1
The redistributive effects of the EU budget:
an analysis and a proposal for reform
Angel de la Fuente
Instituto de Análisis Económico (CSIC)
and
Rafael Doménech*
Universidad de Valencia
February 2000
Abstract
This paper analyzes the redistributive effects of the EU budget during the period 1986-98,
explores the implications of the Berlin budget agreement and advances a proposal for setting
member countries' budgetary balances in a manner consistent with a simple equity criterion
based on relative income per capita. Using an extension of a standard methodology, we find
that the redistributive impact of the EU budget has been considerable in view of its small size,
that it has tended to increase over time, and that it is mostly due to the effects of structural
programmes. We also find that, in spite of the relative loss of weight of structural transfers,
the expenditure side of the Berlin budget agreement represents a noticeable (but small)
improvement over the previous financial perspectives in terms of both its redistributive
impact and its horizontal equity properties. Our proposed allocation criterion involves the
correction of horizontal inequities while preserving the current degree of redistribution. This
would involve a sizable reallocation of net contributions across rich countries and only a
modest reduction in north-south fiscal flows.
Keywords: European Union, fiscal flows
JEL Classification: H11, H77, H87
___________________________
* This paper was written as part of a research project cofinanced by the European Fund for Regional
Development and Fundación Caixa Galicia. Additional financial support was provided by the Spanish
Ministry of Education and Culture under grants SEC99-1189 and SEC99-0820. We are grateful to Juan
Varela, Antonio Maudes, Alberto Cerdá and Andries Brandsma for their helpful comments.
Correspondence to: Angel de la Fuente, Instituto de Análisis Económico, Campus de la Universidad Autónoma de
Barcelona, 08193, Bellaterra, Barcelona, Spain. Tel: 93-580-6612. Fax: 93-580-1452. E-Mail address:
delafuente@cc.uab.es, or
Rafael Domenech, Departamento de Análisis Económico, Universidad de Valencia, Campus de los Naranjos,
46022 Valencia, Spain; E-Mail address: rafael.domenech@uv.es
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1.- Introduction
This paper analyzes the redistributive effects of the EU budget during the period 1986-98, explores
the likely implications of the Berlin budget agreement and advances a proposal for setting member
countries' fiscal balances in a manner consistent with a simple equity criterion. In the positive part of
the paper, we extend a standard methodology for the analysis of the impact of fiscal flows that involves
running regressions of appropriately normalized budget items on relative incomes per capita. The
estimated coefficients and the residuals of these regressions are then used to construct annual
indicators of the degree of redistribution induced by the overall EU budget and by each of its
expenditure and revenue items, as well as measures of total and partial national budgetary balances
corrected for income per capita. The results provide a compact and fairly complete characterization of
the redistributive impact of fiscal flows across Union members over the last decade. Our indicators,
moreover, have some convenient additivity properties and are easier to interpret and to work with than
the Lorenz curves often used to describe the redistributive effects of Union programmes.
The regressions we estimate can also be seen as an attempt to extract from the data a simple
allocation rule for budget resources that is consistent with the principle of cohesion and presumably
reflects the consensus on the desirable degree of redistribution implicit in the status quo. In the second
part of the paper, we argue that the explicit adoption of such a rule (relating national budget balances
to relative incomes per capita) would be useful in focusing and simplifying EU budget negotiations, in
increasing their transparency, and in improving horizontal equity across member states. In addition,
our proposal would change the incentives faced by national governments in a way that should improve
the efficiency of EU expenditure programmes. Using as a reference the 1998 situation, we explore the
implications of the proposed rule and conclude that there is plenty of room for redistributing resources
across member states in a way that will mitigate perceived inequities without reducing the overall
degree of redistribution. We also find that the recent Berlin budget agreement is a partial step in the
right direction, as it can be expected to increase slightly the degree of redistribution of the EU budget
while reducing somewhat the existing fiscal disparities across countries with similar income levels.
3
2.- Measuring the redistributive impact of the EU budget
This section describes the methodology used to analyze the effects of fiscal flows across EU states.
As a number of authors have done in the related literature,
1
we estimate a series of regressions of
various budget items on relative "gross" income per capita (GNP per capita before EU transfers and
contributions) in order to obtain a redistribution coefficient that measures the fraction of the income
differential with the EU average that is eliminated by the relevant fiscal flow. The residual for a given
country in this regression will measure the deviation from the implicit allocation rule described by the
fitted regression line, and will accordingly be interpreted as an indicator of the adjusted "fiscal
treatment" of the country under the relevant programme. It should be noted from the outset that we
regard these regressions as simply a convenient way to summarize the data, and not as a way to test
hypotheses. Hence, we will work only with point estimates and disregard any discussion of statistical
significance or intervals of confidence. We will, however, be concerned with the dispersion of the
residuals as an inverse indicator of the degree of horizontal fairness of the allocation, given the average
degree of redistribution implicit in the estimated equation.
Our starting point will be a decomposition of each country's per capita net budget balance with the
Union (nb) as the algebraic sum of a series of per capita transfers and contributions:
(1) nb
i
= t.tot
i
- c.tot
i
= (t.str
i
+ t.agr
i
+ t.other
i
) - (c.vat
i
+ c.gnp
i
+ c.own
i
)
where t stands for EU transfers or expenditures and c for national contributions to the Union, both in
per capita terms. On the EU revenue side, we distinguish between contributions linked to VAT
revenues (c.vat) and national GNPs (c.gnp) and traditional "own" resources (c.own), comprised mostly
by net tariff revenues. Expenditures are grouped into three categories: i) structural expenditures (t.str),
comprised by the Regional, Social and Cohesion Funds, the Fisheries instrument and the guidance
section of the Agricultural Fund, ii) agricultural expenditures (t.agr), which includes farm subsidies
under the guarantee section of the Agricultural Fund, and iii) other expenditures (t.other), which
includes expenditure under horizontal policies (e.g. R&D programmes), transitory payments to new
member states and various miscellanea. This last item also seems to include a small fraction of
international cooperation programmes as allocated among member countries by the European Court of
Auditors. Although in principle the expenditure data exclude the administrative costs of the various
Union institutions, on the basis of the results for Luxembourg we cannot exclude the possibility that
part of these costs may be included in t.other.
1
See for instance Sala-i-Martin and Sachs (1992), von Hagen (1992), Bayoumi and Masson (1995), de la Fuente
(1997), Martin (2000) and Doménech, Maudes and Varela (2000) on the analysis of fiscal flows within federal or
quasi-federal systems. The details of the specification vary. Some authors regress income after tax and transfers
(instead of these last two variables) on gross income. Specifications in levels with cross-section data averaged over
"long" periods are generally used to try to assess long-term redistributive effects, while specifications in
differences with time-series data for each territory are used to determine the stabilization effects of the federal
budget.
4
Our budget data are taken from the Annual Report of the European Court of Auditors and are
originally expressed in ecus.
2
These figures are converted into national currencies and adjusted,
together with incomes per capita, for differences in purchasing power. The resulting values are then
normalized by average EU income per capita and expressed in differences with the corresponding
(weighted) EU average.
3
Thus, nb
i
is the difference between country i's net balance per capita and the
average EU per capita net balance, measured as a fraction of average real EU income per capita. Notice
that the average EU net balance will generally be different from zero because i) some EU expenditure is
not allocated among member countries (e.g. administrative expenses) and ii) Union payments may
differ from EU receipts in any given year (even more than budgeted expenditure) due to time lags in
the execution of the budget.
Using the transformed data, we will regress member countries' relative net balances per capita and
their various components (total transfers, total expenditures and each of the individual budget items)
on relative income per capita in gross terms (i.e. GNP per head before contributions to or transfers
from the Union budget) normalized in the same way as the other variables (i.e. measured in percentage
deviations from average EU income per capita in purchasing power units). Since we are interested in
redistributive (rather than stabilization) effects, we will run our regressions in levels, using cross section
data, and repeat the exercise for each year in the sample period in order to examine the evolution of the
system over time. Hence, for each year between 1986 and 1998, we estimate cross-section regressions of
the form
(2) nb
i
= -ρ
b
y
i
+ ε
bi
(3) t
ki
= -ρ
tk
y
i
+ ε
tki
and (4) c
ki
= ρ
ck
y
i
+ ε
cki
where y
i
is the relative gross income per capita of country i, t
k
and c
k
are the k-th transfer and
contribution items, ρ
ck
and ρ
tk
the corresponding ("partial") redistribution coefficients and ε
ki
the
regression residuals. Since these residuals capture the deviation from the amount that would
correspond to each country on the basis of its income per capita under the allocation rule implicit in the
regression line, we will refer to them as "adjusted" or "excess" partial balances. Notice that we have
specified the regressions so that ρ
k
is positive if and only if the k-th budget item is redistributive, that is,
if on average poor countries contribute less to the Union or receive more transfers from it than rich
ones. Thus, ρ
b
= nb
i
/(- y
i
) is the relative net per capita transfer from the EU expressed as a fraction of
the income differential with the EU average in a typical member state. The composition of the sample
varies over time, reflecting the accession of new entrants and German unification.
Equations (2)-(4) are estimated by weighted least squares, weighting the observations by population
size. Failure to weigh the observations would give misleading results due mostly to the effect of
Luxembourg (see Figure 1 below). Our normalization of the data (in relative deviations from weighted
2
See Doménech, Maudes and Varela (2000) for a more detailed description of this data set. For 1998 we use the
information provided by the European Commission in Allocation of 1998 EU operating expenditures by member states,
since the annual report of the Court of Auditors for this year does not provide sufficient information about the
allocation of the different expenditure programmes across countries.
3
See the Appendix for a more detailed description of the normalization procedure and the construction of the
variables used in equation (1).
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EU averages) implies that the sum of the weighted residuals in the estimated equations will be zero.
Hence, the exercise of redistributing net balances across countries in a way that adds up is simpler than
it would be in the unweighted case, where a counterfactual budget designed to eliminate deviations
from the fitted line will typically not be feasible (because a reduction in per capita transfers to Ireland
by one ecu will not pay for a reduction of the same amount in the per capita German contribution). The
definition of our variables also ensures that the regression constant will be zero. This feature is
convenient for two reasons. The first one is that it allows us to measure the progressivity of the system
through a single parameter with a straightforward interpretation. The second is that, if we interpret the
estimated regression as an allocation rule, this rule will specify that the budget should be neutral for
countries of average income per capita. This seems sensible if we want to make normative
recommendations as to the "fair" allocation of net contributions.
Another convenient feature of our specification is that the partial redistribution parameters (ρ
k
)
associated with the different programmes and the adjusted partial balances (i.e. the residuals ε
ik
) will
add up, across equations for a given year, to the overall redistribution parameter (ρ
b
) and the adjusted
net balance (ε
bi
) obtained from the overall redistribution equation.
4
This property allows us to
construct a simple indicator of the contribution of each budget item to redistribution across member
states and to trace the sources of a country's net fiscal balance to the effects of specific programmes.
3.- Results for 1986-98
Figure 1 displays the relationship between per capita net budget balances and relative GNP per
capita across the member states of the EU in 1998.
5
The negative slope of the fitted regression line
indicates that the net effect of the EU budget is redistributive, as net balances are, on average, positive
in poor countries and negative in rich ones. The estimated redistribution coefficient is 0.0576. Given the
definition of our variables, this parameter indicates that, for a typical European citizen, the net effect of
the EU budget is equivalent to a flat tax of 5.76% levied on the difference between his gross income
(adjusted for purchasing power differences) and the EU average -- or to a subsidy of the same
magnitude if his income is below average. Although this figure is very small compared with the degree
of regional redistribution achieved by national fiscal systems (which typically lies around 0.30 for
European and North American countries), it is achieved with a volume of expenditure only slightly
above 1% of GNP (as compared to figures between 30 and 60% of GNP for national fiscal systems). In
this sense, then, the EU budget is a rather effective instrument for redistribution among member states.
4
See the Appendix for a derivation of these properties.
5
Our results are slightly different from those reported in a previous version of this paper (de la Fuente and
Doménech (1999)) because i) we have extended the sample period by one year and ii) we now use GNP per capita
rather than GDP as the regressor in our our redistribution equations. Since our emphasis is on income (i.e. ability
to pay), rather than on productivity, this variable seems preferable. On the other hand, the change makes very
little difference in terms of the overall message of the paper, although it is important when evaluating the excess
balances of some specific countries (especially Ireland).
