Last week, the EU announced a coronavirus relief proposal including jointly issued debt—an expansion of the one France and Germany mooted earlier—as part of its €1.85 trillion 2021 – 2027 budget. Pundits treated it as a watershed moment. But in our view, this reaction looks overstated and hasty. The budget likely faces a long, uncertain road to passage, with a lot of compromise along the way. Moreover, it doesn’t look much like stimulus to us—and we don’t think its passage or rejection should materially affect the pace of Europe’s economic recovery or the length of the bear market.
The budget’s key plank—and the piece that drew so many headlines—is a proposed €500 billion in grants and €250 billion in loans for EU member-state governments. They would target those (especially Italy and Spain) with less-sound finances and larger COVID outbreaks. Ideally, by easing perceived fiscal pressure, they would bolster and encourage national coronavirus response efforts.
The purportedly groundbreaking part is the financing. EU revenues currently come from member-states’ required contributions, import duties and a portion of each member’s value-added tax. Initially, funding for this far more expansive budget would come from €750 billion in newly issued (and new, period) common EU debt. The EU hopes an array of new taxes flowing directly to EU coffers would help pay off this debt down the road. These include a tax on companies the EU classifies as significant beneficiaries of access to the EU single market—most likely multinational companies based outside the EU; a digital transactions tax on companies with a “significant digital presence,” in the event ongoing OECD efforts to develop a global digital tax fall short; and a “carbon border adjustment tax” on imports from countries with less strict emissions controls than the EU. [i]
The proposal tries to head off a “two-speed recovery” from COVID-related restrictions’ economic devastation, in which the harder-hit Southern European nations become permanently poorer than Northern. These concerns aren’t new—“imbalanced growth” worries have circulated for years since the financial crisis and the eurozone’s 2011 – 2013 regional recession. They underpin recurrent fears of things like the common currency splintering, since weaker, more indebted regions can’t spend in an effort to bolster growth. The EU’s budget aims to fix that by acting as a temporary fiscal transfer union—sharing debt and tax revenue on the coronavirus response. It also strikes us as an attempt to push through long-stalled EU policy goals. Debate over “finalizing” the monetary union through sharing debt has swirled since its inception, while discussion of some other issues, like the digital tax, have persisted for years.
Whatever you think of the plan’s goals, here is what it isn’t: stimulus. Fiscal stimulus aims to jumpstart demand during a recession by forcibly creating it where it didn’t exist. Typically, this means new government spending on infrastructure projects and the like, which then ripples through the private economy. By contrast, the EU’s plan would mainly shore up member-state public finances. Supporters hope this would free up those governments to spend, but this isn’t assured. Plus, most national COVID fiscal response plans under discussion or implemented mainly seek to tide firms and consumers over to better times—effectively acting as bridge loans. That does little to boost near-term demand. Even if this plan passes, relief funds wouldn’t hit until March 2021 at the earliest. The recovery could be well underway by then.
The budget’s other novel component—taxes issued by the EU as a singular entity—are the opposite of stimulus. Granted, they wouldn’t go into effect immediately, as EU member-state governments would still have to approve and collect them. The EU budget proposes a rollout target of 2024, though national governments could implement them earlier. We aren’t opining on their wisdom as policy, but looming tax burdens don’t seem calculated to encourage commerce. They are more associated with austerity. Consider the digital tax, which would hit EU revenues of global Tech companies with worldwide sales exceeding €750 million annually—principally, large US Tech firms. While we don’t think it would be large enough to materially decrease affected firms’ profits, it could influence future decisions about where—and where not—to expand. Vague tax details—like how you determine where digital revenue was domiciled or which companies the EU will decide draw enough benefits from EU market access to warrant special taxation—could increase uncertainty, which diminishes risk-taking. That is generally the opposite of what you want when you are trying to jumpstart an economy.
For now, all this is largely hypothetical. The proposal may not happen—especially in its current form. The 27-country consensus required for passage seems distant presently, with some northern EU governments already objecting to the grants. Nearly everyone seemingly expects extensive negotiations. Even the digital tax, a relatively minor plank of the plan, seems contentious. The EU’s previous attempt foundered on opposition from low-tax countries (namely Ireland and Luxembourg) that benefit from the current system, in which Tech giants pay taxes only to those countries in which they have a physical presence. The US government may also see the move as protectionist and retaliate. When France passed a digital tax last July, the Trump administration threatened tariffs on French imports. A later compromise scuttled both.
Regardless of the budget’s prospects, we don’t think the length of the current downturn and bear market depend on it passing as-is. Economies don’t need saviors. Eventually, they resume growing with or without government assistance. Presently, it seems to us the key is how fast businesses reopen and commerce regains a semblance of normalcy. Stocks’ reaction to the proposal’s twists and turns over the past couple weeks suggests its progress (or lack thereof) may influence sentiment. However, the impact is typically fleeting and unpredictable. Hence, we don’t think it should factor into your investment decision-making.
[i] “The EU Budget Powering the Recovery Plan for Europe,” The European Commission, 5/27/2020.
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