Back to the Brink: EU Fiscal Rules Threaten Climate Action and Social Justice

After more than four years, the ongoing process of the EU fiscal rules reform is now entering the stage of trilogue negotiations. At this stage, the European Commission (EC), the Council of the European Union and the European Parliament (EP) will decide on the rules for managing the economies of EU countries. The trilogue discussions kicked off in January this year and will continue all through to late April when the Parliament is expected to vote.

While the changes were long overdue since the existing fiscal framework is overly complex, arbitrary and based on outdated and flawed economic assumptions, the proposed rules under negotiation can hardly be seen as an improvement. On the contrary, they risk further undermining the implementation of a just transition in an already challenging environment with the multiple social and environmental crises that negatively impact economies.

What is the new deal about?

The reform of the controversial EU fiscal rules began around four years ago. The so-called EU Economic Governance Framework has been critiqued on several grounds. For example, the rules on debt and deficit spending are totally arbitrary, based on outdated and flawed economic assumptions that have been disproved scientifically. Most importantly, the rules are blind to environmental and social concerns, potentially blocking rapid and effective climate action.

At the moment, EU fiscal policy is largely driven by the Maastricht rules. Two rules are specifically important: a public debt limit of 60% of a country’s GDP and a 3% limit on its budget deficit. These rules were essentially designed to avoid the potentially negative effects of growing public debt but rely on subjective debt-to-GDP limits that have not been proven to produce a positive economic effect. However, as experts pointed out, such constraints mostly affected spending on social and environmental initiatives in the long run. 

The proposed plans offer more flexibility by focusing on country-specific debt reduction plans, but the arbitrary debt and deficit rules of 60% and 3% remain untouched. According to the European Commission’s proposal, governments would have to focus on reducing public debt for at least over four years which can be extended to 7 years. 

This way, countries with debt estimated over 90% of the GDP will be required to reduce their debt by 1% each year, while countries with debt ranging between 60% and 90% – by 0.5% annually. The proposed changes have consistently attracted criticism from the major EU trade unions and Civil Society. They perceive it as a return to austerity and criticise the narrow emphasis on strict debt reduction percentages alone. While public debt is not inherently “good” or “bad”, ignoring broader factors like debt maturity and climate risks paints an incomplete picture of sustainability. Instead of a fixed reduction rate, a more nuanced approach considering multiple factors is crucial. 

Now the EU fiscal rules are being discussed in trialogue. The Council’s position very much reflects German Finance Minister Christian Lindner’s, along with other frugal countries, and includes highly restrictive fiscal rules, including arbitrary yearly debt, deficit reduction targets and safeguards, such as a deficit resilience safeguard’ which means that countries will need to reduce their deficits until they reach 1.5% below the 3% target. The Parliament position is led by the Social Democrats (S&D) and the European People’s Party Group (EPP). While their proposal includes some improvements, such as increasing the participation of stakeholders, it is not substantially better than what the Council wants, as it still includes the safeguards, and is generally weak on the quality of investments. All in all, the EP position would neither guarantee additional fiscal space nor incentivise investments in a green and just transition. It even fails to reduce complexity, as more simplified rules were one of the main goals of the review process. 

What does it all mean for the just transition?

As of today, 13 of the 27 EU Member States have debt-to-annual GDP ratios above 60%, with the EU’s total ratio estimated at 83.5%. If the new stringent measures are adopted, they will undoubtedly make it nearly impossible to continue investment in green and social initiatives and, consequently, achieve the resolutions under the Green Deal (EGD) in time, a study by the Greens/EFA group in the European Parliament found in January. 

According to recent reports, countries in the EU could be forced to cut their budgets by over €100 billion a year from now in line with the new fiscal rules. Countries like France, Italy, Spain, Germany, Belgium and the Netherlands will be expected to make the biggest cuts, ranging between 6 and 26 billion euros per year, in the next four years to meet deficit reduction goals. 

Experts say that the new fiscal rules mean the “return of austerity”, making the achievement of the EGD objectives and the green transition impossible. And much more money will be needed, since Europe requires continuous investment in green industries and infrastructure to reach the goal of reducing net emissions by 55% by 2030, as well as funding socially just solutions to take one step closer towards creating a better future for all. 

While the current fiscal rules reform stresses the threats of rising debt, claiming it puts pressure on future generations, it seems to ignore the pressing need for investment into a sustainable and just future for long-term benefits of the planet’s population. To put it into numbers: the green funding gap is estimated to be €700 billion per year, so almost impossible to reach for countries that have to make additional budget cuts each year to meet the demands of the reform. 

In 2024, the only EU countries that will be able to close their green funding gap under the proposed EU fiscal rules are Denmark, Ireland, Latvia and Sweden, which means that poorer countries will even be less able to finance the transition. It’s also often the poorer countries that are hidden hardest by the climate crisis. However, the crisis is a transnational problem that requires coordinated measures and joint solidarity solutions.

In a recent letter to the European Parliament, the Fiscal Matters – a group of civil society organisations, think tanks and trade union leaders that the EEB is part of –  warned about the direction where the fiscal rules reform is headed. They call for the need to reject the “deficit resilience safeguard” of 1.5%, as well as adopting the “Do No Significant Harm” (DNSH) principle to highlight and strengthen the importance of the quality of public spending.

If these changes are not made and the sides choose to stick to restrictive and ineffective fiscal rules that European financial ministers insist on, we will be risking failure of the implementation of a just transition to a green economy. As the final plenary vote is coming in April, the little remaining time is crucial to pushing for change. In addition, we need to look into the future and think of ways to create additional fiscal space for the transition by implementing a new fiscal capacity and progressive taxes in the EU.