This post estimates the United Kingdom’s net contribution to the 2021-2027 EU multiannual budget at close to €20 billion, taking into account the most significant items of the financial settlement according to the October 2019 EU27-UK draft withdrawal agreement. By: Zsolt Darvas Date: December 16, 2019 Topic: European Macroeconomics & Governance The exit of the United Kingdom from the EU will have an impact on the EU’s next Multiannual Financial Framework (MFF) running from 2021-2027. The 12 December 2019 UK election result makes the ratification of the October 2019 EU27-UK draft withdrawal agreement likely. This agreement says the UK will contribute its share of the EU’s outstanding commitments and liabilities incurred until 31 December 2020. These include outstanding EU budget
Zsolt Darvas considers the following as important: EU budget, EU UK relationship, European Macroeconomics & Governance, Multiannual Financial Framework (MFF)
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This post estimates the United Kingdom’s net contribution to the 2021-2027 EU multiannual budget at close to €20 billion, taking into account the most significant items of the financial settlement according to the October 2019 EU27-UK draft withdrawal agreement.
By: Zsolt Darvas Date: December 16, 2019 Topic: European Macroeconomics & Governance
The exit of the United Kingdom from the EU will have an impact on the EU’s next Multiannual Financial Framework (MFF) running from 2021-2027. The 12 December 2019 UK election result makes the ratification of the October 2019 EU27-UK draft withdrawal agreement likely. This agreement says the UK will contribute its share of the EU’s outstanding commitments and liabilities incurred until 31 December 2020. These include outstanding EU budget commitments, the commitments made in 2021 related to the carrying over of commitment appropriations from the budget for 2020, and contingent financial liabilities related to various loans, and several other smaller items. Key exceptions are EU liabilities with corresponding assets, such as the EU balance sheet liabilities corresponding to EU financial assistance loans.
According to the draft withdrawal agreement, ongoing EU programmes will continue to be executed in the UK after 2020 until the closure of those programmes. The UK would also receive some payments from the EU, such as the UK’s share of the net assets of the European Coal and Steel Community (which is in liquidation), the UK’s share of the paid-in capital of the European Investment Bank (EIB), European Investment Fund (EIF) and European Central Bank (ECB), the UK’s share of fines paid to the EU decided up to 31 December 2020 (and even fines resulting from ongoing procedures even if they are decided on after 2020).
Part Five of the draft withdrawal agreement on financial provisions includes several other items. Yet one can estimate the magnitude of the UK’s contribution to the EU budget well by considering the following five key issues:
- The percent rate at which the UK will contribute to EU liabilities (‘the UK’s share’);
- Outstanding EU budgetary commitments;
- EU spending in the UK;
- Pension and sickness liabilities related to current and former EU employees;
- The budgetary rebate the UK receives in 2021 after its EU budget contribution in 2020.
Other amounts are either small, will not go through the EU budget (eg the repayment of EIF, EIB and ECB capital) or are uncertain (eg whether EU’s financial assistance loan to Ukraine will be repaid).
I, therefore, quantify the five issues listed above, using the methodology we developed with Konstantinos Efstathiou and Inês Goncalves Raposo in 2017.
The UK’s share
The UK’s contribution to a particular EU liability will be calculated by multiplying the liability by the UK’s share, with the UK’s share being the ratio of the UK’s contribution to the EU budget to the contribution of all 28 EU countries, from 2014 to 2020. This contribution is specified by the draft withdrawal agreement as, using the jargon of EU regulations, ’own resources’. They are composed of contributions based on Gross National Income (GNI) and Value Added Taxes (VAT), as adjusted by various rebates and other revenue corrections. They also include the so-called ‘traditional own resources’, which currently only include customs duties, but before 2017 sugar levies were included too. The UK’s share of the contributions to the executed budgets from 2014 to 2018 was 12.5%.
However, in 2019-2020 a somewhat lower UK share is expected, for two reasons related to the drop in the euro value of UK GNI. First, the pound has depreciated against the euro since the 2016 Brexit referendum and thus the UK’s GNI expressed in euros has contracted. Second, UK growth has been somewhat slower than average EU27 growth since 2016, leading to a further small decline in the UK’s GNI relative to the GNI of the EU27. Since the bulk of contributions to the EU budget depend on the share of each country in the euro value of EU GNI, a lower UK GNI measured in euros means the UK contributing a lower share to the EU budget. My projections for 2019-2020 suggests that the UK’s share for the full 2014-2020 period will be 11.9%.
The UK’s actual share might increase compared to my estimation if, for example, the recent appreciation of the pound against the euro continues and/or if the UK economy grows faster than expected in 2020. But big changes to the share are not expected since most of the 2014-2020 period has already passed. Developments in 2020 are unlikely to change the seven-year average much.
Outstanding EU budgetary commitments, or RAL
EU budgeting operates through a combination of a seven-year budget plan (the multiannual financial framework, MFF) and annual budgets. These budgets list the EU’s various planned expenditures. However, both the seven-year plan and annual budgets include two indicators for each expenditure: a commitment, or confirmation that the budget allocation is approved, and a payment, or disbursement of money. The two do not need to fall in the same year. Only a part of the commitments made in a particular year is actually paid in that year. The payment of the rest is deferred for payment from subsequent annual budgets.
Therefore, at the end of each year, there is a stock of commitments deferred for payment from later budgets. These commitments are called ‘outstanding budgetary commitments’ but are most commonly referred to by their French name, reste à liquider (RAL). At the end of 2018, RAL was €281.2 billion. The Commission forecasts the RAL to increase to €290.6 billion by end-2019 and €313.2 billion by end-2024. Unfortunately, the end-2020 RAL value is not given in this forecast, but annual commitment and payment estimates are presented, as is the total amount of decommitments (that is, cancellations of previous commitments) for 2020-2024. Assuming that decommitments are distributed equally across these five years, the estimated end-2020 value of RAL would be €303.5 billion (Figure 1).
The bulk of this RAL will likely be paid down in five years. However, historical experiences with the RAL suggests that some could be paid even later, or might be decommitted. I, therefore, assume that 98% of the end-2020 RAL will be paid down between 2021 and 2027, the period of the EU’s next Multiannual Financial Framework (MFF).Thus, I estimate the UK’s contribution to the next MFF for the end-2020 RAL as 98%*11.9%*€303.5 billion = €35.5 billion.
EU spending in the UK
Some of the €303.5 billion RAL will be spent in the UK, but it is a challenging task to estimate how much. We previously estimated this amount separately for European Structural and Investment Fund (ESIF) commitments and non-ESIF commitments. ESIF includes the European Regional Development Fund (ERDF), Cohesion Fund (CF), European Social Fund (ESF), European Agricultural Fund for Rural Development (EAFRD) and European Maritime and Fisheries Fund (EMFF).
We analysed ESIF and non-ESIF funds separately for three main reasons. First, about two-thirds of RAL is related to ESIF spending. Second, programmes financed by ESIF are under shared management and the corresponding funds are allocated directly to EU countries, which helps to separate the spending plans for the UK. And third, there is more publicly available information on the implementation of ESIF spending than on other spending categories.
For ESIF spending, we used actual flows up to 2015 and simulated the expected flows to member states from 2016 onward, assuming the flows to be proportional to the member state allocations. In these calculations, we considered the most disaggregated expenditure-item level available, ie expenditure sub-headings. On this basis, we estimated that 3.7% of the ESIF-related end-2018 stock of the RAL was related to planned spending in the UK.
For the RAL not related to ESIF, the outstanding stock was multiplied by the UK’s average share of the non-ESIF expenditures from EU budgets from 2007-2015, which is 6.4%.
Combining the two components, we estimated that 4.8% of total RAL relates to planned spending in the UK. I apply the same rate for the estimated end-2020 RAL and therefore estimate that 4.8%*€303.5 = €14.3 billion is the amount committed to be spent in the UK from the end-2020 RAL.
Pension/sickness insurance liabilities related to EU staff
Employees of EU institutions and agencies participate in unique pension and sickness insurance schemes. Officials should contribute one-third to the financing of their pensions via compulsory contributions deducted from their salaries, while two-thirds would come from member states via the general EU budget. Member states jointly guarantee the payment of these benefits.
In contrast to other international organisations, there is no actual fund behind the pension and sickness schemes, but the pension scheme operates as a notional fund with defined benefits. Since there is no fund, active EU employees pay their annual pension contributions to the general EU budget, while actual pensions are paid from the general EU budget. Pension rights are gradually acquired by the active employees, so at each point it time, the total pension liability towards current and former EU staff can be estimated. The EU staff sickness insurance system operates in a similar way (see a detailed analysis in our earlier post).
At the end of 2018, the EU’s consolidated accounts (see Section 2.9 on page 52) estimated this liability at €80.5 billion, of which the Pension Scheme of European Officials (PSEO) stood at €70 billion, while the pension scheme for top officials (current and former members of the Commission, European Parliament, Court of Justice, Court of Auditors, Secretaries General of the Council, the Ombudsman, the European Data Protection Supervisor, the European Union Civil Service Tribunal) stood at €1.7 billion, and the Joint Sickness Insurance Scheme was €8.7 billion.
It is difficult to predict the end-2020 value of this liability. It depends on the demography of pensioners, employees and their dependents, and on the discount rate used to calculate the present value of future liabilities. The 2018 PSEO calculation was based on a nominal discount rate of 1.9%, which corresponds to the euro zero-coupon yield (with a maturity of 20 years) in December 2018. Since then, this rate has fallen by a full percentage point: it was 0.89% on 10 December 2019 (see ‘All bonds’ on the ECB website). If estimated expected inflation does not fall by that much, then the real discount rate will be much lower in 2019 than it was in 2018, implying that the balance sheet value of this liability will be significantly larger.
Instead of making assumptions about the expected nominal discount rate and inflationary expectation for end-2020, I assumed that this liability will increase at the same rate in 2019-2020 as it increased in 2018, which was 6.7% per year (after taking into account a methodological change). This assumption leads to an estimated total liability of €91.6 billion at end-2020 (Figure 3).
The draft EU-UK withdrawal agreement specifies that the UK’s liability for the pension rights of high officials will be paid by the UK in 10 instalments starting on 31 October 2021, while for the other pension rights, the UK will pay its contribution to the actually paid pension/sickness amounts annually. For simplicity, I assumed that 5% of this liability will be paid in each year between 2021-2027 (even though the first actual payment by the UK is foreseen in 2022, based on paid pensions and sickness insurance payments in 2021). Based on these assumptions, I estimate that the UK will contribute €3.9 billion in 2021-2027 to the liabilities of EU staff pensioners, including EU staff sickness insurance.
The last UK rebate
Since 1985, the UK has been entitled to a financial rebate of about 66% of its net contribution to the EU budget of the previous year. While the basic concept of the UK rebate has remained the same, the formula used to calculate it has been amended many times, making the calculations demanding, and leading to a complicated system of rebates (see my post on EU budget rebates). The draft withdrawal agreement confirms that the UK will be entitled to a rebate on its contribution to the 2020 annual budget.
It is quite difficult to project the rebate (see Box 2 in our paper for the current rebate formula). The draft 2020 EU annual budget estimates the rebate in 2020 (after the UK’s contribution in 2019) at €5.3 billion (see pages 445-446 here). For simplicity, I assume that the rebate in 2021 (after the UK’s contribution in 2020) will also be €5.3billion.
The UK’s net contribution to the 2021-2027 MFF
The magnitude of the UK’s total net contribution to the next MFF will likely be close to the sum of the items I quantified above:
- The UK will contribute €35.5 billion to the RAL in 2021-2027;
- EU spending from the RAL in the UK in 2021-2027 will amount €14.3 billion;
- The UK will contribute €3.9 billion in 2021-2027 to the liabilities of EU staff pensioners;
- The UK will receive a rebate in 2021, amounting to €5.3 billion, after its contribution to the 2020 annual budget.
Therefore, my estimate for the total net contribution of the UK to the EU budget in 2021-2027 is €35.5 – €14.3 + €3.9 – €5.3 = €19.8 billion. This is the estimate I use in my paper on net balances in the next MFF.
Note that this calculation relies on two other major assumptions:
- There will be no EU spending in the UK after 2021 beyond the €14.3 billion included in the RAL. However, it is possible that the UK will participate in certain EU programmes after 2021. If such an agreement is signed, I presume that the UK will pay an additional contribution for its participation in these programmes, which will amount to at least the direct cost of the UK’s participation, and possibly more. Since such participation and its financial consequences are uncertain, I do not consider them in my calculations.
- There will be no customs duty revenues from EU imports from the UK, because the transition period which keeps the UK in the EU’s customs union could be extended, or a temporary or a permanent free trade agreement could be signed.
In summary, while the draft EU-UK withdrawal agreement presents a long lists of items to be included in the Brexit financial settlement, we can make a good estimate of the magnitude of possible UK contributions to the 2021-2027 multiannual EU budget by focusing on the largest categories. I estimate that in net terms the UK will contribute €19.8 billion to the next MFF if the withdrawal agreement is ratified. The gap left by Brexit in the EU budget will thus be considerably smaller than what the complete ceasing of UK contributions would have implied.