The Fiscal Compact. The Fiscal Compact also known as the Treaty on Stability, Coordination and Governance in the EMU came into force on 1st January 2013. It binds only the EU states which have ratified it on that date and later binds States which ratify it afterwards. The Treaty applies both to states which are members of the euro zone, or it may apply on their accession to the euro zone, if ever.
The Pact is a stricter version of the previous Stability and Growth Pact signed by 25 out of 27 states (excluding the Czech Republic and the UK) in March 2012. States bound must draft within one year, an implementation law to provide a mechanism to guarantee that budgets will be comply with the Treaty in terms of balance, surplus or deficit. It must be guided by monthly surveillance of an independent Fiscal Advisory Council.
A balanced budget is a general budget, that’s at less than 3 percent of Gross Domestic Product and a structural deficit of less than 1 percent of Gross Domestic Product if the debt-to-GDP ratio is significantly below its 60 percent. Otherwise it is to be 0.5 percent of GDP.
The Treaty provides for a debt break, which defines the rate at which levels above 60 percent must be reduced. If the annual budget or fiscal accounts of a state is noncompliant, it must rectify them. If the state breaches the provisions, the correction mechanism must deliver sufficiently large improvements annually to remain on a predefined path towards adjustment.
That adjustment must meet certain limits at various points in time. If a state is subject to significant recession it is exempted from the requirement to correct until the recession terminates.
Ireland passed a constitutional referendum to permit ratification of the treaty. It has an established an independent Fiscal Council by legislation. Particulars are set out further below.
The Fiscal Pact was a response to the sovereign debt and banking crisis, which enveloped the euro zone (and particularly affecting Ireland) after 2008. It may be part of a longer-term progress towards a fiscal union for which there was insufficient political support. The Fiscal Union would require significantly greater economic integration.
The Pact is viewed by some as part of a longer-term project towards an eventual fiscal union. This would require significant changes through EU treaties, and there has not been sufficient political support in the short medium or longer-term.
An ultimate Fiscal Union may entail the issue of common euro debt in the long-term. However, the first step towards such common joint debt would need to be a significant increase in the harmonisation of fiscal and economic policies.
The emergency bailout fund known as the European Financial Stability Facility was agreed in May 2010, becoming operational later that year. In tandem, a proposal was made by Germany that all states should adapt a balanced budget law. It was proposed that this should be embodied in the Constitution to guarantee compliance with implementation of a debt break. This was ultimately embodied in the Fiscal Compact Regulation.
In December 2011, 17 members of the eurozone agreed on the outlines of a new treat to put caps on government spending. The United Kingdom refused to accept the treaty on the basis that it would be detrimental to the City of London. Accordingly it was proposed to proceed with a new treaty outside of the EU institutions both using them in part final version of the treaty.
The Fiscal Paact was agreed in 2012 by all states except the United Kingdom and Czech Republic. The adoption of the pact was said to be critical in the UK Prime Minister deciding to hold a referendum on membership of the European Union, should he be reelected.
The pact become effective on 1st January 2013, and in the case of later states to ratify when they ratify it. Ireland endorsed the ratification by constitutional amendment on 31st May 2012. States which do not ratify the treaty are ineligible for monies under the European stability mechanism in the event that emergency funding is required.
The government budget should be either balanced or in surplus. The rule operates in accordance with the medium-term budgetary objectives provided for in the stability and growth pacts. States whose debt-to-GDP ratio exceeds 60 percent must reduce it by an average of at least 120 per annum of the excess.
States were granted a three-year exemption to comply with the rule starting the year in which state’s excess deposits is bought below 3 percent, according Ireland’s obligations to not kick in for three years after 2016. Where the states are exempted from the new rule they are — shall oblige to comply with the old rule which requires debt-to-GDP ratios above 60 percent to be sufficiently reduced at a satisfactory pace.
If states does not comply with the requirements, there must be a procedure in accordance with EU principles set out in Directive for automatic corrections. This must involve independent institutions such as in the Irish case, a Fiscal Advisory Council. Where the correction mechanism apply, it must be automatic unless the deviation is used to extraordinary events outside the state’s control or due to a severe ex-economic downturn.
States already subject to the excessive deficit procedure must comply with the adjustment path towards reaching their medium-term budget objective as set out for that state and approved by the Commission. There must be a minimum annual structure – structural deficit improvement of 0.5 percent of GDP.
The mid-term budgetary objective sets out the maximum deficit per year that can be afforded when targeting the debt-to-GDP ratio below 60 percent. The sub 60 percent level should be attained by 2013. This must take account of making contingency savings to meet age, and the demographic related pension costs.
States which are within an excessive deficit procedure must submit to the Commission and Council an economic partnership program for approval setting out structural reforms to correct the excessive deficit. The implementation of the program and the budgetary plans consistent with it must be monitored by the Fiscal Advisory Council and also by the Commission and Council, EU Council.
States must prepare their plans for borrowing on the capital market to the Commission and Council to ensure that a coordination in planning.
The Fiscal Compact rules must be embodied in law. States which fail to comply may be subject to adjudication by the Court of Justice which may make an enforcement determination based on evidence and set a new deadline for compliance.
If compliance issues persist after several notifications, by the Court of Justice, a penalty of up to 1 percent of GDP may be imposed. Such fine goes to the European Stability Mechanism or the EU budget.
The fiscal pact includes provisions for economic coordination and conversion. States must take actions and measures essential to the proper functioning of the ERE area in pursuit of objects of improving competitiveness, promoting employment, contributing to public finance, stability and reinforcing financial stability.
Major policy reforms must be discussed in advance and coordinated, where appropriate with the state and EU institutions. States agree to use measures specified for enhanced coordination of fiscal policy and enhanced cooperation of nations.
The treaty provides for summit of the euro zone members to take place biannually. Meetings include all heads of state in the euro zone, President of the Commission and Central Bank. The agenda is limited to questions arising from the responsibility of the state, states within the euro. With regard to currencies relevant to the EU area rules, strategic orientation, conduct of economic policies and convergence.
In effect, the above act in tandem with existing Stability and Growth Pact. The fiscal provisions under the Compact extend the existing Stability and Growth Pact regulations. This regulation applies to all states. It ensures that plans must comply with the limits for deficit and debt reduction. The Council and Commission monitor compliance.
Under the pact, when States breach the 3 percent budget deficit or do not comply with the level rules, the Commission initiates an Excessive Deficit Procedure. It submits measures to the state for correction of the position. It is up to the State to implement specific provisions.
Program rest towards each state’s medium-term budgetary objective is to be evaluated with reference to the structural balance and analysis of income, expenditure etc. If the state breaches its adjustment pact repeatedly towards compliance with the relevant objectives and limits, the Commission may fine the state up to 1 percent of its GDP. The Council may overrule the fine.
The Fiscal Advisory Act 2012 provides for appointment of Irish Fiscal Advisory Council and for implementation Fiscal Pact rules. The legislation and treaty were approved by constitutional referendum. The rules themselves do not have constitutional status. The state was authorised to approve the Pact.
The Fiscal Council is to be appointed as an independent body. It is independent in the performance of its functions. It monitors, and at least once a year provides an assessment as to whether the state is compliant with its obligations under the legislation and Pact.
An assessment includes an assessment as to whether exceptional circumstances exist or have ceased to exist, whether there is a failure to comply with the budgetary rules, constituting a significant deviation under the EU regulation, whether progress is being made in accordance with the plan towards securing compliance with the budgetary rules.
The Council provides an assessment of official forecast. In relation to which budget and stability program, it provides an assessment of whether the fiscal stance for the year or years concerned in the opinion of the Council conducive to prudent economic and budgetary management, including by reference to the provisions of the Stability and Growth Pact.
If the government do not accept the assessment of the Council within two months, it must prepare a resolution a lay it before the Dail setting out the reasons for non-acceptance.
The legislation enacts the budgetary rules, the debt rules, makes provision for the medium-term budgetary objective and provides for the correction mechanism.
The government has a duty to secure that the requirement imposed by the legislation which derive from the treaty are to be complied with. This includes in particular, the substantive obligation to comply with the budgetary rule and debt rules.
The budgetary rule is that for each year the budget condition is that either the budget position and the position and the failure does not endanger fiscal sustainability in the medium-term — is at the medium-term budgetary objective.
The adjustment path condition is that the annual structural balance of the general government is converging towards the medium-term budgetary objective in line with the timeframe set out in the surveillance and coordination regulations at EU level, or the requirement is not being met as a result of exceptional circumstances and the failure does endanger the fiscal sustainability in the medium-term.
The debt rule is that general government debt to Gross Domestic Product at market price is either less than 60 percent or has been reduced in accordance with the excessive deficit regulation until it reaches 60 percent.
The lower limit of the medium-term budgetary objective is an annual structural balance of the general government of minus 5 percent of gross domestic product at market price. If the ratio is significantly below 60 percent, and risks in terms of long-term sustainability are low, the lower limit of the medium-term budgetary objective is an annual structural balance of the general government of minus 1 percent at market prices.
Provision is made for the correction mechanism. If the Commission addresses a warning to the State under the EU regulation that there is a failure to comply with the budgetary rule which constitutes a significant deviation, the Government must lay a plan before Dáil Éireann within two months as to what required to seek — ensure compliance with the budgetary rule. The plan must specify the period over which compliance is to be achieved, the size and nature of the revenue and expenditure, measures required to secure compliance, and outline how revenue and expenditure measures are to be taken will relate to different subsector.
The provisions of the plan must be consistent with the Stability and Growth Pact, recommendations made to the State under the Pact in relation to the period over which compliance is to be achieved and the size of measures and the current stability program, where the government consider that exceptional circumstances have arisen during the period of the plan, the matter specified in the plan are no longer required to be done provided that the government shall lay a new plan before Dáil Éireann for approval.
If the government considers the failure to comply with the budgetary rule is likely to occur the government may, prepare and lay a statement before Dáil outlining the steps to avoid a failure. Above provide that when exceptional circumstance ceased to exist, the government shall within two months prepare a new plan and lay it before the Dáil.
An exceptional circumstance is a period in which in a neutral event outside the control of the state has a major impact on the financial position of the general government or a period of severe economic downturn as defined by the Stability and Growth Pact. The general government is defined in accordance with the European system of account. The general government debt means the gross debt at nominal value of a general government.
The Gross Domestic Product at market prices of the state is as defined in the European system of account. The annual structural balance of the general government means the general government deficit or surplus for the year cyclically adjusted and net of one-off and temporary measures, expressed as a percentage of gross domestic products at market prices.