Changes to EU budget could benefit Cyprus

LAST week the European Commission published its ideas on possible reform of the budget of the European Union. That is bound to raise the tone of public debate in Brussels. Even though the EU is based on the principle of solidarity between member states, when it comes to money, that solidarity evaporates in an instant. In the past, most deliberations on budgetary arrangements degenerated into a scramble with member states trying to secure as much as possible for themselves.

Cyprus has not done well out of its budgetary contributions and receipts. For the three years 2007-2009, its average annual payments into the EU budget have been 183 million euros, while its average annual receipts reached only 143 million euros: a net negative position of about 40 million euros per year.

To some extent this is not a surprising outcome. Close to 90 per cent of EU resources is spent on agriculture, regional development and research. Cyprus has a relatively small and inefficient agricultural sector; it is fairly prosperous so it does not qualify for much development support, and its research record is very poor, so it attracts few subsidies for research.

Does this mean that EU membership has been a costly mistake for Cyprus? Not necessarily. It is misleading to equate net budgetary flows with the benefits and costs of membership. I have always argued that the biggest benefit for Cyprus is the fact that the economy has been liberalised and that public policy has been put on a more economically sound basis.

Perhaps my views may seem misplaced given the recent spat between the Minister of Finance and the Governor of the Central Bank on the stability of public finances. The Governor questioned the adequacy of the austerity measures of the government and warned that its budget deficit could reach seven per cent of GDP. Under EU rules, public budgets must be kept in balance and any deficit may not exceed three per cent of GDP. If one bears in mind the steep cuts in public spending in countries like Greece, Spain, Ireland and the UK, the Governor may yet proven to be right.

So, you may justifiably ask, how is EU membership making any difference at all? Well, if Cyprus were not a member of the EU and if it did not have the euro as its currency, it could have taken the easy way out: print money and devalue. Of course, no one knows what Cyprus could have done had it not been a member of the EU. But what is clear is that its deficit will have to be reduced one way or another. So far the government has avoided the single most effective but politically most difficult option. And that option is to cut the bloated civil service salaries, pensions and other benefits. Since the EU will not allow the Cypriot government to run an excessive deficit for too long, I would not be surprised if eventually the government musters the courage to do what it should have done already and rein in the ever increasing civil service costs.

As Cyprus is struggling to repair its public finances, the question that arises is whether the reform of the EU budget proposed by the Commission could in the longer run be beneficial to Cyprus. There is no doubt that the government could use that 40 million euros it pays to the EU to reduce its own deficit.

The Commission made a radical proposal. Currently, the EU budget has three main sources of revenue: tariffs, VAT receipts and contributions linked to the GDP of each member state. The Commission suggested that these sources of revenue be replaced by a new tax levied directly by the EU. It identified the following taxes: a charge on the financial sector, auction of emission permits, a tax on air travel, a sales tax, an energy tax and a corporate income tax.

To appreciate how these new taxes may impact on Cyprus it is first necessary to understand the composition of current Cypriot payments into the EU budget. In 2009, 18 per cent of its payments came from tariffs and 14 per cent from VAT receipts. By contrast, tariffs were only four per cent of the payments of Luxembourg, EU’s richest per capita member, and VAT receipts accounted only for eight per cent of the payments of Germany, EU’s largest economy. By contrast, Cyprus’ GNP-related contributions were only 68 per cent of its total payments while those of Luxembourg and Germany were 79 per cent and 77 per cent, respectively.

It follows that a tax not linked to imports [because Cyprus is an economy dependent on imports] or to sales [because Cyprus relies more heavily on easily collected sales taxes] should be to the advantage of Cyprus.

It so happens that Cyprus will hold the Presidency of the EU in the second half of 2012. If member states are not be able to reach an agreement on the new budgetary arrangements by that time, it will become Cyprus’ responsibility as chair of the EU Council to broker a compromise. I very much hope that it will not pursue its own self-interest too crudely.


Phedon Nicolaides is a professor at the European Institute of Public Administration, Maastricht, The Netherlands.