The European Union’s finances. The battle of the budget

A quarrel over the EU budget could become the sleeper issue in referendums on the EU constitution - especially Britain's

MONEY is so often at the root of family squabbles. The European Union is no exception. Ever since Margaret Thatcher wielded her handbag in the 1980s to demand her money back, the budget has caused friction. The then Mrs Thatcher won a rebate for Britain at the Fontainebleau summit in 1984. But summits at Edinburgh in 1992 and Berlin in 1999 saw more budget rows. Now it may happen again, as EU leaders wrestle with the “financial perspective for 2007-13”.

The phrase sounds deceptively technical. What it means is fixing spending on the common agricultural policy (CAP), regional aid and so on for the next seven years. It must be done unanimously by all 25 members, which is hard because the budget is a zero-sum game: more for one country means less for others. The timing makes things harder. The Luxembourg presidency of the EU hopes to do a deal in June, but few believe it will. The presidency then passes to Britain, which will be fighting to protect its rebate and preparing for a referendum next year. On past precedent, the budget row could spill into 2006.

Next week, Britain's House of Lords EU select committee publishes a report* that sets out the main sticking-points. There are essentially four: how big the budget should be, how much should go to the CAP, how to distribute regional aid and the British budget rebate.

The EU budget is out of date. A 2003 report to the European Commission by a group of experts led by Andre Sapir, a Belgian economist, called it an “historical relic”. The Sapir report suggested a rethink, including scrapping CAP spending and shifting regional aid to new members. Sadly the commission, under pressure from national governments, ignored it. Instead, it proposed just to add a dollop to existing spending plans, lifting the budget from 1% of GDP (some €115 billion, or $150 billion, a year) to 1.14% by 2013.

The six biggest net contributors - Germany, Britain, France, the Netherlands, Sweden and Austria - want to keep the budget below 1%. Their views matter, since they account for three-quarters of net payments into the budget. Even so, they may have to compromise. Commission officials are already touting a middle ground around 1.07% of EU GDP.

One problem is that the six do not agree about what to cut. They disagree most about the CAP. In October 2002, France's president, Jacques Chirac, persuaded the German chancellor, Gerhard Schroder, to agree to keep CAP spending unchanged up to 2013. An EU summit pusillanimously endorsed this deal, so the commission had to stick to it in its financial perspective. Over 40% of the EU budget goes on the CAP, in support of a shrinking industry that accounts for less than 4% of EU GDP.

Yet it may be possible to reopen the Chirac-Schroder deal. As the Lords report notes, it sets ceilings, not targets, for spending. In the Doha round of trade talks, the EU has offered to scrap export subsidies for farm products. And, because past reforms of the CAP switch spending from production-linked subsidies to direct payments to farmers, the case for financing these nationally, not at EU level, is growing. If France's government wants its farmers to have higher incomes than Greece's, why not pay for them itself?

The obstacle to either cutting or renationalising the CAP is Mr Chirac himself. He cut his political teeth fighting for French farmers. In Berlin in 1999, he reopened a CAP reform earlier accepted by his own ministers, and also blocked national financing. Having stitched things up in advance this time, he will balk at more talk of reform, even if Doha demands it.

Arguments on the third issue, regional aid, could be just as heated. Britain is leading a camp demanding a switch of regional aid to the new members from central Europe, plus Greece and Portugal, the only old members with below-average GDP per head. There is something ludicrous in the commission's plan to spend over half of EU regional aid in the 15 older members, 13 of which have above-average incomes. But the commission knows that the big beneficiaries, such as Spain, will fight hard for their money. Spain was especially truculent in 1992, thereby securing floods of cash.

All this may, however, pale into insignificance compared with the likely row over Britain's budget rebate, which will pitch 24 countries against one. The commission has suggested replacing the rebate with a “generalised corrective mechanism” that would also produce rebates for Germany, the Netherlands and Sweden. Nobody seems to want this, least of all the British, since it would double their net contribution. The British insist they will veto any changes to the rebate, which they say remains justified because of the continuing distortion of the CAP. As the Lords report notes, a corollary is that, were big reform of the CAP on offer, the case for the British rebate would disappear - but France, the noisiest critic of the rebate, is also the loudest opponent of CAP reform.

Even so, Britain's case for keeping the rebate in its present form is weaker than it was. For one thing, its GDP per head has grown relatively fast. In 1984 Britain was the third-poorest member. Now it is richer than Germany, the Netherlands and Sweden, all three of which pay more per head into the budget. The rebate will also rise as the costs of EU enlargement kick in: from around €4 billion a year now to €7 billion by 2013. Britain, the fourth-biggest net contributor per head now (post-rebate), will be ninth-biggest on average between 2007 and 2013; for the first time, it will pay less than France and Italy. And it will not pay its whack for enlargement (indeed, new members will pay for its rebate).

Yet whatever the economic arguments, the political reality is that no British government could give up any of the Thatcher rebate, least of all when it has to win a tricky referendum. One official says flatly: “no rebate, no constitution”. The problem is the timing. The other 24 may be pushing hardest against the British rebate early next year, just as the referendum campaign is in full swing. One option then might be to stall negotiations on the budget until after the British vote. That might make budget planning for 2007 chaotic in the extreme - but still be preferable to the chaos that could follow a British no vote.

* “Future Financing of the European Union”. Our Europe editor, John Peet, acted as an adviser to the House of Lords committee.

A quarrel over the financial perspectives for 2007-2013 could become the sleeper issue in referendums on the European Constitution - especially in the United Kingdom.

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