  role  played  by  interest  payments  on  debt 
dynamics  is  considered,  and how  market  myopia 
influences the effect of consolidations.    

3.1. 

SHORT-RUN EFFECTS OF FISCAL 
CONSOLIDATIONS

This  Section  analyses  the  effect  of  a  fiscal 
consolidation  relative  to  a  baseline  where  no 
consolidation 
takes  place.  The  effect  of  a 
consolidation  ("a "  in  the  following)  is  given  by 
the  change  induced  by  it  on  debt  and  a  positive 
consolidation effect is found if the debt ratio under 
consolidation  is  smaller  than  the  debt  ratio  in  the 
baseline. (101)  As  Box  III.3.1  shows  the  change 

induced on debt by consolidation
written in full is: 

(100) For  a  similar  analysis  restricted  to  the  effects  of  VAR-
based fiscal multipliers see also Eyraud and Weber (2012).
as

(101) This 

expressed 

is 

Consolidation and dynamics of the multipliers. Are there counter-intuitive effects?

Part III

indirectly  by 

In  the  short-term,  a  consolidation  affects  the  debt 
ratio both via its effect on the primary balance and 
via its effect on the rate of growth of GDP. These 
two  effects  are  given  in  the  formula  above.  First, 
the  debt  ratio  is  affected  by  the  change  in  the 
primary  balance,  which,  in  turn  is  driven  both 
directly  and 
the  consolidation 
measures. The direct effect is given by the fact that 
consolidation  measures  reduce  the  deficit,  while 
the  indirect  effect  is  again  given  via  the  effect  on 
growth; the primary balance is also affected by the 
growth  rate  of  the  economy  via  the  automatic 
stabilizers. ( 102)  The  government  balance 
is 
therefore 
the  direct  effect  of 
consolidation  measures but reduced by the impact 
that these  measures have on the economic  growth 
rate (indirect  effect). Second,  assuming  that there 
is  no  significant  impact  of  a  consolidation  on  the 
interest rate, the debt ratio is increased because of 
the  negative  effect on  economic  growth in  the 
short term. (103) 

increased  by 

The  effect  of  consolidation  measures  on  the 
in  the  first  year (104)  is 
government  balance 
composed by three effects: i) the direct of effect of 
the  consolidation  measures  on  balance  (which  by 
definition is equal to one, because measures worth 
one  euro  reduce  government  deficit  by  the  same 
amount  for  a  given  growth  rate;)  ii)  the  negative 
effect  induced  on  balance  via  the  automatic 
stabilizers  (i.e.  the  product  of  the  multiplier  times 
the effect of balance to  growth equal to the  semi-
elasticity of the government balance to the cycle); 
and iii) the "denominator effect" on the debt ratio 

(102) If the government takes consolidation measures for a total 
a, there will be a reduction in growth compared to baseline, 
leading  to  a  lower  reduction  in  final  deficit  - due  to  the 
operation of automatic stabilizers - than the one due to the 
direct effect of the measures taken.

(103) The higher the growth rate of GDP, the smaller is the debt 
ratio – for any given deficit. This is usually referred to as 
the denominator effect: any change in GDP affects the debt 
ratio via the denominator.

(104) If  m1 is  the  one-year  multiplier  and  ε  is  the  elasticity  of 
is 

formula 

budget  balance 
dpbal
t
da

∂
pbal
t
∂
g

to  growth 
∂
g
t
∂
a

=

×

+

the  precise 
∂
pbal
t
∂
a

t

ε
×−=

m

11 +

The  non-approximated  calculations  and  formulas  are 
presented in Box III.1.

caused by the diminution in growth with respect to 
baseline engendered by consolidation.

Putting these two equations together give the effect 
of consolidations on the debt level, as a function of 
existing  debt  level,  the  multiplier  and  the  cyclical 
budget elasticity, ε: (105)

This  equation  leads  to  the  conclusions  that  i)  a 
high  starting  level  of  debt  tends  to  dampen  the 
debt-reducing  impact  of  consolidation all  else 
equal.  If  the  initial  debt  ratio  is  large  enough, 
consolidations  can  even  bring  about  increases  in 
the short term. The same holds for the elasticity of 
the  government  balance  to  the  cycle;  and  ii)  the 
larger  the  short-term  multiplier,  the  smaller  the 
debt-reducing impact of consolidations. This effect 
is  actually  independent  of  the  economic  growth 
rate  and  of  the  interest  rate  prior  to  the  fiscal 
consolidation.. 

It is therefore possible to compute a critical value 
for  the  multiplier  which  is  the  largest  value  the 
multiplier can take before a consolidation leads to 
a  negative  rather  than  positive  impact.  This  value  

is computed as

It diminishes with the level of debt – the higher the 
debt  the  larger  the  growth  impact  on  the  debt  to 
GDP  dynamic  – and  with  the  cyclical  semi-
elasticity – the effect of consolidation measures on 
deficit  are  smaller 
the  automatic 
stabilizers  react  to  diminished  growth.  For  any 
estimated value of the budget elasticity to growth it 
is  possible  to  draw  the  relationship  between  the 

the  more 

(105) All  the  previous  computations  are  done  with  respect  of  a 
baseline,  i.e.  they  show  the  comparison  between  the  debt 
ratio at time t after the consolidation and the debt ratio that 
would  have  prevailed  at  time  t  in  the  absence  of 
consolidation.    Notice  that  for  one  period  the  result 
presented  here  well  approximates  the  result  of  equation 
III.5  in  Box  III.1.  As  baseline  debt  does  not  differ  much 
from  the  starting  level  of  debt  after  just  one  period,  this 
equation also applies approximately to difference between 
the debt ratios in the first period compared to the period in 
which consolidation is implemented.

137

European Commission

Public finances in EMU - 2012

debt  level  and  the  critical  multiplier.  For  a  debt 
ratio  equal  to  100%  of  GDP,  a  typical  order of 
magnitude  on the value  of  the  critical  multipliers
can be computed to be 2/3 if it is assumed that the
semi-elasticity of budget balance to growth is 1/2.

Graph III.3.1: Debt ratio and critical multipliers

The  critical  values  shown  in Table  III.3.1  can  be
compared  with  the  values  emerging  from the
literature  review  presented  in  Section  III.3.6.  As
explained in the literature review, the value of the
multiplier  depends  on many  factors,  with the
composition  of  the  adjustment,  the  existence  of  a
simultaneous  adjustment in  trade  partners  and  the
situation of the economy playing a prominent role.

e = 0.4

e = 0.45

e = 0.5

Table III.3.1: Critical first year multipliers in EU Member States

at constant interest rates in 2011

1.5

1.4

1.3

1.2

1.1

1

r
e

i
l

p
i
t
l
u
m

0.9

0.8

l

a
c
i
t
i
r
c

0.7

0.6

0.5

30% 45% 60% 75% 90% 105% 120% 135%
debt

Source: Commission services.

Graph  III.3.1  shows  the  relationship  between  the
resulting critical multiplier and the starting level of
debt  and  semi-elasticities.  The  three  curves  show 
the  debt  ratio  and multiplier values such  that  the
effect of consolidation on the debt ratio is zero in
the  short  term,  for  three  different  illustrative
elasticities.  For  any given  semi-elasticity  points
above  the  line  – representing  higher  debt  ratios
and/or  multipliers
characterised  by
consolidations leading to a higher debt ratio in the
first year.

are 

–

Country analysis

in 

theoretical 

relationship  obtained 

The 
the
previous Subsection  can  shed  light  on  the  effects
of  the  consolidation  in  the  short  term  in  the  EU
countries.  The  last  column  of  Table  III.3.1  shows
the estimated critical multipliers for the EU27, for
the  2011  levels  of Maastricht  debt  and  using 
estimated  cyclical  semi-elasticities  of  government
balance  to  the  output gap  to  measure  the  reaction
of  automatic  stabilisers  to  the  change  in growth
induced by consolidation. ( 106)

(106) These  values  are  computed  by  the  Commission  in  the
context  of  the  fiscal  surveillance  on  the basis  of  a
methodology developed by the OECD.

138

Semi-
elasticities
0.51
0.33
0.36
0.65
0.54
0.30
0.44
0.42
0.43
0.53
0.49
0.43
0.30
0.29
0.44
0.44
0.38
0.62
0.47
0.38
0.45
0.32
0.45
0.33
0.58
0.61
0.46
Source: Commission services.

BE
BG
CZ
DK
DE
EE
IE
EL
ES
FR
IT
CY
LV
LT
LU
HU
MT
NL
AT
PL
PT
RO
SI
SK
FI
SE
UK

Debt (2011)

98.0
16.3
41.2
46.5
81.2
6.0
108.2
165.3
68.5
85.8
120.1
71.6
42.6
38.5
18.2
80.6
72.0
65.2
72.2
56.3
107.8
33.3
47.6
43.3
48.6
38.4
85.7

Critical 
Multiplier
0.7
2.0
1.3
0.9
0.7
2.8
0.7
0.5
0.9
0.7
0.6
0.9
1.4
1.5
1.6
0.8
0.9
0.8
0.8
1.1
0.7
1.5
1.1
1.3
0.9
1.0
0.8

These  values  can  be  compared  to  the  values
proposed  in  Section  III.3.1  above,  i.e.  QUEST 
multipliers  of  around  0.4  to  0.7  for  the  euro  area
in 
for  a  composition-balanced  consolidation 
normal  economic  times,  depending  on  credibility
and 0.7 to around 1.2 in crisis situations (up to 1.6 
if one considers the spending multipliers from the
meta-analysis  or  cumulative  first-year  spending 
multipliers from VAR-based analysis).

 
Consolidation and dynamics of the multipliers. Are there counter-intuitive effects?

Part III

Comparing  the  critical  multipliers  given  in  Table 
III.3.1  with  the  results  of  literature  indicates  that
Greece  is  the  only  country  where  short  run  debt 
increases could be observed even  in  normal times 
and  if  consolidation  is  balanced in  terms  of  its 
composition  between  expenditures  and  revenues. 
However,  given  the  high  debt  levels  now  present 
in the EU and given that large government sectors 
induce  large  cyclical  semi-elasticities,  around  one 
third of the EU countries are likely to see their debt 
ratio  increasing  compared  to  the  baseline  in  the 
first  year  when  a  consolidation  process 
is 
implemented  depending  on  the  composition  of 
if 
consolidation.  This 
is 
consolidation 
is  not 
completely  credible  so  that  figures  from  meta-
studies are used and considering the current crisis 
situation, 
in  which  case  multipliers  can  be 
expected  to  be  larger  and  a  large  part  of  EU 
countries  would  be  likely  to  be  in  the  undesired
effect area in the short term.

is  spending-based  and 

especially 

true 

is  preferable 

In any case, it is obvious that this analysis does not 
suggest  that  remaining  at  the  baseline,  i.e.  doing 
In 
nothing, 
particular, the analysis does not suggest that high-
debt countries  should  consolidate  less  than  low-
debt countries, only because they have high levels 
of debt.

to  consolidation. 

3.2.  MEDIUM-RUN EFFECTS OF 
CONSOLIDATION

the 

countries' 

looked  at 

corresponding 

The  previous  Section 
the  critical 
multiplier  and  presented  evidence  about  how  the 
actual  multipliers  in  EU  Member  States  compare 
critical 
with 
multipliers showing that it is not impossible that in 
the  current  situation  consolidation  leads  to  higher 
debt ratios in the short run. This Subsection looks 
at  how  the  multipliers  affect  the  debt  dynamics 
following a consolidation, before the  next  Section 
introduces  possible  effects  of  consolidations  on 
interest  rates  and  moves  to  look  at  debt dynamics 
from a more medium-term point of view. 

As  will  be  shown  in  this  Subsection,  under  most 
parameter  configurations  that  are  in  line  with  the 
evidence  obtained  from  the  economic  literature 
and the simulations presented here, the time period 
necessary  for  a  consolidation  to  have  a  beneficial 

effect  on  the  debt  ratio  is  two  or  maximum  three 
years  unless  multipliers  are  very  high  and 
persistent.  The  exception  to  this  pattern  occurs  in 
the  presence  of  a  high  degree  of  myopia 
concerning 
government 
yields, ( 107)  and  this  will  be  examined  in  the  next 
Section which will enrich the analysis by including 
the impact on government interest rates.

determinants 

of 

the  growth  effect  of 

As  shown  in  more  detail  in  Box  III.3.1  the 
evolution  of  the  debt  ratio,  in  the  absence  of  any 
effect on government yields, it is the sum of same 
three effects  indicated in the  previous  Subsection: 
i) the cumulative effect of growth on debt, which is 
generated by the change that the consolidation has 
on growth developments. (108) This effect is larger 
if the  initial debt  stock  is larger and  if  multipliers 
are larger, while simulations show that the impact 
of the other parameters of the baseline scenario do 
not  have  the  same  relevance.  ii)  The  cumulative 
effect  of  growth  on  government  balance  which 
considers  how 
the 
consolidation  affects  the  budget  balance  via  the 
operation of the automatic stabilisers on the budget 
balance.  This  component  of  the  effect  typically 
increases  debt  in  a  consolidation,  because  it 
worsens  the  government  balance  for  a  given 
consolidation and the effect is greater the larger the 
size  of  the  multipliers  and  the  size  of  automatic 
stabilisers. Finally,  iii) the cumulative effect from 
the  adjustment  of  government  balance  which 
represents  the  cumulative  savings  effect  of  the 
consolidation  i.e.  the  direct  debt  reduction  of  the 
adjustment  in  the  absence  of  any  effects on 
growth.  This  effect  reduces  the  debt  ratio.  It 
increases  with  the  number  of  years  and  with  the 
size of the consolidation implemented.

As the first two effects are act to increase the debt 
ratio,  while  the  third  acts  to  decrease  it.  One  way 
to 
the  medium-term  effects  of  a 
consolidation,  then,  is  to  consider  the  number  of 
(hereafter  "the  critical  year") (109) 
years  n*

look  at 

(107) Gros  (2011)  presents  a  similar  argument  in  a  qualitative 

and incomplete manner.

(108) The  computation  takes  into  account  the  fact  that  the 
evolution of debt over time is influenced by the path of the 
government  balance,  so  that  a  large  government  balance 
influences  the  debt  ratio  more  than  a  smaller  government 
balance.

(109) Notice that n*represents the number of years starting from 
the  year  of  consolidation.  If  consolidation  is  implemented 
in  year  1, n*  represents  the  critical  year. Therefore  n*=1 

139

European Commission

Public finances in EMU - 2012

Graph III.3.2: Critical year and underlying debt trend

104%

102%

100%

98%

96%

94%

92%

112%

110%

108%

106%

104%

102%

100%

98%

96%

94%

baseline scenario

deviation

0

1

2

3

4
year

5

6

7

8

baseline scenario

deviation

0

1

2

3

4
year

5

6

7

8

Source: Commission services.

necessary for  the  consolidation  to  lead  to  a
decrease  in  debt  with  respect  to  a  baseline 
scenario. In terms of the equation presented in Box 
III.1  this  is  equivalent  to  the  number  of years

question  of  debt  sustainability  the  debt  after  a
consolidation will also need to be compared to the
actual starting level of debt.

necessary for

to equal zero (or be negative).

The critical period n* is different from the number
of years  required  for  the  debt  to  go  below  its
starting value  in year  0  unless  the  baseline  is  the
steady  state  of  constant  debt  ratio.  Graph  III.3.2
shows illustrative paths for the debt under baseline
and consolidation scenarios, for a constant baseline
in the left-hand panel and an increasing one in the
right-hand panel. It shows that, while in the case of
a  stable  baseline  scenario  n*  coincides with  the
year in which the debt level returns to its level in
the consolidation year, this does not happen when 
the  baseline  scenario  is  increasing  and  the  solid
line  representing  the  path  of  debt-to-GDP  ratio
following  a  consolidation  returns  to  the  starting 
level  only  after  crossing 
line
representing  the  baseline  scenario  (if  ever). When
looking  at  the  effects  of  a  consolidation  on  the
debt,  the  relevant  comparison  depends  on  the  aim
of
the  exercise.  The  debt  trajectory under  a
consolidation  should  be  compared  to  the  baseline
debt if we are purely interested in the effect of the
consolidation per se; however, if there is an overall

the  dotted 

In order to model debt dynamics and calculate the
value  of  the  critical year  n* under  different
consolidation  scenarios,  to  run  debt  simulations
under  different  consolidation  scenarios,  a  clear
picture of the reaction of GDP to consolidation in
future years (110) is necessary, bearing in mind that
is  likely  to  change  over  time.  The  higher  the
multipliers in  the first  year  and  the  longer the
change  in  GDP  induced  by  the  consolidation,  the
larger the value of n* and the longer it will take for
a  consolidation  to  be  effective.  There  are  three 
broad  effects  emerging  from the  literature  review 
presented in Chapter III.2 that will be incorporated
into 
this
Subsection: 

the  simulations  presented 

later 

in 

i) the  values of  first  year  multipliers  in normal
economic  conditions  are  typically  estimated  at
between  0.3  to  around  1  depending  on  the
composition and nature of the policy changes and 
type  of  estimate;  ii)  the values  of  first  year
multipliers are larger in crisis years, usually within
a range from 0.5 to 1.6; and iii) the impact on GDP
in years following consolidation tends to decrease 
but  does  so  to  different  degrees  depending  on the

means  that  there  is  no  self-defeating  effect  at  all,  while 
n*=2 indicates that the perverse  effects lasts one year and
so on.

(110) See  Box  III.1 that defines the  adjusted  multiplier

which corresponds  to  the  difference  between  GDP  and
baseline at year t in an impulse-response function.

140

Consolidation and dynamics of the multipliers. Are there counter-intuitive effects?

Part III

model used, on the type of estimate and on all the
factors affecting multipliers.

The fiscal multipliers can be very persistent or can
decay  rapidly  in  the  first  years,
following  a
convex,  autoregressive  path. Such  an  AR1-shaped
curve  is  similar  to  the  shape  of  GDP  responses
which  can  be  found  in new  Keynesian  DSGE-
based  assessments  of multipliers for  various  (but
not  all)  types  of  consolidation. (111)  Graph III.3.3
shows  two  stylised  GDP  responses  following  a
consolidation  of  1%  of  GDP,  under  low  and  high 
persistence. ( 112) The main difference between the
two  paths  thus  concerns  the  persistence  of  the
effects of the consolidation.

Graph III.3.3:

Stylised paths of GDP  impulse responses used in the
simulations

HP

LP

2.5

2

1.5

1

0.5

0

e
s
n
o
p
s
e
R
P
D
G

1

2

3

4

5
6
Years

7

8

9

10

Source: SCPs, Commission services.

Simulations

III.3.4  shows 

the  debt-to-GDP 

Graph 
ratio
dynamics for  the  low-persistence multipliers  path
under  different  assumptions  about  the  impact
multiplier.  The  baseline  scenario  is  one  of  a
constant  debt  ratio  of  100%  of  GDP.  The  Graph
shows  debt  dynamics for  a  persistence  rate  of
0.5, (113)  with  first  year  multipliers of 0.5,  1  and

(111) See  for  example  in  Graphs  III.6.1  and  III.6.2  in  European

Commission (2010a).

(112) The precise formula is shown in Box III.1 as equation III.6.
It  is  considered that  the  multipliers  decline  according  to  a
persistence  parameter to reach  a  long-term  value. The
persistence parameter is the ratio between the responses of
two  consecutive years  if  the long-run  impact  of  fiscal
consolidation is null.

(113) 0.6/0.7 is the ratio of second to first year GDP responses in
the case of composition-balanced permanent consolidation

1.5. All values for the first-year multiplier that lie
below the 0.7 level will correspond to an improved 
debt  ratio  from  the first  year – this  is  so  by
construction  as  the  0.7  level  corresponds  to  the
critical value for the multiplier. It should be noted 
that a first year multiplier of 1.5 is on the high side
of  existing  estimates  as  it  is  the  estimate  of  a
temporary  consolidation  based  on  government
spending.

Graph III.3.4: Debt dynamics (baseline steady state, b0 = 100%),
no effect on interest rates – with low persistence

102%

101%

100%

99%

98%

97%

96%

95%

94%

93%

m = 0.5

m = 1

m = 1,5

baseline

0

1

2

3
year

4

5

6

Source: Commission services.

Graph III.3.5 shows the case for a high persistence
parameter (0.8) of the GDP response. The  higher
the  effects  of  consolidation
persistence  of 
generates 
longer-lasting  negative effects  from 
fiscal  consolidation.  If  the  first-year multiplier  is
1.5  the consolidation-based  debt  increase  lasts  for
one  more  year so  that  three  years  are  needed –
taking into account the fact that year 1 is the year
in which the consolidation is implemented – before
debt goes below baseline.

in European Commission (2010a). This is the basis for the
choice of 0.5 as low persistence and 0.8 as high persistence
parameters. Note that the persistence in the following years
is  however  smaller. Values  of  the  GDP  responses  broadly
constant for the first three years are very commonly found 
in  VAR  estimates.  This  wold  make  raise  an hump-shaped
GDP response with the consequence that the debt increases
following  a  consolidation would  be reversed  only  after
three years for values of the impact multiplier of 1.5. This
being the only difference, the case is not developed here.

141

 
European Commission

Public finances in EMU - 2012

Graph III.3.5: Debt dynamics (baseline steady state, b0 = 100%),
no effect on interest   rates – with high persistence

102%

101%

100%

99%

98%

97%

96%

95%

94%

93%

m = 0.5

m = 1

m = 1,5

baseline

0

1

2

3
year

4

5

6

Source: Commission services.

3.3. 

INTRODUCING CHANGES TO
GOVERNMENT YIELDS INTO THE ANALYSIS 

Over  the  medium-term,  changes  to  the  average
effective interest rate are as important a factor for
the  debt  to  GDP  dynamics  as  the growth  rate  of
GDP. This Section incorporates a reaction function
of average effective interest rates into the analysis
to create a  more complete picture of the  medium-
fiscal
term  dynamics  of  debt 
tightening.

following  a

The  impact  of  consolidation on  average  effective
interest  rates  is more visible  in  the medium-term 
than  in  the  short-term, with  limited  first-year
impact on the debt level. (114)

(114) A  more  immediate  impact  can be  seen  on  the  yield  of
government  debt,  which may react  more  abruptly  as
borrowing goes up or down. The more muted effect on the
interest rate is partly driven by the fact that only a share of
overall debt needs to be reissued in any one year and so the
effect  on  the  average  (or  apparent)  interest  rate  is  more 
modest. An increase in interest rate of 50 basis points has a
modest impact in the first year if 20% of the debt is rolled
over every year: for example with debt ratio at 100% and a
20% rollover, 50 basis points increase means an additional
0.1% increase  in  deficit/debt.      Nevertheless,  in  difficult
times,  there  have  been  sizeable  increases  in  the  apparent
interest rate that can be observed in the data. For example,
between 1974 and 1975 the apparent interest rate increased
from 15.7 to 22.2 in Denmark, while it increased from 8.3
to 15.2 in Portugal between 1980 and 1981. Conversely to
these  large  sharp  increases,  decreases are  often  more
gradual  even  when  sustained,  as was  the  case  for  the
countries  with higher yields at the entry in the EMU.

142

As  shown  in  Box  III.1,  taking  into  account  the
effects of changes in apparent interest rates adds a
fourth  element  to  the  drivers  of  debt  dynamics.
Aside from  the impact  of growth  on  the  debt  and
deficit  and  of  the  deficit  on  debt,  a  new  term 
captures the cumulative effect of average effective
interest  rates  on  debt  evolution. The  interest  rate
effect (and  hence  the new  term  in  equation  III.11 
in  Box  III.3.1)  consists  of  the  increased  (or
decreased  if  the  interest  rate  diminishes)  future
debt burden  related  to  the  increased  interest
payments  on  the  rollover  of  existing  debt  stock,
and,  second,  the  increased  payments  on  the new
debt related to future deficits.

The sign of this effect however is not clear cut as it
depends crucially on the way  market expectations
are  generated. (115)  The  normal  case,  in  line  with
the  results  of  the  literature  presented  in Section
III.3.2 and used in the previous Section, is the case
in  which  a  consolidation  improves  the market's
confidence  in  government bonds  and  reduces
yields  so  that  a  consolidation  leads  to  a  lower
average  effective  interest  rate  r. In  this  case,  the
effect of a consolidation on debt is reinforced and
debt-to-GDP  ratios  are  likely  to  decrease  at  a 
higher  speed  (or  increase  less)  than with  constant 
yields.  If,  on  the  contrary,  the  market  reacts  to
and
consolidation 
consequently  average  effective  interest  rates,  the
effect  of  this  term  is  the  opposite.  Such  an  effect
would be rather unusual, however. (116)

increasing

yields 

by 

In  general  real  interest  rates paid  by  governments
are modelled as being composed of the sum of two
elements: central bank real rates – the safe interest
rate  –and  a  risk-premium, which  depends  on  a
number  of very  diverse  factors.  The  central  bank
real  rate's  reaction  to  a  consolidation  depends  on 
the  state  of the  economy,  a  Taylor  rule  in normal
times  and  a  more  accommodative  stance  in  the
crisis. This  is  modelled as  an  integral  part  of the
New  Keynesian DSGE  models  as  seen in  Section
III.2  above  and  thus  is  already  integrated  in  the

(115) Of course, other variables such as the conduct of monetary 

policy also affect this term.

(116) Eyraud  and  Weber  (2012)  provides  evidence  that given
markets'  concerns  about  short-term  growth,  high  fiscal
multipliers  may 
that  deficit  reductions  entail
increases in sovereign CDS spreads.

imply 

Consolidation and dynamics of the multipliers. Are there counter-intuitive effects?

Part III

Graph III.3.6: Confidence effects on debt dynamics - a) low persistence , b) high persistence - first-year m=1,5

102%

100%

98%

96%

94%

92%

90%

a)

µ = 0

µ = -0.3

baseline

102%

100%

98%

96%

94%

92%

90%

b)

µ = 0

µ = -0.3

baseline

0

1

2

3
year

Source: Commission services.

4

5

6

0

1

2

3

year

4

5

6

values. (117)  The

risk-premium's
multipliers' 
reaction 
to  consolidation depends  on many
variables  of  different  nature,  from  the  degree  of
risk  aversion  to the  long-term  sustainability  of
public  finances.  These  can  be  proxied  by  a 
combination of the cyclically adjusted balance and
the debt to GDP ratio expected at a certain horizon
h.

In  the  present  simulation  it  is  assumed  that  the
change on average effective interest rates is driven
by  the  risk  premium so  that  the  change  of  the

average  effective 
consolidation

interest  rate 
is 

a 

due to  a
as

expressed 

can be interpreted as combining the yield
where 
sensitivity 
the  structural  balance,  growth
perspectives,  and  expectation-driven factors  in

to 

level  and  h  refers 

general  while 
represents  the yield  sensitivity  to
the  debt 
the  horizon
considered  by  the  financial markets,  where  h=1
indicates that  markets look at the debt in the year
of  the  consolidation. ( 118) Thus  the  change  in

to 

from  a

consolidation is 
government  yields 
modelled  as  a  function  of  the  shock  to  interest
rates  that  happens  immediately,  which  can  be 
function  of the  improvement  in  deficit  and/or  of
market sentiments, and from the value of expected
debt. A high sensitivity of interest rates to the debt
ratio could  lead  to  make consolidations  self-
defeating and  act  as  a  driver  for  a  divergent  debt
if  a  consolidation 
ratio.  This  could  happen 
increases the  debt  ratio  due  to  the  denominator
effect, which then leads to increase in interest rates
which  then  further increase  the  debt  ratio  and  so

means  that the  decrease  in  the
on.  A  positive
risk  premium  due  to  the  decrease  in  structural
deficit does not offset the increase in central bank's

real rates due to deflationary pressures.

is expressed allows for the impact of
The way 
quantitative  effects  of  consolidation  on  interest
rates  to  be  easily factored  into  the  analysis.  Such
effects can be very relevant in crisis situations and
are not  well  modelled in  linear models.  The
formula does, however, have the disadvantage that
it  does not  take  into  account the spreading  of  the

(117) Certain  versions  of  QUEST  also  integrate  risk  premium

based on debt levels.

(118) It  is  to  be  remarked the  assumption  that  financial  markets
are  assumed  not  to  take  into  account  the  consequences  of
their  own  behaviour  on  debt  evolution.  This 
is  a
simplifying  assumption  which  has  very  reduced  practical

impact  if  myopia is  interpreted  as  backward-looking
behaviour or if the horizon in question is as short as one or
two  years. Notice  that  the  formula  could  apply  to  new
emissions as well, without substantive

143

European Commission

Public finances in EMU - 2012

changes  of  government  yields  on  the  rest  of  the 
economy – or de facto it assumes that such effects 
are  relatively  small  – because  the  path of  the 
multiplier  is  independent  from  the  reaction  of 
interest rates. (119) Moreover, the linear form of the 
interest  rate  function  prevents  from  taking  into 
account  thresholds  effects,  another  characteristic 
literature  shows  being  potentially 
which 
relevant in crisis periods.

the 

Graphs  III.3.6a  and  III.3.6b  show  the  effects  for 
the  two  cases  of  low  and  high  persistence  of 
changes  in  the  interest  rate  on  the  critical  number 
of  years  n*  under  the  condition  that  the  first-year
multiplier  is  1.5.  It  can  be  seen  that  the  critical 
number  of  years  before  the  debt  is  reduced  to 
below its starting level in absence of effects on the 
interest rates remains the same as shown in Graph 
III.4.4,  for  the  case  without  interest  rates,  for 
changes in the interest rates which are in line with 
empirical evidence. 

To  estimate  the  importance  of  confidence  effects 
on interest rates, it is possible to consider the size 
of  the  change  in  interest  rates  which  leads  to  a 
reduction  in  the  critical  number  of  years  before 
debt falls below baseline, based on the assumption 

is  negative  as  market  confidence  reacts 
that 
positively  to  a  consolidation.  Under  an  impact 

multiplier  of  two (not  shown),  the  value  of 
that  allows  debt-to-GDP  ratios  to  fall  below 
baseline  one  year  earlier  in  a  high-persistence 
model  is  -0.4;  this  is  equivalent  to  saying  that 
following  a  structural  adjustment  of  1%  of  GDP, 
the  average  effective  interest  rate  must  fall  by  40 
basis  points.  This  is  in  the  high  part  of  the  value 
range  estimated  in  the  literature,  taking  into 
account that the measured impact on yields of 50-
80  basis  points  refers  to  new  debt,  while  the  40 
basis  point  figure  given  here  refers  to  the  overall 
average effective interest rate on debt. 

Myopic behaviour and debt ratio

be  seen 

So far,  the  possibility  of  a  dynamically  undesired
effect  on  debt  ratios  from  consolidation  does  not 
emerge out of the models presented and the likely 
values  of  key  parameters.  However,  the  presence 
of  financial  market  myopia  can  change  this.  This 
myopia  can
the  contradictory 
requirements  sometimes  made  by  rating  agencies 
when  they  refer  to  the  need  to  consolidate  public 
finances  while  also  noting  the  adverse  effect  of 
negative  short  term  growth  prospects  in  their 
notation  process,  without  apparently  noticing  the 
short  term  negative  relation  between  the  two 
variables at least in the short term.

in 

To  analyse  the  case  in  which  short-termism  of 
market sentiment influences the debt dynamics, the 

in the previous 
second part of the equation for 
Subsection (120)  is  brought  into  the  picture.  This 
part  looks  at  how  yields  are  affected  by  the 
expected  level  of  debt  at  a  certain  horizon  h 
assuming  baseline  rates.  Myopia  is  measured  by 
the numbers of years ahead that the markets looks 
at  (h):  if  markets  are  very  myopic  the  changes  in 
interest  rates  consequent  to  a  consolidation  are 
solely  driven  by  the  debt  of  the  year  immediately 
following consolidation,  while  if  markets  are 
extremely  rational  the  interest  rates  are  solely 
driven  by  the  expected  debt  ratio  at  the  steady 
state.  Expectations  are  adaptive  in  a  sense  that 
agents revise them if the actual level of debt differs 
from what was expected. (121)

In line with the literature it is assumed that γ>0; in 

the analysis  it  will  be  used a  value  of 
as found in Laubach (2009) and used in European 

Commission (2010a), and it is assumed that 
lies 
between -0.3 and 0.3. Thus negative values reflect 
the  normal  reaction  of  yields  to  consolidation, 
while  positive  values  represent  the  case  in  which 
interest  rates 
in 
government balance for reasons that are not related 
to the debt level.

increase  with 

improvements 

(119) Notice that if interest rates decrease with consolidation, the
formula  for  the  change  in  r reinforces  the  possibility  of 
undesired effects.  In  DSGE  models  multipliers  decrease 
with interest rates.

(120) It is reported as equation III.10 in Box III.1.
(121) Such  an  assumption  seems  more  coherent  with  myopic 

behaviour rather than rational expectations.

If interest rate behaviour is modelled according to 
equation III.10, the variation of debt at the end of 

144

Consolidation and dynamics of the multipliers. Are there counter-intuitive effects?

Part III

the period n is determined by the cumulative effect 
of the change in the deficit,  market  sentiment and 
other factors subsumed in the constant part, and a 
cumulative effect from change in expected debt.

Graphs III.3.7 and III.3.8 show how debt dynamics 
would  evolve  under  different  degrees  of  myopia 
and  different  values  for  the  multiplier,  under  a 
high-persistence  and  low-persistence  specification 
respectively.  They  show  that  the  presence  of 
highly myopic financial markets can play a role in 
increasing the number of years after which the debt 
ratio remains above baseline  but that only in  very 
extreme  cases  would  they  really  lead  to  a  debt 
increase in the medium run. 

The panels of these graphs show various examples 
of  debt  ratio  dynamics,  depending  on  the  impact 
multiplier,  under  the  case  in  which  i)  there  is  a 
normal  reaction  of  interest  rate  to  consolidation
(first  row)  in  line  with  estimates  with  a  reduction 
in  sovereign  yields  following  a  consolidation  and 
an annual increase in yields related to the increase 
in  debt  which  can  be  normal  (left)  or  very  large 
(right  column;) ii)  there  is  no  immediate  reaction
to  consolidation 
impact  on 
sovereign  risk  premia  as  a  function  of  the  debt 
ratio expected in the first year which can be small, 
large  (second  row) or  sufficient  to  lead  to  an 
undesired  debt  dynamics  (third  row,  left  column;)
iii)  there  is  an  immediate  shock  on  average 
effective interest rates equal to μ (last rows) which 
is lasting – μ is a constant – that can be interpreted 
as  a  negative  confidence 
following 
consolidation. The impact multiplier is assumed to 
be large at 1.5.

but  an  annual 

shock 

low 

persistence  models 

self-defeating 
In
consolidations  reinforced  by  the  behaviour  of  the 
markets  can  verify  only  if  consolidation  does  not 
bring  any  benefit  in  terms  of  immediate  yield 
reduction  and  each  point  of  increase  in  the  debt 
ratio  entails  an  increase  in  the  average  effective 
interest rate of 100 basis points, a value more than 
30 times larger than average estimated values.

In high-persistence  model,  n*  increases  by  one  or 
two years if the reaction of the financial markets to 
consolidation 
However, 
consolidations-led  debt  increases  happen  only  if 
myopic  market  reactions  are  20  times  larger  than 

non-standard. 

is 

average  estimates,  even  when 
multiplier is as high as 1.5.

the  first  year 

Under  normal  average  conditions,  interpretable  as  
μ  =  -0.3  and    γ=  0.03,  the  results  of  the  previous 
Subsection  are  confirmed  even  under  extreme 
market  myopia  assumed  in  Graphs  III.3.7  and 
III.3.8.

The  existence  of  undesired effects  could 
in 
principle be driven by very high impact multipliers 
(above  two)  and  high  persistence  in  presence  of 
more  standard  behaviour  of  the  financial  markets. 

in 

low  persistence  of 

allowing for a consolidation-
Under values for 
led debt  rise,  short-termism 
the  financial 
markets can become critical and change the critical 
number  of  years  before  debt-to-GDP  falls  below 
baseline  through  an  effect  on  average  effective 
interest rates. This is shown in Graph III.3.9a and b 
and  in  Graph  III.3.10.  Graph  III.3.9  shows  that 
even  with  large  undesired  effects  in  the  financial 
markets  a  high  myopia  can  have  relevant  effects. 
Under  a 
the  effects  of 
consolidation,  when  no  dynamically  undesired 
effects  are  generated,  n*  diminishes  from  4  to  2 
when  the  financial  markets  adopt  a  medium-term 
horizon.  The  horizon  of  the  financial  markets 
becomes  more  relevant  when  the  persistence  is 
high,  because  less  myopia  reduces  n*  to  3.  (122)
Graph  III.3.10  takes  an  extreme  case  to  show  the 
relevance  of  financial-markets  myopia:  a  case  in 
which  impact multipliers  are  very  high  (m=2), 
persistence  is  high  and  financial  markets  react 
contrary  to  expectations.  In  this  case,  h=4  is 
necessary to avoid a fully self-defeating dynamic.

(122) It should be noted that h=2 already would reduce sensibly 

n*.

145

European Commission

Public finances in EMU - 2012

Graph III.3.7: Debt evolution with myopic financial markets (h=1) – low persistence

102%

100%

98%

96%

94%

92%

90%

88%

86%

84%

102%

100%

98%

96%

94%

92%

90%

103%

102%

101%

100%

99%

98%

97%

96%

95%

94%

93%

92%

120%

100%

80%

60%

40%

20%

0%

µ = -0.3, γ = 0.03

m =
0.5

m = 1

m =
1,5

baseli
ne

µ = -0.3, γ = 0.3

105%

100%

95%

90%

85%

80%

m =
0.5

m = 1

m =
1,5

baseli
ne

0

1

2

3

4

5

6

7

1

2

3

4

5

6

year

µ = 0, γ = 0.03

m = 0.5

m = 1

m = 1,5

baseline

0

1

2

3
year

4

5

6

µ = 0.3, γ = 0.03

m = 0.5

m = 1

m = 1,5

baseline

year

µ = 0, γ = 0.3

m = 0.5

m = 1

m = 1,5

baseline

0

1

2

3
ar

4

5

6

µ = 0.3, γ = 0.3

m = 0.5

m = 1

m = 1,5

baseline

105%

100%

95%

90%

85%

80%

75%

105%

100%

95%

90%

85%

80%

0

1

2

3

4

5

6

7

year

µ = 0, γ = 1

0

1

2

3

4

5

6

7

year

m =
0.5

m = 1

m =
1,5

baseli
ne

1

2

3

4
year

5

6

7

Source: Commission services.

146

Consolidation and dynamics of the multipliers. Are there counter-intuitive effects?

Part III

Graph III.3.8: Debt evolution with myopic financial markets (h=1) – high persistence

µ = -0.3, γ = 0.03

105%

100%

95%

m = 0.5

90%

m = 1

m = 1,5

baseline

0

1

2

3

4

5

6

7

8

9

year

µ = 0, γ = 0.03

m = 0.5

m = 1

m = 1,5

baseline

µ = -0.3, γ = 0.3

m =
0.5

m = 1

m =
1,5

baseli
ne

0

1

2

3

4

5

6

7

8

9

year

µ = 0, γ = 0.3

m = 0.5

m = 1

m = 1,5

baseline

105%

100%

95%

90%

85%

80%

75%

70%

65%

60%

105%

100%

95%

90%

85%

80%

75%

70%

65%

60%

0

1

2

3

4

5

6

7

8

9

0

1

2

3

4

5

6

7

8

9

year

µ = 0.3, γ = 0.03

m = 0.5

m = 1

m = 1,5

baseline

year

µ = 0.3, γ = 0.3

105%

100%

95%

90%

85%

80%

m =
0.5

m = 1

m =
1,5

baseli
ne

0

1

2

3

4

5

6

7

8

9

0

1

2

3

4

5

6

7

8

9

year

µ = 0, γ = 0.6

year

m =
0.5

m = 1

m =
1,5

baseli
ne

85%

80%

104%

102%

100%

98%

96%

94%

92%

90%

88%

86%

105%

100%

95%

90%

85%

80%

120%

100%

80%

60%

40%

20%

0%

0

1

2

3

4

5

6

7

8

9

year

Source: Commission services.

147

European Commission

Public finances in EMU - 2012

Graph III.3.9: Debt evolution as a function of market horizon- a) low persistence , b) high persistence -  first year m=1,5

105%

a)

   µ = 0.3

b)

    µ = 0.3

100%

95%

90%

85%

80%

h=1

h=4

baseline

100%

95%

h=1

90%

85%

80%

h=4

baseline

0

1

2

3
year

4

5

6

0

1

2

3
year

4

5

6

Source: Commission services.

The  next Subsection  provides  a  more  complete
analysis of the effects of myopia on debt dynamics
and of the requirements needed to have  undesired
effects.

Graph III.3.10: The effect of myopia on debt projections

108%

106%

104%

102%

100%

98%

96%

h=1

h=2

h=3

h=4

0

1

2

3

4

5

6

Source: Commission services.

Sensitivity to parameters of the year n* in which 
consolidation is effective  

A full  assessment  of  the  sensitivity  of  the  critical
year n* – the year in which the debt ratio decreases
as  a  consequence  of  the  consolidation – to  each
individual  parameter which affects  it  cannot  be
conducted  analytically  because  the  effect  of  each
single  factor  cannot  be  disentangled  easily.  A 
simple, unified  view  is  thus  reached  by  running  a
least  square  regression  of  n*  on  the  value  of  the

148

parameter within a chosen range. (123) The analysis
is  developed  under  the  same  conditions  explained
in  the  Box  III.3.1 (124)  The  values  taken  by  each
parameter – GDP  growth,  interest  rate,  primary
balance, output gap, initial debt, impact multiplier,
multiplier  persistence,
long-term multiplier,  the
three  parameters  driving  the  reaction  of interest
rate to consolidation – are set out in Table III.3.2. 
These  values  reflect  the values found  in  the
literature or the experience of EU countries.

(123) It  is  to  be  noted  that  n*  is  an  exact  function  of  the
parameter An  analysis  which takes  into  account  the 
empirical  correlation  among  the  parameters – thus  giving
more weight  to  more  likely  combination does  not  bring
very different results.

(124) The  baseline  scenario  is  a  steady  state.  Multipliers  are  a 
decreasing  function  of  time  and interest  rates  are  a  linear
function of future debt.

Consolidation and dynamics of the multipliers. Are there counter-intuitive effects?

Part III

Table III.3.2: Range of parameters used to assess the sensitivity of

the critical year n*

Parameter

Minimum Maximum

Baseline growth (g)
Baseline interest rate (r)
Primary balance (pbal)
First year multiplier (m)
Multiplier persistence (α)
Long-term multiplier (β)
Initial debt ratio (b0)
Cyclical elasticity (ε)
Impact of future debt on r (γ)

Impact of consolidation on interest 
rate  (μ)

Degree of myopia (h)

Source: Commission services.

-2%
-1%
-4%
0.3
0.5
-0.1
80%
0.4
0

-0.3

0

2%
3%
1%
1.8
0.8
0.1
140%
0.5
0.3

0.3

2

The value of n* associated with each combination
of these values is then computed and regressed on
the  variables  that  determine  the  result.    Separate 
estimates are run for different degrees of myopia h.

The  result  of  these  regressions (125)  (not  reported)
indicate that the parameters that most affect n* are 
– in  decreasing  order  of magnitude  - the  impact
multiplier,  the multiplier  persistence,  the  level  of
debt, the idiosyncratic shock and the sensitivity of
average effective rates to expected solvability. The 

(125) The regression is

All parameters are very significant, except for the baseline
interest rate. This depends on the fact that changes induced
by  consolidation  are  large  and  affect  n*  and  it  should  not
be  interpreted  as  a  claim  that  sovereign yields  are 
irrelevant. Note  however  that
this  regression  does  not 
represent  a  true  model  of  the  underlying  determinants  of
n*. Given that high number of parameters it is just intended
to  provide  an  indication  of  the  average  effect  of  the 
different parameters.

Table III.3.3:

Potential impact of parameter changes on n*

relevance  of  the  parameter  that measures  the
reaction  of  interest  rates to  debt  - γ  - highly 
depends on the short-termism of the markets: with
short-sighted markets  (low  h)  the  higher  the
sensitivity of rates to solvability, the less effective
is  consolidation  in  bringing down  the  debt  ratio
under  the  case  in which multipliers  are  above  the 
critical  value.  On  the  contrary with more  rational
markets  the higher  is  the sensitivity  to  solvability
the more  efficient  is  consolidation.  The  non-
significance  of  baseline  interest  rate  depends  on
the fact that changes induced by consolidation are
large and affect n* and it should not be interpreted
as a claim that sovereign yields are irrelevant.

Table  III.3.3  shows  the  numerical  impact  on the
critical  number  of years  of  a  change  in  the
variables.  The  second  column,  which  reports  the
coefficient  of  the  regression,  shows  the  average
impact  on n*  of  the  increase  of  the  relevant
parameter by 1 unit. The last column is the product
of the second and third columns and shows – in the
range  of  the  parameter  chosen  as  relevant – the
maximum  potential  impact  on  the  critical year  of
each parameter in the simulations.

The  value  of  the  baseline  scenario  does not
substantially  affect  the  critical  year:  n* increases
only  modestly  with  baseline growth,  average
effective  rates  and  output gap,  and  decreases
moderately with the baseline primary balance.

On  the  other hand,  the  multipliers  are  relevant. 
Impact  multipliers  have  a  significant  impact  on
debt  dynamics since  an increase  in multipliers  by
one point leads to a 6 quarters increase in n*. The

Parameter

Maximum Range size

Coefficient

Baseline growth (g)
Baseline interest rate (r)
Primary balance (pbal)
First year multiplier (m)
Multiplier persistence (α)
Long-term multiplier (β)
Initial debt ratio (b0)
Cyclical elasticity (ε)
Impact of future debt on r (γ)
Impact of consolidation on interest rate (μ)

Source: Commission services.

5%
5%
6%
2
0.3
0.2
100%
0.4
0.3
0.6

0.58 – 0.59
0%
0.48 – 0.49
1.4 – 1.6
1.5 – 1.9
0.5 – 0.6
0.9 – 1.2
2 – 2.3
-0.2 – 1.3
1.6 – 1.8

Order of magnitude of
impact on n*
3%
0%
3%
2.8 – 3.2
0.45 – 0.57
0.1 – 0.12
0.9 – 1.2
0.8 – 0.92
-0.06 – 0.4
1 – 1.1

149

European Commission

Public finances in EMU - 2012

long-term multiplier  and  the  semi-elasticity  of
budget balance have a similar impact on n*. (126) 

Finally,  a  general  picture  of  the  previous  results
shows that:

i) for any given debt-to-GDP ratio, the value of n* 
impact  multiplier  when
increases  with
consolidation has no effect on yields. A three year
horizon is reached only with very high debt (140%
of GDP) and multiplier at around 1.4.

the 

extrapolate from the analysis presented and be able 
to draw conclusions about individual countries, the
underlying  situation  in  these  countries must  be
taken  into  account. Countries with high  and/or
rapidly increasing  debt  are  likely  to  be  on  a  non-
fiscal  policy  and need  to
sustainable  path  of
consolidate  government
finances – especially
when  they  are  under market pressure.  Comparing
countries  on  the  basis  of  the  critical year  only
could  be  very  misleading,  in  that  the underlying
situation  can  be  extremely  different,  especially  in
terms of debt dynamics.

3.4.  COUNTRY ANALYSIS 2011-2020 

Sections III.3.2 has considered debt dynamics from
a  medium-term point  of  view  after  Section  III.2.1 
presented  evidence  of  the  value  of
first-year
critical  multipliers  for  the various  EU  Member
States  in  Table  III.3.1.  However,  in  order  to 

(126) Given these result in what follows it is assumed to set real
growth,  apparent  rate,  primary  balance,  output  gap  and
long-term  multiplier  at  zero  and the  budgetary  semi-
elasticity at 0.5. Multiplier persistence is fixed at 0.7.

and 

high

five groups  of  results for

In  order  to  gain  a  full  picture, Tables  III.3.4 and
III.3.5 present
low 
persistence 
persistence models
respectively. Columns two to six show the critical
number of years that allow debt ratios to be below 
baseline following  a  1%  of GDP  consolidation  in
the 2011 primary  structural  balance.  Second, 
columns eight  to  eleven  – under  the  title  "n0" –
present  the  number  of year  that  are  necessary for
the  country's  debt-to-GDP  ratio  to  return  to  its
2011 level following an adjustment by 1% of GDP

Table III.3.4: Potential impact of a 1% of baseline GDP consolidation on the critical year and return to 2011 debt levels - LP

Member
States

BE
BG
CZ
DK
DE
EE
IE
EL
ES
FR
IT
CY
LV
LT
LU
HU
MT
NL
AT
PL
PT
RO
SI
SK
FI
SE
UK

Low m,
normal
markets
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1

Average 
m, normal
markets
2
1
1
1
2
1
2
2
1
2
2
1
1
1
1
1
1
1
1
1
2
1
1
1
1
1
2

n*
High m,
normal
markets
2
1
2
2
2
1
2
2
2
2
2
2
1
1
1
2
2
2
2
2
2
1
2
1
2
2
2

Source: Commission services.

Low Persistence

n0

High m,
only debt
effect
2
1
2
2
2
1
2
2
2
2
2
2
2
1
1
2
2
2
2
2
2
1
2
2
2
2
2

High m,
myopic
markets
4
1
2
3
3
1
5
≥10
3
3
6
3
2
2
2
3
3
3
3
2
4
2
2
2
2
2
3

Baseline 
n0

inf
inf
inf
inf
1
inf
inf
inf
inf
inf
2
inf
5
inf
inf
1
inf
inf
4
1
8
5
inf
inf
1
1
inf

Low m,
normal
markets
2
3
4
5
1
4
≥10
≥10
≥10
4
2
3
1
2
6
1
1
≥10
2
1
5
2
≥10
≥10
1
1
≥10

Average 
m, normal
markets
2
3
5
5
1
4
≥10
≥10
≥10
5
2
3
1
3
7
1
2
≥10
2
1
5
2
≥10
≥10
1
1
≥10

High m,
normal
markets
2
4
5
6
1
4
≥10
≥10
≥10
5
2
4
2
3
≥10
1
2
≥10
2
2
5
2
≥10
≥10
1
2
≥10

High m,
only debt
effect
3
4
5
6
1
5
≥10
≥10
≥10
6
2
4
2
3
≥10
2
2
≥10
3
2
5
3
≥10
≥10
1
2
≥10

High m,
myopic
markets
5
4
5
6
2
5
≥10
≥10
≥10
7
3
5
2
3
≥10
2
7
≥10
3
2
6
3
≥10
≥10
1
2
≥10

150

Consolidation and dynamics of the multipliers. Are there counter-intuitive effects?

Part III

Table III.3.5:

Potential impact of a 1% of baseline GDP consolidation on the critical year and return to 2011 debt levels - HP

High Persistence

Member
States

BE
BG
CZ
DK
DE
EE
IE
EL
ES
FR
IT
CY
LV
LT
LU
HU
MT
NL
AT
PL
PT
RO
SI
SK
FI
SE
UK

Low m,
normal
markets
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1

Average m, 
normal
markets
2
1
1
1
2
1
2
2
1
2
2
1
1
1
1
1
1
1
1
1
2
1
1
1
1
1
2

n*
High m,
normal
markets
2
1
2
3
2
1
2
2
2
2
2
2
1
1
1
2
2
2
2
2
2
1
2
1
2
2
2

High m,
only debt
effect
3
1
2
3
3
1
3
3
2
3
3
2
2
1
1
3
2
3
3
2
3
1
2
2
2
2
3

High m,
myopic
markets
≥10
1
2
5
6
1
≥10
≥10
4
7
≥10
4
2
2
2
5
4
5
5
3
≥10
2
3
2
3
3
6

Source: Commission services.

in  the  primary  structural  balance  in  2011.  Third,
column seven gives an indication of the underlying
debt dynamic of the EU countries. The projections
of  the  baseline  are  based on  the  Commission
services’  2012  Spring  forecasts  (up  to  2013),  and 
the  macro-economic  scenario  of  the  2012  Ageing
Report (see Annex III.1 for details). Column eight
indicates the first year in which debt is projected to
touch again the debt level of 2011. (127)

this  baseline  scenario, 

Taking 
five possible
parameter  configurations  are  presented.  The  first
three  in which  average  effective  interest  rates
follow a normal market reaction (i.e. they decrease
by 30 basis points upon consolidation and increase
by  3  basis  points with  debt),  and multipliers  are 
low, average or high (first-year multiplier of 0.5, 1
and 1.5 respectively). The last two consider a high 
first  year multiplier  of  1.5 associated with  a  only
impact  from
debt  effect  (and  no 
consolidation)  and  strongly  myopic  reaction  to
consolidation  by financial markets  (both  effects
induce undesired debt dynamics).

immediate 

(127) "Inf" stays for infinity, i.e. the country's debt is diverging. 1

means that the country's debt is converging.

Low m,
normal
markets
2
3
5
5
1
4
≥10
≥10
≥10
5
2
3
1
2
6
1
1
≥10
2
1
5
2
≥10
≥10
1
1
≥10

n0
Average m, 
normal
markets
2
4
5
6
1
5
≥10
≥10
≥10
5
2
4
1
3
≥10
1
2
≥10
2
1
5
2
≥10
≥10
1
1
≥10

High m,
normal
markets
3
4
6
7
1
6
≥10
≥10
≥10
6
2
4
2
3
≥10
1
2
≥10
3
2
5
3
≥10
≥10
1
2
≥10

High m,
only debt
effect
4
4
7
8
1
6
≥10
≥10
≥10
9
2
5
2
4
≥10
2
≥10
≥10
3
2
6
3
≥10
≥10
1
2
≥10

High m,
myopic
markets
≥10
5
7
9
2
6
≥10
≥10
≥10
≥10
3
6
2
4
≥10
2
≥10
≥10
4
3
≥10
3
≥10
≥10
1
2
≥10

Baseline n0

inf
inf
inf
inf
1
inf
inf
inf
inf
inf
2
inf
5
inf
inf
1
inf
inf
4
1
8
5
inf
inf
1
1
inf

Using  high-persistence models  as  a  basis  for
analysis,  it  emerges  that – if  one  believes  that  in
this  moment  first  year  multipliers  are  high,  for
example between  1  and  1.5  – a  1%  of  GDP
consolidation will  take maximum three  years  to
show its effects on the debt ratio unless there is  an
immediate  undesired  effect of  consolidation  on
interest  rates.  Countries  for which n*=3  are in
general  high  debt  countries.  This  is  in  line with
what was  presented  in  the  previous  Subsection.
However a  myopic effect of  the  financial  markets
in  case  of high  persistence  of  the  effects  of
consolidation on GDP  not  only  increase n*  in 
(almost)  all  cases  but  can  induce  a  fully  reverse
dynamic in high debt countries.

These  results  can  then  be  compared with  the
corresponding column under "n0", which provides
the  information  relative  to  the  number  of years
required to return to the 2011 debt ratio, following
a  1%  of GDP  permanent  consolidation  with 
respect  to  the  baseline.  All countries showing  a 
≥10  in  the  optimistic  scenario  have  an  underlying
diverging debt dynamic: it indicates that even after
consolidating the primary structural balance by one
percentage  point,  and  correspondingly  decreasing 

151

European Commission

Public finances in EMU - 2012

like

cases 

debt,  10  years  are not  sufficient  to  bring the  debt
ratio  at  the 2011 level. The  behaviour  of more
counter-intuitive 
Luxemburg,
Netherlands,  Slovenia  and  Slovakia  are  explained
by  the inner  dynamic  of  ageing  costs, which  will
start having an  impact on  government balances in
the  course  of  the next decade.  It  is  important  to
note  that  comparing  n0 with  the  baseline  can  be
misleading:  the  fact  that many  countries  decrease 
their n0 from infinity in baseline to two simply by 
improving  their  balance  by one  GDP  point  does
not mean necessarily that these countries will have
(ageing-related)
sustainability 
solved 
problems with such  a  small  consolidation.  In fact
n0  is  only  the  first year  in which  debt  decreases
back  to  the  level  of  2011  after  a  consolidation.  If
the dynamic of the ageing costs is increasing in the
following years the debt will start increasing again,
and this is not captured in the Table.

their 

Comparing  Table  III.3.4  and  Table  III.3.5  shows
that higher persistence increases n* by one year in
many  all  cases  and magnifies  the  impact  of the
underlying debt dynamic in case of myopic market
behaviour,  but that  his  parameter has  a  smaller
influence than the underlying debt dynamics.

The  required  total  improvement  in  the  structural
balance over the period in order for the debt level
to return to its 2011 level within nine years (for the
countries  that  present  a  diverging  dynamic)  is  in
general below three points. 

III.3.6 presents 

Table 
assumed for the simulation.

the  parameter  values

Table III.3.6:

Parameter values assumed for the simulation
High m,
normal
markets
1.5

High m, no
confidence 
effect
1.5

Avearge 
m, normal
markets
1.0

Low m,
normal
markets
0.5

High m,
perverse 
markets
1.5

m
alpha
beta
mu
gamma
h

0.5 or 0.8
0.1

-0.3
0.03
3

0.0
0.03
3

0.3
0.3
1

Source: Commission services.

152

Consolidation and dynamics of the multipliers. Are there counter-intuitive effects?

Part III

Box III.3.1: Debt evolution as a function of consolidation

The present Box presents the derivation of debt dynamics underlying the formulas 
presented in the main text. In what follows, higher case letters are in level, lower 
case  letters  in  ratios  to  GDP  or  growth  rates.  All  variables  are  real  and  during 
is the cyclically-adjusted general government balance, 
period i, 
is  cyclical  component  of 
is GDP growth in i and 

is  the  cyclically-adjusted  primary balance, 

is government debt at the end of year i, 

the balance, 

is GDP, 

is the apparent interest rate paid on the stock of government debt in year i.

By  definition  the  general  government  balance  BAL  is  the  sum  of  a  structural 
component  and  a  cyclical  component.  Taking  ratios  to  GDP  the  balance, 
expressed as the sum of cyclically adjusted balance and cyclical balance is 

. A permanent consolidation is thus a change in 

where  the  cyclical  part  of  the  budget  varies  proportionally  to  the  percentage 
difference  of  GDP  to baseline,  with  a  coefficient  equal  to  the  semi-elasticity  of 
budget balance 
.  In fiscal policy  analysis the tradition is to consider percentage 
difference from potential GDP.
In  what  follows  the  annual  structural  effort  is  represented  by  a diminution  in 
which is constant in 
terms  of  ratio  of  GDP,  i.e. 
where  the  notation  means 
that  the  change  in  capb  has  been  put  in  place at  the  first  period  so  that  the 
variation of the cyclically-adjusted primary balance remains constant with respect 
to baseline throughout all years from to onwards.
In  the  literature,  the  fiscal  multiplier 
GDP over the decrease in structural primary balance i.e. 

of  year  i  is  defined  as  the  variation  of 

For  the  purpose  of  notational  simplicity  it  is  also  useful  to  define,  first,  the 
as the percentage variation of GDP over the decrease 
adjusted fiscal multiplier 
in structural primary balance-to-GDP ratio, i.e. 

, representing the variation 
and, second, the fiscal multiplier of the growth rate, 
of  growth from baseline growth over the decrease in structural primary balance-
with the convention that 
to-GDP ratio, i.e. 

so  that  the  fiscal  multiplier  growth  rate  in  the  period  in  which  the 
consolidation measures are taken depends only on the first year fiscal multiplier. 
This  will  allow  analysing  the  behaviour  of  the  evolution  of  the  debt  ratio 
following  a  permanent  adjustment  in  the  structural  primary  balance.  Notice  that 
corresponds  to  the  impulse-response  function  used  to  analyse  the  effects  of 

fiscal (or other) shocks in VAR or DSGE models.
It should be noticed also that if the structural primary balance of the basic scenario 
is small, and given that the growth rate is usually small enough, this implies that 
in the first period are well approximated by the fiscal multiplier 

as well as 

(Continued on the next page)

153

European Commission

Public finances in EMU - 2012

Box (continued)

as  usually  defined,  and  that 
the change in the multipliers. 
If stock-flow adjustments are null, debt-to-GDP ratio evolves with the following 
dynamics:

in  the  following  periods  can  be  approximated  by 

To  facilitate  the  readability  of  the  formulas  it  is  supposed  that  the  year  of 
consolidation is year 0. Debt-to-GDP ratio at the end of period n is thus:

(Eq.III.1)

It  is  thus  possible  to  compute  the  variation  of  debt-to-GDP  ratio  in  year  n 
following  a  permanent  consolidation  made  in  year  1,  where  as  a  first 
approximation  it  has  been  assumed  that  interest  rates  do  no  not  vary  with 
consolidation.

(Eq. III.2)

Notice  that  since 
is  constant  and  the  derivative  of  the  cyclical 
if  the 
balance  to  the  structural  adjustment  can  be  computed  to  be 
baseline  GDP  is  assumed  to  be  close  to  potential  GDP,  the  derivative  of 
government  primary  balance-to-GDP  ratio  with  respect  to  the  annual  structural 
adjustment is

The derivative of debt-to-GDP ratio at the end of year n with respect to the annual 
structural adjustment is thus:

Let's assume that the economy was at the steady-state before the adjustment was 
made,  meaning  that  initial  balance  is  constant,  nominal  growth  is  constant and 
equal to potential growth and the apparent interest rate is constant. The marginal 
impact of consolidation on the debt-to-GDP ratio at the end of year n becomes:

(Eq.III.3)

(Continued on the next page)

154

Consolidation and dynamics of the multipliers. Are there counter-intuitive effects?

Part III

Box (continued)

With  some  algebraic  manipulation  Equation  III.3.4  discussed  in  Section  III.4  is 
obtained:  

The first term is the cumulative effect of the change in growth during n years to 
the debt ratio evolution. The second term is the cumulative effect of the change in 
balance  on  debt-to-GDP  ratio.  The  third  term  is  the  cumulative  effect  of  the 
consolidation.  
It  is  important  to  notice  that  this  formula  calculates  the  deviation  of  debt  with 
respect  to  the  baseline  scenario  – considered  here  as  the  steady-state  scenario  –
due to the permanent variation in structural primary balance. It takes into account 
variations  in  growth  rates,  primary  balance  and  GDP  level  that  the  permanent 
consolidation – or stimulus – entails. 
The  short-term  case  corresponds  to  n  =  1,  in  which  case  the  formula  becomes 
(Equation III.5):

We  deduct  the  condition  on  the  impact  multiplier  for  the  ratio  to  decrease  on 
impact:

for small g becomes the formula in the text.

Convex impulse-response model
If one assumes that the shape of the impulse-response function follows the typical 
DSGE  result,  the  path  of  the  adjusted  multiplier 
can  be  approximated  by  the 
following equation:

(Eq. III.6)

and  no  assumption  on  the  sign  of 

With 
the  long-run  impulse 
response  of  GDP  to  fiscal  consolidation.  The  formula  allows  representing  the 
situation in which the effect of present consolidation decreases through time. No 
assumption is made on the sign of the long-run multiplier: a negative figure then 

(Continued on the next page)

155

European Commission

Public finances in EMU - 2012

Box (continued)

which  hysteresis  effects  (see  for  example  de  Long  and  Summers  (2012))  are 
present.    A  positive  one  represents  the  situation  in  which  consolidation  is  made 
via cuts in government consumption or increases in property taxes or a situation in 
which interest rate are lowered by consolidation.
Substituting the function for 

into the previous formula gives 

(Eq. III.7)

Interest rates
It  is  often  argued  that  consolidation  or  stimulus  measures  have  an  impact  on 
yields,  influencing  the  future  path  of  debt.  Indeed,  if  we  assume  that  apparent 
interest rates paid on the stock of debt vary with the implementation of a variation 
of the structural primary balance the overall variation of the debt-to-GDP ratio at 
the end of period n becomes (Equation III.8): 

Where 

is the variation of the apparent interest rate at period i and 

is the 

debt-to-GDP  variation  calculated  in  the  previous  section  with  constant  interest 
rates.  A negative   
indicates  that  consolidation  effort  improve  market's 
confidence  in  government  bonds  and  reduce  yields.  To  describe  the  variation  of 
yields,  as  a  function  of  debt,  deficit,  market  expectations  and  market  short-
termism is expressed as

yields  vary  by  assuming  that  they  depend  on  the  expected  solvability  of  the 
government given the level of rates. Yields depend on the expected level of debt 
at  a  certain  horizon  h  assuming  baseline  rates:  a  small  h  means  that  financial 
markets  are  short-sighted  and  high  h  means  that  financial  long-sighted. 
Expectations are adaptive in a sense that agents revise them if the actual level of 
debt differs from what was expected. We thus have: 

(Eq. III.9)

156

(Continued on the next page)

Consolidation and dynamics of the multipliers. Are there counter-intuitive effects?

Part III

Box (continued)

is  the  yield  sensitivity  to  structural  primary  balance,  growth  perspective  and 
is the  yield  sensitivity  to the 

other external factors that affect confidence and 
debt level.1
The  variation  of  the  debt-to-GDP  ratio 
(Equation III.10): 

at  the  end  of  the  period  n  becomes 

1 It is to be remarked the assumption that financial markets are assumed not to take into 
account  the  consequences  of  their  own  behaviour  on  debt  evolution.  This  seems 
coherent with the assumption of myopic behaviour. 

157

4. CONCLUSIONS

of 

effects 

The  present  Part  has  looked  at  the  possibility  of 
counter-intuitive 
consolidations, 
whereby  consolidations  would  lead  to  an  increase 
rather  than  a  decrease  in  the  debt  burden.  It  has 
shown  that  the  risks  of  such  effect  to  arise from 
consolidation in the present context are overstated 
under  plausible  assumptions,  although  over  the 
short-term increases in the debt-to-GDP ratio may 
be  observed,  driven  by  the  denominator  effect.
Such  debt  increases  are  in  most  cases  short-lived
and  followed  by  a  fall  in  the  debt  ratio below  the 
baseline of unchanged policy. In other words, over 
the  medium-term,  consolidations  are  generally 
successful in reducing the debt-to-GDP-ratio.

More  specifically,  a  simulated  simple  empirical 
model  was  presented  which  showed  that  the 
presence  or  absence  of  counter-intuitive  effects 
from consolidations on debt dynamics is primarily 
driven by the size of  the  GDP multiplier. Chapter
III.2 presented  the  likely  range  of  the  multipliers 
and  Chapter III.3  discussed  the  implications  that 
these  values  might  have  on  debt  dynamics.  The 
the  existing  economic 
range  was  based  on 
literature;  however  it  is  likely  that  one-year 
multipliers  are  larger  in  the  current  crisis  period 
than in normal times. This is borne out by both of 
the  empirical  evidence  based  on  different 
econometric techniques and of a reasoned analysis 
of  the  factors  that  increase  the  value  of  the 
multipliers  in  model-based  assessments.  Chapter
III.3 has  shown 
that,  for  normal  values  of 
estimated cyclical elasticities and at the debt levels 
currently  observed  in  most  of  the  EU  countries, 
with  such  large crisis  multipliers, debt is likely to 
increase following consolidation in the short run.

to  what 

It  is  however  shown  that  for  high  but  plausible 
values  of  the  multipliers,  such  counter-intuitive
effects are short-lived unless the multipliers have a 
high persistence – which can happen only in cases 
where  the  fiscal  adjustments  are  repeatedly  non-
credible– or if effects on interest rates are high and 
contrary 
in 
consolidations.  A  fully  self-defeating  dynamic 
would  only  be  generated  under  very  unlikely 
configurations,  i.e.  situations  in  which  multipliers 
are  very  large  and  interest  rates  rise  significantly 
(and  counter-intuitively)  due  to  the  consolidation 
and debt developments. A high degree of financial 
market myopia is also required for these effects to 
exist. 

is  normally  expected 

158

Finally, some calculations are performed taking as 
baseline  current  economic  projections  for  EU 
countries.  They  first  show  that  the  consolidation-
induced debt increase would end within three years 
or  less, with  the  high  figures  holding  mainly  for 
high-debt  countries.  Second,  the  Part  also  shows 
that  a  number  of  EU  Member  States  have 
underlying diverging  debt  dynamics.  This  means 
that at according to the scenario used here there is 
no  expectation  that  debt  ratios  will  return  to 
current  levels  within  the  next  decade  unless  more 
consolidation is implemented. However, given the 
peak levels of debt ratios observed in the EU today 
and the development in fiscal governance (see Part 
II), a ten-year horizon for debt to revert to current 
levels  is  far  too  long  and  cannot  be  guidance  for 
EU countries. 

The simulation-based analysis proposed in Chapter 
III.3 has  a  main  drawback,  in  that  it  assumes  that 
the  relation  between  the  risk  premia  paid  on 
sovereign  debt  and  fiscal  multipliers  is  relatively 
small.  Such  an  assumption  can  be  problematic  as 
multipliers tend to be large when real interest rates 
increase  with consolidations.  In the case in which
real  interest  rates  increase  with  consolidation,  the 
negative impact on growth is larger which implies 
that a consolidation  will take a long time to bring 
debt  below  baseline.  The  prime  example for 
interest  rates  increasing  with  a  consolidation  is
provided  by the  case  in  which  factors  affecting 
financial  markets  that  cannot  be  modelled  - for 
example  if  financial  markets  come  to  believe  that 
consolidation  will  be  reversed  based  on  political 
economy reasons. This could entail an increase in 
risk  premia  offsetting the  action  of  monetary 
policy.. This simplifying assumption is justified as 
a first approximation in the short run. Moreover it 
is to be noted that, in presence of a normal reaction 
of  financial  markets  to  consolidation. An initial
improvement  in  sovereign  yields  followed  by  an 
increase of yields as a function of debt ratio would 
rather imply an initial diminution in real rates thus 
reducing 
the  debt 
the  undesired  effect  on 
dynamics.  The  assumption  made  in  the  text 
therefore
the  self-defeating 
consolidation  argument,  because  the  transmission 
of  lower  interest  rates  would  reduce the negative
effects  of  consolidation.  The  results  found  here 
constitute  therefore  a  bound  to  the  possibility  of 
having self-defeating consolidation strategies.

is  favourable 

to 

Consolidation and dynamics of the multipliers. Are there counter-intuitive effects?

Part III

The present Part does not answer to the question of 
whether  there  is  a  case  in  favour  of  immediate 
consolidation. The answer would in substance rely 
on  the  belief  concerning  the  reaction  of  interest 
rates to consolidation and at the same time on the 
beliefs  concerning  the  underlying  behaviour  of 
interest rates. If there exist threshold levels of debt 
at  which  the  market  reacts  with  large  and sudden
increase  in  risk  premia  so  that baseline  interest 
rates  increase  quickly,  then  improvements  in  the 
primary  structural  balance  bring  down  the  risk-
premium  for  normal  values  of  the  parameters  and 
markets do not display extreme myopic behaviour. 

A  second  argument  relies  on  the  behaviour  of 
multipliers  with  time.  Even  where  it  is  believed 
that  the  impact  of  consolidation  on  GDP  is 
relatively  persistent,  the  argument  in  favour  of 
anticipating consolidation remains. This is because 
if  multipliers  are  very  resilient  and  the  baseline 
scenario  is  one  in  which  debt  is  increasing,  the 
future  critical  multiplier  can  be  lower  as  its  value 
crucially  depends  on 
the 
beginning of consolidation.  Moreover, if there are 
threshold  effects  from  the  debt  level,  a  larger 
consolidation  would  be  required  in  the  future. 
Although  in 
the  present  Part  the  illustrative 
consolidation  was  standardised  at  1%  of  baseline, 
the size of consolidation matters in influencing the 
negative impact on growth and debt ratios.  

the  debt 

level  at 

A  final  issue  that  was  not  discussed  in  the  Part  is 
the  effect  of  repeated  consecutive  consolidations. 
If consolidations are repeated, especially in periods 
where  multipliers  are  large  and  persistent,  the 
effects on the economy tend to cumulate along the 
line  and  can,  in  presence  of  myopic  behaviour  of 
financial  markets,  bring  to  debt  increases.  This 
could  be  the  case,  for  example,  if  the  target  of 
fiscal policy was set in terms of headline variables, 
like headline debt or deficit ratios and not in terms 
of  cyclically  adjusted  or  structural  figures.  In  this 
situation 
scenario 
consolidation-debt 
increase-consolidation-further 
debt  increase  takes  place  as  far  as  the  current 
multiplier is higher than the critical multiplier. The 
same  spiral  can  happen  with  deficits,  but  for 
sensibly  higher  values  of  the  multipliers.  It  is 
therefore relevant that policy recommendations are 
formulated  in  terms  of  a  (path  of)  structural 
balances  so 
taken, 
sufficient  time  is  left  for  the  effects  of  the 
consolidation measures to deploy fully.

that,  once measures  are 

is  possible 

that 

the 

it 

159

ANNEX 1

Assumptions underlying the baseline scenario in section III.5

to 

The  projections  below  are  based  on 
the 
Commission  services’  spring  2012  forecast  (up  to 
2013),  and  the  macro-economic  scenario  of  the 
2012 Ageing Report: Underlying assumptions and 
projection  methodologies.  The  macroeconomic 
scenario  has  been  brought  into  line  with  recent 
decisions  in  ECFIN  on  producing  a  unified  set  of 
long-term  projections.  This 
medium-term 
decision  entails  that,  as  a  general  rule,  the  output 
gap  is  assumed  to  close  in  t+5,  after  which  the 
potential  growth  rates  converge  linearly  to  the 
AWG  baseline  scenario  by  t+10.  Hence,  up  to 
2021, the spring forecast was linked linearly to the 
baseline  scenario  in  the  2012  Ageing  Report 
(European  Economy  2/2009).  Beyond  2021,  the 
scenarios  discussed  below  assume  a  return  of 
(potential)  growth  to  the  long-term  projection  in 
the 2012 Ageing Report. 

The  following  additional  assumptions  are  also 
made:  

year)  are  used  to  have  a  differential  treatment 
in  terms  of  interest  rates  applied  to  different 
debt  "vintages"  (debt  that  is  rolled  over  or 
newly  issued  in  the  current  year,  versus  debt 
that  has  been  issued  in  the  past  and  is  not 
maturing in the current year).

• Two  different  assumptions  are  made  on  the 
long-run  value  to  which  the  two  interest  rates 
(short-term and long-term) converge. Given the 
AWG  agreed  assumption  of  real  interest  rates 
linearly  converging 
to  3%,  we  project 
representative long-term and short-term interest 
rates  as  converging  respectively  to  a  value 
above and a value below 3% (in real terms) by 
2016  in  a  way  that  the  (real)  implicit  interest 
rate on  maturing debt (new and rolled-over) is 
3%. 

•

•

•

•

the increase in age-related expenditure is taken 
from  the  so  called  'AWG  reference  scenario' 
from the 2012 Ageing Report by the European 
Commission.  Age  related  expenditure  refers 
here  to  the  "strictly"  age-related expenditure 
i.e. 
benefits 
expenditure.  For  Germany  and  France,  the 
change  for  the  long-term  care  expenditure 
component  has  been  projected 
through  a 
specific  scenario  in  which  the  unit  costs  are 
assumed to be constant in real terms.

unemployment 

excluding 

the  primary  balance  is  adjusted  by  using  the 
budget  sensitivities  (OECD  estimates)  in  the 
period  until  the  output  gap  is  assumed  to  be 
closed (by 2016 as a rule); 

the  inflation  rate  (GDP  deflator)  converges 
linearly  to  2%  in  2016  (or  2018),  when  the 
output  gap  is  closed  and  remains  constant 
thereafter, for all countries; 

zero  stock-flow  adjustment  after  2013;  this 
means  no  further  purchases  of  financial  assets 
or recapitalisations of financial institutions, nor 
disposal of such assets. 

• Data 

(extracted 

and 
elaborated  by  DG  ECFIN  staff)  on  maturing 
public debt (debt with residual maturity up to 1 

from  Bloomberg 

160

Part IV
Fiscal decentralisation in the EU - main 
characteristics and implications for fiscal 
outcomes

SUMMARY

recent 

interest, 

increasing 

years,  EU 

policymakers 

targets  set  within 

In 
have 
increasingly  raised  the  concern  that  the  behaviour 
of  subnational  governments  may  be  one  of  the 
factors  hindering  the  achievement  of  budgetary 
targets at general government level. This issue has 
in  part  because 
captured 
subnational  governments'
responsibilities  with 
respect  to  the  provision  of  public  goods  and 
services are expanding and they are being assigned 
additional  revenues  to  finance  their  spending. 
Budgetary 
the  EU  fiscal 
surveillance  framework  apply  to  the  whole  of 
general  government  – which  consists  of  central 
government,  subnational  governments  and  social 
security  funds  whereas  the  responsibility  for  their 
achievement  rests  solely  on  central  government. 
This Part of the report aims at assessing the extent 
and  main  features of  fiscal decentralisation across 
EU  Member  States  as  well  as  the  relationship 
between fiscal decentralisation and fiscal outcomes 
to 
at  general  government 
determine  whether  and  under  what  conditions 
decentralisation can worsen overall fiscal balances. 
The Part is structured along three chapters.

level.  It  attempts 

decentralisation 

Chapter IV.1 provides a cross-country comparison 
of  fiscal  decentralisation  according  to  a  set  of 
indicators that are constructed using Eurostat data. 
It  characterises  EU  decentralisation  arrangements 
according  to  the  following  aspects:  (i)  the  size  of 
expenditure  decentralisation,  (ii) 
the  size  of 
revenue  decentralisation,  (iii)  the  composition  of 
government 
expenditure 
function  (e.g.  education,  health  care  etc.)  and  by
type  or  economic 
function  of  expenditures 
(transfers,  investments  etc.),  (iv)  the  composition 
of  subnational  revenues,  essentially  distinguishing 
taxes  and  transfers  from  the  central  government, 
(v) 
financial 
the 
responsibility 
subnational 
expenditures  covered  by  subnational  taxes  and 
fees, as opposed to transfers).

subnational 

degree 

share 

(the 

by 

of 

of 

The  Chapter  shows  that  there  is  a  trend  towards 
increasing  fiscal  decentralisation  across  most  of 
the  EU  from  both  the  expenditure  and  revenue 
sides,  albeit  with  heterogeneity  across  countries. 
The statutory classification of countries as  federal 
or  unitary  only  imperfectly  reflects  the  effective 
significant 
degree 
decentralisation  can  also  exist  in  formally  unitary 
countries  (for  instance,  Nordic  countries.)  Across 
the  EU,  transfers  slightly  predominate  over  taxes 

decentralisation, 

as 

of 

of 

source 

revenue 

as  main 
subnational 
governments.  The  rate  of  coverage  of  subnational 
expenditures by tax revenues is relatively low (less 
than  50%  in  most  Member  States)  and has  not 
increased on average since 1995 even if the trends 
are  very  diversified  across  Member  States.  The 
revenue  composition  is  a  key  aspect  as  a  greater 
reliance  on  own  resources  compared  to  transfers 
should  strengthen  the  incentives  of  subnational 
governments  to  behave  in  a  fiscally  responsible 
way.  Subnational  deficits  are  not  negligible  in 
several  Member  States,  with  Spain  having  the 
highest  deficits.  Conversely,  subnational  debt 
levels are  mostly low and generally correspond to 
less than 10% of GDP in most countries, although 
Belgium,  Spain  and  Germany  have  higher  levels. 
The actual size of subnational fiscal imbalances is 
to some extent  masked by the tendency of central 
governments  to  provide  additional  transfers  to 
cover  the  gap  between  expenditures and  revenues 
of subnational governments.

IV.2  enriches 

fiscal  decentralisation 

Chapter 
the  assessment  by 
comparing  and  contrasting  key  elements  of 
arrangements 
national 
across  the  EU  based  on  country  descriptions 
compiled  by  ECFIN  services.  This  exercise 
provides  significant  added  value  by  covering 
several  aspects  which  cannot  be  captured  through 
quantitative  data,  such  as  the  number  and  legal 
status  of 
the 
the  different  subnational 
effective  degree  of  subnational  tax  autonomy  (as 
opposed  to  simple  assignment  of  receipts  from 
national taxes), the different typologies of transfers 
and  the  criteria  used  to  determine  their  amounts 
and  the  fiscal  rules  and  budgetary  procedures 
applying  to  subnational  governments  (including 
the  monitoring,  enforcement  and possibilities  of 
bailouts of subnational entities in fiscal distress).   

tiers, 

this 

is  also 

The  Chapter  highlights  that  EU  Member  States 
have  generally  increased  their  decentralisation  in 
recent  decades  – and 
true  of 
traditionally  centralised  countries.  Some  common 
patterns emerge with respects to the functions that 
are  more  frequently  devolved  to  subnational  tiers. 
These include not only functions  with a  markedly 
local  dimension 
local  networks  and 
infrastructure,  local  economic  development  and 
territorial  planning)  but,  in  several  cases,  also 
education, 
environment 
protection,  housing  and  health  care,  albeit  often 
central 
competence  with 
with 

protection, 

shared 

social 

(e.g. 

the 

163

European Commission

Public finances in EMU - 2012

government  and/or  with  responsibilities  restricted 
to  the  implementation  of  national
regulations. 
Autonomous  subnational  taxes  are  quantitatively 
important  in  several  EU  Member  States,  mainly 
those which are more decentralised in general and 
property  tax  is  the  most  widespread  own  revenue 
source of subnational governments. 

The  weight  of  shared  taxes  (without  subnational 
government  having  the  freedom  to  change  tax 
parameters)  is  large  in  most  New  Member  States 
(but  also  in  AT,  PT,  EL  and  BE) and  mainly 
concern  the  sharing  of  the  personal  income  tax. 
Transfers  account  for  a  significant  share  of 
subnational  revenues  in  a  majority  of  Member 
States.  General  transfers  often  coexist  with  those 
to  specific  expenditures  such  as 
earmarked 
investment spending. Funds are generally allocated 
on  the  basis  of  spending  needs  and  to  correct  for 
differences
in  revenue-raising  capacity  across 
subnational  entities  (equalising  transfers).  This 
may  weaken  subnational  governments'  incentives 
for  cost-effective  provision  of  services  and  fiscal 
discipline.  In  terms  of  their  overall  budgetary 
discipline,  subnational governments  are  in  most 
cases  subject  to  rules  constraining  their  fiscal 
behaviour, such as 'golden' rules restricting deficits 
to  capital  expenditures  or  numerical  borrowing 
limits.  Budgetary  coordination  across  government 
tiers  exists 
in  more  decentralised  countries, 
although  its  effectiveness  in  achieving  national 
fiscal 
its  design  and 
implementation.  Generally,  default  of  subnational 
entities  in  fiscal  distress  is  de  facto ruled  out, 
although  central  government  'bailout'  often  comes 
at  the  price  of  much  tighter  central  control  on 
subnational policies.

targets  depends  on 

the  main 

government 

indicators  of 

Chapter  IV.3  analyses  the  relationship  between 
fiscal  decentralisation  and  fiscal  outcomes  of 
general  government.  This  is  done  by  testing  the 
fiscal 
impact  of 
decentralisation introduced in Chapter IV.1 on the 
primary balance, expenditures and revenues of the 
general 
through 
in 
econometric  regressions.  Results  show  that  (i) 
expenditure  decentralisation  leads  to  a  higher 
primary  balance,  through  lower  expenditures  and 
fiscal 
higher 
the  way 
decentralisation 
subnational  governments  are  financed:  if  their 
revenues come predominantly from taxes and fees 
(and,  among  those,  from  autonomous  taxes)  the 

the 
largely  depends  on 

impact  of 

revenues; 

the  EU 

(ii) 

164

effect of decentralisation on the budget balance is 
improved,  whereas  if  they  mainly  come  from 
transfers  decentralisation  is  more  harmful  for  the 
fiscal  balances;  (iii)  high  coverage  of  subnational 
expenditures  with taxes and fees (rather than  with 
transfers)  is  associated  with  an  improved  budget 
balance, 
on 
a 
expenditures  and  a  positive  one  on  revenues;  (iv) 
with respect to fiscal rules applying to subnational 
governments,  borrowing  rules  appear  to  partly 
counteract the adverse effect of transfers on fiscal 
balances, whereas no significant effect is found for 
balanced budget rules.

reflecting 

negative 

effect 

Overall, the analysis in this part suggests that fiscal 
decentralisation  is  not  harmful  for  budgetary 
discipline  at  the  general  government  level  per  se, 
although  it  is  likely  to  have  an  adverse  effect  if 
predominantly  financed  by  transfers  from  the 
central  government  and 
if  not  matched  by 
subnational  governments having the responsibility 
for  financing  the  expenditures  through  their  own 
taxes  and  fees.  This  is  in line  with  theoretical 
predictions  underlining  the  risk  of  a  'soft-budget 
constraint'  associated  with  a  high  reliance  on 
transfers,  as  subnational  governments  can  justify 
their  deficits  by  the  lack  of  own  revenue  sources 
and so credibly threaten the central government to 
drastically cut their services if the centre does not 
provide them with additional transfers. 

by 

subnational 

Therefore, 
the  policy  concerns  over  possible 
adverse  implications  on  budget  balances  should 
not focus on decentralisation as such but on a 'bad' 
design  of  decentralisation,  i.e.  one  which  is  not 
accompanied 
financial 
responsibility.  Finally,  comparison  of  existing 
cross-country  data  with  information  in  country 
descriptions  underlines  the  complexity  and  multi-
dimensionality  of  national  fiscal  decentralisation 
arrangements in the EU and highlights the fact that 
the  cross-country  data  are  not  sufficiently  rich  to 
provide a comprehensive overview of the different 
fiscal  decentralisation 
aspects  of 
the 
implications 
it  can  have  for budgetary 
that 
discipline and economic efficiency.

and 

1. MAIN TRENDS OF FISCAL DECENTRALISATION IN THE EU

1.1. 

INTRODUCTION

to 

large 

to  a 

increasingly 

literature  and  several 
According 
economic  indicators,  there  is  a  widespread  trend 
across  advanced  economies,  including  many  EU 
Member  States, 
the 
responsibility for key public sector functions from 
the  central  government  to  subnational  sectors  of 
government.  Although  the  extent  and  pace  of  this 
process  varies  across  countries,  it  is  no  longer
confined  to  federal  countries  and  increasingly 
involves traditionally centralised ones. 

shift 

the 

can 

retains 

concern 

revenues,  with 

the  central  government 

With respect to a specific government function, the 
transfer  of  competence  can  be  either  partial  –
where 
the 
the  overall  regulation  while 
responsibility  of 
assigning 
and 
of  management 
task 
implementation to  subnational  governments  – or 
total.  Decentralisation 
both 
expenditure  and 
subnational 
governments being increasingly assigned a number 
of  revenue  sources,  mainly  in  the  form  of  grants 
and  taxes,  in  order  to  match,  at  least  partially, 
growing 
responsibilities  with 
corresponding  means  of  financing.  This  Chapter 
aims 
fiscal 
decentralisation  across  EU  Member  States  based
(128)
the 
on  Eurostat  data.
expenditure  and  revenue  sides  of  decentralisation. 
For  both  sides 
the 
aggregate  extent  of  decentralisation  (subnational 
governments' 
revenue  and 
in 
expenditure  of  general  government),  as  well  as  a 
more  detailed  assessment  based  on  available 
break-downs of aggregate data. 

it  provides  evidence  on 

It  covers  both 

at  describing 

expenditure 

extent  of 

shares 

total 

the 

across 

governments 

With respect to expenditure, the relative weight of 
subnational 
different 
government  functions  (health,  social  protection 
etc.)  and  types  of  expenditures  (consumption, 
wages,  capital  expenditures  etc.)  is  assessed. 
However,  available  data  do  not  allow  to  assess 
whether  the  competence  assigned  to  subnational 
governments on their share of expenditure is total 
or partial. With respect to subnational government 
revenues,  the  break-down  between  taxes  and 
transfers from the central government is provided. 

(128) Data cover until 2010 as this was the latest year available at 
the time of data extraction (February 2012) for the purpose 
of drafting the report.  

Unfortunately,  Eurostat  does  not  provide  data  on 
the  share  of  "own-source"  taxes  of  subnational 
governments, i.e. taxes which are set at subnational
level, as opposed to tax revenues which are simply 
transferred  from  the  central  government,  e.g. 
within 
tax  sharing  agreements.  Similarly,  no 
further  breakdown  of  transfers,  e.g.  general  vs. 
earmarked, is available. (129) 

Moreover  expenditure  and  revenue  data  are 
compared to assess whether and to what extent the 
decentralisation  of  spending  functions  has  been 
matched  by  provision  of  adequate  means  of 
financing to subnational governments. Finally, the 
developments  of  debt  and  deficits  at  subnational 
level are also described. 

1.2.  DECENTRALISATION OF EXPENDITURES

1.2.1. Overall degree of decentralisation 

The  overall  decentralisation  of  public  expenditure 
can  be measured  by  the  share  of  subnational
government spending in  total  general  government 
expenditure.  This  is  presented  in  Table  IV.1.1, 
where  subnational  government  expenditure 
is 
given  in  columns  2  to  6  as  percentage  of  total 
general government expenditure and in columns 7 
to 11 as a percentage of GDP. The Table shows the 
levels of expenditure for the earliest and latest year 
available  (1995  and  2010,  respectively)  and  for 
2007, which was the last year before the sovereign 
debt  crisis.  It  also  presents  the  changes  over  the 
1995-2007  and  2007-10  periods.  Graphs  IV.3.1 
and IV.3.2 show the share of subnational spending 
in  overall  general  government  spending  for  2010 
and  in  terms  of  the  change  over  the  1995-2010 
period, respectively, in order to ease cross-country 
comparisons.

The  Table  and  Graphs  present  Eurostat  data.  In 
order  to  properly  interpret  the  data  presented,  a 
qualification  is  needed.  For  most  EU  Member 

(129) However,  information  on both  of  these  aspects  is  to  some 
extent  provided  by country  fiches  describing fiscal 
decentralisation  arrangements  in  individual  EU  Member 
States. These have been compiled by ECFIN services based 
on a common template and questionnaire and are available 
in  Annex  1.  Chapter  IV.2  below  provides  a  summary  of 
them. Furthermore, 
the  OECD  Secretariat  produced 
indicators on effective tax autonomy which are used in the 
analysis of chapter IV.3 below.   

165

European Commission

Public finances in EMU - 2012

Table IV.1.1:

Share of subnational government expenditure in the EU (in %)

Share of subnational governments expenditure in general 
government expenditure

Subnational governments expenditure in % GDP

AT
BE
BG
CY
CZ
DE
DK
EE
EL
ES
FI
FR
HU
IE
IT
LT
LU
LV
MT
NL
PL
PT
RO
SE
SI
SK
UK
EU27

1995
31.4
33.0
23.7
4.2
19.2
33.2
53.7
26.7
4.2
33.1
30.5
17.6
23.5
31.1
24.1
24.1
13.4
19.2
1.5
40.2
18.9
11.6
12.0
37.8
14.5
13.1
25.8
---

2007
30.6
37.1
16.9
4.6
26.1
37.9
63.3
27.8
5.5
49.9
39.6
20.7
23.2
19.6
31.3
24.0
12.2
31.0
1.4
34.0
31.4
15.1
25.5
46.9
19.8
17.6
28.5
29.2

2010
34.5
37.0
18.2
4.8
27.0
37.5
63.4
24.6
5.6
47.9
39.9
20.5
25.4
10.2
30.7
27.6
11.5
26.6
1.6
33.3
32.5
13.8
23.9
47.5
20.4
16.0
27.4
28.9

Change 95-07
-0.8
4.1
-6.9
0.4
6.9
4.7
9.6
1.1
1.3
16.8
9.1
3.1
-0.3
-11.4
7.2
-0.1
-1.2
11.8
-0.1
-6.3
12.4
3.5
13.5
9.0
5.3
4.5
2.7
---

Change 07-10
3.9
-0.1
1.3
0.2
0.9
-0.4
0.1
-3.2
0.1
-1.9
0.3
-0.3
2.2
-9.4
-0.6
3.6
-0.6
-4.4
0.2
-0.7
1.2
-1.2
-1.6
0.7
0.5
-1.6
-1.1
-0.3

1995
17.7
17.2
10.8
1.4
10.2
18.2
31.8
11.0
1.9
14.7
18.7
9.6
13.1
12.7
12.6
8.3
5.3
7.4
0.6
22.7
11.0
4.8
4.1
24.6
7.6
6.4
11.3
---

2007
14.9
18.0
6.7
1.9
10.7
16.6
32.1
9.5
2.6
19.6
18.8
10.9
11.8
7.2
14.9
8.3
4.4
11.1
0.6
15.4
13.2
6.7
9.8
23.8
8.4
6.0
12.5
13.3

2010
18.1
19.7
6.9
2.2
11.9
18.0
36.9
10.0
2.8
22.0
22.1
11.6
12.6
6.8
15.4
11.3
4.9
11.8
0.7
17.1
14.8
7.1
9.8
25.1
10.2
6.4
13.8
14.6

Source: Commission services.

Change 95-07 Change 07-10

-2.8
0.8
-4.1
0.5
0.5
-1.6
0.3
-1.5
0.7
4.9
0.1
1.3
-1.3
-5.5
2.3
0.0
-0.9
3.7
0.0
-7.3
2.2
1.9
5.7
-0.8
0.8
-0.4
1.2
---

3.2
1.7
0.2
0.3
1.2
1.4
4.8
0.5
0.2
2.4
3.3
0.7
0.8
-0.4
0.5
3.0
0.5
0.7
0.1
1.7
1.6
0.4
0.0
1.3
1.8
0.4
1.3
1.3

the 

'subnational 

government' 

States,  Eurostat  only  provides  a  break-down  of
total public expenditure by three sectors; these are 
central government,  subnational government  and
social  security.  This means that  throughout  this
Part
sector
encompasses  all subnational tiers  of  government
(i.e. municipalities,  provinces,  counties,  regions
etc.) even though in most Member States 2 or even 
3  subnational  government  tiers  exist. A further
break-down between local and state government is
only  provided  for four  countries,  three  of which 
are  federal  by Constitution  (DE,  AT  and  BE)  and
one  (ES) which  is largely  regionalised.  In  these
cases 'state' is distinct from 'national' and captures
the  intermediate  layer  between  central  and  local
government, 
in  DE  and
such  as Länder
Comunidades Autònomas in ES.

in 

of 

the 

extent 

According  to  this measure  Member  States  differ
largely 
expenditure
decentralisation.  In  2010  DK  ranked  at  the  top
with about 63% of total expenditure being carried
out by subnational governments. ES and SE come
next with  47-48%,  followed  by FI,  DE,  BE,  NL, 
PL,  AT  and  IT with  figures  ranging  between  30
and 40%. At the opposite end of the spectrum are
MT with a share of only 1.6%, CY (4.8%) and EL
(5.6%), as the least decentralised MS, and IE, LU, 

166

PT,  SK  and  BG  with  shares  ranging  from  10  to
20%.  Clearly  these  figures suggest  that  the  extent
of expenditure decentralisation is not only affected
by  the  institutional framework  but  also  by the
geographical and demographic size of the country.
As for the institutional architecture of the country,
it  is  interesting  to  observe  that  decentralisation  is
relatively larger not only in constitutionally federal
countries but also in a few unitary ones such as the
Nordic countries, NL, PL and IT. (130) 

As  both  Table  IV.1.1 and  Graph  IV.1.2  show,  a
large  majority  of  EU  Member  States  have
increased  the  share  of  public  expenditure  carried
out  by  subnational governments  since  1995.
Exceptions to this are IE (131), NL, BG, EE and LU
this way
where  decentralisation measured 
decreased (132),  and  AT,  MT and  CY  where  it
remained largely stable.

in 

(130) IT  should  be  considered  a  highly  regionalised  country  in
light  of  several  reforms  introduced  over  the past  two 
decades.

(131) In  Graph  IV.1.2  the  figure  for Ireland  relates  to  2008  to
total  public 
correct  for 
expenditure in  2009-10  due  to measures aimed at  the
recapitalisation of the banking sector.

the  exceptional 

increase  of 

(132) See below subsection 1.2.2 for a discussion on the change
in  the  share  of  subnational  governments'  expenditure  by

Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

Part IV

Graph IV.1.1: Subnational government expenditure (% of general government expenditure in 2010)

Local governments

State governments

t
n
e
m
n
r
e
v
o
g

l
a
r
e
n
e
g
l
a
t
o
t
n
i

e
r
u
t
i
d
n
e
p
x
e

t
n
e
m
n
r
e
v
o
g
l
a
n
o
i
t
a
n
b
u
S

)

%

(

e
r
u
t
i
d
n
e
p
x
e

70

60

50

40

30

20

10

0

DK ES

SE

FI

DE

BE NL

PL AT

IT EU27 LT UK CZ

LV HU EE

RO FR

SI

BG SK PT

LU

IE

EL

CY MT

Source: Commission services.

increase 

in  decentralisation

The 
has  been
particularly  pronounced  in  ES,  PL,  RO,  SE,  DK
and  FI where  the  percentage  of  overall  general

function. In IE the figure in Graph IV.1.2 is mainly driven 
by a sharp reduction of the subnational government's share
in health care expenditure. Moreover, Graph IV.1.5 below
shows  that 
in  the  subnational
governments'  share  in  investment  expenditure  by  the
general government between 1995 and 2010 occurred in IE
and NL. 

largest  reduction 

the 

IV.1.3 plots 

the  aggregate 

government expenditure undertaken at subnational
level rose by about 10 percentage points or more.
Graph 
level  of
government expenditure (as a percentage of GDP)
against  the  percentage  of  subnational government
in  total  expenditure  in  2010. (133)  It  shows  that
there is a positive, albeit weak, correlation between
these  two variables,  providing  some  prima  facie

(133) Except for IE (2008), see footnote 130.

Graph IV.1.2: Change in subnational government expenditure between 1995 and 2010 (percentage points of general government

expenditure)

-15

-10

-5

0

5

10

15

20

Changes in points of percentage

Source: Commission services.

ES
PL
RO
SE
DK
FI
CZ
LV
IT
SI
DE
BE
LT
SK
FR
PT
HU
UK
EL
CY
MT
AT
LU
EE
BG
NL
IE

167

 
 
 
 
European Commission

Public finances in EMU - 2012

Graph IV.1.3: Subnational government expenditure as a percentage of general government expenditure and government expenditure as a

percentage of GDP (2010)

70

60

50

40

30

20

10

t
n
e
m
n
r
e
v
o
g

l
a
r
e
n
e
g
o
t

e
r
u
t
i
d
n
e
p
x
e

t
n
e
m
n
r
e
v
o
g
l
a
n
o
i
t
a
n
b
u
S

)

%

(

e
r
u
t
i
d
n
e
p
x
e

0

35

BG

EE

SK

40

DK

FR

SE

BE

FI

ES

PL

DE

IT

SI

HU

NL

AT

EU27

UK

PT

CY

EL

LT

RO

CZ

LV

IE

LU

MT

45

50

55

60

General government expenditure to GDP (%)

Source: Commission services.

evidence  that  decentralisation  may  be  related  to a 
larger  overall weight  of  the public  sector  in  the
economy.

showing the subnational government percentage of
expenditure in each of the 9 functions in 1999 (138) 
and 2009.

1.2.2. Composition of subnational government

expenditures

function 

Eurostat figures on public expenditure by sector of
government  can  be  further  broken  down  by 
government
(cofog),  although  data
availability  does  not go  beyond  2009. (134)  This
allows  an  assessment  of whether  expenditure
decentralisation  is  predominantly  concentrated  in
specific 
the
percentage of subnational government expenditure
over  total  expenditure by  function in  2002  and 
2009 (135) (all government functions considered by 
Eurostat  are  shown). (136) For each  function  the
average,  minimum  and  maximum  figures  for EU
(137)  Table  IV.1.2 
Member  States  are  shown.
presents  the underlying  data by  Member  State,

functions.  Graph 

IV.1.4  plots 

(134) At the time of writing.
(135) 2002 and  2009 are,  respectively,  the  earliest and  most
recent year  for which  a  full  breakdown  in  the  underlying
data is available for all Member States – including an EU
average.

(136) With  the  exception  of  defence,  for  which  the  share  of

subnational governments is basically zero.   

(137) E.g. in the EU on average about 40% of public expenditure
on  public  order  and  safety  is carried out  by subnational
governments  and, across  EU Member  States, this  share
ranges  from  a  minimum  of  zero  to  a  maximum  of  more
than 90% (see table IV.1.2 for details on country data).

168

line  with  economic  rationale,  as

As  the  Graph  shows,  the most  decentralised
functions are environment protection and housing,
for which between 60 and 80% of total expenditure
is  undertaken  by  subnational  governments  on
average,  followed  by  recreation,  culture  and
religion and education, with an average percentage
higher than 40%. This pattern is to a certain extent
several
in 
expenditure  items  included  in  these  functions
concern services to be organised on a fairly small
(i.e. subnational) scale and where heterogeneity of
likely  to  be more
subnational  preferences
pronounced, i.e.  waste  management,  housing and
community  developments,  water supply,  street
recreational  and  sporting  services,
lightning, 
nurseries  etc. At 
least
the  other  end, 
decentralised functions are general public services
(139), social  protection (140)  and  public  order  and

the 

is

(138) The earliest year available for all Member States except LT

(2000), PL and RO (2002).

(139) General public services cover administrative expenditure of
public bodies, general services, debt service, basic research
and foreign aid.

(140) In principle, at least part of social expenditure falls within
the 'social security funds' subsector included in the Eurostat
breakdown  alongside the  subsectors  of  central and 
subnational  governments.  According  to  the  definition  in
national  accounts the  subsector  of  social  security funds
includes  central,  state  and  local  institutional  units  whose

 
 
 
Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

Part IV

Graph IV.1.4: Subnational government expenditure by function (% of general government expenditure by cofog) - EU average for 2002 and

2009 and minimum and maximum for 2009

100

90

80

70

60

50

40

30

20

10

0

t
n
e
m
n
r
e
v
o
g

l
a
r
e
n
e
g

o
t

e
r
u
t
i
d
n
e
p
x
e

'

s
t
n
e
m
n
r
e
v
o
g
l
a
n
o
i
t
a
n
b
u
S

)

%

(

e
r
u
t
i
d
n
e
p
x
e

General public
expenditure

Public order and
safety

Economic affairs

Environment
protection

Housing and
comm. amenities

Health

Recreation,
culture and
religion

Education

Social protection

2002

2009

Min EU27 2009

Max EU27 2009

Source: Commission services.

subnational  governments 

safety where 
are 
responsible  for  below  30%  of  all  spending  on 
average. Comparing  the  figures  from  2009  with 
those  from  2002 (141)  shows  that  the  relative
average weight  of 
subnational  governments
spending  across functions  has  been  reduced  for
housing, public order and safety, economic affairs,
education,  environment  protection  and  general
public services, whereas it increased for health and
social  protection  and 
it  remained  stable  for
recreation, culture and religion.

Across all functions, the EU average figures mask
considerable  variation  across  Member  States.  As
can  be  seen  in  Graph  IV.1.4,  the  minimum
percentage  of  subnational  governments  in  overall
government spending is zero (across all functions),
whereas the maximum  one  ranges from  50-60%
(general  public  services,  economic  affairs  and
to  90-100%  (all  remaining
social  protection)
functions). In more detail, the figures for 2009 (see 
Table IV.1.2) show that:

principal  activity  is  to  provide  social benefits.  Hence
figures  on subnational government  expenditure  for  social
protection may underestimate its actual size. However, the 
situation  may differ  by  country  due  to  their  legal  and
administrative architecture. 

(141) The earliest year with available data for the EU average for

the breakdown by function.

• General  public  services:  the  percentage  of
subnational government spending range from 0
in  MT  to  58.4%  in  DE.  CY,  LT,  IE,  DK  and 
BG all have percentages below 10% of overall
spending, whereas AT and FI have percentages
over 30%.

• Public  order  and 

subnational
governments  have the  highest  percentages  in
DE (88%), BE, ES and UK (41-43%), lowest in 
CY, EE, EL and MT (0).

safety:

• Economic affairs: largest share in ES, BE, DE
and IT (50-60%), lowest in CY, MT and EL.

• Environment  protection:  largest  share  in  BE, 
CY, CZ (100%), ES, FR, PL, PT and RO (85-
90%), lowest in MT, LV, FI and EE.

• Housing:  highest  in  BE,  EE,  ES  and  PT

(100%), lowest in MT, CY and EL.

169

 
 
 
European Commission

Public finances in EMU - 2012

Table IV.1.2:

Percentage of subnational government expenditure by function (% of total general government expenditure by cofog) - 2009 

General public services
1999
2009

Public order and safety
2009 Change 
1999

Economic affairs

1999

2009 Change 

Environment protection
1999
2009 Change 

Housing and comm. 
2009

1999

Change 
in % 
points
2.2
1.6
1.4
1.0
-3.8
9.0
-1.9
-2.2
3.1
4.5
11.7
4.1
2.2
2.8
5.0
-0.5
3.8
-6.2
-9.9
3.6
0.8
5.6
0.8
4.3
3.7
15.4
0.4
---

AT
BE
BG
CY
CZ
DE
DK
EE
EL
ES
FI
FR
HU
IE
IT
LT*
LU
LV
MT
NL
PL**
PT
RO**
SE
SI
SK
UK
EU27

35.2
15.3
7.8
6.1
32.6
49.5
10.7
18.0
8.9
17.4
25.8
21.7
15.9
4.0
17.2
8.1
14.7
30.2
9.9
20.5
18.9
10.1
18.9
23.1
15.3
7.4
12.3
---

37.3
16.9
9.2
7.1
28.8
58.4
8.8
15.8
12.1
21.9
37.5
25.8
18.0
6.8
22.2
7.5
18.5
24.1
0.0
24.1
19.7
15.7
19.7
27.4
19.0
22.8
12.7
19.4

in % 
points
5.1
2.9
1.9
0.0
5.2
-5.5
-1.7
0.0
0.0
0.8
-1.4
6.4
4.1
-6.8
0.0
0.2
-1.1
5.7
0.0
-4.2
1.8
-1.5
1.8
-1.1
0.0
0.5
-8.8
---

in % 
points
2.0
-7.2
8.5
0.0
12.7
3.0
6.3
14.5
0.8
10.0
6.8
-4.4
5.6
-8.8
1.2
1.0
-7.6
9.2
0.0
-4.7
-6.6
2.3
-6.6
3.8
9.9
11.7
-2.6
---

83.3
100.0
90.0
100.0
70.0
100.0
42.9
50.0
80.0
88.9
33.3
85.7
75.0
66.7
80.0
100.0
50.0
33.3
0.0
80.0
83.3
71.4
83.3
100.0
42.9
18.2
66.7
---

66.7
100.0
58.3
100.0
90.0
62.5
60.0
36.4
83.3
90.0
33.3
88.9
42.9
62.5
80.0
83.3
58.3
18.2
0.0
80.0
85.7
85.7
85.7
50.0
54.5
57.1
54.5
77.8

in % 
points
-16.7
0.0
-31.7
0.0
20.0
-37.5
17.1
-13.6
3.3
1.1
0.0
3.2
-32.1
-4.2
0.0
-16.7
8.3
-15.2
0.0
0.0
2.4
14.3
2.4
-50.0
11.7
39.0
-12.1
---

53.3
100.0
50.0
16.0
50.0
81.8
25.0
100.0
50.0
100.0
50.0
75.0
90.9
80.0
90.0
100.0
55.6
92.9
0.0
69.2
76.5
90.0
76.5
53.8
50.0
36.4
62.5
---

75.0
100.0
85.7
13.6
45.5
77.8
42.9
100.0
25.0
100.0
60.0
81.8
92.3
82.6
58.3
80.0
45.5
66.7
0.0
76.9
83.3
100.0
83.3
87.5
66.7
66.7
31.0
64.3

42.9
62.7
14.0
0.0
23.2
51.0
36.1
23.3
2.7
50.0
20.7
35.0
11.1
32.6
48.8
11.5
25.6
18.6
0.0
50.0
48.7
31.9
48.7
28.9
15.1
6.5
28.6
---

44.8
55.6
22.5
0.0
35.9
54.0
42.4
37.7
3.5
60.0
27.5
30.6
16.7
23.8
50.0
12.5
18.0
27.8
0.0
45.3
42.1
34.2
42.1
32.7
25.0
18.2
26.0
33.3

12.5
40.0
4.5
0.0
4.3
93.8
10.0
0.0
0.0
42.1
21.4
16.7
5.0
11.8
10.0
4.8
11.1
3.8
0.0
40.9
12.5
5.9
12.5
15.4
5.9
3.7
50.0
---

17.6
42.9
6.5
0.0
9.5
88.2
8.3
0.0
0.0
42.9
20.0
23.1
9.1
5.0
10.0
5.0
10.0
9.5
0.0
36.7
14.3
4.3
14.3
14.3
5.9
4.2
41.2
27.8

Change 
in % 
points
21.7
0.0
35.7
-2.4
-4.5
-4.0
17.9
0.0
-25.0
0.0
10.0
6.8
1.4
2.6
-31.7
-20.0
-10.1
-26.2
0.0
7.7
6.9
10.0
6.9
33.7
16.7
30.3
-31.5
---

Source: Commission services.

(Table IV.1.2 continued)

1999

Health
2009

AT
BE
BG
CY
CZ
DE
DK
EE
EL
ES
FI
FR
HU
IE
IT
LT*
LU
LV
MT
NL
PL**
PT
RO**
SE
SI
SK
UK
EU27

43.1
4.8
50.0
0.0
1.4
6.3
95.7
18.9
0.0
60.4
63.6
1.4
25.3
54.2
61.1
21.5
0.0
22.5
0.0
5.3
23.2
5.0
23.2
83.6
13.1
1.3
0.0
---

37.4
4.4
9.1
0.0
3.9
6.8
97.7
19.8
0.0
92.8
59.8
1.2
20.2
0.0
60.8
21.4
0.0
27.8
0.0
4.3
29.9
5.6
29.9
82.8
10.3
0.0
0.0
39.0

Change in 
% points
-5.7
-0.3
-40.9
0.0
2.5
0.5
2.1
0.8
0.0
32.4
-3.8
-0.2
-5.1
-54.2
-0.3
-0.2
0.0
5.3
0.0
-0.9
6.7
0.6
6.7
-0.8
-2.9
-1.3
0.0
---

Recreation, culture and religion
2009

1999

Education
2009

63.6
90.0
14.3
22.2
60.0
100.0
56.2
40.9
50.0
71.4
64.3
72.7
37.5
50.0
44.4
33.3
42.1
50.0
0.0
84.6
75.0
46.2
75.0
78.9
46.7
20.0
50.0
---

72.7
92.9
37.5
23.1
64.3
88.9
52.9
45.8
14.3
82.4
64.3
70.6
37.5
50.0
55.6
46.2
35.0
50.0
0.0
80.0
78.6
63.6
78.6
75.0
42.1
45.5
50.0
66.7

Change in 
% points
9.1
2.9
23.2
0.9
4.3
-11.1
-3.3
4.9
-35.7
10.9
0.0
-2.1
0.0
0.0
11.1
12.8
-7.1
0.0
0.0
-4.6
3.6
17.5
3.6
-3.9
-4.6
25.5
0.0
---

1999

45.7
86.8
60.5
0.0
48.3
97.9
52.6
42.7
3.4
79.5
50.6
26.2
50.0
20.4
28.6
68.3
22.0
50.0
0.0
48.1
45.8
7.8
45.8
63.7
38.4
21.4
47.1
---

Change in 
% points
1.4
-2.1
-4.9
0.0
1.0
-2.0
-3.8
17.1
-1.1
16.5
-0.6
5.1
-2.8
-2.7
-2.6
-4.6
0.2
3.3
0.0
1.9
2.9
2.6
2.9
9.9
0.3
26.0
-1.9
---

Social protection

1999

2009

13.5
17.2
5.8
0.0
7.9
18.7
47.1
7.6
0.0
7.5
15.2
5.5
10.4
12.6
3.1
9.6
1.3
5.1
0.0
14.0
5.2
1.7
5.2
25.0
2.9
1.9
19.6
---

12.8
20.0
4.4
0.0
9.7
19.4
52.6
5.6
2.2
11.0
18.2
8.1
7.1
4.1
3.1
6.0
0.7
6.3
0.0
10.3
7.5
2.3
7.5
25.6
4.1
3.6
20.5
25.0

Change in 
% points
-0.7
2.8
-1.4
0.0
1.8
0.7
5.5
-1.9
2.2
3.5
3.0
2.6
-3.3
-8.5
0.0
-3.6
-0.5
1.2
0.0
-3.7
2.3
0.6
2.3
0.6
1.3
1.8
0.9
---

47.1
84.7
55.6
0.0
49.3
95.8
48.8
59.7
2.4
96.1
50.0
31.2
47.2
17.6
26.0
63.8
22.2
53.3
0.0
50.0
48.8
10.4
48.8
73.7
38.7
47.5
45.2
41.5

* 1999 data is replaced by 2000; ** 1999 data is replaced by 2002
Source: Commission services.

170

Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

Part IV

• Health: highest share  in  DK,  ES  (more  than
90%), SE (83%), IT and FI (around 60%); zero
(or close to) in CY, CZ, EL,  IE, MT, SK, UK
and FR.

• Recreation:  highest share  in  BE,  DE,  ES,  NL,
PL  and  RO  (close  to  80%  or more),  lowest  in 
MT, EL, CY, BG, LU and HU (less than 40%).

• Education: highest subnational share in ES, DE
(96%),  BE  (85%),  SE  (74%),  LT  and  EE  (60-
64%),  lowest  in  CY,  MT,  EL  (0-3%),  PT  and 
IE (10-18%).

• Social  protection:  highest  share  in  DK  (52%), 
SE,  (25%), BE,  DE,  FI and UK (18-20%), 
lowest  in CY,  MT  (0),  BG,  CZ,  EE,  EL,  FR, 
HU, IE,  IT,  LT,  LU,  LV,  PL,  PT, RO, SI  and
SK (less than 10%).

As  regards  the  change in  shares  of  subnational
expenditures by function between 1999 and 2009,
taking  as  a  threshold  a  10  percentage  point
difference, the largest variation are observed for i)
housing, with an increase in BG, SE, SK (30+pp),

AT (20-30pp), DK, FI, PT and SI and a decrease in
IT  (32pp),  LV,  EL,  LT  (20-30pp)  and  LU;  ii)
environment, with  an  increase  in  SK  (39pp),  CZ
(20),  DK  and  PT  and  a  reduction  in  SE  (50pp),
BG, DE, HU (30-40pp), AT, EE, LT and LV;  iii)
recreation, with an increase in SK, BG (20-30pp),
PT,  LT,  IT  and  ES  and  a  reduction  in  EL  (36pp)
and DE (11pp); iv) health, with an increase in ES
(32pp)  and  large  reductions  in  IE  (54pp)  and  BG
(41pp);  and  v)  economic  affairs, with  an  increase
in CZ, EE, ES, SI and SK (never exceeding 15pp).

the 

Similarly  to  Table  IV.1.2, Table  IV.1.3  below 
provides  figures for  the  share  of  subnational
government expenditure by economic function (i.e. 
compensation  of  employees, 
transfers,  capital
expenditure etc.) in 2010. Amongst the categories
included, 
subnational
percentage 
governments  in  general  government  spending  is
highest
intermediate
consumption (it represents over 50% of the total in 
AT, BE, CZ, DE, DK, ES, FI, IT, NL, PL and SE), 
compensation of employees (over 50% in BE, DE,
DK, ES, FI, HU, NL, PL, SE and between 45 and
50% in UK, LV, LT, CZ and AT) and investment

expenditure 

for 

on 

of 

Table IV.1.3:

Percentage of subnational government expenditure by economic function - 2010

Intermediate 
consumption

Compensation 
of employees

Interest

Subsidies

Social 
benefits

Other current
expenditures

Capital 
transfers

Investment

AT
BE
BG
CY
CZ
DE
DK
EE
EL
ES
FI
FR
HU
IE
IT
LT
LU
LV
MT
NL
PL
PT
RO
SE
SI
SK
UK
EU27

51,1
69,2
38,7
8,8
51,6
70,8
65,7
38,7
14,5
80,4
64,6
43,1
43,0
24,6
69,5
37,5
32,4
31,9
6,6
59,3
58,1
32,0
33,8
64,9
31,9
40,8
37,4
54,3

45,4
77,0
30,1
5,0
47,4
78,5
71,7
38,7
10,7
78,2
73,6
26,1
50,5
15,4
42,3
47,3
21,3
45,5
0,7
66,3
57,4
17,2
34,7
76,7
33,9
39,0
46,1
52,3

3,8
8,3
0,0
7,1
0,0
44,0
10,5
100,0
0,0
19,0
7,1
4,2
2,4
0,0
4,5
0,0
0,0
11,1
0,0
15,0
3,8
3,1
12,5
18,2
0,0
0,0
6,5
14,3

52,9
20,0
7,7
0,0
63,2
60,0
53,8
27,3
0,0
50,0
13,3
41,2
18,2
0,0
63,6
0,0
11,8
28,6
0,0
26,7
16,7
14,3
16,7
40,0
13,6
23,1
33,3
46,2

17,4
12,7
0,0
0,0
4,1
15,3
71,1
3,4
0,0
17,5
9,6
4,3
3,3
5,0
13,6
7,4
0,5
6,6
0,0
7,8
7,1
3,2
7,3
21,2
2,6
0,5
11,9
12,4

18,5
16,0
1,5
2,7
5,9
30,7
3,6
4,2
0,9
19,5
3,6
11,4
2,9
1,7
3,4
1,0
3,6
12,8
0,0
1,9
3,9
7,6
2,3
5,0
3,3
3,5
0,0
11,1

50,0
57,1
0,0
0,0
14,3
35,3
14,3
16,7
0,0
37,5
0,0
28,6
12,5
0,9
27,3
0,0
0,0
0,0
0,0
17,2
18,2
7,1
33,3
0,0
7,1
0,0
9,1
24,0

70,0
88,2
29,8
18,4
71,9
85,7
61,9
45,8
20,7
71,8
68,0
74,2
66,7
64,9
71,4
51,1
39,0
74,4
4,5
65,7
58,9
45,9
37,9
50,0
57,1
64,0
50,0
65,4

Source: Commission services.

171

European Commission

Public finances in EMU - 2012

Graph IV.1.5: Subnational government percentage of investment expenditure by the general government (1995 and 2010)

Source: Commission services.

spending (at or over 50% in AT, BE, CZ, DE, DK, 
ES, FI, FR, HU, IE, IT, LT, LV, NL, PL, SE,  SI, 
SK and UK).

On  the  other  hand,  the  percentage  of  subnational 
governments  in  overall  spending  is  generally  low 
for  interest  expenditure  with  most  public  debt 
being issued by the central government (exceptions 
to  this  include  EE  and  DE  where  subnational 
governments undertake 100% and over 40% of this 
spending,  respectively,  followed  by  ES,  SE,  NL, 
RO, LV and DK, with a subnational percentage of 
10-20%), social benefits (in all cases except DK), 
other  current  expenditures  (where  the  subnational 
government  percentage is  below  20%  for  all 
Member States except DE,  where it is over 30%), 
and  capital  transfers,  (with  the  exceptions  of  BE 
and AT at 50% or more and ES, DE, RO, FR and 
IT  at  between  25  and  40%).  The  subnational 
percentage  in  the  expenditure  for  subsidies  shows 
larger variation (it is 50% or more in IT, CZ, DE, 
AT, DK and ES).    

The above evidence on the average composition of 
subnational  expenditures  by  economic  function 
across  the  EU  is  to  some  extent  consistent  with 
recommendations 
fiscal 
federalism literature on the optimal assignment of 
main  government  functions  across  sectors  of 
government
(Oates,  1999).  According  to  this 
literature, two out of the three economic functions 
by  Musgrave's 
identified 
of 

the  "classical" 

government 

from 

172

to 

i.e. 

that  most  closely  represents 

classification (Musgrave,  1959), 
income 
redistribution  and  stabilisation  of  macroeconomic 
shocks,  should  be  assigned 
the  central 
government,  leaving  to  subnational  governments 
the  allocation  of  public  goods  with a 
only 
subnational  dimension.  Such  assignment 
is 
consistent  with  the  "benefit  principle"  suggesting 
that  a  service  should  be  provided  by  the  level  of 
government 
the 
community  benefiting  from  it  which  implies  that, 
for  instance,  public  goods  benefiting  only  people 
living  in  a  city  should  be  provided  by  the 
municipality,  whereas  national  public  goods  such 
as  redistribution  and  macroeconomic  stabilisation 
(where  risks  of  spillovers  and  free-riding  are 
larger)  should  be  assigned  to  the  central  level 
(McLure and Martinez-Vazquez, 2000). The larger 
subnational  weight  in  intermediate  consumption 
and  investments  and  the  lower  one  in  social 
benefits  are  by  and  large  consistent  with  this 
recommendation.

Table IV.1.3   shows that subnational government 
spending  accounts  for  a  large  share  of  general 
government  investment.  To  highlight  this  issue 
further,  Graph  IV.1.5  above provides  evidence  on 
the change in the subnational share of government 
capital  expenditure ( 142)  by  plotting  the  sum  of 

(142) The  figures  in  the  graph are  computed  by  summing  up 
expenditures in capital  transfers  and investments  (last two 
columns in table IV.1.3 above).

Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

Part IV

subnational  government investment  spending  and
capital  transfers  as  a  percentage  of  the  sum  of
general government 
investment  spending  and
capital  transfers for  1995  on  the  horizontal  axis
and 2010 on the vertical axis. The figures shown in
Graph IV.1.5 thus contain the sum of the last two 
columns  in  Table  IV.1.3,  as  this  total  is  a more
appropriate way to capture the total contribution of
the  general  government  to  capital  formation (143). 
The  Graph  should  be  considered  against  a
backdrop  of  decreasing
overall  government
investment expenditure in most EU Member States
during recent years. 

The  share  of  subnational  authorities  in  general
government capital expenditure amounts to 50% or
more in  11  Member  States  (BE,  ES,  FR,  FI,  DE,
IT,  AT,  NL,  HU,  PL  and  DK)  including  all  the
most  decentralised  ones  in  terms  of  aggregate

(143) This  mainly  relates  to  the  fact  that  capital  transfers  also
include  capital  injections  granted  by  the  government  to
state-owned  enterprises  which  invest  in  networks  and
infrastructures  (e.g.  railways).  These  enterprises  may  be
classified  out  of  the  general  government  sector  if  they
operate  as  market  operators,  hence  the  investments they
undertake would not be accounted if only looking at figures 
on government expenditure on investments.

Table IV.1.4:

Share of subnational government revenues in the EU

expenditure.  As  the  Graph  shows,  this  share
increased  in  a  majority  of  Member  States  (16 out
of  27  lie  above  the  45  degree  line)  between  1995
and  2010,  with  the  increase  being  particularly
pronounced in FI, DE, HU, SI, CZ, LT and ES. On
the 
governments'
other 
contribution 
investments  decreased
significantly in IE, NL, BG and LU.

hand, 
to  public 

subnational 

1.3.  DECENTRALISATION OF REVENUE 

SOURCES 

1.3.1. Overall degree of decentralisation

This Section discusses fiscal decentralisation in the
EU  from  the  revenue  side.  First,  it  considers the
overall degree of revenue decentralisation and the
extent  to  which  the  broadening  of subnational
governments'  competences
(and  corresponding 
expenditure  responsibilities) are  matched with
corresponding
it 
discusses 
subnational
composition 
governments' revenues, by focusing on the relative
weight  of  two main sources,  i.e.  taxes  and
transfers. 

financial  means.  Second, 

the 

of 

Share of subnational governments revenue in general 
government revenue

Subnational governments revenue in % GDP

AT
BE
BG
CY
CZ
DE
DK
EE
EL
ES
FI
FR
HU
IE
IT
LT
LU
LV
MT
NL
PL
PT
RO
SE
SI
SK
UK
EU27

1995
34.1
34.9
22.4
3.7
30.3
36.8
57.8
24.8
5.2
37.6
36.1
18.8
28.2
33.2
28.3
24.3
13.5
19.7
1.7
48.3
23.1
13.4
13.1
42.2
17.7
6.9
28.9
---

2007
31.5
37.9
16.1
4.2
27.5
39.1
57.2
24.7
6.1
46.5
35.3
21.0
25.7
19.1
32.2
23.8
11.8
29.2
1.5
33.5
33.0
15.6
26.9
43.9
19.6
18.5
30.2
32.3

Source: Commission services.

2010
31.6
38.5
19.8
5.4
29.0
38.8
66.3
25.2
6.6
49.0
41.7
23.2
25.9
19.2
32.5
33.7
11.8
31.3
1.8
35.3
36.3
15.1
28.5
48.0
22.1
17.0
34.2
33.9

Change 95-07 Change 07-10

-2.6
3.0
-6.3
0.5
-2.8
2.3
-0.6
0.0
1.0
8.8
-0.8
2.2
-2.6
-14.1
3.8
-0.5
-1.8
9.5
-0.2
-14.8
9.9
2.1
13.8
1.7
1.8
11.7
1.2
---

0.1
0.6
3.6
1.1
1.5
-0.4
9.1
0.5
0.5
2.6
6.4
2.2
0.2
0.1
0.4
9.9
0.1
2.1
0.3
1.8
3.3
-0.4
1.6
4.2
2.5
-1.5
4.1
1.6

1995
17.2
16.6
8.4
1.2
12.2
16.7
32.6
10.5
1.9
14.0
20.0
9.2
13.3
12.9
12.7
8.0
5.7
7.3
0.6
22.8
10.0
4.9
4.2
24.3
7.8
3.1
11.0
---

2007
15.0
18.2
6.6
1.9
11.1
17.1
31.8
9.0
2.5
19.1
18.6
10.5
11.7
7.0
14.8
8.0
4.7
10.4
0.6
15.2
13.3
6.4
9.5
23.9
8.3
6.0
12.4
15.5

2010
15.2
18.8
6.9
2.2
11.4
16.9
36.8
10.3
2.6
17.8
21.9
11.5
11.7
6.8
14.9
11.4
4.9
11.3
0.7
16.3
13.6
6.3
9.7
25.3
9.8
5.5
13.8
16.2

Change 95-07 Change 07-10

-2.2
1.6
-1.8
0.7
-1.1
0.4
-0.8
-1.5
0.6
5.1
-1.4
1.3
-1.6
-5.9
2.1
0.0
-1.0
3.1
0.0
-7.6
3.3
1.5
5.3
-0.4
0.5
2.9
1.4
---

0.2
0.6
0.3
0.3
0.3
-0.2
5.0
1.3
0.1
-1.3
3.3
1.0
0.0
-0.2
0.1
3.4
0.2
0.9
0.1
1.1
0.3
-0.1
0.2
1.4
1.5
-0.5
1.4
0.7

173

European Commission

Public finances in EMU - 2012

Graph IV.1.6: Subnational government revenues (% of general government revenues - 2010)

l
a
n
o
i
t
a
n
b
u
S

)

%

(

e
u
n
e
v
e
r

t
n
e
m
n
r
e
v
o
g

l
a
r
e
n
e
g

o
t

e
u
n
e
v
e
r

t
n
e
m
n
r
e
v
o
g

70

60

50

40

30

20

10

0

State governments

Local governments

DK ES SE FI DE BE PL NL UK EU27 LT IT AT LV CZ RO HU EE FR SI BG IE SK PT LU EL CY MT

Source: Commission services.

of 

degree

government 

The 
revenue
decentralisation  can  be  measured  by the  share  of 
subnational government  revenues  in  revenues  of
the  general  government.  These  are  defined  as
revenues collected by or transferred to subnational
(144) Table  IV.1.4  presents  these
governments.
figures for  EU  Member  States.  The  format  is  the
same  as for  Table  IV.1.1, which  presented  the
share  of  subnational  government  expenditures;  in
both cases the levels as a percentage of the overall
general government  total  and  GDP are  given  for
1995,  2007  and  2010,  alongside  the  percentage
point  changes  between  1995  and  2007  and
between  2007  and  2010  in  order  to  single  out  the
impact  of  the  recent  economic  crisis.  The  figures
for 2010 are also displayed in Graph IV.1.6 to ease
cross-country comparisons.

As  shown in the Graph,  in  2010  DK had  the
highest  revenue  decentralisation  in  the  EU with
around two  thirds  of  total  government  revenues
to  subnational
being  raised  by  or  assigned 

(144) The  Chapter  differs  here  from  a  number  of  papers  (e.g.
Escolano  et  al.,  2012  and  Eyraud  and  Lusinyan,  2011)
where  revenue  decentralisation  is  defined  as the  share  of
subnational own  revenues  (taxes and  fees) in  general
government  revenues,  thereby excluding  transfers.  This  is 
done as the current focus is on the whole set of subnational
revenues and on their composition across different sources
(taxes,  transfers  and  fees),  see  below.  In  chapter IV.3  the 
indicator of own revenue decentralisation, distinct from the
above indicator (i.e. excluding transfers), is introduced and 
used in the analysis.

174

than  5%  of 

governments.  ES  and SE had
subnational
percentages close  to  50%,  whereas FI,  BE,  DE,
PL, NL, UK, LT, IT, AT and LV had percentages
in  excess  of  30%.  On  the  other  hand,  subnational
total
less
revenues make  up 
government  revenues in  MT,  EL  and  CY  and
under  20%  in  LU,  PT  and  SK.  Subnational
revenues account for 37% of GDP in DK, between
20 and 25% in SE and FI, between 15 and 20% in 
BE,  ES,  DE,  NL, AT  and  IT.  The  share  of 
subnational governments  in  total  public  revenues
has increased  in the  1995-2010  period  in  the
majority  of  Member States (17  out  of  27).  The
increase  has  been  particularly  pronounced 
exceeding 10 percentage points in RO, PL, LV, ES
and SK,  whereas  DK  and  LT have  seen  increases
of just below that amount (fully concentrated in the
crisis  years).  Conversely, reductions  of  over  10 
percentage  points  have occurred  in  IE  and  NL,  in 
both cases concentrated in the pre-crisis period.

1.3.2. Break-down of subnational

governments' revenues: tax vs. transfers 

In  terms  of  composition  of  revenues,  subnational
levels  of  government  rely  on  two main sources –
taxes (which can either be set at subnational level
or  assigned from the  central  government)  and
transfers
from  the  central  government.  Other
in
sources,  which  are  much 
quantitative  terms,  include  fees  paid  by  service

important 

less 

 
 
 
Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

Part IV

Graph IV.1.7: Sources of subnational government revenue (2010)

100%

)
0
1
0
2
(

e
u
n
e
v
e
r

t
n
e
m
n
r
e
v
o
g
l
a
n
o
i
t
a
n
b
u
s

f
o
%

90%

80%

70%

60%

50%

40%

30%

20%

10%

0%

SE DE AT LV FI ES EE SK CZ SI

IT FR DK PT LU EU27 PL LT CY BE HU IE UK RO BG NL EL MT

Taxes

Sales

Transfers

Other revenues (including property income, social contributions, other subsidies on production)

Source: Commission services.

users  and  property  income.  The  use of  borrowing
by  subnational  governments  is covered in  Section
1.5  below.  Graph  IV.1.7  above shows  the  break-
down of total revenues of subnational governments
by four main  sources;  taxes,  transfers,  sales
(essentially fees  or  charges  on  services  provided)

and  other  revenues  (including  property  income,
other subsidies etc.) in 2010.

These  figures  suggest  that  on  average subnational
governments  across  the  EU  rely slightly  more  on
transfers  than  on  taxes  as  their main  source  of

Graph IV.1.8: Decomposition of tax revenues of subnational governments (2010)

100

90

80

70

60

50

40

30

20

10

0

t
n
e
m
n
e
v
o
g
l
a
n
o
i
t
a
n
b
u
s

f
o
e
u
n
e
v
e
r
x
a
t

l
a
t
o
t

f
o
e
g
a
t
n
e
c
r
e
P

IE

EL

HU

AT

RO

PT

IT

CY

BE

BG

NL

CZ EU27 ES

FR

PL

DE

SK

SI

LT

LV

DK

LU

SE

EE

FI

UK

MT

Taxes on production and imports - Value added type taxes (VAT)

Taxes on production and imports - Taxes on products, except VAT and import taxes

Taxes on production and imports - Other taxes on production

Current taxes on income, wealth, etc - Taxes on income

Current taxes on income, wealth, etc - Other current taxes

Capital taxes

Source: Commission services.

175

 
 
 
 
 
 
 
European Commission

Public finances in EMU - 2012

financing. Taxes account for 50% or more of total 
subnational  government  revenues  in  SE,  DE,  AT 
and  LV,  and  for  between  40  and  50%  in  FI,  ES, 
EE, SK, CZ, SI and IT. At the opposite end of the 
spectrum,  subnational  governments  receive  no 
income  from  taxes  in  MT,  whereas they  receive 
less  than 10%  of  their  income  from  taxes  in  EL, 
NL and BG and between 10 and 20% in RO, UK, 
IE, HU and BE. Transfers make up more than half 
of  subnational  government 
in  14 
countries (PL, LT, CY, BE, HU, IE, UK, RO, BG, 
NL,  EL,  MT,  DK  and  IT).  Finally,  fees  and 
charges generally account  for a  much lower share 
than 
subnational 
governments  in  LU,  CY,  FI  and  EL  receiving  the 
greatest  percentage  of  their  income  from  these 
sources  amongst  EU  Member  States  at  or  over 
20%.         

transfers,  with 

taxes  and 

revenues 

to 

Graph  IV.1.8  above shows  the  break-down  of  tax 
revenues of  subnational  governments  by  type  of 
tax  (income  tax,  property  tax,  VAT  etc.)  in  2010
for  all  EU  Member  States.  It  allows  to  highlight 
cross-country  differences  with  respect 
the 
predominant  type  of  tax  which  is  assigned  to 
subnational  governments.  Taxes  on  income  and 
wealth  account  for  70%  or  more  of  total  tax 
revenues  in  13  countries,  including  some  of  the 
more decentralised such as SE, FI, DK and DE, as 
well as the UK, LU, EE, LV, LT, SK, SI, PL and 
FR.  Within  this  group  of  countries,  this  share  is 
almost  entirely  accounted  by  income  taxes  alone 
(both personal and corporate) with the exception of 
UK and FR where wealth taxes (including property 
taxes)  make  up  all  or  most  tax  revenues  of 
subnational governments. 

taxes  on  production  and 

Wealth and property taxes are an important source 
also  in  FI,  NL,  BG,  CY  and  RO.  On  the  other 
hand, 
imports  are 
predominant in 11 MS (IE, EL, HU, AT, RO, PT, 
IT,  CY,  BE,  BG  and  NL),  albeit  not  including 
VAT,  except  in  AT and  PT.  In  CZ  and  ES  the 
weight  of  production  taxes  and  of  income/wealth 
taxes  is  quantitatively  similar,  with  a  significant 
role  for  VAT.  Taxes  on  capital  are  generally  not 
assigned to subnational governments except in BG, 
ES and, to a lesser extent, BE and DE.

176

1.4. 

EXPENDITURE VS. TAX 
DECENTRALISATION, VERTICAL FISCAL 
IMBALANCES

The  literature  on  fiscal  decentralisation  highlights 
that  own-source  revenues,  i.e.  subnational  taxes, 
are a more efficient financing tool for subnational 
governments  than  transfers  from  the  centre.  The 
reason is that if the bulk of subnational expenditure 
is  financed  via  own-source  taxes,  subnational 
public  services  are  paid  by  the  community  which 
benefits  from  them  and  so  their  costs  should  be 
fully  internalised  by  subnational  policy-makers. 
Conversely  if  transfers  are  their  predominant 
source  of  revenues,  subnational  governments  are 
inclined  to  carry  out  looser  expenditure  policies 
because, firstly, the cost of subnational services is 
not  fully  internalised  since  it  is  partly  borne  by 
other  subnational  communities  via  the  national 
budget and, secondly, because they anticipate that 
any  financing  gap  will  eventually  be  covered  by 
the  central  government,  leading  to  a  'soft-budget 
constraint'  at  subnational  level  (see  Chapter  IV.3 
below).  

to 

However, it should be recalled that there are also a 
number  of  economic  arguments  militating  against 
a  full  financing  of  subnational  expenditures  via 
subnational  governments, 
taxes  assigned 
restoring  some  rationale  for  transfer  schemes,  as 
long  as  these  are  well  designed.  These  include  i) 
economies of scale and degree of complexity in tax 
collection  and  administration;  ii)  geographical 
mobility of tax bases (e.g. capital and investments) 
and  the  associated  risk  of  tax  competition  among 
subnational  governments  to  attract  them;  iii)  tax 
exportation,  i.e.  risk  that  the  subnational  tax 
burden  falls  on  non-residents  (i.e.  not  benefiting 
from subnational services financed by those taxes); 
iv)  reduced  stability  of  subnational  governments' 
revenues  against  business  cycle  fluctuations;  v) 
need to carry out redistributive policies from richer 
to  poorer  regions  and  to  ensure  similar  level  of 
services throughout the country (if all subnational 
services  were  financed  by  subnational  taxes  poor 
regions would either be disproportionately taxed or 
receive worse services).

Clearly, the  weight of these arguments, especially 
as  regards  ii),  varies  by  the  type  of  tax.  The 
normative  literature  on  fiscal  decentralisation  is 
fairly  consensual 
recommending  keeping 
personal income and corporate income taxation at 

in 

Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

Part IV

central level, while taxes on immovable bases such
as  property  tax  and  fees  on subnational  services
would  be more 
subnational
suitable 
governments.  VAT  is  often mentioned  to  be too 
complex 
subnational
governments  (Blöchliger  and  Petzold, 2009  and 
IMF, 2009).

administer 

for 

for 

to 

As mentioned  above,  existing  data  on  subnational
tax  revenues  do  not  allow  the  effective  degree  of
subnational governments'  autonomy  in  setting  tax
rates  and  bases to  be captured,  as  they generally
also  include  tax  receipts which  are  transferred
(totally  or  partly)  from the  central 
the
subnational  government, with  no  leeway  for  the
latter  to  adjust  the  main  tax  parameters.  This
means  that  a  part  of subnational  governments' tax
revenues may also be subject to the same adverse
incentive effects as grants.

to 

Bearing  in mind this  data  restriction,  an  indicator
of vertical fiscal imbalance, capturing the share of
subnational governments'  expenditure which  is
covered by  subnational taxes has  been  computed.
The assumption is that the lower the gap between
subnational taxes  and subnational  expenditures  is,
and  so  the  lower  the  reliance  on  complementary
transfers from  the  central government  to  finance
these  expenditures,  the more  efficient  is  the
relationship 
of
government  in  terms  of  the incentives  for  fiscal
discipline  and  prudent  expenditure  behaviour
(Rodden et  al., 2003 and Eyraud  and  Lusinyan,
2011).

different 

between 

levels 

This  indicator  is  presented  in  Table  IV.1.5  and
Graph  IV.1.9  below.  Table  IV.1.5  presents  the
percentage  of subnational  expenditure  covered  by
subnational taxes in 1995 and 2010 and the change
between the two years in percentage points.

The Graph plots the figures for 1995 and 2010 for
EU  Member  States 
to  ease  cross-country
comparisons.  The key finding  is  that  in  2010  tax 
decentralisation fell short of matching expenditure
decentralisation  across  the  EU.  Subnational  tax
revenues  covered more  than  half  of  subnational
expenditures in only two countries, SE and DE. In
AT,  LV,  EE,  FI  and CZ  the  percentage  ranged
between  40  and  50%,  and  in  SI,  IT,  ES,  FR,  SK,
DK, LU and PT, it ranged between 30% and 40%.

Table IV.1.5: Coverage of subnational government expenditure by

subnational tax revenues

1995

2010

AT
BE
BG
CY
CZ
DE
DK
EE
EL
ES
FI
FR
HU
IE
IT
LT
LU
LV
MT
NL
PL
PT
RO
SE
SI
SK
UK
EU27

42.2
15.1
32.4
28.6
41.2
50.9
48.6
43.6
10.0
26.9
49.8
45.5
20.6
6.3
24.0
61.4
39.0
75.6
0.0
5.2
42.7
33.3
59.5
57.5
31.2
25.0
11.0
---

48.6
19.9
8.7
22.7
40.3
51.7
34.1
46.0
7.1
37.0
45.8
36.4
18.9
13.0
38.9
28.3
30.2
47.5
0.0
8.1
26.7
30.6
11.2
62.5
39.2
37.0
12.9
28.0

Change in the coverage 
(in points of %)
6.4
4.8
-23.7
-5.8
-0.8
0.7
-14.5
2.4
-2.9
10.2
-4.0
-9.0
-1.7
6.8
14.8
-33.1
-8.8
-28.1
0.0
2.9
-16.1
-2.8
-48.3
5.0
8.0
12.0
1.8
---

Source: Commission services.

Overall,  there  is no  systematic  pattern  across the
EU  with  respect  to  the  change  in  tax  coverage  of
subnational  expenditures  between  1995  and  2010,
although  reductions  are  slightly more  numerous
and tend to be larger than increases. Tax coverage
decreased  sharply  in  RO,  LT,  LV,  BG  (by more 
than  20pp)  and  more moderately  in  PL  and  DK,
and  increased  in  ES,  IT,  SK (by more  than  10pp)
and, to a lesser extent, in AT, IE, SI and SE (by 5
to 10pp).

177

European Commission

Public finances in EMU - 2012

Graph IV.1.9: Coverage of subnational governments' expenditure by subnational tax revenues (1995 and 2010)

80

70

60

50

40

30

20

10

0

t
n
e
m
n
r
e
v
o
g
l
a
n
o
i
t
a
n
b
u
S

)

%

(

s
e
x
a
t
y
b

e
g
a
r
e
v
o
c

e
r
u
t
i
d
n
e
p
x
e

2010

1995

SE DE AT LV EE FI CZ SI

IT ES SK FR DK PT LU LT EU27 PL CY BE HU IE UK RO BG NL EL MT

Source: Commission sevices.

Table IV.1.6: Subnational government deficit vs. deficit of general government (% of GDP)

1999

2010

Change  in points of %

Local government
State government
Local government
State government

Local government
State government

Local government
State government

AT

BE

BG
CY
CZ

DE

DK
EE
EL*

ES

FI
FR
HU
IE
IT
LT
LU
LV
MT
NL
PL
PT
RO
SE
SI
SK
UK

EU27

Local government
State government

State or local
government deficit in 
% of GDP**
0.0
0.2
0.0
0.4
-0.2
-0.2
0.0
0.2
-0.5
0.4
-0.4
0.0
0.0
-0.2
-0.2
0.3
0.0
0.2
-0.6
-0.6
0.2
-0.6
0.0
0.1
-0.9
0.2
0.1
-0.3
0.1
-0.8
-0.2
0.0
-0.1

General
government deficit
in % of GDP**

-2.3

-0.6

0.1
-4.3
-3.6

-1.6

1.3
-3.5
-3.7

-1.2

1.7
-1.8
-5.5
2.7
-1.9
-2.8
3.4
-3.9
-7.7
0.4
-2.3
-2.7
-4.4
0.9
-3.0
-7.4
0.9
-1.0

State or local
government deficit
in % of GDP**
-0.4
-0.8
-0.3
-0.7
0.0
0.0
-0.5
-0.2
-0.9
-0.2
0.2
-0.2
-0.6
-3.5
-0.3
-0.1
-0.8
0.0
-0.5
0.1
0.0
-0.5
0.0
-0.8
-1.2
-0.8
-0.1
0.1
-0.4
-0.9
-0.1
-0.3
-0.5

General government
deficit in % of GDP**

State or local
government***

General
government***

-4.4

-4.1

-3.1
-5.3
-4.8

-4.3

-2.6
0.2
-10.6

-9.3

-2.5
-7.1
-4.2
-31.3
-4.6
-7.0
-1.1
-8.3
-3.6
-5.1
-7.8
-9.8
-6.9
0.2
-5.8
-7.7
-10.3
-6.5

-0.4
-1.0
-0.3
-1.1
0.2
0.2
-0.5
-0.4
-0.4
-0.6
0.6
-0.2
-0.6
-3.3
-0.1
-0.4
-0.8
-0.2
0.1
0.7
-0.2
0.1
0.0
-0.9
-0.3
-1.0
-0.2
0.4
-0.5
-0.1
0.1
-0.3
-0.4

-2.1

-3.5

-3.2
-1.0
-1.2

-2.7

-3.9
3.7
-6.9

-8.1

-4.2
-5.3
1.3
-34.0
-2.7
-4.2
-4.5
-4.4
4.1
-5.5
-5.5
-7.1
-2.5
-0.7
-2.8
-0.3
-11.2
-5.5

* 1999 value is replaced by 2000
** (-) means a net borrowing
*** (-) means a deterioration
Source: Commission services.

178

 
 
 
 
 
Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

Part IV

Graph IV.1.10: Subnational government deficits (% of GDP), 1999 vs. 2010

1

0.5

0

-0.5

-1

-1.5

-2

-2.5

-3

-3.5

-4

-4.5

P
D
G

f
o
%
n
i

s
t
i
c
i
f
e
d
d
n
a

s
e
s
u
l
p
r
u
s

t
n
e
m
n
r
e
v
o
g
l
a
n
o
i
t
a
n
b
u
S

ES

HU NL PTEU27

CZ IT LV

SK

DE BE

PL AT

FR

DK EL*

RO UK BG CY

IE LU MT

SI FI

SE EE

LT

2010

1999

* 1999 value is replaced by 2000
Source: Commission services.

1.5.  DEFICIT AND DEBT OF SUBNATIONAL 

GOVERNMENTS IN THE EU

This  Section  reviews the  data  on  the  deficits and
debt of subnational governments across the EU in 
order  to  assess their  contribution  to  the  overall
budget  balance  and  borrowing  of  the  general
government.  The  economic  rationale  for  some
degree  of  borrowing  by  subnational governments
may be implied by the need to finance investments
in  subnational  capital  endowments,  given  the
generally significant  share  of  public  capital
expenditure undertaken at subnational level across
the EU (see above). Table IV.1.6 provides data on
the 
a
percentage  of  GDP.  Figures are  decomposed for
local  and state  governments for  DE,  AT,  BE  and
ES. (145)  The  figures are  given  for 1999 which  is
the  earliest year for which  data  are  available and
2010,  and  the  percentage  point  change  between
these  two years  is  also given.  In  each  case  the
Table  also  includes  the  corresponding  figures for
the  deficit  of  the general government (146)  to

subnational  government

deficits 

as 

to 

provide a context to the contribution of subnational
general  government’s
governments 
budgetary  position.  The  subnational  government
deficits  in  1999  and  2010  for  all  EU  Member
States are also shown in Graph IV.1.10 above.  

the

generated  by 

of  which  were

In  2010  the  largest  subnational  deficit,  by far,  is
observed in ES, about 4% of GDP, 3.5 percentage 
points
state
governments.  PL, AT,  DE  and  BE  follow with  a
subnational deficit of 1% of GDP or slightly more,
with, again, a large share of this being run by state
governments,  i.e.  from twice  (AT)  to  more  than
four times (DE) that of local governments. Figures
ranging from 0.5% to 1% of GDP are observed in
SK,  HU,  NL,  PT,  CZ,  IT  and  LV.  On  the  other
hand,  a  subnational government
surplus was
observed  in SE  and  LT, whereas subnational
budgets were balanced in LU, IE, CY and BG. In
ES  half  of  the  general  government  deficit  is
generated  by  subnational governments,  followed
by DE, BE and AT where the share is around one
quarter.

(145) In  this  case  figures  for  local  and  state  governments  are 
shown  separately for  the  five  countries  for  which  this  is
possible  as  it  is  especially  relevant  to  see  which  layer  of
government  contributes  more  to  the  deficit  of  general
government in federal countries.

(146) ESA95 figures, Excessive Deficit Procedure.

to  1999, 

Compared 
the  budget  balance  of
subnational governments  is generally worse  in
2010, with the exceptions of LT, SE, BG, CY, UK,
IT and LV. The largest deterioration is observed in
ES (almost 4 percentage points of GDP), followed

179

 
 
 
European Commission

Public finances in EMU - 2012

Graph IV.1.11: Subnational government debt (% of GDP), 2007 vs. 2010

35

30

25

20

15

10

5

0

P
D
G

f
o
%

t
b
e
d

t
n
e
m
n
r
e
v
o
g
l
a
n
o
i
t
a
n
b
u
S

2010

2007

DE ES BE AT FR NL IT DK FI LV EU27 PT SE UK HU PL EE IE SK CZ RO LU CY SI

LT BG EL MT

Source: Commission services.

by AT,  BE  (1.4  percentage  points),  PT  (1
percentage point), NL (0.9 percentage points), HU
and DE (0.8 percentage points).

Graph IV.1.11 above presents data on the stock of
debt of subnational governments as a percentage of
GDP  across  the  EU. (147) As  the  break-down  of

(147) These  data  should  be  taken  with  caution  as  they  refer  to
gross debt, i.e. unconsolidated, which implies that they do
not  correct  for  possible  cross-sectoral  debt  holdings  (e.g.
state  debt held  by  central  government,  local  debt held  by
state governments etc.). This especially applies to the four
countries (DE, AT, BE and ES) for which debts of the local
and state subsectors are summed up.

debt data by sector of government is only available 
from  2007,  the  Graph shows  the  debt  levels  for
2007  and  2010. This  allows  an  assessment  of
whether the recent recession has led to significant
debt  accumulation  at  subnational  level.  In  2010,
the  largest  subnational  debt  is  observed  in DE,
about 30% of GDP, followed by ES with 15%, BE
with  12%,  and AT,  FR,  IT  and  NL with  around
the  opposite  end,  subnational  debt
8%.  At 
corresponds to below 2% of GDP in MT, EL, BG,
LT  and  SI.  Some  increase  compared  to  2007  is
generally observed, although it is sizeable only in
ES,  DE,  AT  and  LV.  It  should  be  underlined  that

Graph IV.1.12: Coverage of subnational government expenditures by transfers (1995, 2007 and 2010)

1995
2010
2007

f
o
%
n
i

t
n
e
m
n
r
e
v
o
g
l
a
n
o
i
t
a
n
b
u
s
y
b

d
e
v
i
e
c
e
r

s
r
e
f
s
n
a
r
T

e
r
u
t
i
d
n
e
p
x
e

r
i
e
h
t

100

90

80

70

60

50

40

30

20

10

0

MT RO BG UK BE NL LT IE HU DK PL CY EL EU27 LU IT EE FR SK ES SI

LV CZ PT AT DE FI SE

Source: Commission services.

180

 
 
 
 
 
 
 
Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

Part IV

the size of subnational debt is also affected by the 
economic  importance  of  the  subnational  sector, 
which  is  larger  in  more  decentralised  countries 
such as DE, ES etc.  

It  is  reasonable  to  expect  that  data  on  subnational 
deficits may underestimate the actual size of fiscal 
imbalances at subnational government level, since 
the  central  government  may  be  moved  to,  at  least 
partly,  cover  a  rising  gap  between  subnational 
expenditures  and  revenues  with  ex-post  balancing 
transfers.  This  effect  is  often  mentioned  in  the 
literature, and is linked to the fact that a large share 
of  expenditure  may  be  mandated  by  national 
legislation  so  that  subnational  policy-makers  can 
claim  to  have  limited  control  over  it.  This  then 
leads  to  heightened  pressures  on  the  central 
government to provide additional resources. 

way  across  the  EU,  although  one  or  the  other 
probably  occurred  in  different  groups  of Member 
States, during the recent crisis. The figures are also 
likely to be influenced by reforms introduced in a 
number  of  countries  to  increase  the  share  of  tax 
revenues assigned to subnational governments.

However,  further  analysis  (which  is  out  of  the 
scope  of  this  Chapter)  would  be  required  to 
disentangle the different effects as figures in Graph 
IV.1.12  do  not  control  for  a  number  of  factors, 
such  as  denominator  effects  (i.e.  changes in  the 
in 
transfers' 
subnational  expenditures,  rather  than transfers),
offsetting movements of the two above mentioned 
effects,  or  reforms  which  were  not  driven  by 
subnational  spending  pressures  or  consolidation 
needs.   

driven  by 

coverage

changes 

i.e. 

On  the  other  hand,  the  opposite  effect  may  also 
the  central 
occur  (Darby  et  al.,  2005), 
government  may  reduce  transfers  to  subnational 
governments, especially in times of crisis, in order 
to  force  them  to  cut  expenditures  and  hence 
contribute to fiscal consolidations. In order to have 
prima facie evidence on which of these two effects  
prevailed  in  the  EU  during  recent  years,  and 
the  economic  crisis,  Graph 
especially  during 
the  coverage  of 
IV.1.12  plots 
subnational  expenditures  by  transfers  from  higher 
levels  of  government  (i.e.  the  size  of  transfers  as 
percentage  of  subnational  expenditures)  in  1995, 
2007 and 2010. 

figures 

for 

that 

trend 

some 

increase 

towards  an 

No  general 
in 
subnational  governments'  reliance  on  transfers 
during the sovereign debt crisis (i.e. between 2007 
and  2010) is  found  in  the  data,  although  such  an 
increase is observed in CY, HU, FR, LT, SK and, 
to  a  lesser  extent,  LV,  IT,  EE  and  DK.  This 
suggests 
central 
governments to provide additional resources to the 
subnational  ones  may  have  occurred  in  these 
countries. The reverse has occurred in AT, EL, IE 
and  BE.  Over  the  previous  period  (i.e.  1995  to 
in  13 
transfer  dependence  decreased 
2007) 
Member  States,  and  particularly  so  in  CZ,  ES,  IT 
and  HU,  and  increased  in  10,  with  the  increase 
being most significant in RO, BG, LT, SK, AT and 
DK. 

pressure 

on 

1.6.  CONCLUSIONS 

This Chapter has  analysed  evidence  on  the  extent 
and  key  features  of  fiscal  decentralisation  in  the 
EU. It covered expenditures and revenues (both on 
aggregate and in terms of composition) as  well as 
borrowing  of  subnational  governments.  The  data 
show  that,  on  average  across  the  EU,  subnational 
fiscal 
governments  have  a 
responsibilities within general government and that 
this  share  has  been  increasing  in  most  Member 
States  during  the  1995-2010  period.  This  trend 
concerns  both  expenditures  and  revenues  and  is 
not  confined  to  countries  with  a  federal structure 
from the legal point of view.

large  share  of 

In  terms  of  revenue  composition,  subnational 
governments  still  rely  heavily  on  transfers  from 
higher  levels  of  government  in  most  Member 
States,  which  may  lead  to  adverse  incentives  in 
terms  of 
'soft-budget 
fiscal  discipline  via
constraints'.  On  the  other  hand,  the  weight  of  tax 
revenues assigned to subnational governments has 
increased  in  a  few  countries  in  recent  years.  The 
subnational  share  of  general  government  deficit 
has  generally  increased  in  recent  years,  including 
in some of the most decentralised such as ES, AT, 
DE  and  BE  although  there  is  no  one-to-one  link 
between subnational deficit and decentralisation as 
shown by the cases of DK and SE.

Overall, the evidence suggests that none of the two 
above  mentioned  effects  occurred  in  a  systematic 

In Chapter IV.2 below, aspects of decentralisation 
which  cannot  be  assessed  via  Eurostat  data  will 

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also  be  to  some  extent  covered  based on  country-
specific  analysis providing  descriptions  of  fiscal 
decentralisation arrangements across the EU. Such 
aspects mainly include the effective tax autonomy 
of  subnational  governments  (e.g.  distinguishing 
genuine  subnational  taxes  from  assignment  of 
revenues  of  national  ones),  the  type  of  transfers 
frameworks 
rules  and  budgetary 
and 
applying to subnational governments. Furthermore, 
a  more  precise  analysis  of  the  impact  of  the 
various  aspects  of  decentralisation  considered  in 
this  Chapter  as  well  as  others  (e.g.  effective  tax 
autonomy  and  fiscal  rules)  on  fiscal  outcomes  of 
the  general  government  is  carried  out  in  Chapter 
IV.3 below.

fiscal 

182

2.

NATIONAL FISCAL DECENTRALISATION ARRANGEMENTS 

- A DESCRIPTION BASED ON COUNTRY-SPECIFIC 
ANALYSIS

2.1. 

THE CONTENT OF COUNTRY-SPECIFIC 
ANALYSIS ON FISCAL DECENTRALISATION 
ARRANGEMENTS

this  Chapter  presents  more 

Following  the  description  of  the  extent  and  main 
aspects  of  fiscal  decentralisation  in  the  EU  based 
on available data in Eurostat carried out in Chapter 
in-depth 
IV.1, 
description  of  national  fiscal  decentralisation 
arrangements,  based  on  country-specific  analysis 
for  all  27  EU  Member  States.  The  Chapter 
highlights  main  commonalities  and  differences 
across  the  EU,  whereas  the  full  country-specific 
analysis  is  contained  in  country  fiches  which  are 
available in Annex 1.

Compared to information in the previous Chapter, 
those  provided  in  the  fiches  are  more  qualitative 
and institutional. Fiches have been compiled based 
on  a  common 
template  and  questionnaire; 
information  provided  can  be  distinguished  in  four 
main building blocks:

overall  institutional  description  of  the  system,  i.e. 
number  of  government  tiers,  indications  of  main 
laws  and  reforms  which  have  shaped  the  current 
system,  constitutional 
subnational 
government tiers etc.

status  of 

Areas of competence and size and composition of 
expenditures  of  subnational  governments.  This 
includes  indications  of  the  functions  which  are 
devolved  to  subnational  tiers  and,  as  far  as 
possible,  the  extent  of  subnational  autonomy  in 
setting  standards  of  services  within  the  devolved 
functions.  

revenues 

Financing  of  subnational  governments.  This 
includes  a  description  of  the  composition  of 
subnational 
sources 
(essentially  subnational  taxes),  shared  taxes  (i.e. 
national  taxes  the  receipts  of  which  are  totally  or 
partly  allocated  to  subnational  government  tiers) 
and transfers. 

across 

own 

Budgetary frameworks and fiscal rules applying to 
subnational governments.

Points 3 and 4 are those which enrich information 
provided in Chapter IV.1 to a larger extent. Point 3 
allows,  firstly,  to  distinguish  genuine  subnational 
taxes,  where  subnational  authorities  are  free  to 
change,  fully  or  partly,  tax  rates  and/or  bases, 
exemptions  etc.,  from  taxes  which  are  simply 
the  central  and  subnational 
shared  between 
government 
provides 
sector.  Secondly, 
information  on  the  allocation  formulas  of  shared 
tax  revenues  and 
the  central 
government, i.e. whether they are somehow based 
on costs of services to be provided by subnational 
governments  or  compensate  for  differences  in 
fiscal 
(horizontal 
across 
equalisation).  Thirdly,  it  distinguishes  different 
types of transfers, e.g. general or earmarked. 

transfers  from 

capacity 

them 

it 

Point  4  briefly  describes,  among  other  things,  the 
difficulties  encountered  with  ensuring 
fiscal 
discipline  at  subnational  level,  by  highlighting 
recent changes in the budgetary framework; it also 
refers to monitoring, sanctions and enforcement of 
subnational fiscal rules, the role of the ministry of 
finance or other public bodies in this area and the 
possibility  of  bailing-out  subnational  entities  in 
financial distress.

2.2.  A SUMMARY OF MAIN PATTERNS OF 

FISCAL DECENTRALISATION IN THE EU 
BASED ON COUNTRY-SPECIFIC ANALYSIS     

This  Section  summarises  the  main  patterns  of 
fiscal  decentralisation  arrangements  across  EU 
Member States based on the description contained 
in country fiches covering each Member State (see 
Annex 1). The focus is on the main commonalities 
and differences across the EU, or across groups or 
clusters of Member States as regards the four main 
elements listed above.

The  reader  should  be  aware  that  an  exhaustive 
comparison of country systems in this field would 
be an immense task, both for the sheer amount of 
information that need to be collected and analysed 
and  for  the  novelty  of  this  exercise  at  EU  level, 
and hence is beyond the scope of this Chapter. The 
focus  here  is  rather  on  providing  a  preliminary 
overview based on a first attempt to systematically 

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collect  qualitative  information  for  all  Member 
States.  A  more  established  tradition  for  reviewing 
national  systems  in  this  field  exists  at  the  OECD 
Secretariat,  which  set  up  a  Network  on  Fiscal 
Relations across Levels of Government which has 
been active already for a few years by now.

2.2.1. General considerations on the role and 

weight of subnational governments 
across the EU

governments 

recognised 
the 

the  different  status 
in 

As  it  could  be  easily  expected,  there  is  a  large 
variation  in  the  depth  and  main  features  of  fiscal 
decentralisation  across  EU  Member  States, 
to 
reflecting 
subnational 
national 
Constitutions.  A  first  demarcation  can  be  drawn 
between  federal or highly regionalised  states such 
as  DE,  AT,  ES,  BE  and  IT, on  the  one  hand,  and 
unitary  states,  on  the  other.  However,  it  is  quite 
striking to see that the constitutional definition of a 
country  as  federal  or  unitary  only  imperfectly 
reflects 
subnational 
actual  weight  of 
government tiers in the delivery of public services 
and their ability to raise revenues. 

the 

with 

autonomous 

Actually,  all  EU  Member  States,  including  the 
smallest  ones  such  as  MT,  CY  and  LU,  set  up 
(i.e. 
form  of  subnational  government 
some 
municipalities) 
and 
democratically  elected  institutions,  as  opposed  to 
decentralised 
central 
articulations 
administration.  Secondly,  several  Member  States, 
albeit  not  being  statutorily  federal,  assign  a  very 
large  role  in  terms  of  public  service  delivery  and 
revenue 
subnational 
capacity 
governments,  in  some  cases even  larger  than  in 
constitutionally  federal  countries,  see  for  instance 
Nordic  Member  States  such  as  DK,  SE  and  FI  as 
opposed to AT.

raising 

of 

to 

rather 

increasing 

Thirdly,  there  appears  to  be  a  general  trend 
towards 
than  decreasing 
decentralisation  of  state  functions  to  subnational 
authorities  and  this  move  also  concerns  countries 
with  a  strong  centralised  tradition,  such  as  FR, 
which  has  enacted  several  legislative  reforms 
between  the  1980s  (Defferre  laws)  and  the  2000s 
to  create  new  layers  of  subnational  governments 
and strengthen the existing ones, or the UK which 
has  created  devolved  authorities  in  Scotland, 
Wales  and  Northern  Ireland  and  is  currently 
discussing  an  agenda  for  'localism'  to  increase 

184

subnational authorities' leeway in taking decisions 
over their share of expenditure. 

Fourthly, across the EU it is very common to have 
more  than  one  tier  of  subnational  governments, 
with  the  exception  of  smaller  countries  such  as 
CY,  LU,  EE,  LV,  SI,  FI  and  BG,  where 
municipalities are the only subnational level. Other 
countries  have  either  two  tiers  of  subnational 
governments (148) or  three  tiers (149) (DE,  IT,  ES, 
AT, PL, FR, BE, SE and UK (150)). In a few cases 
special entities exist for capital cities ( 151) and the 
division  of  tiers  is  not  the  same  across  the  whole 
national  territory,  e.g.  in  UK  and  IE.  (152) In  BE 
the specific ethnic situation motivated the creation 
of two different types of upper subnational tier, i.e. 
regions  (Brussels,  Wallonia  and  Flanders)  and 
communities, 
three 
language  groups  existing  in  the  country  (French, 
Flemish and German-speaking).  

reflecting 

latter 

the 

the 

them 

prevents 

An  issue  mentioned  in  a  few  fiches  is  the 
excessively small scale (in terms of population) of 
municipalities  which 
from 
maximising  efficiency  in  the  provision  of  their 
services  (e.g.  HU,  FR  and  AT).  Attempts  to 
overcome  this  problem  are  made  by  gradually 
increasing  the  average  size  of  municipalities  by 
cutting  their  number  or  encouraging  mergers  (FI, 
NL)  or  by  setting-up  inter-municipal  associations 
to  jointly  provide  certain  services  (FR,  NL,  IE). 
This  suggests  that  insufficient  exploitation  of 
economies  of  scale  in  providing  public  services 
may constitute a serious challenge for setting up an 
effective decentralised system.   

2.2.2. Expenditures of subnational 

governments

As  far  as  the  government  functions  that  are 
devolved  to  subnational  tiers  are  concerned,  a 
number  of  common  patterns  can  be  highlighted. 
Services  that  are  typically  provided  on  a  smaller 

(148) I.e. municipalities and regions or counties
(149) Including  municipalities, 

provinces/counties 

and 

regions/states.

(150) Including  devolved  authorities  of  Scotland,  Wales  and 

Northern Ireland.
(151) E.g. in UK, LT, LV, EE.
(152) In  UK  'unitary  authorities' are  the  only  subnational tier  in 
certain  areas  whereas  in  others  shire  counties  exist  which 
are  further  subdivided  into  districts. Similarly,  in  IE  two 
tiers  exist in  rural  areas  (town  and  county  councils)  and 
only one in urban areas (city councils).

Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

Part IV

including 

geographical scale and need to be better tailored to 
subnational  preferences,  such  as  subnational 
infrastructures  and  utilities, 
roads, 
subnational  public  transports,  water  and  heating 
supply,  waste  management,  housing,  subnational 
economic development and territorial planning are 
generally  attributed  to  municipalities,  which  is 
consistent  with  the  normative  literature  on  fiscal 
federalism.  At  the  same  time,  in  a  majority  of 
Member States subnational governments also have 
at  least  partial  competence  over  education,  social 
protection/social 
environment 
protection.  

services 

and 

Their  involvement  over  education  may  concern, 
according  to  the  country  considered,  pre-school 
services  (i.e.  nurseries)  but  also  primary  and 
secondary  education  and  vocational  training  (DE, 
BE,  ES,  CZ,  SK,  AT,  Baltics),  whereas  higher 
level  education  (i.e.  universities)  are  normally 
excluded  from  subnational  competence  (except  in 
DE and BE). In case a two or three-tier subnational 
structure exists, responsibilities can be further split 
between  municipalities,  often  being  in  charge  of 
and 
primary 
nurseries 
provinces/counties,  managing  secondary  schools 
(e.g. SK). As regards social protection, subnational 
governments  are  often  attributed  fairly  limited 
tasks  such  as  providing  social  assistance  services 
to vulnerable people such as elderly, homeless and 
disabled (153) (e.g. IT, LT, LV and EE). However, 
in  a  few  countries  their  tasks  also  include  actual 
payment  of  welfare  benefits  to  individuals  (DK, 
FI,  SE,  LT),  which  are  in  some  other  cases 
managed  by  autonomous  social  security  agencies 
(DE, IT).

schools, 

and 

a 

As regards the management of health care systems, 
subnational  governments  have 
relatively 
important  role  in  IT (154),  AT,  ES,  PL,  DK (155), 
SE and FI,  where they are in charge of the actual 
provision  of  medical  services  within  hospitals.  In 
some 
and  EE, 
responsibilities of subnational governments in this 
area  are  more  limited  as,  although  the  latter  may 
have the ownership of hospitals, these are actually 
financed  and  run  by  specialised  agencies  (e.g.  the 
Health  Insurance  Fund  in  Estonia)  or  by  health 

e.g.  LV,  LT 

countries, 

(153) E.g. organising shelters or structures for care of the elderly.
(154) In IT health care is almost completely devolved to regions, 
and  account  for  80%  of  their  expenditure.  In  turn  regions 
account for 2/3rds of total subnational expenditure.  

(155) In DK it is the responsibility of regions.

in 

insurance  companies.  Still 
these  countries 
municipalities are responsible for organising some 
'ancillary' services, such as transport of patients to 
the  health  establishments,  and  may  be  liable  to 
cover  excess  expenditures  of  establishments  of 
their ownership.

it 

large 

to  subnational  governments 

the  attribution  of  specific 
When  discussing 
functions 
is 
important to distinguish cases where they have full 
competence,  i.e.  they  are  free  in  designing  the 
corresponding  policies  subject  to  compliance  to 
national  laws,  from  cases  where  they  are  only  in 
charge  of  implementing  national  guidelines  and 
regulations.  (156) Although  information  in  the 
fiches  on  this  aspect  is  very  limited,  the  overall 
impression is that subnational governments tend to 
enjoy 
setting  policies 
concerning  subnational  community  services  and 
utilities (e.g. road networks, subnational transports, 
waste disposal etc.). On the other hand, when they 
have  responsibilities  in  the  areas  of  health  care, 
education  and  social  protection  (e.g.  payment  of 
social transfers) they are to a large extent bound by 
national  rules  and  guidelines ( 157),  including  in 
highly  decentralised  countries  such  as, 
for 
instance, ES ( 158). In these cases national standards 
often  aim  at  ensuring  homogeneous  level  and 
quality of services throughout the country.

autonomy 

in 

In a few Eastern Member States (e.g. PL, BG, SI) 
an  explicit  distinction  is  made  between  'own' 
competences  of  subnational  governments,  where 
the  latter  retain  a  larger  degree  of  freedom  (i.e. 
economic 
recreation, 
culture 
subnational  networks  and  utilities,  nurseries),  and 
competences  'delegated'  or  'transferred'  from  the 
central  government,  on  which  the  latter  remains 
responsible  for  overall  regulation  (e.g.  social 
protection, education, health care).     

affairs, 

and 

last  observation  on 

the  expenditure  side 
A 
concerns  the  existence  of  shared  competences 
between  the  central  and  subnational  layers  of 
government.  This  is  especially  relevant  in  DE,  a 
federal  country  with  a  large  role  of  Länder and 

(156) Including  those  contained  in  ministerial  decrees,  circulars 

etc.

(157) E.g.  on  the  eligibility  to  benefits,  teachers'  qualifications, 
number  of  pupils  per  class,  minimum  services  in  health 
care etc.

(158) Exceptions  are  Nordic  countries  where  subnational 

autonomy is large even in these three domains.

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Public finances in EMU - 2012

where  most  legislation  is  passed  as  concurrent 
legislation of the federation and the Länder, except 
for social security where policies are shaped by the 
is  Länder
federation  and  education,  which 
competence,  and  AT,  where  the  competence  on 
health  care  is  essentially  split  between  the  social 
security  system,  which  regulates  the  activity  of 
family  physicians,  and  states,  which  run  hospitals 
with a large margin of autonomy. ( 159)

2.2.3. Financing of subnational governments -

own taxes, shared taxes and transfers

Moving 
to  subnational  governments'  revenue 
sources, an important distinction to be made is the 
one  between  Member  States 
to 
subnational  governments  the  possibility  to  raise 
their  own  taxes,  with  at  least  partial  freedom  to 
change key tax parameters, and those that do not. 

that  grant 

Autonomous taxes are an important revenue source 
for subnational governments in SE, FI, DE, where 
there  is  concurrent  legislative  competence  of 
Länder and  federation  on  most  tax  matters,  ES, 
BE, IT, FR (albeit more for municipalities than for 
departments  and  regions),  BG,  PL  (only  for 
municipalities),  CZ  (only  for  municipalities),  CY, 
HU,  DK  (only  for  municipalities)  and  LU. 
Conversely, own taxes of subnational governments 
have  a  low  weight  in  AT,  LT,  EE,  IE,  UK,  NL, 
RO,  SK  and  PT  and,  finally,  there  is  basically  no 
subnational tax autonomy in MT, SI, EL and LV.     

tax  which 

is  more  often  assigned 

The 
to 
subnational governments with autonomy in setting 
its  rate  and/or  base  is  the  property  or  real  estate 
tax,  which  is  levied  on  buildings  and/or  land  and 
on domestic and/or business properties.  This is the 
case  in  all  countries  except  in  MT,  EL  and  LV, 
although even in the latter two countries receipts of 
the  property  tax  are  at  least  partly  assigned  to 
subnational  governments.  This  tax  is  commonly 
assigned  to  municipalities.  In  a  few  Member 
States,  such  as  DE  or  BE,  upper  subnational  tiers 
(Länder and regions, respectively) are also entitled 
to tax properties. 

(159) In the case of AT, in particular, transferring workload from 
hospitals 
to  family  physicians,  which  would  allow 
significant  savings, has  so  far  been  hindered  by  this
division of responsibilities.

186

Subnational  governments  are  also  generally 
allowed  to  levy  taxes  on  vehicles (or  vehicle 
registration),  on  donations/inheritances,  gambling 
and  on  subnational  economic  activities  such  as 
public  markets,  although  such  sources  normally 
represent a small share of subnational revenues. In 
a  few  cases,  subnational  governments  are  also 
entitled  to  autonomously  raise  taxes  on  corporate 
income  or  subnational  business  taxes.  This  is  the 
case  in  IT  (with  the  regional  tax  on  productive 
activities,  the  IRAP)(160),  ES  (for  municipalities), 
DE,  PL,  CZ,  HU,  PT  and  LU.  Finally,  the  tax  on 
personal  income  largely  remains  a  national  tax 
(albeit  quite  often  its  revenues  are  shared  with 
subnational  governments,  see  below)  across  the 
EU with only some exceptions, i.e. DE, ES, SE, FI 
and DK. The VAT remains everywhere a national 
tax,  except  for  a  regional  sur-tax  in  BE  (see 
below). 

In some cases, subnational tax autonomy is granted 
via  the  possibility  to  raise  surtaxes  on  national 
taxes. Regional and municipal surtaxes on personal 
income exist in IT and BE (with leeway to change 
the  rate  within  a  band  in  IT);  BE  also  allows  a 
regional  surtax  on  VAT  and  municipal  and 
provincial  surtaxes  on  the  regional  real  estate  tax. 
A  municipal  surtax  on  corporate  income  exists  in 
DE  and  a  provincial  surtax  on  car  registration  in 
NL. 

Therefore,  the  conclusion  can  be  drawn  that 
despite large historical and institutional differences 
across  the  EU,  general  patterns  in  the  assignment 
of  own  tax  powers  to  subnational  governments 
exist  and  they  are  by  and  large  consistent  with 
recommendations from normative fiscal federalism
literature.  This  especially  concerns  the  use  of  real 
estate  tax  as  a  subnational  own  revenue  source 
almost  everywhere  in  Europe,  as  real  estates  and 
properties  constitute  an  a-cyclical  and  immobile 
tax base and hence are not associated with risk of 
tax  competition  among  subnational  governments 
and of large volatility of tax receipts (see Chapter 
IV.1). However, as shown by IMF staff estimates, 
the revenue potential of property taxes is not fully 
( 161) 
in  most  advanced  economies. 
reaped 

(160) Italian regions have the power to increase or reduce by 1 pp 

the basic IRAP rate (see fiche of Italy in Annex 1). 

(161) According  to  IMF  staff  estimates,  taking  as  a  benchmark 
the  average  revenues  ratios  of  the  best  performers  among 
high income countries, the revenue potential from property 
taxes  is  about  2.5-3%  of  GDP,  with  most  advanced 

Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

Part IV

Similarly,  the  prevalent  assignment  of  personal 
income tax and of VAT to the central government 
is  in  line  with  economic  arguments  related  to 
cyclical  volatility  of  revenues  from  those  taxes, 
redistributive  objectives  of  tax  policy,  tax  spill-
overs 
and 
subnational 
administrative  complexity  which  all  contribute  to 
make  these  revenue  sources  less  suitable  for 
subnational governments.

boundaries

beyond 

to 

taxes 

Additionally,  it  is  important  to  underline  that 
assignment  of  own 
subnational 
governments  does  not  imply  that  the  latter  are 
responsible  for  collecting  revenues  from  those 
taxes. Tax collection  mostly remains a task of the 
central  government,  which  eventually  transfers  to 
tax 
subnational  governments 
revenue they are entitled to based on residence of 
tax-payers or other criteria (see below).  

the  amount  of 

taxes,  EU 

subnational 
Besides  autonomous 
governments  and  especially  municipalities  also 
collect  other  types  of  own  revenues,  such  as  user 
charges/fees on services. ( 162) These account for a 
normally  minor  share  of  subnational  revenues, 
with  some  exceptions  such  as  FI and IE  (see  also 
Chapter  IV.1).  From  the  reading  of  fiches  it 
appears that it is sometimes difficult to draw a line 
between fees and autonomous taxes. A reasonable 
criterion  should  be  that  fees,  unlike  taxes,  are 
prices  to  be  paid  in  return  to  specific  services. 
Further  own  revenues  sources  are  those  from 
subnational properties.   

The  second  category  of  subnational  revenues  is 
shared  taxes.  In  order  to  avoid  confusion  with 
autonomous  taxes,  in  this  exercise  shared  taxes 
only  include  receipts  of  national  taxes  which  are 
fully or partly assigned by the central government 
to subnational governments, with the latter having 
no  autonomy  in  setting  tax  parameters.  This 
implies  that  cases  where  central  and  subnational 
governments  share  receipts  from  a 
tax  but 
subnational governments also have, at least partly, 
the  power  to  set  its  rate  or  base,  falls  within  the 

economies  being  largely  below  this  level,  as  average 
property tax receipts amount to less than 1% of GDP across 
OECD countries.  

(162) E.g.  water  supply,  sewerage,  heating  supply,  issuance  of 
for  certain  professions/economic  activities, 

permits 
construction activities or use of land

category  of  autonomous  taxes.  This  is  to  a  large 
extent the case of DE and ES. (163)

for 

source 

revenue 

With  this  definition  in  mind, tax  sharing  is  an 
important 
subnational 
governments in BE (for the upper tier, i.e. regions 
and communities), AT, LV, LT, EE, RO, PL, CZ, 
SK, EL, HU, PT, SI and LU. On the other hand tax 
sharing  without  subnational  autonomy  in  setting 
tax parameters has a relatively small weight in DE, 
ES (164)
in  both 
(except  for  municipalities 
countries)(165), IT, DK, FI, IE, UK, FR, whereas it 
is basically absent in MT, CY, SE, NL and BG. In 
several  cases,  the  sharing  of  personal  income  tax 
receipts plays a significant role, i.e. in BE, LV, LT, 
EE, RO, PL, SK, EL, HU, PT, SI. Sharing of VAT 
is  important  in  BE,  ES,  IT,  CZ,  EL,  PT  and  LU, 
whereas corporate income tax is shared in DK, FI, 
AT, PL and PT. Property taxes (on either buildings 
or land) are shared in UK (on business properties), 
EE,  LT,  LV  and  EL.  Other  shared  taxes  are  the 
vehicle  tax  (IE,  LU),  inheritance  tax  (LT),  a 
gambling  tax  and  natural  resource  tax  (LV)  and 
excise on alcohol-tobacco (ES, LU), electricity tax 
(ES). In AT the proportions in which tax revenues 
are shared between central government, states and 
municipalities  are  set  every  six  years  through 
negotiations between the three government tiers.

are 

from 

transfers 

The  third  and  last  main  category  of  subnational 
central 
revenues 
the 
government.  They  can be  divided 
two 
categories,  (i)  general  transfers,  i.e.  those  which 
finance 
expenditures  without 
obligation as regards the specific function/ item for 
which 
transfers 
earmarked to finance a specific function or item of 
subnational expenditures.

to  be  used;  (ii) 

subnational 

they  have 

in 

(163) In  DE  and  ES  tax  sharing and  subnational tax  autonomy 
largely  go  together.  In  DE  tax  matters  mostly  fall  within 
concurrent legislation of the Federation and the Länder and 
at the same time the main taxes (income tax, corporate tax 
and  VAT)  are  shared  between  the  two  tiers  in  similar 
proportions. In ES personal income tax rates are composed 
of  two  parts,  one  set  by  the  central  government  and  the 
other  set  by  autonomous  communities.  The  same  applies 
for allowances and exemptions.

(164) See footnote 162. 
(165) In  ES  municipalities  that are  capitals  of  provinces  or 
communities get a share of personal income tax, VAT and 
alcohol-tobacco  excise. A  small  part  of  personal  income 
tax  and  VAT  is  allocated  by  Länder to municipalities  in 
DE,  whereas  the  latter  can  autonomously  raise  a  local 
business tax (Gewerbesteuer).

187

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Public finances in EMU - 2012

General  and  earmarked  transfers,  taken  together, 
are  the  main  revenue  source  for  subnational 
governments (accounting for half of their revenues 
or  more  according  to  the  fiches)  in  MT,  UK,  IE, 
NL,  BG,  IT,  DK,  BE (for  municipalities  and 
provinces),  LT,  CZ  (for  regions),  PL.  They  are 
quantitatively  important,  albeit  to  a  lower  extent, 
also  in  CY,  SK,  RO,  AT  (for  states,  less  for 
municipalities), LV, EE, FR, PT, HU, LU and CZ 
(for  municipalities).  The  incidence  of  transfers 
compared to own taxes and shared taxes is instead 
quite  low  in  ES,  DE,  BE  (for  regions  and 
communities),  AT  (for  municipalities),  SE,  FI,  SI 
and EL.

Normally, general and earmarked transfers coexist. 
This  is  the  case  in  BE,  SE,  DK,  FI,  EE,  IE,  UK,
NL,  MT,  CY,  BG,  FR (166),  PL,  CZ  and  HU 
although  the  distinction  between  the  two  types  is 
not always straightforward based on information in 
the  fiches.  In  some  cases  all  transfers  are  by  and 
large  earmarked  (RO,  LU,  PT,  SK  and  LV).  In 
several  Member  States earmarked  transfers  are 
devoted 
capital/infrastructure 
expenditure (167) (LU,  SI,  HU,  CY,  PL,  BG,  FR, 
UK, IE, EE, LV, DE for municipalities), education 
(LV, IE, UK, PL, CZ, SK, PT, LU for nurseries) or 
social  expenditures  (PT,  CZ,  NL,  UK).  In a  few 
new Member States, own revenues mainly finance 
autonomous 
functions  whereas 
transfers are used to fund state-delegated functions
(168) (CZ, BG, LT, SK). 

subnational 

subnational 

to 

frequently 

transfers  are  allocated 

Quite 
to 
subnational  governments  based  on  equalisation 
criteria, i.e. aiming at ensuring uniform levels and 
quality  of  services  across  different  subnational 
entities  within  the  country.  This  is  normally  done 
in  two  ways:  (i)  via  transfers  from  central  to 
subnational  governments  providing  the  latter with 
sufficient  resources  to  fulfil  their  expenditure 
obligations  (vertical  equalisation)  and  (ii)  via 
transfers 
governments 
compensating  for  differences  in  revenue-raising 

subnational 

between 

(166) Transfers  are  divided  between  current  and  capital 
expenditures,  the  former  category  being  admittedly  very
broad to qualify as earmarked transfer.

(167) The  latter  mainly  including  improvement  of  networks  and 
infrastructures  linked  to  government  functions  carried  out 
by  subnational governments,  e.g.  roads,  school  buildings 
etc.

(168) Albeit  with  some  subnational co-financing  with  own 

resources.

188

capacity and cost of service provision across them
(horizontal equalisation).   

to 

based 

formulas 

normally 

Equalising  transfers  exist  in  DE,  ES,  SE,  LV,  FI, 
LT, EE, IE, UK, NL, RO, BG, PL, SI, PT, FR and 
HU.  The  amounts  assigned 
the  different 
subnational  governments  are  set  via  specific 
on 
allocation 
demographic  variables  (mainly  population  size
(169) and  age  structure)  and  economic  variables 
(e.g. unemployment rate), which allow to compute 
expenditure  needs 
the  various  subnational 
entities,  as  well  as  on  measures  of  tax  capacity. 
The  formula  can  be  more  or 
less  complex 
depending  on 
the  Member  State;  additional 
allocation  criteria  used  are  number  of  properties, 
the  subnational  entity, 
geographical  size  of 
remoteness of local areas, length of roads network 
etc.  In  DE ( 170) and  ES ( 171) the  equalisation 
system is articulated in different steps.

in 

However,  the  equalisation  formula  can  be  applied 
not  only  to  the  allocation  of  transfers,  but  also  to 
that  of  shared  tax  revenues  (these  cases  were 
included  in  the  list  of  countries  in  the  previous 
paragraph),  making  the  distinction  between these 
two  categories  of  revenues  not  always  clear  cut. 
This is the case for the allocation of VAT revenues 
in  DE,  of  the  personal  income  tax  in  SI  and  HU, 
and of a joint pool of taxes, which are put together 

(169) E.g. size of transfers being determined as a lump sum per 

inhabitant.

(170) DE  operates a  strong  system  of  fiscal  equalisation  among 
the  Länder aimed  at  ensuring  equivalent  living  standards 
across  them.  This  is  essentially  achieved  by  a  complex 
system  of  VAT  receipts  redistribution  in  three  steps,  (i) 
vertical  redistribution  (from  centre  to  Länder)  of  part  of 
VAT  to  Länder with  below-average  tax  revenues,  (ii) 
horizontal transfers from Länder with above average fiscal 
capacity  to  those  with  below-average  fiscal  capacity,  (iii) 
supplementary federal transfers to Länder with lower fiscal 
capacity.  This  system  allows  to  largely  compress  cross-
Länder differences  in  per  capita  revenues.  Municipalities 
also receive vertical (from their Land) and horizontal (from 
richer  municipalities)  transfers  to  minimise  differences 
between their fiscal capacity and their expenditure needs.
(171) ES also has an elaborate system of transfers with multiple 
steps to ensure uniform access to social services across all 
Comunidades.  Firstly,  all  Autonomous  Communities
contribute 75%  of  their  tax  revenues  to  a  Guarantee  Fund 
which  is  then  redistributed  among  them  based  on  their 
funding  needs  for  'essential  public  services'.  Secondly, 
the  central 
supplementary 
government  to  those Autonomous  Communities with 
residual  financing  needs  through the  Global Sufficiency 
Fund  and  through other  funds  aimed  to  further  reduce 
differences in financing capacities.  

transfers  are  provided  by 

Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

Part IV

in  subnational  funds  and  then  redistributed  to 
subnational governments, in ES, PT, EL and LU. 

transfers 

Allocation of transfers based on expenditure needs 
and  independent  of  the  quality  and  efficiency  of 
service provided tend to discourage the adoption of 
cost-saving  or  efficiency  enhancing  measures  by 
subnational governments. Although this problem is 
pointed  out  in  several  fiches,  no  Member  State, 
except  DK  (see  2.2.4 below),  appears  to  have 
introduced  mechanisms  to  correct  this  feature. 
However, this may be partly explained by the fact 
should  be 
that  performance-based 
conditional  on  outputs,  i.e.  on  the  quantity  and 
quality of public goods and services delivered and 
on access to them, rather than on outcomes, i.e. the 
short and long-run consequences of public service 
provision for consumers and taxpayers ( 172), as the 
latter can be affected by factors beyond the control 
of subnational authorities. Therefore, performance-
based  transfers  may  be  difficult  to  design  as  the 
distinction between outputs and outcomes is often 
not  clear  cut  (Shah,  2007).  This  being  said,  it 
should  be  pointed  out  that  formulas  based  on 
"presumed"  costs,  measured  by  demographic  or 
socio-economic 
be 
preferable  in  terms  of  incentives  than  systems 
which  simply  cover  the  amount  of  expenditures 
claimed  by  subnational  governments.  This  is 
illustrated  by  recent  experience  in  IT (173),  which 
plans to move from historical to 'standard' costs of 
services  as  main  criterion 
subnational 
financing,  and  NL,  where  reimbursement  of 
subnational claims for social expenditures has been 
replaced  by  assignment  of  fixed  (formula-based) 
amounts of resources.   

indicators,  would 

still 

for 

Another  problematic  feature  of  a  transfer-based 
system  is  the  tendency  to  largely  reduce  the 
amount  of  transfers  to  subnational  governments 
times  while  keeping 
during 
'bad'  economic 
services 
to  provide 
subnational  obligations 

(172) E.g.  in  the  case  of  education,  literacy  rates  and  supply  of 

skilled professionals.

(173) In  IT a far reaching reform to deepen the system of fiscal 
decentralisation  is  currently  being  implemented (starting
from 2009), implying major changes also for the financing 
of  subnational governments:  (i)  introducing  the  'standard 
cost'  principle,  rather  than  the  'historical  cost'  one  to 
determine 
that 
subnational entities  providing  services  at  higher  costs  will 
have  to  raise  additional  resources  to  cover  them;  and  (ii) 
the introduction of equalisation transfers across subnational
governments  to  compensate  for  differences  in  fiscal 
capacities.

expenditure  needs, 

subnational

so 

'extraordinary' 

unchanged. This may force the central government 
to  eventually  provide 
transfers 
aimed at covering widening subnational deficits or 
cope  with  special  economic  difficulties,  hence 
further  discouraging  subnational  governments  to 
behave  in  a  fiscally  responsible  way  (by,  for 
instance,  raising  own  taxes  to  cover  the  gap 
created by reduced  transfers).  

2.2.4. Fiscal rules, budgetary arrangements 

and bail-out possibilities of subnational 
governments

The  remaining  part  of  this  Section  summarises 
main  facts  with  respect  to  fiscal  rules  applying  to 
subnational  governments across  the  EU,  their 
monitoring  and  enforcement,  the  supervisory  role 
of  the  central  government,  the  possibility  for 
subnational governments to borrow, the procedures 
to  be  followed  in  case  a  subnational  government 
the  budgetary 
falls 
coordination  across  different  tiers  of  government. 
A  number  of  conclusions  can  be  drawn  after 
looking  at  information  in  country  fiches  on  all 
these aspects.

financial  distress, 

in 

is 

rule 

the  golden 

Fiscal  rules  apply  to  subnational  governments  in 
most  EU  Member  States.  The  most  widespread 
rule,  whereby 
type  of 
subnational  governments  are  entitled  to  borrow 
exclusively to finance investments, although it is in 
some cases extended to cover borrowing linked to 
repayment 
revenue  shortfalls  and 
temporary 
obligations of existing debt. Another type which is 
quite  recurrent 
limit,  often 
formulated  as  a  threshold  on  the  amount  of 
liabilities  which  can  be  assumed  by  a  subnational 
government  in  a  year  or  as  a  threshold  on  annual 
debt  service  obligations,  both  generally  expressed 
as percentage of subnational revenues.

is  a  borrowing 

Limits  to  the  total  stock  of  subnational  debt  are 
less common, although in some cases borrowing is 
allowed  only  if  the  accumulated  debt  is  below  a 
specified  threshold.  Surprisingly,  statutory  limits 
on  subnational  expenditures  are  mostly  non-
existent across the EU. However lack of control of 
growth  of  subnational  expenditures  is  in  some 
cases,  e.g.  ES,  pointed  out  as  adversely  affecting 
targets  of  general 
the  achievement  of  fiscal 
government,  calling  for  the  introduction  of  such 
ceilings.  In  DK  binding  expenditure  limits  for 
subnational  governments  were  introduced  in  2011 

189

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Public finances in EMU - 2012

after  a  long  trend  of  increase  in  subnational 
expenditures.

As  opposed  to  statutory  thresholds  on  fiscal 
aggregates,  across  the  EU  it  is  quite  common  to 
have  some  form  of  budgetary  coordination  across 
different  government 
tiers.  This  essentially 
consists  in  annual  negotiations  and  adoption  of 
targets  for the budget balance and, in some cases, 
expenditures and revenues of both the central and 
subnational  government  tiers.  These  are  more 
common  in  more  fiscally  decentralised  countries. 
They  are  in  some  cases  called  Internal  Stability 
Pacts (IT, AT) and in general imply monitoring of 
compliance  to  targets  by  the  central  government 
(typically the ministry of finance) and can imply a 
range of sanctions for non-compliance. 

The  existence  of  a  system  of  internal  budgetary 
coordination  appears  to  positively  contribute  to 
fiscal  discipline  at  general  government  level;  in 
some cases (PT, HU) it is precisely the insufficient 
coordination/exchange of information across levels 
of  government  which  seems  to  be  one  of  the 
causes of  fiscal slippages at  subnational levels. In 
the  case  of  PT,  this  occurred  via  a  systematic 
overestimation  of 
subnational 
governments. However, internal stability pacts are 
not a panacea, as their effectiveness depends on a 
number of implementation details, such as the time 
horizon  for  fulfilment  of  fiscal  targets  (if  multi-
annual, deficit in one year can be offset by surplus 
in  another  year),  automaticity  of  sanctions, 
variability  and  degree  of  ambition  of  targets  and 
their  scope  of  application  (the  whole  subnational 
sector vs. individual subnational entities, the latter 
clearly being stricter).

revenues  by 

As for monitoring and sanctions in case of breach 
of fiscal rules or negotiated targets by subnational 
governments,  across  the  EU  these  alternatively 
include the prohibition to issue new debt, the need 
to  ask  authorisation  for  it,  the  need  to  introduce 
corrective  measures  within  specified  timeframes 
under  enhanced  supervision  of  the  ministry  of 
finance,  cuts  in  revenue  allocation  from  transfers 
or shared taxes. The most elaborate example of the 
latter is provided by DK, which has recently made 
its  block  grant  to  subnational  governments partly 
conditional to fulfilment of expenditure targets and 
no increase of own taxes by municipalities.

190

to  borrow 

In any case, it is interesting to observe that there is 
no  generalised  prohibition 
for 
subnational  governments,  although  this  is  often 
restricted  to  investment  financing  (see  above).  In 
spite  of  this  fact  subnational  debt  levels have 
remained  fairly  low  across  the  EU  with  some 
exceptions (e.g. PT, NL and DK). However, ability 
to  borrow  by  subnational  governments  is  in  some 
cases restricted to loans from commercial banks or, 
in  the  extreme,  only  from  the  state  treasury, 
issuing  bonds  in  capital  markets  is 
whereas 
prohibited. 
subnational 
governments  can  issue  bonds  or  obtain  loans 
exclusively through a special public body, e.g. the 
municipal  finance  corporation  in  FI,  which  is 
backed  by  joint  guarantee  from  all  municipalities 
in the country.

cases, 

some 

In 

by 

the 

there 

surveillance 

If  subnational  governments  experience  serious 
financial problems, in several cases they fall under 
central 
strengthened 
government  and  they  have  to  negotiate  with  the 
latter,  sometimes  via  special  joint  committees  or 
boards,  a  stabilisation  plan 
to  restore  fiscal 
sustainability.  In  other  cases  they  are  put  under 
forced  administration  by  the  central  government. 
Generally 
is  no  formal  procedure  for 
insolvency or default of  subnational  governments. 
The overall impression is that, despite the frequent 
lack of formal guarantee by the central government 
on subnational financial obligations, a subnational 
default is de facto ruled out across the EU and the 
to 
central  government  eventually 
provide 
'exceptional'  transfers  to  bail-out  the 
subnational  entity  in  financial  distress.  The  latter 
can  in  fact  threaten  to  drastically  cut  service 
provision or argue that its spending obligations are 
mandated by national legislations and hence oblige 
the  central  government  to  cover  its  debt.  In  the 
extreme, this may occur as a result of legal actions 
in  the  constitutional  court  (as  was  the  case  for 
some  Länder in  DE,  see  also  Von  Hagen  et  al., 
2000).   

intervenes 

In some cases, the application of subnational fiscal 
rules  has  been  circumvented  by  the  practice  of 
subnational governments to delegate the provision 
of  some  services  to  external  enterprises  of  which 
they  hold  the  ownership,  totally  or  partially,  as 
such  enterprises  are  often  out  of  the  scope  of 
application  of  those  rules  implying  that  their 
liabilities  were  not  counted  within  the  amount  of 
debt  or  borrowing  of  subnational  governments.  

Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

Part IV

not 

governments  (i.e.  federal  vs.  unitary  countries) 
does 
actual 
necessarily  match 
fiscal/budgetary  weight  of  subnational  tiers,  the 
systematic  attribution  of  certain  revenue  sources 
(e.g. property taxes) to subnational entities.

the 

This Section also highlighted that the existence of 
subnational  tiers  with  at  least  some  expenditure 
and  revenue  autonomy  does  create  a  number  of 
challenges for overall efficiency of public services 
and  fiscal  discipline  at  the  general  government 
level.  Divergences  of  spending  and  financing 
responsibilities, allocation of revenues often based 
on  'presumed'  costs  of  services  without  rewarding 
efficiency  gains,  lack  of  or  badly  designed  fiscal 
budgetary 
of 
government,  de  facto impossibility  to  allow  a 
default of a subnational entity which behaved in a 
fiscally  irresponsible  way,  insufficient  scale  of 
subnational  entities  to  efficiently  run  services,  are 
features  which  may  weaken  subnational 
all 
incentives  to  run  services  in  a  cost-effective 
manner  and  to  positively  contribute  to  achieve 
national budgetary targets.

coordination 

sectors 

across 

Finally, subnational governments are often subject 
to  fiscal  rules,  especially  golden  rules  (borrowing 
allowed  to  finance  investments)  and  borrowing 
limits,  which  again  underline  a  general  need  to 
constrain subnational fiscal behaviour, and are also 
generally  put  under  some  form  of  monitoring  by 
the central  government (especially the  ministry of 
finance),  which  is  often  substantially  tightened  in 
case  they  fall  in  fiscal  distress  or  deviate  from 
agreed 
the  central 
government.

targets  negotiated  with 

level 

Another common way to circumvent fiscal rules at 
subnational 
running  arrears  on 
payments to suppliers, taking advantage of the fact 
that  subnational  fiscal  accounts  are  often  set  in 
cash terms.   

is  by 

In several cases complex budgetary procedures are 
foreseen  for  subnational  governments  (apart  from 
coordination with the national budget as mentioned 
above), detailing all the steps for drafting, adoption 
and  monitoring  of  subnational  budgets,  typically 
including an important role of  subnational elected 
assemblies,  the  obligation  to  communicate  the 
adopted  budget 
the  ministry  of  finance, 
attribution  of  tasks  of  monitoring  execution  and 
carrying out ex-post checks to external bodies (174)
or  auditors.  A  problem  with  such  bodies  may  be 
their lack of full political independence as they are 
sometimes  appointed  by  subnational  policy-
makers.     

to 

2.3.  CONCLUSIONS

This  Chapter  has  summarised  main  patterns  of 
fiscal decentralisation arrangements across the EU 
based on individual country fiches compiled for all 
27  Member  States.  It  showed  that  cross-country 
data available in Eurostat and described in Chapter 
IV.1,  albeit  rich,  fail  to  capture  all  aspects  and 
details  of  different  national  systems,  and  that 
country  descriptions  provide  a  useful  set  of 
complementary information.

National systems across the EU show a significant 
degree  of  heterogeneity  reflecting  historical  and 
institutional  specificities.  However  a  number  of 
largely  common  patterns  emerge,  such  as  a  rising 
importance of subnational levels of government as 
providers  of  services,  including  the  attribution  of 
responsibilities  in  important  functions  such  as 
education, social protection and health care, albeit 
mostly with the task of delivering the services with  
regulation being largely left with the national level, 
the varying degree of availability of own resources 
(i.e.  taxes  set  autonomously)  or  shared  taxes 
compared  to  transfers  across  the  EU,  the  fact  that 
subnational 
the 

constitutional 

status 

of 

(174) E.g.  the  stability  council  (for  Länder)  and  supervisory 
agencies  (for  municipalities)  in DE.  These  bodies  also 
formulate budgetary  forecasts  at  the  beginning  of  the 
budgetary process.

191

3.

FISCAL DECENTRALISATION AND FISCAL OUTCOMES

3.1. 

INTRODUCTION

on 

the 

different 

indicators 

level  and 

In  this  Chapter  the  relationship  between  fiscal 
decentralisation  at  national 
fiscal 
outcomes  of  the  general  government,  is  analysed, 
based 
of 
decentralisation,  which  were  presented  and 
described in Chapter IV.1. The purpose is to assess 
whether  devolving  expenditure  functions  and 
revenue sources to subnational entities,  which  has 
generally  occurred  across  the  EU  over  past  years 
as  shown  in  Chapters  IV.1  and  IV.2,  may  have 
adverse consequences on overall fiscal balances of 
the general government due to a loss of control of 
the  central  government  on  subnational  fiscal 
behaviour and lower incentives for fiscal discipline 
at subnational level. This concern is very relevant 
and increasingly raised by EU policy-makers given 
that  fiscal  policy  governance  at  the  EU  level  and, 
with the recently adopted Fiscal Compact (see Part
II),  at  the  national  level,  is  based  on  general 
government definitions.

The  fiscal  outcomes  considered  are  the  budget 
balance  and  expenditures  and  revenues,  taken 
separately.  The  analysis  is  done  in  two  steps. 
Firstly,  correlations  between  decentralisation  and 
fiscal  outcomes  are  presented and  analysed  in 
order 
the 
budgetary  impact  of  decentralisation.  Secondly, 
of 
the 
is  also 
decentralisation  and 
estimated via regression analysis.

between 
fiscal  outcomes 

face evidence  on 

to  have  prima 

relationship 

indicators 

3.2. 

FISCAL DECENTRALISATION AND FISCAL 
OUTCOMES: THEORETICAL 
CONSIDERATIONS 

Theoretical priors can be highlighted as regards the 
sign of the effect of different dimensions of fiscal 
decentralisation  on  the  main  fiscal  aggregates  of 
the  general  government,  according  to  the  fiscal 
federalism  literature  (see  among  others  Oates, 
1999  and  2006;  Blöchliger  and  Petzold,  2009; 
Blöchliger  and  King,  2006;  Blöchliger  and 
Rabesona,  2009;  IMF,  2009;  Neyapti,  2010;  De 
Mello,  2007;  Darby  et  al.,  2002).  However,  in 
most cases the net impact is a priori ambiguous as 
a result of conflicting arguments.

192

Decentralization of expenditures 

The  decentralisation  of  expenditures  could  have 
either  positive  or  negative  effects  on  the  fiscal 
balance.  The  government  balance  is  expected  to 
improve via lower expenditures due to:

A more efficient expenditure allocation as 
(1)
public good provision by subnational governments 
is  better 
to  subnational  needs  and 
preferences.

tailored 

across 

Competition 

(2)
subnational 
governments  with  respect  to  the  technology  and 
methods  of  production  of  public  goods,  which 
encourages them to select and adopt the more cost-
effective ones.

(3)
of  public  expenditures 
subnational communities.

Failure  to  internalise  positive  spill-overs 
to  citizens  of  other 

On the other hand, there are arguments pointing to 
an increase in expenditures due to decentralisation 
of  expenditures  with  adverse  implications  for  the 
primary balance, i.e.:

(1)
Decentralisation  may 
exploitation  of  economies  of  scale 
production of public goods.

prevent 

in 

the 
the 

entails 
of 

Decentralisation 

unnecessary 
(2)
administrative 
multiplication/overlapping 
procedures,  especially  due  to  shared  competences 
across  different  territorial  levels  of  administration 
over  the  same  government  function  and  unclear 
division of responsibilities among them.

Lower 

(3)
subnational 
productivity 
administration  compared  to  the  national  one,  due 
to greater capability of the latter to attract a  more 
skilled labour force.

of 

(4)
Greater  proximity  of  subnational  policy-
makers to subnational interest groups, which make 
the  former  more  sensitive  than  national  policy-
makers  to  lobbying  for  increased  expenditures 
from the latter.

Overall,  the  prediction  of  economic  theory  is  that 
the  impact  on  expenditures  and  the  primary 
balance is  a  priori  ambiguous.  Moreover,  a 

Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

Part IV

significant  share  of  subnational  governments' 
expenditures  is  likely  to  be  mandated  by  national 
directives  and  legislation,  leaving  only  limited 
room  for  subnational  governments  to  affect  their 
overall  size  and  evolution.  If  that  is  the  case, 
expenditure  decentralisation  taken  at  face  value 
would not tell much on the effective devolution of 
spending  powers  to  subnational  governments,  and 
could  then  have  no  real  impact  on  the  magnitude 
of expenditures. (175) 

Decentralization of revenues 

Decentralisation of revenue sources can also affect 
fiscal balances. The literature generally underlines 
that if subnational governments can finance a large 
part  of  their  expenditures  with  their  own  revenue 
sources  (taxes  and  fees) 
they  have  stronger 
incentives to behave in a fiscally responsible way, 
with  positive  effects  on  the  fiscal  balance  of  the 
general government. The following arguments can 
explain this effect: 

(1) Subnational governments are more accountable 
to subnational voters on the way they manage their 
resources  as  the  link  between  public  services 
provided  at  subnational  level  and  the  taxes  raised 
to finance them is stronger.

(2) The central  government can  more easily resist 
pressures  of  subnational  governments  to  cover  an 
excess  in  their  expenditures  as  the  latter  have 
sufficient  revenue  autonomy  to  deal  with  their 
expenditure obligations on their own.

(3)  Subnational  policy-makers  have  a  stronger 
incentive to provide high quality public services in 
order  to  contribute  to  greater  economic  growth  in 
their  community,  as  they  would  get  the  resulting 
dividend  in  the  form  of  higher  tax  receipts, 
although  the  strength  of  this  argument  varies 
to 
type  of 
to 
according 
subnational authorities. ( 176)

tax  devolved 

the 

On  the  other  hand,  if  subnational  governments 
the  central 
transfers 
largely 
government to finance their expenditures, they can 

rely  on 

from 

(175) On  the  other  hand,  evidence  from  country  fiches  suggests 
that  subnational  governments  are  often  assigned  also 
increasing 
devolved 
expenditures (see Chapter IV.2.)  

decision-making 

powers 

on 

(176) It  is  likely  to  be  weaker  for  property  taxes  than  for  local 

income or business taxes.

easily justify large unfunded expenditures with the 
lack of own revenue sources and threaten to scale 
down  public  service  provision,  which  is often 
legislation,  eventually 
mandated  by  national 
forcing the central government to intervene to bail 
them  out.  This 
subnational 
implies 
governments  face  a  'soft-budget  constraint',  with 
adverse  effects  on  the  general  government  fiscal 
balance. (177)

that 

Moreover,  in  presence  of  equalising  transfers,  i.e. 
transfers  which  are  allocated  in  such  a  way  as  to 
fill  the  gap  between  expenditure  needs  and  own 
revenues  of  subnational  entities  and  hence  imply 
some degree of redistribution from the richer to the 
poorer of them, subnational governments may fail 
to  internalise  the  cost  of  financing  additional 
expenditures,  thereby  contributing  to  expenditure 
and deficit bias.  

Finally the composition of subnational expenditure 
by  government  function  and  economic  function, 
normally a neglected aspect in the fiscal federalism 
literature,  may  also  weigh  on  the  impact  of 
decentralisation  on  fiscal  outcomes.  A  higher 
relative  weight  of  subnational  governments  in 
expenditure  items  more  affected  by  demographic 
and  political  pressures,  such  as  health  care  and 
social  protection,  may  have  an  adverse  effect  on 
fiscal  balances,  since  subnational  governments 
may have lower incentives or ability to counteract 
such  pressures.  (178) The  same  reasoning  can  by 
to  cases of  strong 
and 
decentralisation  of  expenditures  on  compensation 
of  employees  and  social  benefits.  This  effect  can 
be  tested  by  using  figures  on  the  breakdown  of 
expenditure  decentralisation  by  functions  (such  as 
health,  education  etc.)  or  economic  category, 
which were also discussed in Chapter IV.1.    

large  be  extended 

larger  weight  of 

transfers  may  give 

(177) However, a counter-argument is proposed in some papers.  
A 
the  central 
government a stronger lever to control the fiscal behaviour 
of  subnational  governments and,  hence,  reduce  the  risk  of 
subnational  fiscal  slippages.  This  effect  should  be
especially  relevant 
to  subnational
if  most 
transfers 
to  specific  expenditures, 
governments  are  earmarked 
leaving little leeway to subnational governments to decide 
upon their use. 

(178) For  instance,  subnational  administrations  may  lack  the 
technical  expertise  to  anticipate  the  future  evolution  of 
health  expenditure  or  may  have  less  political  will  to  curb 
health  expenditure  because  they  would  assume  that  the 
central  government  would  eventually  intervene  to  provide 
additional  funding  for  such  a  politically  and  socially 
sensitive expenditure item.

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Overall,  although  a  number  of 
theoretical 
predictions can be drawn from the literature about 
the  impact  of  fiscal  decentralisation  on  fiscal 
outcomes  of  the  general  government,  they  are 
often conflicting as regards its sign, implying that 
this is ultimately an empirical question. Therefore, 
the remainder of this Chapter turns to the empirical 
analysis  of  these  issues.  In  Section  3.3 stylized 
facts  will  be  presented.  Then,  in  Section  3.4  the 
main  hypotheses  derived 
theoretical 
predictions  are  reformulated  and  qualified  based 
on the  stylised  facts (Subsection 3.4.1 below) and 
then tested through regression analysis. 

from 

The  effect of  fiscal  decentralisation can  be  tested 
by  using  the  indicators  which  were  introduced  in 
Chapter  IV.1  to  describe  the  extent  and  main 
characteristics  of  fiscal  decentralisation  across  the 
EU. These indicators are:

i)  expenditure  decentralisation,  defined  as  the 
percentage
governments' 
expenditures  in  total  expenditures  of  the  general 
government;

subnational 

of 

ii)  own  revenue  decentralisation,  defined  as the 
percentage of  subnational  taxes  and  fees  (i.e. 
subnational  own  revenues)  in  general  government 
revenues;

iii) 
the 
revenue  decentralisation,  defined  as 
percentage  of  subnational  revenues  (including 
transfers)  in  general  government  revenues (this 
indicator will be used exclusively in the Section on 
stylised  facts  and  not  in  the  one  on  econometric 
analysis);

iv)  the  percentage of  tax  revenues  in  subnational
revenues;

v)  the  percentage  of transfers  from  the  central 
government in subnational revenues;

vi)  subnational  expenditure  coverage  by  own 
revenues, defined as the percentage of subnational 
expenditures  covered  by  subnational  taxes  and 
fees. (179)

(179) The  latter  measures  the  decentralisation  of  revenues 
relative  to  expenditures.  The  complement  to  one  of  this 
indicator,  i.e.  the  share  of  subnational  expenditure  not 
covered  by  own  subnational  revenues  is  generally  called 
'vertical fiscal imbalance' (Eyraud and Lusinyan, 2011 and 

194

vii) transfer dependency, defined as the percentage 
of subnational expenditures covered by transfers.

3.3. 

STYLISED FACTS ON DECENTRALISATION 
AND FISCAL OUTCOMES

3.3.1. Pair-wise correlations between fiscal 

decentralisation and fiscal outcomes          

This  Subsection  presents  evidence  on  pair-wise 
correlations  between  fiscal  decentralisation  and 
general  government  fiscal  outcomes  in  order  to 
identify  a  few  stylised  facts before  moving to 
econometric  analysis of  the  fiscal  impact  of 
decentralisation  in  Section  3.4  below.  The  data 
sample  used  consists  of  annual  data  covering  all 
EU27  Member  States  in  the  period  1995-2010. 
(180) 

indicators 

The  first  exercise  consists  of  a  comparison  of 
average  values  of  main  fiscal  outcomes,  across 
high  and  low  decentralisation  subsamples  of  the 
data.  To  do  this,  the  data  are  divided  into  two 
the  different 
subsamples,  with  values  of 
decentralisation 
lower  and  higher, 
respectively,  than  their  overall  sample  average. 
(181) The exercise is undertaken for four indicators 
in  Section  3.2 
of  decentralisation  mentioned 
above:  expenditure  decentralisation,  own  revenue 
decentralisation, subnational  expenditure coverage 
by own revenues, share of transfers in subnational 
revenues.  The  comparison  is  carried  out  for  the 
following  fiscal  variables:  primary  balance (182), 
cyclically-adjusted  primary  balance,  primary 
expenditures  and  total  revenues  of  the  general 
government,  in  order  to  assess  the  correlation  of 
decentralisation  with  both  the  net  fiscal  balance 

It 

of 

and 

own 

it  captures 
revenues 

the  gap  between 
Karpowicz,  2012),  as 
expenditures 
subnational 
governments which must be covered either by transfers or 
subnational  borrowing. 
the  above 
considerations that a lower vertical fiscal imbalance should 
'harder  budget  constraint'  for  subnational 
lead 
governments, with positive effects on fiscal balances.
(180) This is the longest time period with available data by sector 
of  government  in  Eurostat,  except  for  the  breakdown  by 
functions (cofog) which is shorter, see below.

follows 

to  a 

from 

(181) For  instance,  in  the  case  of  the  indicator  of  overall 
expenditure decentralisation, the sample is divided between 
observations  where  the  value  of  this  indicator  is  below  or 
above its sample average.

(182) ESA95 figures, Excessive Deficit Procedure. 

Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

Part IV

Table IV.3.1:

Fiscal outcomes of general government (% of GDP), averages for observations with low and high values of different indicators
of fiscal decentralisation (EU27 Member States, 1995-2010 period)

Expenditure decentralisation

Subnational expenditure coverage by own revenues

Own revenue decentralisation

Share of transfers in subnational revenues

Low

High

Low

High

Low

High

Low

High

pb

-0.8

1.3

-0.2

0.6

0.0

0.7

0.5

-0.1

capb

-0.9

1.2

-0.2

0.4

-0.3

0.7

0.4

-0.2

exp

35.6

39.8

36.0

38.9

35.9

40.2

38.8

36.0

rev

39.1

44.5

39.6

43.3

39.8

44.7

43.2

39.6

Notes: pb = primary balance of general government, capb = cyclically adjusted primary balance of general government, exp = primary expenditure of
general government (% of GDP), rev = total revenues of general government (% of GDP).
Source: Commission services.

and  the  spending  and  revenue  side,  separately.
Results are shown in Table IV.3.1.

averages  over  the  same  period  of  the  primary
balance, expenditures and revenues. (185)

The following patterns emerge:

i) High  expenditure  decentralisation  goes  together
with  a higher primary  balance  on  average,  higher
(primary)  expenditure  and higher  revenues  of
general  government.  (183)  The  same  occurs with
own revenue decentralisation.

ii) High subnational expenditure coverage by own
revenues  is  associated  to  higher  primary  balance,
higher 
revenues
although  the  difference  is  smaller than  between
low and high decentralisation of expenditures.

expenditures  and 

(primary)

iii) Conversely,  a  higher share  of  transfers (or  a
in  subnational
lower  share  of  own  revenues)
revenues  is  associated  to  lower  primary  balance,
lower  primary  expenditure and  lower  revenues. 
(184) 

These  main messages  are  by and  large  confirmed
country 
by  computing  correlations  between
averages
the
decentralisation  indicators  considered  and  country 

the  1995-2010  period  of 

for 

(183) +2.1pp  of  GDP  for  the  primary  balance,  +4pp  for

(184) Looking  at

expenditures and +5½pp of GDP for revenues.

the  link  between  decentralisation  and  the
magnitude  of subnational government  expenditure  (not
shown),  data  show  that  the  latter  is  significantly  larger
when decentralisation of either expenditures or revenues is
higher  than average. Less  obviously,  it  is around  2pp 
higher  on  average  when  subnational expenditure  coverage
by own revenues is higher and transfer dependency lower.

However,  comparisons  of  fiscal  outcomes  across
low  and  high  levels  of  a  single  decentralisation
indicator  do  not  control  for  the fact  that  different
aspects  of  decentralisation may go  together.  It  is
quite  likely,  for  instance,  that  decentralisation  of
expenditures goes together with decentralisation of
own revenues and larger subnational responsibility 
their  own
their  expenditures with 
to  cover 
resources. Therefore, it is possible that the positive
effect  of  expenditure  decentralisation  on 
the
primary  balance  is  in fact  due  to  the  greater
subnational  financial  autonomy  and  responsibility 
which may  often
it.  Controlling
simultaneously  for  the  fiscal  impact  of  different
decentralisation  variables  requires  econometric
analysis, which is carried out in Section 3.4 below;
however  two  simpler  exercises  can  already  shed
some light on these issues:

go with 

Looking  at 

the  relationship  between 
(1)
different aspects of decentralisation to test whether
expenditure 
be
accompanied  by greater  subnational  responsibility 
on  the  revenue  side  and  a  lower  reliance  on

decentralisation 

tends 

to 

and  own 

(185) The figures are not shown. Specifically, across the EU the 
average  of  both 
revenue
expenditure
decentralisation is positively  correlated  with  the  average
primary  balance, cyclically  adjusted  primary  balance, 
primary  expenditures and  revenues  in  the  1995–2010 
period. The correlation coefficients are always in the range
of  0.5-0.6.  The  average  rate  of  coverage  of subnational
expenditures  by subnational own revenues is  positively
correlated  with  primary  expenditures  and 
revenues, 
whereas both  expenditures  and  revenues  are  negatively
correlated with subnational dependency on transfers. As for
the mix of revenue sources of subnational governments, the
average  share  of  taxes  in  total  subnational revenues  is
positively correlated with expenditures and revenues.

195

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Public finances in EMU - 2012

transfers and to assess how the different aspects of
revenue  decentralisation
far
(revenue  decentralisation,  share  of  taxes,  share  of
transfers and subnational expenditure coverage by 
own  revenues)  tend  to  be  combined with  each
other.

considered 

so 

Computing  averages  of fiscal  outcomes
(2)
for  low vs. high  expenditure  decentralisation
controlling  for  high  vs.  low  levels  of  the  other
indicators of decentralisation.

Both exercises are carried out in the remainder of
this Section.

The upper part of Table IV.3.2 below compares the
average  values  of  the  indicators  capturing  the
different  aspects  of  revenue  decentralisation  for
low vs. high  decentralisation  of  expenditures,
whereas  the  bottom  part  compares  the  average
in  subnational
shares of 
revenues and  the  average level  of  subnational
financial  responsibility  (i.e.  coverage  of
their
spending with  own  revenues) for  low vs.  high 
revenue decentralisation. (186) 

taxes and transfers 

shows 

The Table
higher  expenditure
that
decentralisation  is  on  average  associated with
higher  revenue  decentralisation,  both  including 
(first  column)  and  excluding  (second column)
transfers,  higher  rate  of  coverage  of subnational
expenditure  by  own  revenues,  as well  as  a  higher
share  of  taxes  and  a  (marginally) lower  share  of
transfers 
revenues.  Moreover, 
revenue  decentralisation  is  accompanied  by a 
higher share of taxes and a lower share of transfers
in  subnational revenues,  as well  as  by  higher

in  subnational

(186) I.e.  the  share  of  all  revenues  of  subnational  governments, 
including transfers from the central government, in general
government  revenues (see  above).  This  indicator  differs
from  own  revenue  decentralisation  by  the inclusion  of
transfers.

subnational
revenues.

expenditure  coverage with  own

These findings are by and large confirmed by pair-
wise  correlations  between  the  mean values  of
decentralisation indicators by country in the 1995-
2010 period. (187)

it 

to 

that 

cover 

appears

responsibility 

Overall, 
expenditure
decentralisation, own revenue decentralisation and
subnational
their
expenditures with their tax revenues and fees tend
to  go  hand-in-hand  across  the  EU.  Moreover,  in
countries where  total  revenue  decentralisation  is
high,  taxes  tend  to  be  more  important  than 
transfers  as  subnational revenue  source.  These
findings  imply  that  simple  relationships  between
individual  aspects  of  decentralisation  and fiscal
outcomes  should  be  interpreted with  caution,
without inferring too easily causal effects and that
it  is  important  to  look  at  the  effects  of  different
decentralisation  aspects  simultaneously. A  first
attempt  to  do  this  is  done with  the  exercise
mentioned  in  point  (2)  and  discussed  below,
whereas  an  econometric  analysis  is  carried  out  in
Section 3.4.

Table  IV.3.3  below  compares  the  average  values
of  primary  balance,  expenditures  and  revenues
across  the  two sub-samples with  low  and  high 
expenditure decentralisation, conditional on low or
level of  own  revenue  decentralisation,
high 
own 
subnational 

coverage  by

expenditure 

(187) These  are  not 

shown.  The  correlations

between 
decentralisation  of  expenditures,  on  the  one  hand,  and
decentralisation of own revenues (taxes and fees), share of
taxes  in  subnational  revenues  and  subnational  expenditure
coverage with  own  resources  are  all  positive  and 
significant.  Also, 
decentralisation
(including transfers) is positively correlated with the share
of  taxes  in subnational  revenues  and  negatively  correlated
with the share of transfers, although it is significant only in
the first case.

revenue 

overall 

Table IV.3.2: Conditional means of selected indicators of fiscal decentralisation for high vs. low expenditure and revenue decentralisation

Expenditure 
decentralisation

Revenue 
decentralisation

Own revenue 
decentralisation

% of transfers in 
subnational revenues

Subnational expenditure 
coverage by own resources

% of taxes in subnational  
revenues

Low

High

0.17

0.37

0.08

0.18

0.53

0.5

0.45

0.49

0.32

0.39

Revenue decentralisation 
(transfers included)

Low

High

Source: Commission sources.

% of transfers in 
subnational revenues

Subnational expenditure 
coverage by own resources

% of taxes in subnational  
revenues

0.53

0.51

0.46

0.49

0.32

0.38

196

Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

Part IV

Table IV.3.3: Conditional means of fiscal outcomes of general government (% of GDP) for low vs. high expenditure decentralisation,
controlling for low vs. high values of other decentralisation indicators (by column) - EU-27 Member States, 1995-2010

Expenditure 
decentralisation

Own Revenue decentralisation

Own Revenue decentralisation

Own Revenue decentralisation

Low

-0.62

1.67

Primary balance

High

-2.42

1.20

Low

High

Primary  expenditure

35.55

37.11

35.63

40.96

Total revenues

Low

39.13

41.73

High

38.50

45.77

Subnational expenditure coverage by own 
resources

Subnational expenditure coverage by own 
resources

Subnational expenditure coverage by own 
resources

Low

-1.23

0.93

Primary balance

High

-0.52

1.65

Low

High

Primary  expenditure

34.61

37.52

36.30

41.39

Total revenues

Low

37.70

41.74

High

40.10

46.53

Transfers (% subnational revenues)

Transfers (% subnational revenues)

Transfers (% subnational revenues)

Low

-0.57

1.62

Primary balance

High

-1.20

0.97

Low

High

Primary  expenditure

36.30

41.38

34.54

37.52

Total revenues

Low

40.10

46.50

High

37.60

41.77

Taxes (% subnational revenues)

Taxes (% subnational revenues)

Taxes (% subnational revenues)

Low

-1.01

1.12

Primary balance

High

-0.58

1.48

Low

High

Primary  expenditure

35.08

37.47

36.26

41.07

Total revenues

Low

38.39

41.77

High

40.00

46.08

Low

High

Low

High

Low

High

Low

High

Notes: the Table should be read in the following way, taking the example of the first four figures in the top-left corner (primary balance): the sample is
broken down between observations with lower and higher than average expenditure decentralisation. Each of these subsamples is then broken down 
across cases with lower and higher than average own revenue decentralisation, so that the relationship between own revenue decentralisation and the
primary balance can be (partly) isolated from the relationship between expenditure decentralisation and the primary balance
Source: Commission services.

resources  and  shares  of  taxes  and  transfers  in 
subnational revenues.

Compared to Table IV.3.1, this exercise allows to
relationship  between
the 
better  disentangle 
expenditure  decentralisation  and  fiscal  outturns
from the  one  between  the  different  aspects  of
revenue decentralisation and fiscal outturns. 

As  regards  the primary  balance,  the following
patterns emerge:

expenditure 

low  own-revenue  decentralisation, 

Restricting  the  analysis  to observations
(i)
low
with 
subnational 
coverage  by  own
resources,  low  share  of  taxes  and  low share  of
transfers  in  subnational  revenues, moving  from 
low 
is
to  high  expenditure  decentralisation 
associated to an increase in primary balance.

of

For 

high 

levels 

expenditure
(ii)
decentralisation,  moving  from low  to  high own
revenue decentralisation is associated to a decrease 
of  primary  balance,  contrary  to  findings  in  Table 
IV.3.1. 

For 

(iii)
expenditure
decentralisation, moving from low to high share of

levels 

high 

of 

transfers in subnational revenues is associated to a 
decrease in primary balance, whereas moving from
low to high  subnational expenditure coverage and
from low  to high  share  of taxes  in subnational
revenues goes  together with  an  increase  of  the
primary balance.

As regards expenditures and revenues:

For 

low 

levels  of  own 

(i)
revenue
decentralisation, subnational expenditure coverage
and  share  of  taxes  and  transfers  in subnational
revenues,  moving  from  low  to  high  expenditure
decentralisation 
to  both  higher
is  associated 
expenditures and revenues.

of

the 

level 

Once 

expenditure 
(ii)
decentralisation is  high  moving  from low  to  high
own  revenue  decentralisation,  from  low  to  high
subnational
coverage  by  own
resources  and from  low  to  high  share  of  taxes  in 
subnational revenues  is  associated with  a (quite
sizeable) increase in expenditures and revenues.

expenditure 

Once 

(iii)
expenditure 
decentralisation is  high,  moving  from low  to  high
weight  of  transfers  in  subnational revenues  is

level 

the 

of

197

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Public finances in EMU - 2012

associated  with  a  decrease  in  expenditures  and 
revenues. 

3.3.2. Conclusions on stylised facts on the link 

between fiscal decentralisation and 
fiscal outcomes

Overall, preliminary evidence based on comparing 
average fiscal outcomes in the EU for low vs. high 
fiscal  decentralisation, 
the 
expenditure and revenue side of the latter, suggests 
that:

looking  at  both 

is  strengthened 

(1)
Decentralising  expenditures  does  not 
appear  to  increase  government  deficit.  On  the 
contrary,  it  is  associated  with  improved  primary 
if 
balance.  This  relationship 
accompanied  by  a  large  rate  of  coverage  of 
subnational expenditures  by  own  resources  (i.e. 
taxes  and  fees)  and  a  high  weight  of  taxes  in 
subnational  revenues.  Conversely  this  relationship 
the  central 
is  attenuated 
transfers 
government  account 
large  share  of 
subnational revenues.

for  a 

from 

if 

(2)
Expenditure  decentralisation  appears  to 
go together with higher expenditures and revenues 
and  this  link  is  strengthened  if  accompanied  by a 
large  coverage  of  subnational  expenditure  with 
own resources, large  share of taxes in subnational 
revenues, whereas it is weakened in case of a large 
share of transfers in subnational revenues.

These  facts  appear  to  confirm  the  argument  that 
subnational governments  do  not  fully  exploit 
economies  of  scale  in  public  goods  provision  and 
tend to generate inefficiencies via overlapping and 
duplications  of  administrative  procedures,  leading 
to  higher  expenditures 
in  more  decentralised 
countries. However expenditure decentralisation is 
also  associated  with  higher  government  revenues
the 
to  more 
and 
relationship  with  expenditures,  resulting  in  a  net 
positive  link  between  expenditure  decentralisation 
and the primary balance. 

this  appears 

than  offset 

All  these  relationships  seem  to  be  strengthened  if 
expenditure  decentralisation  is  accompanied  by 
larger 
responsibility  of  subnational 
governments (188)  and  a  larger  share  of  taxes  in 

financial 

(188) They cover a large part of their expenditures with their tax 

revenues and fees.

198

their revenues whereas they are partly counteracted 
if transfers account for a large share of subnational 
revenues.  This  appears  to  confirm  the  prediction 
that  if  subnational  governments  have  to  finance 
most  of  their  spending  with  their  own  taxes  and 
fees and these make up most of their revenues they 
tend 
their 
expenditure  needs,  whereas  a  large  reliance  on 
transfers  creates  a  soft-budget  constraint  on 
subnational  governments,  reducing  the  positive 
effect  of  expenditure  decentralisation  on 
the 
primary balance.           

to  raise  more  revenues 

to  cover 

3.3.3. Stylised facts on decentralisation of 

individual expenditure functions and 
fiscal outcomes

in 

decentralisation 

This  Subsection  complements  the  discussion  in 
Subsections  3.3.1  and  3.3.2  above,  by  presenting 
the  main  stylised  facts  on  the  link  between 
individual 
expenditure 
government functions (i.e. education, public order, 
health  care  etc.,  see  Chapter  IV.1)  and  fiscal 
outcomes  based  on  comparison  of  conditional 
means as done in Subsection 3.3.1. Essentially, the 
goal is to assess whether the main messages on the 
relationship  between  decentralisation  and  fiscal 
outcomes  are  enriched  by  looking  also  at  the 
break-down  of  decentralisation  by  functions.  For 
simplicity,  no  charts  or  tables  are  shown  in  this 
Subsection  and  only  the  main  findings  are  briefly 
presented and discussed.

that 

suggests 

(1)
Looking  at  the  relationship  between  the 
total expenditure in each function and its degree of 
is  no 
decentralisation 
systematic 
two 
relationship  between 
variables,  except  for  social  expenditure  and,  to  a 
lesser  extent,  health care. Social  and  health  care
expenditures  are on  average  around 4pp  of  GDP
and 1pp of GDP higher, respectively, in countries 
where such functions are highly decentralised.       

these 

there 

Looking  at 

the  relationship  between 
(2)
decentralisation  by  function  and 
the  primary 
balance of the general government conditional on a 
high level of total expenditure decentralisation (in 
the  effect  of  overall 
order 
decentralisation) 
decentralising
general services and education is associated with a 
lower
higher 
decentralisation  of  health, economic  affairs and 

balance,  whereas 

for 
suggests 

to  control 

primary 

that

Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

Part IV

social  protection goes  together  with  a  higher
primary balance.

in 

(2) 

suggests 

Repeating 

that  overall 

the  exercise 

for 
(3)
expenditures  and  revenues  (instead  of  the  fiscal 
balance) 
expenditure 
decentralisation  is  no  longer  associated  to  higher 
total  expenditures  if  education,  social  protection 
and  health  remain  centralised,  whereas 
is 
associated  to  substantially  higher  expenditures  if 
these  three  functions  are  decentralised.  Similarly, 
expenditure
longer 
associated  to  larger  total  revenues  when  social 
protection and education are relatively centralised.

decentralisation 

no 

is 

it 

The  same  caveat  as  for  evidence  presented  in 
Subsection  3.3.1  also  applies  to  stylised  facts  on 
the 
relationship  between  decentralisation  by 
function  and  fiscal  outcomes,  i.e.  no  conclusions 
on  causal  effects  should  be  drawn  from  them  as 
their robustness should be tested with econometric 
analysis.  In  any  case  the  above  stylised  facts 
total 
suggest 
fiscal 
decentralisation  of  expenditure  and  of 
its 
composition  by  function  should  be  tested  at  the 
same time.  The next Section turns to econometric 
analysis  of  the  effect  of  fiscal  decentralisation  on 
fiscal outcomes. 

impact  of 

that 

the 

3.4. 

REGRESSION ANALYSIS OF THE IMPACT 
OF DECENTRALISATION ON FISCAL 
BALANCE

3.4.1. Model specification and main 

hypotheses

This Section  presents  an  econometric  analysis  of 
the impact of fiscal decentralisation on the primary 
balance  of  general  government  and  on  primary 
expenditures  and  revenues,  taken  separately.  The 
model  used  is  the  fiscal  reaction  function  – an 
equation which tests the impact of the outstanding 
government debt ratio on the primary balance after 
controlling  for  a  number  of  macroeconomic  and 
institutional  variables.  The  basic  underlying 
that  governments  are  fiscally 
assumption 
responsible  and  hence 
increasing 
(decreasing) 
levels  of  accumulated  debt  by 
increasing  (decreasing)  the  primary  balance.  This 
methodology  has  become  quite  widespread  in  the 
empirical  literature  on  fiscal  policy  (see  Bohn, 
1998  and  European  Commission,  2011a)  and  has 

react 

to 

is 

recently 

also  been  used 
the 
budgetary impact of fiscal decentralisation (Eyraud 
and  Lusinyan,  2011  and  Escolano  et  al.,  2012). 
(189) 

investigate 

to 

indicators 

Therefore,  this  Section  presents  and  discusses 
estimates  of  fiscal  reaction  functions  for  the  EU 
the 
fiscal 
enriched  with 
of 
decentralisation 
discussed.  The 
previously 
dependent variable of the model is alternatively the 
primary  balance,  primary  expenditures  and  total 
revenues of the general government.  As discussed 
in Section 3.2 above,  it  is  difficult  to  formulate 
clear cut predictions on the impact of the different 
aspects  of 
fiscal 
outcomes  as 
theoretical  arguments  are  often 
conflicting.  However,  the  literature  presented  in 
Section 3.2 above and  the stylised  facts discussed 
in Section 3.3 suggest a list of main hypotheses to 
be tested with regression analysis. 

fiscal  decentralisation  on 

duplication 

(1)
Expenditure  decentralisation  may  lead  to 
larger  primary  expenditures  due to  a  number  of 
reasons  such  as  less  exploitation  of  economies  of 
of 
scale, 
administrative  procedures,  lower  productivity  of 
subnational administrations as they are less able to 
attract  more  skilled  civil  servants  and  greater 
to 
proximity  of 
subnational interest groups. 

subnational  policy-makers 

overlapping 

and 

of 

net 

that 

The 

(2)
expenditure 
effect 
decentralisation  on  the  primary  balance  should 
depend  on  how  the  former  is  combined  with 
revenue decentralisation. Essentially, stylised facts 
suggest 
if  decentralised  expenditures  go 
together  with  large  financial  responsibility  of 
subnational  governments  to  cover  them  with  their 
own  resources  (i.e.  taxes  and  fees assigned  to 
subnational  governments)  and  taxes  account  for  a 
large  share  of  subnational revenues  compared  to 
transfers, there should be no adverse effect on the 
primary  balance  (or  possibly  even  a  positive  one) 
as  subnational  governments  are  encouraged  to 
raise  more 
larger 
expenditure responsibilities. On the other hand, the 
combination  of  high  expenditure  decentralisation 
with a strong reliance on transfers from the central 
government  would  be  more  harmful  for  fiscal 
balances as subnational governments would face a 

to  cover 

revenues 

their 

(189) Both these papers use decentralisation indicators similar to 

those considered here.

199

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Public finances in EMU - 2012

soft  budget  constraint  and  are  likely  to  be  less 
concerned about balancing their expenditures with 
their revenues. (190)

The 

total 

effect 

(3)
expenditure 
of 
decentralisation  on  fiscal  outcomes  may  differ 
according to the specific expenditure item which is 
decentralised.  Decentralisation  of  health-care, 
social protection,  education  or  general  services 
may  be  particularly  likely  to  lead  to  larger 
expenditures and/or a worse fiscal balance.   

Finally,  a  greater  share  of  subnational 
(4)
expenditures  covered  by  subnational  own  taxes 
and  fees  (low  vertical  fiscal  imbalance)  implies 
greater financial responsibility at subnational level 
as  the  central  government  can  more  easily  resist 
pressures  to  'bail-out'  subnational entities  if  the 
latter are endowed with sufficient own resources to 
finance their expenditures. In these situations there 
should  be  a  positive  effect  on  the  fiscal  balance, 
reflecting  a  positive  effect  on  revenues  and  a 
negative 
expenditures.  However, 
descriptive  evidence  discussed  in  Section  3.3
suggests a positive effect on both expenditures and
revenues  which  needs 
through 
econometric analysis.  

effect  on 

to  be 

tested 

As for own revenue decentralisation – the 
(5)
share of subnational own revenues (taxes and fees, 
as  transfers  are  excluded  from  own  subnational 
revenues) in general government revenues – theory 
does not provide clear predictions on its impact on 
fiscal  balances.  On  the  one  hand,  a  high  value  on 
this  variable  means  that  subnational  governments 
have more own resources to cover a given amount 
of  expenditures,  leading  to  better  fiscal  balances. 

(190) As explained in Chapter IV.1, figures on the shares of taxes 
in  subnational  revenues  do  not  distinguish  autonomous 
taxes, i.e. on which subnational governments are allowed to 
change  main  tax  parameters,  from  the  assignment  of 
revenues  from  national  taxes  to  subnational  governments. 
This  may  prevent  to  fully  capture  the  'true'  degree  of 
subnational financial autonomy. Hence, a robustness check 
for  the  hypothesis  (2)  above,  is  carried  out  estimating  the 
effect  of  an  indicator  of  'true'  subnational  tax  autonomy 
compiled by the OECD Secretariat. The indicator measures
the share of subnational tax revenues on which subnational
governments  can  change  the  rate  and/or  base.  However, 
this  exercise  implies  a  substantial  reduction  of  available 
observations  as  non-OECD EU  Member  States  are  not 
included.  Moreover,  this  indicator  has  not  been  computed 
with annual frequency and is available only for 1995, 2002, 
2005  and  2008,  implying  that  the  assumption  of  constant 
tax autonomy had to be made for missing years in order to
compute regressions.

200

On the other hand, this variable tells us nothing on 
the  relative  size  of  subnational  own  revenues 
compared to their expenditures which is probably 
a  better  way  to  capture  subnational  incentives  to 
behave in a financially responsible way. Moreover, 
the impact  of  own  revenue  decentralisation  may 
also differ based on whether it goes together with a 
high or low share of transfers/taxes in subnational 
revenues, similarly  to  the  case  of  expenditure 
decentralisation discussed above.

3.4.2. Regression results on the effect of 

decentralisation on the primary balance

(apart 

variables 

independent 

The  first  set  of  estimates  test  the  impact  of 
decentralisation  on 
the  general  government 
primary balance (as a share of GDP). The number 
of 
from 
decentralisation)  is  limited  in  order  to  keep  the 
specification  of  the  model  parsimonious,  and 
includes  (i)  the  lagged  debt-to-GDP  ratio,  (ii)  the 
lagged  output  gap  to  control  for  the  budgetary 
effect  of  cyclical  fluctuations,  (iii)  the  occurrence 
of  legislative  election  in  the  year.  ( 191)  Further 
control variables are included in the regressions for 
expenditures and revenues (see below). 

to 

test 

3.4.1 

above): 

Then,  the  different  decentralisation  indicators  are 
the  above  hypotheses  (see 
included 
Subsection 
expenditure 
decentralisation (192), own revenue decentralisation
(193), the share of taxes and transfers in subnational
revenues and the share of subnational expenditure 
that
is  covered  by  subnational own  revenues. 
Moreover,  as  the  above  hypotheses  (points  2  and 
5)  also  concern  the  impact  of  combinations  of 
different aspects of decentralisation, the following 
interactive terms (i.e. the product of two variables) 
are also included in the regressions: 

(i)
share of transfers in subnational revenues;

Expenditure  decentralisation  and 

the 

Expenditure  decentralisation  and 

(ii)
share of taxes in subnational revenues;

the 

(191) This  is  systematically  found  to  have  good  explanatory 
power  of  the  developments  of  fiscal  balances (see  among 
others  Mendoza  and  Ostry  (2008)  and  Gali  and  Perotti 
(2003).

(192) Percentage  of  subnational government  expenditures  in 

general government expenditures.

(193) Percentage of subnational government own revenues (taxes 

and fees) in general government revenues. 

Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

Part IV

Own  revenue  decentralisation  and  the 

(iii)
share of transfers in subnational revenues;

taxes  and  fees  in  subnational  governments  and  a 
small  share  of 
the  central 
transfers 
government.

from 

(iv)
share of taxes in subnational revenues.

Own  revenue  decentralisation  and  the 

As in Section 3.3 above, the sample includes all 27 
EU  Member  States  and  covers  the  1995–2010 
period.  As  the  model  specification  considered 
includes  lagged  dependent  variable  among  the 
explanatory  variables (194)  estimations  are  carried 
out  with  the  Least  Squares  Dummy  Variables 
Bias-Corrected  estimator  (LSDVC,  Bruno,  2005), 
which  corrects  for  the  bias  of  Fixed  Effect 
estimators  in  dynamic  panel  data  models,  i.e. 
panels  which 
lagged  dependent 
variable.

include 

the 

significant 

statistically 

Results  of  estimates  for  the  primary  balance  are 
shown  in  Table  IV.3.4.  The  lagged  debt  has  an 
positive 
expected 
coefficient  in  all  specifications  of  the  model, 
suggesting  the  existence  of  a  debt-sustainability 
motive in the setting of fiscal policies, whereas the 
lagged  output  gap has  a  negative  and  mostly 
significant  coefficient  suggesting  some  degree  of 
pro-cyclicality of fiscal policy across the EU. The 
occurrence  of  elections  has,  as  expected,  a 
negative impact on the primary balance, albeit not 
always significant. 

for 

the 

As 
indicators  of  decentralisation, 
expenditure  decentralisation  has  a  positive  and 
statistically  significant  effect  on 
the  primary 
balance, whereas own revenue decentralisation has 
a  negative  and  significant  effect. Subnational
expenditure coverage has a positive and significant 
effect on the primary balance, which is in line with 
expectations.

Expenditure  decentralisation  interacted  with  the 
share  of  transfers  in  subnational  revenues  has  a 
negative effect on the primary balance (columns 2, 
10,  12  and  13)  whereas  it  has  a  (further)  positive 
effect  if  interacted  with  the  share  of  taxes  in 
subnational  revenues  (column  3).  This  confirms 
the  expectation  that  expenditure  decentralisation 
has  a  more  favourable  impact  on  the  primary 
balance  if  accompanied  by  a  large  share  of  own 

(194) This is the case, for instance, for the primary balance as it 
is  commonly  found  to  exhibit  a  high  degree  of  time 
persistence

of 

term 

taxes 

interactive 

own 
the  share  of 

revenue 
The 
decentralisation  with 
in 
subnational revenues, has a positive and significant 
coefficient  (columns  6  and  8).  Such  an  effect 
approximately  offsets 
the  negative  effect  on 
primary  balance  of  own  revenue  decentralisation 
per se.  On the other hand, the interactive term of 
own  revenue  decentralisation  and  the  share  of 
transfers  in  subnational  revenues  has  a  negative 
and  significant  coefficient  (column  9).  The  shares 
of taxes and transfers have, respectively, a positive 
and  negative  effect  on  the  primary  balance  also 
when included individually (columns 4 and 5). 

Finally, as explained above (see footnote (188)), a 
robustness  check  of  the  impact  of  the  weight  of 
subnational taxes on the fiscal balance was carried 
out by estimating the effect of 'true' tax autonomy, 
i.e.  the  weight  of  taxes  for  which  subnational 
governments  can  change  rate  and/or  base (see 
above). This is captured via three interactive terms:

Share  of  subnational  tax  revenues  on 
(i)
which 
exert 
governments 
subnational 
autonomy multiplied by the share of taxes in total 
subnational revenues; this would capture the share 
of 'truly' autonomous revenues (column 13); 

can 

Expenditure  decentralisation  times  the 
(ii)
term  (i),  in  order  to  test  the  joint  impact  of  large 
decentralisation  on  the  spending  side  and  large 
'true' revenue autonomy (column 11);

of 

Share 

subnational 

expenditures 
(iii)
covered  by  subnational  taxes  and  fees  times  the 
share  of  subnational
tax  revenues  on  which 
subnational governments can exert autonomy; this 
the  coverage  of  subnational 
would  capture 
expenditures  by  effectively  autonomous  revenues 
(column 12).

201

European Commission

Public finances in EMU - 2012

Table IV.3.4: Regressions on the effect of fiscal decentralisation on the primary balance of general government (LSDVC estimator, EU27,

1995-2010)

1

2

3

4

5

6

8

9

10

11

12

13

7

Pb

0.02*

-0.06

0.4***

VARIABLES

L.D

L.og

Expdec

Revdec

Expcov

Expdec* trsf

Ele

Expdec* tax

% tax

% trsf

Revdec* tax

Revdec *trsf

Tax *auton

Expdec *tax*auton

Expcov* auton

Obs.

Number of panel

0.03*

-0.1**

0.12**

-0.12*

0.03***

-0.12***

1.19***

0.03**

-0.1**

0.13**

0.03*

-0.09*

0.22***

0.03**

-0.09**

0.28***

0.03**

-0.08*

0.22***

0.03**

-0.05

0.03**

-0.06

0.03***

-0.09

0.04**

-0.08

0.47***

0.52***

1.22***

0.57***

-0.1**

1.2***

0.04***

0.04***

-1.15***

-0.43***

-0.36***

-0.45***

-0.81***

-0.73***

-1.27***

-0.5***

-1.48***

-1.34***

-1.7***

0.19***

0.18***

0.16***

0.17***

0.37***

0.3***

-0.1**

1.2***

-1.7***

0.3***

-1.12***

-0.45*

-0.43*

-0.44*

0.34**

-0.44*

-0.37

-0.42*

-0.29

-0.28

-0.25

-0.3

-0.89***

-0.76***

-0.74***

-0.26

-0.26

-0.31

-0.02

0.08***

-0.11***

0.87***

0.73***

-1.15***

405

27

405

27

405

27

405

27

405

27

405

27

405

27

405

27

405

27

405

27

297

21

0.04***

0.06**

297

21

0.05***

297

21

Notes: List of variables: pb = primary balance of general government (% of GDP), L.D = lagged stock of debt of general government (% of GDP),
L.og = Lagged output gap (% of potential output), Expdec = expenditure decentralisation, Revdec = own revenue decentralisation, Expcov = coverage 
of subnational expenditures by own resources, Expdec*trsf = expenditure decentralisation*share of transfers in subnational revenues, Ele = legislative
elections (1 if elections occurred in the year, 0 otherwise), Expdec*tax = expenditure decentralisation*share of taxes in subnational revenues, % tax =
share of taxes in subnational revenues, % trsf = % of transfers in subnational revenues, revdec*tax = own revenue decentralisation* share of taxes in
subnational revenues, revdec*trsf = own revenue decentralisation* share of transfers in subnational revenues, tax*auton = share of taxes in subnational
revenues*share  of  autonomous  taxes in  subnational tax  revenues,  expdec*tax*auton  =  expenditure  decentralisation*share  of  taxes in  subnational
revenues*share of autonomous taxes in subnational tax revenues, expcov*auton = coverage of subnational expenditures by own resources* share of
autonomous taxes in subnational tax revenues.
***, **, *: coefficient estimates statistically significant at the 1, 5 and 10% level, respectively.
Source: Commission services.

Results  confirm  expectations:  greater  'true'  tax
autonomy improves the primary balance as all the
three 
terms  have  a  positive  and  significant
coefficient. (195)   

of 

addition  of 

Table IV.3.5 presents the results of a model similar
to the one used for Table IV.3.4, but enriched with 
interacting  overall
terms 
the 
the
with 
expenditure 
decentralisation
decentralisation 
three 
in 
expenditures 
government
functions,  i.e.  health  care,  social
protection and general services (columns 1 to 3) in
order to test the hypothesis in point 3 above. These
terms 
significant
negative 
coefficients,  implying  that  if  overall  expenditure
decentralisation  is  positive  per  se for  the  primary 
if
balance, 
accompanied  by  large  decentralisation  in general
services,  social  protection  and  health.  ( 196) This

is  partly  counteracted 

this  effect 

have 

and 

all 

(195) Moreover, when  the  term  (ii)  is  included  the  interactive 
term of expenditure decentralisation and the share of taxes
in  subnational revenues  is no  longer  significant  (column 
11), suggesting that it is the true tax autonomy rather than
the  share of 
tax  revenues  assigned to subnational
governments as such which improves fiscal balances.

(196) The  same  test  was  carried  out  also  for  decentralisation  of
to  be

turned  out 

education  expenditures,  which 
insignificant.

202

was  already  detected  among  the  stylised facts  in
Section 3.3 only for general services.

Interactive  effects  between  overall  expenditure
decentralisation  and  decentralisation  by economic
function  are  also  tested  for public  consumption,
compensation  of  employees  and  social  benefits
(columns 4 to 6.) The coefficients for the first and
the  third  term  are  insignificant, whereas  the
coefficient  on  employee compensation  is  positive
and significant, suggesting, quite surprisingly, that
a  large  subnational  share  in  the  expenditure  for
compensation  of  employees  improves  the  positive
effect of  overall  expenditure  decentralisation  on
the  primary  balance.  (197)  The  other  indicators  of
decentralisation 
sign  and
significance. 

the  usual 

retain 

(197) Clearly, it is quite difficult to interpret this finding as there
are  no  clear  economic  reasons  on  why local  governments
should be more disciplined than the central government in
their wage expenditures.

Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

Part IV

Table IV.3.5: Results of regressions with the primary balance of general government as dependent variable and decentralisation by

government function and by economic function included among regressors (LSDVC estimator, EU27, 1995-2010)

1

2

3

4

5

6

VARIABLES

L.D

L.og

Expdec

Revdec

Ele

Expdec * trsf

Expdec * decHealth

Expdec. * decSoc

Expdec * decGS

Expdec. * decCons

Expdec * decWag

Expdec. * decSocBen

Observations

Number of panel

0.0530***

0.0483***

0.0358***

0.0335***

pb

-0.154***

1.414***

-1.297***

-0.504**

-1.191***

-0.123***

-0.148***

1.315***

-1.288***

-0.474*

-1.123***

-0.242**

-0.152***

1.529***

-1.340***

-0.518**

-1.348***

-0.528***

-0.128***

1.215***

-1.151***

-0.425*

-1.127***

-0.0788

382

27

382

27

383

27

405

27

0.0286**

-0.131***

1.018***

-1.151***

-0.395*

-1.119***

0.0333***

-0.116***

1.148***

-1.144***

-0.448**

-1.108***

0.417**

405

27

0.188

405

27

Notes: List  of variables:  see  Table  IV.3.4  above.  New  variables  added: Expdec  *  decHealth  =  expenditure  decentralisation * subnational  share  of
general government  expenditure for health  care,  Expdec *  decSoc  =  expenditure  decentralisation  *  subnational  share of general government
expenditure for social protection, Expdec * decGS = expenditure decentralisation * subnational share of general government expenditure for general
services, Expdec * decCons = expenditure decentralisation * subnational share of general government expenditure for consumption, Expdec * decWag
=  expenditure  decentralisation  *  subnational  share  of general government  expenditure  for  compensation of  employees,  Expdec  *  decSocBen =
expenditure decentralisation * subnational share of general government expenditure for social benefits.
***, **, *: coefficients estimates statistically significant at the 1, 5 and 10% level, respectively.
Source: Commission services.

3.4.3. Regression results on the effect of

decentralisation on expenditures and
revenues

Expenditures 

Regressions  were  also estimated  with  general
government  primary  expenditure  (as  a  share  of
GDP),  instead  of  the  primary  balance,  as  the
dependent variable  (see  Annex  2).  The  model  is
adapted  relative  to  the  one  for  primary  balance
with the addition of inflation and trade openness as
further  control  variables  (Eyraud  and  Lusinyan,
2011.)  Focusing  on  the decentralisation  indicators
the following findings can be highlighted:

Overall expenditure decentralisation has a 
(i)
negative  and significant  coefficient,  suggesting
that  expenditure  decentralisation  per  se  tends  to
decrease the magnitude of overall expenditures of
the general government.

Subnational own revenue decentralisation
significant  effect  on

(ii)
has  a  positive  and 
expenditures.

taxes  in  subnational revenues  have  a positive  and 
negative effect, respectively (both significant).

The same  is found  for  the  interaction 
(iv)
between  own  revenue  decentralisation  and  the
share  of 
in  subnational
revenues, respectively.

transfers  and 

taxes

between 

findings  contradict 

These 
the  stylised facts
discussed in Section 3.3 above, which suggested a
positive 
expenditure 
correlation 
decentralisation  and 
total  expenditures.  This
confirms  the  need  to  interpret  stylised  facts  based
on simple correlations with special caution and the
importance  to  check  their  robustness  through
econometric 
also
disconfirms the hypothesis (1) above and confirms
opposite  arguments  proposed  in  the  literature
whereby 
should
increase  public  sector  efficiency  due  to  better
subnational
tailoring  of  public
preferences  and 'healthy'  competition  and mutual
learning  across  subnational governments  on  the
most efficient ways to provide public services.

analysis.  This

decentralising 

expenditures 

services 

finding 

to 

The 

(iii)
expenditure 
interaction  between
decentralisation  and  the  share  of transfers  and  of

Stylised  facts  in  Section  3.3  also  suggested that 
large  subnational  financial  responsibility,  a  large
share of taxes in subnational revenues and a lower

203

European Commission

Public finances in EMU - 2012

share  of  transfers  were  also  associated  to  higher 
expenditures,  whereas  the  reverse  is  found  in  the 
above  regression  which  properly  controls  for  the
impact  of  several  variables.  In  other  words, 
whereas  from  the  stylised  facts  it  seemed  that  the 
positive  effect  of  high  subnational  financial 
responsibility  and  high  subnational 
taxes/low 
transfers  on  the  primary  balance  only  came  from 
the revenue  side, the regression shows that it also 
comes  from  restraints  on  expenditures,  which  is 
more consistent with literature predictions.   

the 

regards 

functional  composition  of 
As 
expenditures,  the  interactive  term  of  expenditure 
decentralisation  with  decentralisation  by  function 
has  a  positive  and  significant  coefficient  only  for 
expenditure  on  general  services,  meaning  that  if 
overall  decentralisation  leads  per  se  to  lower 
expenditures 
large 
decentralisation  of  general  services.  Therefore, 
stylised  facts  suggesting  a  specific  role  of 
decentralisation  of  health,  education  and  social 
protection 
in  affecting  expenditures  are  not 
confirmed.       

is  partly  undone  by 

this 

Revenues 

Finally,  the  impact  of  fiscal  decentralisation  on 
revenues  was  estimated  through  regressions  with, 
alternatively, general government revenues and the 
tax  burden  (both  as  shares  of  GDP)  as  the 
dependent  variable  to  add  a  further  robustness 
check (see Annex 2). (198) 

the  other  hand,  own 

Expenditure  decentralisation  does  not  appear  to 
have a significant effect on revenues or on the tax 
burden.  On 
revenue 
decentralisation  has  a  negative  and  significant 
effect,  whereas  its  interaction  with  the  share  of 
transfers  becomes  insignificant  and  its  interaction 
with the share of taxes in subnational governments 
has  a  positive  and  significant  effect  on  the  tax 
burden  only.  Similarly  the  interaction  between 
expenditure  decentralisation  and  the  share  of 
transfers  in  subnational  revenues  is  insignificant, 
whereas  the  interaction  with  the  share  of  taxes  is 
positive
subnational 
expenditure  coverage  by  own  resources  has  a 
positive and significant coefficient.

significant.  The 

and 

(198) To check for the possibility that tax revenues may be more 
affected  by  the  economic  incentives  created  by  the 
governance structure of a country. 

204

it 

the 

that 

their 

impact 

appears 

Overall 
of 
decentralisation is stronger on the expenditure than 
on the revenue side, although two dimensions of it 
also  affect  revenues  in  a  way  which  is  consistent 
with 
impact  on  primary  balance  and 
expenditures.  These  are  the  decentralisation  of 
own  revenues,  which  according  to  these  results 
revenues, 
spending  and  decreases 
increases 
thereby  adversely  affecting  fiscal  balances  from 
both  sides,  and 
the  subnational  expenditure 
coverage  by  own  resources,  which  decreases 
expenditures  and 
revenues,  hence 
increases 
positively  affecting  fiscal  balances  from  both 
sides.  Also,  a  high  relative  weight  of  taxes  in 
subnational revenues appears to (weakly) improve 
revenues  for  a  given  level  of  expenditure  and 
revenue decentralisation. 

3.5. 

FISCAL RULES, DECENTRALISATION AND 
FISCAL OUTCOMES  

This Section complements the analysis carried out 
so  far  by  looking  at  the  role  of  fiscal  rules
constraining  the  fiscal  behaviour  of  subnational 
governments.  Data  used  are 
the indexes  of 
strictness  of  such  rules  computed  by  DG  ECFIN 
based  on  information  provided  by  the  Member 
States.  (199)  Essentially,  the  aim  is  to  assess  two 
aspects:

Whether  fiscal  rules  constraining 

(1)
the 
behaviour  of  subnational  governments  are  used 
more  frequently  in  highly  decentralised  countries 
and whether there is a tendency to adopt a specific 
type of rules (i.e. balanced budget vs. debt rules) at 
level.  (200)  As  regards 
the  first 
subnational 
that  when 
is 
it 
question, 
subnational  governments  have  more  fiscal  power 
on  both  the  expenditure  and  revenue  side  central 
governments  attempt  to  constrain  their  behaviour 
via fiscal rules.

to  expect 

logical 

(2)
Whether  the  relationship  between  fiscal 
decentralisation  and  fiscal  outcomes  changes  in 
presence  of  strict  subnational  fiscal  rules  so  that 

(199) http://ec.europa.eu/economy_finance/db_

indicators/fiscal_governance/index_en.htm

(200) As  regards  the  second  point,  it  is  expected  that  balanced 
budget rules should be more frequently used than debt rules 
at  subnational level  as  subnational governments  are  quite 
constrained  in  their  possibility  to  issue  debt  anyway  (e.g. 
due to lower access to capital markets). 

Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

Part IV

rules  act  as  a  substitute to  subnational  financial
responsibility/large  reliance  on  taxes  as  a  tool  to
increase fiscal discipline.

As regards question (1), Table IV.3.6 below, looks
fiscal
at whether  different  dimensions  of 
decentralisation  go  together with  stricter
fiscal
rules at subnational level.

decentralised  countries,  in  line with  expectations.
With respect  to  the  type  of  rules  applying  to 
subnational governments, balanced  budget  rules
are  stricter  in  countries with  higher subnational
financial  responsibility  and  greater  reliance  on
taxes compared to transfers, whereas debt rules are
stricter in the opposite case. 

they  are 

be much 

stricter  when 

The Table shows that subnational fiscal rules tend
to 
expenditure
decentralisation and own  revenue  decentralisation
are high. As for the type of rules used, on average,
balanced  budget  rules  applying  to  subnational
governments are  much  stricter when  expenditure
and own revenue decentralisation are high, as well
as when the tax share in subnational revenues and
the subnational financial  responsibility ( 201)  are 
high, while
transfer
dependency is higher. On the other hand, strictness
of  debt  rules does  not  change  significantly  with
expenditure  decentralisation;  however 
is
correlated  with 
decentralisation
the 
indicators with opposite sign compared to balanced 
budget  rules,  i.e.  debt  rules  are  looser  with high
own  revenue  decentralisation,  high  expenditure
coverage  with own subnational revenues and high 
share  of  taxes  in  subnational  revenues,  whereas
they  are  stricter when  transfer  dependency  is
lower.

looser when 

other 

it 

Overall,  fiscal  rules  applying 
governments  are 

stricter 

to subnational
fiscally

in more 

(201) High expenditure coverage with own resources.

This  appears  to  disconfirm  the  substitutability
story  as
far  as  balanced  budget  rules  are
concerned,  i.e.  they are  not  used  to  correct  for
weak  subnational fiscal  discipline  in  case  of  high
imbalances.  On  the
transfers  and  vertical fiscal
other  hand,  the  argument may  be  valid  as  far  as
debt  rules  are  concerned. Moreover,  this  finding 
raises  the  hypothesis  that  the  positive  effect  of
taxes/low
financial 
transfers on the fiscal balance found in Section 3.4
above may  in  reality  be  due  to  the  more  frequent
use  of  balanced  budget 
rules  constraining
subnational behaviour.

responsibility 

and  high 

These  hypotheses were  tested  through  regression
analysis (see Table IV.3.7). The above model with
the  primary  balance  as  dependent variable  was
enriched  by including  the  strictness  of  rules
applying  to  subnational governments  (column  1),
its  balanced  budget  rule  and  debt  rule  component
(column 2 and 3, respectively). Further tests were 
carried  out  with interactive  terms testing  the  joint 
impact of balanced budget rules and, respectively,
expenditure  decentralisation  with  high  share  of
taxes  in  subnational  revenues  and  the  subnational 
expenditure coverage by own resources (columns 4
and 5 respectively, to test whether the effect of the

Table IV.3.6:

Strictness of fiscal rules applying to subnational governments, averages for observations with low and high values of different
indicators of fiscal decentralisation (EU27 Member States, 1995-2010 period)

Expenditure decentralisation

Own revenues decentralisation

Low
High

Low
High

Subnational expenditure coverage by
own subnational resources

% of taxes in subnational revenues

Low
High

Transfer dependency

Source: Commission services.

Low
High

Low
High

Strictness fiscal rules – 
subnational gov.
1.9
4.9

Strictness debt rules – 
subnational gov.
1.2
1.1

Strictness balanced budget
rules – subnational gov.
0.6
2.4

2.6
4.4

3.5
3.2

3.3
3.4

3.2
3.6

1.3
0.9

1.6
0.8

1.7
0.6

0.7
1.7

0.7
2.7

1.0
1.9

0.7
2.2

2.0
0.9

205

European Commission

Public finances in EMU - 2012

latter  variables  is  in  fact  due  to  the  fact  that  they
tend to be accompanied by balanced budget rules), 
the  joint  impact  of  balanced  budget  rules  and,
respectively,  expenditure  decentralisation  (column
6)  and  own  revenue  decentralisation  (column  7)
and the joint impact of debt rules and expenditure
decentralisation with large  share  of  transfers in
subnational revenues (column  8,  to  test  whether
decentralisation with large transfers is less harmful
for fiscal balance if accompanied by debt rules).

Overall, regression results suggest that strictness of
fiscal rules in general and of balanced budget rules
in  particular  applying  to  subnational  governments
do not affect  the  impact  of fiscal  decentralisation
on  the  primary  balance. Specifically,  the  positive
impact of subnational financial responsibility and a 
large reliance on taxes compared to transfers does
not  appear  to be  due  to  their  positive  correlation
with 
the  presence  of  balanced  budget  rules
applying  to  subnational governments,  as  all  the
corresponding  interactive  terms  are  insignificant.
to
the  other hand,  debt  rules  applying 
On 

subnational governments appear to have a positive
effect  on  fiscal  balance  on  their  own  (column  4)
and  to  slightly  counteract  the  negative  budgetary
effect of expenditure decentralisation accompanied
by large transfers. (202)

Finally, in order to test if the positive effect of debt 
rules  occurs via  the  expenditure  side,  two further
tests were  carried  out  by  enriching  the model  for
primary  expenditures  discussed  in  Section  3.4 
above  with the  two  terms  capturing  the  impact  of
debt rules (see above). Results show that debt rules
have  a  negative  and  significant  effect  on  primary
expenditures  (column  9)  and that they  reduce  the
positive  impact  on  expenditures  of  expenditure
decentralisation  accompanied  by  large  transfers
(column 10).

Overall,  the  conclusion  is  that,  while  balanced
the  relationship 
budget  rules  do  not  change 

(202) See  positive 

and 

significant 

coefficient  of 

the

corresponding interactive term in column 8.

Table IV.3.7: Results of regressions on the effect of fiscal decentralisation and fiscal rules on primary balance and expenditures of the

general government (EU27, 1995-2010, LSDVC estimator)

VARIABLES

L.D

L.og

Expdec

Revdec

1

2

3

4

5

6

7

8

9

10

pb

primexp

0.03**

0.0289**

0.0346***

0.0289**

0.0294**

0.0283**

0.0287**

0.0337***

-0.0234*

-0.0223*

-0.0691*

-0.0691*

-0.0750*

-0.0681*

-0.0667

-0.0702*

-0.0681

-0.0947**

0.174***

0.179***

0.398***

0.400***

0.403***

0.397***

0.399***

0.402***

0.396***

1.232***

-0.782***

-0.790***

-0.995***

-1.004***

-1.012***

-0.995***

-1.000***

-1.001***

-0.988***

-1.494***

0.936***

0.951***

Expdec * tax

0.292**

0.328**

0.311**

0.333**

0.315**

0.337**

0.327**

Expcov

frilg

fribbr

fridr

Expcov * fribbr

Expdec * fribbr

Expdec * trsf

Revdec * fribbr

Expdec * trsf * fridr

 fridr

Expdec * tax * fribbr

fribbr

Ele

L.infl

TO

0.190***

0.187***

0.197***

0.186***

0.190***

0.186***

0.186***

0.176***

-0.0850***

-0.0850***

-0.0376

-0.137

0.183*

-0.00164

-0.00403

-0.240**

-0.00565

-0.910***

0.662***

0.682***

0.0100*

-0.0130**

-0.0055

-0.282

-0.286

-0.288

-0.299

-0.29

-0.296

-0.297

-0.288

0.0739

0.0553

0.0358***

0.0358***

0.0354***

-0.539

-0.625

Observations

Number of panel

405

27

405

27

405

27

405

27

405

27

405

27

405

27

405

27

401

27

401

27

Notes: List of variables: see Table IV.3.4 above, new variables added: Primexp = general government primary expenditures (% of GDP), L.infl =
lagged inflation rate, TO = trade openness (% of exports plus imports in GDP), frilg = strictness of fiscal rules applying to Subnational Governments
(SNG), fribbr = strictness of balanced budget rules applying to SNG, fridr = strictness of debt rules applying to SNG, Expcov * fribbr = coverage of
subnational expenditures by own resources * strictness of balanced budget rules applying to SNG, Expdec * fribbr = expenditure decentralisation *
strictness of balanced budget rules applying to SNG, Revdec * fribbr = own revenue decentralisation * strictness of balanced budget rules applying to 
SNG, Expdec * trsf * fridr =  expenditure decentralisation*share of transfers in subnational revenues* strictness of debt rules applying to SNG, Expdec
* tax * fribbr = expenditure decentralisation*share of taxes in subnational revenues* strictness of balanced budget rules applying to SNG.
***, **, *: coefficients estimates statistically significant at the 1, 5 and 10% level, respectively.
Source: Commission services.

206

Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

Part IV

between decentralisation and fiscal outcomes, debt 
rules  applying  to  subnational  governments  reduce 
the negative effect on the fiscal balance of a large 
weight  of  transfers  in  subnational  revenues,  and 
this effect occurs through the expenditure side.   

3.6.  CONCLUSIONS

Although it is highly challenging to summarise in a 
few lines all the analysis shown in this Chapter, a 
number of key points can be highlighted as regards 
the  effect  of  fiscal  decentralisation  on  general 
government fiscal outcomes.

Expenditure  decentralisation  per 

(1)
se 
appears to be associated with better fiscal balances 
compared  to  cases  of  low  decentralisation.  This 
reflects a  negative effect on expenditures  whereas 
the effect on revenues is not significant according 
to  regression  analysis.  This  finding  lends  support 
to  a  few  economic  arguments  proposed  in  the 
literature  which  underline 
subnational 
governments  should  be  more  able  to  tailor  public 
that 
goods 
competition 
among 
subnational  governments  should  help  them  select 
more  cost-effective  techniques  for  the  production 
of  public  goods.  This  should  in  turn  lead  to  more 
efficient  expenditure 
in  more  decentralised 
countries  ceteris  paribus  with  positive  effects  on 
the primary balance.

subnational  preferences  and 

and  mutual 

learning 

that 

to 

low 

subnational 

in  shaping 

The revenue side of decentralisation plays 
(2)
a  key 
the  net  effects  of 
role 
decentralisation  on  fiscal  outcomes.  Regression 
results  suggest  that  expenditure  decentralisation 
financial 
accompanied  by 
responsibility to cover their expenditures with their 
own resources (i.e. taxes and fees) and by a large 
share  of  transfers  from  the  central  government  in 
to  be  overall 
is 
subnational  revenues 
detrimental  for  the  fiscal  balance.  On  the  other 
hand,  the  budgetary  effect  of  decentralisation  is 
more  favourable  if  it  goes  together  with  a  large 
coverage  of  subnational  expenditures  by  own 
resources  and  a  large  weight  of  taxes  in  total 
subnational revenues. This result reflects effects on 
both the expenditure and (albeit to a lesser extent) 
the revenue side.

likely 

from 

'bail-out' 

depend  on  transfers  from  the  central  government 
they would be subject to a soft-budget constraint as 
they would take it for granted that possible excess 
spending  from  their  part  would  be  eventually 
covered  by  a 
the  central 
government.  On  the  other  hand,  if  they  can  raise 
sufficient  own  resources  to  cover  most  of  their 
expenditures and the weight of transfers is low the 
central government can  more easily resist bail-out 
pressures. Moreover, in the latter case subnational 
policy-makers are more accountable to subnational 
voters  as  the  link  between  subnational  taxes  paid 
and subnational public goods delivered is stronger 
which  also  exerts  a  disciplining  effect  on 
subnational governments fiscal behaviour.

This  conclusion  is  strengthened  by  the 
(3)
finding  on  the  positive  effect  on  the  primary 
balance  of  'effective'  tax  autonomy,  i.e. of  a  large 
weight of taxes on which subnational governments 
can exert autonomy with respect to the rate and/or 
the  base.  This  suggests  that  the  positive  effect  of 
decentralisation  on  primary  balance  is  improved 
not  only  if  subnational  tax  revenues  are  high  and 
transfers  low  but  also  if  subnational  governments 
can set those taxes autonomously.   

in 

total 

governments 

The  most  puzzling 

(4)
result  concerns 
decentralisation of own revenue sources, i.e. a high 
share  of  tax  revenues  and  fees  assigned  to 
subnational 
general 
government revenues, which has an adverse effect 
on  the  primary  balance,  reflecting  an  increasing 
effect  on  expenditures  and  a  decreasing  one  on 
revenues.  On  the  one  hand,  this  contradicts  the 
idea  that  devolving  relatively  large  own  revenue 
sources to subnational governments is positive for 
fiscal discipline which would follow logically from 
the  above  mentioned  arguments  on  the  benefit  of 
subnational 
responsibility, 
avoiding  soft-budget  constraints  etc.  Upon  closer 
reflection, though, this variable is less suitable than 
those  discussed  in  point  2  above  to  capture  those 
aspects  as  it  tells  nothing  on  the  size  of  own 
revenues  relative  to  subnational  expenditures  and 
on  the  relative  weight  of  transfers  vs.  taxes  and 
fees  in  subnational  revenues.  This  does  not  yet 
explain the fact that it has an adverse effect on the 
budget  balance,  though,  rather  than  being  simply 

revenue  autonomy, 

This  result  confirms  literature  predictions  which 
underline  that  if  subnational  governments  largely 

207

enrichments 

In methodological terms, the econometric analysis 
carried out in this Chapter draws on Escolano et al. 
(2012).  However, 
are 
several 
introduced compared to this paper, such as testing 
the impact of subnational expenditure coverage by 
own 
tax 
resources,  of  effective  subnational 
autonomy (as measured by the OECD Secretariat), 
of several interactions between different aspects of 
decentralisation (i.e. between expenditure and own 
revenue decentralisation, on the one hand, and the 
share  of  taxes  and  transfers,  on  the  other  hand; 
between effective tax autonomy, on the one hand, 
and  expenditure  decentralisation  and    expenditure 
coverage by own resources, on the other hand) and 
of  the  functional  composition  of  expenditure 
decentralisation. Furthermore, the Chapter extends 
the  analysis  of  the  impact  of  subnational  fiscal 
rules by looking at the joint impact of expenditure 
decentralisation,  share  of  transfers  and  rules, 
finding  statistically  significant  results  for  debt 
rules  as  opposed  to  the  above  mentioned  paper, 
and, finally, runs separate estimates on the impact 
of  decentralisation  on  expenditures  and  revenues, 
in addition to those on the primary balance.

European Commission

Public finances in EMU - 2012

insignificant.  (203) Further  research  would  be 
advisable on this issue.

to 

the 

respect 

Finally,  divergences  between  stylised 
(5)
facts  based  on  simple  or  conditional  correlations 
and  results  of  regression  analysis,  in  particular 
impact  of  expenditure 
with 
financial 
decentralisation, 
responsibility  and  the  relative  size  of  taxes  vs. 
transfers  on  expenditures,  highlight  the  need  to 
simultaneously control for several features of fiscal 
decentralisation to disentangle their impact on  the 
fiscal outcomes of the general government.   

subnational 

(6)
As for the impact of rules constraining the 
fiscal  behaviour  of  subnational  governments; 
stricter  debt  rules  appear  to  affect  positively  the 
primary  balance  via  restraints  on  expenditures. 
Moreover, they partly alleviate the negative effect 
of  expenditure  decentralisation  combined  with  a 
large  share  of  transfers  in  subnational  revenues,
suggesting  a  partial  substitutability  between  debt 
rules  and  subnational  fiscal  responsibility/large 
share  of  own  resources  as  a  tool  to  encourage 
fiscal discipline. On the other hand, the budgetary 
impact of fiscal decentralisation does not appear to 
be  affected  by  stricter  balanced  budget  rules 
applying to subnational governments.

Overall,  it  appears  that  fiscal  decentralisation 
matters  for  fiscal  outcomes  and  that  the  interplay 
between the expenditure and the revenue side of it 
is  crucial  to  determine  its  net  effect  on  fiscal 
balances.  Overly  pessimistic  statements,  often 
heard recently, on a generalised fiscal deterioration 
caused by increasing  fiscal decentralisation across 
the  EU  do  not  seem  to  find  support  in  the  data. 
This  may  have  occurred  in  some  Member  States, 
but probably not as a result of decentralisation per 
se but of a 'bad' design of decentralisation, i.e. one 
which 
financial 
ensure 
responsibility of subnational governments.   

strong 

does 

not 

to 

of 

than 

sources 

revenue 

(203) Although  an  explanation  could  be  that  own  revenue 
the 
decentralisation  may  capture  other  effects 
devolvement 
subnational 
governments, such as business cycle effects. An economic 
downturn  would  decrease  general  government  revenues 
and so (if subnational revenues are kept constant) increase 
own  revenue  decentralisation  via  its  denominator,  even 
though  no  policy  measure  to  increase  decentralisation  is 
enacted. At the same time this would also lead to a worse 
primary  balance,  being  consistent  with  a  negative  sign  of 
the revenue decentralisation coefficient in the regression.   

208

ANNEX 1

National fiscal decentralisation arrangements in the EU -
country fiches

A1.1.  BELGIUM

1. General description

(204)  and 

linguistic  communities

Since  1970,  five  constitutional  reforms  have 
gradually  transformed  the  Belgian  unitary  state 
into  a  federal  state  made  up  of  three tiers  of 
subnational  government:  six federated  entities 
three 
(three 
territorial  regions),  (205)  11  provinces and  589 
municipalities.  Regions  and  communities  have 
legislative  and  administrative  competences,  while 
provinces  and  municipalities  have  administrative 
powers  and  implement  upper  levels'  legislation.
Belgium therefore has one of the most far-reaching 
levels of decentralisation in the EU.  Although the 
decentralisation  process  has  already  transferred  a 
considerable  number  of  competences 
the 
subnational levels, federalisation does not seem to 
federal 
its  endpoint  as 
have 
government  formed  in  December  2011  plans  a 
sixth constitutional reform and a further transfer of 
competences.

reached 

the 

to 

to 

those 

Since  the  first  constitutional  reform  of  1970,  the 
Belgian  Constitution  explicitly  stipulates 
the 
existence  of  communities  and  regions. From  that 
moment on, several waves of reform (1980, 1988-
1989, 1993, 2001) have transferred a considerable 
number  of  competences  and  hence  spending 
authority 
federated  entities.  The 
distribution  of  competences  among  the  federal 
state  and  the  federated  entities has  been  anchored 
in  the  Constitution.  The  federal  government  has 
spending  power  for  all  competences  that  do  not 
expressly  come  under  the  authority  of  regions  or 
communities.  Regions  are  competent  in  areas 
their 
linked 
territory.  Communities  are 
to 
for  person-related matters. The 
responsible 
distribution 
leads 
of 
communities  and  regions  to  realise  almost  24% 
and  provinces  and  municipalities  approximately 
13%  of  total  general  government  expenditure 
(12.7% and 7.2% of GDP) (206).

competences 

theses 

(204) The  German-speaking  Community,  the  French-speaking 

Community and the Flemish Community

(205) The Wallonia Region, the Brussels-Capital Region and the 

Flemish Region

(206) 2009 

data 

providing 
Decentralisation database

from 

the  OECD  Fiscal 

revenue 

from  which 

The transfer of the corresponding financial  means 
is  for  the  federated  entities  regulated  by  the  1989 
Special Financing Act, which was amended by the 
Special  Act  of  13  July  2001  to  take  into  account 
the  further  decentralisation  of  competences.  This 
has extended the  fiscal autonomy of the  federated 
entities  but  has  also  led  to  a  complex  system  of 
grants,  shared  and  own-source  tax  revenues.  The 
type  of 
subnational 
governments can benefit differs considerably from 
one  tier  to  another.  Communities  benefit  from 
shared  tax  revenues  (mainly  personal  income  tax 
and  VAT)  and  from  some  non-tax  revenues, 
whereas  regions  do  also  perceive  own-source  tax 
revenues,  like  registration  duties,  property  and 
vehicle  taxes  (8.9%  of  total  general  government 
revenues  or  4.3%  of  GDP).  Local  authorities,  i.e. 
provinces  and  municipalities,  do  not  share  taxes 
with the federal level but benefit from own-source 
tax revenues, general and earmarked grants. Their 
total  general 
revenue 
government revenues or 3.6% of GDP.

represents  7.5%  of 

2. Government spending

A  substantial  number  of  government  functions 
were  devolved  to  subnational  entities in  Belgium. 
In  2010,  local  authorities  were  in  charge  of  EUR 
25  billion  of  public  spending  (13.8%  of  total 
public expenditure) and  federated entities of EUR 
53  billion  (28.9%  of  total  public  expenditure).  As 
often  subnational  governments  are  only  in  charge 
of  part  of  a  government  function,  the  remaining 
competences  that  were  not  expressly  attributed  to 
one  of  the  sub-levels  stay  under  the  authority  of 
the  federal  state.  As  a  result,  most  of 
the 
government  functions  are  scattered  among  the 
different government tiers. 

At  local  tier,  subnational  governments  are  mainly 
involved  in  general  public  services,  education, 
social  protection  and  public  order  and  safety. 
Provinces have spending power in certain person-
related areas, like secondary and higher education, 
and  are  responsible  for  the  general  affairs  of  the 
provinces.  Municipalities'  spending  competence
includes local planning, elections and registration, 
as  well  as police and  some  social  protection 
functions, like public social welfare centres.

At  the  level  of  the  federated  entities  education  is 
by 
item, 
followed  by  economic  affairs,  social  protection 

important  spending 

the  most 

large 

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Public finances in EMU - 2012

to 

the  competence  of 

and  general  services.  Those  competences  that  are 
person-related  were  mainly  attributed 
the 
communities,  whereas  territory-linked  areas  are 
regions.  Hence, 
under 
communities  are  highly  involved  in  education,  as 
they finance large parts of primary, secondary and 
higher  education.  Regions  are  largely  involved  in 
economic  affairs  like  agriculture  and  transport,  as 
well as in environmental protection and housing.

it 

is 

The  federal  state  remains  largely  in  charge  of 
general  public  services  and 
the  only 
government  tier  competent  for  defence  matters. 
The  federal  state  spends  almost  two  thirds  of  its 
budget  on  general  services,  while  approximately 
5%  is  spent  on  defence.  Although  health  is  a 
person-related service and is therefore expected to 
be  part  of  the  communities'  responsibilities,  it  is 
the  federal  state  that  has  the  largest  spending 
power with respect to that economic function.

The  federated  entities  and  local  authorities  are 
autonomous 
implementing 
in  designing  and 
policies  in  the  areas  of  competence  which  were 
attributed  to  them ( 207).  Once  a  responsibility  is 
transferred 
the 
federal  state  no  longer  has  power  to  act  or 
intervene regarding this matter.

to  a  subnational  government, 

An analysis by type of expenditure highlights that 
more  than  85%  of  expenditures  are  linked  to
current expenditures at all government levels. The 
remaining  part  of  expenditures  is  related  to  the 
reimbursement  of  capital  and  the  payment  of 
interest costs.

(207) Areas  of  competence  of  communities  include  cultural 
matters,  education  (except  for  determining  the  beginning 
and  end  of  compulsory  schooling,  minimum  conditions 
governing the granting of diplomas, and the pension plan), 
services  offered  to  individuals,  the  use  of  languages  in 
respect  of  administrative  matters,  teaching  and  contacts 
between  employers  and  their  staff,  intra-Community  and 
international  cooperation,  including  the  conclusion  of 
treaties, in respect of cultural matters, teaching and services 
offered to individuals.
Areas  of  competence  of  regions  include  economic  policy, 
including  assistance 
investment  and 
employment,  employment,  transportation,  public  works,
financing  of  sub-ordinate  powers,
scientific  policy 
pertaining to their fields of jurisdiction, energy, wastewater 
treatment  and  the  protection  and  distribution  of  water,
policy  governing  waste  and  environmental  protection, 
monuments 
agriculture,
international  relations  from  the  standpoint  of  the  Regions' 
fields of jurisdiction.

respect  of 

foreign 

trade, 

sites, 

and 

in 

210

3. Financial arrangements

Throughout  the  several  constitutional  reforms, 
subnational  governments  have  gained  a  lot  of 
fiscal autonomy, not only from an expenditure but 
also  from  a  revenue  point  of  view.  The  Special 
Financing Act of 1989 sets the pillars for revenue 
allocation  to  the  federated  entities  and  guarantees 
that  the  latter  have  the  means  to exercise  their 
competences.  At  local  tier,  regions  regulate  the 
funding  of  the  local  authorities  and  can  introduce 
limits  (regarding  type  and  rate)  on  taxes  set  by 
and 
municipalities.  Hence,  municipalities 
provinces  are  subject  to  different  financing  rules, 
according to the region in  which they are located. 
Whether  at  federated  or  local  level,  subnational
financing is done through tax revenues, as well as 
through  grants  from  the  upper  government  level. 
All subnational entities also have the possibility to 
borrow. 

Municipalities  and  provinces  depend  for  almost 
half of their  financing on grants  from the regions. 
Those  grants  are  allocated  to  municipal  and 
provincial  funds  or  are  earmarked  to  specific 
projects.  Local  authorities  are  also  financed 
through  own-source 
taxes,  which  are  mainly 
surtaxes  on  the  federal  personal  income  tax,  the 
regional 
tax  for 
municipalities  and  on  the  regional  real  estate  tax 
for  provinces.  Often  the  upper  government  level 
determines the tax base and the local authority sets 
the  rate  of  the  surtax.  Local  authorities  are  also 
free to levy other local taxes, like waste and leisure 
taxes.  Other 
interests 
received  and  fee  revenues,  which  account  for 
approximately 18% of total revenues.

tax  and  real  estate 

local  revenues 

include 

traffic 

The  financial  autonomy  of  communities  and 
regions  differs  considerably.  Both  communities 
and  regions  benefit  from  shared  tax  revenues  and 
the  federal  state.  Only  regions, 
grants  from 
however,  levy  their  own-source  taxes.  The  latter 
amount  to  approximately  16%  of  the  federated 
entities'  total  revenues  and  include  real  estate 
taxes,  registration  duties,  inheritance  taxes  and 
vehicle  taxes. Regions  are  entirely  free  to  set  the 
tax  base  and  tax  rate  of  those  regional  taxes. 
Although  the  federated  entities  have  the  right  to 
collect  the  taxes  themselves,  tax  collection  is 
ensured by the federal state. The lion's share of the 
regions  and  communities'  revenue  comes  from 
shared  taxes,  i.e.  a  fraction  of  the  proceeds 

Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

Part IV

providing  from  the  personal  income  tax  and  the 
value added tax, collected by the federal state. On 
top  of  this  fraction,  regions  can  decide  to  levy 
surtaxes  on  those  federal  state  taxes.  Additional 
means, amounting to almost 11% of total federated 
entity  revenue,  are  transferred  from  the  federal  to 
the  federated  level  in  the  form  of  grants.  Those 
the 
include  grants  for  foreign  students,  for 
Brussels-Capital  Region, 
a 
as 
compensatory  grant  for  abolishing  the  radio-
television licence fee.

as  well 

The increasing budgetary autonomy of subnational 
governments also includes the right to run deficits 
and  to  borrow  accordingly.  Although  in  the  past 
budgetary  correcting  mechanisms  and  equalising 
transfers  existed  at  almost  all  government  levels, 
now  only  an  automatic  compensation  mechanism 
remains  regarding  health  spending  by  the  federal 
government.

4. Fiscal rules

The  project  of  joining  the  EU  Economic  and 
Monetary  Union in  1992 gave  Belgium  an 
incentive  to  reduce  its  deficit  and  its  debt  ratio, 
which was the highest in the EU at that moment. In 
order to do so, the country engaged in a thorough 
reform  of  its  fiscal  framework.  Two  independent 
fiscal bodies (the National Account Institute (NAI) 
and a new section of the High Council of Finance 
(HCF))  were  established  to  give  the  federal  and 
federated  governments  advice  on  public  finance 
issues.  Moreover,  numerical  fiscal  rules  were 
introduced  from  1990  on  to  monitor  the  budget 
balance,  the  expenditures  and  the  revenues  of  the 
federal government, as well as of some subnational 
governments.

institutional  part  of 

the  renewed  fiscal 
The 
framework  has  proven  crucial,  as  with 
the 
increased  fiscal  autonomy  of  the  subnational 
governments  it  guaranteed  a  coordination  of  the 
fiscal  policies  of  the  different  government  tiers. 
The annual budget recommendations of the HFC's 
advisory  section  were  at  the  basis  of  budgetary 
conventions  which  acted  as  "internal  stability 
pacts"  by  setting  the  medium-term  budgetary 
targets for the different government tiers. Although 
never  used,  it  allowed  the  federal  level  to  impose 
borrowing limits to the regions in case they did not 
respect their budgetary targets. Regions cannot be 

liable,  however,  for  providing  fiscal  surpluses  to 
offset a potential federal deficit.

the  reformed  fiscal 
The  rule-based  part  of 
framework  turned  to  be  more  problematic,  as  the 
improvement  of  the  federal  deficit  and  the  debt 
ratio relaxed the fiscal tension from the end of the 
1990s  on.  Several  fiscal  rules  at  federal,  regional 
and local level adopted earlier on, were abolished. 
As  a  result,  only  the  federal  ceiling  for  health 
spending  and  the  regional  budget balance  rule 
in  place.  This  fiscal  framework, 
were  kept 
sixth 
following 
however,  may  change 
constitutional  reform  which  was  agreed  upon  in 
autumn 2011.

the 

Council 

country-specific 
issued 
The 
recommendations  to  Belgium with respect  to 
subnational governments (see Box I.3.2 above).

A1.2.  BULGARIA

1. General description

ratified 

in  1991  enshrines 

Bulgaria  is  a  unitary  state.  Article  136  of  the 
Constitution 
the 
principle of local self-government. The Local Self-
Government  and  Local  Administration  Act  was 
passed  the  same  year,  providing  the  legislative 
framework for the 264 Bulgarian municipalities.  

According  to  the  Constitution,  the  territory  is 
divided  into  regions  and  municipalities.  While  a 
region  is  defined  as  an  administrative  unit  in 
charge  of  conducting  the  national  policy  for 
regional development and ensuring of harmony of 
national  and  local  interest,  the  municipality  is  the 
only  subnational  level  of  the  general  government 
with fiscal autonomy. Municipalities have the right 
to cooperate in a way they can better protect their 
own  interest.  They  are  defined  as  legal  entities  in 
which government citizens participate directly and 
through  elected  bodies.  Municipalities,  in  contrast 
to  regions,  possess  their  own  budgets  and  are 
entitled to permanent revenues by law.  According 
to  2010  figures,  total  spending  by  municipalities 
amounted to only 6% of GDP, around 16% of total 
public  expenditure.  In  turn,  in  the  same  year 
municipalities'  revenues  also  amounted  to  6%  of 
GDP,  representing  18%  of  total  revenues  of  the 
general government.

211

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Public finances in EMU - 2012

The  National  Association  of  Municipalities  was 
constituted in 1996 and nowadays represents to all 
municipalities.  Besides 
to 
developing  the  legislative  framework  applied  to 
municipalities, 
the  Association  also  makes 
proposals  on  their  respective  section  of  the  draft 
budget.  Since  1996  there  have  been  ongoing 
efforts to deepen the decentralization process.  

contribution 

its 

2. Government spending

According  to  the  Local  Self-Government  and 
Local  Administration  Act  there  are  two  different 
types of powers devolved to municipalities. These 
are  the  State  delegated  services  and  the  local 
services.

State delegated services comprise the management 
and  financing  of  a  number  of  services,  of  which 
the  State  retains  the  responsibility  to  define  the 
main  policy  principles,  such  as  the  type  of 
services,  the  quality  and  the  eligibility  criteria
thereof. According to the functional breakdown of 
public  expenditure (COFOG) 
these  delegated 
services  to  municipalities  include  education up  to 
the  secondary  level,  social  protection services, 
such  as  family  and  child  support  and  care  for  the 
elderly,  healthcare and  culture.  However,  the 
devolution of powers in the area of healthcare have 
limited to the ownership and maintenance of health 
care institutions in that since 2001 they have been 
transformed  into  legal  entities  under  the  meaning 
of  the  Commercial  Law  with  state  or  municipal 
ownership .

have 

contrast,  municipalities 

By 
own 
responsibilities  in  some  areas  of  general  public 
services, housing and community amenities (public 
utilities  and  networks  such  as  urban  heat, 
electricity  and  water  supply),  economic  affairs 
(urban 
and 
maintenance  of  roads,  building  and  upkeep  of 
public  buildings  and 
territorial  development), 
environmental protection (including also sewerage 
and  waste  collection)  and  recreation  culture  and 
religion  (public  libraries,  tourism,  some  cultural 
activities and sports facilities). 

construction 

transport, 

public 

3. Financial arrangements

Municipalities are financed by three main sources, 
notably  own  revenues:  including  own  local  taxes 
(patent tax, property taxes, other taxes) and nontax 

212

revenue and assistance (revenue and income from 
property, local  fees,  fines,  penalties,  and  forfeits, 
concessions, other nontax revenues ). 

The annual State Budget Law grants the provision 
of  financing  for  current  expenses  in  activities 
delegated by the state entirely with funds from the 
general subsidy for state-delegated activities, while 
the  local  activities  are  financed  by  own  revenues, 
consisting  of 
tax 
revenues,  as  well  as  transfers  from  the  Central 
including  common 
Bank  for 
for  winter 
equalising 
maintenance and snow cleanup.

local  activities, 
subsidy  and 

taxes  and  fees,  non 

transfer 

local 

3.1. Own revenues

Tax revenues sum up to 35.8% of total revenues in 
municipal  revenues  in  municipal  budgets  on  31 
December 2010. According to data from the report 
on  municipal  budget  cash  implementation,  tax 
revenues,  donations  and  aid  sum  up  to  64.2%  of 
own  municipal  resources  on  31  December  2010. 
Revenues  from  municipal  fees  have  the  largest 
share  of  non  tax  revenues  and  donations  in 
municipal budgets in 2010 – 69.3%.

Municipalities  have  full  powers  on  local  fees  and 
taxes.  The  Municipal  Council  determines  the  tax 
levels  in  line  with  the  conditionalities,  order  and 
limits set by the Law on Local Taxes and Fees.

3.2. Expenditures

The expenditures on the activities delegated by the 
state  to  the  municipalities  and  on  the  local 
activities  are  being  distributed  relatively  equally, 
but  municipal  financing  is  predominantly  with 
funds  from  transfers  and  interactions  with  the 
central  budget  – approximately  57%  of  total 
municipal  revenues.  Subsidies  from  the  central 
budget  for  local  activities  finance  18-25%  of 
expenditures on local activities. Subsidies from the 
central budget  for activities delegated by the  state 
finance approximately 98% of the expenditures on 
state  activities.  Municipal  own  resources  finance 
predominantly  local  activities  (over  90%)  and  co-
finance  delegated  activities.  In 
the  common 
municipal  expenditure  structure  on  31.12.2010, 
according  to  data  from  the  report  on  municipal 
budgets, activities delegated by the state total 49%, 
co-financing  with  own  resources  – 2.3%,  and  the 

Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

Part IV

remaining  48.7%  are  expenditures  on 
activities.

local 

The  expenditures  on  the  state-delegated  activities 
are  financed  through  state  transfer,  determined  by 
standards  used  for  shaping  the  total  amount  of 
funds needed and as criteria for their distribution to 
the  municipalities.  The  budget  of  each  function 
delegated by the state is determined by established 
standards and natural indicators determined by the 
sectoral  ministries.  The  standards  are  worked  out 
in working groups consisting of representatives of 
the  corresponding  sectoral  ministry,  the  Ministry 
of  Finance  and the  National  Association  of 
Municipalities  in  the  Republic  of  Bulgaria.  This 
ensures 
transparent 
distribution  of  funds  to  the  municipalities  and 
ensures predictability in financing.

comprehensible 

and 

3.3. Grants from the central government

The  transfers  to  municipalities  are  made  on  the 
basis of entirely comprehensible criteria.

the 

the 

funds 
target  subsidy 

The targeted transfers amount to 90% compared to 
the  non-targeted  ones.  The  targeted  transfers 
consist  of:  general  subsidy  for  the  activities 
for  winter 
delegated  by 
state, 
for  capital 
maintenance, 
expenditures  (including:  road  maintenance  and 
other expenditures whose purpose is determined by 
the municipal council), for co-financing municipal 
travel 
projects, 
expenditures  (for  students,  pensionser,  military 
handicaps) and other targeted transfers.

compensating 

funds 

for 

Municipal  capital  expenditures  are 
financed 
through  a  targeted  subsidy  distributed  to  projects 
by  the  municipal  councils.  In  addition,  a  target 
subsidy  is  assigned  to  ecological  projects  and  for 
maintenance  and  construction  of  municipal  roads 
at parameters determined by the annual State Law 
Budget.  The  target  subsidy  is  distributed  on  the 
basis  of  comprehensible  criteria  on  population  –
weight  40%;  number  of  cities/towns  – weight 
40%; municipal territory – 20%.

Additionally  the  municipalities  receive  transfers 
(within  the  limits  of  8-17%  of  the  total  transfer 
specific 
size) 
programmes 
managing 
environmental activities, etc.).

activities  on 
example: 

financing 

(for 

for 

to 

is  distributed 

Non-targeted  transfers  consist  of an  equalizing 
subsidy  assigned  to  municipalities  to  provide 
services to the public, as its size is approximately 
7-9%  of  the  total  transfer  structure.  The  total 
amount  of  the  equalizing  subsidy  is  determined 
according to the rule in Art. 34, p. 5 from the Law 
on  Municipal  Budgets  (valid  since  2005),  namely 
“The size of the general equalizing subsidy cannot 
be smaller than 10% of the report on own revenues 
of  all  municipalities  for  the  previous  year”.  The 
subsidy 
the  municipalities 
according  to  a  mechanism  consisting  criteria 
determined  annually  by  the  Minister  of  Finance 
and  the  National  Association  of  Municipalities  in 
the  Republic  of  Bulgaria  (Art.  34,  p.  4  from  the 
Law  on  Municipal  Budgets).  The  mechanism  for 
determining  the  municipal  subsidies  from  the 
central  budget  is  an  annex  in  the  State  Budget 
Law. The municipalities are potential beneficiaries 
on  four  of  the  seven  Operational  Programmes 
financed  by  the  Structural  and  Cohesion  Funds  in 
the  EU  (SCF).  In  order  to  be  approved  for 
financing,  the  municipal  projects  should  meet  all 
the  criteria  set  by  the  European  and  Bulgarian 
legislation.

4. Fiscal rules

to 

of 

financing 

– The 
Municipal  departments'  monitoring
Municipal  Debt  Law  limits  local  government 
borrowing 
infrastructure 
investment and rollover of previously accumulated 
debt.  There  are  no  limits  on  the  amount  of 
borrowing of local governments; however there are 
limits  on  the  debt  service  payments.  Current 
observation  of  municipal  debt  amount  is  in  place. 
Legislative changes were introduced form the
beginning of 2011.  According to the Municipal
Debt Act:  “Art  12. (1)  (Amended 2010,  effective 
1.01.2011) The annual amount of payments on the 
debt during each particular year may not exceed 15 
per  cent  of  the  sum  total  of  revenues  from  own 
sources  and  the  block  equalizing  grant  under  the 
last  audited  report  on  the  implementation  of  the 
budget  of  the  municipality.” (Guarantees  rule) By 
the  end  of  2010  it  was 25 per  cent. “Article  17a.
(New  2010,  effective  1.01.2011) 
(1)  The 
Municipal  Council  may  not  adopt  decisions  to 
assume  long-term  municipal  debt  after  the  expiry 
of 39 months of its election.” The nominal value of 
the  guarantees  may  not  exceed  5%  of 
the 
abovementioned sum. 

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The debt rules have been very efficient in fostering 
the decrease  of  the  consolidated  debt  in  good 
economic  times  and  preventing  the  accumulation 
of debt at local government level. 

Coverage  and  exclusion: Municipal  debt  includes 
the principal, interests and commissions excluding: 
(i) non-interest loans from the central budget made 
available  to  the  local  governments  in  order  to 
finance  projects  and  programmes  co-financed  by 
the EU funds until their reimbursement; (ii) debt to 
the  Fund  for  Local  Authorities  and  Governments 
(FLAG)  aimed  at  providing  bridge  financing  for 
co-financed  with  the  EU  projects;  and  (iii)  debt 
assumed under the “Loan Agreement for Structural 
Programme  Loan  between 
the  Republic  of 
Bulgaria  and  the  European  Investment  Bank” 
(pursuant  to  §  15  of  the  Transitional  and  Final 
Provisions of the 2011 State Budget Law) .

in  previous  periods 

the  accumulated 
When 
municipal debt or guarantees exceed 15% and 5%, 
respectively, of the sum of total own revenues and 
the  total  balancing  subsidy  under  the  last  audited 
report  for  the  municipal  budget  execution,  local 
governments  cannot  issue  new  debt  or  grant  new 
guarantees  until  the  requirements  of  the  rules  are 
complied  with.  To  prevent  the  accumulation  of 
liabilities that should be serviced beyond the term 
of  the  local  governments,  they  could  issue  long-
term  debt  only  in  the  first  39  months  after  their 
election.

is  monitoring 

The  Ministry  of  Finance 
the 
application  of  the  rules  based  on  a  public  registry 
for  municipal debt, securities and  guarantees. The 
content 
the 
information  provided  in  the  registry  are  fixed  by 
the Ministry of Finance.

and  quality 

requirements 

for 

rules  have  been  amended  and 

The 
further 
strengthened  in  2010  in  order  to  preserve  fiscal 
sustainability  and  avoid  an  accumulation  of 
municipal  debt  and  guarantees  in  particular  by 
insulating  local  governments’  liabilities  from  the 
impact of political cycles. However, it is important 
to ensure that the capacity of highly indebted local 
government  to  provide  the  most  important  public 
services is not impaired.

214

5. Other relevant institutional features 

total 

local 

local 

level  of 

independence 

the  Law  on 

taxes  determined  by 

Municipalities  have 
in 
forecasting their own revenues, as they conform to 
the 
the 
municipal council regulations within the limits set 
by 
taxes  and  fees.  The 
expenditures  forecasts  for  local  activities  shall  be 
forecasts  and 
according 
programmes  for  municipal  development  adopted 
by the municipal council, in line with the trends in 
the  amount  and  types  of  public  services  provided 
and  according  to  the  resources  available  to  the 
local government.

strategies, 

the 

to 

The  preparation  of  the  municipal  draft  budget  is 
organized  by  the  municipal  mayor  in  cooperation 
with  the  town  and  regional  mayors.  The  revenue 
administration 
in 
determining  the  size  of  the  annual  and  monthly 
revenues.

the  municipality 

assists 

The  municipal  budget  determines  and  provides 
funds  for  financing 
local  and  state-delegated 
activities.

the 

The municipal mayor submits the draft budget for 
public  debate  by 
local  community.  The 
municipal  mayor  submits  the  draft  budget  to  the 
municipal  council  within  30  workdays  after  the 
State  Budget  Law  for  the  corresponding  year  has 
been made official.

The municipal council adopts the municipal budget 
within 45 workdays after the State Budget Law has 
been  made  official  and  in  accordance  with  the 
common budget classification. The municipal draft 
budget  is  presented  at  the  local  branches  of  the 
Court  of  Auditors  and  at  the  Ministry  of  Finance 
within one month after it has been approved by the 
municipal council.

subjects 

applying 

economic 

Municipal  (local)  structures,  their structural  units 
and 
budgets, 
budgetary  and  non-budgetary  accounts  and  funds 
according  to  the  Municipal  Budget  Law  are 
included in the scope of budget enterprises defined 
in  paragraph  1  from  the  Additional  provisions  in 
the Accounting Law.

In  addition,  the  Minister  of  Finance  approves 
annually  the  Single  Budget  Classification  as  an 
accounting framework for cash basis reporting.

Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

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Municipalities and all budget enterprises report on 
the  incoming  and  outgoing  funds  on  a  cash  basis 
according to the Single Budget Classification. This 
report is the basis for periodic (monthly, quarterly 
and  annual)  report  on  the  cash  implementation  of 
budget and non-budget accounts and funds.

The  annual  report  on  the  budget  and  non-budget 
accounts  and  funds  cash  implementation  is  a  part 
of the annual financial report.

According  to  the  Municipal  Budget  Law  the 
municipality  prepares  a  budgetary  forecast  giving 
revenues  and 
the  parameters  of  municipal 
expenditures 
three  years.  The 
the  next 
for 
municipal  mayor presents  at  the  Ministry  of 
Finance a forecast for the amount of own revenues 
and  local  expenditures  for  the  budgetary  year,  as 
well  as 
for  debt 
accumulation in the following year. 

the  municipal 

intentions 

the  central, 

it  determines 

The  process  of  decentralization,  started  in  2002, 
continues in 2012 as the main priorities and goals 
are  set  in  the  long  term  programme  document 
Decentralization Strategy (2006-2015). It is related 
to  conducting  national  policy  for  improving  the 
territorial  management  and 
the 
directions for distributing jurisdiction and financial 
regional  and 
resources  among 
municipal 
level  of  government,  aiming  at  a 
providing public services more effectively. In 2010 
the  Council  of  Ministers  adopted  updated 
Decentralization Strategy and a Programme for the 
period 
measures, 
responsibilities  and  deadlines  for  implementation, 
such  as  for  example  giving  more  authority  to  the 
local  government  in  relation  to  the  transfer  of 
special  and  professional  schools  without  national 
importance.

2010-2013 

including 

Each  year  the  Council  on  public  government 
decentralization prepares a report using an adopted 
system of indicators for monitoring evaluating the 
implementation and results of the Decentralization 
Strategy.

The  policies 
opportunities 
municipal development. 

in 
for 

the  budget  aim  at  creating 
and  balanced 

sustainable 

full  municipal  authority  in  administering  local 
taxes and the authority to determine independently 
the size of these taxes according to the conditions 
set in the Law on local taxes and fees.

A1.3.  CZECH REPUBLIC

1. General description

Overview

The  Czech  Republic  is  a  unitary  state  with  two 
tiers  of  subnational  self-governments:  14  regions 
(kraj)  defined  as  "higher  autonomous 
local 
government  units"  and  about  6250  municipalities 
(obce).  Prague  has  a  special  statute  as  both  a 
municipality and a region. 

The  existence  of  regions  and  municipalities  is 
recognized  in  the  constitution  articles  99-104 
stating  that  the  Czech  Republic  is  divided  into 
municipalities  which  are 
the  basic  units  of 
territorial  self-administration.    Higher  units  of 
territorial self-administration are regions.

Recent institutional reforms

The  most  recent  major  reform  took  place  in  2000 
and entered into force in stages in 2001 and 2002. 
In 2001 14 new regions were established from the 
already  existing  administrative  districts  (okres) 
that  existed  since  1996.  This  led  to  a  substantial 
inequality  in  terms  of  size  of  individual  regions 
that was greater compared to the period 1949-1960 
when similar regions existed as well. At the end of 
2002  the  administrative  districts  were  abolished 
and their responsibilities were transferred. 

2. Government competencies (spending)

of 

the 

is  a  distinction  between  autonomous 
There 
responsibilities  and  delegated  responsibilities.  In 
terms 
responsibilities, 
autonomous 
subnational  governments  have  considerable  legal 
freedom  to  handle  questions  of  local  interest  in 
compliance 
Delegated 
the 
responsibilities  are  executed  in  line  with  central 
government policy. 

with 

law. 

Regarding  tax  policy  and  local  budget  revenues, 
the 
toward  higher  municipal  financial 
autonomy is clearly visible in light of the provided 

trend 

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Regions

Healthcare

Regions  are  autonomously  responsible  mainly  for 
upper  secondary  education,  the  regional  road 
network,  regional  economic  development  and 
planning, and healthcare. Similar areas are also the 
most  significant  in  terms  of  spending.  Education 
requires  around  60%  of  total  spending  by  regions 
while  almost  20%  of  total  spending  is  devoted  to 
transport and infrastructure.

Municipalities

Municipal  autonomous  responsibilities 
include 
education  (pre-elementary  and  primary  schools), 
the  provision  of  local  social  and  welfare  services
(retirement  homes,  homes  for  disabled  etc.), 
environment  (water  and  waste  management), 
public  housing,  local  roads,  city  public  transport, 
territorial  planning,  urban  hygiene  and  others. In 
terms  of  spending,  transport  and  infrastructure 
together  with  housing  and  education  are  the  most 
significant elements of the overall spending.

Education 

A  municipality is  obliged  to  create conditions  for 
pre-school  education  in  the  last  grade  prior  to 
commencing  compulsory  school  attendance  and 
conditions  for  compulsory  school  attendance  of 
children.  For  such  purposes  a  municipality  can 
establish  or  close  down  a  nursery  and  a  primary 
school.  Also,  a  municipality  may  establish  and 
close down certain special types of schools such as 
artistic primary schools etc.

A region is  obliged  to  ensure  conditions  for 
secondary and tertiary professional education.  For 
such  purposes  a  region  can  establish  and  close 
down  secondary  schools  and  tertiary  professional 
schools.

Infrastructure/Transport

Management, maintenance and repair of highways 
and category I roads is provided on a central level 
by  the  Road  and  Motorway  Directorate  of  the 
Czech  Republic.    Category  II  and  III  roads  are 
owned  by  regions  that  are  responsible  for  their 
repair. 
maintenance 
management, 
Municipalities  own 
roads.  Subnational 
local 
governments  have  also  number  of  responsibilities 
in terms bus and railway public transport. 

and 

216

The conditions for establishment and management 
of  a  healthcare  facility  are  prescribed  by  law  in 
accordance  with  uniform  national  guidelines.  At 
the  same  time,  health  care  facilities  can  be 
established not only by the Ministry of Health, but 
also by regions, municipalities, and private bodies.
(208)  Subnational  governments  also  provide 
guidance  and  coordinate  in  areas  such  as  medical 
emergency  service  and  medical  and  first  aid,  the 
quality  of  health  care,  the  training  of  health 
of 
professionals, 
pharmaceuticals and medical supplies and number 
of others. 

purchasing 

central 

Social services

There  is  a  rather  complex  system  of  shared 
responsibilities  in  social  services.  Subnational 
governments,  among  other  things,  identify  the 
needs of providing social services, ensure adequate 
availability  of  social  facilities  and  cooperate 
together  in  preparing  and  implementing  medium-
for  social  services. 
term  development  plan 
Municipalities  were also responsible for accepting
applications 
for  certain  social  benefits  and 
determining the  adequacy  and  level  of  these 
benefits.  However,  as  of  2012  Regional  branches 
of  the  Labour  Office  of  the  Czech  Republic  are 
responsible  for  granting  and  disbursing  these 
benefits.

3. Financial arrangements

Revenues  of  municipalities  and  regions can  be 
divided  into  tax  revenues,  non-tax  revenues  and 
transfers. 

Tax  revenues  include  both  shared  taxes  and  non-
shared taxes. Shared taxes include personal income 
tax,  corporate  income  tax  and  value  added  tax. 
taxes  are  collected  centrally  and  are
These 
subsequently 
and 
municipalities.  Since  2008,  new  criteria  were 

redistributed 

regions 

to 

(208) In terms of hospital, there were 166 hospitals in the Czech 
Republic  of  which  19  were  set  up  by  the  Ministry,  24  by 
regions and 17 by municipalities in 2010. The rest includes 
either  hospitals  managed  by  other  entities  (such  as 
ecclesiastical)  but  also  hospitals  that  were  turned  into 
private companies. However, these private companies were 
mostly set up by a region or a municipality which now act
as  the  only  shareholder. (Institute  of  Health  Information 
and Statistics of the Czech Republic - www.uzis.cz)

Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

Part IV

introduced  for  redistribution  of  shared  taxes  to 
municipalities. These are based mainly on the size 
of the population and also on the geographical size 
of  municipality.  The  4  biggest  cities  are  excluded 
since  they  have  special  coefficients.  In  terms  of 
regions,  the  law  directly  determines  the  share  of 
individual  regions  on  the  total  amount  of  shared 
taxes. 

Non-tax  revenues  include  items  such  as  interest 
income,  revenues  from  renting  property,  own 
entrepreneurial activity etc. 

Finally,  transfers  represent  a  complicated  system 
of various earmarked and non-earmarked items. In 
terms  of  delegated  responsibilities,  the  central 
government provides a contribution to both regions 
and  municipalities  specifically  aimed  at  these 
responsibilities.  However,  the  funds  provided  do 
not fully cover all the costs and both municipalities 
and regions need to pay the rest of the costs from 
other  sources.  The  current  system  doesn’t  allow 
the  central  government  to  control  the  use  of  the 
funds  or  to  obtain  any  feedback  about  efficiency 
etc. As a result, the contribution to cover delegated 
responsibilities can be spent on other purposes. 

Revenues of municipalities

is 

tax 

the  most 

Municipalities  derive  about  one half  of  their 
revenues  from  taxes  that  include  both  shared  and 
non-shared  taxes.  In  terms  of  shared  taxes  the 
important  one 
value  added 
accounting for about 40% of overall tax revenues. 
Non-shared  taxes  include  real  estate  tax  and  a 
special type of corporate income tax in cases when 
the  municipality  itself  is  a  taxpayer.  The  rate  of 
tax  can  be  partially  affected  by 
real  estate 
municipalities 
through  a  system  of  certain 
coefficients.  Apart  from  these,  various  fees  and 
charges  are  included  in tax  revenues.  These 
include  fees  and  charges  related  to  environment, 
municipal  waste,  gaming  machines,  dogs  etc. 
These  own  sources  represent  only  about  14%  of 
total  tax  revenues. (209)  There  is  also  a  tax 
incentive  scheme  by  which  municipalities  are 
motivated 
to  encourage  entrepreneurship  and 
employment in their territory in order to raise their 
tax revenues. 

(209) Ministry of Finance, 2010

Transfers represented about 36% of total revenues 
in 2010 of which almost 40% were provided by the 
Ministry of labour and social affairs and over 10% 
by the Ministry of Education.

Revenues of regions

is 
largest  part  of  revenues  for  regions 
The 
represented by transfers that  accounted  for almost 
64%  of  total  revenues  in  2010.  The  vast  majority 
of this, almost 90% of all transfers and loans from 
the  state  budget,  was  provided  by  the  Ministry  of 
Education.

Tax  revenues  only  include  shared  taxes  and 
accounted  for  32%  of  overall  revenues  in  2010. 
The  value  added  tax  is  again  the  most  important 
contributor accounting for over one half of overall 
tax revenues for regions.

Education

Funds  from  the  state  budget  are  provided  for 
activities of schools and school facilities to be used 
for salaries and other non-investment costs. These 
funds  from  the  state  budget  are  provided  on  the 
basis of the real number of pupils or students and 
other  criteria.  The  funds  are  transferred  from  the 
centre  to  individual  regions  that  transfer  them 
directly to individual schools. 

A  municipality  or  a  region  cover  the  expenses  of 
school facilities established by a municipality or a 
region  with  the  exception  of  expenses  paid  from 
(i.e. 
funds  provided  from 
subnational 
operating 
governments 
subsidies directly to schools).

the  state  budget 
provide 

Transport

the  State  Fund 

The  biggest  contributors  in  terms  of  providing 
for  Transport 
funds  are 
Infrastructure (90%) and the Ministry of Transport. 
In terms of railway transportation, regions receive 
contribution from the state to cover the losses from 
this 
maintaining  public 
contribution  is  not  sufficient  and  in  recent  years 
the major part of the losses had to be covered from 
the  regions'  own  budget.  Regions  also  receive 
contributions  to  cover  loses  in  the  intra-regional 
bus  transport which  does  not  include  city  public 
transport  that  is  funded  from  the  budgets  of 
individual municipalities.

transport.  However, 

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Healthcare

Healthcare facilities are mainly financed by health 
insurance  companies.  For  example  hospitals,  in 
terms of financing the most demanding element of 
the  system,  received  over  80%  of  their  overall 
revenues  from  health  insurance  companies  in 
2010. Operating subsidies are provided by regions 
or  municipalities  and,  in  terms  of  hospitals,  they 
accounted  for  2%  of  total  revenues  in  2010.  The 
rest  represents  other  revenues  including  revenues 
from sold goods etc. Besides hospitals, subnational 
governments  also  provide  operating  subsidies  to 
emergency  medical  service 
facilities,  special 
medical institutes and other facilities. 

Social services

Until  2012  the  largest  part  of  the  funds  provided 
by the state to municipalities was used as benefits 
(material  need,  care  allowance)  transferred  to  the 
citizens.  However,  Regional  branches  of 
the 
the  Czech  Republic  are 
Labour  Office  of 
responsible  for  disbursing  these  benefits as  of 
2012. The state also contributes to the financing of 
social service facilities in the form of subsidies to 
regional 
finance  current  expenditures.  While 
authorities  are  involved  in  financial  control  and 
use  of  grants  provided  by  the  government,  both 
regions  and  municipalities    also  provide  further 
grants to finance current and other expenditures of 
social service facilities.

4. Deficit/debt

Budgets  of  subnational  governments  do  not  have 
to  be  balanced  as  long  as  the  deficit  is  financed 
either by surpluses from previous years or by loans 
or bonds. 

In 2010 the debt of municipalities was about 2% of 
GDP. Almost one half of this sum  was caused by 
the 4 biggest cities. Smaller cities have to be much 
more  careful  in  running  deficits.  Recently  there 
were certain cases of smaller municipalities having 
problem  with  their  deficit  cause  by  excessive
investments co-financed by EU funds. 

In  terms  of  regions,  their  overall  debt  was  much 
lower, only about 0.5% of GDP.

218

In  terms  of  fiscal  rules,  the  Ministry  of  Finance 
calculates  monitoring  indicators, such  as  total 
liquidity  and  the  share  of  non-own resources  to 
total assets, and sends a letter to municipalities that
do  not  comply  with  certain  criteria.  The  list  of 
municipalities  with  insufficient  criteria  values  is 
sent to relevant regional authorities. Municipalities 
should  explain  reasons  for  not  achieving  the  pre-
defined  values.  Ministry  of  Finance  submits 
information  on  municipalities'  management  to  the 
government annually at the end of September.

The government is currently discussing a reform of 
fiscal  framework  which  would  also  affect  fiscal 
rules  targeted  at  subnational  governments.  In 
addition, a reform of the system of shared taxes is 
also currently under discussion. 

A1.4.  DENMARK

1. General description

Denmark is  a  unitary  state  where  the  central 
the 
is  predominant.  However, 
government 
Constitution  of 5 June 1953 establishes
the 
principle of municipal autonomy under supervision 
of the state.

The  administrative  structure  in  Denmark  consists 
of  three tiers  including  the  national  government, 
regions and municipalities. The scope of both local
layers is governed by national legislation.

On 1 January 2007, the Local Government Reform 
came into force. The number of municipalities was 
reduced  from  271  to  98  by  mergers,  and  the  13 
counties were abolished and replaced by 5 regions. 
A reform of the grant and equalisation system was 
carried  out,  which takes  into  account  the  new 
distribution of tasks.

of 

service 

public  welfare 

Provision 
is 
predominantly  carried  out  by  the  municipalities 
and  partly  by  the  regions.  National  legislation 
stipulates  which  services  and  to  some  extent  a 
minimum quality of the services local government 
is to provide. 

Municipalities'  activities  are  financed  through  the 
municipal  income  tax  and  land  value tax and 
transfers from the state in the form of block grants
and  reimbursements of  specific  expenditures.  In 

Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

Part IV

addition,  municipalities  have  significant  revenues 
from  user  charges, while  interest  income  and 
borrowing also contribute to  municipal  finance.
Municipalities  have  autonomy  to  vary  certain  tax 
rates  (municipal  income  tax  and  municipal  tax  on 
land value).

Regions  rely  entirely  on  a  block  grant  from  the 
central  government and  activity-based  funding 
from 
the 
municipalities.

government 

central 

the 

and

the 

and 

regions 

the  regions  with 

Every year, typically in June, the government sign 
an  agreement  on  the  following year's  budgets in 
the  municipalities and 
the 
municipalities' national association (Kommunernes 
national 
Landsforening) 
association  (Danske  Regioner),  respectively.  The 
agreements  include  boundaries for  service  and 
investment costs  as  well  as  targets  for  total  local 
taxes. This practice has been in place since 1979. It 
should be noted that the agreements are signed for 
municipalities  and  regions  as  a  whole,  allowing  a 
certain  room  for  manoeuvre  for  the  individual 
municipality/region. This  also  creates  uncertainty 
of  the  overall  enforcement  of  the  agreements. 
Since  the  local  government  reform  of  2007,  the 
central  government  was  given  a  clearer  role  in 
overseeing efficiency in the provision of municipal 
and regional services. In recent years the collective 
agreements  have been supplemented by automatic 
mechanisms  to  ensure  enforcement  of  the  agreed 
level of local government spending and municipal 
tax collection.

In  2010,  total  spending  by  local  government 
amounted  to  38.2%  of  GDP  – around  2/3  of  total 
public  spending  (including  income  transfers  and 
capital 
local  government 
revenue excluding  borrowing  stood  at  38.0%  of 
GDP
central 
government).

investments).  Total 

(including 

transfers 

from 

2. Government spending

The division of tasks between administrative levels 
and  the  responsibilities  of  municipalities  and 
regions  are  defined  in  a  variety  of  legislation  on 
different subjects (rather than a law defining local 
responsibilities). 

Municipal  responsibilities  include:  social  services 
(including  income  replacing  transfers);  child  care; 

compulsory  education;  special  education 
for 
adults;  rehabilitation  and  long-term  care  for  the 
elderly;  preventive  health  care;  nature  and 
environmental  planning;  local  business  services; 
promotion  of tourism;  participation  in  regional 
transport companies; maintenance of the local road 
network; 
local  sports  and  cultural 
facilities;  and  a  responsibility  for  employment, 
shared with the central government.

libraries; 

The new regions took over responsibility for health 
care  from  the  counties,  including  hospitals  and 
general 
public 
practitioners  and  specialists,  pharmaceuticals,  etc. 
The regions also have a number of tasks involving 
regional development.

insurance 

covering 

health 

In  2010,  total  spending  by  local  government 
amounted to DKK 670 billion or 38.2% of GDP –
around  2/3  of  total  public  spending  (including 
capital  investments).  96% of  local  government 
spending  was 
expenses.
cover 
Municipalities  account  for  the  vast  part  of  local 
government spending.

current 

to 

Local  government  responsibilities  mainly  concern 
the  practical  provision  of  public  goods,  whereas 
the regulation of their (eligibility, quality and other 
requirements)  is  to  a  large  extent determined  by
the 
are
central  government.  Municipalities 
responsible  for  paying  all  income  transfers  to 
citizens  and  in  some  cases  decide  on  eligibility 
criteria.
according 
Municipalities are partly or fully reimbursed by the 
central  government  for  their  expenditures  for 
income transfers. The rate of reimbursement varies 
among  types  of  income  transfers  to  provide 
appropriate incentives to municipalities, it is set by 
the  central  government,  with  local  governments 
having no influence on it, and periodically revised.

nationally 

defined 

to 

3. Financial arrangements

In 2010, total local government revenue excluding 
borrowing  stood  at  DKK 665 billion  or  38.0%  of 
central 
GDP
government).

(including 

transfers 

from 

Municipalities'  activities  are  financed  through  the 
municipal  income  tax  and  land  value tax and 
transfers from the state in the form of block grants
and  reimbursements of  specific  expenditures.  In 
addition,  municipalities  have  significant  revenues 

219

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Public finances in EMU - 2012

from  user  charges, while  interest  income  and 
borrowing also contribute to municipal finance.

The central government collects the local taxes and 
reimburses local governments monthly.

The  number  of  taxation  levels  was  reduced  from 
three to two in the 2007 reform, since the regions,
unlike the counties, no longer have the authority to 
impose  taxes.  Their  revenues consist  of  block 
grants and activity-based funding  from the central 
government and the municipalities.

DKK 232 billion or 35% of total local revenue was 
raised by municipal taxes in 2010.

transfers 

government 

Central 
grants 
represented  59%  of  total  revenue  in  2010.  These 
falls  into  three categories:  block  grants, (partial) 
reimbursement  of  specific current  spending and 
compensation for transfer of responsibilities. 

and 

The  remainder  stemmed  from  the  sale  of  goods 
and services, asset  management and extraordinary 
revenue.

Net borrowing of local governments varies around 
0 and amounted to 0.2% of GDP in 2010.

The local taxes are:

• Municipal income tax account for around 85% 
of  local  tax  revenues. Municipalities  are  in 
principle free to set the tax rate as they wish. In 
2012, the average municipal income tax rate is 
24.923%.  The  lowest  rate  is  22.7%  and the 
highest  27.2%.  The  tax  base  is  defined  by  the 
parliament.

the 

• The municipalities levy a tax on the property's 
land  value  (on  average  land  value  represents 
about  ¼  of 
total  property  values). 
Municipalities  can  vary  the  rate  between  a 
minimum  of  16‰  and  a  maximum  of  34‰. 
in  2012. 
The  average 
Commercial  properties  and 
some  public 
buildings also pay municipal tax on land value.

tax  rate 

is  24‰ 

• Moreover,  business  properties  pay  municipal 
reimbursement  duty  on  the  building  value  and 
the land value.

• Finally, the  municipalities  receive 3/25  of  the 
corporate  income  tax  paid  by  companies  in 
their jurisdiction.

220

income 

tax  rate  has 
The  average  municipal 
increased  constantly  since  1971.  In  the  same 
period, the tax base has also been broadened. The 
increase  in  the  average  municipal  income  tax  rate 
partly reflects increased expenditures and taxation 
agreed in the annual agreement on the economy of 
the  municipalities  and  partly  reflects  breaches  of 
the agreed levels of expenditures and taxation.

The total tax revenues of municipalities as a whole 
is  stipulated  in  the  annual  agreement  between  the 
central government and the municipalities' national 
association on 
the  following year's budgets. 
Municipalities can change the balance between the 
income  tax  and  the  property  value  tax  within  the 
agreement.

actions  will 

However,  since  the  agreement  is  between  the 
central  government 
the  municipalities 
and 
collectively,  there  is  no  guarantee  that  the  sum  of 
the  municipalities' 
the 
agreement.  Since  2007,  the  collective  agreements 
have been supplemented by automatic mechanisms 
to provide incentives to the individual municipality 
and ensure enforcement of the agreed level of local 
government spending and municipal tax collection 
(see Section 4).

fulfil 

The  Ministry  of  Economics  and  Internal  affairs
and the Ministry of Finance are responsible for the 
surveillance  of  the  local  entities  budgets  and 
accountings  and  handles  block  grants  and 
equalisation,  municipal  taxes  and  municipal  and 
regional borrowing.

Since  the  local  government  reform  of  2007,  the 
central  government  was  given  a  clearer  role  in 
overseeing efficiency in the provision of municipal 
and regional services. 

4. Fiscal rules

Three  main  fiscal  rules  are  in  place  along  with 
general  requirements 
the  budgeting  and 
for 
accounting at local government level to control the 
spending of local governments.

Conditional block grants

Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

Part IV

With  effect  for  the  year  2009,  a  part  of  the  block 
grant  to  the  municipalities  (DKK  1  billion)  was 
made  dependent  on  the  total  budgeted  public 
expenditure  by  the  municipalities  as  a  whole 
keeping  within  the  agreement.  (210)  In  2010,  after 
the  accounting  of  municipal  expenditures  in  2009 
showed a substantial excess spending compared to 
the budgets, the conditional part of the block grant 
to  the  municipalities  was  increased  to  DKK  3 
billion  from  the  year  2011  and  the  conditionality 
was  broadened 
the  accounted 
to  also  cover 
expenditures. (211) If the municipalities as a whole 
exceed the  budgeted  expenditure  in  2011  and 
beyond,  the  block  grant  for  the  following  year  is 
reduced  with  the  same  amount  (up  to  DKK  3 
billion).  The  conditional  block  grant  is  reduced 
collectively  for  the  municipalities  as  a  whole  in 
case  of  infringement  of  the 2011  budgets.  For 
2012, however, 60% of the possible reduction will 
be applied to the individual municipality exceeding 
the  budget  with  the  reaming  40%  reduction 
collectively.

Tax mechanism

subsequent years, an overall municipal tax increase 
in  year 1 lead to collective reduction of the block 
grant  of  100%  of  the  tax  increase.  (213)  This 
individual  municipalities 
mechanism 
autonomy over their tax rates while ensuring better 
enforcement of the overall municipal spending and 
taxation level.

allows 

Spending ceilings

To  further  strengthen 
the  control  of  public 
expenditures  and  ensure  that  fiscal  targets  are 
implemented,  in  March  2012  the  government  will 
present a bill introducing a framework and detailed 
rules  for  a  new  fiscal  surveillance  system.  This 
new fiscal surveillance system will include binding 
expenditure  ceilings  for  the  state,  municipalities 
and regions, respectively. The expenditure ceilings 
will  each  year  be  defined  for  a  rolling  four-year 
period  and  is  to  be  adopted  by  the  parliament. 
State,  municipalities  and  regions  must  stay  within 
the  ceilings  each  year.  New  economic  sanctions 
will be introduced to support compliance with the 
expenditure ceilings.

in 

As  part  of  the  strengthening  of  management  of 
local  spending  and  to  keep  the  municipal  tax 
revenues  constant  in  real  terms,  a  mechanism  to 
reduce the block grant to municipalities in case of 
increases  in  municipal  taxes  was  introduced  from 
2009. (212) If the municipalities as a whole increase 
tax  revenues 
the  budget  (through  overall 
increased  rates  of  the  municipal  income  tax,  land 
value  tax  and  reimbursement duty  on  business 
properties),  the  extra  municipal  revenues  will  be 
clawed  back  through  a  combination  of  individual 
and  collective  reductions  in  the  block  grant.  The 
individual reduction of the block grant will amount 
to  75%  of  tax  increase  in  the  1st year  in  each 
municipality  increasing taxes  in the budget (if the 
municipalities  as  a  whole  increase  taxes  in  that 
year) with the collective reduction representing the 
remaining  25%  in  the  1st year.  In  the  2nd and  3rd
year  following  a  tax  increase,  the  individual  and 
collective  reduction  both  amounts  to  50%  of  the 
tax  increase.  In  the  4th year  following  a  tax 
increase, 
individual 
municipality  increasing  taxes  is  25%  of  the 
increase, while the collective reduction is 75%. In 

the  block  grant  of 

the 

(210) L 172 (2007-082).
(211) L 219 (2009-10).
(212) L 173 (2007-082).

Borrowing

Municipalities have access to borrowing (including 
issuing bonds) and are allowed to issue guarantees 
under  certain  limitations.  ( 214) Municipalities  and 
regions can issue bonds in capital markets through 
their  common  credit  institute  (kommunekredit). 
loans 
Municipalities 
corresponding  to  the  sum  of  expenditures  in  the 
fiscal  year  for  specific  purposes:  1)  capital 
expenditures,  2)  paying  off existing  loans  and  3) 
the costs of deferred property values taxes granted 
to pensioners.

allowed 

take 

are 

to 

Furthermore,  the  central  government  establish 
minor  loan  pools  for  specific  purposes  which  the 
the  annual 
in 
to  support 
government  wish 
agreement  about 
the  following  year's  budget 
between  local  governments'  association  and  the 
central  government.  In  2012,  these  specific  loan 

(213) For  2009  and  2010,  the  individual  reduction  amounted  to 
75%/50%/0%  in  the  1st,  2nd and  3rd year, respectively,  in 
each  municipality  following  a  tax  increase.  The  collective 
reduction  thus  represented  25%/50%  in  years  1  and  2 
respectively and 100% in subsequent  years.  An extra  year 
with  50%/50%  individual/collective  reduction  was  added 
as of 2011.

(214) BEK nr 1238 af 15/12/2011.

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Public finances in EMU - 2012

pools  amount 
municipalities.

to  DKK  1.6 billion  for 

the 

A1.5.  GERMANY

Municipalities  can  issue  loan  guarantees.  The 
amount  of  the  loan  guaranty  is  fully  subtracted  in 
the municipality's' allowed loan amount. However, 
this  is  not  the  case  for  loan  guaranties  for  social 
housing.

Municipalities'  entering  into  rental- and  lease 
agreements  is  perceived  as  borrowing  when  the 
lease 
replaces  a  capital 
expenditure and causes a deduction  from the total 
borrowing limit.

rental  agreement 

/ 

Regions have  more restricted access to borrowing 
than the  municipalities.  (215)  As  a  general  rule, 
regions  can  only  borrow  or  issue guarantees
following  a  dispensation  by  the  Ministry  of 
Economics  and  Internal  affairs.  Regions  may, 
however,  without  ministerial  approval  take  up 
loans and  issue guarantees  for  certain  specified 
capital  costs. Regions  may only  enter  into  rental-
and 
lease  agreements after  approval  by the 
Ministry of Economics and Internal affairs.

For both municipalities and regions, the portion of 
loans  of  partnerships,  cooperatives, 
limited 
liability  companies,  private  foundations  etc.  with 
participation  of  municipalities/regions is  deducted 
from the municipality's' allowed loan amount. Sale 
and  lease-back  contracts  require  the  approval  of 
the Ministry of Economics and Internal affairs.

A  liquidity  rule  stipulates  that  the  liquidity  of 
municipalities  and  regions  measured  over  the  last 
12  months  cannot  be  negative  (time  deposits  and 
bonds are included in the balance).

Municipalities  and  regions  had  a  gross  debt  of 
DKK 123 billion in 2010.

Local  entities  in  financial  difficulties  can  be  put 
under  administration  of  the  Ministry  of  Economy 
and Internal affairs.

1. Introduction 

entities 

display 

Germany  is  a  federal  state,  in  which  the  federal 
entities  – the  Länder – are  the  primary  units  to 
carry state powers. Five, together with the Eastern 
part  of  Berlin, have  acceded  to  the  Federation  in 
1990.  These 
considerable 
heterogeneity.  Berlin,  Hamburg,  and  Bremen  are 
city-states;( 216) among  the  others, territories  range 
from  2,500  km² 
to  70,500  km² 
(Saarland) 
(Bavaria),  populations  from  1,000,000  (Saarland) 
to  17,800,000  (North-Rhine-Westphalia,  NRW), 
and  population  densities  from  71  (Mecklenburg-
Vorpommern) 
to  524  (NRW). The  German 
constitution  – Grundgesetz or  Basic  Law,  BL 
hereafter  – stipulates  that  “the  exercise  of  state 
powers  and  the  discharge  of  state  functions  is  a 
matter  for  the  Länder”  unless  otherwise  specified 
by  the  Basic  Law  (Art.  30  BL).  Its  federal 
organisation  is  a  constituent  characteristic  of 
special  constitutional 
Germany 
protection: 
rules  out  any 
constitutional  amendment  that  would  affect  the 
division  of  the  Federation  into  Länder and  their 
participation on principle in the legislative process 
(Art. 79 (3) BL). 

the  Basic  Law 

that  enjoys 

and 

legislative, 

This Chapter provides an overview of the decision-
making  powers,  spending  responsibilities,  and  the 
assignment  of  revenues  of  the  different  sectors  of 
general  government  – the  Federation,  the  Länder, 
the municipalities, and the institutions of statutory 
social  insurance  – in  Germany.  Section  2  reviews 
the 
spending 
executive, 
responsibilities  by  sectors  of  general  government 
(Sections  2.1  to  2.3)  respectively.  Section  3 
provides an account of revue raising competences 
by  sectors  of  general  government  (Section  3.1)  as 
well  as  cross-sector  transfers  and  equalisation 
transfers  specifically  (Section  3.2).  Section  4 
portrays 
fiscal  governance 
applying  to  public  deficits  and  debt  (Section  4.1) 
as well as mechanisms that improve co-ordination 
and  fiscal  planning  across  sectors  of  general 
government  (Section  4.2).  Section  5  concludes 
the  German 
with  a  summary  assessment  of 

the  elements  of 

(215) BEK nr 1299 af 15/12/2011.

(216) Berlin and Hamburg consist of a single administrative unit. 
Bremen  consists  of  the  municipalities  of  Bremen  and 
Bremerhaven.

222

Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

Part IV

framework  of  fiscal  federalism  in  view  of  fiscal 
stability. 

the  design,  execution, 
2.  Responsibilities  for
and financing of policies by sectors of general 
government

Legislative  powers  of  the  Federation 

2.1
and the Länder

the 

the 

the  Federation, 

Legislative  powers  are  assigned  to  the  Länder
unless  conferred  on  the  Federation  by  the  Basic 
Law (Art. 70 BL); in practice, both the Federation 
and  the  Länder play  an  important  role  in  the 
legislative 
legislative  process. Concerning 
power  of 
the  Basic  Law 
exclusive 
distinguishes  matters  within 
legislative power of the Federation (Art. 71) from 
matters  which  fall  under  concurrent  legislative 
powers of the Federation and the Länder (Art. 72): 
in matters of the former, the Länder may legislate 
insofar as they are authorised by a  federal law; in 
matters  of  the  latter,  the  Länder may  legislate  as 
long as  the  Federation  has  not  exercised  its 
legislative  power  (Art.  72  (1)). (217) As  a  general 
rule, federal law takes precedence over Länder law 
(Art.  31  BL). In  the  adoption  of  federal  law, 
Länder are  represented  by  a  constitutional  body 
comprises  Länder
that 
called  Bundesrat, 
government  representatives,  as  opposed  to  the 
Bundestag,  the  genuine  legislative  body  of  the 
Federation.  In  certain  areas  including  those  with 
financial implications on the Länder, the adoption 
of  federal  legislation  requires  the  consent  of  the 
Bundesrat. In all other areas, the Bundesrat has the 
right 
legislation,  which  can  be 
overruled by the Bundestag though. Constitutional 
amendment  requires  a  Bundesrat majority  of  two 
thirds.

to  suspend 

Most  legislation  in  Germany  is  passed  by  the 
the  Länder under  concurrent 
Federation  and 
legislation.  Art.  73f.  of  the  Basic  Law  specifies 
matters  of  exclusive  legislative  power  of  the 
Federation  and  of  concurrent  legislative  power  of 
respectively. 
the  Länder
the  Federation  and 
legislation  extends  over 
Exclusive  Federation 

(217) Concurrent  legislation  established  by  the  Federation  still 
allows for variance enacted by the Länder in certain areas; 
while  in  others,  the  Federation  may  legislate  only  to  the 
extent that the establishment of equivalent living conditions 
or  the  maintenance  of  legal  or  economic  unity  renders  it 
necessary to do so (Art. 72 (2) BL).

and 

postal 

security, 

railways, 

including 

foreign affairs and defence, citizenship, migration, 
currency  and  measurement,  customs  and  trade, 
federal 
and 
telecommunication services. Concurrent legislation 
covers  a  broad  area  comprising  civil  and  criminal 
law,  court  organisation  and  procedure,  public 
welfare,  economic  legislation  including  industry, 
energy, commerce, banking, and insurance, labour 
law  including  employment  agencies,  as  well  as 
social 
unemployment 
insurance, educational grants and the promotion of 
research,  agriculture,  urban  real  estate  matters, 
economic  aspects  of  hospitals,  shipping,  road 
traffic, and long-distance highways, most issues of 
environmental  protection,  regional  planning,  and 
state  liability.  Initially  a  small  fraction,  laws 
passed  under  concurrent  legislation  covered  more 
than  half  of  the  federal  legislation  passed  in  the 
1990s.  Concurrent 
legislation  has  often  been 
difficult  because  of  the  frequent  mismatch  of 
the  Bundestag  and 
in 
political  majorities 
Bundesrat,  though.  The  fiscal  federalism  reforms 
of  2006  and  2009  realigned  legislative  powers 
to  revert  centralisation.  Areas  of 
somewhat 
that  have  remained  under  Länder
legislation 
competence  to  date  include  education  policy, 
municipal  law,  police  law  (except  the  Federal 
Office  of  Criminal 
the 
construction  of  roads  (except  federal  motorways).
In  practice,  most  policy  areas  are  shaped  by  joint 
legislative  decision-making  of  the  Federation  and 
the  Länder,  notable  exceptions  being  social 
the 
security where  policy 
Federation,  and  education,  which  has  remained 
under  Länder competence  (information  from  the 
ECFIN country questionnaire). 

Investigation),  and 

is  designed  by 

Municipalities  are  granted  by  power  of  the  Basic 
Law  the  right  to  regulate  all  local  affairs  on  their 
own responsibility, within the limits established by 
law. However,  municipalities  cannot  issue  fiscal 
legislation themselves. Instead the main provisions 
governing  the  planning,  structure,  execution  and 
accounting  of  local  authority  budgets  are  codified 
in  the  Local  Authority  Codes  and  in  the  local 
government  constitutions  of  the  Länder.  (218) In 
order  to  regulate  the  individual  aspects  of  local 
authority  budgets,  the  Interior  Ministers  of  the 
Länder
ordinances, 
compounded  by  special  decrees.  In  particular,  the 
Local  Authority  Budget  Ordinance  prescribes, 

enacted 

several 

have 

(218) Bundesministerium der Finanzen, (2008), p. 77.

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Public finances in EMU - 2012

among  other  things,  how  the  budgets  are  to  be 
structured. Local authority budgets are executed on 
the  basis  of  the  budget  by-law,  which  must  be 
adopted by the municipality anew each year. That 
by-law  establishes  the  budget  proper,  the  ceiling 
for short-term borrowing and the tax rates.

a

by 

reformed 

As  of  1999  the  Länder envisaged replacing  the 
traditional cameral system by introducing a system 
of  double-entry  budgeting  and  accounting, 
compounded 
cash-based 
governmental  budgeting  and  accounting  system, 
and  adopted  this  from  2003  onwards.  ( 219)  The 
underlying idea of this far-reaching reform was to 
base  budgeting  system  on  the  actual  consumption 
of resources rather than cash flows. The first states 
to  have  implemented  the  new  system are North 
Rhine-Westphalia,  Hesse,  Lower  Saxony  and 
Saxony-Anhalt. 
Baden-Württemberg, 
Brandenburg, Mecklenburg-Western  Pomerania, 
Rhineland-Palatinate,  Saarland  und  Saxony  have 
also  committed themselves  to  introducing  double-
entry  accounting.  Schleswig-Holstein  and  Hesse 
permit  their  local authorities  to  choose  between 
double-entry  bookkeeping  and  an  extended 
cameral  accounting  system.  In deviation,  the  Free 
States  of  Bavaria  and  Thuringia  plan  to  retain  the 
traditional  cameral  accounting  system,  but also  to 
allow  their  local  authorities  to  introduce  double-
entry bookkeeping on a voluntary basis. 

Executive  powers  of  sectors  of  general 

2.2
government

As a general rule, federal laws are executed by the 
Länder in  their  own  right,  unless  provided  for 
differently by the Basic Law (Art. 8ff. BL). Some 
federal  legislation  is  also  to  be  executed  by  the 
Länder on  federal  commission  (Art.  85  BL).  The 
federal government is in charge of oversight of the 
execution  of  federal  laws  by  the  Länder. The 
Federation  is  not  entitled  to  assign  governmental 
tasks to the  municipal level (Art. 84 (1) BL). The 
Federation  executes
its  own 
laws 
administrative  bodies  specifically  in  the  areas  of 
foreign  service,  federal  financial  administration, 
federal waterways and shipping, policing activities 
related to the protection of the constitution and to 
dangers  towards  Germany’s  external  interests, 
jurisdictions 
social 
extending over  several  Länder,  armed  forces  and

institutions  with 

insurance 

through 

(219) Ibid. 

224

federal  defence  administration,  air 
transport 
administration,  sovereign  functions  of  post  and 
telecommunications,  central  banking, 
federal 
waterways, inland shipping extending over several 
Länder,  and  maritime  shipping,  as  well  as  in 
matters on which it has legislative power and may 
establish  own  administrative  bodies (Art.  87ff. 
BL). In  some areas – the peaceful production and 
use of nuclear energy, air transport administration, 
and rail transport administration – the Länder may 
be  assigned  the  execution  of  legislation  under 
exclusive 
federal 
commission or in their own right respectively (Art. 
87ff. BL). In addition, there are special rule for the 
administration 
and 
motorways (Art. 90 BL).  

federal  waterways 

competence 

federal 

on 

of 

the 

joint 

Länder, 

so-called 

The  Basic  Law  allows  for  some  tasks  that  fall 
under the joint responsibility of the Federation and 
the 
tasks 
(Gemeinschaftsaufgaben) (Art.  91aff.  BL).  Joint 
responsibility is assigned for two tasks principally 
innate to the Länder: the improvement of regional 
economic  structures and  the  improvement  of  the 
agrarian  structure  and  of  coastal  protection (Art. 
91a (1)). Joint tasks are such on condition that they 
are  important  to  society  as  a  whole,  and  federal 
participation  is  necessary  for  the  improvement  of 
living conditions (Art. 91a). Besides, co-operation 
of  the  Federation  and  Länder is  provided  for  in 
matters  of  scientific  research  with  supra-regional 
relevance  and  the  promotion  of  research  facilities 
than  higher  education 
and  projects 
institutions),  projects  and 
research  at  such 
institutions,  the  construction  of  large  scientific 
installations, 
the 
performance  of  education  systems  in  particular 
(Art.  91b  BL).  Voluntary  co-operation  of  the 
Federation  and  the  Länder is  further  provided  for 
in  the  area  of  construction  and  operation  of 
information  technology  systems  (Art.  91c  BL). 
Besides, concerning basic support for job-seekers, 
the Federation or the Länder or municipalities and 
their  associations  responsible  according  to  Land
law respectively shall generally co-operate in joint 
institutions (Art. 91e). 

assessment 

(other 

and 

the 

of 

In  the  area  of  social  security,  public  tasks  are 
delegated  to  autonomous  institutions  under  public 
law. The  pillars  of  the  German  statutory  social 
security system comprise health insurance, pension 
funds, 
as 
unemployment insurance respectively. Since 2005, 

as  well 

long-term 

accident, 

Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

Part IV

regional 

federal  and 
insurance  agencies  are 
organised in a common umbrella association at the 
federal 
level,  Deutsche  Rentenversicherung. 
Health insurance is provided by  statutory carriers, 
each  of  which  operates  a  long-term  care  fund  as 
well.  Statutory  accident  insurance  is  provided  by 
occupational  associations  as  well  as  public 
territorial  grounds. 
associations  organised  on 
Unemployment 
the 
Federal  Employment  Agency.  The  respective 
autonomy 
institutions 
including 
self-
government;  control  of  legality  is  carried  out  by 
the  Federation  (and  by  the  Federal  Ministry  for 
Labour  and Social  Affairs  specifically)  unless  the 
scope  of  the  activity  extends  over  no  more  than 
three Länder (Art. 87 (2) BL). 

financial  and  organisational 

is  provided  by 

administrative 

insurance 

enjoy 

from 

transport.  Apart 

Executive responsibilities of municipalities include 
notably public utilities such as the supply of water, 
gas,  electricity,  heating,  refuse  collection  and 
wastewater  services.  They  also  include  various 
aspects  of  town  planning  including  land  use  and 
permission  to  build,  road  construction,  green 
these 
spaces,  public 
mandatory tasks there are also voluntary ones such 
as the operation of cultural entities (theatres, opera 
houses,  museums), 
or 
multifunctional  municipality  halls.  Apart  from 
these  various 
local  self-
tasks  pertaining 
government  there  are  also  tasks  having  been 
transferred  upon  municipalities  by  the  federal  or 
state  government,  including  notably  the  tasks  of 
the  Registrar's  Office,  but  also  tasks  relating  to 
youth,  schools,  public  health,  social  policy 
including  the  support  of  long-term  jobseekers  (in 
most  cases  jointly  with  the  Federal  Employment 
Agency, in some even alone).

facilities, 

sports 

to 

Spending  responsibilities  of  the  sectors 

2.3
of general government

As  a  general  principle,  among  the  Federation  and 
the  Länder, 
for  a 
government 
is  matching  administrative 
responsibility (Art.  104a  (1)  BL).  (220) Tasks 

responsibility 

spending 

tasks 

(220) The 

link 

between 

administrative 

financial 
responsibility  is  bidirectional:  if  a  law  provides  that  the 
Federation assumes at least 50 per cent of the expenditure, 
it  will  be  executed  by  the  Länder on  federal  commission 
(Art. 104a (3)). Federal  laws that establish expenditure on 
money  grants or in-kind benefits by the Länder – be it on 

and 

expenditures 

the  Federation.  Of 

carried out on federal commission are financed by 
the Federation (Art. 104a (2) BL). If money grants 
are  to  be  administered  by  the  Länder on  the 
grounds  of  a  federal  law,  the  Federation  may  pay 
(221)  The 
for  part  or  all  of  such  grants.
apportionment  of  expenditure  on  joint  tasks  is 
governed by special rules (Art. 91a ff. BL). Of the 
expenditures  on  the  improvement  of  regional 
economic structures, 50 per cent have to be borne 
by 
on 
improvement  of  the  agrarian  structure  and  of 
coastal  preservation,  the  Federation  has  to  bear  at 
least  one  half  of  the  expenditure,  in  the  same 
proportion  in  each  Land (Art.  91a  (3)  BL).  The 
apportionment  of  expenditures  related 
to  co-
operation in the area of education and research and 
of  information  technology  systems  has  to  be 
regulated by agreement (Art. 91b (3) and Art. 91c 
(2)  BL).  Concerning  expenditure  related  to  basic 
support  for  persons  seeking  employment,  if  the 
respective  tasks  are  executed  by  municipalities  or 
associations of municipalities (at their request), the 
expenditures  have  to  be  borne  by  the  Federation 
(Art.  91e  (2)  BL).  Further,  the  Federation  may 
for 
grant  financial  assistance 
particularly important investment (Finanzhilfen für 
Investitionen,  Art.  104b  BL).  Conditions  for  such 
grants  are  that  the  investment  falls  under  the 
is 
legislative  remit  of 
necessary  to  avert  a  disturbance  of  the  overall 
economic 
economic 
capacities  within 
the  federation,  or  promote 
economic growth (Art. 104b (1)). Such investment 
grants  can  only  be  temporary  and  have  to  be 
provided 
in  descending  annual  contributions. 
Special  rules  also  apply  to  fiscal  consequences  of 
international relations and obligations respectively. 
Specifically,  the  costs  of  occupation  and  internal 
and  external  burdens  resulting  from  war  are  to  be 

the  Federation,(222)

equilibrium, 

the  Länder

equalise 

to 

it 

federal  commission  or  in  their  own  right  – require 
Bundesrat consent (Art. 104a (4)).

(221) Examples of  such  laws  are  are  the Federal  Training 
Assistance  Act (Bundesausbildungsförderungsgesetz),  the 
Housing  Benefit  Act (Wohngeldgesetz),  and  the  Federal 
Act
Parental 
(Bundeselterngeld-
the 
Federation  bears  65,  50,  and  100  per  cent  of  the  funding 
respectively  (Bundesministerium  der  Finanzen  2010,  p. 
14). 

Parental 
und  Elternzeitgesetz),  where 

Benefit 

Leave 

and 

(222) Exceptions to the confinement of investment support to the 
legislative  remit  of  the  Federation  are  allowed  in  cases  of 
natural  disasters  or  exceptional  emergency  situations 
beyond governmental control with substantial harm to state 
fiscal capacities. 

225

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Public finances in EMU - 2012

international  or  supranational 

borne  to  the  Federation  (Art.  120  (1)  BL).  Costs 
stemming from a violation of obligations assumed 
under 
law  are 
assigned in accordance with the internal allocation 
of  competencies  and  responsibilities  between  the 
Federation  and  the  Länder (Art.  104a  (6)).  Of  the 
costs  arising  from  the  breach  of  SGP  provisions 
that  transcend  one  specific  Land,  15  per  cent  are 
assigned  to  the  Federation,  35  per  cent  to  the 
Länder as a whole, and 50 per cent to those Länder
that  have  caused  the  fiscal  burden  (Art.  104a  (6) 
BL).

As  a  rule,  the  Federation  and  the  Länder bear  the 
administrative expenditure of their own authorities 
each  (Art.  104a  (5)  BL). Such  expenditures 
therefore  have  to  be  distinguished  from  purpose-
related  expenditure. As  an  exception,  if  tasks 
related  to  basic  support  for  persons  seeking 
employment  are  executed  by  municipalities  or 
to  be 
their  associations,  all  expenditure  has 
covered 
including 
the 
administrative expenditure (Art. 91e (2) BL). 

Federation, 

by 

As in the case of the Federation and the Länder, as 
a  general  principle,  spending  and  executive 
responsibilities match. Note that, in contrast to the 
federal  and  Länder levels, where  there  is  one 
budget, local authority budgets are divided into an 
administrative  budget  and  a  capital  budget.  (223)
The  capital  budget  shows 
the  revenue  and
expenditure  affecting  capital  formation  (including 
loan
investment  expenditure,  new 
repayments),  while  the  other  payment  flows  that 
do not affect capital formation are included in the
administrative budget.

loans  and 

Finally,  the  social  insurance  carriers  bear  their 
spending 
responsibilities  under  administrative 
autonomy. 

3.  Arrangements  determining  the  revenues  of 
the sectors of general government

Legislative  powers  of  taxation  and 

3.1
apportionment of tax revenue

The assignment of taxing powers and tax revenues 
in Germany rests upon the principle that sectors of 
general government must have their means to meet 
the  mandated  tasks;  powers  to  legislate  on  taxes 

(223) Bundesministerium der Finanzen, (2008), p. 77.

226

autonomy 

are assigned to the Federation, the Länder, or both 
(Art.  105  BL). Exclusive  legislative  powers  are 
conferred to the Federation with respect to customs 
duties  and  fiscal  monopolies.  The  Federation 
enjoys concurrent legislative power with respect to 
all  other  taxes  where  it  receives  part  or  all  of  the 
revenue, or on condition that the establishment of 
equivalent living conditions or the maintenance of 
legal or economic unity renders federal regulation 
necessary  (Art.  72  (2)  BL).  The  Länder have 
legislative  powers  with  regard  to  local  taxes  on 
consumption  and  expenditures,  and  may  besides 
establish  the  rate  of  the  tax  on  acquisition  of  real 
estate.  (224) Bundesrat  consent  is  required  for 
federal legislation on taxes where part or all of the 
revenue goes to the Länder or municipalities. The 
the  municipalities 
of 
financial 
guaranteed by the Basic Law includes the right to a 
source of tax revenues upon  economic ability and 
the right to establish the rates of taxation of these 
sources  (Art.  28  (2) BL).  However,  unlike  in  the 
higher  levels  of  government,  local  authorities  are 
bound  by  principles  relating  to  the  raising of 
(225)  Specifically,  under 
said
revenue. 
revenues  necessary to  meet 
principles, 
municipal obligations are to be generated firstly by 
means  of  special  charges  (fees,  contributions, 
charges under private law), to the extent that this is 
reasonable  and  necessary,  for  services  provided. 
Thereafter, these  services  are  to  be  financed  by 
taxes  insofar  as  the  other  sources  of  revenue 
(including  transfers from  reserves,  cost  refunds, 
general  financial  grants  from  the  Länder)  do  not 
suffice.  Only  as  a  last  recourse, funds  may  be 
obtained by borrowing.

the 

the 

taxes 

duties, 

customs 

apportionment. Under 

Tax  revenues  are  distributed  among sectors  of 
general  government  under  separate  apportionment 
separate 
or 
shared 
apportionment, 
on 
consumption unless not regulated differently, taxes 
on transactions related to motorised vehicles, taxes 
on  capital  transactions  and  insurance,  and  the 
surtax on income tax and corporation taxes among
others are federal taxes (Art. 106 (1) BL). Revenue 
from  the  property  tax,  the  inheritance  tax,  the 
motor  vehicle  tax,  taxes  on  certain  transactions, 
and  taxes  on  beer  and gambling  establishments 
(2)  BL). 
goes 

the  Länder

(Art.  106 

to 

(224)  Municipalities have the right to establish the rates on taxes 

on real property and trades (Art. 106 (6) BL). 

(225) Ibid.

Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

Part IV

from 

local 

populations

trades,  and 

Municipalities  receive  revenue  from  taxes  on  real 
property, 
taxes  on 
consumption and expenditures. By apportionment, 
the income tax, corporation tax and VAT are joint 
taxes:  their  revenues  accrue  to  the  Federation,  the 
Länder,  and 
in  different 
the  municipalities 
quantities  (Art.  106  (3)  BL).  The  Federation  and 
Länder receive  income  tax  and  corporation  tax 
revenues in equal shares (Art. 106 (3) BL). Based 
on federal legislation requiring Bundesrat consent, 
a  share  of  the  income  tax  revenue  has  to  be 
distributed  to  the  municipalities  according  to  the 
taxpaying  ability  of  the  inhabitants. (226)  The 
apportionment  of  VAT  (turnover  tax)  revenues  to 
the  Federation  and  the  Länder is  determined  by 
federal  law  with  Bundesrat  consent,  in  line  with 
expenditure  needs  established  by  multi-annual 
planning and the aim to achieve a fair balance and 
ensure the uniformity of living standards (Art. 106 
(3) BL). Of the Länder VAT share, at least 75 per 
cent is distributed among the  Länder according to 
their 
(Umsatzsteuer-
Vorwegausgleich);  the  remainder  is  distributed 
within  the  framework  of  horizontal  equalisation 
(Ergänzungszuweisungen)(Art.  107  (1)  BL,  see 
below). (227) Part  of  VAT  revenue  also  goes  from 
the  Länder to  their  municipalities,  based  on  a 
formula  reflecting  geographical  and  economic 
factors  (Art.  106  (5a)  BL).  Finally,  Länder
legislation  has to establish a  share of the joint tax 
revenue  to  accrue  to  municipalities;  it  may  also 
assign  part  of  other  Länder tax  revenues  to  them 
(Art. 106 (7) BL). As a result of the above system 
of joint tax apportionment, the Federation and the 
Länder receive  50  per  cent  of  the  corporation  tax 
each.  Of  the  income  tax,  42.5  per  cent  go  to  the 
Federation  and 
the 
municipalities receive 15 per cent as established by 
the  Municipal 
Act 
Finance 
(Gemeindefinanzreformgesetz).  Of  the  VAT,  a 
share  from  the  Federation  goes  to  the  European 
Union,  that  is  recalculated  annually.  In 2011,  the 
planned  VAT  revenue  shares  were  as  follows:  53 
per  cent  to  the  Federation,  45  per  cent  to  the 
Länder,  and  2  per  cent  to  the  municipalities 
In 
(Bundesministerium  der  Finanzen,  2012). 

the  Länder each,  while 

Reform 

(226) The  same  law  provide  the  municipalities  with  the  right to 
establish  supplementary  or  reduced  rates  with  respect  to 
their share of the tax (Art. 106 (5) BL).

(227) This  apportionment  of  VAT  share  among  the  Länder
according  to  their  revenue  raising  capacity  constitutes  the 
first 
the  multi-step  process  of  horizontal  fiscal 
equalisation as described in section 3.2.

in 

addition,  there  are  special  rules  regulating  the 
apportionment  of  motor  vehicle  tax  and  federal 
grants  for  local  mass  transit  (Art.  106a  and  106b 
BL). 

Municipalities  also  receive  their  share  in  the 
intergovernmental distribution of tax revenues. As 
to the shared taxes, they receive shares of income 
tax and VAT. In particular, they are empowered to 
draw on the property tax and the local business tax 
(raised  on  top  of  corporate  tax  and  mainly  based 
on  company  profits  albeit  corrected  for  a  number 
of items), of which a minor part are still ultimately 
paid  to  the Länder and  federal  governments.  To 
this  add
taxes  on  consumption  and 
expenditure  (including  taxes  on  hunting,  fishing, 
drinks, dog ownership, second residences). 

local 

Joint  taxes  provide  the  largest  part  of  federal 
revenues. For  instance,  of  the  total  projected 
federal gross revenues of 306 billion euro in 2011, 
about  60  per  cent  were  receipts  from  joint  taxes, 
while about 30 per cent were federal tax revenues, 
in addition to other revenues  amounting  to 10 per 
cent. 

i.e. 

The pillars of social security receive revenues from 
contributions  of  contributors  – typically  by 
employers and employees in equal shares – that are 
complemented  by  grants  (see  Section  3.2). Social 
security 
ceilings 
contribution 
(Beitragsbemessungsgrenzen)  and  contribution 
rates (Beitragssätze) are established by concurrent 
legislation, 
in  practice  by  governmental 
ordinance  with  the  consent  of  the  Bundesrat.  The 
tasks of the statutory accident insurance providers 
are financed by employers and the Federation, the 
respectively; 
the  municipalities 
Länder
contributions  are  being  established  ex-post  to 
cover outlays based on employment compensation, 
occupational risk and the number of inhabitants (in 
the case of municipal bodies) and insured members 
respectively. 

or 

Fiscal  transfers  across  and  within 

3.2
sectors of general government

To  equip  each  Land  with  the  necessary  means  to 
cover  their  necessary  expenditures  and  ensure 
equivalent  living  conditions,  Germany  operates  a 
powerful  system  of  fiscal  equalisation  involving 
the Federation and the Länder. It consists of three 
(1)  primary  horizontal  equalisation 
schemes: 

227

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Public finances in EMU - 2012

tax 

the 

Länder

federal 

income 

from 
the 

revenue 
and 

between 
(gesamtdeutscher 
Länder
Finanzausgleich)  by means  of  distributing  part  of 
the  Länder share  of  VAT  according  to  revenue 
raising capacities (Art. 107 (1) BL), (2) secondary 
horizontal equalisation – Länderfinanzausgleich in 
the narrow sense – across the Länder (Art. 107 (2) 
BL),  and  (3)  secondary  vertical  equalisation  by 
grants 
supplementary 
(Bundesergänzungszuweisungen)(Art. 107 (2) BL). 
In the first step, a maximum of 25 per cent of the 
Länder share  of  VAT  goes  to  the  Länder with 
below-average 
tax, 
taxes 
corporation 
(Umsatzsteuer-Ergänzungsanteile)  as  established 
by  Art.  107  (1)  BL.  Receipts  are  established 
according  to  the  volume  of  the  Länder receipts 
from  the  joint  taxes  (without  VAT)  plus  the 
Länder taxes. The second step further equalises tax 
revenues  at  the  Länder level  (Art.  107  (2)  BL), 
based  on  a  measure  of  fiscal  capability and  a 
measure of theoretical equal revenues. The former 
consists of the sum of tax revenues at Länder level 
and  64  per  cent  of  municipal  tax  revenues  in  the 
respective  Land.  The  latter  is  calculated  in  the 
same  way,  but  using  average  per  capita  revenues; 
adjustments  then  are  made  to  reflect  structural 
characteristics  of  the  city  states  (with  adjustment 
coefficients  of  1.35)  and  some  Länder of  the 
former  GDR  with  low  population  densities  (with 
adjustment  coefficients  of  1.02  to  1.05).  Länder
with a negative difference between the two indices
are  entitled  to  equalisation  payments  from  the 
Länder with  above  average  capabilities,  where 
contributions  and  receipts  decrease  towards  the 
mean respectively. In the third step, supplementary 
non-earmarked  grants  are  provided  by 
the 
Federation  to  Länder with  subpar  fiscal  capacity, 
levelling  the  gap  between  the  revenues  against 
99.5  per  cent  of  the  mean  by  77.5  per  cent 
(Bundesergänzungszuweisungen).  Even  further  to 
that,  Länder with  weak  revenue  raising  capability 
receive  transfers  to  compensate  from  specific 
spending  needs (Art.  107  (2)  BL)(Sonderbedarfs-
Bundesergänzungszuweisungen).  In  2011,  such 
transfers  were  granted  (1)  to  Berlin  and  the  five 
eastern  Länder to  cope  with  investment  backlogs 
resulting  from  the  separation  of  Germany  within 
the renewed Solidarity Pact (Solidarpakt II); these 
payments will be discontinued as of 2020;(228) (2) 

the five eastern Länder (without Berlin) to support 
fiscal needs from structural unemployment and the 
combination  of  unemployment  benefits  and 
welfare  aid,  and  (3)  grants  to  fiscally  weak  small 
Länder to compensate for above average expenses 
on political governance. In sum, these equalisation 
funds  provide  considerable  and  projectable 
statutory  transfers  to  the  Länder with  below-
average fiscal capability. 

per 

cent 

(Hesse 

The  variance  of  per  capita  revenues  across  the 
Länder has  been  considerably  compressed  by 
fiscal equalisation. In 2011, the three  mechanisms 
(without  transfers  for  specific  needs)  reduced  the 
range  of  Länder tax  revenues  relative  to  the 
average  from  156  and  128  to  51  per  cent 
(Hamburg and Bavaria versus Thuringia) to 105 to 
98 
versus 
Saxony)(Bundesministerium  der  Finanzen,  2011). 
The  volumes  involved  in  the  first  and  the  second 
step amounted to about 7.3 billion euro, i.e. around 
3.3 per cent of the total amount of Länder revenues 
without  federal  grants  (but  including  the  VAT 
Länder share),  while  the  federal  grants  under  the 
third step made up 2.6 billion euro, 1.2 per cent of 
the  Länder revenues  without  these  grants.  The 
largest part of revenue – 90 per cent of the vertical 
distribution  of  VAT  (step  one),  and  81 per  cent 
respectively  involved  in  horizontal  redistribution 
and the non-earmarked federal transfers (steps two 
and three) – were received by the ex-GDR eastern 
Länder.  The  first  step  reduced  the  relative  fiscal 
positions  of  seven  countries  (Hamburg,  Bavaria, 
Hesse,  Baden-Württemberg,  North  Rhine-
Westphalia,  Rhineland-Palatinate,  and  Schleswig-
Holstein)  while improving positions of the others. 
In  the  second  and  third  step  were  twelve  and 
(Lower 
eleven 
Saxony,  Saxony,  Rhineland-Palatinate,  Saxony-
Anhalt, 
Thuringia, 
Schleswig-Holstein, 
Brandenburg, 
Mecklenburg-Vorpommern, 
Saarland,  Berlin,  and  Bremen,  and  North  Rhine-
Westphalia  (only  step  2).  The  federal  grants  for 
special 
(Sonderbedarfs-
Bundesergänzungszuweisungen)  made  up  for  a 
total  of  another  12  billion  euro.  Non-earmarked 
grants to the Länder made up about 10 per cent of 
the projected budget – 28.8 billion euro – in 2011. 

recipient  Länder

respectively 

needs 

(228) The  first  cycle  of  the  Solidarity  Pact  was  established  in 
1995.  As  a  result  of  a  challenge  by  Baden-Württemberg, 
Bavaria,  and  Hesse,  the  solidarity  pact  was  renewed  in 

228

2005, 
limiting 
discontinuation after 2019.

the 

transfers  and 

scheduling 

their 

Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

Part IV

insurance, 

unemployment 

Revenues  of  the  social  insurance  institutions, 
including 
are 
complemented  by  federal  grants  as  established  by 
the  Basic  Law  (Art.  120  (1)  BL). In  case  of  the 
statutory  pension  insurance  scheme,  Deutsche 
Rentenversicherung,  the  Federation  provides  co-
funding  by  balancing  the  difference  between
revenues  and  expenditure.  In  the  federal  budget 
plan  of  2011,  grants  to  the  pension  scheme 
amounted to 26 per cent of the federal budget; high 
subsidies also result from the merger of the social 
insurance  funds  of  the  former  GDR  with  the 
German  statutory  insurance  carrier.  Bodies  of  the 
statutory  health  insurance  system  (Gesetzliche 
Krankenversicherung)  also  receive  annual  grants 
to  compensate  for  the  execution  of  tasks  that  are 
immediate  remit  (such  as  co-
outside 
insurance  of  non-contributing  family members); 
these were projected to amount to 5 per cent of the 
federal budget (amounting to 15.3 billion euro) in 
2011. (229)

their 

The own revenues of municipalities are augmented 
by equalisation revenues. With the exception of the 
receive  an 
states,  municipalities 
three  city 
additional  source  of  revenue  where  required  to 
minimise differences in financial power among the 
municipalities. Indeed on average this is the largest
spending  item  in  Länder budgets.  This  system  of 
vertical and  sometimes  horizontal  equalisation 
(where  municipalities  become  net  contributors) 
within  each  Land  varies  and  is  laid  down  in 
individual  Länder laws.  Some  of  these  vertical 
transfers  are  disbursed  as  matching  grants, 
involving  co-financing,  occasionally  also  by  the 
federal  government  or the  EU.  Those  matching 
grants  would  typically  be  for  transport  and  other 
infrastructure projects. However the largest part of 
the 
out 
transfers 
unconditionally,  with  spending  decisions  being 
fully  at  the  discretion  of  the  recipients.  The  fiscal 
transfers are calculated on the basis of two criteria: 
fiscal  capacity  and  fiscal  need.  Fiscal  capacity  is 
computed based on tax revenue at standardised tax 
rates,  while fiscal  need is determined on the basis 
of  a  politically  chosen  acceptable  amount  of 
spending per resident.

equalisation 

paid 

is 

(229) Concerning  employment,  the  federal  budget  plan  2011 
foresees  no  grant  to  the  Federal  Employment  Agency 
(2010, such grants made up 5.2 billion euro or 1.7 per cent 
of the budget), while loans of comparable magnitude – 5.4 
billion euro – are budgeted instead. 

For  2011,  the  Federation  has  allocated  11.2  per 
cent of its planned budget related to basic benefits 
to 
by 
municipalities or their associations. 

administered 

jobseekers, 

that 

are 

4 

Fiscal governance

Provisions 

4.1
issuance of bonds, insolvency, and bailout

on  public

borrowing, 

in  1969 

Applying to the Federation and the Länder, before 
2011,  public  borrowing  was 
restricted  by 
constitutional provisions in principle but less so in 
practice. The “golden rule” was introduced into the 
to  ban  financing  non-
Basic  Law 
investment  expenditure 
similar 
provisions were enshrined in Länder constitutions. 
(230)  Exceptions  made  allowed 
to  prevent 
disturbances 
equilibrium. 
economic 
Arbitrary application of this possibility resulted in 
the  rise  in  public  debt  at  the  Länder level.  Fiscal 
imbalances  have  become  particularly  pressing  in 
three Länder: Berlin, Bremen and Saarland.

from  credit; 

the 

to 

With entry into force in 2011, Germany introduced 
a  constitutional  structural  budget  balance  rule 
applicable  to  the  Federation  and  the  Länder.
Specifically, the amendments agreed in 2009 (231) 
require  that  the  budgets  of  the  Federation  and  the 
Länder be  balanced  without  revenues  from  credit 
(Art.  109  (3)  BL).  For  the  Federation,  this 
principle  is  established  to  be  satisfied  when 
revenue from borrowing does not exceed 0.35 per 
cent  of  nominal  GDP,  while  cyclical  effects  have 
to  be  taken  into  account  symmetrically.  (232)  The 
Basic  Law  further  establishes  a  notional  control 
account  where  deviations  from  the  ceiling  are 
recorded; debits on this account exceeding 1.5 per 
cent  of  GDP  have  to  be  reduced  in  accordance 
with  the  economic  cycle  (Art.  115  (2)  BL).  The 

(230) Before  the  1969 reform,  the  Basic  Law  allowed  public 
borrowing  only  to  cover  extraordinary  needs  and  only  for 
profitable  purposes.  The  reform  in  1969  enabled  debt-
financed public expenditure for economic stabilisation. 
(231) In  the  deliberation phase,  the  Länder maintained  strong 
reservations  against  the  introduction  of  the  debt  brake, 
based  on  their  right  to  fiscal  autonomy;  positions  only 
moved 
the  financial  crisis  2008. 
Schleswig-Holstein even – unsuccessfully – challenged the 
debt brake at the federal Constitutional Court in 2010. 
(232) At the level of the  Federation, cyclical adjustment is done 
using  the  common  OECD/Commission  methodology.  On 
the Länder level, there is a lack of an agreed methodology 
for cyclical adjustment: this may result in differences in the 
effective implementation of the rule. 

the  course  of 

in 

229

European Commission

Public finances in EMU - 2012

established  credit  limits  may  be  exceeded  in  the 
case of natural catastrophes or unusual emergency 
situations beyond  governmental  control  and  with 
substantial  harm  to  the  state’s  financial  capacity. 
Such deviation requires decision by the majority of 
Bundestag members  as  well  as  the  submission  of 
an  amortisation  plan  including  repayment  of  such 
excess  credit  within  an  appropriate  time  horizon. 
The  deficit  ceiling  of  the  budget  balance  rule  is 
phased  in  with  a  transition  period  to  gradually 
reduce  the  excess  structural  deficit  by  about  0.3 
per  cent  of  GDP  p.a.  to  reach  the  ceiling  as  from 
2016. For the Länder, a transition period is granted 
to  reduce  excess  structural  deficits  and  comply  as 
of  2020.  During  the  adjustment  path,  Schleswig-
Holstein,  Berlin,  Bremen,  Saarland,  and  Saxony-
Anhalt,  Länder with  particularly  difficult  fiscal 
positions  will 
assistance  payments 
provided in equal shares by the Federation and the 
other  Länder
(Konsolidierungshilfen).  These 
grants  are  conditional  on  compliance  with  an 
agreed consolidation path. 

receive 

to 

the  risk  of 

Seemingly  strong  at  first  sight,  the  debt  brake 
carries  implementation  risks  at the  federal  level; 
substantial scope  for variation in the  transposition 
to constitutional and secondary law at Länder level 
adds 
inconsistent  and  overly 
permissible application. Specifically, at the federal 
level,  inconsistent  accounting  provisions,  the  lack 
of  consideration  of  financial  transactions,  and 
insufficient consideration of fiscal positions of the 
social  security  sector  and  of  special  funds  have 
to  an 
been 
identified  as  potential  obstacles 
effective 
debt 
(Sachverständigenrat,  2011).  The  Länder are  free 
to 
relevant 
implementation  provisions.  Four  Länder have 
already  enshrined  balanced  budget  rules  in  their 
constitution,  while  in  another  such  an  amendment 
is  being  drafted.  Another  six  Länder have 
incorporated  budget  balance  rules  in  their  state 
budget  acts.  The  latter  typically  allow  for  more 
generous  possibilities  for  non-compliance  though, 
and  can  besides  be  modified  by  ordinary 
legislative  procedures.  (233)  Further  scope  for 

legal  basis 

containment 

specify 

and 

the 

of 

(233) Schleswig-Holstein,  Hessen,  Rhineland-Palatinate,  and 
Mecklenburg-Vorpommern have enshrined a debt brake in 
their constitutions, while such amendment is in the process 
of  adoption 
in  Lower  Saxony.  Baden-Württemberg, 
Bavaria,  Hamburg,  Saxony,  Saxony-Anhalt  and  Thuringia 
have  adopted  balanced  budget  rules  in  their  budget  acts
(Landeshaushaltsordnungen). 

230

differences  in  implementation  is  given  by  the 
choice  with  regard  to  applying  the  debt  brake  to 
nominal  or  structural  budget  balances, 
the 
methodology for cyclical adjustment, or whether to 
use  a  control  account.  (234)  The  effectiveness  of 
debt  brake  provisions  at  the  Länder level  might 
further  be  hampered  by  the  insufficient  coverage 
of municipal public finances (Sachverständigenrat, 
2011). 

The institutional framework to monitor compliance 
with  the  debt  brake  has  been  strengthened  in 
Germany,  while  enforcement  provisions  are  less 
strict. Compliance  with  the  constitutional  debt 
brake  at  both  the  federal  and  the  Länder level  is 
monitored  by  the  newly  established  Stability 
Council that  is  composed  of  the  federal  ministers 
of finance and economics and the finance ministers 
of  the  Länder.  Assessments  are  based  on  a 
federation  wide  early  warning  system  to  indicate 
fiscal  distress:  in  their  presence,  a  consolidation 
will  be  established  in  the  concerned  Land. (235)
Concerning  enforcement  provisions,  there  is  the 
option  of  filing  an  action  with 
the  Federal 
constitutional  court  (covering  the  Länder as  well 
as  of  2020)  or  at  the  Länder constitutional  courts 
in  case  that  respective  constitutional  amendments 
have been made at the level of the respective Land. 
the 
sanctions  are  available 
Additional 
recipients of consolidation support (see Section 3) 
that are suspended in case of non-compliance. 

for 

Budget  balance  rules  have  also  been  in  place  for 
the  local  government  sector, typically  codified  in 
the  Länder Local  Authority  Acts. Local  authority 
budget law  generally obliges  the  municipalities to 
balance 
its 
administrative  and  capital  accounts,  but  does 
permit some borrowing, for investment purposes in 
particular.  The  monitoring  is  carried  out  by  the 
municipal supervisory agencies of the Länder. The 
local authority supervisory agencies can refuse the 

expenditure 

revenues 

and 

in 

(234) E.g., to date, only Rhineland-Palatinate has set up a control 
account similar to the one at the federal level. , based on a 
federation  wide  early  warning  system  to  indicate  fiscal 
distress.

(235) Potential  fiscal  distress  is  monitored  using  the  following 
indicators: structural budget balance per capita, borrowing-
to-expenditure  ratio,  interest-tax  ratio  and  debt  level  per 
the 
these 
capita.  When 
established  thresholds,  budgetary  distress is  identified. 
Threshold  are  defined  against 
the  Länder average. 
Therefore, a simultaneous worsening of the fiscal situation 
of the Länder is left undetected.

indicators  exceed 

three  of 

Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

Part IV

the 

local 

authority 

authorisation  of  the  municipal  budgets  in  case  of 
impose  sanctions 
non-compliance.  They  can 
against 
concerned. 
Municipalities  with  financial  difficulties  can  be 
obliged  to  implement  consolidation  programmes. 
In  particular  cases,  the  supervisory  agencies  can 
also temporarily take over the administration of the 
municipality. The rule has been respected in more 
than  50%  of  cases  and  contributes  to  fiscal 
discipline.  Non-compliance  is  justified  mostly  by 
poor financial endowment of the local authorities.

Default  of  public  authorities  has  not  been  a 
credible  scenario  in  Germany  in  the  past,  but 
expectations  could  be  changing  at  present.
Specifically,  according  to  the  bankruptcy  code 
(Insolvenzordnung), bankruptcy procedures against 
public  bodies  are  inadmissible.  At  the  same  time, 
the  highly  indebted  Länder recurrently  obtained 
large  transfer  payments  to  alleviate  their  fiscal 
distress.  In  1988,  Bremen  and  Saarland  turned  to 
the  Constitutional  Court 
transfer 
payments  from  the  Federation,  arguing  that  their 
high 
levels  of  debts  resulted  from  adverse 
economic  developments  outside  their  control  and 
claiming  that  they  would  be  unable  to  fulfil  their 
constitutional  mandate  otherwise.  A  ruling  of  the 
Constitutional Court of 1992 posited that financial 
support  indeed  was  to  be  granted  to  states  in 
financial  hardship.  As  a  result  of  a  Constitutional 
Court  decision  of  2005,  payments  to  Bremen  and 
Saarland  are  to  be  discontinued  until  2019  (Stehn 
and Fedelino, p. 9). 

to  demand 

have 

In 
the  event  of  municipalities  being  highly 
indebted or experiencing  payment  difficulties,  the 
responsibility  rests  with  the  government  of  the 
respective  Land  to  restore  the  financial  capability 
of the municipalities concerned. To that end many 
Länder
announced 
implemented 
programmes for local authority debt reduction and 
fiscal consolidation. Regional government support 
generally  is  linked  to  consolidation  efforts  at  the 
local  authority 
level.  Municipalities  are  not 
directly  involved  in  the  debt  brake.  However,  at 
present  there  are  concerns  that  its  introduction  at 
state  level  may  imply  a  shift  of  the  financial 
burden to municipalities.

or 

4.2
budgetary procedures

Medium-term  planning  and  other 

for 

Although  not  legally  binding,  some  co-ordination 
is  applied  in  medium-term  budgetary  planning  of 
the Federation and the Länder. For the Federation, 
medium-term  planning  is  anchored  in  the  Basic 
Law (Art. 110 BL). A medium-term financial plan 
is  adopted  with  the  federal  budget  each  year,  it 
extends  over  three  forthcoming  years. The  plan 
the  main 
includes  detailed  projections 
expenditure items by spending areas and revenues 
broken  down  on  different  taxes.  The  budgetary 
targets  can  be  revised,  but  medium-term  planning 
is  part  of  the  coalition  negotiations,  so  that  new 
drafts  are  in  line  with  (maintained  or  revised) 
budgetary  objectives. Owing 
fiscal 
autonomy, the Länder operate separate procedures 
for  medium-term  budgetary  planning 
that 
correspond  to  that  of  the  federal  level.  Co-
ordination  of  medium-term  planning  between  the 
Federation  and  the  Länder is  provided  by  the 
Stability  Council.  The  Stability  Council  makes 
recommendations  for  budgetary  discipline  and  for 
line  on  expenditure  specifically. 
a  common 
Furthermore, 
it  biannually  discusses  budget 
projections for the federation and the Länder used 
as inputs to the Stability Programme. 

their 

to 

fiscal 

institutions 

five  economic 

Consistency  of  budgetary  planning  across  sectors 
of  general  government  is  also  by  the  work  of 
traditionally 
independent 
operating in Germany. Specifically, projections for 
taxes  provided  by 
research 
institutes, the Bundesbank, the German Council of 
Economic  Experts  (Sachverständigenrat)  and  the 
federal Ministry of Finance are co-ordinated by the 
Working  Party  on  Tax  Revenue  Forecasting 
(Arbeitskreis  Steuerschätzung).  This  body  acts  as 
advisory council to the federal Ministry of Finance 
and  consists  of  representatives  of  the  federal 
ministries of finance and economic affairs, the five 
research  institutes,  the  federal  Statistical  Office, 
the Bundesbank, the German Council of Economic 
the  Federal  Union  of  Central 
Experts,  and 
Authorities
Associations 
of 
(Bundesvereinigung 
kommunalen 
Spitzenverbände).  The  co-ordinated  tax  revenue 
estimates  are  extrapolated  to  tax  revenue  for  the 
federal  government,  the  Länder governments,  the 
local  authorities,  and  the  EU;  this  provides  the 
grounds  for  the  annual  budget  and  medium-term 
the  Federation.  The 
budgetary  planning  of 
consistency  of  budgetary  planning  across  sectors 
of  general  government  is  further  enhanced  by  the 
scrutiny of independent fiscal institutions. Notably, 

Local 
der 

231

European Commission

Public finances in EMU - 2012

of 

Council 

Economic 

Experts 
the 
(Sachverständigenrat),  a  body  of 
independent 
economic experts, provides fiscal analyses as well 
long-term 
as  macroeconomic 
forecasts  and 
projections 
for  all  general  government,  and 
assesses the medium-term budgetary framework of 
the  Federation.  Yet  another  institution,  the  Joint 
leading 
Macroeconomic  Forecast 
research  institutes  (Gemeinschaftsprognose),  co-
ordinates  the  data,  assumptions  and  conclusions 
applied  by  several  leading  research  institutions  in 
their  analyses  of  general  government  public 
finance,  and  also  scrutinises  the  medium-term 
planning framework of the Federation. Finally, the 
Advisory Board to the Federal Ministry of Finance 
advises  the  ministry  on  all  issues  of  fiscal  policy, 
fiscal 
covering  all  general  government  and 
relations between its sectors as well.

initiative  of 

Council 

The 
country-specific 
issued 
recommendations  to  Germany with  respect  to 
subnational governments (see Box I.3.2 above).

A1.6.  ESTONIA

1. General description

Estonia is  a  unitary  country.  It  has  a two-tier 
government  structure introduced  in  1993,  which
includes  the  central  government  and  266  local 
governments.  The  municipalities  have  their  own 
councils  elected  every  four  years  and  their  own 
budget.  The  size  of  the  local  governments  varies 
greatly: the biggest municipality is the capital city 
Tallinn,  while around  two  thirds  of  the  local 
governments have less than 3000 inhabitants. The 
local  governments  can  form  districts  on  their 
territory in accordance with the law.

The  local  governments  are  integrated  into  15 
counties, which are not a separate governance tier, 
but  state  administrative  units.  Their  role  is  to 
facilitate  coordination  between  the  state  and  the 
local  level  in  implementing  regional  development 
are 
programmes.  The 
appointed  by  the  government  in  consultation  with 
the local governments to represent interests of the 
state in the county.  

governors 

counties' 

is the Local Government Organisation Act (1993). 
Estonia  ratified  the  European  Charter  of  Local 
Self-Government  without  reservations  in  1994.
local  governance  framework 
Since 
remained broadly stable.

then, 

the 

the 

According  to  the  OECD  data, (236)  in  2010,  the 
local 
total  expenditure  and  revenue  of 
governments  amounted  to  EUR  1435.4  m  and 
1467.9  m,  respectively,  which  is  around  25%  of 
general  government  expenditure  (slightly  below 
the  historical  average)  or  10%  of  GDP.  Taxes 
represent around 46% and grants 42% of the total 
local  government  revenue,  while  the  respective 
shares for the central government are 86% and 0%.  

2. Government spending

include

The  main  areas  of  responsibilities  of the local 
governments
education,  health  care, 
culture and sports, social welfare services, housing 
and  utilities,  waste  management,  maintenance  of 
infrastructure, and spatial planning:

is 

the 

education  budget.

• Education accounts for roughly 40% of all total 
expenditure of the local governments and 58% 
Local 
of 
total 
governments'  responsibility 
to  organise 
maintenance  of  public  pre-schooling  (e.g. 
kindergartens),  basic  and  secondary  schools, 
and 
their  operational  expenses 
(teachers' salaries, etc). The local governments 
are  also  responsible  for  organising  student 
transport.  The 
for
development  of  education  policies and  for 
establishing 
the 
education  system  (such  as qualifications  and 
basic salaries of teachers). 

the  overall  standards 

responsible 

to  cover 

state 

in 

is 

• Healthcare accounts  for  16%  of  the  total 
expenditure  of  the  local  governments  and for
about  one  third  of  the  total  healthcare  budget. 
However, this data does not reflect the fact that 
the healthcare is funded from the budget of the 
Estonian  Health  Insurance  Fund (HIF),  who 
with  the  central  government  is  responsible  for 
policy development and implementation. While 
formally 
local 
hospitals,  their  operational  expenditures  are 
financed from the HIF. Local governments are 

local  governments

own 

Basic provisions concerning local governments are 
established  in  the Constitution  and  regulated  by 
laws. The  main legal act  governing  municipalities 

(236) OECD  Fiscal  Decentralisation  Data  includes  expenditure 
of both local governments and dependant units (hospitals). 

232

Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

Part IV

partly responsible for the provision of the  first 
level  health  care  services  (family  physician), 
though  the  counties  (state)  have  the  overall 
responsibility.

• Social  welfare  services account  for  8%  of  the 
total  expenditure  of  the  local  governments. 
Local authorities are responsible for organising
maintenance  of  social  welfare 
institutions 
owned by them (e.g shelters, care homes, etc.) 
and for organising social assistance and welfare 
for elderly, disabled, and other persons in need 
of  assistance (e.g.  homeless). The  state  is 
responsible  for  the  development  of  the  social 
welfare  policy,  the  identification  of  social 
needs,  and  for  the  organisation  of  victim 
support and conciliation service. 

• Economic  activities (provision  of  transport), 
recreation (culture and sports), and housing and 
utilities (water supply,  heat  supply,  waste 
management,  etc.)  are under  responsibility  of 
the local governments. 

3. Financing

According  to  the  Estonian  legislation,
the  state 
budget  and  the  local  governments' budgets  are 
the 
separated. Local  governments  may  use 
following  means  to  finance  their  expenditures:
shared 
taxes;  grants  and 
local 
allocations from the state budget; locally generated 
from  municipal 
income 
property. There is a mechanism for equalisation of 
revenue between the municipalities.

and  proceeds 

(state)  and 

fees

Revenues from taxes

• The  biggest  portion  of  income  for  the  local 
budgets  comes  from  the  state  personal  income 
tax (46% of total revenues in 2010 (237). This is 
a  shared  tax,  and  the  local  authorities  receive 
11.4% of resident’s total revenue ( 238). The tax 
threshold and tax exemptions are not applied to 
the local government share, but are settled fully 
out  of  the  state  share.  This  means  that  in 
practice the local share of the tax revenues was 
as high as 80%.

(237) Data  based  on  local  budget  execution  reports  prepared  by 
the  Estonian  Statistical  Office.  It excludes  expenditure  of 
the dependent units (hospitals).

(238) The personal income tax rate is 21%, to be reduced in 2015 

to 20%

• Land  tax accounted  for  4%  of  the  local 
governments'  revenues  in  2010. While  it  is  a 
state  tax  by  law,  it  is  fully  paid  into  the  local 
budgets. The tax base and the limits of the tax 
rate  (0.1–2.5%  of  the  estimated  value  of  land; 
0.1–2.0% for agricultural land) are set by law, 
and the  local  authorities can  determine  the  tax 
rate  within  those  limits.  In  2013,  Estonia 
abolished the land tax requirement for the most 
of the residential land provided that the primary 
residence of a taxpayer is located on that land. 

• Local  governments can  impose  and  levy  local 
taxes and user charges in accordance with law. 
The main local taxes include advertisement tax, 
road  and  street  closure  tax,  motor  vehicle  tax, 
animal  tax,  entertainment  tax,  and  parking 
charges.  However,  the  local  taxes  and  fines 
represented  only  about  1%  of  the  total  local 
revenues in 2010. 

State grants and allocations

The  second  largest  source  of  income  for  the  local 
governments are grants  from  the  state  budget
which  accounted  for  34%  of  the  total  revenues  in 
2010.  They  are  allocated  through  the  equalisation 
fund  and  the  block  grant  (together  representing 
some 90% of total grant distribution), and through 
earmarked  grants 
from  ministries  and  state
agencies.

• The purpose of the block grants (ca 3.5% of the 
2012  state  budget  expenditure)  is  to  support 
service  delivery in  several  areas.  The  most 
important area (87% all grants) is education, as
the local  authorities  are  obliged  to  maintain 
their  school houses  and  to  pay  salaries to 
teachers.  Other  areas  include the subsistence 
benefits,  some  types  of  social  benefits  and 
services,  a  support  for  registration  of  the 
changes in population (birth and deaths), and a 
support to small islands. 

• The purpose of the equalisation fund (ca 1.1% 
of  2012  the  state  budget  expenditure)  is  to 
balance  the  excessive  differences  among  the 
income bases of different local authorities, and 
to  ensure 
that  all  municipalities  provide 
adequate  public  services  to  their inhabitants. 
The amount of the equalisation fund in a draft 
its  distribution  among 
state  budget  and 

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Public finances in EMU - 2012

in 

are 

determined 

municipalities 
the 
negotiations  between  the  local  governments 
and  the  state. The  equalisation  grants  are 
divided  between  the  local  governments  based 
on the  equalisation  mechanism  that  takes  into 
account the average expenditure need based on 
population  size  and  age  structure,  and  the 
weighted lagged accounting revenues. Overall, 
a  large  majority  of  the  local  governments 
receives the equalisation grants, with a notable 
exception  of  Tallinn  area  and  the  oil-shale 
production region in the north-east of Estonia.

• Other  earmarked  grants cover  mainly  local 
governments' activities to maintain and develop 
infrastructure and are provided from the annual 
budgets of ministries.

Other sources of revenue

Local  governments  receive  revenue  from  their 
economic  activity  (sale  of  goods  and  services,  ca 
11%  of  revenues  in  2010),  property  income 
(2.4%), and a sale of property (1%). The amounts 
of fees  for the use of  natural  resources and  water, 
as  well as the size of the share paid into the local 
budgets are determined by a government decree. 

4. Fiscal rules

the 

The  difference  between 
revenues  and 
expenditures  of  the local  governments is  financed 
by  borrowing.  In  2009,  local  governments'  debt 
burden  reached  50.8% (239).  Due  to  eroding 
revenue  base  during  the  financial  crisis, one-off 
measures  were  introduced  to  limit  the  borrowing 
by local authorities. Consequently, the debt burden 
of local governments fell slightly to 50% in 2010, 
marginally  outpassing  the  60%  threshold  only  in 
Harju  and  Parnu  counties  (60.7  and  60.5%, 
respectively).

From  2009  until end-2011,  the  local  government 
could undertake new financial obligations (i.e. take 
loans,  issue  debt  securities,  sign  financial  leasing 
agreements)  only  under  the  double  condition  that 
the  total  amount  of  the  outstanding  financial 
obligations  by  a  local  government  and  their 
servicing  would not  exceed  60%  and  20%, 

respectively,  of  the  budget  revenue  planned  for  a 
given  budget  year  (excluding 
the  earmarked 
transfers  from  the  state  budget).  Moreover,  since 
2009, the local governments could only borrow to 
co-finance  structural  funds  and  to  re-finance  their 
existing liabilities, and only with the consent of the 
Ministry of Finance.

is 

of 

the 

and 

modernises 

As  of  2012, a  new  local  government  financial 
management  act 
force,  which  makes 
in 
provisions  for  medium- to  long-term  financing 
increases 
frameworks, 
financial  governance, 
and 
transparency  of 
reinforces 
local 
discipline
fiscal 
governments. It establishes a net debt ceiling (debt 
minus  liquid  assets)  of  60%-100% ( 240) of  the 
revenue  in  the  current  fiscal  year 
operational
self-financing  capacity  of 
depending  on  a 
municipalities.  The  ceiling 
to  be 
is  allowed 
exceeded  by  the  amount  of a 'bridge  financing', 
to  ensure  sufficient  co-
essentially 
financing  of  the  EU  structural  funds.  The  bridge 
loan can be taken in the amount of targeted foreign 
financing  and  received  co-financing  to  provide 
payments until the receipt of the targeted financing
and co-financing. The new rule is applicable to all 
borrowing  by  the  local  governments  and  their 
dependent units, with no escape clauses. 

in  order 

to  correct 

the  situation.  A 

The responsibility for monitoring and enforcement 
of  the  rule  lies  with  the  Ministry  of  Finance.  In 
case of deviations, the Ministry of Finance  makes 
local 
proposals 
government  has  to  submit  to  the  Ministry  of 
Finance  an  operational  plan 
t+3  years 
indicating  measures  to  ensure  financial  discipline. 
In  case  of  a  risk  of  a  difficult  financial  situation, 
the  Ministry  of  Finance  forms  a  committee 
independent of the local government at risk, which 
in cooperation with the local government prepares 
a recovery plan for t+4 years, which includes be a 
sound financial plan. 

for 

To  ensure  implementation  and  timely  submission 
of the corrective plans, the Ministry of Finance can 
suspend  the  transfers  from  the  equalisation  fund 
and  of 
local 
governments.  In  practice  this  means  that  the 

tax  share  of 

income 

the 

the 

(239) Debt  divided  by  net  revenue,  based  on 

local 
governments  budget  execution  reports.  Data  provided  by 
the Estonian Statistical Office.

the 

(240) Exceptionally, in 2012 local governments cannot take new 
loans  if  it  results  in  a  debt  burden  of  over  60%.  Local 
governments  whose  debt  is  already  above  60%  cannot 
borrow at all in 2012. 

234

Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

Part IV

financial  sanctions  are  only  applied  if  the  local 
governments  ignore  or  disobey  the  corrective 
procedure. 

A1.7.  IRELAND

1. General description

the 

forum 

the  role  of 
a 

local  government 
for 

Ireland is a unitary country. The Irish Constitution
recognises 
in 
providing 
democratic 
representation  of  local  communities, in  exercising 
and performing at local level powers and functions 
conferred by law and in promoting by its initiatives 
the  interests  of  such  communities. The  Local 
Government  Act  2001  is  the  principal  legal  code 
governing local government in terms of structures, 
operations  and  functions.  In  addition  to  the  2001 
Act,  the  operation  of  local  authorities  is  affected 
by a range of other legislation dealing with specific 
services  such  as  housing,  roads,  planning  and 
waste.

two-tiers  of 

Ireland  has  a  three-tier  government  structure  –
central  government  and 
local 
government.  26  county  councils  and  5  city 
councils are the primary units of local government, 
which cover the entire territory of the state. In the 
second  tier  of  the  local  government  are  80  town
councils  with  limited  functions  in  smaller  urban 
areas. (241) 

The  most  recent  wide-ranging  reform  of  the  local 
government  sector  was  in  2001.  It  simplified  the 
fragmented  structure  that  existed  since  1898  and 
introduced the second tier of the local government. 
are  on-going, 
lower-level 
Several 
including  merging  of  some 
local  authorities; 
efficiency  reforms  (shared  services,  common 
procurement  platform,  staff  number  reductions) 
and improvements in budget control and reporting 
framework.

reforms 

Elected  members  of  the  local  authority  form  the 
principal  decision-making  body  in each  authority. 
They adopt an annual budget, pass or revoke local 
laws (secondary  legislation),  approve  borrowing

(241) Administrative  areas  of  town  councils  are  limited  and  do 
not cover the whole country. Town councils do not have all 
functions  of  the  county  councils  – both  institution  levels 
have distinctive responsibilities in the same territory.

and lay  down  the  policy  framework  under  which 
the  county  managers  must  operate. The  county  or 
city  managers are appointed chief executives  with 
delegated  powers  to  manage  local  authorities  on 
daily basis.

Local  government  sector  in  Ireland  is  one  of  the 
smallest  in  Europe.  Total  expenditure  of  the  local 
governments  amounted  to  6.8%  of  GDP  in  2010 
on  unconsolidated  based.  Level  of  control  of  the 
local  authorities  is  even  lower  as  the  central 
government funds about 60% of local government 
expenditure. 

2. Government spending

Local  authorities  are  responsible  for  an  extensive 
range of  services  including  housing,  roads,  water 
services,  community  development,  environmental 
services  and  protection,  planning,  fire  services, 
libraries,  arts  and  culture,  parks,  open  spaces  and 
leisure  facilities,  higher  education  grants 
to 
students (242), motor tax collection, maintaining the 
register  of  electors,  and  other  services.  Local 
authorities  are  exclusively  responsible  for  certain 
services,  notably  water  supply,  waste  water 
management  and  fire-protection  services,  as  well 
as  cover  large  share  of  other  public  services  in 
their area of responsibility. However, they are not 
autonomous  in  the  decision  making  process,  as 
services are largely coordinated and funded by the 
central  government.  Higher  control  of 
local 
authorities  and  lower  central  government funding 
are in the areas of housing and urban development, 
cultural  services  and  fire  protection.  The  range  of 
services  provided  by  the  local  government  sector 
in  Ireland  is  relatively  narrow  in  an  international 
context,  with  a  number  of  key  services  such as 
health and policing being provided through central 
government  systems.  However,  local  government, 
and  government  in  general,  is  highly  involved  in 
the housing  market as compared to other Member 
States.  Local authorities' housing services account 
for a quarter of their budget and serve almost 16% 
households 
local 
Ireland. They 
authority-owned  housing (7%  of  all  households), 

include 

in 

(242) The  Higher  Education  Grants  Scheme  is  one  of  four 
different student grant schemes and it is processed by local 
the  central 
authorities,  while  money  comes 
government  (the  Department  of  Education  and  Skills). 
Most  of  the  responsibility  for  education  system  rests  with 
the  central  government.  Universities 
in  Ireland  are 
classified outside the government sector. 

from 

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Public finances in EMU - 2012

rent supplement schemes (6%)(243), housing leased 
by  local  authorities (2%)  and  housing  owned  by 
approved  voluntary  and  co-operative  housing 
bodies (1%).

excluding 

expenditure 

total  public 

to  EUR  10.5  billion 

Total  expenditure  of  the  local  government  sector 
amounted 
in  2010  on 
unconsolidated  bases  (about  15%  of  general 
government 
banking 
support  measures),  of  which  EUR 6.7 billion  in 
current expenditure and EUR 3.8 billion in capital 
expenditure.  Current  expenditure  covers 
the 
local  authorities, 
service  provision  costs  of 
including  staff  salaries,  housing  maintenance, 
pensions,  operational  costs  of  water  treatment 
plants,  etc.  Current  expenditure  is  funded  through 
a  combination  of  commercial  rates,  charges  for 
goods  and  services,  specific  and  general  grants
from central government. Local authorities employ 
approximately  30.6 thousand  people  – about  10% 
service  employees.  Capital 
of 
expenditure is spent on road construction, building 
or  purchase  of  houses,  swimming  pools,  libraries, 
etc. Capital  expenditure  is  funded  through  a 
combination  of  central  government  grants, 
borrowings and income from other sources such as 
development 
local 
the  general 
authorities  spend  some  70%  of 
central  government 
government 
determines  large  share  of  investment  priorities  as 
specific  capital  grants  from  central  government 
account  for  around  one-third  of  capital  spending. 
Road  construction  and  maintenance is  supervised 
and  coordinated,  and  funded from the  National 
Roads  Authority  (part  of  the  central  government). 
Other  projects  are  coordinated  between  local 
authorities  and  respective  central  government 
departments. For example, water supply and waste 
water 
and 
is
maintained by the local authorities, but it is largely 
funded  by 
the  Department  of  Environment, 
Community  and  Local  Government,  also  being 
involved in the decision making process. 

levy  contributions.  While 

infrastructure 

administered 

investment, 

3. Financial arrangements

Main source of local government revenue is grants 
from the central government, which accounted for 
60% of total revenue in 2010. There are two types 
of central government grants to local authorities –

(243) Provided  by  central  government  (Department  of  Social 

Protection)

236

general  and  specific.  General  grants  are  not 
constrained  by  specific  spending  parameters  and 
include  most  of  the  financing  allocated  from  the 
Local  Government  Fund.  Specific  grants  are 
earmarked  for  specific  purposes  and  cover  the 
delivery  of  specific  state  services  or  projects 
through  local  government  such  as  roads  or  higher 
education grants. Local Government Fund is made 
up  of  a  contribution  from  the  central  government 
and  motor  tax  receipts.  Motor  tax  is  collected  by 
the local authorities, but rates are set at the national 
level, as well as revenue is recorded in the central 
government  accounts.  General  grants  account  for 
90% of the fund and the rest is specific grants for 
non-national  roads. General  grants  are  structured 
to  bring  about  equalisation of  resources  among 
local  authorities  over  time.  For  the  purposes  of 
allocations, a range of factors is taken into account, 
including  each  local  authority’s  expenditure  and 
revenue, as  well as the overall amount of  funding 
available for distribution. A computer-based model 
assists  in  determining  whether  spending  level  and 
resources are adequate in each local authority. 

High  share  of  specific  grants  in  revenue  implies 
limited control of local authorities over this part of 
their  budgets.  Excluding  expenditure  funded  by 
specific  grants,  local governments  have  discretion 
over some 7% of general  government expenditure 
(about 3% of GDP). The share of the grants in the 
local  government  has  increased  as  other  revenue 
sources  declined during  the  financial  crises.  This 
in 
required  an  appropriate  adjustment 
has 
expenditure  of 
local  authorities,  given 
the 
borrowing restrictions. 

Other major revenue source of local government is 
commercial  rates,  charges  for  goods  and  services 
and  development 
local 
authorities  have  some  control  over  this  revenue 
and  its  use,  although  some  charges  (such  as 
planning application fees) are set centrally. 

contributions.  The 

Commercial  rates  are  property  taxes  (indirect 
taxation) levied on commercial property. Revenue 
from  commercial  rates  amounted  to  13%  of  total 
local government revenue in 2010 (0.9% of GDP). 
The  level  of  the rate  is  determined  each  year  by 
local  authorities as  part  of  their annual  budgetary 
process.  The  rates  are  applied  on  the  value  of  the 
property  determined  by  the  Commissioner  of 
Valuation, 
revaluates 
commercial properties in local authorities. 

periodically 

which 

Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

Part IV

Charges  are  levied  on  services  provided  by  local 
authorities, 
for  example,  commercial  water 
charges,  housing  rents,  waste  charges,  parking 
charges,  planning  application  fees,  refuse  and 
landfill charges,  library  fees  and  fire  charges.
Development  contributions  are  paid 
local 
governments 
condition  of  planning 
permissions  and  allow  recouping  some  of  the 
public costs for providing public infrastructure and 
facilities  that  benefit  development
in  the  area. 
Development  contributions  and  related  capital 
expenditure  have  substantially  declined  after  the 
crash in the property market. 

as 

to 

a 

In  order  to  place  local  government  on  a  sound 
financial footing and reduce reliance on the central 
government grants, new income streams are being 
developed.  A  charge  on  non-principal  private 
residences of EUR 200 was introduced in 2009 and 
an  additional  household  charge  of  EUR  100  in 
2012. Both charges yield more than 0.1% of GDP. 
revenue-increasing  measures  will  be 
Further 
introduced 
fiscal 
in 
adjustment  plans,  yielding  additional  0.4%  of 
GDP. In particular, a valuation-based property tax 
will  be  introduced  replacing  the  current  interim 
measures. 

in  2013-15, 

line  with 

In  the  national  accounts,  different  charges  and 
development  contributions  are  recorded  as  sales, 
property income and transfers from private sector. 
Total  revenue  of  this  kind  amounted  to  23%  of 
total  local  government  revenue  in  2010  (1.5%  of 
GDP).  Social  contributions  received  by  local 
government  sector  are  those  paid  on  wages  for 
own employees. 

4. Fiscal rules

A  fiscal  rule  for  local  government  sector  was 
established  in  2004  – the  sector's  fiscal  deficit  on 
ESA95  basis  should  not  exceed  EUR  200  million 
in any year. The rule was established as a political 
agreement  and  is  laid  down  in  administrative 
circulars.  The  implementation  of  the  rule  is 
controlled by the Department of the Environment, 
Community  and  Local  Government.  The  overall 
deficit  rule  is  expressed  in  the  operational  limits 
for 
into 
account existing loan repayments. 

local  government  borrowing 

taking 

The adherence to the rule is  monitored by current 
and  capital  account  controls,  and  loan  sanctions.

Control  measures  have  been  tightened since  2009 
to strengthen adherence to the rule. Accrual-based 
fiscal  target  can  be  measured  from  both  the  non-
financial  transactions  and  the  financial  balance 
sheets. The  former  are  recorded  in  current  and 
capital accounts of the local authorities, which are 
required  to  have  balanced  revenue–expenditure 
positions.  However,  as  these  accounts  include 
certain financial transactions, a control of financial 
balance sheets and borrowing limits are necessary.  
Borrowings by the local authorities are sanctioned 
by  minister,  ensuring  that  the  required  borrowing 
local 
limits  are 
authorities are  monitored  throughout  the  year  and 
any  expenditure  overruns  should  be  compensated 
for  by  either  a  reduction  in  another  expenditure 
area or increased income.

respected.  The  budgets of 

Local  government  debt  was  at  3.4%  of  GDP  in 
2010,  of  which  2.8%  to  central  government  and 
0.6%  to  private  sector.  While  default  by  local 
government is possible, it is most likely to be bail-
out the  central  government.  In  2010,  the  central 
government  repaid  some  of  the  loans  of  local 
authorities  in  financial  difficulties.  Alternatively, 
these  troubled  authorities  would  have  cut  their 
services. 

A1.8.  GREECE 

1. General description

The  Greek  state  has  been  highly  centralised  since 
its  founding  in  1832.  This  situation  has  been 
gradually  changed  since  the  adhesion  to  the 
European Union in 1981. In 1987, 13 programme-
regions  were  established  by  a  presidential  decree. 
In  1994,  the  51  nomoi  (prefectures),  which  have 
been acting as state territorial administration units 
for  160  years,  became  self-governments  with 
directly elected prefects and councils (law 2218/94 
on  the  establishment  of  democratically  elected 
government  at  prefecture  level).  In  1997,  the  law 
2539/97 on the "formation of the first level of local
government"  was  an  attempt  to  empower  the 
municipalities  by increasing 
their  size.  This 
programme, called Cappodistrias Plan reduced the 
number  of  primary  local  authorities  from  5825  in 
1997  to  1034  in  2005.  In  2001  a  constitutional 
revision  reinforced  decentralization  and  explicitly 
stated that there are two levels of local government 
in  Greece.  From  2003,  discussions  between  the 

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Public finances in EMU - 2012

Hellenic  Ministry  of  interior,  the  Parliament  and 
local authorities were focused on redrawing (under 
a  Cappodistrias  2  plan) 
administrative 
boundaries  of  the  local  authorities,  in  order  to 
better profit from EU funding. 

the

Greece 
two-tier 
is  a  unitary  state  with  a 
government  structure.  Its  constitution  was  ratified 
on June 11, 1975. The articles 101 and 102 recall 
local 
the  principles  of  decentralisation  and 
autonomy.  The  2001  constitutional 
revision 
explicitly  states  that  the  administration  of  local 
affairs shall be exercised by local governments of 
that 
first  and  second 
they  enjoy 
level  and 
administrative  and  financial 
independence.  In 
particular  the  article  102,  paragraph  5  of  the 
the 
constitution  states:  "The  state 
legislative,  regulatory  and  fiscal  measures  needed 
for  guaranteeing  the  economic  and  resources 
autonomy 
self-Government 
Organizations  (OTA),  together  with  assuming  the 
responsibility 
administration 
securing 
transparency of these resources".

takes  all 

local 

the 

of 

of 

Law  3852/2010  on  the  "New  architecture  of  self-
governance  and  decentralized  administration-
Programme  Kallikratis" 
recent 
modification  of  the  decentralised  governance  in 
Greece. 

the  most 

is 

In  particular,  there  are  two  levels  of  subnational 
self-governments:

• At the first level, 325 municipalities have been 
established  (substituting  the  1034  ones  from 
the previous legislation). Each is comprised by 
the unification of a number of the pre-existing 
local departments which have been renamed as 
local  communes  (when  population  is  up  to 
(when 
2000) 
2000).  
population 

or  municipal 
is 

communes 

more 

than 

The  municipalities  (the  1st
level  of  self-
governance)  are  self-governed  autonomous 
public law legal entities. They are governed by 
the  municipal  council  (the  number  of  its 
the  corresponding 
members  varies  with 
population), 
the 
committee of quality of life (for municipalities 
of more than 10000 inhabitants), the executive 
committee  and 
the 
municipal  communes  and  local  communes  are 

the  economic  committee, 

the  mayor.  Each  of 

238

governed  by 
president.

the  council  and  a  council 

• At the 2nd level, 13 regions (peripheries; in the 
previous legislation they were the decentralised 
state  administration  units)  are  established. 
Those are governed by the Head of the Region 
(peripheriarchis),  the  vice-heads  of  the  region
(antiperipheriarchis)  the  Region  Council,  the 
economic  committee  and 
the  executive 
committee.  The  number  of  these  offices  is 
determined  by 
the 
population features of each region. 

law  according 

the 

to 

At  the  national  level  Greece  is  divided  in  7
integrated  decentralised  state  administration  units, 
Administrations
called 
(apokendrwmenes  diikiseis),  for  each  of  which  a 
Secretary  General  is  appointed  by  the  central 
government.

Decentralised 

have 

undertaken 

After Kallikratis Law implementation, subnational 
governments 
extended 
competences    in  functions  such  as  environment, 
life  quality,  social  protection,  education,  culture 
and  sports,  agriculture,  breeding  and  fishery 
development, etc (as set by Law 3852/2010). 

Subnational  governments'  share  of  responsibility 
has increased after Kallikratis Law implementation 
as they have also accepted exclusive duties, in all 
cases served under central government directives.

They  do  not  have  autonomy  in  legislation  but 
according  to  Constitution  (Syntagma)  they  have 
administrative and financial autonomy.

2.  Revenues  of 
governments 

the  decentralized 

self-

Law  1828/1989  introduced  the  model  of  direct 
state funding to the local self-governments through 
institutionalisation  of  the  Central  Autonomous 
Resources  (Kendrikoi  Autoteleis  Poroi,  KAP) 
within the national budget.

After  20  years  in  service  the  KAPs  have  been 
restructured  according  to  the  Law  3852/2010 
(Kallikratis)  aiming  to  the  long  term  economic 
sustainability of the local government finances and 
their  protection  towards  economic  risks.  The  new 
sources of these funds are as follows:

Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

Part IV

• The revenues for the municipal KAPs are 

i)  The  21,3%  of  the  total  annual  receipts  of  the 
income  tax  of  the  physical  persons  and  legal 
entities,  once  revenues  earmarked  for  OGA  have 
been deducted;

ii)  The  12%  of  the  V.A.T.  total  annual  revenues; 
and

iii) The 50% of the total annual receipts on regular 
property tax.

Two  thirds  (2/3)  of  the  category  (i)  revenues  and 
the  total  of  (ii)  and  (iii),  comprise  the  account 
covering 
general 
expenditures  of  the  KAP.  The  rest  one  third  (1/3) 
of the (i) category covers investment expenditures.

operational 

other 

and 

KAP  covers  46%-49%  of  total  Revenues  of 
to 
this  share 
municipalities  (and 
decrease  according 
the  Medium  Term  Fiscal 
Strategy 2013-2016.

is planned 

• The revenues of the regional KAPs are:

i)  The  2,40%  of  the  total  annual  receipts  of  the 
income  tax  of  the  physical  persons  and  legal 
entities,  once  revenues  earmarked  for  OGA  have 
been deducted;

ii) The 4% of the V.A.T. total annual revenues.

Those  revenues  are  distributed  to  the  regional 
accounts specific for operational and other general 
costs  and,  to  the  regional  accounts  specific  for 
investment  expenditure,  according  to  a  common 
decision taken by the  ministry of Internal  Affairs, 
the  ministry  of  Decentralization,  the  ministry  of 
Economics  after  consultation  of  the  Union  of  the 
Regions. Recently,  an  annual  cap  of  5.200  mln 
Euros  has  been  introduced  as  part  of  the  Medium 
Term Fiscal Strategy for the sum of the earmarked 
revenues 
local 
governments.  On  a  Regular  Basis,  Regions’ 
Revenues come from KAPs and a part of it comes 
from  Public  Investment  Programs.  Additional 
Revenues  include  income  from  taxes  of  movable 
and  immovable  property,  insurance  contributions, 
fines and fees.

for  municipal  and 

regional 

3. Municipal expenditures and revenues (other 
than the KAPs)

include: 

Expenditures  of  municipalities 
(i) 
Operational  costs  such  as  remuneration  and 
personnel  expenses,  remuneration  of  elected  and 
other  staff;  costs  for  serving  the  public  trust  (i.e. 
loans  for  covering  operational  and  investment 
costs),  costs  for  consumable  goods  (i.e.  school 
maintenance and building materials); leasing costs 
and  other  general  operational 
(ii) 
Investments  such  us  purchase  of  buildings, 
technical  works  and  procurement  of  fixed  assets; 
works;  fixed  assets/holdings  in  enterprises,  and 
(iii)  payments,  returns  and  forecasts  incurred  in 
previous years.

costs. 

revenues 

cemeteries 

Revenues  may  be  distinguished  as  regular  and 
irregular.  Regular  revenues  are  (i)  revenues  from 
immovable  properties  (i.e.  rents  from  the  use  of 
public areas such as forest rents or fish-farm rents), 
(ii)  revenues  from  movable  properties  (i.e.  capital 
interest  etc),  (iii)  revenues  from  retaliatory fees 
(e.g.  cleaning,  lighting,  port,  water,  and  sewer 
fees),  (vi)  revenues  from  royalties  and  services 
and 
from 
(e.g. 
slaughterhouses, fees on gross tradesmen income), 
(v) revenues from taxes and duties (electricity tax, 
beer  tax,  other  municipality  specific  taxes)( 244). 
Irregular  revenues  are  mainly:  revenues  from 
and  movable  property; 
selling 
subsidies 
costs; 
operational 
investment  subsidies  (state  or  community  funds); 
donations  and  inheritance;  surcharges  fines  and 
fees  (e.g.  parking  fines);  loans.  Taxes  and  their 
range are set by legislation with the only exception 
being the retaliatory fees  for  which  municipalities 
can set their own rate.

immovable 

covering 

for 

4. Fiscal Decentralisation 

The  article  261  of  the Law  3852/2010,  explicitly 
states  measures  concerning  fiscal  decentralization 
of taxation. 

1. A percentage of the actual increase of the VAT 
receipts  within  the  administrative  territory  of  a 

(244) The  main  taxes  and  fees  (imposed  as  taxes)  are  6. 
Electricity tax, beer tax, immovable property charge, gross 
income fee, sojourn fee and local tax of Dodecanese. Total 
taxes  and  fees  imposed  by  municipalities  are  about  40. 
Apart  from  the  main  6  the  rest  of  them  account  for  an 
important part of total revenues from taxes-fees.

239

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Public finances in EMU - 2012

municipality  will  be  assigned  to  the  municipality 
concerned  and  it  will  exclusively  be  used  for 
services of  social  solidarity.  This  is  an  attempt  of 
certification,  reception  and  allocation  of  local 
public revenues by the local government itself.

2.  A percentage of 20 of the property tax revenues 
may  be  considered  as  local  municipal  revenue 
depending on the total amount of taxes collected in 
the  administrative  area  of  a  municipality  and  the 
related  ministerial  decision.  This  revenue 
is 
allocated  to  actions  concerning  urbanization  and 
related services.

3.  The  municipalities  are  given  the  power  to  ask 
for information on wealth elements (properties and 
income)  of  the  physical  and  legal  persons  in  their 
administrative territory.

5. Credit Policy

the 

total  debt  of 

Regions  and  municipalities  may  take  loans  from 
financial  organisations  in  the  country  or  abroad 
only  in  the  context  of  financial  investment  and 
debt financing purposes and, under the constraints: 
(a) that the annual cost of a debt financing does not 
exceed the 20% of its annual regular revenues; (b) 
the 
region/municipality 
to  borrowing  does  not  exceed  a 
proceeding 
threshold  percentage  of  its  total  revenues.  This 
threshold  is  determined  by  a  ministerial  decision. 
The total debt of the region/municipality is defined 
as  the  sum  of  its  short  and  long  term  obligations. 
Subnational  governments can issue bonds but this 
has  not  been  applied  yet.  Local  Government debt 
contributed with  a  minor  percentage  to General 
Government fiscal slippages.

Budgetary  (5  years'  term  same  as  the  mandate  of 
the local governments) and financial control of the 
local  governments  is  made  by  the  Conference  of 
Auditors  (Elegktiko  Synedrio). There  have  been 
cases of bail-outs of local governments in financial 
difficulties.

A1.9.  SPAIN

1. General description

Spain  is  a  highly  decentralized country  with  a 
significant  share  of  spending  powers  devolved  to 
Autonomous 
the 

denominated 

regions 

240

Communities  (CCAA  henceforth),  mainly  on 
health care, education and social services. Article 2 
of the Constitution ratified in 1978 (245) guarantees 
the  right  of  the  CC.AA.  and  the  regions  to  have 
their  self  government  and  ensures  the  solidarity 
amongst  them.  In  turn,  Article  137  sets  out  that 
CC.AA.,  provinces  and  municipalities  enjoy 
autonomy  for  the  management  of  their  respective 
interests. Article 140 also ensures full autonomy to 
the municipalities. 

As  a  snapshot,  around  35%  of  total  consolidated 
general  government  expenditure  is  made  by  the 
CCAA, whereas local governments are responsible 
for  some  13%.  Hence,  altogether  public  spending 
under the responsibility of State (CCAA) and local 
governments  amounts  to  almost  48%  of  total 
general  government  spending.  Likewise,  Spain 
also  enjoys  a  high  degree  of  fiscal  autonomy.  A 
sizeable  share  of 
tax  receipts  and  fees  are 
transferred  to  subnational  governments,  while  at 
the  same  time  they  enjoy  a  high  regulatory 
capacity over  both  shared  and  transferred  taxes. 
Thus,  shared  and  transferred  taxes  to  the  CCAA 
and  local  governments  amount  to  some  29%  and 
15%  of  total  consolidated  government  revenues, 
respectively;  the  remaining  56%  remains  in  the 
hands of the Central Government.  

The  Autonomous  Communities  are  divided  into 
two  main  groups,  namely 
the  Autonomous 
Communities (CCAA) of Ordinary Regime and the 
Communities  with  Foral  Regime.  The  financing 
systems  differ  between  the  two  groups.  The 
Autonomous  Communities  of  Ordinary  Regime 
are  Andalusia,  Galicia,  Cantabria,  Asturias, 
Castile-León,  Castile-La  Mancha,  Aragón,  La 
de  Madrid, 
Rioja,  Catalonia,  Comunidad 
Comunidad  Valenciana,  Extremadura,  Murcia, 
Balearic  and  Canary  Islands,  and  the  autonomous 
enclaves  of  Ceuta  and  Melilla.  Their  financing 
system of the  Autonomous  Communities (CCAA) 
of Ordinary Regime in Spain has been revised very 
recently  (Law  22/2009  of  18  December).  In  turn, 
the  Communities  with  Foral  Regime  are  Navarre 
and  the  Basque  Country,  which  enjoy  full  fiscal 
autonomy  excluding  customs  tariffs,  with  the 

(245) http://www.boe.es/aeboe/consultas/enlaces/

documentos/ConstitucionCASTELLANO.pdf or also in its 
English translation
http://www.congreso.es/constitucion/ficheros/c78/
cons_ingl.pdf

Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

Part IV

limitation that the overall effective tax burden does 
not fall below that of the rest of Spain. 

Finally,  the  principles  of  the  Social  Security (246) 
are enshrined in Article 41 of the Constitution and 
its  main  tasks  are  assigned  to  different  public 
agencies within the general government. 

2. Government spending

The  central  government holds  full  legislative 
power  only  in  the  areas  of  international  relations, 
nationality,  migration,  political  asylum  rights, 
defence, 
justice,  customs,  currency,  general 
finance and Central Government debt, commercial, 
criminal,  labour,  civil  and  intellectual  property 
legislation,  general  coordination  of  the  public 
Health  Care 
on 
pharmaceutical  products.  The  central  government 
also has legislative powers on the basic legislation, 
definition  of  principles  and  economic  regime  of 
the  Social  Security 
including  Health  Care, 
although  the  provision  of  services  is  devolved  to 
the  CC.AA.  and  Local  Governments.  In  many 
areas  the  central  government  shares  competences 
with the CC.AA.

legislation 

system 

and 

By the functional breakdown of public expenditure
the  different 
(COFOG) 
competences can be summarized as follows:

the  assignment  of 

• General  public  services:  Definition  of  policy 
principles  and  their implementation  lie  within 
the  remit  of  the  central  government  except  for 
debt 
and  Local 
Governments.

issuance  by  CC.AA. 

• Defence:  Full  responsibility  of  the  central 

government.

• Public  order  and  safety: The  definition  of 
policy  principles  lie  within  the  remit  of  the 

(246) These  agencies  are  the  National  Social  Security  Institute 
(INSS in its acronym in Spanish), the National Institute of 
Healthcare  Management  (INGS),  the  National  Institute  of 
Social  Services  (IMSERSO),  the  Social  Institute  of  the 
Navy  (ISM)  and  the  General  Treasury  of  the  Social 
Security  (TGSS). However,  this  national  institutional 
definition of the Social Security does not coincide with the 
Social  Security  subsector  as  defined  in  ESA95,  which 
comprises the Social Security System (the main function of 
which is the functioning of the public pension system), the 
Public National Employment Service (SPEE in its acronym 
in Spanish) and the Wage Guarantee Fund (FOGASA).

central  government  except  for  the  areas  of 
police  and 
fire  protection  services.  The 
effective  implementation  of  public  order  and 
safety  policies  is  accomplished  by  the  central 
government, the CC.AA and the municipalities. 

while 

spending 

• Economic  affairs:  The  definition  of  policy 
principles  lies  within  the  remit  of  the  central 
government, 
powers 
concerning  areas  such  as  agriculture,  forestry, 
mining,  fishing,  construction,  transport  and 
communication  have  been  devolved  to  the 
CC.AA.  Local  Governments  have  also  powers 
on  public  transport  within  their  geographical 
area.

• Environmental  protection:  The  definition  of 
policy  principles  and  the  implementation  of 
these policies lie within the remit of the central 
government.  The  CC.AA.  enjoy  additional 
legislative  power,  while  municipalities  also 
enjoy  spending  powers  on  waste  management 
and pollution abatement. 

• Housing  and  community  amenities:  These 
spending  competences  have  been  mostly 
transferred  to  the  municipalities,  although  the 
CC.AA can define the basic principles of town 
and country planning and housing. 

• Health: The definition of policy principles and 
general coordination lie within the remit of the 
the  effective 
central  government,  whereas 
spending  powers  have  been  devolved  to  the 
CC.AA.  However, 
on 
pharmaceuticals  lies  exclusively  on  the  hands 
of the central government.

legislation 

the 

• Recreation culture and religion: The definition 
of  policy  principles  and  general  coordination 
lie  within the remit of the central  government, 
whereas  the  effective  spending  powers  have 
been devolved to the CC.AA.

• Education:  The  definition  of  policy  principles 
and general coordination lie within the remit of 
the  central  government;  the  effective  spending 
powers have been devolved to the CC.AA.

• Social  protection:  The  definition  of  policy 
principles  and  general  coordination  lie  within 
the  remit  of  the  social  security,  as  well  as 

241

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Public finances in EMU - 2012

on 

areas 

spending 

effective 
as 
unemployment and old age. Effective spending 
powers  on  social  services  have  been  devolved 
to  the  CC.AA  and,  to  a  lower  extent,  to 
municipalities.

such 

3. Financial arrangements

3.1. Autonomous Communities

There are basically two different financing systems 
for Autonomous Communities in Spain depending 
on their regime. The two Communities with  Foral 
Regime, notably Navarre and the Basque Country, 
enjoy  full  fiscal  autonomy  excluding  customs 
tariffs, with the limitation that the overall effective 
tax  burden  does  not  fall  below  that  of the  rest  of 
Spain.  They  are  responsible  for  taxes  collected  in 
their respective territory and  negotiate the amount 
to  be  transferred  to  the  central  government  on 
responsibilities 
taxes
account  of 
remaining  centralized,  and  in  proportion  to  their 
relative income and population. This transfer is set 
to evolve in line with the observed growth rate of 
tax  revenues.  This 
the  Central  Government's
agreement is revised every  five  years. In turn, the 
Autonomous  Communities  (CCAA)  of  Ordinary 
Regime enjoy a different financing system that has
been  revised  very  recently  (Law  22/2009  of  18 
December).  This  system  is  described  in  greater 
detail in the next subsection.

such 

for 

The financing system of Autonomous Communities 
of Ordinary Regime

The  current  financing  system  introduced  some 
amendments  to  the  previous  one  in  effect  until 
2008.  In  essence,  the  functioning of  the  financing 
system can be summarized as follows: 

a.  The  new  system  first  determines  the  funding 
needs (spending needs in the previous system) for 
all  the CCAA  in  a  base  year augmented  with 
additional  resources  contributed  by  the  Central 
Government. 

b.  These  funding  requirements are distributed 
among the CCAA according  to the agreed criteria
concerning 
"essential  public 
so-called 
services"(247)  (Guarantee  Fund)  and  confronted 

the

(247) In  the  previous  system  funding  needs  were  distributed 

according to all the powers transferred.

242

with  the  75%  of  the  transferred  tax  revenues  in 
each  Autonomous  Community. The  difference 
between them takes the form of a grant from (+) or 
to (-) the Central Government.

c. Levelling  transfers  are  set  to  ensure that  each 
Autonomous  Community
enough
resources  in  the  base  year  for  the  competences 
assumed (Global Sufficiency Fund). 

receives

d. Two  additional  Convergence  funds are  set, 
notably 
the 
Cooperation  Fund,  whose  basic  function  is  to
provide certain CCAA. with additional resources.

the  Competitiveness  Fund  and 

e.  Finally,  standards  for  the  evolution  of  transfers 
are  set.  In  practice,  there  are  advanced  payments 
on account of budgetary projections in the Central 
Government Budget for a given year, with its final 
settlement normally taking place after two years. 

a. Overall financing needs in the base year 

For each Autonomous Community the resources in 
the base year were gauged on the basis of the funds 
that  it would  have  received  under  the  previous 
system. Thus, the overall funding needs in the base 
year were assimilated to the finally settled ones by 
the  previous  funding  system,  augmented  with 
additional  resources  that  amounted  to  some  €  7.4 
billions (0.7% of GDP). These additional resources 
were allotted  according  to  some  pre-determined 
criteria. 

b. Tax capacity 

to 

related 

tax  capacity  of  CCAA 

The 
to  finance 
the 
the  spending  powers 
expenditure 
assumed  is  also  estimated  for  the  base  year.  Such 
tax  capacity  includes  both  the  collection  of  taxes 
assigned and the specific fees linked to the powers 
assumed. 

TThe  new  system  raised the  amount  of  taxes 
transferred (personal income  tax, VAT and excise 
duties) and tax powers on the personal income tax 
and  other  traditionally  transferred  taxes  such  as 
Property Transfer and Stamp duty, Inheritance and 
Gift, taxes on gaming, hydrocarbon-oil taxes, taxes 
fees. 
on  certain  means  of 
Specifically,  the  share  of  taxes  transferred  to  the 
CC.AA. are:

transport

and 

Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

Part IV

• Personal  Income  Tax:  50% of  total  net  tax 
revenues thereof (33% in the previous system), 
with  normative  capacity  on  the  regional  rate 
(progressive)  without  restrictions  on  brackets, 
though  subject  to  approval.  CC.AA.  also  have 
normative  capacity  on  personal  and  family 
allowances  (±  15%  limit  for  each  of  the 
for  personal 
components)  and  deductions 
circumstances, 
housing 
business 
investments. However, the definition of family 
circumstances  covered  by  such  allowances 
cannot be changed. Restrictions on the number 
of  income  brackets  and  marginal  rates  were
removed on condition that the autonomic rate is 
progressive.  Moreover, 
rates  are 
subject to annual approval. 

regional 

and 

• VAT: 50% of total receipts thereof (35% in the 
previous  system),  although  with  no  normative 
capacity.  These  are  distributed  among  CCAA 
according  to  regional  consumption  indexes 
gauged by the National Statistical Office (INE).

• Excise  duties  on  manufactured  production  of 
alcohol,  tobacco  and  hydrocarbons: 58%  of 
total  net  tax  revenues  thereof  (40%  in  the 
previous  system),  with  no  normative  capacity. 
These  revenues  are  distributed  among  CCAA 
according  to  regional  consumption  indexes 
gauged by the National Statistical Office (INE), 
the  Ministry  of  Industry,  Energy  and  Tourism 
or the Tobacco Market Commissioner.

• Hydrocarbon-oil retail sales: 100%, with some 

normative capacity on the tax rate.

• Electricity: 100%  of  total  net  tax  revenues, 
with no normative capacity. These revenues are 
distributed among CCAA according to regional 
consumption  indexes  gauged  by  the  National 
Statistical  Office  (INE) and the  Ministry  of 
Industry, Energy and Tourism.

• Property Transfer and Stamp Duty: 100%, with 
normative  capacity  on  the  tax  rate  (except  for 
corporate  transactions)  and  on  deductions  and 
allowances.

• Registration  of  motor  vehicles:  100%,  with 

some normative capacity on the tax rate.

• Taxes  on  gaming:  100%,  with  normative 
capacity  on  exemptions,  rate,  tax  base,  fixed 
fees, allowances and accrual.

• Wealth  tax:( 248)  100%,  with  full  normative 
capacity  on  the  tax  rate,  allowances  and 
allowances.

•

Inheritance  and  gift  tax: 100%,  with  full 
normative  capacity  on  the  tax  rate  and  some 
normative capacity regarding  reductions  in the 
and 
tax 
coefficients of existing wealth.

deductions, 

allowances 

base, 

c.  Guarantee  fund  for  essential  public  services  in 
the base year 

The distributing criteria of resources across CCAA 
only  apply to  the  so-called  "essential  public 
services  of  the  welfare  state",  namely health  care, 
education  and  social  services.  ( 249) A Guarantee 
Fund  for  Essential  Public  Services  (Guarantee 
Fund henceforth) aims to ensure uniform access to 
these  basic  services to  all  citizens  regardless  of 
their place of residence. All CCAA contribute 75% 
of  the  tax  revenues  and  fees  assigned  to  them to 
this  fund,(250)  to  which  €  8.7 billions  contributed 
by the Central Government were added in the base 
year.  Notwithstanding  the  way  these  funds  are 
gauged,  most  financial  resources  assigned  to  the 
CC.AA. are not earmarked.

so-called 

This  fund  was theoretically  distributed  among  the 
CCAA  based  on 
"adjusted 
the 
population",  which  is  gauged  as  a  weighted 
average of seven variables: population (30%), area 
insularity  (0.6%), 
(1.8%),  dispersion  (0.6%), 
equivalent protected population (38%), population 
aged  65  years  or  above  (8.5%)  and  population  up 
to 16 years of age (20.5%). 

Thus,  the  net  transfer  from the  Guarantee  Fund 
(NT)  was  gauged  as  the  difference  between  the 
amount  of 
the  share  of  each  Autonomous 
Community in the Guarantee Fund in the base year 

(248) This tax was withdrawn in 2009 and has temporarily been 
re-introduced to assuage the budgetary impact of the crisis. 
The tax is envisaged to take effect in 2012 and 2013.  
(249) In  the  previous  system  only  the  first  two  were  considered 

as such.

(250) All the calculations are based on "normative taxes", which 
basically consist on taxes transferred to the CC.AA. before 
exerting their normative capacity.

243

European Commission

Public finances in EMU - 2012

tax 

revenues 

(GF)  and  amount  of  its  contribution (75%  of  its 
respective 
terms 
(TREV). Such  net  transfer  takes  the  form  of  a
grant  between  the  Central  Government  and  the 
relevant Autonomous Community according to the 
following formula:

in  normative 

NTi = GFi - 75% TREVi 

d. Global Sufficiency Fund in the base year 

In  order  to  ensure  enough  resources  for  the 
competences  assumed,  a  levelling  grant called 
Global  Sufficiency  Fund  (GSFi)  for  the  base  year 
and  for  each  Autonomous  Community  was set. 
Such  grant covered the  difference  between  the 
overall  financing  needs  (NFi),  on  the  one  hand, 
and  the  sum  of  the  tax  capacity  (TREVi)  and  the 
transfer  (positive  or  negative)  from  the  Guarantee 
Fund,  on  the  other.  In  practical  terms  this  implies 
that each  Autonomous  Community will  have  the 
25% of its tax revenue in normative terms, plus its 
participation in the Guarantee Fund, plus its share 
on  the  Global  Sufficiency  Fund  to  cover  its 
financing needs. 

NFi = 25% TREVi + GFi + GSFi 

to 

the  central  government 

This Global Sufficiency Fund consists of a transfer 
from 
respective 
Autonomous Community if overall spending needs 
exceed the resources provided jointly by the fiscal 
capacity  and  the  participation  in  the  Guarantee 
Fund,  or  a 
the  Autonomous 
Community concerned to the Central Government
otherwise. 

transfer 

from 

e. Additional resources 

The  Central  Government provides
additional 
resources  to  the  CCAA  to  strengthen  the  Welfare 
State according to some different criteria under the 
umbrella  of  the  so-called  Competitiveness  Fund 
and  the  Cooperation  Fund.  Both  funds  amount  to 
some  €  3.7  billions,  around  0.4%  of  GDP.  The 
former  aims to  strengthen  horizontal  equity  and 
reduce  differences  in  per  capita  funding  across 
CCAA;  the  latter  is  intended  to  promote regional 
income  convergence. These  funds  are  primarily 
assigned  to  the  CCAA  with  lower  revenues,  per 
capita income and population density.

f. Evolution of the system in subsequent years 

244

the 

transferred 

After  the  base  year  the  CCAA  obtain  their 
taxes, 
corresponding  share  of 
jointly  with 
(positive  or 
the  corresponding 
negative)  grants from  the  Guarantee  and  Global 
Sufficiency Funds. The variables of distribution of 
the  Guarantee  Fund  are
reviewed  annually, 
although final settlements typically take place with 
to  data  availability 
a 
limitations.  The  Central  Government contribution 
to the Guarantee Fund and the Global Sufficiency 
Fund  are  set  to  evolve  in  line  with  the  observed 
growth 
tax 
revenues. Finally,  tThe  structural  variables  of  the 
system are revised every five years.

the  Central  Government's

two-year  delay due 

rate 

3.2. Local Governments

The Royal Legislative Decree 2/2004, of 5 March 
2004,(251) which  approves  the  revised  text  of  the 
Local Tax Offices Regulatory Law, forms the basis 
of the local financing system. According to Article 
2  therein,  the  resources  of  local  governments 
consist  of  revenues  stemming  from  its  property, 
own taxes, fees and surcharges accrued on taxes of 
CC.AA., their agreed shares on central government 
and  CC.AA.  taxes,  subsidies,  regulated  prices, 
fines and sanctions within the remit of their powers 
and resources stemming from credit operations and 
debt issuance. 

In particular, own taxes are divided in two groups: 
regular-basis  taxes  and  other  taxes.  The  former 
comprise  taxes  on  immovable  property,  the  local 
business  tax  and  the  tax  on  motor  vehicles;  the 
latter  comprise  taxes  on  construction,  settlements 
and works and the tax on the increase in the value 
of  land  of  urban  nature.  Town/city  councils  can 
raise or lower tax rates and establish discretionary 
tax benefits but are not allowed to set new taxes.

Municipalities  that  are  capitals  of  a  province  or 
Autonomous  Community,  or  which  have  over 
75,000  inhabitants  ,  are  assigned  a  part  of  the 
Personal  Income  Tax,  VAT  and  special  taxes  on 
alcohol,  hydrocarbons  and 
tobacco  products 
(approximately between 1% and 2%, depending on 
the tax and whether it is a municipal or provincial 

(251) http://www.minhap.gob.es/Documentacion/

Publico/NormativaDoctrina/FinanciacionTerritorial/Financ
iacion%20Local/REAL%20DECRETO%20LEGISLATIV
O%202%202004%20_Haciendas%20Locales_.pdf

Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

Part IV

one).  The  so-called  “tourist  municipalities”( 252)
enjoy somewhat similar special regime. 

4. Fiscal rules

Fiscal rule

The  current  Budgetary  Stability  Act  entered  into 
force in  2008.  (253)    According  to  it,  the  general 
government as a  whole, its subsectors and public-
owned  entities  must  attach  to  the  principle  of 
budgetary stability. Budgetary stability implies that 
the  Autonomous 
the  Central  Government, 
Communities  and  the  Local  Governments  have  to 
be  in  balance  or  in  surplus  in  an  ESA95  basis 
along  the  economic  cycle.  This  implies  that  their 
cyclically adjusted balances  have to be in balance 
or  in  surplus.  In  their  case,  an  upper  and  a  lower 
threshold  for  GDP  growth  are  defined.  Hence,  if 
GDP  growth  falls  short  the  lower  threshold,  the 
general  government  as  a  whole  could  register  a 
deficit  no  higher  than  1%  of  GDP,  of  which  the 
central government deficit should not exceed 0.2% 
of  GDP, 
the  Autonomous 
Communities  should  not  exceed  0.75%  of  GDP 
and  the  deficit  of  the  Local  Governments  should 
not  exceed  0.05% of  GDP.  If  GDP  growth  stands 
between  both  thresholds,  these  subsectors  and  the 
general  government  as  a  whole  should  be  in 
balance  at  least.  Finally,  if  GDP  growth  exceeds 
the  upper  thresholds  these  subsectors  and  the 
general  government  as  a  whole  should  register 
surpluses. Moreover, the Social Security subsector 
is  set  to  be  in  balance  or  in  surplus,  regardless  of 
the cyclical position. 

the  deficit  of 

projects, 

including 

Higher  deficits,  however,  are  exceptionally 
allowed if they are devoted to financing productive 
investment 
Research, 
Development  and 
Innovation.  Higher  deficit 
derived  from  these  programmes  cannot  exceed 
0.2% of GDP in the central government, 0.25% of 
GDP for the Autonomous Communities as a whole 
and  0.05%  of  GDP  in  the  Local  Governments 
subsector.

(252) These are places that, although they do not comply with the 
requirements  for  accessing  the  tax  assignment  system,  do 
have a population of over 20,000 inhabitants and a greater 
number of second homes than first homes.

(253) This  Act  revised  the  first  Budgetary  Stability  Act  due  to 

2001 and in force between 2002 and 2007.

In the case of the Central Government, a ceiling on 
total non-financial expenditure is set in the Budget 
Law  each  year.  No  expenditure  ceiling  though  is 
set for either the Autonomous Communities or the 
Local Governments.

Budgetary targets

Budgetary  targets  have  to  be  formulated  within  a 
multiannual  scenario.  In  the  first  semester  of  the 
year  the  government  has  to  set  the  budgetary 
targets  (as  a  percentage  of  GDP)  for  the  general 
government as a whole, its subsectors and each of 
the  different  entities  therein  for  the  next  three 
years.  Such  targets  will  be  set  on  the  basis  of  a 
report  on  the  cyclical  position  of  the  economy 
conducted  by  the  Bank  of  Spain,  and  taking  into 
account  the  economic  forecast  by  the  European 
Commission and the European Central Bank. 

Accountability and enforcement

Before the 1st of October each year the Ministry of 
Finance  will  submit  to  the  Government  a  report 
assessing  the  degree  of  compliance  with  the 
budgetary targets in the previous year. This report 
will be made public. In case of deviations from the 
specified  targets,  the  Autonomous  Community  or 
the  Local  Government  concerned  has  to  present  a 
3-year rebalancing plan. In case of non-compliance 
with  the  previous  provisions  the  Government  will 
be  entitled  to  impose  constraints  to  credit  or  debt 
issuance to the relevant entity.

Sanction mechanism

In  case  of  non-compliance 
the  concerned 
administration  will  have  to  contribute  to  any 
financial  sanction  raised  according  to  the  EU 
Stability and Growth Pact in proportion to its fiscal 
slippage. 

Debt issuance and bailouts

Autonomous Communities and Local governments 
can  issue  debt  on  condition  of  compliance  with 
their budgetary targets. In case of non-compliance 
with  the  budgetary  stability  target,  but  with  an 
approved  corrective  plan,  any  new  long-term 
indebtedness is  subject to approval by the Central 
Government.  In  case  of  not  having  any  approved 
corrective  plan, 
indebtedness  operation 
all 
regardless of the term is subject to approval.

245

European Commission

Public finances in EMU - 2012

In  any  case,  the  central  government  will  not  bail 
any  autonomous  community  or  local  government 
out in case of default.

Due  to  the  current  economic  and  financial crisis
the budgetary targets have been missed since 2008 
on.  No  default  by  any  entity  within  the  general 
government has taken place. 

5. Other relevant institutional features 

spending  by 

increase.  However, 

In  normal  years 
subnational 
governments, especially on healthcare, has risen at 
elevated  rates.  Buoyant  revenues,  partly  linked  to
the  housing  sector,  allowed  offsetting  to  a  large 
extent  such  spending 
the 
collapse  of  tax  revenues  due  to  the  economic  and 
financial  crisis  has  unveiled  the  main  weaknesses 
of the system as expenditure levels at the onset of 
the  crisis were  clearly  oversized.  On  the  other 
hand,  the  normative  capacity  of  Autonomous 
Communities  on  a  number  of  taxes  has  mainly 
been  used  to  raise  allowances  and  deductions, 
thereby  increasing  tax  expenditure,  while  being 
largely reluctant to use it to increase taxes. 

The  system  lacked  credible  enough  incentives  to 
prevent  fiscal  profligacy  by  regional  and  local 
administration. No expenditure ceiling rule applied 
to  subnational  levels  of  government  prior  to  the 
approval  of  the  new  Budgetary  Stability  and 
Financial Sustainability Act. The new Law though 
aims  to  fill  this  gap,  jointly  with  imposing  more 
stringent deficit criteria. This is a promising step to 
underpin budgetary discipline. 

The  new  Budgetary  Stability  and  Financial 
the  previous 
Sustainability  Act, 
Budgetary  Stability  Act,  has  been  passed  and 
entered  into  force  on  28  April  2012.  The  basic 
principles of the reformed law are:

amending 

• The  general  government  deficit  in  structural 
terms cannot exceed 0.4% of GDP in periods of 
low or negative growth. The structural balance 
will  be  gauged  according  to  the  methodology 
employed by the European Commission. 

• The general  government and its subsectors are 
financial 
the 
to 
subject 
sustainability 
to  meet  present  and  future 
expenditure  needs  within  the  deficit  and  debt 

principle 

of 

246

limits  enshrined  in  the  Spanish  and  European 
legislation.  In  this  connection,  no  bail-out 
clauses  among  the  different  subsectors  are 
established.

• A  transition  period  is  envisaged  to  resume  to 

debt levels below 60% of GDP.

• An  expenditure  ceiling  is  set  for  all  entities 
within  the  general  government.  Thus,  the 
relevant  government  expenditure  should  not 
breach the reference rate of medium-term GDP 
growth.  This  reference  growth  rate  will  be 
gauged 
the  methodology 
to 
employed by the European Commission.

according 

• The sanction mechanism is reinforced.

country-specific 
The 
Council 
recommendations 
to 
respect 
subnational governments (see Box I.3.2 above).

to  Spain with 

issued 

A1.10. FRANCE

1. General description

is  a  unitary  state  where 

is  predominant.  However, 

the  central 
France 
the 
government 
Constitution adopted on 4 October 1958 recognises 
the  principle  of  local  government  autonomy.  This 
principle  has  been  consolidated 
the 
constitutional reform of 28 March 2003.

since 

(and  also 

The  country  is  broken  down  into  three  tiers  of 
subnational government  the  main  units  of  which, 
the  Constitution  as  collectivités 
defined  by 
territoriales, are the regions, the departments, and 
the  municipalities 
the  overseas 
territories). There is no subordinated link between 
the  three  entities;  all  three  layers  are  governed  by 
national  legislation.  There  are  22  regions  and  96 
departments  of  mainland  France,  4  regions  and  6
nearly 
departments 
37 000 
overseas, 
municipalities,  which 
gather  within 
coopération 
établissements 
intercommunale (EPCI).  A  small  number  of  local 
governments, known as collectivités territoriales à 
statut 
different 
have 
administrative  frameworks;  among  these  are  the 
island of Corsica and the country’s largest cities.

particulier, 

and 
can 

slightly 

publics 

de 

Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

Part IV

The  so-called  Defferre  laws  of  1982–83  together 
with  the  2003  constitutional  reform  are  the  main 
institutional  reforms  that  have  shaped  over  time 
these  French 
the  current  system.  Prior 
municipalities  and  departments  enjoyed  a  limited 
autonomy,  and 
the 
department was  the  government-appointed  prefect 
(préfet)  who  also  had  strong  powers  over  other 
local authorities.

the  chief  executive  of 

to 

The  decentralisation  process  initiated  in  the  early 
1980s  translated  into  a  number  of  key  changes. 
The administrative stewardship of the prefect  was 
replaced by a legal check and balance exercised by 
the administrative courts and the regional courts of 
auditors.  Departmental  executive  power  was 
transferred from the prefect to the president of the 
departmental  council (Conseil  général).  Regions 
were  given 
recognised  as 
collectivités  territoriales,  with  directly  elected 
regional  councils  and  the  power  to  elect  their 
executive.  The 
local 
governments many functions hitherto belonging to 
the  central  government,  in  particular  economic 
development,  social  welfare,  regional  planning, 
secondary schools, cultural matters, etc.

law  also  devolved 

full  powers  and 

to 

financial 

autonomy  of 

The  2003  constitutional  reform  introduced  the 
local 
principle  of 
governments.  The  changes  also  introduced  the 
possibility of holding local referenda and the right 
to  petition.  New 
responsibilities  were  also 
transferred  to  local  governments  as  part  of  the 
Decentralisation  Act 
in  2004, 
particularly 
departments
regions 
(responsibility  of  non-teaching  staff  in  schools, 
vocational training, ports, airports, etc.).

that  followed 

and 

to 

In  2010,  total  spending  by  local  government 
amounted  to  11.8%  of  GDP (254).  Three  quarters

(254) To be noted is one of the measures of November 7 (article 

les 

108 of LFI 2012) :
'Chaque  année,  le  Gouvernement  dépose  en  annexe  au 
projet  de  loi  de  finances  un  rapport  qui  comporte  une 
présentation de la structure et de l’évolution des dépenses 
ainsi que de l’état de la dette des collectivités territoriales. 
A  cette  fin, les  régions,  les départements  et  les communes 
ou 
coopération 
intercommunale  de  plus  de  50  000  habitants  transmettent 
au  représentant  de  l’Etat,  dans  des  conditions  fixées  par 
décret  en  Conseil  d’Etat  pris  après  avis  du  comité  des 
finances locales, un rapport présentant notamment :
• les orientations budgétaires,
• les engagements pluriannuels envisagés,
• la composition et l’évolution de la dette,

établissements 

publics 

de 

were  to  cover  current  expenses.  Total  revenue
excluding borrowing stood at 11.7% of GDP. 55% 
of  total  revenue was  covered  by  taxes  set  and 
raised  locally  or  by  shared  taxes.  The  main  direct 
taxes  are  the  property  tax  on  buildings  and  land, 
the  residence  tax  and  up  until  2009  the  local 
business  tax.  Central  government  transfers  and 
grants represented 28% of total revenue. These fall 
into  two categories:  grants  and  subsidies  for 
current spending and compensation for transfer of 
responsibilities, and grants  and  subsidies  for 
capital  expenditure.  Borrowing  is  yet  another
source of revenue for local governments in France, 
and represents around 1% of GDP each year. Local 
authorities do not need to seek central government 
authorisation  in  order  to  borrow  money  but  all 
resources  from  borrowing  can  only  be  spent  on 
investment (not current spending)( 255).

2. Government spending

a 

from 

benefit 

assistance 

responsibilities 

Municipalities 
general 
responsibilities clause: they can intervene over and 
above  their  responsibilities  in  all  fields  of  local 
include 
interest.  Traditional 
register office functions, electoral functions, social 
aid,  primary  education,  sports  and  art  facilities, 
maintenance of municipal roads, land development 
and  planning,  local  public  order,  and  local  public 
utilities.  Departments  are  mainly  in  charge  of 
social 
prevention,
construction  and  maintenance  of  secondary  roads, 
secondary 
construction  and  maintenance  of 
schools and  management  of  some  non-teaching 
staff (collèges),  culture  and  heritage,  economic 
development,  and  environment.  Regions  are 
responsible  for  economic  development,  territorial 
development  and  planning,  transport,  vocational 
and 
training 
maintenance 
and 
management  of  some  non-teaching  staff  (lycées), 
as well as special education institutions.

construction 
schools 

and  medical 

programmes, 

secondary 

of 

In  2010,  total  spending  by  local  governments 
amounted to EUR 228.7 billion or 11.8% of GDP. 
local 
Based  on 

the  COFOG  classification, 

•  ainsi  que  la  composition  et  l’évolution  des  dépenses  de 
et 
personnel, 
d’immobilier'.

communication 

subvention,

de 

de 

(255) Funds obtained through borrowing can no longer be used to 
service  outstanding  debt  (which  has  to  be  financed  by  a 
surplus of the operating budget).

247

European Commission

Public finances in EMU - 2012

governments spent 18% of their budget on general 
public services, 17% on social protection, 16% on 
education,  15%  on  housing  and  community 
amenities,  13%  on  economic  affairs,  9%  on 
recreation, 
on 
and 
environmental  protection,  and  4%  on  other 
functions.  The  share  of  social  protection  in  total 
expenditure has increased substantially since 2000 
(+4 pps.) while that of general public policies has 
registered a significant decrease (–6 pps.).

religion, 

culture 

8% 

Among  capital  expenditure  items,  housing  and 
community  amenities  accounted  for  one  third  of 
total  spending,  general  public  policies  and 
education  represented  approximately  15%  each, 
followed by recreation, culture and religion (12%), 
(10%),  and  environmental 
economic  affairs 
protection (9%).

Local  government  responsibilities  mainly  concern 
the  implementation  of  policies,  whereas  their 
regulation  is  generally  entrusted  to  the  central 
government. In the case of education, for instance, 
overall  standards  (i.e.  requirements  of  educational 
institutions, level of qualification of teachers, etc.) 
are  set  by 
the  central  government,  whereas 
municipalities  are  responsible  for  establishing, 
reorganising  and  closing  education  institutions. 
The  same  goes  for  social  allowances  such  as  the 
revenu  de 
the  allocation 
personnalisée pour l’autonomie and the prestation 
de  compensation  du  handicap:  local  governments 
are  responsible  for  paying  such  allowances (256), 
while  the  amount  and  eligibility  criteria  are 
determined nationally.

solidarité  active, 

3. Financial arrangements

In  2010,  total  revenue of  local  governments 
excluding borrowing stood at EUR 227 billion, or 
11.7% of GDP.

Tax  revenue (own-source  local  taxes  and  shared 
taxes)  accounted for  55%  of  total  revenue  while 
operating  and 
represented 
approximately  28% (257). The  remainder  stemmed 
from  the  sale  of  goods  and  services  to  end  users, 

investment  grants 

(256) Including  associated  proximity  services 

(monitoring, 

activation measures etc.).

(257) Figures  reported  here  come  from  Dexia  Crédit  Local’s 
Note  de  conjuncture available  at:  http://public-dexia-
clf.dexwired.net/collectivites-
locales/expertise/Documents/ndc_france_2011.pdf

248

asset  management  and  extraordinary  revenue. 
Municipal  and  departmental  revenue  was  mainly 
tax-based,  while  that  of  regions  was  broadly 
balanced between tax revenue and grants.

Own-source  tax  revenue,  which represents  80  to 
100%  of  total  tax  revenue  for  each  of  the  three 
tiers  of  collectivités  territoriales, mainly  comes
from  four  direct  local  taxes,  which  account  for 
nearly  two  thirds  of  total  tax  revenue.  These  are 
levied  by  local  governments  and  by  some  inter-
municipal  cooperation  structures.  French  local 
taxation  works  on  a  system  of  rate  stacking:  the 
overall  rate  of each  tax  is  calculated  by  summing 
up  rates  imposed  by  different  local  government 
tiers, thus varying across land areas. However, the 
role of regions and departments in setting tax rates 
has  recently  decreased,  while 
they  are  not 
empowered  to  set  up  new  taxes.  The  central 
government  collects  the  local  taxes  annually,  and 
reimburses local governments monthly.

The four main local taxes are:

• The 

CET 

économique 
(contribution 
territoriale)  which  replaces  the  local  business 
tax (taxe  professionnelle).  The  local  business 
tax was paid by companies and was essentially 
based on the rental value of fixed assets. It was 
subject  to  exemptions  decided  by  the  central 
government.  This  tax  was  abolished  in  2010 
and  replaced  by  a  new  economic  contribution 
for  business,  the  CET,  a  flat-rate  tax  on 
network businesses, and new tax revenue were 
transferred to local governments. The CET tax 
comprises  a  land  tax  levied  on  companies 
(cotisation  foncière  des  enterprises or  CFE) 
and  a  new  levy  on  the  value  added  by  a 
company  (cotisation  sur  la  valeur  ajoutée  des 
enterprises or  CVAE).  Local  government 
(municipalities)  can  only  set  the  rate  for  the 
CFE.

the  property’s 

• The property tax on buildings, paid by property 
owners  (companies  and  individuals),  is  based 
theoretical  rental  value 
on 
according  to  the  local  land  registry,  and  is 
adjusted in line with inflation. As of 2011, the 
tax  rate  is  set  only  by  departments  and 
municipalities.

Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

Part IV

Box IV.A1.1: Equalisation mechanisms across subnational entities in France*

The basis for vertical equalisation is the "financial potential", applicable to all subnational entities and set 
each year by the Finance Law. This corresponds first to the income which would be generated if the local 
government concerned were applying to its tax base, and for the four main local taxes presented above, the 
average rate observed nation-wide at a similar level of sub-government. Since 2005, was added to this "tax 
potential" the amount perceived the preceding year from the global operating grant (regions and EPCI are 
also  concerned since  2011  only).  The  financial  potential  therefore  corresponds  to  the  revenue  the 
subnational entity should be able to rely on if it were applying "average" tax policies. 

With the dying out of the "professional tax" in 2011, it was also decided to create for a fund for horizontal 
equalisation at  the  municipal  level  (fonds  de  péréquation  national  des  recettes  intercommunales et 
communales (FPIC)), on the model of a fund created specifically in 2010 for the Ile-de-France region (Paris 
and surroundings). The FPIC will begin operating in 2012. 

* For more information, please refer to Péréquation financière entre les collectivités territoriales : les choix 
de  la  commission  des  finances  du  Sénat,.Rapport  d'information  n°  731  (2010-2011)  de  MM.  Philippe 
DALLIER,  Charles  GUENÉ,  Pierre  JARLIER  et  Albéric  de  MONTGOLFIER,  fait  au  nom  de  la 
commission des finances, déposé le 6 juillet 2011, http://www.senat.fr/rap/r10-731/r10-731.html . 

is  also  based  on 

• The  residence  tax,  paid  by  the  residents  of 
the 
housing  buildings, 
property’s theoretical rental value and adjusted 
in line with inflation. There are exemptions for 
over  60s,  low-income  households  and  also  if 
the property is incapable of occupation due to it 
needing  extensive  renovation.  As  of  2011,  the 
tax rate is set only at the municipal level.

• The property tax is also paid by owners of non-
built  land  (companies  and  individual).  As  of 
2011,  the  tax  rate  is  set  only  at  the  municipal 
level.

contribution 

Local governments levy other own-source direct or 
indirect taxes, including transfer taxes on property 
transactions  (municipalities  and  departments),  a 
transport 
a 
household  waste  disposal  tax  (municipalities),  a 
vehicle  registration  tax  and  a  tax  on  driving 
licences (regions), an electricity tax (municipalities 
and departments), and various town planning taxes 
levied by local governments as a whole.

(municipalities), 

The  central  government  has  increasingly  shared 
tax revenue with local governments to compensate 
for  transferred  responsibilities  and  reforms  such 
the local business tax abolition. Regions have been 
receiving  a  fraction  of  the  domestic  tax  on 
les 
(taxe 
petroleum  products 

intérieure  sur 

produits pétroliers or TIPP) and a surcharge on the 
apprenticeship  tax  (taxe  additionnelle  à  la  taxe 
d’apprentissage)  since  2005.  Departments  have 
also been receiving a fraction of the TIPP tax and a 
fraction  of  the  special  tax  on  insurance  contracts 
(taxe  spéciale  sur  les  conventions  d’assurance  or 
TSCA) since 2005. Except for an earmarked share 
of  the  TIPP  tax,  where  regions  have  the  power  to 
set 
local 
governments  do  not  fix  the  rate  of  any  of  these 
indirect  taxes.  Some  new  tax  revenue  has  been 
transferred to local governments since 2011 as part 
of  the  local  business  tax  reform,  including  the 
remaining fraction of the TSCA tax.

(within  a 

limited 

range), 

rates

Grants  from  the  central  government consist  of 
operating  grants  and  capital  expenditure  grants
(82%  and  18%  respectively  in  2010).  In  the  past 
the central government set up various mechanisms 
(pacte  de  stabilité,  contrat  de  croissance  et  de 
stabilité,  contrat  de  stabilité)  aiming  at  better 
controlling  increase  in  grants.  Under  the  second 
multi-annual  public  finance  planning  act,  which 
covers  the  period  2011–14,  transfers  to  local 
governments  have  been  frozen  in  nominal  terms
(258).

(258) And a 200 M€ decrease was voted in the 2012 budget law 

as part of the fiscal consolidation package.

249

European Commission

Public finances in EMU - 2012

grant 

globale 

(dotation 

The  main  operating  grant  is  the  so-called  global 
operating 
de 
fonctionnement or DGF), which amounted to EUR 
41.1 billion  in  2010 and  represented  around 85% 
of all operating grants. It has increased drastically 
since the 2004 budget, which simplified operating 
grant  structure  by  integrating  various  grants  and 
compensations  for  tax  exemptions  into  the  DGF. 
This  reform  also  introduced  a  share  for  regions, 
and  reviewed  financial  equalisation  mechanisms: 
each  local  government  receives  a  fixed  grant, 
where  the  amount  allowed  may  vary  according  to 
local  needs, and  an  equalisation  fraction  with  a 
view  to  remedying  the  adverse  effects  of  the 
unequal  distribution  of  resources  and  expenditure 
requirements.

means  that  debt  annuities,  in  turn,  have  to  be 
financed by own resources ( 262). The rule has been 
into  force  since  1983  for  municipalities  and 
departments, and since 1988 for regions.

Any decision to borrow is subject to ex-post legal 
control on the decision to borrow. It is also subject 
to  a  budgetary  control  by  the  central  government 
representative  – the  prefect  – together  with  the 
regional  chamber  of  auditors  to  ensure  that  debt 
annuity  has  been  included  in  the  budget  as  a 
compulsory  expenditure  and  to  check  compliance 
with  the  rule.  In  case  a  significant  deficit  is 
recorded  (see  above  mentioned  thresholds),  the 
regional  chamber  of  auditors  shall  propose 
corrective action within one month.

In  addition,  capital  expenditure  grants  include 
reimbursement of the VAT that local governments 
pay  on 
rural  area 
equipments  grant,  a  school  equipments  grant  for 
regions and departments, and also some ministerial 
subsidies.

investment  spending,  a 

4. Fiscal rules

Principles  of  sincerity  and  balance  cover  both  the 
operating  and  capital  formation  sections  of  the 
budget  of  all  subnational  entities,  requiring 
expenditure and revenue to match in each section. 
The  term  budget  as  used  under  the  rule  refers  to 
the  voted  budget.  Ex-post,  the  budget  can  be 
unbalanced but deficits (259) may not exceed 5% of 
the  year’s  current  revenue  (10%  for  small 
municipalities).  There  are  no  pre-existing  escape 
clauses. Average deficits, observed ex post, shrank 
from  close  to  5%  of  the  annual  revenue  in  2007 
and 2008 to less than 1% in 2010 (260).  

The  golden  rule  applicable  to  the  collectivités 
territoriales prohibits  current  expenditure  to  be 
financed by debt; borrowing can thus only be used 
to finance capital expenditure and is today used to 
cover  about  one  third  of  investment  spending 
undertaken  by  subnational  entities (261).  This  also 

(259) Of the operating part of the budget.
(260) For  detailed  statistics,  see  Insee  "Dépenses  et  recettes  des
at  

collectivités 
(S13131)", 
locales 
http://www.insee.fr/fr/themes/comptes-
nationaux/tableau.asp?sous_theme=3.2&xml=t_3206
(261) Net  borrowing  is  at  5/10%  of  investment  but  gross 
borrowing  is  at  around  16M€  for  45  M€  of  capital 
expenditures.

available 

250

the 

since 

decreased 

Since  1982  French  local  governments  have  been 
able  to  borrow  freely,  without  requiring  central 
government’s permission. The outstanding amount 
of  subnational  government  debt,  which  has 
substantially 
1990s, 
represented  6.3%  of  GDP  in  2011 (263)  (mainly 
driven  by  regions  and  municipalities),  thus  less 
than one tenth of the outstanding debt of the public 
sector.  Banks  have  been  the  biggest  source  of 
external  funding  to  local  governments,  which 
borrow around EUR 20 billion or 1% of GDP each 
year  in  the  form  of  loans,  structured  loans, 
revolving 
loans. 
Although  legally  allowed,  direct  financing  via 
capital markets has been little used to date.

loans,  and  foreign  currency 

Local  governments  are  obliged  to  deposit  their 
liquid assets and cash with the French treasury in a 
non-interest  bearing  cash  account.  They  are 
therefore  not  allowed  to  invest  their  daily  cash 
with  banks.  However,  local  governments  are 
entitled to use bank lines to cover their day-to-day 
liquidity shortfalls.

Local  governments  cannot  be  declared  bankrupt. 
In  the  event  of  default,  there  is  no  central 
government  guarantee.  For  example, when  the 
cities  of  Angoulême  and  Briançon  defaulted  on 
their debt, in 1991 and 1992 respectively, they had 
to  negotiate  a  debt  rescheduling  with 
their 
creditors and had to undertake a stringent plan for 

(262) It  is  in  fact  even  tighter  than  this,  as resources  of  the 
investment part  of  the  budget  cannot  be  used  to  that 
purpose.

(263) )  Eurostat's  Excessive  Deficit  Procedure  press  release, 

April 2012.

Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

Part IV

provide 

liquidity 

however 

tensions, 

tax  payments;  for 

the  consolidation  of  their  public  finances.  In case 
the  central 
of  extreme 
government  may 
local 
governments with exceptional transfers in the form 
of  advances  on 
instance, 
Angoulême was granted 10.7 million francs (about 
1.5 EUR mn) over 7 years, in 1991, to support the 
stabilization  of  its  financial  situation  and  meet 
mandatory 
the
representative  of  the  central  government  can  put 
local  governments  under  supervision  (tutelle  de 
l’État). 

Furthermore, 

payments. 

A1.11. ITALY

1. General description

As  in  many  other  European  countries,  fiscal 
decentralisation  in  Italy  has  historically  been 
driven  by  pressures  from  regions  for  more  direct 
participation  and  control  in  the  political  process. 
Italy 
is  currently  composed  of  20  regions, 
including  five  that  have  a  special  status  granting 
them  more  autonomy (264),  110  provinces  and 
8092  municipalities.  Regions  were  granted 
political autonomy by the 1948 Constitution of the 
Italian  Republic,  but  the  actual  implementation  of 
regional  autonomy  was  postponed  until  the  first 
regional  elections  of  1970.  Since  then,  the  Italian 
public  finances  have  been  characterised  by  a 
combination of  high centralisation of revenue and 
expenditure, 
sizeable 
decentralisation 
important  devolution  of
corresponding 
to  an 
levels. 
functions
to 
the 
powers 
Subnational
increased 
somewhat 
the  1990s,  alongside  a further
decentralisation of administrative functions. 

government 
taxation 

lower
of 

of 

in 

In  2001  a  Constitutional  reform  introduced  deep 
changes in the relationships between State, regions 
and  local  authorities,  opening  the  way  to  fiscal 
federalism. However, delays in the adoption of the 
ordinary legislation required to allow the entry into 
force of the new fiscal configuration has kept alive 
the  funding  of  subnational
a  system  where 
government  expenditure  is  highly  dependent  on 
transfers from the centre.  A crucial step was taken 
in  May  2009,  with  the  approval  of  a  framework 

(264) The  five  regions  with  special  status  are  Friuli  Venezia 
Giulia,  Sardegna,  Sicily,  Trentino-Alto  Adige  and  Valle 
D'Aosta.

law  that  delegated  the  government  to  adopt 
legislative  decrees  enacting  fiscal  federalism,  on 
the basis of identified principles and guidelines. 

subnational

relatively  high 

(15%  of  GDP),  while 

In  2009,  sub-central  government  expenditure 
to  31%  of  general  government 
amounted 
expenditure 
local 
government  revenue  excluding  transfers  from  the 
central government is estimated at 17% of general 
government revenue (8% of GDP). In this context 
of 
government 
spending  but  limited  revenue  de-centralisation, 
fiscal  relations  between  the  central  government 
and  the  local  authorities  during  the  past  decade 
have  been  regulated  by  a  domestic  stability  pact 
(DSP),  setting  annual  constraints  on  expenditure 
and/or the budget balance of the subnational units, 
regional 
and 
a 
governments' 
services.
Parliament is now about to adopt a bill introducing 
a  balanced  budget  rule  in  the  Italian  Constitution
that applies to all government levels.

controlling 
spending  on  health 

health 

pact, 

2. Government spending

A  major  Constitutional  reform  of  the  distribution 
of  powers  across 
levels  of  government  was 
approved  by  the  Italian  Parliament  in  2001.  The 
reform  increased  the  regulatory  and  spending 
functions  falling  under  the  jurisdiction  of  sub-
central governments. 

The  Italian  central  government  is  exclusively,  or 
near-exclusively,  responsible  for  expenditure  on 
social  protection  transfers  (38%  of  total  general 
government  expenditure),  defence 
(3%),  and 
public  order  and  safety  (4%).  On  the  other  hand, 
health  care  (14%  of  total  general  government 
expenditure) is practically completely devolved to 
the  regions.  Sub-central  authorities  also  make  a 
large majority of national spending on housing and 
total  general 
community  amenities  (1.5%  of 
government  expenditure)  and  on  environmental 
protection  (1.5%),  reflecting  the  limited  scope  for 
economies of scale in centralised provision of such 
services.  Municipalities  and  regions  are  also 
directly responsible for town planning. 

The  new  Title  V  of 
the  Constitution  and 
subsequent  legislation  also  specified  functions  of 
shared  competence  between  the  central  and  sub-
central governments. These include general public 
total  general  government 
services 

(18%  of 

251

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Public finances in EMU - 2012

expenditure, more than half of which is accounted 
for  by  debt  servicing  expenditure  by  the  central 
government),  education  (10%),  economic  affairs 
(8%),  and  recreation,  culture  and  religion  (1.5%). 
Following  conflicts  over  the  actual  division  of 
responsibilities in the areas of shared competence, 
the Constitutional Court stated that responsibilities 
should  be  split  up  as  follows:  (a)  the  central 
government  legislates  the  fundamental  principles 
for  the  exercise of  the  power  in  question;  (b)  the 
region  undertakes  the  financing,  administrative, 
and  management  functions  for  this  exercise;  and 
(c)  the  local  authorities  perform  “hands  on” 
delivery of services unless there are strong reasons 
to do so at a higher level.

Table  IV.A1.1 lists  the  different  competencies 
devolved 
tiers  of  sub-central 
governments in Italy. 

three 

the 

to 

• Equalising transfers for territories having lower 

per-capita taxable capacity.

rule 

is,  however,  envisaged 

for 
A  golden 
subnational governments,  which  are  allowed  to 
borrow  only  for  investment financing.  Moreover, 
the  central  government  has  the  possibility  to 
allocate  supplementary  resources  to  subnational
governments 
to  promote  economic 
development  and  social  cohesion or  to  perform 
functions that go beyond their normal remit.

in  order 

the 

total 

revenue  of  sub-central 
In  2009, 
governments 
to  33%  of 
in  Italy  amounted 
(consolidated)  general  government  revenue  (15% 
of  GDP).  Transfers  from  the  central  government
accounted  for  50%  of  sub-central  revenue  (8%  of 
GDP). 

Sub-central  government  revenue  from  indirect 
taxation (excluding  taxation  on  property)  was  in 
2009  the  most  important  source  of  own-revenue 
for  sub-central  authorities,  accounting  for  more 
than  25%  of  their  total  revenue  (4%  of  GDP). 
the  sub-central  government 
Almost  60%  of 
indirect tax revenue is collected through a regional 
tax  on  productive  activity (IRAP  -
Imposta 
regionale  sulle  attività  produttive). IRAP  is  a  tax 
on  the  value  added  of  firms,  with  some  tax 
deductions  for  labour  costs  gradually  introduced 
since the inception of the tax in 1998 (including in 
the December 2011 budgetary package). The basic 
rate  of  IRAP  stands  at  3.9%,  with  regions  having 
the power to increase or reduce the rate by around 
1%. Sub-central authorities also receive a share of 
the  national  revenue  from  VAT,  which  in  2010 
was  equivalent  to  10%  of  sub-central  indirect  tax 
revenue. The distribution of national VAT revenue 
across  regions  takes  into  account  health-related 
indicators 
regional 
differences  in  health  spending  pressures.  The  five 
special-statute regions are entitled to a higher share 
of  the  national  taxes  due  on  economic  activity 
carried  out  in  their  territories.  Other  important 
sources  of 
for  sub-central 
governments include taxation on car insurance and 
motor  vehicle  registration  (6%  of  sub-central 
government  indirect  tax  revenue),  taxation  on 
building  permits  (5%)  and  a  surtax  on  electricity 
consumption (3%).

to  measure 

designed 

taxation 

indirect 

Expenditure by regional governments accounts for 
around  two-thirds  of  total  sub-central  government 
expenditure  in  Italy.  Reflecting  the  fact  that  80% 
of  regional  expenditure  goes 
to  health  care 
provision, the purchase of goods and services and 
wages  account  for  50%  and  25%  of  regional 
spending  respectively.  Provinces  account  for  only 
5% of sub-central government expenditure, or less 
than  2%  of  total  general  government  spending. 
Their  very  limited  role  in  the  current  fiscal 
devolution  set-up  confirms  that  there  is  scope  for 
administrative  expenditure  savings  through  the
integration of their functions in the other two tiers 
of sub-central governments, as has been stipulated 
in the December economic and budgetary package.
Capital expenditure is a relatively important part of 
the  combined  budget  of  municipalities  and 
provinces,  with  investment  spending  representing 
around 20-25% of their total  expenditure between 
2005 and 2010. 

3. Financial arrangements

(Art.119)  establishes 

The  Constitution 
that 
subnational governments  have  revenue  autonomy 
to  perform  the  new  functions  attributed  to  them. 
Specifically, they can raise revenue from:

• Own taxes;

• Shares in the national tax revenue;

252

Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

Part IV

Table IV.A1.1: Subnational government competencies in Italy following the 2001 constitutional reform

Municipalities

Provinces

Regions

Social housing

Road network maintenance

Health

Town planning
Aid to the disabled and other
services

social

Local public transport

Road network maintenance

schools

(construction

Transport
Secondary
buildings)
Environment
protection
improvement of the energy resources
Cultural heritage

including

Local police

Household waste and sewage

Health centres and hospitals

Vocational training

Culture

of

and

Town planning
Road networks, civil engineering and
regional railway transport

Pre-primary (all), primary and vocational
and
schools
maintenance)
Culture

construction

(building

Sport

Sewage and waste disposal

Upkeep of pharmacies in rural areas

Source: ISAE.

Management of employment services and
subsidies 

Agriculture

Vocational teaching

Economic development

Environment
Country side planning and economic
development

Management of employment services and
subsidies

Social services

Education

Sub-central  taxes  on  personal  income (IRPEF -
Imposta  sul  reddito  delle persone  fisiche)  were
equivalent to 10% of sub-central revenue (1.5% of
GDP).  Regional  and municipal  income  surtaxes
are levied on top of the national income tax, using
the  same  tax  base.  The  regional  income  surtax  in
2010 stood at 0.9%, but the regions can increase it
financial
to  1.4%.  Regions  running  substantial
deficits  on health  care  provision  have  been
authorised  to  increase  their surtax  to  1.7%.  The
December 2011 package increased the basic rate of
regional  income  tax  from  0.9%  to  1.23%  as  from
the  2011  tax year.  The  maximum  municipal
income  surtax  rate  is  0.8%, although  the  rate  is
automatically increased by 0.3% for municipalities
in breach of "stability pact" provisions.

Taxation  on  property (ICI  – Imposta  Comunale
sugli Immobili) accounted for less than 5% of sub-
central  revenue  (0.5%  of  GDP)  in  2009,  with  the
intakes accruing to municipalities. The tax base is
based  on  so-called  cadastral  values  of  property,
which  are  official  reference  values  that  take  into
account  property specificities  but which  are  well
below  market  values. The  importance  of  property
taxation 
of
municipalities is expected to increase substantially
starting from  the  current year,  especially with the
widening of the property tax base to include homes
of first residence. 

financing 

activities 

the 

for

4. Fiscal rules

Fiscal relations between the central and sub-central
governments have  been  regulated  over  the  past
decade  through  a  domestic  stability  pact  (DSP)
and, for spending on health services, a health pact.
The  entry 
federalism's
force  of 
permanent  provisions will make  both  pacts
unnecessary; however, they will remain in place in
the current long transition period.

fiscal 

into 

4.1 Domestic Stability Pact

A Domestic  Stability  Pact  (DSP) was  introduced
for  the first  time  in  the  budget  law for  1999 to
improve the governance of fiscal relations between
the central and sub-central governments. The DSP
rules, which  are established  each year  by  the 
budget  law, set  annual  constraints  on  expenditure
and/or  the  budget  balance  of  the  sub-central
governments. The rules changed substantially over
time,  in  part  reflecting  successive  attempts  to
correct  identified weaknesses  in  rules  set  in
preceding 
enforcement
mechanisms have  been  strengthened,  the  frequent
changes  in  the  DSP  targets  and  coverage  have
reduced the effectiveness of the DSP as a tool for
the  central government 
to  ensure  budgetary 
discipline  at  local  level  and  as  a  mechanism for
expenditure planning  by  sub-central governments.
Initially,  regions  and  local  governments  respected

Although

years. 

253

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Public finances in EMU - 2012

the 

the 

result  of 

the  DSP  rules,  but  the  high  degree  of  compliance 
was  primarily 
relatively 
unambitious  constraints  set  by  the  rules.  Regional 
and  other  local  administrations  in  breach  of  the 
DSP  must  increase  regional/local  surtax  rates.  In 
case  of  serious  and  protracted  breach,  the  central 
elected 
government 
replace 
appointed 
administrators 
commissioners. 

centrally 

locally 

with 

can 

As  from  2012,  sub-central  governments  have  to 
provide  a  significant  contribution  to  the  national 
consolidation  effort,  by  around  0.4%  of  GDP  per 
year.  This  will  be  shared  among  them  also 
according  to  a  system  based  on  "virtuosity", 
namely  the  respect  of  previous  years'  DSPs,  and 
pending  the  identification  of  essential  service 
levels and their standard cost. 

4.2 Health Pact

The  Health  Pact  is  a  separate  fiscal  mechanism 
governing  regional  government's  health-related 
spending.  The  Pact,  which  is  updated  every  three 
years, sets limits to current and capital expenditure 
for  health  care  by  region.  Sanctions  apply  to 
regions  exceeding their  limit:  local  tax  shares  are 
increased,  citizens'  contributions 
to  costs  are 
raised,  and/or  administrative  sanctions  (including 
the dismissal of administrators) are imposed. Still, 
over  the  last  decade,  annual  health  expenditure 
exceeded its funding by around 0.3 pp. of GDP per 
year on average. The health pact also incorporates 
specific  caps  on  the  share  of  pharmaceutical 
expenditure  in  total  health  expenditure,  with  the 
purpose  of  encouraging  savings  both  through 
tougher  price  negotiations  with  suppliers  and  the 
wider use of generic drugs.

5. Design of a new institutional set-up 

5.1  The  2009 
federalism 

framework 

law  on 

fiscal 

of 

granting 

implementation 

The 
the  Constitutional 
financial 
provisions 
greater 
responsibilities  to  sub-central  authorities  requires
enabling legislation. Postponement of the adoption 
of  such  legislation  sustained  a  system  where  the 
funding  of  subnational government  expenditure 
remains highly  dependent  on  transfers  from  the 
centre. A crucial step was taken in May 2009, with 
the  adoption  of  a  framework  law  setting  down 

254

broad guidelines to support the transition towards a 
more  complete  federal  fiscal  structure  by  2017.
The 
law,  however,  still  required the  central 
government  to  adopt,  in  agreement  with  the 
subnational governments, enacting decrees in order 
to specify the rules governing fiscal federalism. To 
date,  eight  decrees  have  been  adopted  by 
government and approved in Parliament, including 
on  the  definition  of  essential  financing  needs  and 
standard 
authorities 
(November 2010), the role of municipalities in tax 
assessments (March 2011), allocation of additional 
financial  resources  to  less  prosperous  areas  (May 
2011), standard costs and financial needs for health 
care  provision  (May  2011),  and  sanctioning  and 
reward  mechanisms 
(September  2011).  This 
Section describes  the  fiscal  federalism  set  up  that 
is expected to take place over the next few years as 
a result of the 2009 framework law and subsequent 
legislation.  

sub-regional 

costs 

for 

The  most  innovative  and  important  principle 
established in the 2009 framework law consists in 
the  introduction  of  the  so  called  “standard  cost” 
criterion  in  place  of  the  “historical  expenditure” 
criterion  used  so  far  to  determine  the  costs 
necessary to the pursuit of the functions entrusted 
to  the  territorial  bodies.  Standards  of  quality  and 
efficiency are to be adopted in establishing proper 
unit  costs  and  service  provision  methods  and 
procedures.  Subnational governments  providing 
essential services at a higher cost, or offering more 
services  that  those  identified  as  standard  needs  of 
the  population  have  to  raise  additional  sources  of 
financing.  Another 
the 
key 
introduction of equalisation transfers redistributing 
revenue  across  subnational governments.  These 
transfers  will  partially  compensate  for  differences 
in  fiscal  capacity, as  measured  assuming  identical 
tax  rates,  so  as  to  bridge  the  financing  gap  in 
providing essential services. 

principle 

is 

The  main  sources  of  financing  for  regions  will 
continue  to  be  the  regional  tax  on  productive 
activity  (IRAP),  part  of  the  revenue  from  VAT, 
and  the  surcharge  on  the  personal  income  tax. 
Regions will be able to increase the latter by up to 
0.5 pp. in 2013, 1.1 pp. (cumulative) by 2014 and 
2.1  pp.  as  from  2015. An  equalizing  fund  will 
transfer  resources  to  regions  with  lower  fiscal 
capacity. 

Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

Part IV

di 

sperimentale 

riequilibrio") 

The decree law on municipal fiscal federalism sets 
up  a  temporary  experimental  re-balancing  fund 
("Fondo 
to 
aggregate  all  the  proceeds  that  are  intended  to 
replace permanent and general transfers from other 
administrations,  namely:  30%  of  the  recurrent 
taxes  raised  on  real  estate  property part  of  the 
resources  coming  from  a  new  tax  on  property 
leasing (21.6% from 2012 onwards), and a share in 
VAT  revenues.  The  aim  of  this  fund,  which  will 
cease to operate after 2013, is to ensure a gradual 
and 
to 
municipalities  of  real  estate  taxation.  In  a  second 
and  final  phase,  which  was  originally  planned  to 
get  underway  in  2014,  existing  taxes  are  planned 
to  be  replaced  by  two  new  forms  of  municipal 
taxes: (i) a municipal tax on real property (unified 
municipal  tax  IMU)  that  would  combine  the 
current ICI tax and the part of personal income tax 
(IRPEF) payable  on  property  income;  (ii)  a 
secondary municipal tax on the occupancy of state 
property. 

geographically-balanced 

devolution 

In December 2011, the Italian government brought 
forward  to  2012  the  introduction  of  the  unified 
municipal  tax  (IMU)  and  extended  it  to  owner-
occupied dwellings (homes of first residence) that 
had  been  excluded  from  taxation  in  2008.  Part  of 
the receipts from IMU will be initially assigned to 
the  central  government.  The  government  also 
announced  plans  for  a  substantial  revision  to  the 
cadastral  property  valuation  register,  which  is  the 
tax base of IMU.

Although  several  enacting  decrees  specifying  the 
rules  governing  fiscal  federalism  have  been 
adopted  in  2010  and  2011,  crucial  details  are  still 
to  be  determined  through  administrative  acts. 
Chief  among 
the  revenue  sharing 
mechanism and the definition of essential levels of 
services and their standard costs. They will have to 
be  defined  by  2016,  with  fiscal  federalism 
expected  to  enter  into  full  force  by  the  end  of 
2017.

them  are 

5.2  Constitutional  amendments  establishing 
balanced budgets principle

On  15  December  2011,  the  Italian  parliament 
approved a bill introducing a balanced budget rule 
in 
the  Italian Constitution.  The  amendments 
approved  by  parliament  as  part  of  this  process 
included  changes  to  Article  119  that  establish  the 

subnational

governments  must

financial  autonomy  of  subnational governments. 
The  amending  provisions  introduce  the  principle 
that 
balance 
revenue  and  expenditure  in  their  budgets.  The 
Constitutional amendment also retains the existing 
possibility for subnational governments to resort to 
indebtedness  to  fund  investments,  but  under  the 
condition  that  the  aggregate  budget  of  all  sub-
central  governments  within  a  region  must  be  in 
balance.  The  key  to  the  success  of  this  new 
provision  to  contribute  to  the  achievement  of  a 
balanced budget for the whole general government 
for 
will  hinge  on  enforcement  mechanisms 
execution. Effective ordinary legislation  will  need 
to  be  designed,  specifying  the  balance  to  be 
considered,  modalities  of  application  (e.g.  on 
cyclical  conditions)  and  appropriate  correction 
mechanisms, as required by the fiscal compact.

country-specific 
The 
Council 
to 
respect 
recommendations 
subnational governments (see Box I.3.2 above).

Italy with 

issued 

to 

A1.12. CYPRUS 

1. General description

the  Council 

Cyprus  became  an  independent  republic  on  the 
16th  August  1960.  It  is  a  member  of  the  United 
Nations, 
the 
Commonwealth  and  the  Non-Aligned  Movement. 
According  to  the  above  treaty,  Britain  retains  two 
Sovereign  Bases  (158.5  sq.  km)  on  the  island,  at 
Akrotiri-Episkopi.
Dekeleia 

Europe, 

and 

of 

Administrative districts

Cyprus  is  divided  into  six  administrative  districts
(eparcheies).  These  are:  Nicosia,  Limassol,  Pafos, 
Larnaka, (in the government-controlled areas) and 
Famagusta  and  Keryneia  (in  the  occupied  areas). 
Each  District  is  headed  by  a  District  Officer
(eparchos) who 
local 
representative or extended arm of the government. 
The  District  Officer  acts  as  the  chief-coordinator 
of  the  activities  of  all  Ministries  in  the  District. 
District Officers are answerable to the Ministry of 
the  Interior,  which  is  headed  by  a  Permanent 
Secretary as chief administrator.

essentially 

the 

is 

255

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Public finances in EMU - 2012

Local authorities

in 

rural  areas.

Municipalities and Communes are the two types of 
local  authorities and are  governed  by  separate 
laws.  In  principle,  Municipalities  constitute  the 
form  of  local  government  in  urban  and  tourist 
centres  while  communities  constitute  the  local 
33  municipalities
structure 
(dimarchia)  account  for  about  60  per  cent  of  the 
population, while 353 communes (koinotita) cover 
the  rest  of  the  population.  The  functions  of 
Municipalities 
the 
Municipalities' Law of 1985. Their finances derive 
from  municipal  taxes,  fees  and  duties  as  well  as 
state subsidies.

determined 

are 

by 

In October  1985,  a  new  comprehensive  law  on 
local  government,  the  Municipalities'  Law  111  of 
1985, was passed by the House of Representatives. 
This Law has since been amended by 25 amending 
Laws.  In  addition  to  the  six  principal  (Nicosia, 
Limassol,  Famagusta,  Larnaca,  Paphos  and 
Kyrenia)  and  nine  rural  communities,  the  Law 
provided 
new 
for 
of 
this  Law,  any 
municipalities.  According 
commune may  become  a  municipality  by  local 
referendum, subject to the approval of the Council 
of Ministers, provided it has either a population of 
more than 5,000 or has the economic resources to 
function 
new 
municipalities  were  established  in  1986,  five  in 
1994 and one more in 1996, increasing the number 
to thirty-three.

establishment 
to 

a  municipality.  Eleven 

the 

as 

Mayors  are  elected  directly  by  the  citizens  on  a 
separate ballot, for a term of five years and are the 
executive  authority  of  the  municipalities.  The 
Mayor  represents  the  municipality  in  a  court  of 
Law  and  before  any  state  authority,  and  presides 
over 
all  Council  meetings,  Administrative 
Committee  meetings  and  any  other  municipal 
committee.  He  executes  the  Council's  decisions 
and  heads  all  municipal  services  which  he  directs 
and supervises.

Municipal  councils,  which  are  the  policy-making 
bodies of the municipalities, are elected directly by 
the citizens for a term of five years, but separately 
from 
the 
the  Mayor.  The  Council  appoints 
members  of  the  Administrative  Committee.  The 
latter's  duties  include  the  preparation  of  the 
municipality's  budgets  and  annual 
financial 
statements,  the  provision  of  assistance  and  advice 

256

to  the Mayor  in  the  execution  of  his  duties, 
coordination  of  the  work  of  other  committees 
appointed  by  the  Council  and  the  carrying  out  of 
any  other  duties  entrusted  to  it  by  the  Council  or 
the Mayor. The Council may also set up ad-hoc or 
standing committees which have an advisory role.

of 

the 

areas, 

protection 

of  waste, 

the  municipal 

According  to  the  law,  the  main  responsibilities  of 
municipalities  are  the  construction,  maintenance 
and lighting of streets, the collection, disposal and 
treatment 
and 
improvement  of  the  environment  and  the  good 
the 
appearance 
construction,  development  and  maintenance  of 
municipal gardens and parks and the protection of 
public  health.  The  Municipal  Council  has  the 
authority to promote, depending on its  finances, a 
vast  range  of  activities  and  events  including  the 
arts,  education,  sport  and  social  services.  In 
addition  to  the  Municipalities  Law,  there  are 
important 
several 
powers  other  than  those  already  mentioned.  Such 
laws are the Streets and Buildings Regulation Law, 
the Town Planning Law, the Civil Marriages Law 
and the Sewerage Systems Law.

laws  giving  municipalities' 

2. Local government finances  

The main sources of revenue of municipalities are 
municipal taxes,  fees and duties (professional  tax, 
immovable property tax, hotel accommodation tax, 
fees  for  issuing  permits  and  licences,  fees  for 
refuse  collection,  fines  etc.),  as  well  as  state 
subsidies.  Taxes,  duties  and  fees  represent  the 
major  source  of  revenue  while  state  grants  and 
subsidies amount to only a small percentage of the 
income. The central government, however, usually 
finances  major  infrastructure  projects  undertaken 
by  the  municipalities,  but  this  is  dependent  very 
much  on  each  individual  project.  The  yearly 
budgets  of  the  municipalities  are  submitted  to  the 
their 
Council  of  Ministers  for  approval  and 
accounts  are  audited  annually  by  the  Auditor 
General of the Republic. Municipal loans also need 
to  be  approved  by  the  Council  of  Ministers. The 
concerning  municipalities 
following
finances are  rough  estimations  and  may  vary 
among municipalities:

figures

Municipalities’  revenues mainly  come  from  (i) 
government  subsidies estimated  to  approximately 
40%  of  total  revenues;  taxes,  licence  fees  and 
rights  estimated  to  approximately  45%  of  total 

Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

Part IV

revenues and;  fines  approximately  to  5%  of  total 
revenues

Municipalities'  expenditure is mainly  categorised 
into: (i) salaries and payments to pension schemes 
estimated  to  approximately  55%-65%  of  the  total 
spending; 
works/maintenance 
utility 
approximately  15%  of  the  total  and;  (iii)  loan 
repayments  to  approximately  10%-15%  of  total 
spending.

(ii) 

Main legal acts governing municipalities in Latvia 
are  the  Law  on  Self-governments  (in  force  since 
1995),  the  Law  on  the  Equalisation  of  Self-
government Finances (in force since 1998) and the 
Law  on 
the  Stabilisation  of  Self-government 
finances  and  the  Monitoring  of  the  Financial 
Activities  of  Self-governments  (in  force  since 
1999).  The  territorial  administrative  reform  was 
implemented  on  the  basis  of  the  Administrative-
Territorial Reform Law (in force since 2005).

A1.13. LATVIA

1. General description

Latvia is a unitary country. Local self-government 
is only indirectly recognised in the Constitution via 
references in certain articles.

structure, 

including 

A  major  territorial  administrative  reform  took 
effect  from  July  2009,  implementing  a  two-tier 
government 
the  central 
government  and  local  governments,  the  latter 
comprising  9  republican  cities  and  110  local 
municipalities. Before the reform, the government 
structure  had  three  tiers  and  included  over  500 
local  government  units,  with  districts  being  the 
intermediate level. As a result of the reform,

• Most  municipalities  were  amalgamated  into 
larger  ones,  by  forcing  rural  municipalities 
which  did  not  have  the  scale  and  resources  to 
efficiently  provide  public  services  under  their 
competence, to merge with others.

• Districts were abolished.

a 

separate  governance 

To  facilitate  planning  and  resource  management, 
the  municipalities  are  furthermore  integrated  into 
five  planning  regions  since  2003.  These  do  not 
tier  but 
represent 
nevertheless  play  an  important  administrative  role 
as  an  interface  between  state  administration  and 
local governments in preparing, co-ordinating and 
implementing  regional  development  programmes, 
including those co-financed from the EU structural 
funds.  Legally  these  regions  have  a  status  of 
derived  public  persons.  The  governing  bodies  of 
planning  regions  are  elected  by  municipalities, 
while  their operational costs  are covered from the 
state budget.

2. Government spending

functions  of 

The  main  autonomous 
local 
governments  are  the  provision  of  utilities  (water 
supply and sewerage, supply of heat, management 
of  municipal  waste,  water  management  etc.); 
provision  of  education  services  (including  pre-
school,  primary  and  general  secondary  education, 
extracurricular  training  etc.);  ensuring  access  to 
lifestyle; 
health  care  and  promoting  healthy 
maintaining  public  facilities  (buildings,  streets, 
roads,  parks  etc.);  providing  social  assistance  to 
poor  and  socially  vulnerable  persons;  determining 
procedures for utilisation of public-use forests and 
waters;  maintaining  of  cultural  objects  and 
preservation  of  traditions;  performing  civil  status 
document 
issuing  permits  and 
licences for commercial activity and others. 

registrations; 

Total  expenditure  of  local  governments  amounted 
to  LVL  1,534  m  in  2010,  which  formed  27%  of 
(broadly 
general 
corresponding  to  historical  average)  or  12%  of 
GDP.

government 

expenditure 

is  by  far 
local 
in 

the 
governments' 

Education 
largest  expenditure 
budgets, 
category 
representing  ca  37%  of  their  total  expenditure  in 
2010; 
local  governments  are  responsible  for 
delivering ca 70% of the overall education budget. 
The  role  of  local  governments  in  the  provision  of 
pre-school,  primary  and  secondary  education  is, 
however,  restricted 
the 
to the 
education policy by establishing, reorganising and 
institutions,  while  overall 
closing  education 
standards 
educational 
requirements 
institutions,  level  of  qualification  of  teachers and 
their  basic  salaries etc.)  are  set  by  the  central 
government. Following  the  implementation  of  the 
"money follows a pupil" principle from 2009, local 
governments  receive  transfers  from  the  central 
government  in  accordance  with  the  number  of 

implementing 

(i.e. 

for

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Public finances in EMU - 2012

children  enrolled 
in  schools  and  pre-school 
establishments  on  their  territory  ,  but  they  can 
supplement  educational  expenditure  from  own 
resources. 

patients 

provision 

local  governments 
relatively 

The provision of healthcare services is organised at 
the  level  of  the  central  government  and  direct 
in  health 
involvement  of 
services 
limited. 
is 
Nevertheless, municipalities can play an important 
role  in  ensuring  the  accessibility  of  healthcare 
services  (e.g.,  organising  transport  for  socially 
health 
to 
vulnerable 
establishment),  as  well  as  by  providing 
the 
necessary  infrastructure  and  support  services  (e.g. 
rooms  for  general  practitioners).  Moreover,  as 
most  formal  health  establishments  in  Latvia  are 
owned  as  limited  liability  companies  either  by 
state  or  by  municipalities,  the  municipalities  may 
be  confronted  with  a  need  to  cover  operational 
losses  of  municipal  hospitals.  The  healthcare 
related  expenditure  accounts  for  around  9%  of 
municipalities' budgets. 

reach 

a 

to 

an 

have 

exclusive 
almost 
Municipalities 
competence  with  regard 
the  provision  of 
housing and community amenities, which accounts 
for another 10% of their budgets' expenditure side. 
Moreover, provision of public transport services is 
another area  where the local  governments play an 
important role by organising urban public transport 
in  cities  and  regional  transport  at  the  level  of 
planning regions; this function is partly covered by 
earmarked transfers form the central government. 

With  regard  to  the  social  sphere,  the  autonomous 
role  of  municipalities  relates  to  the  provision  of 
social assistance to socially vulnerable citizens and 
groups; this function accounts for another 10% of 
municipal expenditure (while social insurance and 
categorical 
financed 
respectively  by  the  Social  Insurance  Agency  and 
the  Ministry  of  Welfare).  While  legal  minimum 
requirements  governing  the  provision  of  social 
assistance are  set in the law,  the  financing  for the 
social  assistance  function  of  local  governments  is 
not  allocated  from  the  central  budget (265)  and  its 

benefits 

social 

are 

(265) Except  in  2009-2012  when  the  provision  of  Guaranteed 
Minimum  Income  (GMI)  was  50%  co-financed  and  the 
provision  of  housing  benefits  20%  co-financed  from  the 
state  budget  under  the  Emergency  Social  Safety  Net 
Strategy.

258

financing  remains 
governments.

the  responsibility  of 

local 

in  ensuring 

Overall,  local  governments  in  Latvia  play  an 
important  role 
that  state's  basic 
functions  are  delivered  to  citizens  according  to 
appropriate  standards,  from  the  provision  of  basic 
infrastructure  and  transport  services  to  social 
assistance and the provision of preschool, primary 
and  secondary  education.  However,  only  part  of 
the  financing  for  implementing  these  functions  is 
provided from the central government budget.

3. Financial arrangements

Local  governments  in  Latvia  do  not  have  own-
source  taxes.  The  financing  mainly  comes  from 
shared  taxes  (56%  of  total  revenue  of  local 
governments  in  2010)  and  grants  from  the  central 
government  (36%  of  total  revenue  in  2010). 
Furthermore,  within  the  local  governments'  sector 
there  is  a  mechanism  for redistributing  revenue 
between richer and poorer municipalities.

Shared taxes include:

tax  revenue  of 

• The  Personal  Income  Tax,  which  is  the  most 
important tax revenue source for municipalities 
(representing  close  to  50%  of  overall  revenue 
and  over  85%  of 
local 
governments).  The  overall  tax  rate,  base  and 
sharing formula of the PIT are however defined 
by the central government and these parameters 
have  been  frequently  changed  in  the  recent 
past. Thus, until 2009 the personal income tax 
rate  was  set  at  a  flat  rate  of  25  %,  while  the 
share  of  local  governments  in  the  overall  PIT 
revenue  was  gradually  increasing  from  71.6% 
in 2005 to 83% in 2009. However, the flat rate 
was lowered to 23% in 2010, increased to 26% 
2011 and lowered again to 25% in 2011, while 
the share  of  local  governments  was  first 
lowered to 80% in 2010, then increased to 82% 
in  2011  and  lowered  again  to  80%  in  2012. 
These  frequent  changes  create  an  unstable 
planning  environment  for  local  governments; 
moreover,  the  tax  revenue  itself  is  rather 
volatile,  making  local  governments'  revenue 
base  highly  cycle-sensitive. However,  the  fact 
that  local  governments  receive  their  share 
based  on  forecasted  rather  than  actual  tax 
collection,  adds  some  predictability  for  local 
governments.

Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

Part IV

• The  real  estate  and  land  tax  (representing 7% 
of local governments' total revenue and 12% of 
tax revenue  in  2010).  Municipalities  receive 
100%  of  the  receipts  from this  tax,  although 
currently they have no leeway over the tax rate 
or  base;  however,  according  to  current  plans 
local  governments  will  receive  considerable 
flexibility  in  application  of  the  real  estate  and 
land tax rates from 2013.

the 

level  of 

the  natural  resources 

• Other  taxes  include  ca  ¼  of  gambling  tax  and 
below  half  of 
tax 
the  general 
collected  at 
government;  these  taxes  together  represented 
0.5%  of  local  governments'  total  revenue  and 
1%  of  tax  revenue  in  2010.  In  particular  the 
natural  resource  tax  has  a  potential  to  become 
more prominent revenue source in the future.

• Other  sources  of  own  non-tax  revenue  are 
formed  by  self-earned  revenue  (e.g. payments 
for  services),  non-tax  revenue  (e.g. property 
income)  and  to  a  marginal  extent  donations. 
These  other  sources  accounted  for  9%  of  total 
revenue of local governments in 2010.

Grants  from  the  central  government  formed  ca 
35%  of  total  revenue  of  local  governments  in 
recent  years.  All  these  grants  are  earmarked;  they 
cover education expenditures (i.e. teachers' salaries 
and  education  activities)  as  the  biggest  category, 
road maintenance (via the Road Fund), investment
projects and other.   

In  addition  to  own  revenue  and  earmarked  grants 
from the central government, there is a mechanism 
for  re-distribution  of  revenue  through  the  Local 
Government Finance Equalisation Fund (LGFEF), 
with  the  aim  to  ensure  availability  of  sufficient 
resources also for regions with lower tax base. The 
fund  is  mainly  financed  by  municipalities  with 
more  solid  revenue  base  (in  particular  the  city  of 
Riga)  and,  to  a  much  lesser  extent,  by  the  central 
government.  According 
total 
envelope  is  decided  annually  via  negotiations 
between  the  central  government  and  the  Latvian 
association of local and regional governments. The 
redistribution  formula  is  based  on  expenditure 
need, i.e. the minimal amount required to carry out 
municipal tasks, calculated based on demographic 
and other criteria, and on revenue equalisation, so 
that municipalities with tax revenue from PIT and 

law, 

the 

its 

to 

real estate tax which exceeds by 10% or more their 
calculated expenditure needs have to contribute to 
the  Fund.  Most  municipalities  are  net  receivers 
from the LGFEF.

Overall,  while  the  local  governments  are  free  to 
attribute  non-earmarked  revenue  sources  (which 
form  approximately  two-thirds of  total  revenue) 
across expenditure categories – including to top up 
earmarked grants – several minimum requirements 
for the provision of  services  are set in legislation, 
thus  limiting  notably  the  discretion  of  local 
governments  and  possibly  creating  disparities  in 
the standard of provision of various services across 
the municipalities. Most of the revenue sources of 
local  governments  have  a  marked  cyclical  nature, 
while the ability to raise own taxes currently does 
not  exist  (although  a  more  flexible  approach  with 
regard  to  the  real  estate  and  land  tax  will  be 
adopted  from  2013).  During  years  of  fiscal 
consolidation  in  2009-2012,  local  governments 
shared  the  burden  of  the  adjustment,  as  their 
revenue  sources  (notably  personal  income  tax) 
considerably  declined  both  as  a  result  of  both 
cyclical  developments  and  discretionary  policy 
decisions,  while  expenditure  pressures  coming 
from social assistance needs increased.

4. Fiscal rules

to 

rule,  which 

rule  applicable 

fiscal 
is  a  debt 

local 
The  main 
governments 
targets 
stabilisation  of  local  governments'  debt  level  in 
nominal  terms  and  thus  acts as  a  de  fact  budget 
balance  rule.  According  to  the  legislation,  annual 
debt servicing by a municipality should not exceed 
20%  of  its  local  tax  revenue.  The  borrowing  and 
is 
issuing  of  guarantees  by  municipalities 
constrained  by  the  central  government  on  an 
annual  basis,  with  aggregate  borrowing  and 
guarantees 
limits  being  negotiated  between 
municipalities  and  the  central  government  and 
these  limits  included  in  the  annual  budget  law. 
During  the  budgetary  year,  the  municipalities  are 
allowed 
loan 
loans  and 
guaranties  only  within  these  limits.  Furthermore, 
regarding each individual loan within the limit, the 
municipalities  must  consult  the  Board  monitoring 
and 
loan 
guaranties, which involves officials of the ministry 
of  finance.  Such  permissions  are  granted  only  for 
financing  of  investment  projects  – and  in  more 
recent years only for investments co-financed from 

supervising  municipal 

to  provide 

loans  and 

take 

to 

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EU  structural  funds  – thus  imitating  the  "golden 
rule".  The  rule  has  been  in  place  since  1994  and 
generally  respected,  thus  contributing  to  limiting 
the expenditure growth and nominal debt levels of 
local  governments.  The  gross  debt  of 
local 
governments amounted to 6.4% of GDP as of end-
2010. 

Given 
local 
the  considerable  volatility  of 
governments'  revenue  and  restrictive  borrowing 
regulation, 
use 
precautionary savings; as of end-2010 accumulated 
liquid  assets  of  local  governments  amounted  to 
2.4% of GDP.

municipalities 

several 

In  case  of  intra-year  financial  difficulties,  short-
term  borrowing  is  allowed  only  to  cover  a  short-
term deficit and has to be repaid within a year. The 
main  lender  of  local  governments  is  the  State 
Treasury, although few bigger municipalities have 
loans from  financial institutions; loans taken from 
another  institution  need  to  be  authorised  by  the 
minister  of  finance.  The  Treasury  can  impose 
sanctions  to  local  governments  if  they  do  not 
comply with repayment obligations. Municipalities 
in  financial  difficulties,  as  stipulated  by  law,  are 
required  to  prepare  and  implement  a  financial 
stabilisation  plan  under  a  supervisor  appointed  by 
the  minister  of  finance.  Currently  only  one 
municipality  is  under  the  financial  supervision 
procedure,  although  the  number  was  considerably 
higher before the implementation of the territorial 
reform.

the  general  government 

As  a  result  of  the  debt  rule  and  other  financial 
requirements  applicable  to  municipalities,  their 
fiscal  position  has  been  overall  sound  in  recent 
years  and  their  debt  level  is  modest.  Given  the 
involvement  of  central  government  in  setting 
borrowing  limits  and  borrowing  procedures  for 
municipalities, it is unlikely that local governments 
can  pose  a  serious  threat  to  meeting  fiscal  targets 
at 
level,  although 
expenditure  of  local  governments  financed  from 
previously  accumulated  reserves  falls  outside  the 
control  of  the  central  government.  Before  the 
2009-2010  crisis  local  governments  (similarly  to 
the  central  government)  contributed 
the 
loosening  of  the  fiscal  position  of  Latvia  by 
spending  large  part  of  the  windfall  revenue, 
although  some municipalities  did  accumulate 
precautionary  reserves.  While  at  the  level  of  the 
central government the envisaged Fiscal Discipline 

to 

260

Law  is  expected  to  substantially  improve  the 
counter-cyclical nature of fiscal policy making, no 
particular  changes  are  foreseen  at  the  level  of 
municipalities.

A1.14. LITHUANIA

1. General description

Lithuania  is  a  unitary  country.  The  government 
structure has three tiers, with 10 counties being the 
intermediate level. There are 60 local governments 
whose  self-governing  right  is  secured  by  the 
Constitution and other laws. 

to 

right 

and  operation  of 

local 
The  development 
governments are legally defined in the Constitution 
of  the  Republic  of  Lithuania  and  in  the  Law  on 
Local  Self-government.  The  Constitution  grants 
free  and 
the 
administrative  units 
independent  governance  within  the  limits  of  their 
local 
competence, 
government 
local 
councils.  Members 
government  councils  are  elected  for  three-year 
terms in direct elections. Law establishes that local 
government  councils  have  the  right  to  form 
executive  bodies  for  the  direct  implementation  of 
laws and the decisions of the government and local 
government council. 

through 
of 

implemented 

The Constitution gives local governments the right 
to draft and approve their own budgets, to establish 
local  duties  and  to  levy  taxes  and  duties.  Local 
governments  also  must  have  a  reliable  financial 
basis.  According  to  the  Law  on  Methodology  for 
the Establishment of Local Government Budgetary 
Revenues, part of the personal income tax income 
is ascribed to the local government budget. 

(ii) 

ascribed 

In  the  Law  on  Local  Government,  local  authority 
functions  are  strictly  defined  and  according  to 
decision making freedom they are divided into: (i) 
independent, 
(insufficiently 
independent),  (iii)  state  (relegated  by  the  state  to 
(iv) 
municipalities 
conventional.  The  Laws  on  Budget  Structure  and 
on  Local  Government  define 
their  financial 
resources  that  could  be  split  into  tax  and  non-tax 
transfers.  Local 
income  and 
authorities  may  also  use  bank  credits,  take  and 
give  loans  in  the  order  established  by  law.  All 
financial resources of local authorities are included 

state  budget 

execution), 

and 

for 

Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

Part IV

in  local  government  budgets  which  according  to 
the Constitution and the Law on Budget Structure 
are  independent.  Independent  municipal  functions 
are financed at most by tax and non-tax income of 
local governments. Execution of state and a part of 
ascribed  functions  as  well  as  projects  of  the 
Parliament and  Government  are  financed  by 
transfers from the state budget of special purpose.

•

The local government expenditure and revenue are 
around  25-30%  of 
total  general  government 
expenditure  and  revenue  and  these  make  around 
10% of GDP. 

institutions.  Local  governments  also  organize 
health control.

and 

other 

theatres 

the  field  of  culture  and 

local 
leisure 
In 
libraries,  museums, 
governments  manage 
cinemas, 
cultural 
establishments.  Since  such  institutions  may  be 
subordinate  to various  central,  regional  and 
municipal  organs, 
local  governments  are 
responsible  only  for  those  that  they  establish. 
However,  they  may  not  reorganize  or  abolish 
such  institutions  without  the  permission  of  the 
Ministry of Culture.

2. Government spending

Local  governments  are  charged  with  providing 
services in the fields of education, social security, 
health  care,  culture  and  leisure  and  communal 
economy.

•

In  the  field  of  education  local  governments 
establish,  reorganize  and  abolish  primary  and 
secondary  schools,  as  well  as  appoint  and 
dismiss,  with  the  approval  of  the  Ministry  of 
Education  and  the  county  governor,  the  heads 
of  these  institutions.  They  also  approve  the 
regulations  of  educational  institutions,  ensure 
their  functioning  and  maintenance,  administer 
the  registration  of  children  under  the  age  of 
sixteen  and  organize  transport  to  school  for 
children in remote areas.

Generally 

resources. 

• The functions of local governments concerning 
social  security  focus  on  providing  social 
services  and  benefits.  Local  governments  may 
also engage in social care if they have adequate 
local 
material 
governments  establish,  reorganize  and  abolish 
local  government  institutions  in  charge  of 
social  services  and  regulate  the  activities  of 
social  service  providers.  Local  governments 
also  collect  and  analyse  data  on  persons  who 
are  in  need  of  social  support,  administer  their 
registration  and  establish 
the  scope  and 
methods of assistance.

• Concerning  health  care,  local  governments 
manage primary health care centres, clinics and 
ambulance  services,  centres  of  psychological 
health  and  a  number  of  other public  health 

collection 

treatment; 

• Concerning economic issues, local government 
services  provide  communal  services  such  as 
water,  gas,  electricity  and  heating  supply; 
waste 
and 
and 
administration  of  engineering  networks.  These 
services  may  be  provided  by  state  and  local 
government enterprises, joint-stock companies, 
private  and  non-profit  companies.  Local 
governments  also  address  public  transport, 
construction  and  maintenance  of  local  roads 
and various construction projects.

local 

services,  but 

There  are  no  specific  legal  restrictions  on  the 
privatisation  of 
local 
governments  manage  a  number  of  companies 
specifically  designated  for  such  service  provision 
that  would  not  be  able  to  function  without  local 
government  support.  Local  governments  have  the 
right to privatise up to 30% of their shares in such 
companies.

3. Financial arrangements

The  National  budget  is  comprised  of  the  state 
budget  and  of  independent  budgets  of  local 
authorities. The latter have to be balanced. 

local 
The  process  of  designing  budgets  of 
authorities  is  regulated  mainly  by the  Law  of  the 
Budget  Structure  and  the  Law  of  the  Methods  for 
Determining  Local  Authority  Budged  Income  and 
Government decision. Designing their budgets, the 
local authorities must observe the financial indices 
for  local  authorities' budgets  approved  by  the 
Parliament.  The  local  authorities  have  to  approve 
their  budgets  no  later  than  in  two  months  after 
approval  of  financial  indicators  of  the  state  and 
local  authorities' budgets.  Thus,  rather  strict  time 

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limits  are  set  for  local  authorities  to  adjust  and 
coordinate  financial  indicators  of  their  budgets 
with  those approved  by the  Parliament.  If  a  local 
authority fails to confirm its budget before the end 
of the budgetary year, then in the following year its 
activities  are  limited  and  it  is  allowed  only  to 
pursue existing obligations (i.e. not allowed to take 
new obligations) and to serve debt until the budget 
is  approved.  Resources  allocated  to  that  purpose 
cannot  exceed  1/12  of  the  last  year’s  budget  per 
month  (until  the  budget  is  approved).  Because  a 
fortnight is likely to be short to adopt the budgets 
of the local government (following the adoption of 
the financial indicators by the Parliament, probably 
there are only two weeks left before the end of the 
year, see above), execution of the functions of the 
local authorities might be limited until the budgets 
are  adopted (266). Following  the  requirements  of 
the  law,  a  local  authority  has  to  submit  to  the 
Ministry of finance not only approved budgets, but 
also the estimate of the privatisation fund.

Lithuanian  legal  acts  set  the  following  kinds  of 
budget receipts for local authorities:

• Tax  revenue, comprised  of  taxes  assigned  to 
local  authorities  and  part  of  common  taxes  set 
by law.

• Non-tax revenue received from the property of 
a  local  authority,  local  levies,  fines,  and  other 
non-tax sources.

• Transfers  from  the  state  budget,  allotted  for 
equalising 
income  and 
the  differences  of 
expenditure  among  local  authorities  and  for 
performing the functions relegated by the state.

Tax revenue includes following different taxes: (i)
part of personal income tax, after mandatory health 
insurance  deduction,  (ii)  land  tax,  (iii)  tax  on 
renting state land and use of state water reservoirs 
for commercial or amateur fishing, (iv) tax on real 
estate  of  enterprises  and  organizations,  (v)  stamp 
duties,  (vi)  tax  on  the use  of  marketplaces,  (vii) 
inheritance and donations tax and (vii) other minor 
taxes established by law.

(266) Essentially,  this  implies  that  the  local  authorities  may  not 
manage to approve their budgets by the end of the year and 
hence  their  functions  and  budgetary  means  might  be 
limited  for  a  few  weeks  or  months  in  the  following  year 
until their budgets are approved.

262

Non-tax  revenues  include (i)  revenues  received 
from  municipal  property,  (ii)  fines  and  revenues 
from  the  sequestration of  property,  (iii)  local 
duties,  (iv)  revenue  from  the  services  of  local 
government  budgetary  institutions,  (v)  interest  on 
funds  in  current  accounts,  (vi)  revenue from  non-
agricultural  state 
in 
accordance  with  established  procedures,  and  (vii) 
other non-tax revenues established by law.

leasing  or  sales 

land 

The  local  government  can  set  the  level  of  the  tax 
on  income  from  economic  activities  requiring  a 
business  certificate  and  on  related  charges,  the 
level of the real estate tax, within the limits set by 
the  Law  on  Immovable  property,  and  rates  of  the 
taxes  for  the  state  land  lease  within  the  limits  set 
by  laws  or  decisions  of  the  Government.  In  other 
cases  (i.e.  for  the  remaining  taxes)  the  local 
government can reduce the rate of the tax or grant 
an exemption from it and cover the financial losses 
from  its  budget.  The  local  government  has  no 
freedom of  imposing taxes on personal income of 
residents,  on  pollution  of  the  environment  and  on 
natural resources of the state.

the  on 

regulated  by 

the  Law  of 

Transfers  from  the  state  budget  are  either  general 
or earmarked. The allocation from the state budget 
the 
are
Income 
Methodology  of  Municipal  Budget 
Estimation.  The  general  transfers  are  for  creation 
of  reserves  for  unforeseen  expenses  during  the 
planned budgetary year, for the equalization of tax-
related  revenues  and  for  the  equalization  of 
structural  differences  in  expenditures  caused  by 
objective  factors  that  do  not  depend  on  local 
government activities. The earmarked transfers are 
allocated  to  perform  state  functions  prescribed  to 
municipalities  and  implement  programs  approved 
by  the  Parliament  and  the  Government.  Amounts 
of transfers are approved by the Law on State and 
Municipality  Budget  Financial  Indices  of  the 
corresponding  budgetary  year,  based  on  rules  set 
by  the  Government. These  transfers  are  related  to 
very  clear  functions  to  be  performed  by  the  local 
government  assigned  by  different  ministries  and 
the  needs  are  calculated  according  to  approved 
methodology.  Since  2009,  if  these  funds  are  not 
used for purpose of a specific function they have to 
be  returned  back  to  the  state  budget  at  the  end  of 
the budget year. 

According  to  the  Law  on  Charges municipal 
councils  have  the  right  to  determine  eleven  types 

Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

Part IV

of  local  charges.  Income  from  local  charges 
comprises  only  1%  of  all  the  municipal  budget 
revenue.  In  accordance  with  the  Law  of  Charges, 
the local council has a right to set local charges in 
its territory for giving permissions. The council of 
a  local  government  makes  its  own  decision  on 
local  charges  and approves  the  rules. A local 
government  may  index  the  size  of  charge  once  a 
year, 
index  of 
commodities is larger than 1.1. 

the  annual  price 

in  case 

As  mentioned  above,  budgets  of  local  authorities 
have to be formed without deficit, i.e., expenditure 
should  not  exceed  revenues.  Local  authority  is 
under  an  obligation,  set  by  law,  to  undertake 
functions  committed  to  them.  Appropriations  for 
local authorities can be used only to carry out the 
state functions devolved by law to local authorities 
as  well  as  to  pursue  the  programmes  approved  of 
the common councils.

However,  local  authorities  are  also  permitted  to 
raise  short-term  and 
long-term  domestic  and 
foreign  loans  if  they fail  to  balance  their budget, 
according to the decision by the Government.

Concerning borrowing rules for local governments, 
borrowing  can  be  permitted  only  for  following 
purposes:

• Take  long-term  domestic  and  foreign  loans  to 
finance  investment  projects,  to  buy  movable 
and immovable properties, to cover debts;

• Take  short-term  domestic  and  foreign  loans  to 
cover  a  temporary  income  shortfall  in  a  fiscal 
year, 
if  committed  budgetary  means  are 
insufficient;

• Provide  guarantees  for  loans  to  companies 
controlled  by  the  municipality  used  to  finance 
investment projects.

Borrowing limits are set annually and approved by 
the  Parliament  in  the  Law  on  State  and  Local 
law  sets 
Government  Budgets.  2012  budget 
borrowing limits for local authorities as following:

• The  debt  of  municipalities,  with  the  exception 
of  Vilnius  city  municipality,  cannot  exceed 
70%  of  the  approved  2012  municipal  budget 
revenues  (excluding  state  grants  of  special 

purposes).  For  Vilnius  city  municipality  debt 
cannot  exceed  120%  of  the  approved  2012 
municipal  budget  revenues  (excluding  state 
grants  of  special  purposes),  at  least  30%  of  it 
can only be related with payments for arrears in 
services provided until 31 December 2011.

• The  municipality's  annual  net  borrowing  shall 
not  exceed  20%  (the  Vilnius  city  municipality 
– 35%)  of  approved  2012  municipal  budget 
revenues  (excluding  state  grants of  special 
purposes);

• Loans  to  be  repaid  in  2012  and  subsequent 
years  and  interest  to  be  paid  may  not  exceed 
15%  of 
the  approved  municipal  budget 
revenues  (excluding  state  grants  of  special 
purposes);

• Guarantees provided by the municipal may not 
exceed  10%  of  the  approved  2012  municipal 
budget  revenues  (excluding  state  grants  of 
special purposes).

• According  to  2012  budget  law,  municipalities 
(except Vilnius) with a debt of more than 45% 
of 
the  approved  2012  municipal  budget 
revenues  (excluding  state  grants of  special 
in  2012  can  borrow  only  for 
purposes) 
implementation  of  projects  co-financed  by  the 
EU  and  other  international  financial  support. 
Vilnius  city  municipality  can  borrow  only  to 
cover the payments  for services provided until 
31  December  2011  and  the  implementation  of 
projects 
the  EU  and  other 
international donors.

funded  by 

Local  authorities  have  to  inform  the  Ministry  of 
Finance about undertaken borrowing and provided 
guarantees  according  to  the  rules  defined  by  the 
Ministry. 

According  the  Law  on Local  Self-government,  a 
controller  elected  by  the  local  council  supervises 
the  use  of  municipal  budgetary  funds  and  the 
legitimacy,  suitability  and  effectiveness  of  the 
municipal property use and state property entrusted 
to the local authority. The main problem seems to 
be  the lack  of  independence  from  the  local 
government council as the council may dismiss the 
controller by a majority vote on proposal of at least 
one-third of the councillors. 

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The  State  Audit Office,  which  is  subordinated  to 
the  Parliament,  supervises  the  legal  and  effective 
use  of  state  property,  the  fulfilment  of  the  state 
budget and financial discipline of state institutions. 
While  performing  its  functions  concerning  local 
self-governments, 
the  State  Audit Office 
determines if local authorities are using state funds 
appropriately  and  efficiently  and,  if  necessary, 
evaluates  municipal  budget  performance  and  the 
economic  and  financial  activities  of  municipal 
offices and enterprises.

4. Fiscal rules

the 

Until  2011,  the  main  fiscal  rule  concerning  the 
local  government  budget  was  a  balanced  budget 
rule,  which  requested  that  the  approved  local 
budget  has  to  be  balanced  as  defined  by  the  Law 
on  Budget  Structure.  However,  as 
local 
authorities  might  receive  additional  revenue  than 
planned in the budget and also use borrowed funds 
limited  purposes  as  described  above), 
(for 
in  a  deficit.
budgetary outturn might  result 
Therefore, 
in  2010. 
the  Law  was  amended 
Currently, the Law states that the approved deficit 
of  the  municipal  budget  must  not  exceed  the 
planned 
approved 
borrowing limits set by the Law on State and Local 
Government  Budgets)  for  financing  of investment 
projects. To ensure that local government does not 
borrow more than set in the limits, the Government 
representative  participates  in  the  council  meetings 
local 
and 
government  makes  a  decision  for  additional 
spending. However, there are no official sanctions
set in legislation.

supervision  before 

borrowing 

ensures 

(within 

the 

the 

is  a  debt 

rule,  which 

Therefore,  the  main fiscal  rule  applicable  to  local 
governments 
targets 
stabilisation  of  local  governments'  debt  level  in 
nominal  terms.  Annually  the  Law  on  State  and 
Local  Government  Budgets  sets  clear  limits  for 
additional  long-term  borrowing,  debt  servicing 
(shall  not  exceed  15% of  its  budget revenue)  and 
guarantees  issued  by  municipalities. During  the 
budgetary  year,  the  municipalities  are  allowed  to 
take  loans  and  to  provide  loan  guaranties  only 
within  these  limits.  The gross  debt  of  local 
governments  increased  somewhat  from  1.3%  of 
GDP  in  2008  to  1.8%  of  GDP  in  2011  but 
remained 
the  general 
government  debt  of  around  40%  of  GDP.
loans  for 
take 
Municipalities  can 

limited  compared 

long-term 

to 

264

investment  purposes  only;  short-term  loans  are 
only to cover temporary revenue shortfalls.

A1.15. LUXEMBOURG

1. General description

and 

106 

Luxembourg's 

The  Grand  Duchy  of  Luxembourg  is  a  unitary 
state. 
municipalities 
(communes)  are  the  only  tier  of  subnational
government.  Their  autonomy  is  anchored  in  the 
Constitution (267). Communes  have  mandatory 
responsibilities  defined  by  the  Constitution  or 
delegated  by  laws  related  to  spatial  planning, 
enforcement  of  public  order 
safety, 
organization  of  nursery  and  primary  school 
education  and  supply  of  public  utilities  and 
networks  (local  road  network,  drinking  water 
distribution,  sewerage,  waste  collection  and 
disposal,  cemeteries,…).  In  addition,  communes 
have  optional  responsibilities  such  as  providing 
infrastructure  for  sports,  culture,  tourism,  health 
care  or  public  transport.  In  order  to  increase 
efficiency,  communes  are  allowed  to  form  legal 
associations ('syndicats  de  communes') to  fulfil
certain services jointly. A territorial reorganisation 
of  the  communes is  on-going  in  order  to  increase 
quality and efficiency of services.

Municipalities are  allowed  to  impose communal 
taxes after  approval  by  the  central  government.
Total  expenditure  of  local  governments  amounted 
to  EUR  2283.9  million  in  2011,  which  represents 
12.7 % of general government expenditure and 5.2 
%  of  GDP. In  2011,  local  government  realized  a 
consolidated  surplus  of  EUR  50  mio  (0.12%  of 
GDP).  Gross  debt  of  local  government  amounted 
to around 975 million EUR or 2.3% of GDP.

2. Government spending

The  main  areas  of  spending  of  local  government 
are  education,  general  public  services,  economic 
affairs,  recreation  and  culture,  and  environment 
protection. The Minister of the Interior supervises 
municipal  acts  and  can  reject  municipal  budgets. 
For this administrative surveillance, the communes 

(267) Art. 107 of the Constitution: Communes form autonomous 
authorities,  on  a 
legal 
personality  and  administrating  through  their  institutions, 
their  patrimony  and  own 
interests  under  central 
government control.

territorial  basis,  possessing 

Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

Part IV

are  grouped  into  three  administrative  districts 
(Luxembourg,  Diekirch  and  Grevenmacher),  each 
managed  by  a  district  commissioner appointed  by 
the  government.  The  City  of  Luxembourg  falls 
outside  these  districts  and  reports  directly  to  the 
Minister of the Interior.

3. Financial arrangements

the  State  via 

Luxembourg  communes receive  an  overall  grant 
from 
the  communal  financial 
endowment  fund (Fonds  communal  de  dotation 
financière or  FCDF).  The  FCDF  is  funded  by 
revenues  from  taxes  on  alcohol,  10%  of  VAT 
revenues, 20% of the motor vehicle taxes and by a 
budget  line  from  the  Ministry  of  the  Interior.  The 
yearly  transfer  from  the  fund  to  the  communes  is 
determined as the sum of 18% of personal income 
tax receipts,  10%  of  VAT receipts,  and  20%  of 
motor  vehicle  tax receipts,  on  top  of  a  subsidy 
which  is  established  on  an  annual basis.  It 
amounted 
in  2010, 
to  EUR  740 million 
third of  overall  communal 
representing  one 
revenues.  The  amount 
is  divided  between 
communes  in  accordance  with  the  municipality's 
surface and population.

or  IF),  which  nowadays  only represents  a  small 
share of their revenues (around 1.5%).

taxes  exist 
Furthermore,  a  variety  of  other 
(property  transfer  duty,  gaming  taxes,  tourist  tax, 
dog  tax,  etc)  which  constitute  however  only  a 
minor  share  of  overall  municipal 
revenue. 
Municipalities have also some own revenues from 
the provisions of services (autres recettes propres 
des  communes or  ARP)  such  as  drinking  water 
supply,  waste  water  treatment,  waste  collection, 
distribution of electricity and gas. Lastly they also 
get part of their revenue from own property. 

In  addition,  municipalities  receive  extra-ordinary 
revenues.  The  Ministry  of  the  Interior allocates 
earmarked  grants  to  municipalities  and  inter-
municipal groupings for basic utilities, constituting 
capital expenditure arising from the municipalities' 
mandatory  missions.  These  grants  are  targeted 
towards the creation or expansion of schools, town 
halls,  infrastructure  for  water  supply,  technical 
services and cemeteries.

4. Fiscal rules

from 

this  general  grant

receive  earmarked  grants 

the  FCDF, 
Beside 
for 
municipalities 
specific  purposes,  such  as  musical  education, 
nurseries  and  compensation  of  employees  in  the 
municipal administration.

taxes  are  collected  by 

Local  authorities  have  also  limited  availability  to 
raise  their  own  revenues  via  taxes.  All  municipal 
taxes,  levies  and  fees  must  be  approved  by  the 
municipal  council  and  the  central  government.
the  central 
Most 
government,  and 
local 
authorities.  Total  local  government  receipts  from 
own taxes amounted to EUR 742 million in 2011, 
representing  about  32%  of  their  total  revenue  and 
around  6.7%  of  total  general  government  tax 
revenue.

transferred 

then 

to 

The  municipal  business  tax  (impôt  commercial 
communal or ICC) accounts for around one fourth
of total revenues. This tax on local business profits 
is  levied  by  the  central  administration  for the 
benefit  of  municipalities.  Municipalities  are 
allowed to set the rate freely but the rates must be 
approved  by  the  government.  The  municipalities 
are allowed to collect a property tax (impôt foncier

is

responsible  for 

surveillance  of 

the 
The  Interior  Ministry 
budgetary 
local  authorities. 
According  to  the  Communal  Law,  municipalities 
are  not  allowed  to  run  an  operating  deficit. 
Investments can be  financed  by issuing debt if  no 
other financing is possible or viable and only when 
a regular reimbursement of the annuities is ensured 
through the operation budget (268). 

A1.16. HUNGARY

1. General description

Fiscal governance in Hungary is characterised by a 
mixed,  hybrid  system  with  a  decentralised 
structure,  strong  financial  dependence  on  the 
centre  and,  until  recently,  broad  local  public 
service obligations.

In  1990,  after  the  change  in  the  political  regime, 
local  communities  (regardless  of  their  size)  were 
given the right for self-governance, which was also 
enshrined  in  the  constitution.  The  intermediate 
layer of counties was kept but municipals were not 

(268) Art. 118 of the Loi communale of 13 Dec 1988

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subordinated  to  counties  and  thus  their  influence 
on  local  affairs  was  significantly  reduced.  This 
resulted 
in  a  very  fragmented,  decentralised 
structure with nearly 3200 municipalities and with 
an average population of around 3100.

level. At the same time, the lack of fiscal space of 
the  general  government 
to  decreasing 
allocation of funds to municipalities, together with 
the  increasing  use  of  earmarking  or  ex  post 
financing through reimbursement formulas.

led 

Municipalities  enjoy  a  wide  range  of  freedoms 
(independence,  legislative  power,  right  to  levy 
taxes, etc.) but, at the same time, the 1990 Act on 
Local  Governments  (ALG)  also  delegated  to  the 
local  level  the  delivery  of  a  sizable  part  of  public 
services.  According  to  the  COFOG  classification, 
in  2010,  66%  of  government  expenditure  on 
education  was  carried  out  at  the  local  level;  this 
ratio stood at 37% for health, 44% for spending on 
recreation 
for 
environmental protection. Overall, local authorities 
are  responsible 
total  government 
for  ¼  of 
expenditure.

culture, 

73.5% 

and 

and 

the 

together  with  an  extensive 

Thus,  there  are  effectively  two  layers  of  public 
administration 
central 
in  Hungary: 
administration  and  the  local  governments  of  the 
municipalities. The rather small average size of the 
range  of 
latter 
mandatory  services  makes  the  Hungarian  system 
distinct  from  other  unitary  models,  such  as  the 
Mediterranean-type  system  (small  units,  fewer 
responsibilities)  or  the  Scandinavian-type  system 
(larger  units,  wide  range  of  competences).  Some 
features, such as the 'multi-purpose micro-regional 
associations',  were  introduced  to  move  towards  a 
more  balanced  mix  of  size  and  competence  at  the 
local  level.  Also,  the  main  role  of  the  additional 
layer of counties has been to bundle together some 
of  the  public  services  (especially  in  the  education 
sector)  of  small  municipalities  or  parishes  by 
taking  over  both  their  service  obligation  and  the 
associated  central 
the 
apparent mismatch between the size of local units 
and  their  obligation  in  delivering  public  services 
has  been  a  driving  factor  in  the  evolution  of 
subnational fiscal governance in Hungary.

transfers.  Nevertheless, 

Local  governments  compensated  shrinking  fiscal 
transfers  by  a  rundown  of  their  wealth;  initially 
through  sales  of  assets  and  eventually  through 
growing  indebtedness.  Ineffective  regulations  and 
the  practice  of  central  government  to  cover  local 
deficits  created  the  perception  of  a  soft  budget 
constraint  and  diminished  incentives  to  fill  the 
financing gap through raising local taxes.

lacking  both 

The  Hungarian  subnational  fiscal  governance 
system  has  become  almost  dysfunctional,  with 
entities inadequate in size to deliver the wide range 
of  obligatory  services  and 
the 
incentives  and  the  institutions  to  ensure  prudent 
financial management at the local level. However, 
the ALG being an organic law, little changes to the 
regulatory  environment  were  possible  until 
recently. The amended the  ALG,  which  has come 
into  force  on  1  January  2012,  has  significantly 
reduced the range of obligatory services, especially 
in  the  education  and  health  sectors.  Moreover,  a 
draft  law  on  the  establishment  of  administrative 
micro-regions  ("járás")  has  been  submitted  to 
Parliament in late March 2012. The new regulation 
foresees  that  a  number  of  public  tasks  will  be 
carried  out  by 
these  new  districts  (notably, 
permission  for  buildings,  issuance  of  various  IDs, 
etc). These efforts should bring the optimal size of 
local  public  service  provision  better  aligned  with 
the  actual  size  of  municipalities,  reducing  their 
reliance  on  vertical  government 
transfers. 
However, the implications of the amended ALG on 
the  functioning  of  intra-government  transfers  and 
on  public  financial  management  as  whole  are  not 
yet known.

2. Government spending

Local  governments  also  got  a  free-hand 
in 
managing their financial affairs. They had acquired 
the  ownership  of  formerly  state-owned 
local 
properties,  received  block  grants  and  shared  taxes 
from  central  government  and  were  free  to  issue 
liabilities.  However,  the  wide  range  of  service 
obligations  relative  to  the  average  size  (and  thus 
revenue raising capacity) of municipalities created 
a  challenge  in  financing  the  activities  of  the  local 

The  1990  ALG  assigned  numerous  service 
obligations  to  the  local  level.  The  compulsory 
responsibilities of local entities included education 
(up to secondary level), health (basic medical care,
specialised  health  services  and  hospitals),  social 
welfare,  provision  of  local  public  utilities  and 
tourism.  The  overall  expenditure  of 
local 
governments  reached  to  12.7%  of  GDP  in  2010, 
which is in line with the EU average of 12.2%.

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Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

Part IV

are, 

grants 
effect, 

Spending  in  education  is  mainly  covered  by 
normative  grants,  whereas  operational  grants 
primarily  contribute  to  healthcare  services  and 
public  goods  provision  (e.g.  public  lightning, 
from 
infrastructure).  These 
central 
government 
formula-based 
in 
reimbursements  of  (part  of)  the  expenditure  by 
local authorities. Thus, unlike block grants, they de 
facto limit the municipalities' room for manoeuvre 
when  it  comes  to  reshuffling  funds  between  the 
different expenditure items. Besides these funding 
constraints,  the  municipalities  enjoy  a  substantial 
flexibility with respect to the quality of the service 
they  provide.  This  has 
to  a  significant 
dispersion  in  the  quality  of  obligatory  public 
services, especially in the health sector.

led 

in 

Difficulties 
the  cash-based 
funding  and 
accounting  and  budgeting  system  (in  which  the 
costs  of  the 
'wear  and  tear'  are  not  shown 
explicitly)  led to  an  under-spending  on  fixed 
capital. Indeed, gross fixed capital formation in the 
first  decade  of  the  2000s  was  only  sufficient  to 
cover  amortisation;  the  former  averaged  at  1.8% 
and the latter at 1.7% of GDP. At the same time, in 
EU27 
local 
governments  amounted  to  1.5%  of  GDP  but  it 
more  than  covered  the  consumption  of  capital 
which averaged at 1% of GDP.

investments  of 

capital 

fixed 

in  parallel 

The  recently  amended  ALG, 
to 
completely  evacuating  the  county  level  activities, 
shifted  to  the  central  administration  the  duties 
related 
to  secondary  education  and  hospital 
services. This rearrangement  of duties is expected 
to  considerably  alleviate  the  burden  of  local 
authorities  and  to  improve  the  efficiency  and 
effectiveness  of  public  services  by  leaving  those
tasks  at  the  municipal  level  in  which  they  are 
likely to be more competent than the state.

3. Financial arrangements

Revenues  of  local  governments  come  from  own 
resources,  shared  taxes,  state  transfers  and  other 
grants.  Own-source  revenues  and  grants  from the 
central budget each cover around one third of total 
revenues.  Shared 
investment  grants 
taxes, 
(including EU grants) and grant-like revenues from 
other  government  entities  (such  as  the  Health 
Insurance  Fund  and  the  Labour  Market  Fund) 
make up the remaining one third.

Local governments have the authority to levy local 
taxes, the most important of which is the business 
tax  levied  on  gross  corporate  profits,  covering 
more than 80% of all local taxes. Local authorities 
can  decide  on  the  tax  rate  (within  the ceiling  of 
2%)  but  revenues  are  effectively  collected  by  the 
central  tax  authority.  The  vehicle  tax  (which  was 
initially shared with the central budget) is collected 
the  same  way,  but  it  amounts  to  only  7%  of  all 
own-source  revenues.  A  similar  amount  is  raised 
through  the  locally  collected  property  tax  (levied 
on buildings and land).

Revenues  from  the  personal  income  tax  (PIT)  are 
shared between the central and local levels through 
different  channels.  First,  some  of  the  PIT receipts 
used to be passed on to municipalities in the form 
of  normative  grants.  However,  starting  from 
January  2012,  all  normative  grants  have  been 
delinked  from  PIT,  while  maintaining  their  level; 
thereby  reducing  the  cyclicality  of  state  transfers. 
Second,  8%  of  PIT  revenue  is  allocated  to  the 
municipalities  based  on  the  residence  of  the  tax 
payer,  representing  4%  of  total  revenues  of  the 
local  government  level.  Finally,  the  PIT  is  the 
source  for  the  revenue  equalising  grant  which  is 
used  to  diminish  the  gap  between  municipalities 
stemming from their different fiscal capacity.

in 

the 

revenue 

transfers 

functions,  mostly 

Around ¾ of the transfers from the central budget 
are  provided  as  normative  grants.  Investment 
grants, 
and 
equalising 
operational  grants  make  up  the  remaining  part. 
While only a small part of the normative grants are 
explicitly earmarked for specific purposes, general 
normative  grants  are  also  allocated  to  narrowly 
defined 
fields  of 
education,  social  protection  and  culture.  These 
transfers are in general based on expenditure needs 
rather  than  on  actual  output  (also  with  a  view  to 
balance 
among 
the 
effectively 
feature 
municipalities), 
discourages raising the efficiency or the quality of 
local  public  services.  Moreover,  the  nearly  100 
normative titles and the more than 150 operational 
grants  (prior  to  the  recent  reduction  in  obligatory 
services)  also  makes  the  system  administratively 
very costly, while frequent changes in the formulas 
increases  uncertainty  and  hinders  medium-term 
planning.

disparities 
that 

financial 
a 

The  equalisation  system  for  local  governments 
includes  adjustments  to  the  normative  grants,  a 

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Public finances in EMU - 2012

designated  equalising  transfer  and  a  mandatory 
deficit grant. The latter  was designed to cover the 
deficits  that  the  municipalities  encounter  for  no 
fault  of  their  own.  While  deficit  grants  are  used 
extensively 
local 
governments  received  a  mandatory  deficit  grant 
and  even  more  received  a  discretionary  deficit 
grant)  the  amount  so  distributed  has  remained 
limited (less than 0.1% of GDP).

(roughly 

third 

one 

of 

To  summarise,  local  governments  enjoy  – by 
design  – a  great  deal  of  autonomy;  however,  the 
mix  of  local  public  services  is  determined  to  a 
large  extent  by  their  financial  ties  with  central 
budget.  At  the  same  time,  the  intra-governmental 
financial system is overly complicated and without 
a  clear  relationship  between  different  instruments 
and  their  policy  purposes  (e.g.  the  equalisation 
system).  Hence,  this  government  structure  is  not 
conducive  to  raising  the  efficiency  and  quality  of 
public  goods  provision  or  to  improving  financial 
prudency at the subnational level.

4. Fiscal rules

to  oversee 

that  would  have  allowed 

Given  the  legal  independence  of  local  authorities, 
ensured by the Constitution, little constraints apply 
to 
the  financing  or  wealth  management  of 
municipalities.  In  fact,  local  governments  are 
allowed  to  borrow  from  financial  institutions  or 
directly from the market (by issuing bonds). Also, 
until  recently,  there  has  been  no  procedure  put  in 
the  central 
place 
administration 
such  borrowing. 
Furthermore,  no  'golden  rule'  exists;  hence,  even 
operational  deficits  were  often 
financed  by 
borrowing or disinvestment (i.e. sale of assets). As 
a result, assets in the local government sector have 
been  declining  while  the  sector's  debt  has  been 
increasing in the past decade. This serious problem 
has  been 
the  recently 
amended  ALG  now  forbids  operational  deficits. 
However,  it  is  yet  unclear  how  this  will  be 
enforced in practice.

long  recognised  and 

In fact, government control (either central or local) 
over local financial affairs are also hindered by the 
extensive use of state owned enterprises (SOEs) in 
the  public  service  provision.  Transparency  of 
financial  management  is  further  reduced  by  the 
possibility  for  local  governments  to  open  an 
account  in  commercial  banks  and  by  the use  of 
cash-based  accounting  and  reporting  systems. 

268

Moreover,  in  case  of  insolvency  of  a  local 
authority existing procedures only concern settling 
liabilities vis-à-vis creditors but no remedial action 
is  triggered  to  correct  structural  problems  or  to 
prevent the recurrence of such situations.

at 

subnational 

Finally,  there  is  no  'national  stability  pact'  type 
agreement between the central and the local levels. 
On  a  positive  note,  fiscal  rules  governing  public 
finances 
level  have  been 
strengthened by the 2011 Economic  Stability  Act. 
In  particular,  municipalities  engaging  in  new 
financial  liabilities  are  in  general  subject  to 
authorization  by  the  central  government  (both  for 
new  loans  and  for  rolling  over  existing  ones). 
Loans  can  be  taken  out  only  for  investment 
purposes (operational loans with a longer maturity 
are  forbidden)  and  only  if  debt  redemption  would 
not exceed 50% of own revenues in any given year 
during  the  maturity  of  the  loan  contract  (a  more 
precise  formulation  is  yet  to  be  established  by 
secondary legislation).

Prior to the new regulation and starting from 1996, 
the Local Government Act set a ceiling on the debt 
stock  of  subnational governments,  which  was 
specified  at  70%  of  the  "annual  own  revenue 
capacity"  (calculated  as  receipts  from  local  taxes 
and  other  revenues  minus  interest  payments). 
However,  this  provision  was  not  monitored  or 
enforced  by  any  official  entity.  As  a  result,  from 
the  early  2000s,  local  governments  started  to 
increasingly  circumvent  the  regulation  e.g.  by 
accumulating  debt
local 
government-owned  public  companies  instead  of 
their  own  accounts. Indeed,  the  consolidated  debt 
of local governments increased from roughly HUF 
200 billion in 2000 to more than HUF 1200 billion 
(4½ % of GDP) in 2011; although this amount has 
been reduced by HUF 180 billion in 2012, due to 
the fact that the central government took over both 
the  assets  and  the  liabilities  of  the  counties.  In 
addition, according to the State Audit Office, 80% 
of  the  servicing  costs  of  the  liabilities  (mostly 
accumulated  in  2007-2008)  will  weigh  on  local 
governments' budget starting from 2014.

the  books  of 

in 

Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

Part IV

A1.17. MALTA

1. General description

As one of the most centralised countries in the EU,
Malta  has a 
three-tiered unitary  government 
system,  based  on  central  government,  regional 
committees  and  local  councils.    There  are  also 
administrative  committees  which  fall  under  their 
respective  Local  Council.  .  Local  government 
(local  councils)  was  established  in  1993  through
the  Local  Councils  Act,  which  is the  regulatory 
primary legislation, complemented with subsidiary 
legislation  on  financial,  tendering,  audit,  human 
resources  and  other  matters.  The  Local  Councils 
Act was  modelled  on  the  European  Charter  of 
Local  Self-government  of  the  Council  of  Europe 
and  has  been  amended  on several  occasions..  The 
system  of  local  government  is  also  entrenched  in 
the  Constitution  of  Malta  through  an  amendment 
in 2001 (269). 

and 

There  are  currently  5  Regional  Committees,  68 
Local  Councils 
16  Administrative 
Committees.  According  to  Eurostat’s  Government 
Finance  Statistics  for  2010,  local  government 
expenditure  represents  around  1.5%  of 
total 
general  government  expenditure  (0.7%  of  GDP), 
intermediate 
mainly 
consumption 
investment 
(21%)  and  compensation  of  employees  (15%). 
Local  government  revenue  corresponds  to  around 
1.7%  of  total  general  government  revenue  (0.7% 
of GDP).

form 
followed  by 

the 
(64%), 

taking 

of 

2. Government spending

Local  authorities have  gradually  gained  more 
responsibilities  over the  years. They have  powers 
in  the  areas  of environment,  internal  security  and 
infrastructure.  In  particular,  they  are  responsible 
for  the  general  upkeep  and  embellishment  of  the 
locality,  establishment  and  maintenance  of 
playgrounds,  public  gardens,  local  libraries  and 
sports 
refuse 
and  carry  out  general  administrative 
collection

enforcement, 

facilities, 

local 

(269) "The  State  shall  adopt  a  system  of  local  government 
whereby  the  territory  of  Malta  shall  be  divided  into  such 
number  of  localities  as  may  by  law  be  from  to  time 
determined,  each  locality  to  be  administered  by  Local 
Council  elected  by  the  residents  of  the  locality  and 
established and operating in terms of such law as may from 
time to time be in force"

duties  for  the  central  government, such  as  the 
collection  of  government  rents  and  funds,  and 
answering  government-related  public  inquiries.
Local  Councils  do  not  participate  directly  in 
national economic planning. Their participation in 
national  spatial  planning  is  limited;  they  are 
allowed 
to  any 
competent authority in relation to any planning or 
building scheme.

recommendations 

to  make 

3. Financial arrangements

Local  Councils  depend  mainly  on  central 
government  for  their  financing.  Their  annual 
financial  allocation  is  determined  by  a  formula  in 
the Local Councils Act. Originally the formula for 
allocating  funds  to  Councils  was  based  on  each
locality’s population and surface area. However, in 
1999,  a  new  funding  formula  was  introduced to 
better  reflect  the  financial  needs  of  each  locality, 
based on the cost it incurs for the provision of local 
services and  administration.  This  funding  formula 
was  further  refined  in  2009.  The  Minister  for 
Finance may approve a supplementary allocation if 
it is found, after due consultation with the Minister 
responsible for local government, that the original 
amount  was  insufficient,  while  payments  to  cover 
special needs of a locality or localities are possible 
in exceptional cases.  Since 2009 

Local  Councils  have  benefitted  from  a  number  of 
financial schemes launched by central government.
These  schemes  have  been  directed  towards  all 
aspects  of  society  and  include  such  diverse  areas 
as:  accesibility,  cultural  activities,  alternative 
energy,  sustainable  localities  and  localities  with 
special needs.  

and 

furniture 

Local  Councils  are  empowered  to  raise  funds  “by 
means  of  any  scheme  designed 
to  provide 
additional  funds”.  They  enact  bye-laws  to  charge 
fees for, for instance, advertisements on (Council) 
street 
the 
administration  of  (Council)  property  and  use  of 
(Council)  facilities,  etc.  Local  Councils  may  also 
be empowered to act as agents for public bodies or 
government  departments,  for  instance  when  the 
handling of licences is delegated to the local level, 
in which case they can be granted a percentage of 
the collected fees. 

boards, 

notice 

Local  Councils  need  written  authorisation  from 
both the Minister responsible for local government 

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Public finances in EMU - 2012

and  the  Minister  for  Finance  in  order  to  take  a 
bank  loan  (there  are  no  statutory  criteria  for  such 
loan approvals but Councils have to follow a strict 
procedure in applying for such loan approvals) and 
the local commercial banks are the main sources of 
their borrowing. There are no provisions regarding 
guarantees given by the state or by other bodies. 

while the 12 provinces spend around 1% of GDP. 
Joint arrangements among (mainly)  municipalities 
also exist. ( 270) In parallel to this tiered system, an 
additional  feature  of  Dutch  public  administration 
rooted  in  history  and  the  topographic  specificities 
of the country is the separate, autonomous network 
of  water  authorities ( 271)  which  raise  their  own 
taxes and run specific elections.  

4. Fiscal rules

There  are  no  fiscal  rules  guiding  the  finances  of 
local  government.  However,  a  portion  of  the 
financial  allocation  of  a  local  council  may  be 
retained if necessary to correct a local deficit or a 
balance  below  the  benchmark  established  in  its 
annual  budget.  A persistent  breach  of  financial 
responsibilities  could  constitute  a  ground  for  the 
Prime Minister to advise the  President to dissolve 
the local council concerned.

5. Other relevant institutional features 

The  local  councils’  accounts  are  audited  by  local 
government auditors under the responsibility of the 
Auditor  General.  The  auditors  also  verify  that 
proper  arrangements  are  in  place  for  securing 
economy, efficiency and effectiveness.

A1.18. THE NETHERLANDS 

1. General description

The  Netherlands  is  a  unitary  state,  defined  in  its 
Constitution (last revised in 2002) as decentralised 
with  a  three-tier  government  structure  (provinces 
and municipalities).

Throughout  history  the  Netherlands  was  first 
constituted  as  a  federal  republic  of  sovereign 
provinces  in  the  16th century,  but  a  unitary  and 
centralised form of government prevailed since the 
Napoleonic period. In the past 30 years the country 
has,  still  being  a  strong  unitary  state,  moved 
somewhat  towards  a  more  decentralised  model 
local 
which 
governments.  Municipalities  remain  by  far  the 
most  important  level  of  local  government,  and 
the  Second  World  War  a  steadfast 
since 
efficiency 
driven
consolidation 
considerations,  has  seen  their  number  cut  from 
over  1100  to  430  currently.  Their  expenditure 
amounts  to  around  10%  of  GDP  (2009  figures), 

the  responsibilities  of 

increased 

trend, 

by 

responsibilities 

While  an  overwhelming  majority  of  revenue  is 
raised by the central government, sizeable transfers 
grant  significant  spending  responsibilities  to  the 
provincial and, in particular, municipal levels. The 
main 
cover 
environmental and infrastructure issues at regional 
levels,  whereas  municipalities  are  in  charge  of 
delivering  some  major  expenditure  items  such  as 
social  protection,  health,  primary  education,  and 
housing. 

provinces 

of 

The  recent  trend  over  the  past  two decades  has 
been  to  accompany  the  greater  transfer  of  these 
tasks to  municipalities  with an increased focus on 
resource 
greater 
accountability  and  financial  controls,  aligned 
incentives  for  spending,  and  fewer  earmarked 
transfers.

efficiency, 

through 

e.g. 

2. Government spending

in 

By  and 
the 
large,  government  functions 
Netherlands  remain  largely  centralised,  whereby 
policy  is  determined  centrally  and  implemented 
subnationally through the provincial and municipal 
governments'  delegated  authority.  This  is  for 
instance 
the  case  for  education,  social  and 
healthcare  policy:  the  financial  responsibility  and 
discipline of municipalities is spurred by financial 
management  incentives  but  leaves  little  policy 
discretion. Only for a few areas directly relevant to 
local/regional-scale  management,  responsibilities 

(270) Joint  arrangements  are  partnerships  between  different 
government levels, mainly municipalities (in isolated cases, 
central  government,  provinces  and  water  boards  may  be 
involved).  Municipalities  work  together  especially  in  the 
field  of  public  transport,  employment,  health,  waste 
disposal,  and  environmental  management  and  planning 
(source: CBS).  Joint  arrangements  represent  a  combined 
total annual expenditure of around €7.5 bn.

(271) Water  authorities  form  a  separate  network  of  public 
the  general  government's 
administrations  mirroring 
structure at local, provincial and national level. The nature 
of 
large-scale 
infrastructure  funding  also  implies  much  longer  term 
financial commitments.  

their  activity  dealing  mostly  with 

270

Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

Part IV

  The  main  areas  where  spending 

are  more  equally  shared  across  government  tiers 
e.g.  spatial  planning,  transport  and  environmental 
issues. 
is 
devolved  to  regional  and  local  authorities  reflect 
the increasing transfer of spending competences to 
the local level.

of the municipality and provincial funds is indexed 
on  the  overall  expenditure  of  central  government, 
which has the drawback of occasionally increasing 
in 
their  allocation  with  no  specific 
matching  responsibilities;  however,  austerity  at 
central  government  level  also  results  in  a  shared 
effort at subnational scales.

increase 

is 

social  protection, 

For  instance,  the  government's  major  expenditure 
item, 
split  between 
government  layers,  with  municipalities  assuming 
charges  such  as  social  assistance  (incl.  minimum 
income),  unemployment  benefits,  support 
to 
families  and  the  elderly,  special  care…  whereas 
provinces  focus  their  action  on  child/youth  action 
programmes. 

3. Financial arrangements

The power of provinces and municipalities to raise 
tax  revenue  is  very  limited.  The  provinces'  only 
source  of  own  revenue  stems  from  collecting  a 
share  of  the  national  car  registration  tax  (in  the 
form  of  a  surcharge,  with  a  capped  rate). 
Municipalities can collect tax and sales revenue on 
a  broader  variety  of  local  bases  (e.g.  real  estate, 
building  permits,  parking  fees,  sewage,  rubbish 
collection,  pets,  tourism…)  but  this  still  only 
constitutes  a  limited  share  of  their  operational 
income.

Most of the revenue of subnational governments is 
therefore  based  on 
from  central 
government.  In  the  case  of  municipalities  (the 
major  tier  of  subnational  government)  transfers 
make up almost 2/3 of their revenue.

transfers 

Provinces  and  municipalities  then  dispose  of  a 
certain  leeway  in  the  use  of  the  general  funds, 
while having to fulfil their devolved competences. 
The recent trend has moved towards more aligned 
incentive schemes in those areas of responsibility, 
e.g.  social  services:  "More  incentives  implied  a 
change 
in  financing  Dutch  social  assistance 
benefits.  In  the  past,  municipalities  could  claim 
most  of  their  expenses  on  social  benefits  to  the 
central  government.  However,  since  2004,  they 
receive a fixed budget which is insulated from the 
macro-economic 
a 
the  CPB.  As  a  consequence, 
calculation  by 
municipalities now have an incentive to reduce the 
number of social assistance benefits."

developments 

through 

Earmarked transfers

the  municipality 

In  addition  to  the  general  transfers  channelled 
through 
/  provincial  funds, 
subnational governments still receive a large share 
of  specific  transfers  allocated  by  the  central 
government 
implementation  of 
specific  missions.  The  breakdown  by  government 
ministries  illustrates  the  predominance  of  social 
service costs in specific transfers. 

for  devolved 

General transfers

4. Fiscal rules

General  transfers  to  municipalities  (respectively 
provinces) are managed through the operation of a 
dedicated  fund  and  distributed  using  a  formula 
based on fairly sophisticated criteria. (272) The size 

(272) Which  "[not  only  takes  into]  account  the  number  of 
inhabitants, but corrects also for differences in tax earning 
capacity  (real  estate  value  of  dwellings  and  business 
property)  and  external  circumstances,  like  a  regional 
function  or  the  social  and  physical  structure.  Indicators 
used  are  the  number  of  households  receiving  social 
benefits,  number  of  people  from  ethnic  minority  groups, 
number  of  young  or  elderly,  density  of  addresses  and  the 
surface  area  of  the  historical  centre.  However,  differences 
in other revenues, like interest, dividend or from the sale of 
land,  are  not taken  into  account.  Supplementary  to  the 
general  distribution  formulae,  the  Frisian  Islands  and  the 
four major cities receive a fixed amount." (Bos, 2010)

Provincial  governments  exert  a  role  of  financial 
control over municipalities; however, both tiers of 
subnational governments may borrow without any 
prior  authorisation  and  from  the  establishment  of 
their choice; bond emissions are rarely used (Dexia 
2008). 

In  practice  however,  since the  medium-term 
budgetary  framework  imposes  a  "golden  rule"  for 
subnational governments’  budgets,  borrowing  is 
only used to  finance investment,  which is defined 
using  self-defined  accounting  standards ( 273).  No 
to  borrowing  has  been  set  so 
upper 

limit 

(273) This budget balance would therefore technically result in a 

deficit by ESA standards.

271

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Public finances in EMU - 2012

subnational governments  can  borrow  as  long  as 
they can finance the debt service.

end  when  it  comes  to  the  contribution  of  sub-
national governments’ own revenue to total public 
sector revenue (2%)(275).

Following decentralisation efforts between the two 
world  wars, 
the  debt  of  municipalities  had 
increased  sharply  in  the  1920s  to  over  40%  of 
GDP.  It  stabilised  around  20-30%  of  GDP  in  the 
1970s  where  it  still  constituted  the  overwhelming 
majority  of  Dutch  public sector debt.  With 
increased  fiscal  discipline  the  trend  has  been 
steadily  decreasing  since  then,  when  at  the  same 
time 
increased 
government 
significantly. By 2009, the outstanding debt of the 
Dutch 
(mostly 
municipalities) had been reduced to 8.2% of Dutch 
GDP  (still,  the  second  highest  level  in  the  EU)  at 
nearly 47.9 bn€ (2'890€ per inhabitant, the highest 
amount in the EU).

subnational

central 

public 

sector 

debt 

In the unlikely event of a municipality threatening 
to declare bankruptcy, the entity in question would 
lose  control  over  their  budget  and  the  national 
government takes charge. The strictest form is the 
control  under  article  12  of 
the  "financiele 
verhoudingswet".  In  2009-2012,  4  municipalities 
were  under  this  special  control  scheme  of  the 
central  government  and  received  in  total  around 
22.4 million euro (2011) in financial support.

A1.19. AUSTRIA

1. General description

is  a 

Austria 
federation,  where  government 
responsibilities  are  shared  among  three  different 
territorial  levels:  federal,  regional  (9  states)  and 
local  (2357  municipalities).  As  in  other  similarly 
organised  countries,  the  reasoning  behind  the 
federal  structure  is  that  it  provides  increased 
efficiency from  the  decentralisation  of  allocative 
functions  and  that  public  services  should  be 
produced  and  financed  in  accordance  with  the 
preferences of the residents of the area that enjoys 
the  benefits (274).  Compared  with  the  degree  of 
fiscal decentralisation in other countries, Austria is 
moderate  in  terms  of  the  share  of  sub-national 
government  outlays  in  total  general  government
spending (34% in 2010) and at the lower-medium 

the 

three 

three 

coordinate 

(ASP).  The 

relations  between 

The 
layers  of 
government  in  Austria  are  defined  by  the  Fiscal 
Constitutional  Law  (1948)  and  governed  by  the
periodically  negotiated Fiscal  Equalisation  Law 
(Finanzausgleichsgesetz  - FAG)  and  the  Austrian 
Stability  Pact 
layers  of 
government 
their  medium-term 
budgetary  plans  in  the  FAG,  which  allocates  the 
revenues  to territorial authorities for the period of 
six years (previously four years). The law specifies 
the types of taxes that are to be shared among the 
three 
the 
levels  of  government,  as  well  as 
proportion at  which they are  to be divided among 
them.  Revenues  from  most  of  the  tax  categories 
are  collected  by  the  federal  government  and  then 
distributed to the three levels according to the key 
agreed  on  in  the  FAG  negotiations.  A  part  of  the 
revenue  from  the  shared  taxes  is  withheld  before 
the distribution to the various levels of government 
and earmarked for special purposes, e.g. financing 
of  family  benefits.  The  FAG  also  determines  the 
horizontal  distribution  of  revenues  at  the  regional 
and  local  level.  The  rules  set  out  in  the  FAG  are 
rather  complex  and  lacking  in  transparency.  Not 
only  are  revenues  from  most  individual  taxes 
shared  among  the  three territorial  levels  in fixed 
proportions,  but  also  decision-making  in  many 
areas is divided among various levels of authority. 
Revenue-raising  and  spending  responsibilities  for 
different  activities  do  not  reside  within  the  same 
level  of  government.  In  its  present  form,  the
system  does  not  encourage  the  agents  involved  to 
use  resources  in  the  most  efficient  way  and  keep 
firm  control  over  spending.  Therefore,  there  is 
considerable  potential  for  increasing  efficiency  in 
the public sector. 

2. Government spending

Austria's  Fiscal  Constitutional  Law  defines  the 
spending  competences  of  the  federal government, 
the  main  ones  being tertiary  education,  parts  of 
social policy (family allowances and private sector 
pensions), 
internal 
justice,  foreign  policy,  defence  and
security, 

unemployment 

benefits, 

(274) Balassone  F.  and  D.  Franco  (2005),  Fiscal  federalism in 
Fiscal  Policy  in  Economic  and  Monetary  Union,  Edward 
Elgar, Cheltenham, UK

(275) Bergvall, D. et al (2006), Intergovernmental Transfers and 
Decentralised  Public  Spending,  OECD,  Journal  on 
Budgeting, Volume 5, No. 4

272

Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

Part IV

national infrastructure. The competences not listed 
by  the  Constitution  fall  in  the  remit  of  the  states. 
These 
include:  social  assistance,  health  care 
(hospitals),  parts  of  primary  and  secondary 
education, environment and regional infrastructure. 
Communes  are  responsible  mainly  for 
local 
planning,  the  functioning  of  local  infrastructure 
(roads,  waste  and  water  management)  as  well  as 
for  providing 
services  as  obligatory 
education,  kindergartens,  old  peoples' homes  etc.
The  problem  with  the  Austrian  municipalities  lies 
in the fact that many of them are very small (more 
than half of them have less than 5000 inhabitants), 
which  makes  the  provision  of  local  services  very 
costly.  

such 

A  marked  weakness  of  the  set-up  of  inter-
governmental  relations  in  Austria  lies  in  the  fact 
that  in  many  areas  the  decision-making,  funding 
and  spending 
responsibilities  are  shared  by 
different  levels  of  government.  Streamlining  of
these competences  could  potentially  result  in 
significant efficiency gains and reduction in public 
expenditure.  The  most  notable  examples  here  are 
health care and education systems. 

federal  government  sets  out 

The  Austrian  health  care  system  is  organised  is  a 
fairly  complex  way.  The  social  security  system 
funds  practising  physicians.  In  terms  of  hospitals, 
the 
framework 
conditions, but the real decision-making powers lie 
with the states, even though they provide less than 
half  of  the  government  outlays  for  hospitals  (the 
rest  comes  from  social  insurance  as  well  as  from 
the  federal  and  local  governments).  In  running 
hospitals,  the  states  and  municipalities  do  not 
always  pursue  an  exclusively  health  services 
provision  agenda.  There  are  also  economic  and 
political  interests  at  stake,  which  make  closing 
down of redundant hospitals literally impossible in 
many  cases.  Since  different  actors  are  responsible 
for the in-patient and out-patient services, there is 
no  incentive  to  move  workload  from  costly 
hospitals  to  practising  physicians  whose  services 
are  cheaper.  The  number  of  hospital  stays  in 
Austria  is  one  of  the  highest  among  the  OECD 
countries.  According  to  the  federal  audit  court, 
hospital  services  worth  more  than  1%  of  GDP 

should  be  shifted  from  the  hospital  service  to 
practising physicians ( 276). 

The  financing  of  the  education  system  is  also
highly controversial.  The  federal  government  is 
responsible  for  the  curriculum  and  funds  teacher
salaries  to  a  large  extent.  The  latter,  though,  are 
formally  employed  by  the  states,  which  have  far-
reaching  competences  in  terms  of  organisation  of 
schooling (among others the determination of pupil 
numbers  per  class  and  teaching  periods).  Such 
division  of  competences  does  not  encourage 
effective  allocation  of  resources.  In  fact,  cross-
country  efficiency  analyses  show  that  Austria 
spends  roughly  the  same  amount on  education  as 
other 
the 
(i.e.  Finland), 
performance in PISA is relatively poor. 

economies 

but 

3. Financial arrangements

The  three  layers  of  government  coordinate  their 
medium-term  budgetary  plans  in  the  FAG,  which 
allocates  the  revenues  to  territorial  authorities, 
usually  for  the  period  of  six years.  The  law 
specifies  the  types  of  taxes  that  are  to  be  shared 
among  the  three  levels  of  government,  as  well  as 
the  proportion  according  to which  they  are  to  be 
divided  among  them.  Most  of  the  tax  categories 
are  collected  by  the  federal  government  and  then 
distributed to the three levels according to the key 
agreed  on  in  the  FAG  negotiations.  A  part  of  the 
revenue  from  the  shared  taxes  is  withheld  before 
the distribution to the various levels of government 
and earmarked for special purposes, e.g. financing 
of 
family  benefits.  The  federal  government 
receives about 73% of the remaining revenue from 
the shared taxes. The states and municipalities get 
respectively (277).  A 
about  15%  and  12%, 
significant part of the shared revenue that flows to 
the  regional  and  local  governments  is  earmarked 
for special spending activities. Some of these flows 
sub-national 
require 
authorities.  As  a  last  step,  the  FAG  determines  a 
horizontal  distribution  of  the  revenue at  the 
regional and local level. 

co-financing 

the 

by 

(276) Vorschläge  des  Rechnungshofes  zur  Verwaltungsreform 
und  zum  Bürokratieabbau,  Positionen  Reihe  2007/1, 
August 2007

(277) Fuentes, A. et al (2006), Reforming federal fiscal relations 
in Austria, OECD, Economic Department Working Papers 
no. 474

273

European Commission

Public finances in EMU - 2012

Own tax resources (generated and collected within 
a  given  state  or  municipality)  constitute  a 
significant  part  of  the  local  government  revenue. 
However, the only significant tax parameter, which 
municipalities  can  set  autonomously,  is  the  real 
estate tax rate. Own tax resources are negligible in 
the case of the states, indicating a very low degree 
of tax autonomy. In fact, by international standards
Austria is one of the countries  where the share of 
own  tax  in  the  regional government’s  revenue  is 
the lowest (about 2% of the total)(278). On the one 
hand,  economic  theory  suggests  that  the  central 
government  should  collect  taxes  from  tax  bases 
that  are  more  mobile,  more  sensitive  to  cyclical 
factors and less uniformly distributed (279). On the 
other  hand,  though,  splitting  the  funding  and 
spending  powers,  like  in  Austria,  weakens  the 
cost-benefit  relationship  associated  with  public 
services, 
allocative 
the 
advantages of a federal structure (280). 

reducing 

thereby 

The  FAG  also  defines  rules  governing  the  inter-
governmental  transfers  which  in  2009  constituted 
41%,  16%  and  27%  of  the  total  revenues  of  the 
regional  authorities,  local  authorities  and  social 
security  funds  respectively ( 281).  The  system  of 
transfers  was established to ensure that each level 
of government has at its disposal sufficient means 
to  carry  out  the  tasks  assigned  to  it  by  the 
legislation.  However,  these  transfers  make  the 
fiscal  relations  between 
layers  of 
government overly complex and in many instances 
discourage  efficient  use  of  funds.  The  FAG 
negotiated  in  2008  introduced  the  conversion  of 
some of the transfers from the federal government 
to  the  state  and  local  governments  into  revenue 
shares which are devoted to certain activities (e.g. 
housing assistance scheme and road maintenance). 
This  introduced  some  transparency  to  the  most 
opaque  part  of  fiscal  federal  relations,  but  further 
steps  toward  simplification  of  the  system  are 
needed.  

three 

the 

Austria's  Federal  Budgetary  Law  enables  the 
into  credit 
federal  finance  minister 

to  enter 

(278) Schratzenstaller,  M. 

(2007), 

Undurchschaubares 

transactions  on  behalf  of  the  states  through  the 
Austrian  Federal  Financing Agency (AFFA).  The 
Agency carries out a quarterly survey of the states' 
financial needs. The amount of debt issued by the 
federal  government  for  the  financing  of  the  states 
cannot  surpass  20%  of  total  general  government 
expenditure in the given year. In the period 2009-
2011 about 4.4% of the potential amount was used 
on  average (282).  Austria's  Fiscal  Constitutional 
Law  gives  the  states  the  competence  to  adopt 
legislation  regulating  credit  operations  of  the 
communes.  As  a  general  rule,  municipalities  are 
only  allowed  to  take  loans  in  order  to  cover 
extraordinary 
the 
conditions which govern granting the approval for 
drawing  debt  by  communes  differ  significantly 
between  states  in  terms  of  e.g.  which  types  of 
transactions  have  to  be  notified  and  starting  from 
which amount. Nevertheless,  a common  feature is 
that  in  most  states,  the  credit  approval  conditions 
concerning  cities  are  more  lenient  than  those 
regarding  smaller 
the 
assumption  that  the  former  are  equipped  with 
superior  know-how 
risk 
in 
management (283). The AFFA plays only advisory 
role for the municipalities.  

local  governments  on 

terms  of  debt 

expenditure. 

However, 

4. Fiscal rules

targets 

deficit/surplus 

(ASP),  which 
The  Austrian  Stability  Pact 
prescribes 
(so-called 
“stability  contributions”)  to  the  federal,  regional 
and local governments, was first set up informally 
in 1996 in the context of Austria’s preparation for 
entering  the  euro  area,  which  required  significant 
fiscal consolidation. The  ASP  was  meant to solve 
the  asymmetry  created  by  the  high  degree  of 
decentralisation  of  fiscal  policy  responsibilities  at 
national level on the one hand and the introduction 
– at the European level - of rules (i.e. Stability and 
Growth Pact) on the other, assigning responsibility 
for  the  general  government  balance  solely  to 
central  governments.  In  1999,  this  enforcement 
mechanism  was  formalised  for  the  first  time.  Its 
successors  were  then  adopted  for  the  2001-2004, 
2005-2008, 2008-2013  and  2011-2014  periods. 

Transfergeflecht in der Standard, 25 October 

(279) Balassone  F.,  Franco,  D.  (2005),  Fiscal  federalism in 
Fiscal  Policy  in  Economic  and  Monetary  Union,  Edward 
Elgar, Cheltenham, UK

(280) Oates, W. (1972), Fiscal Federalism, New York: Harcourt 

Brace Jovanovich

(281) Öffentliche  Haushalte  in  Österreich (2010),  editor  G. 

Steger, Verlag Österreich, Vienna 

274

(282) Refinanzierungsmöglichkeiten  der  Bundesländer  über  die 
OeBFA (2011),  presentation  by  M.  Oberndorfer,  Vienna, 
November 

(283) Grossmann,  B.  and  E.  Hauth,  (2009),  Kommunales 
Risikomanagement  und  Aufsichtsbehördliche  Kontrolle  in 
Österreich, 
des 
im 
Staatsschuldenausschusses, April 2009

Auftrag 

Studie 

 
Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

Part IV

The  FAG  foresees  financial  sanctions  in  case  a 
State does not ratify the ASP. Once ASP is ratified 
it fixes the amount of the sanction in case of non-
compliance,  which  takes  the  form  of  an  interest-
bearing  deposit.  If  in  the  following  year  the 
respective  target  is  not  reached,  the  deposit  is 
supposed  to  be  transferred  to  those  governments 
that  are  in  compliance.  However,  if  the  target  is 
achieved,  the  deposit  would  be  reimbursed.  The 
sanction option has never been used under the Pact 
as it covered all deviations from numerical targets 
(negative deviations were compensated by positive 
deviations). 

of the Pact, but at the same time it should be noted 
that  the  revised  budgetary  goals  under  the  2011-
2014  Pact  were  significantly  less  ambitious  than 
those in the past. In the Pact editions between 2001 
and  2010,  the  local  and  state  governments  were 
required  to  run  balanced  budget  or  come  up  with 
surpluses,  respectively,  whereas  now  deficits 
(albeit  gradually  decreasing)  are  allowed  on  both 
levels.  Also, the  federal  government  now  has  the 
right  to  close  its  books  with  much  higher  deficits 
than in the past (average deficit of 2.5% of GDP in 
the  period  2011-14  versus  1.2%  of  GDP  in  the 
years 2001-2010).    

for 

commitments 

In  providing 

that  after  an 

The  ASP  is  a  useful  tool  aimed  at  involving  all 
levels of government in the consolidation of public 
legally-enshrined 
finances. 
budgetary 
various 
across 
government levels, Austria can be considered as a 
benchmark  in  the  EU.  Nevertheless,  it  should  be 
initial  stage  of  general 
noted 
compliance  with  the  Pact  in  the  years  1999-2002, 
slippages occurred in individual years at all levels 
of  government.  However,  since  according  to  the 
ASP's rule the targets were met on average within 
the duration of the subsequent Pacts, the sanctions 
foreseen  by  the  ASP  have  never  been used. 
Initially  budgetary  surpluses  were  meant  to  make 
up only for the slippages in the past and were not 
supposed  to  be  carried  over  to  future  years. 
Subsequently,  the  initial  approach  towards  carry-
overs was criticised as pro-cyclical and carry-over 
of surpluses was admitted with the aim of reaching 
the  goals  on  average  within  the  duration  of  the 
Pact. It should be noted that, striving to fulfil their 
obligation 
sub-national 
governments  resorted  to  some  methods  that  went 
such  as 
against 
reclassification  of  public  entities,  transfer  of  real 
assets  to  various  federal  and  regional  real  estate 
companies, etc. These were, however, not accepted 
as part of the stability contributions. Following the 
recent 
the 
discrepancy  between  the  ASP  goals  and  the 
budgetary outcomes became so significant that the 
goals  were  revised  in  March  2011.  This  revision 
was  accompanied  by 
the 
enforcement  mechanism  of 
the  Pact,  which 
consisted  among  others  in  shifting  the  focus  back 
to attaining the budgetary goals in individual years, 
enhancing  the  role  of  the  Court  of  Auditors  and 
making  the  launch  of  the  sanctioning  procedure 
automatic.  This  should  increase  the  effectiveness 

strengthening  of 

the  ASP, 

the  Pact, 

spirit  of 

economic 

financial 

crisis, 

under 

and 

the 

introduced 

Currently,  the  latest  edition  of  the  ASP  is  being 
renegotiated yet again in order to align it with the 
in 
debt  brake  ("Schuldenbremse")
December 2011, which limits the structural federal 
government  deficit  to  0.35%  of  GDP  starting  in 
2017.  The  original  attempt  to  anchor  the  debt 
brake  limiting  the  structural  general government 
deficit to 0.45% of GDP in the Constitution failed 
due  to  insufficient  support  by  the  parliamentary 
opposition  parties.  In  spite  of  the  lack  of  the 
constitutional status i.e. not having bearing on sub-
national authorities, the states committed to respect 
it
too.  This  is supposed  to  be reflected  in  the 
updated goals of the ASP, which should be agreed 
on in May 2012.

5. Need for reform

The  need  for  reform  of  the  set-up  of  the  fiscal 
relations between the three layers of government in 
Austria has been discussed for decades. Numerous 
experts' groups put forward various proposals as to 
how to simplify these relations and adjust them to
the  changed  economic  reality.  In  spite  of  the 
general consensus on the issue, the implementation 
of  the  suggested  reforms  has  so  far  been  very 
limited.  The  most  urgent  problem  which  needs 
addressing  is  the  fragmentation  of  the  various 
the 
competences  between 
levels  of 
government.  It  seems 
that  without  bringing 
together the decision-making powers with funding 
and  spending  competences  in  a  given  area,  the 
system will continue discouraging cost-cutting and 
efficient use of public means. The streamlining of 
competences should be accompanied by significant 
expansion of the tax autonomy of the sub-national 
authorities  in  order  to  strengthen  the  latter's 
accountability  to  voters  and  tax  payers.  The 
the 
complicated  system  of 

transfers  between 

three 

275

European Commission

Public finances in EMU - 2012

should  be 

federal,  regional  and  local  authorities,  which  has 
grown over time to such an extent that it is almost 
completely  opaque, 
substantially 
simplified  to  allow  analysis  of  flows  between  the 
three  layers  of  government.  The  division  of 
responsibility  for  certain  areas as  well  as  the 
general formulation of goals of the FAG should be 
reviewed in order to bring it up to date with today's 
in  particular  with 
economic  reality  and 
its 
(284).  Last  but  not  least, 
international  context
merging  small  municipalities  and  improving  the 
legal  environment  for  cooperation  between  them 
(in  particular  across  different  states)  could 
significantly contribute to raising the efficiency of 
provision of local services. 

Council 
The 
recommendations 
to  Austria  with  respect 
subnational governments (see Box I.3.2 above).

country-specific 
to 

issued 

A1.20. POLAND

1. General description

the 

local  communities. 

The public administration reform of 1999 aimed at 
the  decentralisation  of  power  and  fostering  self-
determination  by 
It 
established  a  three-tiered  system  of  local  public 
administration.  According  to  the  Constitution, 
local  governments  assume  the  public  tasks  which 
are  not  explicitly  assigned  to  the  other  organs  of 
public  administration.  The  entities  of  different 
tiers,  although 
territorially  overlapping,  are 
independent of each other in the sense that entities 
of  a  higher  level  do  not  exercise  authority  or 
control over the entities of a lower level.

2. Tiers of local government and their 
responsibilities

The  basic  tier  of  local  government  in  Poland  is  a 
gmina (commune/municipality)  which  is  defined 
as  a 
self-governing  community  of  people 
inhabiting  a  defined  territory.  Currently  there  are 
2479 gminas, 1571 of which are classified as rural, 
602  as  rural-municipal,  and  306  as  municipal.  A 
gmina can  be  established,  dissolved,  merged  or 
divided by the national government on the basis of 

(284) Grundlegende 

Finanzausgleichs: 
Reformoptionen  und  Reformstrategien (2011),  Technische 
Universität Wien, Vienna, January 

Reform 

des 

276

its  ability 
its  public 
to  effectively  exercise 
functions. The law guarantees gminas autonomy in 
all matters of local concern which are not regulated 
by  other  legislation  or  assigned  to  other  tiers  of 
local  government;  grants  them  legal  identities, 
ownership  rights  and  independent  budgets.  In 
broad terms, a gmina is responsible for meeting the 
collective needs of the community. In this context, 
it  assumes  two  types  of  tasks:  those  which  are 
directly  assigned  to  it  by  laws  ('own  tasks')  and 
those  which  are  delegated  by  the  central  level  of 
government  ('delegated  tasks').  Own  tasks  are 
divided  into  obligatory,  which  a  gmina is  obliged 
to  assume  due  to  their  elementary  character,  and 
facultative  which  should  be  assumed  to  a  degree 
depending  on  the  financial  resources  and  local 
community's  needs.  In  particular,  most  important 
areas  of  gmina's  own  responsibilities  include: 
public  transportation,  water  supply  and  sewage 
treatment,  waste  collection  and  disposal,  energy 
and  heating  systems,  local  roads  and  buildings, 
land  use 
spatial  planning,  municipal 
cemeteries,  libraries  and  cultural  services,  non-
obligatory  pre-school  education  for  children  from 
to  5  years  of  age,  obligatory  pre-school 
3 
education  for  children  of  6  years  and  primary 
education.   

and 

legal 

forms.  Usually  powiats

(county)  which,  depending  on 

The  second  level  of  local  administration  are
powiats
the 
character  of  the  municipality,  can  have  two 
different 
are 
composed  of  several  gminas and  have  separate 
administrative  organs  (currently  there  are  314  of 
them).  However,  larger  cities  (65  of  them)  are 
categorised  as  'cities  with  powiat status'  (city 
county  /  miasto  na  prawach  powiatu),  which  are, 
de facto, gminas which assume also the tasks and 
responsibilities of a powiat (they have no separate 
gmina's  and  powiat's  organs). In  several  cases, 
cities  have  been 
rural 
neighbourhoods  to  constitute  an  independent  'city 
with  powiat status'.  This  has  administratively
separated the population of a significant area from 
an infrastructure (mainly secondary education) and 
(tax  base  being 
own 
concentrated 
to 
widening  economic  and  social  disparities  within 
the  same  region.  A  powiat  as  a  new  entity 
introduced  by  1999  reform  has  been  assigned 
relatively 
of 
responsibilities, 
including:  managing  general 
healthcare  and  hospital  services  (whose  financing 

resources 
the  cities),  contributing 

financial 
in 

separated 

narrowly 

defined 

range 

from 

its 

Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

Part IV

remains  however  within  the  responsibility  of  the 
National  Health  Fund),  secondary  education, 
roads, sanitary and health inspection, public safety 
and  social  welfare  services  (in  particular  running 
local  employment  offices  responsible  for  active 
labour  market  policies  and 
the  payment  of 
unemployment benefits).  

the 

seen 

their 

reform, 

competences 

A  third,  highest  level  of  territorial  division  is  a 
voivodship (województwo),  where  two  tiers  of 
government co-exist with separate responsibilities. 
Since 
the 
administrative 
representatives of the central government (voivods) 
have 
shrinking 
considerably at the benefit of independent regional 
bodies (sejmik). While the former have maintained 
some  role  in  maintaining  the  police,  security  and 
criminal 
the  national 
government  and  monitoring  the  use  of grants  by 
local  governments,  the  latter  have  become  fully 
function  of  a 
the  primary 
responsible 
voivodship which 
regional  development 
planning (as such they are the main players in the 
process  of  planning  and  management  of  the  EU 
structural funds), and a number of other tasks, such 
as  higher  education,  culture,  health  care  and 
transport 
is 
divided into 16 voivodships.   

infrastructure.  Currently  Poland 

functions  of 

justice 

for 

is 

3. Local government's finances 

The amount of tasks and degree of responsibilities 
are reflected in the structure of financial resources 
used  by  different  tiers  of  local  government.  Over 
the  past  decade  local  governments  have  been 
responsible for providing an increasing amount of 
public  goods  and  services  to  their  respective 
populations  (a  real  increase  of  ca.  70%  in  total 
revenues and expenditures). Among them, gminas' 
budgets, given the widest range of tasks, accounted 
for almost half of total public finances managed by 
the  local  governments.  Cities  with  powiat status, 
given  the  significant  size  of  population  covered, 
but  relatively  small  number,  accounted  for  over 
30%,  powiats for  less  than  20%  and  voivodships, 
due  to  their  limited  responsibilities,  for  less  than 
10%.

Revenues

The law defines three basic categories of revenues
local  government  entities:  own  revenues, 
of 
the  state  budget  and 
general  subsidy  from 

appropriated  allocations.  In  2010,  ca.  48%  of 
revenues  of  all  local  government  entities  came 
from  own  revenues,  29%  were  transferred  as 
subsidies  from  the  state  budget,  and  23%  were 
earmarked grants.

Own revenues consist of incomes from local taxes 
(only  for  gminas and  large  municipalities),  user 
fees,  charges  and  fines,  revenues  of  productive 
entities  owned  by  the  local  government,  income 
from the  sale or rental of  municipal property, and 
shares of revenues from personal income tax (PIT) 
(CIT)  paid  by 
and  corporate 
individuals 
are 
who 
residents/located on the territory of the entity.

tax 
companies 

income 

and 

Local  taxes levied  by  gminas include:  real  estate 
tax (flat per metre charge on land and a percentage 
of the construction costs of buildings), agricultural 
and forestry tax (based on the price of per hectare 
yields  of  particular  types  of  land),  motor  vehicle 
tax, inheritance and donation  tax, tax on civil law 
transactions, and a simplified income tax on small 
businesses.

The share of income tax revenues transferred to an 
entity  amounts  to  39.34%  of  PIT  and  6.71%  of 
CIT revenues collected on the territory of a gmina, 
10.25%  of  PIT  and  1.40%  of  CIT  revenues 
collected  in  a  powiat,  and  1.60%  of  PIT and 
14.75% of CIT revenues collected in a voivodship. 

component 

Total  amount  of  the  general  subsidy transferred 
from  the  state  budget  to  the  local  government 
entities  is  defined  annually  in  the  budget  law, 
separately  for  gminas,  powiats and  voivodships. 
The subsidy has a redistributive  function: the size 
of  a  major  ('equalization')  component  depends  on 
the sum of tax revenues (local taxes plus share of 
PIT  and  CIT)  per  inhabitant  of  a  gmina and,  to  a 
minor extent, on its density of population. A minor 
is  distributed  among 
('balancing')
gminas according  to  the  amount  of  housing 
subsidies  paid  by  them and  overall  level  of  their 
population's wealth. For powiats and voivodships a 
similar  mechanism  is  complemented  with  slightly 
different  criteria.  In  case  of  powiats,  the  size  of  a 
subsidy 
tax  revenues  per 
inhabitant,  the  level  of  unemployment,  and  a 
combination  of  factors:  total  length  of  local, 
regional  and  national  roads,  size  of  family 
transfers,  and  a  trend  in  a  powiat's  revenues.  For 
voivodships,  it  depends  on  the  tax  revenues  per 

is  determined  by 

277

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Public finances in EMU - 2012

inhabitant  and  the  overall  number  of  inhabitants 
(higher  subsidy  for  small  voivodships),  and  a 
number  of  other  factors:  the  length  of  regional 
roads,  unemployment  rate,  subsidies  to  regional 
railway operation and GDP per capita. A separate 
education  subsidy is  distributed  among  entities 
(gminas, powiats and voivodships) by the Minister 
of  Education,  taking  into  account  the  range  of 
education  tasks  under  their  responsibility.  The 
subsidy is the main source of financing for primary 
and  secondary  level  of  education  in  Poland.  The 
current  formula  takes  into  account  the  number  of 
pupils  weighted  according  to  the  type  of  schools 
they  attend  and  the  pupil-per-teacher  ratio  in  the 
area.  Such  formula  implicitly  favours  rural  areas, 
where the latter ratio is the lowest.

The  third  source  of  local  governments'  revenue  is 
earmarked  grants. They  are  either  paid  from  the 
state budget, in the framework of the programmes 
financed  from  the  EU  funds,  or  from  other 
earmarked funds. The former ones are allocated for 
the  execution  of  the  own  functions  of  the  local 
government  and 
functions  delegated  or 
commissioned to them by the national government. 
They must be co-financed (at least 50%) from own 
resources  of  an  entity  and  are  mainly  granted  for 
investments in education, culture and sports. 

the 

Expenditures

Local government entities spend their resources on 
current  expenditures,  including  mainly  wages  and 
salaries,  purchase  of  goods  and  services,  social 
benefits,  grants  for  subordinate  organisational 
entities,  and  debt  service,  and  on  investment 
expenditures. 

reflects  main 

The  structure  of  expenditure  of  various  levels  of 
local  government 
tasks  and 
responsibilities  legally  assigned  to  them.  While 
classification  of  public  expenditure  according  to 
COFOG  is  not  available  at  a  regional  and  local 
level, a national budget classification can serve as 
a  proxy.  Gminas' main  items  of  expenditure  are: 
education  (33.3%)  and  social  protection  (16.5%), 
powiats and  large  municipalities  finance  mostly 
education  (respectively  28.5%  and  27.8%)  and 
transport  and  communication  (respectively  21.7% 
and  20.3%),  while  voivodships are  predominantly 
responsible 
and 
financing 
communication (39.1%).

transport 

for 

278

4. Fiscal framework

Apart  from  the  legal  obligation  to  exercise  the 
functions assigned to them by law, freedom of the 
their 
entities 
local  government 
autonomous  fiscal  policy  is  constrained  by  the 
fiscal 
framework  composed  of  medium-term 
programming and fiscal rules. 

to  pursue 

least 

longer 

levels  of 

the  State)  and  all 

time  span.  The  Projection 

Medium-term  programming  involves  both  central 
government  (in  a  form  of  Multiannual  Financial 
Plan  of 
local 
government. Multiannual Financial Projections are 
prepared  for 
three 
the  current  and  at 
subsequent budget years, but the coverage may be 
extended  if  investment  projects  are  implemented 
is 
over  a 
established 
the  annual  budget 
resolution  and  submitted  to  a  local  accounting 
council for agreement. The document indicates the 
level  of  revenues  and  expenditures for  the  entire 
programming  period,  serves  as  a  numerical 
guidance for the fiscal policy adopted in the annual 
budgets and provides a limit for the budget deficit 
and debt for a given  year, although is not binding 
in more specific details.

together  with 

Local  governments  are  also  subject  to  a  series  of 
fiscal rules. The general rule can be considered as 
a  type  of  golden  rule:  it  states  that  current 
expenditures  planned  for  a  given  budget  year 
cannot be higher than the sum of current revenues, 
budget  surplus  from 
the  previous  year  and 
unassigned  resources.  An  additional  rule  applying 
to debt and interest paid on it is expected to change 
soon.  The  current  rule,  in  force  until  end  2013, 
requires  that  the  overall  debt  level  of  each  entity 
do  not  exceed  60%  of  its  revenues  at  the  end of 
each year and each quarter (although bonds issued 
and  loans  incurred  in  order  to  co-finance  the  EU-
financed  projects  are  not  accounted  for).  At  the 
same  time, the  interest  paid  on  the  debt  cannot 
exceed  15% (285) of  the  planned  revenues. From 
2014, a new, more flexible rule established by the 
Public  Finance  Law  of  27  August  2009 (286),  will 
individual 
enter 
coefficient  of  debt,  which  defines  the  specific 
maximum  expenditure  on  debt  service  for  each 

into  force.  It 

introduces  an 

(285) If the state budget debt exceeds 55% of GDP, the limit will 

be lowered automatically to 12%.

(286) A  4-year  vacatio legis has  been  decided  in  order  to  allow 
the local governments to adopt their budgetary policy to the 
new rules.

Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

Part IV

local government entity. It is calculated as a three-
year  average  ratio  of  the  sum  of  current  surplus 
(current  revenues  minus  current  expenditure)  and 
sales  to  total  revenues.  The  new  rule,  contrary  to 
the  existing  one,  will  allow  the  entities  to  devise 
their  individual  fiscal  strategy  in  a  more  flexible 
manner,  depending  on 
to  raise 
additional  debt  in  order  to  finance  sustainable 
investment projects.

their  ability 

The 
Council 
recommendations 
to  Poland with  respect 
subnational governments (see Box I.3.2 above).

country-specific 
to 

issued 

A1.21. PORTUGAL

1. General description

Portugal  is  a  relatively  centralized  country,  but 
subnational governments enjoy a very large degree 
of  autonomy  including  at  the  financial  level. 
are 
Subnational 
in  Portugal 
governments 
composed  of  308  municipalities  and 
two 
autonomous  regions,  each  subnational  structure 
being  governed  by  a  separate  law.  (287)  Portugal 
has  no  formal  regional  level,  except  for  two 
autonomous  regions  that  cover  the  islands  of 
Azores  and  Madeira.  The  two  regions  enjoy 
broader  autonomy  than  municipalities.  They  have 
their own regional legislative assembly, their own 
regional  government  presidents  (Presidente  do 
regional 
Governo  Regional)  and 
secretaries 
two 
regions  also  include  municipalities  and  parishes 
governed  by  regional  regulations  and  inspection 
bodies.

(Secretários  Regionais).  The 

their  own 

Municipalities  are  politically  and  administratively 
independent from central government. They have a 
municipal  assembly,  a  mayor  (presidente  da 
Câmara  municipal)  and  an  executive  council 
(Câmara  municipal)  elected  for  a  four-year  term. 
Municipalities  are 
into  parishes 
(freguesias),  which  also  have  an  independent 
status, being in charge of some local administrative 
tasks  (there  are  currently,  4,259  parishes).  The 
majority  of  municipalities  are  small  in  size  (less 
than 50,000 inhabitants).

subdivided 

(287) Local  Finance  Law  2/2007  of  15  January,  and  subsequent 
amendments and  Regional  Finance  Law,  Organic  Law 
1/2007 as amended by Organic Laws 1/2010 and 2/2010.

There  has  been  growing  devolution  of  tasks  to 
subnational government  levels. According  to  the 
Constitution, 
the  allocation  of  responsibilities 
among  levels  of  government  is  based  on  the 
subsidiarity  principle.  The  subsidiarity  principle 
also applies to Azores and Madeira, but their own 
regulations  prevail  over  national  ones.  The 
devolution  of  tasks  at  local  level  is  revised 
annually  through  a  Protocol  signed  between  the 
central  government  and 
the  Association  of 
Municipalities.  The  Association  of  Municipalities 
and  the  Association  of  Parishes  take  part  in  the 
formal  consultation  procedures  established  by  the 
constitution or by law. They are also consulted by 
the government on an ad hoc basis, in some cases 
informally 
consultation 
the 
procedures,  and  are  informed  on  developments  of 
central  government policy  such as the preparation 
of  the  state  budget  and  the  Stability  and  Growth 
Program.

formal 

before 

2. Government spending 

in 

current 

government 

Spending at subnational government level has been 
increasing  steadily  over  the  last  decade,  with 
budget  deficits  widening  over  the  last  five  years. 
The  increase  in  spending  is  mostly  due  to  an 
expenditure,  mainly 
increase 
intermediate 
compensation  of  employees  and 
consumption,  which  has  markedly  contributed  to 
general 
expenditure. 
Expenditure  competences  do  not  seem  to  be 
defined clearly and are revised on an annual basis 
through the signature of annual protocols between 
the 
governments. 
Subnational  governments  are  responsible  for  a 
significant part of general government investment, 
which however has fallen sharply in the last years.
A  review  of  the  adequate  levels  of  investment  at 
local 
eliminate 
inefficiencies and redundancies.

is  needed 

subnational 

to  help 

current 

central 

level 

and 

structure  of 

The 
subnational  governments' 
expenditure  in  Portugal  is  similar  to  other  EU 
countries,  with  a  high  percentage  of 
total 
expenditures  on  general  public  services.  Data 
indicates  important  responsibilities  in  providing 
housing  and  community  amenities,  environmental 
protection, and recreation, culture and religion and 
general  public services,  while  responsibilities  in 
health,  education  and  social  protection  are  shared 
with  central  government.  An  increase  in  the 
education  services  attribution  can  be  observed 

279

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Public finances in EMU - 2012

since  2006.  Municipalities  play  an  important  role 
in  supervising  and 
in 
licensing,  as  well  as 
enforcing  national  regulations,
in  areas  such  as 
water  supply,  drainage  network,  urban  waste
disposal,  parks  and  gardens,  street  repairs,  social 
and  cultural  facilities,  primary  schools  and  the 
municipal road network. The shared competencies 
central 
governments
between 
government  are  being  revised  annually  through  a 
Protocol,  and  are  not  considered  and/or  reviewed 
in a multi-annual framework.

local

and 

central government revenues (currently set at 25.3 
per  cent)  from  personal  and  corporate  income  tax 
and value added tax as accrued in the  year before 
the  last  in  which  the  state  budget  authorising  the 
transfers  refers;  and  iv)  an  earmarked  grant  to 
finance  tasks  and  responsibilities  transferred  from 
the  central  government.  The  revenue-sharing 
local 
between 
governments  is  carried  out  according  to  detailed 
formulas set out in the Local Finance Law, through 
the following funds: 

government 

central 

and 

3. Financial arrangements 

About  40  per  cent  of  regional  governments' 
revenues  and  about  50  per  cent  of 
local 
municipalities'  revenues  derive  from  transfers.
According  to  the  Regional  Finance  Law,  the 
transfers are updated annually according to the rate 
of  change  of  the  current  expenditure (288) of  the 
State  in  the  year  previous  to  the  State  budget 
authorising  the  transfers.  The  allocation  between 
regions  is  determined  by  their  population,  their 
relative periphery distances, the number of islands 
and  a  tax  ratio.  The  regions  also  benefit  from  a 
Cohesion Fund for investment projects. Each year 
funds are transferred from the State budget to this 
Fund  according  to  the  ratio  between  regional  and 
national GDP per capita. 

to 

its  own 

the  central 
Own  revenues  are  collected  by 
government’s 
(Autoridade 
tax  administration 
Tributária)  for  all  local  and  regional  entities 
besides  Madeira,  which  has 
tax 
administration.  The  information  on  taxes  paid  is 
sent  monthly 
tax 
them  by 
administration as requested by law. Municipalities 
in  the  regions  benefit  from  the  same  revenue  and 
transfers  system  as  all  other  municipalities  on  the 
mainland.  Own  revenues  represent  about  30  per 
cent  of  local  governments'  revenues  and  56  per 
cent  of  regions'  revenues. In  addition,  regions 
retain all taxes levied on their territory.

the  central 

Municipalities' own revenues include according to 
the  Local  Finance  Law:  i)  a  5  per  cent  share  in 
state personal income tax collected from residents; 
ii)  own  taxes  (property  taxes,  surcharges on  state 
corporate  income  tax,  tax  on  vehicles,  fees  and 
fines),  iii)  a  block  grant  defined  as  a  share  of 

(288) It excludes the transfer for social security and contribution 

to the civil servant pension system.

280

•

to 

its 

attributes 

the  Financial  Balance  Fund  (FEF),  composed 
of:  i)  the  General  Municipal  Fund  (FGM), 
adjusts  the  resources  of  each  administrative 
level 
and 
respective 
competences;  and  ii)  the  Municipal  Cohesion 
Fund  (FCM),  designed  to  correct  asymmetries 
among local authorities resulting from different 
capacities 
to  collect  revenue  or  different 
expenditure needs. The two sub-funds are equal 
in size and are financed through the block grant 
of 23.5 per cent.

• The  Municipal  Social  Fund 

(FSM),  an 
earmarked  grant  to  finance  responsibilities 
transferred  from  the  central  government  in 
education,  health  and  social  services.  If  the 
the  allocated
municipality  does  exhaust 
amount,  the  savings  are  deducted  from  the 
amount to be received the following year.

• The  Parishes  Financing  Fund  (FFF),  financed 
through  a  share  of  2.5  per  cent  of  central 
government  average  tax  revenues  obtained 
from  personal  and  corporate  income  tax  and 
value added tax.

Municipalities can legally exercise tax powers only 
to  the  extent  defined  in  the  Local  Finance  Law. 
They  can  adjust  the  tax  rate  or  base  for  the  taxes 
under their powers according to the law. Although 
the  overall  amount  of  transfers  from  State's  tax 
revenues is determined in the Local Finance Law, 
the  central  government  can  modify  the  attribution 
by a discretionary decision.  Moreover, the overall 
growth in transfers is capped at 5 per cent.

There  is  no  budget  calendar  for  subnational 
governments.  They  finalise  their  draft  budgets 
following  the  submission  of  the  State  budget  to 
the 
Parliament.  The  State  budget  conveys 

Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

Part IV

there 

is  very 

information  on  transfers  as  well  as  on  central 
government’s tax revenue, which serves as a basis 
for projecting local and regional taxes. Before the 
little 
State  budget  submission 
exchange  of  information  between  the  central 
government  and 
levels. As  a 
subnational 
consequence,  regional  and  local  governments’ 
their 
budgets  have  consistently  overestimated 
projected  revenue. During  the  last  five  years, 
average collected revenues were equivalent to only 
65  per  cent  of  the  amounts  projected  by  local 
governments.  Revenue  overestimation together 
with  a  weak  public  financial  management  is  the 
main cause for the weak budgetary execution.

4. Fiscal rules 

imposes  debt 

Portugal 
rules  and  borrowing 
constraints to subnational governments. The Local 
and  Regional  Finance  Laws  define:  (i)  net  debt 
local 
ceilings,  and  borrowing  constraints  for 
governments,  (ii)  and  a  debt  service  rule  for 
regions. In addition, the 2012 budget law prohibits 
any  increase  in  the  net  debt  of  regions  and 
municipalities  in  2012.  This  target  temporarily 
supersedes other borrowing constraints.

Net  indebtedness  of  municipalities  cannot  exceed 
125 per cent of the sum of own taxes, shared tax, 
intergovernmental  transfers  and  dividends  from 
municipal  enterprises  recorded  in  the  previous 
year.  (289) Within  the  this  limit: i)  medium- and 
long-term financial liabilities, which are earmarked 
for  investment  purposes,  cannot  exceed  100  p.p.;
and ii) short-term financial liabilities, which are to 
be  used  for  cash  management  purposes  only, 
cannot exceed 10 p.p. If a municipality exceeds the 
limit for net indebtedness, and/or for medium- and 
long-term  financial liabilities, it  must reduce it by 
at  least  10  per cent  per  year  until  it  falls  back 
within  the  limit.  In  addition,  if  a  municipality 
exceeds the limit for net indebtedness, the transfers 
it receives from central government are reduced by 
a  corresponding  amount.  The  money  is then
allocated  to  a  regularisation  fund  (Fundo  de 

financial  assets, 

(289) Net  indebtedness  is  defined  as  the  difference  between  the 
sum of liabilities (financial and non-financial) and the sum 
of 
to 
including 
associations  of  municipalities  and enterprises  owned  by 
local governments. Loans for financing urban rehabilitation 
programs,  those related  to  EU  co-financed  projects  and 
those  for  areas  affected  by  public  disaster  are  excluded 
from the computation of net indebtedness by authorization 
of the Ministry of Finance. 

those  pertaining 

Regularizaçao Municipal) to deal with situations of 
structural financial imbalances of municipalities.

financial 

imbalance  becomes 
A  situation  of
“structural”  if  at  least  three of  the  following 
conditions  occur:  a)  medium- and 
long-term 
financial  liabilities  exceed  the  100  per cent  limit; 
b) net indebtedness is higher  than 175 per cent of 
previous  year  revenues;  c)  arrears  exceed  50  per
cent of revenues of previous year; d) total financial 
liabilities  (including  those  not  included  in  the 
computation  of  the  net  indebtedness  limit)  in 
excess  of  300  per cent  of  last  year  revenues;  e) 
average length of arrears above 6 months; f) failure 
to reduce liabilities by at least 10 per cent per year 
if the limits for net indebtedness and medium- and 
financial  debt  are  exceeded.  The 
long-term 
municipality  is  required  to  prepare  an  adjustment 
plan which, in this case, needs the approval of the 
Ministry  of  Finance.  Approval  of  the  plan  gives 
access to the regularisation fund. The municipality
must report quarterly on the implementation of the 
plan. Failure  to  report  or  to  implement  the  plan 
results  in  the  retention  of  20  per cent  of  transfers 
from the central government. ( 290)

limits  for 

framework 

institutional 

that 
local  governments 

sets  out 
The 
indebtedness 
in 
relation  to  past  revenues  weakens  the  budgetary 
constraints  in  a  pro-cyclical  pattern.  Growing 
revenues  in  good  times  raise  the  nominal  amount 
of  permitted  borrowing  under  the  debt  ceiling, 
while  servicing  the  liabilities  incurred  becomes 
more  difficult  during  downturns  when  revenue 
transfers are declining. As a consequence, regional 
and  local  governments  have  built  up  significant 
amounts  of  debt  over  the  last  decade. Financial 
debt reached 5½ per cent of GDP at end-2010 (291), 
while  debt  to  suppliers  above  90  days  stood  at 
EUR  2.7  billion  (about  1.6  per  cent  of  GDP)  at 
end-2011 according to the survey on arrears.

imbalance”  and 

(290) On a voluntary basis, a municipality may declare to be in a 
situation  of  “temporary 
trigger  a 
rebalancing procedure  which  foresees  the preparation  of  a 
debt  restructuring  plan  and  of  measures 
to  reduce 
expenditure  and  increase  revenues.  Any  of  the  following 
triggering  criteria  can  be  used:  a)  breaching  the  net 
indebtedness  limit;  b)  arrears  in  excess  of  40 per  cent  of 
previous  year  revenues;  c) 
liabilities 
(including  those  not  considered  to  compute the  net 
indebtedness  limit)  in  excess  of  200 per  cent  of  revenues; 
d) average length of arrears above 6 months.

total  financial 

(291) Municipalities’ debt represented 3½ percent of GDP at the 
end  of  2010,  and  Madeira’s  amounted  to  1.8  percent  of 
GDP. 

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Box IV.A1.2: Subnational governments' institutional reform under the Economic Adjustment 
Programme of Portugal

1/ The Local and Regional Finance Laws will be revised to adapt subnational budgetary frameworks to the 
principles and rules of the revised Budgetary Framework Law, namely (i) the inclusion of all relevant public 
entities in the perimeter of local and regional government; (ii) the multi-annual framework with expenditure, 
budget balance and indebtedness rules; and (iii) the interaction with the Fiscal Council.

2/  Public  financial  management  measures  for  fiscal  reporting  and  monitoring  and  accounting  in  line  with 
central administration will be implemented, and an effective commitment control system will be introduced. 
The number of public employees will be reduced by 2 per cent per year over the duration of the program.

3/ The fiscal rules for subnational governments will be reviewed and early triggers for corrective action will 
be  introduced. At  municipality  level,  fiscal  rules  will  not  be  defined  in  structural  terms as  at  the  national 
level,  other  solutions  to correct  for  possible  pro-cyclical  bias  will  be  determined.  By  contrast,  at  regional 
level,  the  fiscal  rules  at  the  national  level  may  be  replicated  conditional  on  appropriate  development  of 
statistical  methods  for  regional  GDP  figures.  These  have  the  advantage  of  being  simple  and  easy  to 
understand.

4/  A  procedure  for  an  orderly  debt  resolution  for  regional  and  local  governments  will  be  designed  and 
implemented. 

5/ The revenue sharing mechanisms are to be revised and a fully-fledged medium-term fiscal framework in 
line with the central government will be introduced. The revisions also need to be designed in the light of the 
new EU fiscal framework.

IV.A1.2).  Currently,  there  are  50  municipalities 
who  should  fall  under  the  structural  financial 
rebalancing  programme according  to  the  criteria 
set by the law.

the 

and 

is  causing  on 

central  government 

In  addition,  a  financial  assistance  programme
the 
between 
Autonomous Region of Madeira was concluded in 
January  2012  to  limit  the  fiscal  risks  that  the 
the  Portuguese  public 
region 
fiscal 
includes 
arrangement 
finances.  The 
consolidation  measures,  but  also  measure for 
structural  performance  such  as  introducing  an 
effective 
an 
information
integrated 
system, 
and 
reporting  in  line  with  central  administration,  a 
restructuring  plan  for  regional  publicly-owned 
for 
enterprises, 
investment projects and PPPs.

commitment 
financial  management 

fiscal  monitoring 

cost  benefit 

accounting, 

analysis 

system, 

control 

and 

Moreover,  a significant  number  of local  state-
owned  enterprises  and  other  quasi-fiscal  entities 
have  been  created  by  municipalities.  Although, 
municipalities are not allowed by law to guarantee 
debt of these entities, the creation of such entities 
allows  further  accumulation  of  debt  outside  the 
local  governments’  balance  sheet  and  weakens 
their current indebtedness ceilings. New legislation 
enacted  end- 2011  establishes  mandatory  rules  on 
transparency  and  information  on  the  operation  of 
the local business sector and suspends the creation 
of  new  businesses  by  municipalities, 
inter-
municipalities  and  metropolitan  areas,  as  well  as 
the acquisition of shares by them. 

The  government  has  tried  to  address  growing 
financial  imbalances  in  subnational  governments 
through  a  number  of  measures:  i) triggering  of 
corrective  actions  as  stipulated  by  the  Local 
Finance  Law 
by 
municipalities 
rebalancing 
programmes”; ii) ad hoc measures included in the 
annual  budget  law,  such  as  a  limit  of  zero  net 
indebtedness on aggregate local governments; and 
iii) 
the  Economic 
Adjustment Programme  for  Portugal  (See  Box 

several measures  under 

through 
of

“financial 

adoption 

the 

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Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

Part IV

A1.22. ROMANIA

1. General description

Romania 
is  a  unitary  national  state  with  a 
predominant  central  government  and  a  two-tier 
structure  of  local  government (292).  The  territorial 
administrative  framework (293) consists  of  41 
counties  (judete)(294) and  the  capital  city  of 
Bucharest, which are defined by limited autonomy, 
both  in  terms  of  decisional  power,  and  financial 
and fiscal areas. A second-tier local administration 
is made out of localities (localitati). In 2011, there 
were  3,181  such  jurisdictions,  consisting  of  2,861
communes  (comune)(295),  217 towns (orase),  103
cities (municipii). The city of Bucharest has a dual 
status of municipality and county.

During  the  last  two  decades,  Romania  has  made 
important  steps 
in  adjusting its  system  for 
financing the administrative-territorial units, which 
could  be  broadly  divided  into  3  separate  reform 
cycles: (i) covering the period 1991-1994, in which 
important  steps  were  made  with  regard  to  the 
administrative  structure  and  financing  of  public 
local  authorities  (including  the  local  tax  system); 
(ii) concerning the period 1998-2000, which saw a 
further  increase  of  the  revenues  transferred  to  the 
local budgets (from 3.6% to 6.5% of GDP between 
1998-2001);  and  (iii)  covering  the  period  2001 
onwards, with the adoption of the 215/2001 Local 
Public Administration  Act  that set out the general 
conditions  for  self-government,  autonomy  and 
organisation  at  public  level and  the  273/2006 
Local  Public  Finances  Act 
the 
framework and the rules for revenues and spending 
at local level.  These changes  were  mainly driven 
by  the  need  to  increase  the  performance  of  local 
public  administration,  as  well  as  to  assure  a  high 

that  set  out 

(292) This  is  according to  the  Constitution  of  Romania  (articles 
119-120), adopted in 1991, amended in 2003 and 2011, as 
well  as  in  the  Law  on  Public  Administration  (as amended 
in 1996).

(293) Historically,  the  public  administration  in  Romania  was 
subject to multiple reforms (i.e. approximately 30 reforms 
during  the  last  two  centuries).  The  current  structure  is the 
result of this step-by-step approach in institutionalising the 
local and regional administrative structures.

(294) The  counties  are  formally  grouped  into  8  development 
regions, according to the NUTS-2 criteria. The regions are 
not  territorial-administrative  units,  but  rather  created  as  a 
group  of  counties,  aiming  to  facilitate  the  implementation 
of the European regional development policy.

(295) The  communes  together  comprise more  than  13,000 
villages, with populations of up to 5,000 inhabitants each.

195/2006  Framework  Law 

level  of  transparency  and  stability  of  the  inter-
governmental fiscal relationship. Several other acts 
(e.g. 
on 
the 
the  286/2006  Local  Public 
Decentralisation, 
Administration  Act,  and  the  51/2006  Community 
Services  of  Public  Interest  Act)  reinforced  the 
reforming process of local public administration.

In  2010,  total  spending  by  local  government 
amounted to 9.6% of GDP (excluding the interest), 
of  which  over  70%  are  used  to  cover  current 
expenses.  Total  revenue  accounted  for  9.7%  of 
GDP. Central government transfers and grants (296)
represented  almost  7.6%  of  GDP,  around  19%  of 
total  public  expenditure.  Local  authorities  also 
have  the  possibility  of  borrowing  money  within  a 
total  annual  ceiling  approved  by  the  central 
government. 

2. Government spending

the 

central 

the  supporting 

The  responsibilities  of  local  government  mainly 
concern  the  implementation  of  certain  public 
policies,  with  some  autonomy  in  particular  over 
local 
capital  expenditure  for 
infrastructure,  while  their  regulation  is  conducted 
by 
government.  Nevertheless, 
municipalities  exert  some  management  control  on 
(e.g.  water  supply, 
specific  public  utilities 
sewerage,  waste,  district  heating,  and  in  larger 
cities  public  transportation).  The  majority  of  sub-
national  discretionary  spending  is  devoted  to 
infrastructure,  street  maintenance, 
community 
cultural 
and 
operating 
maintenance, and social assistance programs.

programs, 

school 

(i.e.  COFOG  classification), 

In  2010,  total  spending  by  local  governments 
amounted  to  EUR  11.9  billion  or  9.8%  of  GDP. 
Based  on  the  functional  breakdown  of  public 
expenditure 
the 
budgets  of  local  governments  are  dominated  by 
spending  on  education.  Education  accounted  for 
more  than  20% of  local  government  expenditure, 
closely  followed  by  economic  affairs  with  19%. 
However, with regard to the education, their role is 
rather limited, mainly acting as paymasters, as well 
as  for  operating  and  maintaining  school  buildings 
(financed  from  discretionary  revenues). Similarly, 

(296) They fall  into  two  categories:  grants  and  subsidies  for 
current  spending  and  compensation  for 
transfer  of
responsibilities,  and  grants  and  subsidies  for  capital 
expenditure.

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they  act  as  agents  of  centrally-financed  social 
assistance  programs  (e.g.  guaranteed  minimum 
income). 

because  not  all  local  communities  are  financially
sound.

An  analysis  by  type  of  expenditure  shows  that 
current  expenditure  accounted  for  EUR  8,578.6
million and  represented  more  than  71.4%  of  sub-
national  public  expenditure,  while  the  remaining 
part is related to the reimbursement of capital and 
the  payment  of  interest  costs.  In  the  last  years, 
local investment has been on the rise, mainly as a 
result of the greater decentralisation. In particular, 
the ratio of capital expenditure in total expenditure 
for counties stood at 26.5%, due to their increased 
responsibilities 
the  management  of  public 
services,  as  well  as  maintaining  the  road  network 
and public transportation.

in 

3. Financial arrangements

is  divided 

the 
Local  budgets  are  highly  dependent  on 
transfers received from the central budget. A small 
number  of  local  communities  generate  sufficient 
revenues by their own. The source of revenues for 
into  several 
local  administration 
categories: (i) current fiscal revenues (e.g. taxes on 
properties,  land  and  transportation  vehicles);  (ii) 
current  non-fiscal  revenues  (e.g.  transfers  and 
grants from the state budget); (iii) capital revenues 
(e.g.  through  the  privatization  process);  and  (iv) 
revenues  from  special  sources  (e.g.  taxes  and 
unused  expense  allocations  for  year  t,  which  are 
carried forward to year t+1).

the 

largest  single  source  of 

In  2009, 
local 
government  revenue  (i.e.  28%  of  the  total  sub-
national  revenues)  consisted  of  earmarked  grants 
the 
for  decentralized  functions,  followed  by 
personal income tax (i.e. 25%) and local taxes and 
fees 
(14%).  Subventions,  which  consist  of 
earmarked  subsidies  from  sectoral  ministries, 
comprised another 10% of total revenues.

Following an ever increasing budgetary autonomy 
of  local  governments,  the  equalization  plays  an 
important role and implies a greater responsibility 
with  regard 
to  efficiency  and  rationality  of 
utilizing  local  resources.  That  is  why  budgetary 
correcting mechanisms and equalising transfers are 
set in place. Their aim is to correct imbalances that 
occur locally both vertically (e.g. local taxes do not 
cover  the  public  expenditures),  and  horizontally, 

284

4. Fiscal rules

to  finance 

There  are  two fiscal  rules  currently  applying  in 
Romania  (i.e.  budget  balance  rule,  and  debt  rule), 
both having a statutory basis in the  Local Finance 
Public Law. 'The budget balance rule' is applicable 
to  local  governments,  being  in  force  since  1990. 
Loans  used 
investment  and  debt 
refinancing  are  excluded from  the  scope  of  this 
rule.  'Debt  rule'  is  defined  as  a  ceiling  (i.e. 
percentage) of current revenue and is in force since 
1999. Local  government  cannot  contract  or 
guarantee loans if their annual public debt service 
(e.g.  principal  payment,  interest,  commissions) 
including the loan they want to contract, is greater 
than 30% of their own revenue. From this rule, the 
loans  for  co-financing  EU  projects  are  excluded. 
Local  lending  is  subject  to  authorisation  by  a 
central  commission  organised  at  the  level  of  the 
Ministry of Public Finance.

A1.23. SLOVENIA

1. General description

two-tier

for  a  decentralised, 

The  Constitution  of  the  Republic  of  Slovenia 
( 297) 
provides 
structure,  composed  of  central 
government 
governments 
government 
(municipalities).  This  structure  was  shaped  in  the 
second  half  of  the  1990s  when  the  number  of 
municipalities  gradually  increased  from  60  to 
almost 200; it now stands at 211.

local 

and 

for 

can  provide 

independently 

Municipalities  are  responsible  for  local  functions 
they 
their 
inhabitants  (original  functions)  and  for  functions 
transferred  by  the  central  government,  with  their 
consent  and  if  sufficient  financing  is  provided 
(transferred  functions).  More  than  half  of  their 
revenue comes  from the redistribution of personal 
income tax.

(297) The  Constitution  foresees 

the  possible  formation  of 
regions, which is the autonomous local government level to 
administer  local  functions  of  a  broader  importance  than 
those of municipalities as well as other functions as defined 
by  law.  However,  this  provision  has  to  date  not  been 
implemented.

Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

Part IV

total 

general 

consolidated 

According  to  the  OECD  Fiscal  Decentralisation 
database,  the  share  of  municipalities'  expenditure 
in 
government 
expenditure  was  25.5%  in  2010,  corresponding to 
about  10%  of  GDP.  Their  share 
total 
consolidated  general  government  revenue  was 
15.4%  (5.9%  of  GDP).  Municipalities  usually 
record  a  marginal  deficit  position  of  around  0.1% 
of  GDP  (over  the  period  2001-2011,  the  deficit 
was  higher  at  around  ½%  of  GDP  on  average  in 
the years 2008-2010)(298).

in 

There  are  also  two  social  security  funds:  the 
pension  and  disability  insurance  fund  (PDIF)  and 
the health insurance fund (HIF). Any PDIF deficit 
is  covered  by  financing  from  the  central  budget, 
while  the  HIF  has  been  in  deficit  in  recent  years, 
following several years of surpluses.

2. Government spending

to 

According 
the  COFOG  classification  of 
government  expenditure,  municipalities’  main 
functions are: (i) economic affairs, especially road 
transport (24% of their total spending in 2010); (ii) 
education,  especially  pre-primary  and  primary 
education  (20%);  (iii)  general  public  services 
(17%);  and  (iv)  recreation,  culture  and  religion
(16%).  Other  non-negligible  functions  in  terms  of 
spending  are  environmental  protection  (waste  and 
waste water management) and housing.

Policies for pre-primary and primary education are 
designed,  and  standards  formulated,  at  the  central 
level,  whereas  municipalities 
their 
implementation, with some autonomy in particular 
over  capital  expenditure 
the  supporting 
infrastructure.  Municipalities  have  some  more 
autonomy  in  policy  and  decision  making  for  the 
other main functions highlighted above.

ensure 

for 

The  PDIF  administers  various  old-age  and 
disability  pension  schemes.  The  HIF  pays  for  the 
provision  of  medical 
related 
compensations of policyholders.

services  and 

in 

(298) The  municipalities’  revenue  and  expenditure  shares  as 
percentage  of  GDP  do  not  add  up  to  the  deficit  ratios 
total  general 
because 
the  database  consolidated 
government  expenditure 
total 
expenditure  at  general  government  level  plus  the  total 
inter-governmental  property  expenditure  and  consolidated 
total general government revenue is global total revenue at 
general government level plus the total inter-governmental 
property income.

is  defined  as  global 

3. Financial arrangements

to 

funding” 

spend  on 

is  assumed 

responsibilities 

Municipalities’  financial  arrangements  are  based 
on  the  concepts  of  “adequate  spending”  and 
the  principle  of 
and 
“adequate 
proportionality  between 
and 
resources (299). Adequate spending is the amount a 
municipality 
its 
responsibilities. It is based on a formula including 
a lump sum per inhabitant (300) and the number of 
inhabitants  adjusted  for 
the
municipality on some specific parameters (such as 
its  relative  area  surface,  length  of  local  roads  and 
proportion of inhabitants under 15 and over 65). It 
is  financed  through  the  redistribution  of  personal 
income  tax  (PIT)  revenue,  which  is  based  on  the 
concept of adequate funding and represents around 
58%  of  municipalities’  total  revenue,  and,  where 
needed, additional government transfers ( 301).

the  situation  of 

Municipalities’ revenues also consist of other own 
resources and municipal  fees.  Examples  of  the 
former  are  taxes on  vessels,  on  inheritance  and 
gifts and on winnings from conventional games of 
chance  as  well  as  real  estate 
tax; 
municipalities have  no  autonomy  for  setting 
underlying  tax  rates  or  bases.  They  do  have  this 
autonomy  (to  some  extent)  for  municipal  fees, 
environmental 
including 

concessions, 

turnover 

fines, 

(299) Financial  arrangements  are  presented  in  detail  in  the 
Municipalities' Financing Act and the Public Finance Act.

the  adjustment 

(300) Set at €554.50 in 2012 at the state level.
(301) Adequate funding is based on a similar formula as adequate 
spending  but  with 
reflecting  each 
municipality’s  specific  situation  assuming a  lower  weight. 
In year t, the central government redistributes 54% of PIT 
revenue  paid  in  year  t-2  indexed  for  inflation  in  years  t-1 
and  t,  in  three  steps.  First,  70%  of  this  amount  is 
redistributed, based on the proportion of total PIT collected 
in each municipality (and limited to its adequate funding). 
Second,  additional  PIT  revenue,  eventually  increased  by 
part of redistributed PIT revenue from the first step which 
individual 
already  exceeded  adequate 
municipalities, is allocated up to the total adequate funding 
for  all  other  municipalities  (solidarity  compensation). 
Third,  in  case  the  total  available  amount  of  PIT  revenue
exceeds  total  adequate  funding,  the  remainder  is  further 
redistributed  to  proportionally  cover  as  much  as  possible 
the gap with municipalities’ adequate spending (additional 
solidarity  compensation).  If  a  municipality’s  total  PIT 
revenue still falls short of its adequate spending (expected 
to  apply  to  150  municipalities  in  2012),  it  receives  an 
additional equalising transfer from the central government 
(financial  compensation)  to fill  the  gap.  Municipalities 
with  a  higher  proportion  of high-income  earners  end  up 
with redistributed PIT revenue exceeding the amount they 
are  assumed  to  spend  on  their  responsibilities (adequate 
spending).

funding 

for 

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( 302) and  payments  for 

charges
local  public 
services.  Finally,  municipalities  receive  property 
income as well as donations and transfers from the 
EU  and  central  government  for  specific  purposes 
(e.g. investment). 

The PDIF is funded  with  mandatory contributions 
for pension and disability insurance as well as with 
transfers  from  the  central  government  budget,
which  must  fully  cover  any gap  between  PDIF
expenditure and revenue. These transfers are on an 
increasing trend and stood at around 4% of GDP in 
2011. The  PDIF  is  not  permitted  to  accumulate 
debt.

The  HIF  is  funded  with  mandatory  contributions 
for  health  insurance.  It  was  in  surplus  until  2008; 
its  deficits  since  then  have  been  covered  by 
reserves.

4. Fiscal rules

Municipalities  are  only  allowed 
to  borrow
domestically, and for investment purposes, up to a 
certain ceiling. A municipality can also borrow for 
liquidity  purposes  up  to  5%  of  the  last  adopted 
budget.  Debt  assumptions  are  prohibited  and 
municipalities  cannot  issue  bonds  but  they can 
issue  debt  guarantees  for  indirect  budgetary  users
(303) and  local  public  enterprises.  The  Minister  of 
Finance  has  to  authorise  any  borrowing  when  the 
repayment is not foreseen to occur within the same 
budgetary year.

The Municipalities' Financing Act specifies a debt 
rule for municipalities. The annual ceiling for their 
payment  of  loans  principal  and  interest,  financial 
leasing,  trade  credits  and  contingent  liabilities  is 
set  at  8%  of  their  revenue  in  the  previous  year
(excluding  donations,  investment  transfers  from 
the  central  government,  EU  funds  and  revenue 
from business activities). The rule is based on cash 
accounting  and  there  are  no  predefined  escape 
clauses. It  was  introduced  in 1995  and  the  most 
recent revisions have made the rule more coherent 
treatment  of  certain 
by  abolishing 

special 

(302) Environmental  charges  are  earmarked  for  infrastructure 
implementation  of  environmental  measures  and 

and 
standards.

(303) These  are  institutes  and  foundations,  i.e.  legal  entities  for 
the  provision  of  specific  public  services,  such  as  schools, 
libraries, medical centres, sports and cultural centres, etc.... 
There are some 1500 indirect budgetary users in Slovenia.

286

investments  (e.g.  in  education,  housing,  water 
supply).  It  is  monitored  and  enforced  by  the 
Ministry  of  Finance.  Over-indebted  municipalities
are  not  authorised  to  borrow  by  the  Ministry  of 
Finance  and  first  have  to  reduce  their  debts. The 
available  information  does  not  suggest  that  any 
municipality has ever defaulted or been bailed out, 
although there are few municipalities with blocked 
transaction accounts due to over-indebtedness.

The  local  debt  rule  generally  appears  to  have 
ensured  that  municipalities  curb  their  expenditure 
rather  than break  the  debt  ceiling.  Municipalities
are estimated to spend on average around 5.4% of 
their revenue on the annual payment of liabilities,
which suggests  that  they  are  generally  below  the 
8%  threshold  by  a  relatively  wide  margin.  Still, 
local  government  debt  in  ESA95  terms  increased 
from  0.7%  to  1.7%  of  GDP  between  2007 and 
2010  and  the  number  of  municipalities without
debt  has  shrunk.  To  improve  public  finance 
surveillance  at  the  local  level,  the  government 
intends  to  launch  an  online  tool  for  an  up-to-date 
and  comprehensive  calculation  of 
individual 
municipalities'  indebtedness  levels  in  the  near 
future.

5. Other relevant institutional features 

Several  legal  provisions  seek  to  limit  deviations 
from the fiscal targets adopted by the municipality 
council.  During the  budget  execution  phase,  the
mayor  can,  on  a  proposal  from  the  municipal 
department  responsible  for  finance,  impose  a 
temporary  moratorium  (of  up  to  45-days)  on  new 
expenditure  by  (i)  blocking  new  contracts  from 
being signed; (ii) prolonging payment periods; and 
(iii)  ending  the  redistribution  of  budgetary  funds 
is  not 
among  users.  If  such  a moratorium 
sufficient, 
a 
propose 
supplementary  budget  and  can  prolong 
the 
moratorium  until  this  supplementary  budget  is 
approved. These arrangements are similar those for 
the central government budget.

the  mayor must 

A1.24. SLOVAK REPUBLIC

1. Introduction 

Slovak Republic is a unitary state with two tiers of 
sub  national  entities:  8  regions  (VUC)  and  2887 
of 
municipalities 

existence 

(obce). 

The 

Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

Part IV

municipality  and  region  (higher  territorial  unit)  is 
embodied in the Constitution which states that the 
basic  unit  of  territorial  self-administration  is  the 
municipality.  The  territorial  self-administration  is 
then  composed  of  a  municipality  and  a  higher 
subnational 
territorial  unit.  Both 
government  are 
territorially  and 
independent 
administratively  and  they  are  also  independent  of 
each other.

levels  of 

Significant  changes  to  the  system  took  place 
between  2001  and  2003.  In  2001  the  regional 
governments  were  established  as  units  of  self-
administration  and 
transfer  of 
competences  to  regions  and  municipalities  began. 
Between  2002  and  2003  over  90  competencies 
were  transferred  to  regions  and  over  60  to 
In  2004,  administrative 
municipalities. 
districts (okres) were abolished. 

in  2002 

(304)

the 

2. Government spending

Main  responsibilities  of  municipalities  lie  in  the 
fields  of  education,  social  welfare  for  elderly, 
social  housing  (construction  and  maintenance), 
local  utilities,  health  (outpatients  departments, 
hospitals and medical centres of first type), tourism 
and  public  order.  In  terms  of  spending,  over  30% 
of  overall  expenditures  in  2011  were  devoted  to 
education where municipalities are responsible for 
preschool  education 
(kindergartens,  nursery), 
primary  education  and  activities  which  are  not 
directly  related  to  primary  education  such  as  art 
schools, school kitchens and canteens etc.

Main responsibilities of regions are in the fields of 
secondary  education,  social  welfare  and  social 
policy,  regional  roads,  transport,  railways,  health 
(hospitals and medical centres of second type, non-
state  health  care)  and  regional  development. 
Education  is  again  the  most  significant  area  of 
spending with almost 40% of overall expenditures 
devoted to it in 2011.

3. Financial arrangements

Municipalities and regions provide services in two 
different  ways 
through  autonomous  and 
delegated  competences.  These  two  ways  differ  in 
degrees of competences and ways of financing.

-

is  bounded  by 

When  exercising  autonomous  responsibilities  the 
subnational  government 
the 
Constitution  and  laws  but  the  actual  exercise 
powers  are  under  the  discretion  of  a  municipality 
or  a  region.  Subnational  governments  decide 
independently  and  carry  out  all  autonomous 
responsibilities  as  defined  by  law  and  the  state 
only  monitors  whether  subnational  governments 
comply with the law. Autonomous competences of 
subnational  governments  are  funded  from  own 
revenues. 

For example, in case of education, financing of art 
schools,  kindergartens,  language  schools,  clubs, 
children's  educational  centres  for  leisure  activities 
and other facilities within the scope of autonomous 
is 
responsibilities  of  subnational  governments 
secured in this way (i.e. from own revenues).

In  terms  of  delegated  responsibilities,  subnational 
governments  have  a  role  of  executive  bodies  that 
apply state administration under the control of the 
state.  Subnational  authority  is  bound  not  only  by 
the Constitution and law, but also by lower levels 
of  legislation  such  as  government  regulations, 
decrees,  ministerial 
etc.  Although 
subnational  governments  finance  these  services 
from their budget, the funds in fact come from the 
state  budget  and  individual  ministries  in  the  form 
of  transfers.  In  this  case,  the  state  controls 
extensively  the  use  of  the  funds  provided  to 
subnational  governments.  For  example,  current 
in  primary  and 
expenditures  on  education 
secondary schools are funded in this way. 

actions 

Revenues  

of 

both 

levels 

of 
from  shared 

subnational 
Revenues 
governments  come 
taxes,  own 
revenues and grants. Shared taxes include personal 
income  tax  which  is  collected  by  the  state  and 
shared  among  regions  (23.5%),  municipalities 
(70.3%)  and  the  central  government  (6.2%).  The 
sharing  key  is  a  function  of  demographic  criteria. 
From  January  2012  a  new  rule  for  sharing  tax 
income  revenue  entered  into  force  setting  new 
shares  for  government  layers  - regions  (21.9%), 
municipalities (65.4%) and the central government 
(12.7%).

(304) http://www.infostat.sk/vdc/pdf/slavikdoc.pdf

For municipalities,  tax  revenues  account  for  over 
50%  of  overall  revenues.  These  include  own-
source  revenues  such  as  the  real  estate  tax  and 

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Public finances in EMU - 2012

other  taxes  on  goods  and  services  on  which 
municipalities  can  freely  decide  the  rate  (except 
for  a  capping).  However,  the  personal  income  tax 
revenues  is  the  most  important  revenue  source 
accounting  for  almost  70%  of  all  tax  revenues  in 
2010.  This  can  in  a  way  problematic  because 
revenues  from  the  personal  income  tax  are  rather 
cyclical. 

Grants  represented  almost  35%  of  total  revenues 
and they were all earmarked to cover all delegated 
responsibilities or to finance specific projects. 

For  regions,  tax  revenues  represented  about  47% 
of total revenues in 2010 of which over one quarter 
is  own-source  revenue  from  the  vehicle  tax.  The 
rest  comes  again  from  the  personal  income  tax. 
Grants accounted for over 45% of total revenues in 
2010  and  were  again  all  earmarked  to  cover  all 
delegated  responsibilities  (or  to  finance  specific 
projects).

4. Fiscal rules

Fiscal  rules  aimed  at  local  governments  include  a 
debt  rule,  a  budget  balance  rule  and  recently 
certain new measures embodied in the constitution. 

Debt  rule  states  that  subnational  governments  are 
allowed to take out credit/loan/issue bonds only if: 
a) the total sum of the debt of the municipality or 
self-governing  region  does  not  exceed  60  %  of 
final current revenues of the preceding budget year 
and  b)  the  sum  of  the  annual  instalments  of  the 
loans  does  not  exceed  25%  of  final  current 
revenues of the preceding budget year. 

the  overall  budgets  of 

Budget  balance  rule  says  that  the  current  budget 
(one  part  of 
local 
governments) has to be adopted either as balanced 
or  in  surplus.  The  Act  on  budgetary  rules  of 
subnational governments lists possible exceptions, 
for example in cases when a subsidy from the state 
budget  is  envisaged  or  when  EU  financing  is 
budgeted  for  the  fiscal  year  in  question.  Capital 
budget  may  be  set  up  with  a  deficit  if  this  deficit 
can  be  covered 
from  previous  years,  and 
reimbursable sources of financing (loans), or if this 
deficit is covered by the current budget surplus in 
the budget year.

Generally,  it  can  be  said  that  the  budget  balance 
rule  has  been  respected.  If  a  subnational  entity 

288

breaks rules the Ministry of Finance may impose a 
fine  of  up  to  €16  597.  However,  this  kind  of 
punishment  is  not  automatic  and  has  been  used 
certain 
only 
municipalities  did  not  provide  their  financial 
statements.. 

cases  when 

exceptional 

in 

Finally,  Constitutional  law  no  493/2011  article  6 
paragraph  (3)  states  that  if  the  total  debt  of  the 
municipality or higher territorial unit reaches 60% 
of actual current income of previous financial year 
or  more,  municipality  or  higher  regional  units  are 
obliged  to  pay  a  fine  imposed  by  the  Ministry  of 
Finance  amounting 
the  difference 
between  the  total  debt  and  60%  of  actual  current 
income  of 
the  previous  financial  year.  The 
paragraph will be effective from 1.1.2015.

to  5%  of 

regime" 

In  terms  of  bankruptcy,  subnational  governments 
cannot  declare  bankruptcy.  Constitutional  law  no 
493/2011  article  6  paragraph  (1)  states  that  the 
Government  does  not  guarantee  funding  for 
provision  the  solvency  and  is  not  responsible  for 
the solvency of the village or higher territorial unit. 
A  procedure  for  dealing  with  insolvency  of  a 
municipality or higher territorial unit is provided in 
a secondary legislation. In case of serious financial 
difficulties  municipalities  are  obliged  to  introduce 
(1st mode)  which  gives 
"recovery 
municipalities  120  days 
to  demonstrate  an 
improvement  in  their  financial  condition.  If  they 
fail to meet this deadline the Ministry of Finance is 
entitled to decide about the introduction of  forced 
administration  (2nd mode)  in  which  case  the 
Ministry  has the authority to approve all financial 
transactions  and  to  request  adoption  of  revenue 
raising  measures.  The  Ministry  does  not  provide 
additional  funds  to  a  municipality.  Out  of  2900 
municipalities,  12  municipalities 
introduced  a 
recovery  regime in  2011.  Forced  administration 
was used in 6 municipalities since 2005.

A1.25. FINLAND

1. General description

is  unitary 

country  with 

Finland 
two-tier 
government  structure.  Municipalities  are  self-
governing units where the highest decision-making 
authority  is  vested  in  local  councils  elected  by 
residents.  Autonomy  of  the  local  authorities  is 
protected  by  the  constitution.  The  law  on  local 

Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

Part IV

self-governance  (Kuntalaki)  states  that  the  local 
authorities have to perform the functions delegated 
to  them  in  the  laws  and  can  decide  to  take  other 
functions  by  virtue  of  their  autonomy. Local 
authorities  may  not  be  allotted  new  functions  or 
duties,  nor  shall  they  be  deprived  of  functions  or 
rights,  other  than  by  passing  legislation  to  this 
effect.

Municipalities have very important role in Finnish 
public  finances.  They  are  responsible  for  wide 
variety  of  public  services,  they  have  right  to  levy 
taxes on their inhabitants. The budgets of local and 
joint  municipal  authorities  were  approximately  42 
billion  euros  in  2011  or 22%  of  GDP.  Some  430 
000  employees,  or  close  to  20%  of  the  Finnish 
workforce, are working for the municipalities.

The tax ratio, i.e. the ratio of taxes and compulsory 
social  security  contributions  to  gross  domestic 
product was  42.9  per  cent  in  2011 in  Finland. 
Local  governments  collected  19.2 billion  euros  or 
10%  of  the  GDP  in  local  taxes.  In  addition,  the 
local  governments  receive  revenues  from  state 
transfers  and  for  the  provision  of  their  services. 
The  stock  of  loans  of  local  municipalities  is  ca 
12.2 bln euros at the end of 2011. 

The  Ministry  of  the  Finance  is monitoring the 
operations  and  finances  of  local  authorities  in 
general  and  ensures that  municipal  autonomy  is 
taken into account in the preparation of legislation 
concerning local authorities. Central Government's 
Regional 
Agencies 
Administrative 
(Aluehallintovirasto) supervise the activities of the 
municipalities, verifying that these are in line with 
the  laws  in  force.  They  also  investigate  any 
complaints  in  this  regard.  However,  this  does  not 
give rise to three-tier structure. 

At  the  beginning  of  year  2012,  Finland  had  336 
municipalities.  The  municipalities  are  relatively 
small  – there  are  less  than  6000  inhabitants  in 
more  than  half  of  the  municipalities.  Seven  urban 
municipalities have more than 100,000 inhabitants. 
joint 
Municipalities  are  encouraged 
municipal  authorities  to  provide  services  to  their 
inhabitants.  There  are  ca.  180  joint  authorities  in 
Finland.  These  are  set  up  by  two  or  more  local 
tasks  on  a 
to  carry  out  specific 
authorities 
permanent  basis.  The  most 
joint 
authorities  are  hospital  districts,  districts  for  care 
of  the  disabled  and  joint  authorities  for  the 

important 

to  form 

performance  of  functions  related  to  public  health 
and education. Three-quarters of all joint authority 
expenditure  is  incurred  from  organising  health 
services. 

in  given  geographical 

There is also special joint authority called regional 
council  or  “Maakuntaliito”  which  consists  of  the 
region 
municipalities 
corresponding  to  the  NUTS  region.  There  are  19 
regions  in  Finland  and  it  is  obligatory  for  the 
municipalities of the given region to be associated 
with  a  regional  council.  However,  this  must  also 
not be confused with three-tier governance system. 
The  councils  are 
regional 
development,  including  the  EU  structural  funds 
programmes  and  regional  spatial  planning.  These 
their 
represent  and  promote 
economic importance is limited – the total number 
of  staff  of  all  offices  is  about  650  persons,  the 
budgets  about  50  million  euros  or  around  1%  of 
local government sector expenditure.

the  regions  but 

responsible 

for 

The  number  of  municipalities  has  been  declining 
(there were 452 municipalities in the beginning of 
year  2000)  but  is  generally  still  considered  to  be 
too  large  in  Finland,  arising  concerns  that  the 
municipalities  are  not  efficient  in  delivering  the 
services.  Fusions  of  municipalities  have  been 
encouraged  by  the  government.  There  is  an  on-
going debate regarding the reorganization of local 
authorities,  dramatically  lowering  the  number  of 
the  municipalities,  mainly in order to improve the 
cost-effectiveness  of  their  services.  The  reform 
would  also  concern  legislation  governing  the 
activities of the municipalities. 

Municipal finances are based on annual budgeting. 
This  consists  of  the  budget  for  the  next  financial
year  and  budget  framework  for  minimum  three 
years, including the budget year. The law requires 
that  the  budget  must  be  in  balance  over  the  four-
year  period.  Ministry  of  Finance  supervises  the 
compliance regarding the budget balance rule. The 
primary responsibility rests within the municipality 
itself  – committee  appointed  by  the  council 
monitors and reviews the execution of the budget, 
including  the  achievement  of  the  objectives  set  in 
the 
of 
municipalities  are  subject  to  annual  audits  by 
professional  audit  companies.  Auditors  report  to 
the municipal council.

budget.  Activities 

accounts 

and 

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Public finances in EMU - 2012

2. Government spending

in 

the 

Local governments' budgetary expenditure in 2011 
was  40.4  bln  euros  while  the  general  government 
sector  spent  103.5  bln  euros.  Largest  share  of 
expenditure  goes  towards  the  production  of  basic 
services,  the  most  important  of  which  relate  to 
social  welfare  and  health  care,  education  and 
culture,  the  environment  and  local  infrastructure. 
In each area there is an elaborate division of labour 
between  the  central  and  local  government,  clearly 
defined 
legislation.  Generally,  central 
government  agencies  are  responsible  for  making 
the  transfer  payments  to  the  citizens  while  local 
authorities provide the services. Nature and quality 
of  the  services  (for  example,  the  content  of  the 
curricula  at  schools  or  the  required  medical 
services) is mostly pre-defined in legislation. Often 
the 
the 
municipality has to reach but leaves its hands free 
in  choosing  the  means.  Municipal  council  has  to 
decide  on  the  allocation  of  resources  to  achieve 
targets set by the laws. In most cases the council is 
free  to  select  the  level  of  resources  but  can  be 
made responsible when standards are not met. This 
includes  the  possibility  to  levy  fines  on  the 
municipality. 

legislation  defines 

the  objective 

As  an  example  of  the  division  of  labour,  central 
government  agency  KELA  is  responsible  for  the 
payment of pensions, including disability pensions, 
and  compensation  for  the  medication.  Similarly, 
they  pay  compensation  for  income  lost  due  to 
sickness  and  compensate  some  form  of  treatment 
received in the private medical services sector. At 
the same time, the local authorities are responsible 
for  the  organization  of  the  provision  of  medical 
services  in  medical  centres  and  hospitals.  They 
organize  children’s  day-care,  services  for  the 
elderly, including long-term care etc. In principle, 
the  inhabitants  are  expected  to  use  the  services 
offered by their municipality. 

the 

services  depending  on 

Important  challenge  in  this  system  is  that  the 
services are fragmented and citizens have unequal 
the 
to 
access 
municipality  where 
live.  Fragmentation 
they 
increases  costs  per  se,  but  apparent  lack  of 
competition  in  service  provision  has  enabled 
steady  decrease  in  the  productivity  in  delivering 
these services. 

290

49%  of  municipal  expenditure  was  directed 
towards  social  welfare  and  healthcare  services  in 
2011. Education and culture accounted for 22% of 
expenditure,  municipal  investments  11%.  Debt 
servicing  expenditure  was  4%  of 
total 
expenditure. 

the 

In  the  provision  of  education,  the  municipalities 
are  responsible  for  all  levels  of  primary  and 
secondary  schools.  They  are  also  responsible  for 
life-long  learning  activities  and  youth  activities. 
Universities  are  independent  institutions,  with 
the  constitution  and 
in
autonomy  granted 
governance regulated by special legislative acts. 

In  addition,  the  municipalities  are  responsible  for 
spatial  planning  and  supervising  the  construction 
activities.  Municipalities  arrange  the  provision  of 
water, energy and  waste services, take care of  the 
streets  and  environmental  protection.  Often  these 
services are provided by companies owned by the 
municipalities or groups of municipalities. 

3. Financial arrangements

Taking the example of year 2010, the tax revenue 
of the local authorities accounted for 46% of their 
total  revenue.  It  consists  of  municipal  tax  on 
earned income, real estate tax and part of company 
tax. Average municipal tax rate is 18.3%. The tax 
rate of the municipal income tax  can be set to any 
level  decided  by  the council,  but  according  to  the 
law  the  tax  rate  is  flat  and  the  tax  base  is  earned 
income,  capital  income  is  not  taxed  by  the  local 
authorities. 

Land  and  buildings  are  subject  to  real  estate  tax, 
except land used for agriculture or forestry. Tax is 
paid by the owner of the real estate, taxable value 
is  defined  in  the  act  on  the  valuation  of  assets  in 
taxation.  Municipal  councils  can  determine  the 
rates  in  the  limits  set  by  law.  These  limits  are 
rather  low  for  primary  residences  and  higher  for 
real  estate  related 
industry. 
Interesting  aspect  is  punitive  rate  towards  empty 
lots allocated for construction. 

to  business  and 

Corporation  tax  is  tax  collected  from  companies, 
the rate of which is 26% of the taxable income of a 
is  paid 
the  state, 
corporation.  This 
municipalities
the  Finnish 
and  parishes  of 
Evangelical  Lutheran  and  Finnish  Orthodox 
Churches. The share of municipalities is ca 1/5 of 

tax 

to 

Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

Part IV

the tax collected. However, this tax is national tax 
and  municipalities  do  not  have  right  to  decide  on 
the level or base of the tax. 

Operating  revenue  accounted  for  27%  of  the 
revenues, its sources are revenues from companies 
owned by the municipalities in water, energy, and 
waste  and  public  transport  sectors.  Some  revenue 
is also earned by the provision of social and health 
services.  Education  is  always  provided  free  of 
charge. 

local  government 

revenues 
Further  18%  of 
stemmed  from  the  central  government  transfers 
(7.7  billion).  Central  government  finances  certain 
state  functions  delegated  to  the  municipalities. 
These  include  obligations  of  the  municipalities  to 
provide  services 
for 
children,  healthcare,  social  security,  protection  of 
minors, assistance to disabled, prevention of health 
consumer 
hazards, 
protection  and  culture,  including  the  provision  of 
library services. 

in  education,  day-care

environmental 

services, 

The  government  transfers  are  also  aimed  at 
streamlining the economic differences between the 
municipalities in order to achieve uniform level of 
services across the country. Municipalities can also 
apply for  additional  discretionary  governmental 
support  in  case  of  lasting  economic  difficulties. 
However, the discretionary support is used on very 
limited cases and the amounts granted are small. In 
2011, 63 municipalities applied for the exceptional 
support  (for  the  amount  of  €70  mln)  and  it  was 
granted  to  31  in  the  amount  of  €20  mln.  Largest 
amount  granted  was  €1.2  mln  euros.  As  such,  the 
possibility  to  receive  discretionary  support  does 
not  lower  the  fiscal  discipline  of  municipalities. 
Any request for discretionary support must include 
a  programme  to  balance  the  budget.  Special 
conditions could be set by the government and the 
municipality  cannot  count  that  the  support  would 
be  awarded  also  in  the  following  years.  The 
complicated  formulas  for  determining  the  central 
government 
the 
services, 
presumed  costs  of  providing 
population  structure  and  density,  existence  of 
island  conditions,  remoteness  from  larger  centres, 
unemployment  level,  number  of  disabled  and 
elderly  needing  care etc.  If  the  estimated  tax 
income per capita is lower than 91.86% of national 
average,  government  transfer  is  increased. The 
transfers  are  based  on  the  central  government 

into  account 
the 

transfers 

take 

estimations  of  the  cost  of  required  services' 
provision  but  the  funds  are  not  earmarked  to 
specific  activities.  This  means 
is 
incentive  to  be  economical  in  service  provision  –
cost-efficiency  enables  additional  expenditure  in 
other areas whereas the municipality does not have 
possibility  to  receive  additional  transfers  when 
actual  cost  for  some  service  proves  to  be  higher 
than central government calculation foresees.

there 

that 

4. Fiscal rules

Local  governments  are  obliged  by  law  to  keep 
their budgets balanced over a four-year period and 
municipalities  generally  abide  by  the  law. The 
Ministry  of  Finance  monitors  the  ability  of  the 
municipalities  to  meet  their  funding  needs  and 
forecasts  short-term  trends  in  local  government 
finances,  both  in  individual  municipalities  and  at 
regional 
level. The  government  has  specific 
powers  to  enforce  a  review  of  a  municipality’s 
finances and to work toward a recovery plan if the 
local government has fallen below target financial 
ratios.  In  case  the  ratios  are  breached  in  two 
consecutive  years,  a  special  committee  is  formed. 
This  includes  representative  from  the  Ministry  of 
Finance,  representative  from 
the  municipality 
under  question  and  an  independent  chairperson. 
The committee forms a proposal on the  necessary 
measures  to  guarantee  the  continued  delivery  of 
services  to  the  citizens.  Based  on  the  review, 
Ministry  of  Finance  can  decide  to  start  the 
procedures to merge the municipality with another.  
Municipalities  are  not  subject  to  the  bankruptcy 
law.

So  far,  on  the  aggregate  level,  local  government 
deficits and debt have remained modest (local debt 
amounts only to about 6% of GDP). 

The municipal  council  has  very  wide  authority:  it 
sets the tax rates, decides on the general principles 
for  the  charges  to  be  collected  for  services  and 
other  performances,  sets  operational  and  financial 
targets for a municipal enterprise, decides whether 
to provide a guarantee or other security for another 
party’s  debt,  decide  on  the  principles  for  the 
financial 
remunerations  of  elected  officials, 
chooses  the  auditor  and approves  the  financial 
statements. 

When approving the budget, the council must also 
approve  a  financial  plan  for  three  or  more  years. 

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The  financial  plan  must  be  in  balance  or  show  a 
surplus  during  the  planning  period  of  maximum 
four years. 

of  the  Finnish  local  government  and  government-
related sectors make a refusal unlikely. 

Municipalities  are  also  subject  to  strict  reporting 
rules.  Financial  statements  on  each  financial  year 
have  to  be  drawn  up  by  the  end  of  March  of  the 
following  year and  submitted  to  the  auditors  for 
inspection.  The  documents  include  a  report  on 
operations,  providing  an  account  of  how  far  the 
operational and financial targets set by the council 
have been achieved. 

Auditors  (professional  audit  organisations)  verify 
that  the  local  authority  has  been  administered  in 
accordance  with  the  law  and  council  decisions, 
financial  statements  give  correct  and  adequate 
information  on  finances  and  that  the  information 
given  on  the  bases  for  and  use  of  government 
grants is correct. 

5. Other relevant institutional features 

Local  government 
is  dominated  by 
lending 
Municipality  Finance  Corporation  (Kuntarahoitus 
OY).  Owned  by  municipalities and  the  Finnish 
state, Municipality Finance is a credit institution in 
the  service  of  its  members.  The  credit  ratings  for 
Municipality  Finance's  long-term  funding  are  the 
highest  possible:  Aaa  from  Moody's,  and  AAA 
from Standard & Poor's and thus the institution has 
access to low-cost funding.

terms 

Municipality  Finance  offers  financial  services  on 
market 
for  municipalities,  municipal 
federations,  municipally  controlled  organisations 
and  non-profit  housing  organisations.  The 
from  both 
company's 
international 
and  domestic 
investors.

capital  markets 

is  obtained 

funding

all 

Board. 

Almost 

All  the  borrowing  is  guaranteed  by  the  Municipal 
Guarantee 
Finnish 
municipalities  are  members  of  the  MGB  and  are 
consequently liable for its liabilities. If a municipal 
member  failed  to  pay  on  its  obligation,  other 
members  would  be  jointly  liable  for  the  shortfall 
according  to  their  share  of  participation  to  the 
MGB. 

A1.26. SWEDEN

1. General description

responsible 

Sweden  is  a  decentralised  country  with  a  high 
degree of local self-governance. Local government 
has a long tradition in Sweden. The country's 290 
municipalities and 20 county councils and regions 
for  providing  a  significant 
are 
proportion  of  all  public  services.  They  have  a 
considerable  degree  of  autonomy  and  have 
independent  powers  of 
taxation.  Local  self-
government  and  the  right  to  levy  taxes  are 
stipulated in the Instrument of Government, one of 
the four pillars of the Swedish Constitution.

is  no  hierarchical 

relation  between 
There 
municipalities,  county  councils  and  regions,  since 
all have  their own  self-governing local authorities 
with responsibility for different activities. The only 
exception  is  Gotland,  an  island  in  the  Baltic  Sea, 
where the municipality also has the responsibilities 
and  tasks  normally  associated  with  a  county 
council. A  region  is  a  county  council  with 
extended responsibilities.

About half of all public revenues and expenditures 
relate  to  subnational  governments,  corresponding 
to  about  24%  of  GDP.  Tax  revenues,  most  of 
which consist of taxes on earned income, make up 
about two thirds of overall revenues,  with  general 
state transfers providing another 15% and targeted 
state  transfers,  user  fees,  rents  and  other  revenues 
making up the rest.

2. Government spending

The  municipalities  are  legally  or  contractually 
responsible  for  providing  the  following  services: 
social  services,  childcare  and  preschools,  elderly 
care,  support  for  the  physically  and  intellectually 
disabled,  primary  and  secondary  education (305), 
planning 
and 
environmental  protection,  refuse  collection  and 
waste  management,  emergency  services  and 
emergency  preparedness  and  water  and  sewerage. 

issues,  health 

and  building 

Municipality  Finance  has  not  suffered  any  loan 
defaults. It is not obliged to extend a loan and may 
decline  a  loan  application,  although  the  strengths 

(305) All  compulsory  education 

is 

the 

responsibility  of 

municipalities.

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Other activities are provided on a voluntary basis, 
such  as  leisure  activities,  cultural  activities  (apart 
from 
statutory 
responsibility),  housing,  energy  as  well  as 
industrial and commercial services. 

libraries,  which 

are 

a 

The county councils are legally obliged to provide 
health  care  (managing and financing  hospitals), 
dental  care  for  people  up  to  the  age  of  20  and 
public transport (in some cases, public transport is 
managed 
in  cooperation  with  municipalities).
Other activities are provided on a voluntary basis, 
such  as  cultural  activities,  education,  tourism 
services and regional development.

Generally,  subnational  governments  enjoy  a 
relatively high degree of freedom to organise their 
activities,  which  can  be  adapted 
local 
circumstances.  The  Local  Government  Act 
governs 
responsibilities,  obligations  and 
mandate  of  local  governments.  There  are  some 
restrictions  on  what  local  government  can  do, 
notably  in  the  commercial  sector  in  cases  where 
they enter into competition with private firms ( 306).

the 

to 

The  distribution  of  municipalities'  expenditures  is 
as  follows:  kindergartens  and  after-school  care 
14%, education 28%, elderly care 19%, support for 
handicapped  people  11%,  economic  support  3%, 
other  individual  and  family  support  4%,  business 
activities  5%,  and  others  16%.  For  the  counties, 
the  largest  items  are  various  forms  of  health  care 
support  for  medicine  expenditure  8%,
79%,
transport  and  infrastructure  6%, dental  care  4% 
and regional development 2%.

3. Financial arrangements

income.  Municipalities, 

Municipalities,  county  councils  and  regions  are 
entitled  to  levy  taxes  in  order  to  finance  their 
activities.  Taxes  are  levied  as  a  percentage  of  the 
county 
inhabitants' 
councils and regions decide on their own tax rates. 
The  average,  overall  local  tax  rate  is  30  per  cent. 
Approximately  20  per  cent  goes 
the 
municipalities  and  10  per  cent  to  the  county 
councils and regions. Tax revenues are the largest 
source  of  income  for  Sweden's  municipalities, 

to 

(306) The  Competition  Act  was  modified  in  this  sense  in  2010 
giving  the  Competition  Authority  to  take  action  against 
local, regional and central  government that are deemed to 
harm competition.

county  councils  and  regions  and  account  for 
approximately  two-thirds  of  their  total  income. 
Technically,  it  is  collected  by  the  state,  but  the 
the  various 
revenues 
subnational  levels  according  to  their  tax  base  and 
applicable tax rates. 

redistributed 

are 

to 

Grants  from  the  State  are  either  general  or 
targeted.  General  state  grants  represent  15%  and 
total  revenues  for  municipalities  and 
9%  of 
counties, 
respectively.  These  are  paid  per 
inhabitant.  Each  municipality,  county  council  or 
region  can  use  this  money  on  the  basis  of  local 
conditions (307). Targeted grants, which make up 3-
4%  of  total  revenues,  must  be  used  to  finance 
specific  activities (308),  sometimes  over  a  specific 
period of time.

There  are  major  variations  in  the  average  income 
of  the  inhabitants  of  Sweden's  municipalities, 
county  councils  and  regions.  The  cost  per 
inhabitant, for providing the services to which they 
are entitled, also varies. In order to ensure fairness, 
a  system  has  been  introduced  with the  aim  of 
all 
providing 
municipalities, county councils and regions. This is 
the  local  government  equalisation  system,  which 
entails 
the 
municipalities, county councils and regions on the 
basis  of  their  tax  base  and  level  of  expenditure
(309).  The  equalisation  system  is  managed  by  the 
State.

revenues  of 

redistributing 

conditions 

equitable 

the 

in 

Municipalities,  county  councils  and  regions  may 
charge  users  for  their  services.  A  non-profit 
principle applies,  however,  which  means that fees 
may  not  be  higher  than  the  costs  relating  to  the 
service concerned. Fees account for about 6% and 
3%  of  revenues  for  municipalities  and  counties, 
respectively. If the municipalities, county councils 
and  regions  are  obliged  to  provide  a  service,  they 
may  only  charge  for  the  service  if  specifically 
permitted to do so by law.

(307) General grants come with no strings attached, but as local 
gov't  spending  to  a  large  degree  is  made  up  of  the  wage 
bill, increasing central government grants to local gov't is a 
rather efficient way of counteracting cyclical downturns, as 
it  may  prevent  local  gov't  from  reducing  staff  in  cyclical 
downturns  (which  they  otherwise  may  deem  necessary  to 
comply with the local gov't balanced budget requirement).
(308) Specific grants can be given for any  purpose and depends 
on the priorities of the central gov't at any given moment in 
time.

(309) Measured by structural factors, such as age structure etc.

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4. Fiscal rules

Municipalities  and  counties  are  subject  to  a 
balanced-budget  requirement,  meaning  that  they 
cannot  plan  a  budget  with  a  deficit.  The  law 
requires them to conduct their financial planning in 
a prudent way, which has come to mean in practice 
that they should aim for a surplus of about 2% of 
total revenues from taxes and general state grants. 
Since 2005, the average  has  been 3%. If, ex post, 
there  is  a  deficit,  it  has  to  be  compensated  within 
three years, unless special circumstances apply, for 
which  exceptions  can  be  granted (310).  The 
experience  so  far 
that  municipalities  and 
counties  take  this  requirement  seriously  and  the 
rule  has  thus  contributed  to  the  overall  positive 
performance of Swedish public finances. There are 
no  formal  sanctions  for  breaches  of  the  rules,  but 
the system has so far  worked on the basis of self-
discipline, relying on voters to punish bad financial 
management. 

is 

A1.27. UNITED KINGDOM

1. General description

The  United  Kingdom  is  constitutionally  a  unitary 
state:  ultimate  sovereignty  resides  with  the  UK 
Parliament,  and  it  is  up  to  Parliament  to  decide 
what  powers  and  responsibilities  (if  any) 
it 
devolves to local or regional bodies, and how such 
bodies  are  organised  and  financed.  This  contrasts 
with  federations  such  as  Germany  and  the  United 
States  of  America,  where 
the  autonomy  of 
subnational  authorities  (Länder in  Germany  or 
states  of  the  USA)  and  the  division  of  powers 
between  federal  and  subnational  governments  are 
constitutionally  entrenched. Historically,  the  UK 
has been relatively centralised even compared with 
other unitary states.

Devolved country governments

designed  differently  for  each  of  Scotland,  Wales 
and Northern Ireland

There are three devolved national administrations. 
Each  was  set  up  in  1997  or  later  and  they  have
varying  power and  are situated  in  Belfast,  Cardiff 
and  Edinburgh;  the  capitals  of  Northern  Ireland, 
Wales  and  Scotland  respectively. The 3  nations 
have  their  own  institutions,  legislative  (Wales  –
only  secondary  ones)  and  administrative  powers, 
i.e.  they  can  modify  all  laws  in  their  sphere. 
Scotland  and  Northern  Ireland  particularise  the 
central powers, while Wales specifies the assigned 
ones. 

Unlike  the  other  countries  of  the  UK  England 
(which has over 80% of the UK population) has no 
devolved assembly or government of its own but is 
represented  solely  by  the  UK  parliament  and 
government.  English 
(9)  have  only 
administrative  competences  (and  the  Regional 
Development 
(RDAs)  have  been 
abolished). 

agencies 

regions 

Local government

Systems of subnational authorities differ across the 
UK:

•

•

•

In England there are 34 shire counties (divided 
into 238 districts), 47 shire unitary authorities, 
33  London  boroughs  (overseen  by  the  Greater 
London Authority - GLA) and 36 metropolitan 
(311).  England 
(urban)  unitary  authorities
therefore  has  a 
territorial 
governments,  354  at  local  level  and  35  at 
intermediate  level  (county  councils  and  the 
GLA)

total  of  389 

in Wales – 22 unitary authorities

in Scotland – 32 unitary authorities, 

The United  Kingdom consists  of  four  countries: 
England,  Northern  Ireland,  Scotland  and  Wales. 
The  territorial organisation  of  the  UK  is  highly 
complex  and  differs  widely  across 
the  four 
least  because  devolution  was 
countries,  not 

(310) Exceptions could be related to unrealized capital losses on 
financial  assets  (to  avoid  the  ups  and  downs  of  the  stock 
market  to  lead  to  yearly  fluctuations  in  the  operations  of 
local gov't) or other (unspecified) special circumstances.

(311) See Dexia  (2008).  Only  the  shire  counties  and  GLA  are 
'intermediate' – all the other entities are 'local'. The London 
boroughs,  other  urban  metropolitan  authorities  and  shire 
unitary  authorities  are  all  basically  at  the  same  level  and 
similar size (usually around 100,000 – 300,000 inhabitants) 
with similar powers except that in London some powers are 
with  the  higher  level  GLA.  The  shire  districts  are  often  a 
bit  smaller  and  more  'local'.  A lot  of UK  'local' 
governments have much larger populations than the lowest 
tier  of  government  would  have  in  most  other  countries  (a 
few  of  the  biggest  unitary  authorities  have  over  500,000 
people).

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• Northern Ireland has 26 district councils. 

protection,  culture  and  recreation,  fire  and  police 
services, refuse disposal. 

All  local  authorities  of  all  types  have  only 
administrative  competences. There  are  also  some 
smaller-scale community, parish and town councils 
which deliver some services for local authorities at 
a very local level ( 312).

2. Government spending

The  UK  government  remains  responsible  for 
national  policy  on  all  matters  that  have  not  been 
devolved, including foreign affairs, defence, social 
security, macro-economic management and trade. 

It  is  also  responsible  for  government  policy  in
England on all the matters that have been devolved 
to  Scotland,  Wales  or  Northern  Ireland.  The  UK 
Parliament  is  still  able  to  pass  legislation  for  any 
part  of  the  UK,  though  in  practice  it  only  deals 
with  devolved  matters  with  the  agreement  of  the 
devolved governments.

Local  government  spending  is  about  a  quarter  of 
all public spending in the UK. Local authorities are 
funded  by  a  combination  of  grants  from  central 
government,  Council  Tax  and  business  rates.  In 
Northern Ireland, district councils still raise money 
through a domestic rate and a business rate.

economic 
forestry 

planning, 
agriculture, 

The  main  responsibilities  of  Scottish,  Wales  and 
Northern  Ireland  central  authorities  are  local  and 
development, 
regional 
transport, 
fishery, 
and 
environment,  housing,  health,  education (313), 
culture and leisure. Scotland and Northern Ireland 
has  additional  competences  of  local  government 
organisation, civil law (only  Scotland), and police 
and public order. Scotland’s unitary authorities and 
Northern  Ireland’s  councils  are  assigned  areas  of 
local planning, registration, primary and secondary 
transport,  highways, 
education, 
personal  social  services (314),  housing,  consumer 

traffic,  public 

(312) For 

more 

details, 

see 

http://www.hm-

treasury.gov.uk/d/pesa_2011_chapter7.pdf.

in running  services.  On  education,

(313) The  Scottish  and  Welsh  governments  do  have  some
autonomy 
local 
authorities  have  traditionally  run  schools  (not  higher 
education)  although  there  is  now  a  mix  with  'academies' 
and 'free schools' which are funded centrally and not under 
local  authority  control,  while  other  schools  remain  under 
local authority control.

(314) 'personal social services' is usually referred to in the UK as 
meaning social care for the elderly and disabled (washing, 

transport, 

The capital city London has a special statute, with 
the Greater  London  Authority (GLA)  holding 
some  powers  allocated  to  local  authorities  and 
counties  elsewhere  (the  GLA  covers  the  33  local 
authorities  that  are  part  of  London).  The  GLA  is 
for  strategic  planning,  economic 
responsible 
development, 
environment,  public 
health,  fire  services,  police,  and  culture.  Counties 
have  powers  in  areas  of  local  planning,  transport, 
primary  and  secondary  education,  culture  and 
leisure,  personal 
consumer 
protection, refuse disposal, fire services and police. 
Districts  have  competences  of  local  planning 
registration,  housing, 
(shared  with  county), 
environment, culture and recreation (315).

services, 

social 

However, even  in  many  of  the  policy  areas 
administered by local government, implementation 
is still largely on the basis of national policy rules 
and  guidelines.  This  limits  the  ability  of  local 
government  to  vary  the  way  in  which  it  operates 
policy  much  from  a  nationally  set  template  (for 
example education, planning)(316).

cleaning,  providing  meals,  etc.)  and  services to  provide 
support  to  other  vulnerable  people  (e.g.  social  workers 
whose job it is to work with problem families and protect 
children).

(315) Some  local  authorities  are  trying  to  move  to  having  more 
shared services where a number of local authorities provide 
a single service.

(316) The  current  UK  government  has  a policy  of  'localism'  see 
http://www.communities.gov.uk/localgovernment/decentral
isation/)  whereby  local  bodies  are  meant  to  be  given 
increasing autonomy. 

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Table IV.A1.2: Local government in England - Functions and powers

Arrangement

Shire counties

Unitary authorities

Metropolitan counties

Greater London

education,

Lower tier authority
housing, waste collection, council
collection,
cemeteries and crematoria

Upper tier authority
waste management,
libraries,
social services, transport, strategic planning,
consumer protection, police, fire
housing, waste management, waste collection, council tax collection, education, 
libraries, social services, transport, planning, consumer protection, licensing, cemeteries 
and crematoria †, police and fire come under Shire councils
housing, waste collection, council tax collection, education, libraries, social services,
fire, cemeteries and
transport, planning, consumer protection,
crematoria †

tax
licensing,

licensing, police,

planning,

local

transport,
development, police, fire

strategic

planning,

regional

housing, waste collection, council
education,
collection,
services,
local
protection,
crematoria †

tax
social
consumer
and

cemeteries

licensing,

planning,

libraries,

+ = in practice, some functions take place at a strategic level through joint boards and arrangements.
Source: Commission services.

3. Financial arrangements

Tax

All  taxes  are  set  and  collected  by  the  British
government,  aside from Council  tax  (for  local
government),  and  in  Scotland  the  power  to vary 
income tax by 3% (so far unused). 

the  preserve  of 

Tax  (and  social  security)  policy  remains  almost
entirely 
the  UK  central
government, meaning that, crucially, devolved and
local  authorities have  little  control  over  their
overall  budgets.  By  international  standards,  UK
government finances  are highly  centralised.  The 
UK  has  95%  of  tax  revenue  going  to  central
government.

About  85%  of  taxation  revenue  is  collected  by
national  government. Local  authorities  impose  a
council  tax  on  property. Scotland,  Wales  and 
Northern  Ireland  set  rates for  business  property
taxes,  in  England  they  are  set  by  the  central
authorities.  The  revenue  is  allocated  to  local
authorities  on  a  per  capita  basis. Scotland has
control  over  local  government  taxation  and  can 
vary  the  rate  of  income  tax,  but  it  has  no
borrowing powers. The revenue is mainly in form 
of  transfers.  Wales  and  Northern  Ireland  have no
taxation  autonomy  and  receive  block  grants.  The
Greater  London  gets  a  share  of  council  taxes  in
addition to intergovernmental grants.

A  large  proportion  of  local  authority  spending  is
financed 
grants.
However, they are also entitled to levy one tax, i.e.

government 

central

from 

296

the Council  Tax.  This  is  a  domestic  property  tax
the  rate  of which subnational  governments  can
change  to  raise  revenue  to  finance  spending, 
whereas  they  cannot  change the  tax  base ( 317).  It
provides  about  a  quarter  of local  funding. Local
authorities set the total Council Tax based on their
overall  budget for  the  year.  Each  household  pays
an amount depending on the value of their home.

to  ensure 

The  government  has  powers 
that
increases  in  local  authority  budgets  and Council
Tax  are  not  excessive. The  current  Government
has decided in April  2012  that  any  council that
budgets for  an  increase  in  council  tax  of  3.5%  or
more will be capped unless they have their budget
local  referendum ( 318).  Central 
passed  by  a 
government  has  also  offered  additional  grant  to
councils who  budget for  increases  of  less  than
2.5%.

Business rates are a property tax on businesses and
other  non-domestic  properties.  Their  formal  name
is  national  non-domestic  rates.  The  national  rates
are  set  by  central  government.  The  revenue  is
collected  by  local  authorities,  pooled  by  central
government,  and 
local 
authorities (319).  As such  local  authorities  don’t

redistributed 

then 

to 

(317) An  adjustment  is  made  so  that  local  authorities  with  low
value property and so low council tax revenues get a more
generous block grant from central government

(318) Some  councils  have  predictably  responded  by  budgeting

for an increase of 3.49%.

(319) Redistribution is broadly on a per capita basis but there are
some adjustments based on the cost of providing services –
for  instance  Westminster  in  central London  gets  extra
money for  the  cost  of  providing  services  to  the  unusually
large number of people that pass through the borough and
travel around its streets. 

Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

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benefit  directly  from  increased  business  activity 
but  they  are  often  responsible  for  providing 
infrastructure  for  new  commercial  development. 
To  remedy  the  disincentive  to  development  this 
creates  (especially  given  up-front  costs  that  may 
not be compensated at the time), the government is 
introducing a system whereby local authorities will 
be  allowed  to  retain  additional  revenue  from  new 
commercial developments for a number of years.

Local  authorities  may  also  impose  charges for 
services  as  an  additional  revenue  source  and  to 
the cost  of  service  provision  where 
recoup 
appropriate  (for  example  parking  charges  and 
charges 
recreational  and  personal  care 
services).  Due  to  the  ongoing  squeeze  on  their 
budgets  as  a  result  of  fiscal  consolidation,  many 
local  authorities  are  currently  increasing  both  the 
scope of charges and their level.

for 

Overall the key point to note about the UK system 
is  that  although  some  taxes  are  collected  at  local 
level and a lot of spending is administered at local 
level,  subnational  governments  have  very  limited 
scope to borrow or to affect the overall level of tax 
and government spending. Fiscal policy in the UK 
is  therefore  effectively  set  and  controlled  almost 
exclusively  by  national  government  – if  the  UK 
misses  deficit  targets  it  will  not  be  due  to  the 
actions of subnational governments.

Provision of Funds and equalisation

to  enable 

Central  government  (or  the  devolved  government 
in Scotland, Wales and Northern Ireland) provides 
specific  and  general  grants 
local 
authorities to deliver all the necessary services. To 
divide  up  the  funding,  the  government  uses  a 
system  that  takes  into  account  the  number  and 
value of properties in each area, and how  much it 
costs to provide services there. Given this, and that 
locally raised taxation provides only a minority of 
local 
central 
government grants provide the majority, UK local 
government  financing  is  strongly  characterised  by 
equalising transfers.

budgets  while 

government 

Local  authority  spending  is  the  sum  of  central 
government  support  for  local  authorities  within 
Departmental  Expenditure  Limits  (DEL)  and 
Departmental  Annually  Managed  Expenditure 
(AME), plus locally financed expenditure in AME 
(council  tax  and  other  local  revenue).  Central 

government  support  for  local  authorities  consists 
of current and capital grants, and supported capital 
expenditure (permissions to borrow). 

The  largest  grants  are  the  revenue  support  grant
(320) and the redistribution of pooled national non-
domestic  rates  (NNDR).  These  count  within  the 
(CLG) 
Communities  and  Local  Government 
departmental expenditure limit. Other departments 
provide  grants  for  specific  purposes  (for  example 
education) and these also count in the department's 
DEL, as does supported capital expenditure.

includes  grants 

Departmental  annually  managed  expenditure 
(AME) 
local 
authority payments of social benefits - mainly rent 
rebates  and  rent  allowances (321) - and  capital 
grants from the lottery distribution funds. 

that  reimburse

Local  authority  spending  can  also  be  analysed  in 
terms  of  what  the  expenditure  is  for  - such  as 
education  or  social  services.  Or  it  can  be  broken 
down  by  economic  category  such  as  pay, 
procurement,  subsidies,  other  grants  and  capital 
expenditure.  Economic  categories  are  used  by  the 
Office for National Statistics in the compilation of 
national accounts. 

Local Authority own expenditure is defined as the 
contribution of local authorities to Total Managed 
Expenditure  (TME)  as  measured 
in  national 
accounts.  TME  is  a  consolidated  measure  in  the 
sense that transactions between parts of the public 
sector  do  not  add  to TME.  So,  for  example,  total 
local  authority  expenditure  defined  here  excludes 
capital  grants  paid  to  public  corporations  and 
interest paid to central government. 

Devolved country governments

instance, 

The  devolved  bodies  are  largely  unable  to  use 
fiscal policy to influence economic performance or 
to deliver other distributive or redistributive goals. 
For 
in 
Scotland and Northern Ireland have both called for 
the  ability  to  reduce  the  rate  of  corporation  tax 
imposed  in  their  territory  in  order  to  attract  more 
inward  investment.  Both  have  been  rebuffed.  As 

the  current  administrations 

(320) The block  grants  that  central  government  give  to  local 

authorities are funded by a wide range of taxes. 

(321) As  most  social  transfers  are  paid  by  central  government 
agencies. Support  for  rents  paid  by  local  authorities  (but 
ultimately funded by central government) is an exception.

297

European Commission

Public finances in EMU - 2012

noted above the Scottish government does have the 
power to vary income tax by up to 3p in the pound, 
but this has not been used to date.

the UK Government if borrowing within the public 
sector needs to be constrained.

The UK does not have local income taxes.

The  subnational  governments’ 
lack  of  fiscal 
powers  means  they  have  no  direct  ability  to 
influence  the  size  of  their  own  budgets. The  UK 
government allocates to each of the three devolved 
territories  a  “block  grant” out  of  its  general  tax 
revenues,  which  the  devolved  bodies  then  use  to 
fund  the  public  services  for  which  they  are 
responsible.  The  size  of  these  grants  is  calculated 
principally  via  the  Barnett  Formula,  based  on  the 
respective population shares of the four parts of the 
UK.  (322)  The  advantage  for  the  subnational 
governments is that they have complete autonomy 
over how to spend the grant. 

there 

formula:  Lack  of 
Weaknesses  of  Barnett 
accountability; 
is  no  clear  relationship 
between  taxes  paid  and  services  received.  A 
devolved  administration  has  little  influence  over 
the  size  of  the  block  grant  and  revenues  are  not 
related  to  management  or  performance  of  the 
economy.  Overall 
devolved 
budget  is  not  needs-based  (the  Barnett  formula  is 
the  devolved  governments  and 
generous 
spending  per  head 
in  Scotland,  Wales  and 
Northern Ireland is significantly higher than it is in 
England).  The  UK  Government 
remains 
responsible for borrowing to meet any shortfall in 
tax revenues.

administration’s 

to 

Local  authorities  (applies  to  England,  and  in 
most policy areas to the rest of the UK)

Local  governments  are  mainly  funded  by  grants 
from  central  government  but  they  also  levy  the 
Council tax. 

Local  Authorities  are  also  prevented  from  issuing 
their own debt, but they are permitted to borrow to 
finance  capital  investment.  Prudential  borrowing 
regimes  for  local  authorities  in  England,  Scotland 
and Wales (and for the Northern Ireland Executive 
in the case of Northern Ireland) were introduced in 
2004-05.  HM  Treasury 
for 
determining  the  overall  affordability  of  the  UK’s 
public  sector  debt  levels  against  the  general 
economic and fiscal environment, and for advising 

responsible 

is 

(322) See 

http://www.parliament.uk/documents/commons/lib/

research/rp98/rp98-008.pdf.

298

4. Fiscal rules

of 

the  Office 

The  UK  government  introduced  a  new  fiscal 
framework  after taking  office  in  May  2010.  The 
three  key  pillars  are  the  setting  of  a  new  "fiscal 
mandate"  targeting  the  cyclically-adjusted  current 
balance,  the  setting  of  a  net  debt  target  and  the 
for  Budget 
establishment 
Responsibility (OBR), an independent body tasked 
with  producing  the  official  forecast.  The  fiscal 
mandate 
the  cyclically-adjusted 
current budget be on track to be in balance by the 
end  of  a  rolling  5-year  forecast  period,  currently 
ending in 2016-17.  This is supplemented by a debt 
sustainability  target  which  requires  the  public 
sector  net  debt  as  a  percentage  of  GDP  to  be 
falling by 2015-16. The OBR must judge whether 
the  chances  of  the  government  meeting  the  fiscal 
mandate  and  debt  sustainability  rule  are  greater 
than 50%. 

requires 

that 

Government  spending  is  set  out  in  the  Spending 
Review  which  is  published  every  three  or  four 
limits  for 
years.  This  sets  out  multi-annual 
predictable  spending  in  every  department  through 
"departmental  expenditure  limits"  (DELs).  The 
remainder of spending, mainly social security, debt 
interest  payments,  public  sector  pensions  and  EU 
contributions,  is  classified  as  "annually  managed 
expenditure" (AME) and is not capped in advance.
The devolved administrations are financed through 
grants  from  central  governments  and  cannot  issue 
their own debt.  

Due  to  the  limited  control  over  their  overall 
budgets  that  the  devolved  country  governments 
and  local  authorities  have,  and  their  very  limited 
powers to borrow, the UK's overall fiscal strategy 
and 
its  performance  against  fiscal  rules  are 
determined  almost  wholly  by  the  central  UK 
government. In  the  context  of  the  size  of  overall 
UK  tax  and  government  spending  any  fiscal 
decisions  made  by  subnational  authorities  have 
very limited impact.

Fiscal decentralisation in the EU - main characteristics and implications for fiscal outcomes

Part IV

5. Other relevant institutional features 

There are a couple of recent and current reforms to 
subnational  government  with 
implications  for 
subnational policy:

• Abolition  of  RDAs:  Following 

the  2010 
election the UK government decided to abolish 
the Regional Development Agencies (RDAs) in 
England.  There  were  nine  RDAs  which  sat 
above  local  authorities  and  below  national 
government.  The  RDAs  did  not  have  any  tax 
limited  policy 
raising  powers  and  had 
responsibilities  and  budgets  but  one  of  their 
main  roles  was  in  making  use  of  EU  funding 
streams.  The  RDAs  did  however  have  a 
significant impact on the implementation of the 
English European Regional Development Fund 
(ERDF)  (2007-2013)  programmes  both 
in 
terms  of  management  -
the  RDAs  were 
intermediate  implementing  bodies- and  match 
funding  - the  RDA budgets  were an important 
source  of  match  funding 
the  English 
programmes.

in 

• Localism:  The  current  UK  government  is 
pursuing  a  'localism'  agenda,  which  seeks  to 
give  greater  power  and  flexibility  to  local 
communities.  This  means  giving 
local 
authorities  (and  other  local  groups,  inside  and 
outside  government)  more  control  over  how 
they allocate their budgets, implement national 
policy  and  run  services.  Historically  UK  local 
authorities  have  been  quite  constrained  by 
compartmentalised  financial  allocations  from 
central  government  and  detailed  rules  on  how 
national  policy  should  be  implemented  across 
the  country.  It  is  not  yet  clear  how  much  of  a 
difference  the  localism  agenda  will  make  in 
practice.  However  the  (national)  government's 
current  plans  for  localism  are  more  about  the 
allocation of spending than its overall level and 
do  not  envisage  major  new  borrowing  powers 
for  subnational  government.  Therefore  they 
should  not  have  a  significant  fiscal  impact  in 
aggregate.

299

ANNEX 2

Results of regressions on the impact of fiscal decentralisation
on government expenditures and revenues

Table IV.A2.1: Results of regressions with primary expenditure of general government as dependent variable (LSDVC estimator, EU27,

1995-2010)

1

2

3

4

5

6

7

8

9

VARIABLES

primexp

primexp

primexp

primexp

primexp

primexp

primexp

primexp

primexp

lagdebt

L. og.

expdec

revdec

-0.0204*

-0.0173

-0.0144

-0.0192

-0.0125

-0.00912

-0.0118

-0.00653

-0.0168

0.190***

0.166***

0.159***

0.166***

0.173***

0.219***

0.220***

0.223***

0.188***

-0.784***

-0.0405

-0.185***

-0.222***

-0.216***

-0.699***

-0.723***

-0.782***

-0.715***

0.800***

0.346***

0.437***

0.803***

0.212***

0.863***

0.865***

0.864***

0.957***

Expdec* trsf

0.792***

0.577***

0.607***

0.691***

0.662***

ele

L infl

tradeopen

Expdec* tax

expcov

Expdec* decSoc

Expdec* decHealth

Expdec* decGS

Snownrevdec* %tax

Snownrevdec* trsf

Expdec* decWag

Observations

Number of panel

0.123

0.116

0.0258

0.0311

0.0607

0.114

0.118

0.137

0.059

0.0290**

0.0259*

0.0355***

0.0323***

0.0264**

0.113***

0.112**

0.117***

0.0344***

-0.736*

-0.736

-0.850**

-0.871**

-0.965***

-1.056***

-1.027***

-1.084***

-0.672*

-0.298**

-0.109***

-0.0953***

-0.0683***

-0.0833***

-0.0805***

-0.0685***

-0.0848***

0.138

0.0405

0.213**

-0.524***

0.744***

401

27

401

27

401

27

401

27

401

27

380

27

380

27

381

27

-0.145

401

27

Notes: List of variables: see Table IV.3.4 above. New variables added: Primexp = general government primary expenditures (% of GDP), L.infl =
lagged inflation rate, TO = Trade Openness (% of exports plus imports in GDP).
***, **, *: coefficients estimates statistically significant at the 1, 5 and 10% level, respectively.
Source: Commission services.

Table IV.A2.2: Results of regressions with total revenues and tax burden of general government as dependent variable (LSDVC estimator,

EU27, 1995-2010)

(1)

totalrev

0.0235***

-0,000552

-0,0863

(2)

totalrev

0.0191**

-3.697***

0,166

-0.239**

-0,168

(3)

totalrev

0.0185**

-3.612***

0,0297

-0.218**

(4)

totalrev

0,0117

0,0116

-0.192**

(5)

(6)

(7)

(8)

taxburden

taxburden

totalrev

taxburden

0,0114

-2.333**

0,142

-0.253**

-0,131

0,00967

-2.235**

0,0402

0.0194**

-3.643***

0,0141

0.0154*

-2.350**

0,0292

-0.265***

-0.227***

-0.283***

0.0308**

0.0372***

0.0406***

0.0359***

0.0411***

0.0397***

0.0402***

0.0465***

-0.201*

0,0034

-0,108

0,00922

-0,0795

-0,00538

-0,327

-0,0658

-0,00458

-0,299

0,149

405

27

375

27

375

27

-0,0723

0,111

0,115

0,536

348

27

-0,107

0,00259

-0,0995

-0,096

0,00312

-0,0683

0.184*

-0,0816

-0,00428

-0,316

-0,103

0,00353

-0,142

0.146*

0.128*

373

27

373

27

375

27

373

27

VARIABLES

L.D

Rgrowth

Expdec

Revdec

Expdec* trsf

Expcov

Ele

L.infl

TO

L.og

Revdec * tax

L.rgrowth

Expdec * tax

Constant

Observations

Number of panel

R-squared

Notes: List of variables: see Tables IV.3.4 and IV.A2.1 above. New variables added: totalrev = general government total revenues (% of GDP),
taxburden = tax revenues of general government (% of GDP), Rgrowth = real growth rate of GDP, L.rgrowth = lagged real growth rate of GDP.
***, **, *: coefficients estimates statistically significant at the 1, 5 and 10% level, respectively.
Source: Commission services.

300

Part V
Resources

1.

ABBREVIATIONS AND SYMBOLS USED

Member States

BE

BG

CZ

Belgium

Bulgaria

Czech Republic

DK 

Denmark

DE

EE

EI 

EL 

ES 

FR 

IT 

CY

LV

LT

Germany

Estonia

Ireland

Greece

Spain

France

Italy

Cyprus

Latvia

Lithuania

LU 

Luxembourg

HU

Hungary

MT

Malta

NL 

The Netherlands

AT 

Austria

PL

PT 

RO

SI

SK

FI 

Poland

Portugal

Romania

Slovenia

Slovakia

Finland

302

SE 

Sweden

UK 

United Kingdom

EA

EU

Euro area

European Union

EU-25 European Union, 25 Member States (excl. BG and RO)

EU-27 European Union, 27 Member States

EU-15  European Union, 15 Member States before 1 May 2004

EU-10 European  Union,  10  Member  States 
(CZ, EE, CY, LV, LH, HU, MT, PL, SI, SK)

that 

joined 

the  EU  on  1  May  2004 

Non-EU countries

AU 

Australia

CA 

Canada

CH 

Switzerland

JP  

KO

NO

Japan

South Korea

Norway

NZ 

New Zeeland 

US(A) United States 

Currencies

EUR 

euro

ECU 

European currency unit

BGL

Bulgarian lev

CZK 

Czech koruna

DKK  Danish krone

EEK 

Estonian kroon

GBP 

Pound sterling

LTL

Lithuanian litas

Part V

Resources

303

European Commission

Public finances in EMU - 2012

LVL

Latvian lats

HUF

Hungarian forint

RON

New Rumanian leu

SEK 

Swedish krona

SKK

Slovak koruna

CAD

Canadian dollar

CHF 

Swiss franc

JPY 

Japanese yen

SUR 

Russian rouble

USD  US dollar

Other  

AMC      Asset management company

AMECO Macro-economic database of the European Commission

CAPB Cyclically-adjusted primary balance

CMFB    Committee on monetary, financial and balance-of-payment statistics

COFOG Classification of the functions of government

DEA  Data envelope approach

DG ECFIN Directorate-General Economic and Financial Affairs

DGS  Deposit Guarantee Scheme 

DR

Debt requirement

DSGE Dynamic stochastic general equilibrium

DWF      Discount window facility

EAMS    Euro Area Member States

ECB

European Central Bank

ECOFIN Economic and Financial Council

EDP

Excessive deficit procedure

EERP European Economic Recovery Plan

304

EFC

Economic and Financial Committee

EFSF     European Financial Stability Facility 

ELA      Emergency Liquidity Assistance 

EMU   Economic and Monetary Union

EPC

Economic Policy Committee

ESA(95) European System of National and Regional Accounts

ESM       European Stability mechanism

ESSPROS European System of Integrated Social Protection Statistics

EU KLEMS European database on capital, labour, energy, material and services

FDI 

Foreign direct investment

FIRB  Foundation Internal Ratings Based 

GDP

Gross domestic product

GLS 

Generalised least squares

IBP

Initial budgetary position

ICT 

Information and communication technologies

IMF 

International Monetary Fund

INSEE   Institut National de la Statistique et des Études Économiques

ISCED   International Standard Classification of Education

LGD       Loss Given Default 

LIME     Working group on methodology to assess Lisbon-related Structural Reforms

LTC

Long-term budgetary cost of ageing

MTBF  Medium-term budgetary framework

MTO Medium-term budgetary objective

NAIRU  Non accelerating inflation rate of unemployment

OECD Organisation of Economic Co-operation and Development

OLS 

Ordinary least squares

PBB 

Performance-based budgeting

Part V

Resources

305

European Commission

Public finances in EMU - 2012

PISA 

Programme for International Student Assessment

pp

Percentage points

PPS

Purchasing power standard

R&D

Research and development

RAMS  Recently acceded Member States

RF          Resolution Funds

RoEA Rest of euro area

ROW Rest of the world

SCPs

Stability and convergence programmes

SGP 

Stability and Growth Pact

SLS       Special liquidity scheme

SSC

Social security contributions

TFP 

Total factor productivity

VAT

Value added tax

WGHQPF Working Group on the quality of public finance

WHO  World Health Organization

306

2. GLOSSARY

Asset  management company    Public  or  private 
body  aiming  at 
recovering  or 
disposing of nonperforming assets. 

restructuring,

Candidate  countries    Countries  that  wish  to 
accede to the EU. Besides the accession countries, 
they include Croatia and Turkey.

Automatic  stabilisers  Features  of  the  tax  and 
spending  regime  which  react  automatically  to  the 
economic  cycle  and  reduce  its  fluctuations.  As  a 
result, the budget balance in percent of GDP tends 
to improve in years of high growth, and deteriorate 
during economic slowdowns.

for 

Basel  Committee  on  Banking  Supervision is a 
forum 
regular  cooperation  on  banking 
supervisory  matters aiming  at enhancing the 
understanding  of  key  supervisory 
issues  and 
improving the  quality  of banking  supervision 
worldwide. 
It  also  develops guidelines  and 
supervisory  standards  in  areas  where  they  are 
considered desirable. In this regard, the Committee 
is  best  known  for  its  international  standards  on 
capital adequacy; the Core Principles for Effective 
Banking Supervision; and the Concordat on cross-
border banking supervision. 

Broad  Economic  Policy  Guidelines  (BEPGs)  
Annual guidelines for the economic and budgetary 
policies  of  the  Member  States.  They  are  prepared 
by the Commission and adopted by the Council of 
Ministers  responsible  for  Economic  and  Financial 
Affairs (ECOFIN).

Budget balance  The balance between total public 
expenditure and revenue in a specific year, with a 
positive  balance 
indicating  a  surplus  and  a 
negative  balance  indicating  a  deficit.  For  the 
monitoring  of  Member  State  budgetary  positions, 
the  EU  uses  general  government  aggregates.  See 
also  structural  budget  balance,  primary  budget 
balance, and primary structural balance.

Budgetary  rules    Rules  and  procedures  through 
which  policy-makers  decide  on  the  size  and  the 
allocation  of  public  expenditure  as  well  as  on  its 
financing through taxation and borrowing.

Close-to-balance  requirement    A  requirement 
contained  in the  'old'  Stability  and  Growth  Pact, 
according  to  which  Member  States  should,  over 
the  medium  term,  achieve  an  overall  budget 
balance  close  to  balance  or  in  surplus;  was 
replaced 
country-specific  medium-term 
budgetary objectives in the reformed Stability and 
Growth Pact.

by 

Code  of  Conduct  Policy  document  endorsed  by 
the  ECOFIN  Council  of  11  October  2005 setting 
down  the  specifications  on  the  implementation  of 
the  Stability  and  Growth  Pact and  the  format  and 
content  of 
convergence 
stability 
programmes.

the 

and

COFOG (Classification  of  the  Functions  of 
Government)  A statistical  nomenclature  used  to 
break  down  general  government  expenditure  into 
its  different  functions    including  general  public 
services,  defence,  public  order  and  safety, 
economic 
protection, 
housing 
amenities,  health, 
recreation,  culture  and  religion,  education  and 
social protection.

environmental 

community 

affairs, 

and 

Composite  indicator: a  compilation  of  several 
indicators 
the 
different dimensions of a measured concept.

index  reflecting 

into  a  single 

Convergence  programmes 
  Medium-term 
budgetary  and  monetary  strategies  presented  by 
Member States that have not yet adopted the euro. 
They  are  updated  annually,  according  to  the 
provisions of the Stability and Growth Pact. Prior 
to 
third  phase  of  EMU,  convergence 
programmes were issued on a voluntary basis and 
used  by  the  Commission  in  its  assessment  of  the 
progress  made  in  preparing  for  the  euro.  See  also 
stability programmes.

the 

Budgetary sensitivity  The variation in the budget 
balance in percentage of GDP brought about by a 
change in the output gap. In the EU, it is estimated 
to be 0.5 on average.

Crowding-out effects  Offsetting effects on output 
due to changes in interest rates and exchange rates 
triggered  by  a  loosening  or  tightening  of  fiscal 
policy.

Cyclical component of budget balance  That part 
of  the  change  in  the  budget  balance  that  follows 

307

European Commission

Public finances in EMU - 2012

automatically  from  the  cyclical  conditions  of  the 
economy, due to the reaction of public revenue and 
expenditure  to  changes  in  the  output  gap.  See 
automatic stabilisers, tax smoothing and structural 
budget balance.

Cyclically-adjusted  budget  balance 
structural budget balance.

  See 

Defined-benefit  pension  scheme A  traditional 
pension  scheme  that  defines a  benefit,  i.e.  a 
pension,  for  an  employee  upon  that  employee's 
retirement is a defined benefit plan.

Defined-contribution pension scheme A scheme 
providing  for  an  individual  account  for  each 
participant,  and  for  benefits  based  solely  on  the 
amount  contributed  to  the  account,  plus  or  minus 
income, gains, expenses and losses allocated to the 
account.

Demand  and  supply  shocks    Disturbances  that 
affect  the  economy  on  the  demand  side  (e.g. 
changes  in  private  consumption  or  exports)  or  on 
the supply side (e.g. changes in commodity prices 
or technological innovations). They can impact on 
the  economy  either  on  a  temporary  or  permanent 
basis.

Deposit  Guarantee  Schemes  reimburse  a  limited 
amount  of  deposits  to  depositors  whose  bank  has 
failed.  From  the  depositors'  point  of  view,  this 
protects  a  part  of  their  wealth  from  bank  failures. 
From a financial stability perspective, this promise 
prevents 
panic 
withdrawals  from  their  bank,  thereby  preventing 
severe economic consequences.

from  making 

depositors 

receive  government 

Dependency  ratio  A  measure  of  the  ratio  of 
people  who 
transfers, 
especially  pensions,  relative  to  those  who  are 
available  to  provide  the  revenue  to  pay  for  those 
transfers.

acquired  assets  or  returns  on  assets.  Thus,  the  net 
direct fiscal costs reflect the permanent increase in
public debt.

Direct  taxes  Taxes  that  are  levied  directly  on 
personal or corporate incomes and property.

Discretionary  fiscal  policy  Change in  the  budget 
balance and in its components under the control of 
government. It is usually measured as the residual 
of the change in the balance after the exclusion of 
the budgetary impact of automatic stabilisers. See 
also fiscal stance.

Early-warning mechanism  Part of the preventive 
elements  of  the  Stability  and  Growth  Pact.  It  is
activated when there is significant divergence from 
the  budgetary  targets  set  down  in  a  stability  or 
convergence programme.

Economic  and  Financial  Committee  (EFC)  
Formerly  the  Monetary  Committee,  the  EFC  is  a 
Committee  of  the  Council  of  the  European  Union 
set  up  by  Article  114  of  the.  Its  main  task  is  to 
prepare  and  discuss  (ECOFIN)  Council  decisions 
with regard to economic and financial matters.

Economic  Policy  Committee  (EPC)    Group  of 
senior government  officials  whose  main task is to 
prepare  discussions  of  the  (ECOFIN)  Council  on 
structural policies. It plays an important role in the 
preparation  of 
the  Broad  Economic  Policy 
Guidelines,  and  it  is  active  on  policies  related  to 
labour  markets,  methods  to  calculate  cyclically-
adjusted budget balances and ageing populations.

Effective tax rate The ratio of broad categories of 
income, 
income,  capital 
tax  revenue  (labour 
consumption) to their respective tax bases.

Effectiveness The  same  concept  as  efficiency 
except  that  it  links  input  to  outcomes  rather  than 
outputs.

Direct  fiscal  costs  (gross,  net) of  a  financial 
crisis  The  direct  gross  costs  are  the  fiscal outlays
in  support  of  the  financial  sector  that  increase  the 
level of public debt. They encompass, for example,
recapitalisation,  purchase  of  troubled  bank  assets, 
pay-out  to  depositors,  liquidity  support,  payment 
when  guarantees  are  called  and  subsidies.  The 
direct  net  costs are the  direct  gross  cost  net  of
recovery  payments,  such  as  through  the  sale  of 

Efficiency Can be defined in several ways, either 
as the ratio of outputs to inputs or as the distance 
to  a  production  possibility  frontier  (see  also  Free 
Disposable Hull analysis, Data Envelope analysis, 
stochastic 
frontier  analysis).  Cost  efficiency
measures the link between monetary inputs (funds) 
and outputs; technical efficiency measures the link 
between  technical  inputs  and  outputs.  Output 
efficiency indicates by how much the output can be 

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increased  for  a  given  input;  input  efficiency
indicates  by  how  much  the  input  can  be  reduced 
for a given input.

Emergency  Liquidity  Assistance (equivalent  to
lender-of-last- resort),  the  most  traditional  tool 
available  to  a  central  bank  for  dealing  with 
financial instability. It includes both the provision 
of  liquidity  to  the  financial  system  as a  whole 
through  market  operations,  as  well  as  emergency 
lending  to  individual  banks.  Not  all  liquidity 
injections  aimed  at  preventing  the  spread  of  a 
liquidity problem relate to a crisis, as central banks 
routinely offer liquidity against specified collateral 
requirements  in  order  to  support  the  orderly 
functioning of markets.

ESA95  /  ESA79    European  accounting  standards 
for the reporting of economic data by the Member 
States to the EU. As of 2000, ESA95 has replaced 
the  earlier  ESA79  standard  with  regard  to  the 
comparison and analysis of national public finance 
data.

European  Financial  Stability  Facility is  a 
company  owned  by  Euro  Area  Member  States 
created following the decisions taken in May 2010 
by  the  Council.  EFSF  is  able  to  issue  bonds 
guaranteed  by  EAMS  for  up  to  €  440  billion  for 
on-lending  to  EAMS  in  difficulty,  subject  to 
conditions 
the  European 
Commission  in  liaison  with  the  European  Central 
Bank  and  International  Monetary  Fund  and  to  be 
approved  by  the  Eurogroup.  EFSF  has  been 
assigned  the  best  possible  credit  rating;  AAA  by 
Standard  &  Poor’s  and  Fitch  Ratings,  Aaa  by 
Moody’s.

negotiated  with 

European semester New governance architecture 
approved  by  the  Member  States  in  September 
2010. It means that the EU and the euro zone will 
coordinate  ex  ante  their  budgetary  and  economic 
policies, in line with the Europe 2020 strategy, the 
Stability and Growth Pact and the Macroeconomic 
Imbalances  Procedure.  Based  on  previous 
discussions  on  Commission's  Annual  Growth 
Survey,  each  summer,  the  European  Council  and 
the Council of ministers will provide policy advice 
before Member States finalise their draft budgets.

Excessive Deficit Procedure (EDP)  A procedure 
according  to  which  the  Commission  and  the 
Council  monitor  the  development  of  national 

budget balances and public debt in order to assess 
and/or  correct  the  risk  of  an  excessive  deficit  in 
each  Member  State.  Its  application  has  been 
further  clarified  in  the  Stability  and  Growth  Pact. 
See  also  stability  programmes  and  Stability  and 
Growth Pact.

Expenditure rules  A  subset  of  fiscal  rules  that 
target (a subset of) public expenditure.

Foundation  Internal  Ratings  Based framework 
used 
to  set  minimum  regulatory  capital  for 
internationally  active  banks.  The  Basel  II  FIRB 
framework  sets minimum 
regulatory  capital 
requirements  using  a  modified  version  of  an 
industry model, the so-called Gaussian asymptotic 
single  risk  factor  model  of  credit  risk  developed 
chiefly by Vasicek.

Fiscal  consolidation  An  improvement  in  the 
budget balance through measures of discretionary 
fiscal policy, either specified by the amount of the 
improvement  or 
the 
improvement continues.

the  period  over  which 

Fiscal  decentralisation    The  transfer  of  authority 
and  responsibility  for  public  functions  from  the 
central  government  to  intermediate  and  local 
governments or to the market.

Fiscal  federalism    A  subfield  of  public  finance 
that investigates the fiscal relations across levels of 
government.

Fiscal governance Comprises all rules, regulations 
and procedures that impact on how the budget and 
its  components  are  being  prepared.  The  terms 
fiscal  governance  and  fiscal  frameworks  are  used 
interchangeably in the report.

is  usually  calculated  by 

Fiscal  impulse  The  estimated  effect  of  fiscal 
policy on GDP. It is not a model-free measure and 
it 
simulating  an 
econometric model. The estimates presented in the 
present 
the 
Commission services’ QUEST model.

report  are  obtained  by  using 

Fiscal  institutions Independent  public  bodies, 
other 
than the central  bank, which prepare
macroeconomic and  budgetary forecasts, monitor 
the 
the 
fiscal  performance 
government on fiscal policy issues.

advice 

and/or 

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Fiscal  rule  A  permanent  constraint  on  fiscal 
policy, expressed in terms of a summary indicator 
of  fiscal  performance,  such  as  the  government 
budget  deficit,  borrowing,  debt,  or  a  major 
component 
thereof.  See  also  budgetary  rule, 
expenditure rules.

Growth  accounting  A technique  based  on  a 
production function approach where total GDP (or 
national  income)  growth  is  decomposed  into  the 
various  production  factors  and  a  non-explained 
part  which  is  the  total  factor  productivity  change, 
also often termed the Solow residual.

the  effect  of 
Fiscal  stance  A  measure  of 
discretionary  fiscal  policy.  In  this  report,  it  is 
defined  as  the  change  in  the  primary  structural 
budget  balance  relative  to  the  preceding  period. 
When  the  change  is  positive  (negative)  the  fiscal 
stance is said to be expansionary (restrictive).

General  government    As  used  by  the  EU  in  its 
process  of  budgetary  surveillance  under 
the 
Stability and Growth Pact and the excessive deficit 
procedure,  the  general  government  sector  covers 
national 
local 
government,  as  well  as  social  security  funds. 
Public enterprises are excluded, as are transfers to 
and from the EU Budget.

government, 

regional 

and 

to 

the  public 

A  basic 
Government  budget  constraint 
finances, 
condition  applying 
according to which total public expenditure in any 
one year must be financed by taxation, government 
borrowing, or changes in the monetary base. In the 
context  of  EMU,  the  ability  of  governments  to 
finance  spending 
is 
prohibited.  See  also 
stock-flow  adjustment, 
sustainability.

through  money 

issuance 

to 

the  government 

that  are  subject 

Government  contingent  liabilities  Obligations 
for 
the 
realization of specific uncertain and discrete future 
events.  For  instance,  the  guarantees  granted  by 
governments  to  the  debt  of  private  corporations 
bonds 
issued  by  enterprise  are  contingent 
liabilities,  since  the  government  obligation  to  pay 
depend on the non-ability of the original debtor to 
honour its own obligations.

Government  implicit  liabilities 
  Government 
obligations that are very likely to arise in the future 
in spite of the absence of backing contracts or law. 
The  government  may  have  a  potential  future 
obligation  as  a  result  of  legitimate  expectations 
generated  by  past  practice  or  as  a  result  of  the 
implicit 
pressure  by 
liabilities  are  contingent,  i.e.,  depend  upon  the 
occurrence of uncertain future events.

interest  groups.  Most 

310

Indirect taxation  Taxes that are levied during the 
production  stage,  and  not  on  the  income  and 
property  arising 
from  economic  production 
processes. Prominent examples of indirect taxation 
are  the  value  added  tax  (VAT),  excise  duties, 
import  levies,  energy  and  other  environmental 
taxes.

Integrated  guidelines
A general  policy 
instrument for coordinating EU-wide and Member 
States  economic  structural  reforms  embedded  in 
the Lisbon strategy and which main aim is to boost 
economic growth and job creation in the EU.

Interest  burden General  government
payments on public debt as a share of GDP.

interest 

Strategy

in  2000, 
in  2005.  Based  on 

for  Growth  and  Jobs
Lisbon
Partnership  between  the  EU  and  Member  States 
for  growth  and  more  and  better  jobs.  Originally 
the  Lisbon  Strategy  was 
approved 
the  Integrated 
revamped 
Guidelines  (merger  of  the  broad  economic policy 
guidelines and the employment guidelines, dealing 
with  macro-economic,  micro-economic 
and 
employment  issues)  for  the  period  2005-2008, 
Member States drew up three-year national reform 
programmes at the end of 2005. They reported on 
the 
reform 
programmes for the first time in autumn 2006. The 
these 
Commission  analyses  and  summarises 
reports  in  an  EU  Annual  Progress  Report  each 
year, in time for the Spring European Council.

implementation  of 

the  national 

Loss Given Default The loss incurred if an obligor 
defaults.

Maastricht reference values for public debt and 
deficits  Respectively, a 60 % general government 
debt-to-GDP  ratio  and  a  3  % general  government 
deficit-to-GDP ratio. These thresholds are defined 
in a protocol to the Maastricht Treaty on European 
Union. See also Excessive Deficit Procedure.

Maturity structure of public debt The profile of 
total  debt  in  terms  of  when  it  is  due  to  be  paid 

back.  Interest  rate  changes  affect  the  budget 
balance  directly  to  the  extent  that  the  general 
government sector has debt with a relatively  short 
maturity  structure.  Long  maturities  reduce  the 
sensitivity of the budget balance to changes in the 
prevailing interest rate. See also public debt.

framework

An
Medium-term  budgetary 
institutional  fiscal  device that  lets  policy-makers 
extend the horizon for fiscal policy making beyond 
the  annual  budgetary  calendar  (typically  3-5 
years).  Targets  can  be  adjusted  under  medium-
term  budgetary  frameworks  (MTBF)  either  on  an 
annul  basis  (flexible  frameworks)  or  only  at  the 
end of the MTBF horizon (fixed frameworks). 

(MTO)
Medium-term  budgetary  objective 
According  to  the  reformed  Stability  and  Growth 
Pact,  stability  programmes
and  convergence 
programmes present  a  medium-term  objective for 
the  budgetary  position.  It  is  country-specific  to 
take  into  account  the  diversity  of  economic  and 
budgetary  positions  and  developments  as  well  as 
of  fiscal  risks to  the  sustainability  of  public 
finances,  and  is  defined  in  structural  terms  (see 
structural balance).

Minimum benchmarks    The  lowest  value  of  the 
structural  budget  balance  that  provides a  safety 
margin against the risk of breaching the Maastricht 
reference  value  for  the  deficit  during  normal 
cyclical  fluctuations.  The  minimum benchmarks 
are estimated by  the European Commission. They 
do  not  cater  for  other  risks  such  as  unexpected 
budgetary  developments  and  interest  rate  shocks. 
They  are  a  lower  bound  for  the  'medium-term 
budgetary objectives (MTO).

Monetary Conditions Index (MCI)  An indicator 
combining  the  change  in  real  short-term  interest 
rate  and  in  the  real  effective  exchange  rate  to 
gauge  the  degree  of  easing  or  tightening  of 
monetary policy.

Mundell-Fleming  model    Macroeconomic  model 
of  an  open  economy  which  embodies  the  main 
Keynesian  hypotheses  (price  rigidity,  liquidity 
preference). In spite of its shortcomings, it remains 
useful in short-term economic policy analysis.

NAIRU 
Unemployment.

  Non-Accelerating  Inflation  Rate  of 

effects 

  Supply-side 

Non-Keynesian 
and 
expectations  effects  which  reverse  the  sign  of 
traditional  Keynesian multipliers.  Hence,  if  non-
Keynesian  effects  dominate,  fiscal  consolidation 
would be expansionary.

Old age dependency ratio   Population aged over 
65  as  a  percentage  of  working  age  population 
(usually  defined  as  persons  aged  between  15  and 
64).

One-off  and temporary  measures  Government 
transactions  having  a  transitory  budgetary  effect 
that  does  not  lead  to  a  sustained  change  in  the 
budgetary position. See also structural balance.

Outcome  indicator Measures  the  ultimate  results 
(outcomes)  of  policy  choices  (e.g.  education 
attainment, healthy life years, economic growth). 

Output  costs from  a  financial  crisis This is  the 
gap  between  the  hypothetical  output  development 
without  a  crisis  and  the  actual  output  realised 
against the back of the crisis. Various methods are 
available  to  calculate  output  losses,  in  particular 
either  using the trend GDP  growth or the level of 
GDP as a benchmark.

Output gap  The difference between actual output 
and  estimated  potential  output  at  any  particular 
point  in  time.  See  also  cyclical  component  of 
budget balance.

Output  indicator Measures  the  technical  results 
(outputs)  of  policy  choices  (e.g.  number  of 
university  graduates,  number  of  patents, 
life 
expectancy).

Pay-as-you-go pension system (PAYG)  Pension 
system  in  which  current  pension  expenditures  are 
financed  by 
current 
employees.

contributions  of 

the 

Pension fund A legal entity set up to accumulate, 
manage  and  administer  pension  assets.  See  also 
private pension scheme.

Performance-based  budgeting  A  budgeting 
technique  that  links  budget  appropriations  to 
than 
performance 
focusing 
practice, 
performance-informed budgeting is more common 
which  basis  decisions  on  budgetary  allocation  on 

(outcomes, 
input 

rather 
In 

controls. 

results) 

on 

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performance  information  without  establishing  a 
formal link.

Policy-mix    The  overall  stance  of  fiscal  and 
monetary  policy.  The  policy-mix  may  consist  of 
various 
and 
restrictive policies, with a given fiscal stance being 
either supported or offset by monetary policy.

combinations  of 

expansionary 

Potential  GDP The  level  of  real  GDP  in  a  given 
year  that  is  consistent  with  a  stable  rate  of 
inflation.  If  actual  output  rises  above  its  potential 
level,  then  constraints  on  capacity  begin  to  bind 
and  inflationary  pressures  build;  if  output  falls 
below  potential,  then  resources  are  lying  idle  and 
inflationary  pressures  abate.  See  also  production 
function method and output gap.

Pre-accession  Economic  Programmes  (PEPs)  
Annual  programmes  submitted  by  candidate 
countries  which  set  the  framework  for  economic 
policies  The PEPs  consist  of  a  review  of  recent 
economic 
detailed 
macroeconomic framework, a discussion of public 
finance  issues  and  an  outline  of  the  structural 
reform agenda.

developments, 

a 

Pre-accession  Fiscal  Surveillance  Framework 
(PFSF)  Framework for budgetary surveillance of 
candidate  countries  in  the  run  up  to  accession.  It 
closely  approximates  the  policy  co-ordination  and 
surveillance mechanisms at EU level.

Primary budget balance  The budget balance net 
of interest payments on general government debt.

Primary  structural  budget  balance 
  The 
structural budget balance net of interest payments.

Principal  components A statistical  technique 
used to reduce multidimensional data sets to lower 
dimensions for analysis. This technique provides a 
compression  of  a  set  of  high  dimensional  vectors 
(or  variables)  into  a  set  of  lower  dimensional 
vectors  (or  variables)  and  then  reconstructing  the 
original  set  summarizing  the  information  into  a 
limited number of values.

Private pension schemes The insurance contract 
specifies a schedule of contribution in exchange of 
which  benefits  will  be  paid  when  the  members 
reach  a  specific  retirement  age.  The  transactions 
are  between  the  individual  and  the  insurance 

312

provider and they are not recorded as government 
revenues 
and, 
therefore,  do  not  have  an  impact  on  government 
surplus or deficit.

government 

expenditure 

or 

Pro-cyclical  fiscal  policy    A  fiscal  stance  which 
amplifies  the  economic  cycle  by  increasing  the 
structural  primary  deficit  during  an  economic 
upturn,  or  by  decreasing  it  in  a  downturn.  A 
neutral  fiscal  policy  keeps  the  cyclically-adjusted 
budget  balance  unchanged  over  the  economic 
cycle  but  lets  the  automatic  stabilisers  work.  See 
also tax-smoothing.

Production  function  approach    A  method to 
estimate  the  level  of  potential  output  of  an 
economy  based  on  available  labour inputs,  the 
capital stock and their level of efficiency. Potential 
output  is  used  to  estimate  the  output  gap,  a  key 
input in the estimation of cyclical component of the 
budget.

Public  debt  Consolidated  gross  debt  for  the 
general  government  sector.  It  includes  the  total 
nominal  value  of  all  debt  owed  by  public 
institutions  in  the  Member  State,  except  that  part 
of  the  debt  which  is  owed  to  other  public 
institutions in the same Member State.

Public  goods  Goods  and services 
that  are 
consumed  jointly  by  several  economic  agents  and 
for  which there is no effective pricing  mechanism 
that  would  allow  private  provision  through  the 
market.

Public investment  The component of total public 
expenditure  through  which  governments  increase 
and  improve  the  stock  of  capital  employed  in  the 
production of the goods and services they provide.

Public-private  partnerships  (PPP)    Agreements 
that  transfer  investment  projects  to  the  private 
sector  that  traditionally  have  been  executed  or 
financed by the public sector. To qualify as a PPP, 
the  project  should  concern  a  public  function, 
involve  the  general  government  as  the  principal 
purchaser,  be  financed  from  non-public  sources 
and  engage  a  corporation  outside  the  general 
government as the principal operator that provides 
significant  inputs  in  the  design  and  conception  of 
the project and bears a relevant amount of the risk.

Quality  of  public  finances
Comprises  all 
arrangements  and  operations  of  fiscal  policy  that 
support the  macroeconomic  goals of fiscal policy, 
in particular economic growth.

Quasi-fiscal  activities 
  Activities  promoting 
public policy goals carried out by non-government 
units.

QUEST    The  macroeconomic  model  of  the  EU 
Member  States  plus  the  US  and  Japan  developed 
by  the  Directorate-General  for  Economic  and 
Financial Affairs of the European Commission.

Recently acceded Member States Countries that 
became  members  of  the  EU  in  May  2004  and 
include  Cyprus,  the  Czech  Republic,  Estonia, 
Hungary,  Latvia,  Lithuania,  Malta,  Poland, 
Slovakia  and  Slovenia.  Two  additional  countries, 
Romania and Bulgaria joined in January 2007.

Resolution Funds Privately financed funds whose 
function 
support  crisis  management 
authorities  in  their  effort  to  avoid  contagion 
between banks and limiting systemic risk.

to 

is 

the 

assumptions  on 

Ricardian  equivalence  Under  fairly  restrictive 
theoretical 
consumer’s 
behaviour  (inter  alia  infinite  horizon  for  decision 
making),  the  impact  of  fiscal  policy  does  not 
depend  on  whether  it  is  financed  by  tax  increases 
or  by  a  widening  deficit.  The  basic  reasoning 
behind  this  statement  dates  back  to  Ricardo  and 
was revisited by Robert Barro in the 1970s.

Securitisation  Borrowing (issuing of bonds) with 
the  intention  of  paying  interest  and  capital  out  of 
the proceeds derived from assets (use or sale of) or 
from future revenue flows.

Sensitivity analysis  An econometric or statistical 
simulation  designed  to  test  the  robustness  of  an 
estimated  economic  relationship  or  projection, 
given  various 
the  underlying 
assumptions.

changes 

in 

Significant  divergence    A  sizeable  excess  of  the 
budget  balance  over  the  targets  laid  out  in  the 
stability or convergence programmes, that triggers 
the  Early  warning  procedure  of  the  Stability  and 
Growth Pact.

Size  of  the  public  sector Typically  measured  as 
the ratio of public expenditure to nominal GDP.

‘Snow-ball’  effect    The  self-reinforcing  effect  of 
public  debt  accumulation  or  decumulation  arising 
from a positive or negative differential between the 
interest  rate  paid  on  public  debt  and  the  growth 
rate of the national economy. See also government 
budget constraint.

Social  security  contributions  (SSC)    Mandatory 
contributions paid by employers and employees to 
a  social  insurance  scheme  to  cover  for  pension, 
health care and other welfare provisions.

Sovereign  bond  spread The  difference  between 
risk  premiums imposed  by  financial  markets  on 
sovereign  bonds  for different states. Higher  risk 
premiums can  largely stem  from (i)  the  debt 
service ratio, also reflecting the countries' ability to 
raise their taxes  for a given level of GDP, (ii) the 
fiscal  track  record,  (iii)  expected  future  deficits, 
and (iv) the degree of risk aversion.

Stability  and  Growth  Pact  (SGP)    Approved  in 
1997 and  reformed  in  2005,  the  SGP  clarifies  the 
provisions  of  the  Maastricht  Treaty  regarding  the 
surveillance  of  Member  State  budgetary  policies 
and  the  monitoring  of  budget  deficits  during  the 
third  phase  of  EMU.  The  SGP  consists  of  two 
Council  Regulations  setting  out  legally  binding 
provisions 
the  European 
Institutions  and  the  Member  States  and  two 
Resolutions  of 
in 
Amsterdam  (June  1997).  See  also  Excessive 
Deficit Procedure.

the  European  Council 

to  be  followed  by 

Stability  programmes    Medium-term  budgetary 
strategies  presented  by  those  Member  States  that 
have  already  adopted  the  euro.  They  are  updated 
annually,  according  to  the  provisions  of  the 
Stability  and  Growth  Pact.  See  also  Convergence 
programmes.

The 

adjustment
(also  known  as 

Stock-flow 
stock-flow 
the  debt-deficit 
adjustment 
adjustment)  ensures  consistency  between  the  net 
borrowing (flow) and the variation in the stock of 
gross  debt.  It 
the  accumulation  of 
financial  assets,  changes  in  the  value  of  debt 
denominated  in  foreign  currency,  and  remaining 
statistical adjustments.

includes 

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Total factor productivity  Represents the share of 
total  output  not  explained  by  the  level  of  inputs 
(labour, capital or primary product). It is generally 
considered  as  a  measure  of  overall  productive 
efficiency.

UMTS  Third  generation  of  technical  support  for 
mobile  phone  communications.  Sale  of  UMTS 
licences  gave  rise  to  sizeable  one-off  receipts  in 
2001.

Welfare  state  Range  of  policies  designed  to 
provide insurance against unemployment, sickness 
and risks associated with old age.

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Public finances in EMU - 2012

Structural  budget  balance  The  actual  budget 
balance net of the cyclical component and one-off 
and  other  temporary  measures.  The  structural 
balance gives a measure of the underlying trend in 
the  budget  balance.  See  also  primary  structural 
budget balance.

Sustainability    A  combination  of  budget  deficits 
and  debt  that  ensure  that  the  latter  does  not  grow 
without  bound.  While  conceptually  intuitive,  an 
agreed  operational  definition  of  sustainability  has 
proven difficult to achieve.

SYstemic  Model 

SYMBOL
of  Banking 
Originated  Losses developed  by  a  joint  team  of 
Commission  services  (Joint  Research  Centre  and 
the  Directorate-General  for  Internal  Market  and 
services  of  the  European  Commission)  together 
with  academic  experts  on  banking  regulation 
aiming  at  estimating  the  losses  originated  in  the 
banking system.

Tax elasticity  A parameter measuring the relative 
change  in  tax  revenues  with  respect  to  a  relative 
change in GDP. The tax elasticity is an input to the 
budgetary sensitivity.

Tax gaps  Measure  used  in the assessment of  the 
sustainability of public finances. They measure the 
difference  between  the  current  tax  ratio  and  the 
constant tax ratio over a given projection period to 
achieve a predetermined level of debt at the end of 
that projection period.

Tax smoothing  The idea that tax rates should be 
kept  stable  in  order  to  minimise  the  distortionary 
effects  of  taxation,  while  leaving  it  for  the 
automatic  stabilisers  to  smooth  the  economic 
cycle. It is also referred to as neutral discretionary 
fiscal policy. See also cyclical component of fiscal 
policy.

Tax  wedge
The  deviation  from  equilibrium 
price/quantity  as  a  result  of  a  taxation,  which 
results  in  consumers  paying  more,  and  suppliers 
receiving less. When referring to labour tax wedge 
more  specifically, 
is  usually 
regarded  as  the  difference  between  the  difference 
between  the  salary  costs  of  an  average  worker  to 
their employer and the amount of  net income  that 
the worker receives in return, the difference being 
represented  by  taxes  including  personal  income 
taxes and compulsory social security contributions.

tax  wedge 

the 

314

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4.

USEFUL INTERNET LINKS

European Union

European Commission

ec.europa.eu

Directorate-General  for  Economic  and 
Financial Affairs

ec.europa.eu/economy_finance/index_en.htm

Eurostat

epp.eurostat.ec.europa.eu

European Council

consilium.europa.eu

European Parliament

www.europarl.europa.eu

Economics and Finance Ministries

Belgium

www.treasury.fgov.be/interthes

Ministère 
Ministerie van Financen

des 

Finances 

-

Bulgaria

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Ministry of Finance

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Ministry of Finance

Denmark

Germany

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Italy

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Latvia

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Ministry of Finance

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Department of Finance

www.mnec.gr/en/

Ministry of Economy and Finance

www.mineco.es/

www.finances.gouv.fr

www.tesoro.it

Ministerio 
Hacienda

de 

Economía 

y 

Ministère  Économie,  Finances  et 
l'Industrie

Ministero  dell’Economia  e  delle 
Finanze

www.mof.gov.cy

Ministry of Finance

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Ministry of Finance

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www.finmin.lt

Ministry of Finance

Luxembourg

www.etat.lu/FI

Ministère des Finances

324

Hungary

Malta

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finance.gov.mt

Ministry of Finance

Ministry of Finance and Economic 
Affairs

Netherlands

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Ministerie van Financien

Austria

Poland

Portugal

Romania

Slovenia

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Bundesministerium für Finanzen

www.mofnet.gov.pl

Ministry of Finance

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www.mfinante.ro

Ministry of Finance

www.gov.si/mf

Ministry of Finance

Slovak Republic

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Ministry of Finance

Finland

Sweden

www.vn.fi/vm

Ministry of Finance

finans.regeringen.se

Finansdepartementet

United Kingdom

www.hm-treasury.gov.uk

Her Majesty's Treasury

Central Banks

European Union

www.ecb.int

European Central Bank

Belgium

www.nbb.be

Banque  Nationale  de  Belgique  / 
Nationale Bank van België

Bulgaria

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Bulgarian National Bank

Czech Republic

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Czech National Bank

Denmark

Germany

Estonia

Ireland

Greece

Spain

France

www.nationalbanken.dk

Danmarks Nationalbank

www.bundesbank.de

Deutsche Bundesbank

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Eesti Pank

www.centralbank.ie

Central Bank of Ireland

www.bankofgreece.gr

Bank of Greece

www.bde.es

Banco de España

www.banque-france.fr

Banque de France

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Resources

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European Commission

Public finances in EMU - 2012

Italy

Cyprus

Latvia

www.bancaditalia.it

Banca d'Italia

www.centralbank.gov.cy

Central Bank of Cyprus

www.bank.lv

Bank of Latvia

Lithuania

www.lb.lt

Lietuvos Bankas

Luxembourg

www.bcl.lu

Banque Centrale du Luxembourg

Hungary

Malta

www.mnb.hu

National Bank of Hungary

www.centralbankmalta.com

Central Bank of Malta

Netherlands

www.dnb.nl

De Nederlandsche Bank

Austria

Poland

Portugal

Romania

Slovenia

www.oenb.at

www.nbp.pl

Oestereichische  Nationalbank

Narodowy Bank Polski

www.bportugal.pt

Banco de Portugal

www.bnro.ro

www.bsi.si

National Bank of Romania

Bank of Slovenia

Slovak Republic

www.nbs.sk

National Bank of Slovakia

Finland

Sweden

www.bof.fi

Suomen Pankki

www.riksbank.com

Sveriges Riksbank

United Kingdom

www.bankofengland.co.uk

Bank of England

EU fiscal surveillance framework

Stability and Growth Pact:

http://ec.europa.eu/economy_finance/sg_pact_fiscal_policy/index_en.htm?cs_mid=570

Excessive deficit procedure:

http://ec.europa.eu/economy_finance/sg_pact_fiscal_policy/fiscal_policy554_en.htm

Early warning mechanism:

http://ec.europa.eu/economy_finance/sg_pact_fiscal_policy/fiscal_policy1075_en.htm

326

Stability and convergence programmes:

http://ec.europa.eu/economy_finance/sg_pact_fiscal_policy/fiscal_policy528_en.htm

Sustainability of public finances:

http://ec.europa.eu/economy_finance/sg_pact_fiscal_policy/fiscal_policy546_en.htm

Quality of public finances

http://ec.europa.eu/economy_finance/publications/publication_summary12186_en.htm

http://ec.europa.eu/economy_finance/epc/epc_publications_en.htm#Quality%20of%20public%20finances

Lisbon Strategy for Growth and Jobs

http://ec.europa.eu/growthandjobs/index_en.htm

Institute for National Accounts: www.inr-icn.fgov.be

www.deutsche-rentenversicherung.de

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327

 
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