The budget of the European Union: a guide

Introduction

On 23 June 2016, voters in the UK will be asked to decide whether they wish to remain in the European Union (EU) or leave. While the EU budget may not be so central to the current debate as it was in the 1970s and 1980s, claims about how the UK fares under the budget, and whether the way the EU raises and spends its money are ‘fair’, ‘efficient’ and ‘sensible’, will likely rear their head in the coming months.

This guide provides background on the EU’s budget and its impacts on the UK, looking at questions that include:

  • How big is the EU budget and how has it changed over time ?
  • What are the EU’s main sources of revenue ?
  • How is the EU budget allocated across different budget areas ?
  • Why does the UK benefit relatively little from EU spending ?
  • How much does the UK contribute and receive from the EU, and how does this compare to other countries ?

This information is generally in the public domain already but is scattered across different documents on the UK government and EU websites. By bringing the information together and explaining it in a clear and concise way, we hope this ‘guide’ helps demystify the EU budget and how it works – although, as we shall see, the workings of some major parts of the budget are less than transparent.

The full version of the guide is available here. An interactive summary of the main facts, figures and information is also available.

The EU Budget – the big picture
EU revenues
EU spending
The UK’s rebate
The UK’s net contributions to the EU Budget

This report on the EU’s budget is the first of a series of analyses the IFS will be publishing in the run up to the EU referendum examining public finance and budgetary issues. The net contributions the UK makes to the EU budget are the most direct impact of EU membership on the UK’s public finances, and are the easiest to calculate. But they not necessarily the most important: if leaving the EU significantly increased or reduced national income, the impact on the public finances would dwarf the UK’s current net contribution (around £5.7 billion in 2014, the last year for which data are available, and perhaps around £8-8.5 billion a year on average over the next few years). Our later analysis will draw on published macroeconomic forecasts to examine this issue, and will consider a number of other issues that may arise if the UK votes to leave the EU, such as the potential scale of budgetary contributions that may be required to access the EU’s internal market from outside the Union. We will also examine how the UK’s net budget contribution might evolve if the UK decides to remain in the EU, and the options for EU budget.

The EU budget – the big picture

Total spending by the EU in 2014 across all 28 member states was €142 billion, or just over 1% of the Gross National Income (GNI) of the whole EU. This is a relatively small component of public spending within the EU: across the whole EU, public spending was 48.2% of GDP in 2014, with a range from 34.8% of GDP in Lithuania to 58.3% in Finland.

The Figure below shows how total EU spending as a share of total GNI has changed since 2000. We can see that spending by the EU gradually increased as a share of the community’s income over the seven years covering the multiannual financial framework (MFF) from 2007 to 2013, but fell in the first year of the new financial framework covering the period 2014 to 2020.

Source: European Commission.

The latest MFF involves total ‘commitments’ of 1% of GNI over the seven year period and actual payments of 0.95% of GNI (‘commitments’ can include plans for spending in subsequent years beyond the end of the period in 2020). Total spending will be increasing in real terms over this period, but falling as a share of community GNI.

Over the longer term, however, the size of the EU budget has certainly increased substantially: when the UK joined the then European Economic Community (EEC) in 1973, total spending was only 0.5% of community GNI. Most of this increase came in the late 1970s and early 1980s as the EEC expanded its structural funds for less developed regions.

Figure 2 shows the breakdown of the EU’s spending and revenues in four years: 2000, 2005, 2010 and 2014.

On the spending side, the two biggest components in both years are spending on the Common Agriculture Policy (CAP), and the structural and cohesion funds, which provide resources for the poorer regions and nations of the EU. We see that the main change in recent times has been a reduction in the share of the EU budget going towards direct support for farmers through the Common Agricultural Policy (CAP), and a corresponding increase in the share of spending on structural funds supporting less well-off regions. There have also been increases in the share of the budget spent on research and other internal policies (infrastructure, culture and managing migration flows), though these still represent a relatively small share of the overall budget. This reduction in the share of the EU budget being spent on agricultural support is part of a long term trend: when the UK first joined the EEC in 1973, this made up more than three quarters of the EU’s total budget, whereas in 2014 it was less than a third.

The three main sources of revenue for the EU budget are customs tariffs and levies that are applied at a common rate to imports entering the EU (so-called ‘traditional own resources’), a contribution from member states based on the size of their hypothetical VAT base if they followed standard EU rules for defining their VAT base, and a contribution from member states based on their Gross National Income (GNI). The EU is not allowed to run a budget deficit: all spending must be covered by the EU’s revenues (budget surpluses can be carried forward to subsequent years, however, and can be used to top up subsequent revenues). To ensure that this is the case, the GNI-based contributions of member states are set to ensure that spending does not exceed revenues.

The main change in the way revenues are raised is that there has been a shift from VAT-based contributions towards GNI-based contributions as the call-up rate (effectively the ‘tax rate’) applied to the harmonised VAT base was reduced during the early 2000s. As we discuss below, this is probably a sensible change: the VAT-based contributions are complex and untransparent, and arguably unfair. The share of revenue coming from traditional own resources has also declined as a result of the decision to increase the share of these levies that member states are allowed to retain to reflect the cost of collection (although this is soon to be partially reversed).

What is the process by which these spending and revenue allocations are determined?

The MFF sets out the planned level of ‘commitments’ for each of the EU’s functions for each year, and also a (lower) ceiling on the total level of actual payments each year. It has to be agreed both by the European Council (the governments of the 28 member states) on a unanimous basis and the European Parliament.

Each year, an annual budget is produced in advance of the start of the year that sets out levels of commitments and payments for each budget heading, which cannot exceed those set out in the MFF. The annual budget is initially proposed by the European Commission, and can then be amended by the Council (in contrast to the decision making for the MFF, by qualified majority voting rather than unanimity) and then the European Parliament. If the positions of the Council and the European Parliament differ, a conciliation committee is set up to attempt to reach a common position.

After a budget has been adopted for a particular year, ‘amending budgets’ are produced by the Commission to account for changes in circumstances that require more or less spending in a particular area, and to increase spending on areas where there were underspends in the previous year. These amending budgets have to go through the same procedure as those for the original annual budget proposal.

From this description of the budget process, it is unsurprising that the process is characterised by the different member states attempting to improve their overall budget position. In many areas of spending or revenues, different member states get additional spending allocations or reductions in the amount they have to pay compared to what would happen under the regular rules. Furthermore, in some areas, particularly agriculture, spending is allocated in line with historical spending allocations rather than current needs. The process then involves some objective criteria layered on top of historical precedent and with a good dose of compromise and political horse trading. Eventual allocations reflect all these elements of the process.

EU Revenues

As already mentioned, the EU has three main sources of revenue:

  • Nearly three quarters comes from GNI based contributions – that is countries contribute according to their Gross National Income. In principle, this is a relatively straightforward basis for making contributions. There are two riders to that however. First, revisions to earlier estimates of GNI can lead to quite significant retrospective adjustments, as happened to the UK in 2014 when data adjustments led to a demand for an additional £1.7 billion. Whilst clearly reasonable to adjust payments in the light of new information this can be politically awkward. Second, adjustments are made to payments as a result of negotiation. For example over the current MFF Denmark, the Netherlands and Sweden have secured significant reductions in their GNI based contributions, which will come into effect when the ‘own resources decision’ (the Council agreement that determines how revenue for the EU budget is raised) is ratified by all national governments;
  • About 13% of the EU budget comes from so called “VAT based contributions”. This is effectively a contribution based on a harmonised measure of consumer spending – it has little or nothing to do with actual VAT payments in each member states – and exists as a result of earlier hopes that VAT would become a union wide harmonised tax. This makes little sense as a basis for contributions and is arguably unfair on those countries where spending on VATable goods and services forms a large fraction of overall economic output. As already mentioned, the share of VAT based contributions has been declining over time and ought to be ended altogether with the slack taken up by GNI-based contributions;
  • Finally tariffs – also known as traditional own resource – make up about 11% of the budget. They are duties levied on goods entering the EU. Since the EU is a customs union with no duties levied on within EU trade this is indeed a natural source of funding for the EU as a whole. It is perhaps odd that the countries where the duties are levied are entitled to keep 25% (falling to 20%) of the duties levied in recognition of “collection costs”. The average collection costs for taxes are a small fraction of this.

Figure 3 shows the amount each member state contributes to the EU budget through each of these sources on a per person basis in 2014. Member states are ordered from richest to poorest and there is a clear pattern of richer countries contributing more per person than poorer ones (although not more as a percentage of national income).

The UK’s gross contributions (before its rebate – discussed below) amounted to €313 per person, with around €225 of this from GNI-based contributions, and the rest roughly equally split between VAT-based contributions and tariffs revenues. As one of the richer EU member states, it is unsurprising that this is above the figure for the EU as a whole: €262 per person. The largest countries with the largest measured contributions are the Netherlands and Belgium reflecting high tariff revenues from goods entering the EU via these countries. As we will discuss below, it is not clear that it is best thinking of such tariffs as being contributions from these particular countries. Excluding such tariffs, the largest per-capita contributor was Sweden.

Member states are ranked by GNI per capita with the poorest on the bottom and the richest on the top.
Source: Contributions, receipts and GNI from http://ec.europa.eu/budget/library/biblio/documents/2014/Internet%20tables%202000-2014.xls, population from Eurostat table demo_pjan.

EU Spending

Structural and cohesion funds on the one hand, and agriculture and rural development on the other, each account for almost 40% of total EU spending.

The structural and cohesion funds are the main means by which the EU redistributes from richer countries and regions to poorer countries and regions, though at less than 0.5% of EU GNI, the scale of redistribution involved is very modest by comparison with the sort of redistribution which occurs within countries from richer to poorer regions. The aim of this spending is to provide resources for regions and member states to boost their competitiveness and invest in their physical and human capital.

Cohesion funds are available only to poorer EU countries – those with GNI per capita below 90% of the EU average – and account for around 20% of total structural and cohesion funds. Structural funds, on the other hand, are allocated to regions within countries depending on their GDP per capita. Regions with GDP per capita less than 75% of the EU average are designated as ‘less developed regions’ and will receive 52% of total structural and cohesion funds in the current MFF period, while regions whose GDP per capita is between 75% and 90% of the EU average are designated ‘transition regions’ and will receive 12%. Regions with GDP per capita above 90% of the EU average will receive 16%. These rules create big discontinuities: if GDP or GNI per capita increases slightly funding can drop dramatically. There are other elements to the rules for determining entitlement to these funds such as employment rates and population density, and a number of countries, including Germany, have negotiated additional spending for certain regions. The interaction between these factors has the effect that the UK – where the employment rate and population density are high – receives somewhat less in structural funds than do some other rich countries which have fewer less developed and transition regions.

The stated rationale for the agriculture and rural development budget (or Common Agriculture Budget, CAP) is threefold. First, is to support viable food production, with a particular focus on income support for farmers. Second is the promotion of sustainable management of agricultural land, including boosting biodiversity and reducing greenhouse gas emissions. Third is to boost employment and growth and tackle poverty in rural areas.

The two main components of this area of the budget are funding for direct payments for farmers, and funding for rural development projects. EU rules determine how much each member state receives and place certain restrictions on how those funds are then used.

The EU has moved a long way from the production subsidies and price supports of the 1980s and 1990s which resulted in butter mountains and wine lakes, and dumping of surpluses onto international markets. While countries can link some payments to production, the majority of payments are area-based, and 30% are linked to farmers undertaking “greening” activity. In other respects, countries have a considerable degree of freedom over the structure of payments to individual farmers, and the balance between direct payments and funds for rural development.

While the rules on how much farmers get in each country are generally published by the national governments, the actual rules for determining how much each country receives from the overall EU budget are not published. This is apparently in an effort to prevent the periodic negotiations of the CAP from getting bogged down in horse-trading. But it does mean that the process by which national allocations are determined is far from transparent.

The EU’s budget also provides funding for other areas, where it often shares responsibility with national governments including: science and technology; market regulation; consumer protection; transnational policing; border control, migration and asylum; and foreign aid. The last few items have seen substantial growth in recent years but remain a small part of the overall budget. Central administrative costs make up around 6% of the budget – a figure which excludes the costs countries themselves bear to administer EU spending and policy (such as the CAP). Unfortunately, lack of comparable data means it is difficult to assess the scale of these costs.

Figure 4 shows the amount each member state receives from the EU budget on a per person basis. The UK receives a relatively low amount of spending per person from both the CAP and rural development. This largely reflects a relatively low amount of agricultural land per person, but also reflects relatively low payments per hectare of agricultural land: this arises because the UK has a large amount of unimproved agricultural land, for example in the highlands of Scotland, that historically attracted a much lower per-hectare subsidy rate. It also receives relatively little in the way of structural funding despite having a number of rather poor regions such as West Wales and the Valleys. Overall receipts per person in 2014 amounted to €109, compared to an average across all member states of €254.

The largest recipient by far is Luxembourg – EU statistics show that it benefited from €3,118 of spending per person. But over four-fifths of this relates to expenditure on administrative expenses at EU institutions based out of Luxembourg. Arguably this is expenditure which benefits member states as a whole rather than the country where those institutions are based. Stripping out administration expenses, Hungary was the largest recipient of EU funding per person - €670. In general, poorer states receive more than richer ones, although the newest member states – Bulgaria, Romania and Croatia are still in the process of spending ramping up.

Member states are ranked by GNI per capita with the poorest on the bottom and the richest on the top.
Source: Contributions, receipts and GNI from http://ec.europa.eu/budget/library/biblio/documents/2014/Internet%20tables%202000-2014.xls, population from Eurostat table demo_pjan.

The UK’s rebate and other ‘corrections’

We have just seen that the UK benefits less than other EU member states from the main areas of EU spending, namely the CAP (direct payments to farmers and rural development) and structural and cohesion funds. This has been the case ever since the UK joined the EU in 1973. As a result of this perceived unfairness, since 1984 the UK has secured a ‘correction’ or rebate to limit the size of its net contribution to the EU Budget. The rebate reduced the UK’s contribution to the EU budget by about 0.2% of GDP in 2014, or €6 billion (£4.4 billion). In per person terms, this reduced the UK’s contribution to the EU budget by around €94, meaning a post-rebate gross contribution of €219 per person.

The UK’s rebate was originally set at 66% of the difference between the UK’s share of the harmonised VAT base (which at that time was the main basis for contributions to the EU Budget) and the UK’s share of receipts from the EU Budget. The precise design of the UK rebate has changed more recently, with the most important change being that the UK does not receive a rebate on non-CAP spending in the member states that have joined the EU since 2004. The effect of this has been to limit the size of the rebate and increase the UK’s net contribution to the EU Budget, though it is important to note that without this change, the UK would have borne only a small share of expanding the EU to poorer countries.

This reduction in the UK’s contribution of course has to be made up by additional contributions for other member states. These are allocated on top of other revenue contributions, according to the GNI shares of the other member states, though Germany, The Netherlands, Austria and Sweden only pay a quarter of their GNI-share contribution to the rebate, with the remaining three quarters reallocated to the other member states, again based on their shares of total GNI. These countries have negotiated reduced contributions to the UK’s rebate because they are also significant net contributors to the EU Budget. The result is that France is the largest contributor to the UK rebate in aggregate terms (€1.5 billion in 2014), although Luxembourg (€40) and Denmark (€35) are the largest contributors per person.

Other significant net contributors to the budget (Germany, the Netherlands, Sweden, Austria and Demark) also receive ‘corrections’, though these take the form of lower contribution rates for their VAT-based and GNI-based contributions rather than a refund of some of their net contribution.

The UK government is able to veto any effort to try to abolish the rebate. In the absence of an agreement on future funding rules, the UK would continue to receive the rebate on the current basis. The same does not apply to the reductions in contributions obtained by other member states, which will all expire at the end of the current MFF period in 2020 unless similar arrangements are agreed for the next MFF period.

Net contributions to the EU

There are several different ways of calculating how much the UK contributes to the EU Budget.

The first main difference in the figures that are frequently quoted is whether the figure for the contribution is gross or net of the funds the UK receives from the EU budget, in other words whether the amounts received by the UK from the EU budget are deducted. HM Treasury says that the gross amount paid by the UK into the EU budget was £12.9 billion in 2015, £14.4 billion in 2014 (the year we focus on in much of this report) or £14.5 billion in 2013. This is a potentially meaningful figure, as this is the additional amount the UK government might have available to spend if the UK left the EU if two conditions were to hold. First, if the UK did not then have to continue making budget contributions as part of any future relationship with the other EU countries, as for example Norway does as part of the European Economic Area (EEA). And second if leaving the EU were not to reduce UK growth and hence tax revenues. In practice it is unlikely that either of these conditions would be satisfied. Nevertheless it is useful to know what this gross contribution is.

Larger figures for the gross contribution which do not take account of the UK’s rebate are not sensible. As already discussed, the UK is able to veto any attempts to abolish the rebate. And if we were to vote to leave the EU we would, at best, save only our actual contribution (accounting for the rebate): the EU would presumably not continue to pay the rebate to the UK!

One can also examine the net contribution after receipts from the EU budget are taken into account. The HM Treasury figures for this measure only capture those receipts that are received by the UK government, which includes structural and rural development funds and direct payments to farmers that are administered by government departments, but ignores items such as EU funding of research carried out at UK universities. Netting off these receipts by the UK government reduces the overall contribution to £8.5 billion in 2015, £9.8 billion in 2014 and £10.5 billion in 2013. If we further net off receipts by other organisations or businesses in the UK, the net contribution falls to around £5.7 billion in 2014 or £9.1 billion in 2013 (figures for 2015 for this measure have not yet been published by the European Commission).

Figure 5 shows the UK’s net contribution to the EU budget on this basis back to the 1970s. It shows that the UK’s net contribution in 2014 was rather lower than in the preceding few years. Over the next few years, OBR forecasts and historic receipts by the non-governmental sector suggest the UK’s net contribution on this basis seems likely to average around £8 – 8.5 billion per year.

Source: Net contributions: 1976 to 1999 from EU Budget 2008 Financial Report, available from http://ec.europa.eu/budget/library/biblio/publications/2008/fin_report/fin_report_08_en.pdf, 2000 to 2014 from http://ec.europa.eu/budget/library/biblio/documents/2014/Internet%20tables%202000-2014.xls, GDP from Eurostat table nama_10_gdp.

Figure 6 shows contributions on this basis for each member state in 2014. We see that the UK contributed an amount roughly similar to France (€110 per person). In the next few years, the rebound in the UK’s net contributions to more typical levels will likely see it contribute an amount per person closer to that of Austria (€153 in 2014).

As already discussed in the revenues section, European Commission spending and revenue statistics allocates spending to the countries in which that spending takes place and revenues to the countries which collect that revenue. This may not always be appropriate. The tick boxes above the graph allow you to see the impact of instead:

  • Allocating administrative spending on an equal per-capita basis to each member state. Assuming that each EU citizen benefits equally from this spending seems a closer approximation to reality that assuming that the benefit goes to those member states that house the EU’s headquarters. This is the approach taken by the Government Expenditure and Revenue Scotland publication to allocate administrative spending within the UK that cannot be directly linked to a specific nation or region.
  • Allocating tariffs revenues in proportion to each country’s GNI rather than where they are initially collected on the borders of the EU. Ideally, we would like to allocate these taxes on the basis of consumption of goods and services produced outside the EU, but as an approximation to this we could assume it is proportional to GNI.
  • Allocate aid given to non-EU countries in proportion to each country’s GNI. The UK counts this as counting towards its target of spending 0.7% of GNI on foreign aid. The UK would have to give this money directly in aid rather than via the EU if it voted to leave the EU in the forthcoming referendum, and still wanted to meet its commitment to give 0.7% of GNI. And since GNI-based contributions make up the majority of the EU’s revenue, we can think of this money more generally as being given by countries in proportion to their GNI.

Doing all of these sees a reduction in the UK’s estimated net contribution to €75 per person (rather than €110) in 2014. This reduction (around €35 per person or £1.8 billion in aggregate terms) would likely be of a broadly similar magnitude in the years ahead.

Across the EU, the impact of these adjustments is largest for Belgium and Luxembourg who now no longer appear to be benefiting greatly from administrative spending, and to a somewhat lesser extent the Netherlands, who no longer appears to be contributing so much via tariffs.

Boxes may be ticked one at a time, or in combination.

In broad terms these adjustments make little difference to the big picture impact of the EU budget: redistribution of resource from richer to poorer member states. That is part of the purpose of the EU budget. There is by no means a one for one correlation, though, between income per person and net contributions to, or receipts from, the EU. A combination of historical accident, the focus on the EU budget on agricultural subsidies, and other specific features of the way in which contributions are determined and (especially) spending negotiated, means that some relatively rich countries such as Ireland make rather small net contributions while some poor countries such as Slovakia do less well than one might expect.

It is important to put the within EU redistribution into perspective. The UK’s net contribution in 2014 (following all these adjustments) was just €75 per person or 0.22% of GNI, made up of a gross contribution of 0.64% of GNI and gross receipt of 0.42% of GNI. No country contributes more than 1% of GNI net. Some of the poorest countries receive up to 6% of their GNI, net. These net transfers across countries within the EU are very much smaller in magnitude than net transfers between richer and poorer regions of individual countries: experimental statistics from the Scottish Government suggest that in 2014–15, London’s total tax revenue exceeded public spending at a time when the UK’s overall budget deficit was 5.9% of GDP, suggesting that London’s ‘net contribution’ to the UK public finances was more than 6% of its GDP.