The future economic governance of the EU - European Union Committee Contents

Supplementary letter from Mark Hoban MP, Financial Secretary, HM Treasury (EGE 23)

  Thank you for inviting me to give evidence to your Committee on 14 December. I enjoyed the discussion and I hope that you and your Committee members found our evidence helpful.

  I promised the Committee a note on the sanctions procedure, to explain how this works currently, and the likely size of sanctions under the Commission legislative proposals. As I explained to the Committee, the essential elements of the Commission's proposals and the Taskforce conclusions have been firstly, to extend sanctions to the preventative arm of the Stability and Growth Pact (currently, they only exist in the corrective arm) and secondly, to improve the speed and automaticity with which these sanctions are applied to Member States.

  There is already provision for sanctions in Articles 11 and 12 of Regulation 1467/97 on the Excessive Deficit Procedure. The first step of sanctions is, "as a rule" to require a non-interest-bearing deposit of the Member State, which may be supplemented by other fines. The non-interest-bearing deposit consists of a fixed amount (0.2 per cent of the Member State's GDP) plus a variable component (10 per cent of the difference between the Member State's deficit as a percentage of GDP in the preceding year and the Treaty reference value for deficit of 3 per cent of GDP). Each year thereafter, the Council may decide to require additional deposits from the Member State, again fixed at 10 per cent of the difference between the Member State's actual deficit and the Treaty reference value. The Regulation states that any single deposit must not exceed 0.5 per cent of the Member State's GDP. There is also a general rule in the Regulation whereby the non-interest-bearing deposit is converted into a fine two years after the deposit was levied, if the Member State has not taken sufficient action to address its excessive deficit in that time.

  The Commission proposals aim to improve this system in a number of ways. Assuming that the Commission proposals are adopted without changes, in the preventative arm (COM 2010 524), if the Commission reports that a Member State's fiscal policies are acting against the Broad Economic Policy Guidelines, it proposes that an interest bearing deposit of 0.2 per cent of the Member State's gross GDP in the previous year should be levied. Council would then have a maximum of 10 days to decide whether or not to apply this deposit—it would take a qualified majority of Member States to reject the Commission's proposal (this is known as "reverse qualified majority voting" in EU terms). If the Member State takes the appropriate policy action, it will receive its money back plus any interest (which is calculated on the basis of the Commission's credit risk and prevailing market conditions). If not, and the Member State enters the Excessive Deficit Procedure (EDP), the deposit is converted into a non-interest bearing deposit, ie, the Member State cannot receive any interest.

  In the corrective arm of the Stability and Growth Pact, under the Commission proposals (COM 2010 522), once a Member State enters EDP, it is required to make a non-interest-bearing deposit to the EU of 0.2 per cent of gross GDP plus the 10 per cent variable component. If the Member State has already paid an interest-bearing deposit under the preventative arm, this will be converted into a non-interest-bearing deposit, so the Member State will only need to pay the 10 per cent variable component. As per current practice, the total deposit cannot exceed 0.5 per cent of the Member State's GDP. The proposals also make it clear that the variable component may be calculated on the basis of the debt criterion if the breach of the Stability and Growth Pact has been on the basis of high debt, rather than high deficits—currently, the 10 per cent difference is only calculated on the basis of the divergence between the Member State's deficit and the 3 per cent Treaty reference value.

  If the Member State subsequently takes effective action to correct its deficit, it will receive its deposit back, but without interest. However, if the Member State has not taken effective action, the Commission will propose that the deposit should be converted into a fine. Again, the Council have 10 days within which they must decide whether to fine the Member State, and it would take a qualified majority of Member States to reject the Commission proposal.

  A further new proposal by the Commission (COM 2010 525) is for sanctions to euroarea Member States that have repeatedly breached Council recommendations on addressing macroeconomic imbalances. There is no system of escalation—these are fines, which will be levied on an annual basis until the Member State takes corrective action to address its imbalances. The fines are set at 0.1 per cent of the Member State's GDP in the preceding year. Once again, Council would decide the application of these sanctions by reverse majority voting on a proposal from the Commission.

  The Taskforce report proposes a very similar model of escalating fines to the Commission proposals. However, there is one major difference—the Taskforce report concluded that once a Member State is identified as running fiscal policies that deviate from the principles of prudent fiscal policymaking as set out in the Broad Economic Policy Guidelines, the Council should give the Member State recommendations within one month. After that period, the Member State has five months to take corrective action. If, after that time, the Member State has not made sufficient progress, Council decides by reverse majority voting whether to apply an interest bearing deposit to the Member State.

  The Commission and Taskforce proposals represent a significant improvement on the current system, as they shorten the time between the different stages for application of sanctions. As I said at the evidence session, the effectiveness of any sanctions system will be determined by the degree of political will within the Council to apply the system fairly. However, although the reverse majority voting method rightly requires the Council, rather than the Commission, to make the ultimate decisions on application or escalation of sanctions, it also makes it considerably more difficult for a Member State to gather sufficient political support to escape sanctions.

  The Committee asked about the feasibility of applying sanctions to a Member State that already has a high deficit and/or high public debt levels. I would draw the Committee's attention to provisions in the draft Commission proposals that allow for sanctions to be reduced or cancelled. This may be done "on grounds of exceptional economic circumstances" or if the Member State in question makes a successful appeal to the Commission within 10 days of the Council deciding to impose or escalate the sanction.

  Naturally, these proposals may be amended by the Council prior to adoption. If there are any significant changes to the proposed mechanisms for adopting sanctions, I will write to the Committee to provide an update.

  I hope that you find this information useful in your inquiry, and I wish you and your Committee a very happy Christmas.

December 2010

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