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IFS - The EU Budget: a guide

In a new report and accompanying interactive online tool out yesterday, IFS researchers provide an explanation of how the EU budget works, its size, where revenues come from and what the main areas of spending are.

They also provide an estimate of the UK’s net contributions to the EU. The overall net contribution will be a little over £8 billion a year going forward, though it fluctuates from year to year and was £7.5 billion in 2012, £9.1 billion in 2013 and £5.7 billion in 2014.

This is not an estimate of how much stronger the public finances would be if we were to leave the EU. That would depend in part on the deal reached with EU – it is possible that an alternative arrangement of relations with the remaining EU countries would involve the UK continuing to make significant contributions to the EU Budget. More importantly it would depend on the economic effects of leaving. We will come back to the overall fiscal consequences of Brexit in a later publication.

The EU budget and the UK contribution

The overall EU budget is about 1% of the EU’s GNI (Gross National Income) and GDP. That compares with national budgets of between 35% and 58% of GDP. European Commission figures show that the UK’s gross contribution to the EU Budget was £11.3 billion in 2014, compared to total UK public spending of £734 billion. We received back £5.6 billion through various programmes leaving a UK net contribution of £5.7 billion.

Different numbers have been put in the public domain. Much larger numbers for the gross contribution (figures of £18.8 billion in 2014, £17.8 billion in 2015 have been quoted) don’t take account of the UK’s rebate. Ignoring the rebate in this way does not seem sensible.

As for net contributions we have taken our figures from the European Commission, which include flows from the EU which don’t go through Whitehall departments – for example grants to universities – since this is money that comes back to the UK even if it does not go via the UK government. Other figures, which exclude these flows and account for the timing of payments in a different way to the European Commission figures mentioned above, give a net contribution of £9.8 billion in 2014. The OBR has forecasted that the net contribution calculated on this basis will average £9.6 billion a year between 2015 and 2020. Since the receipts by the non-governmental sector that are excluded from these figures are around £1-£1.5 billion a year, we can expect the UK’s overall net contribution to average just over £8 billion a year in the medium term, although it’s important to note that figures can jump about rather a lot from year to year.

Funding and spending the budget

If those are the headline figures, what else can be said about the EU budget?

The EU’s budget is rather complex and opaque. While there is a rational process in place to determine its size and allocation it is, perhaps inevitably, subject to considerable political horse trading between countries. The UK’s rebate on its contributions to the EU budget is perhaps the most famous of the special deals negotiated by a member state but it is far from unique. There are numerous allowances, rebates, additional allocations and the like negotiated within it.

It raises most of its revenues from three sources. Nearly three quarters comes simply from GNI based contributions – that is countries contribute according to their Gross National Income. This is a pretty straightforward and sensible basis for funding. About 13% of the EU budget comes from so called “VAT based contributions”. This is neither straightforward nor sensible as contributions are based on a hypothetical VAT base that no EU member state actually applies. This element remains because of earlier hopes that VAT could be fully harmonised and a source of EU revenue. This method disadvantages countries in which spending on goods and services that form part of this hypothetical construct constitute a large fraction of national income. Finally tariffs on goods entering the EU provide the remainder of the budget. These tariffs sensibly belong to the EU given that the goods are entering a single EU wide market. The fact that countries which collect the tariffs get to keep 25% (falling to 20%) as costs of collection, though, seems less reasonable. The average cost of collecting taxes is, thankfully, a tiny fraction of this.

The spending side of the EU budget is dominated by two spending areas which together account for over three quarters of the budget: Structural and cohesion funds on the one hand, and agriculture and rural development on the other, each account for about 38% of total EU spending.

Cohesion funds go to the poorer EU nations – those with GNI per capita below 90% of the average. Given the way the EU is funded they, alongside the structural funds which go to poorer regions, ensure that the EU budget is redistributive from richer countries such as the UK to poorer countries, largely in Eastern and Southern Europe. Recall though that the total budget is just 1% of GNI so the scale of redistribution is inevitably limited.

Structural funds go to regions within countries according to how poor they are relative to the EU average, but also according to levels of employment and population sparsity. Relative to other rich countries the UK looks like it should do relatively well from these funds because it has some really quite poor regions such as West Wales and the Valleys and Cornwall. In fact this is offset by our high employment rates and high population density and a relatively poor track-record of getting European Commission approval for projects to be funded from our structural funds allocation. A number of other countries such as Germany have also negotiated special deals for regions that would usually not qualify under the standard rules.

The agriculture and rural development budgets remain large, though they have been shrinking as a fraction of the total budget. They have also been reformed such that they no longer directly subsidise production – we no longer create wine lakes and butter mountains. The exact basis for their allocation is obscure though – and this is deliberately so. The idea is that by avoiding explicitly spelling out the formulae used, that it is easier for agreement to be reached (otherwise much time may be spent by member states trying to tweak the formulae in ways that benefit them and can attract the support of other influential members). The cost is a lack of transparency.

The UK gets relatively little from these budgets, partly because we have relatively little farmland given the size of our population and partly because, for historical reasons, we get lower payments per hectare of farmland than many other countries. It was, in large part, because of these relatively low receipts that the UK negotiated for and obtained its rebate back in the 1980s.

There is clearly room for reform and improvement of the budget and budget processes on both the spending and revenue side. But since the overall fiscal flows between the UK and the EU are relatively small – our gross contribution is around 2% of public spending, our net contribution around 1% - the scale of the benefits to the UK from improving the budget processes should not be overestimated.

This report was produced with funding from the Economic and Social Research Council’s The UK in a Changing Europe initiative.

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