The European Court of Justice, in a historic step forward for European integration, has upheld the European Union's ability to withhold funding from member countries for failure to adhere to relevant European rules and regulations. The February 16 ruling led to headlines describing it as a warning to or rebuke of Hungary and Poland, where severe crackdowns on political freedoms have outraged Brussels.
Now for the first time, the European Commission has the legal clout to withdraw funding from an EU member state without having to secure the backing of all other members. In due course, this lower political threshold for taking member states' money will prove a powerful political tool for Brussels.
But no less important, at a time of increasing solidarity in Europe in response to Russia's threats—and now attacks—against Ukraine, the ruling upholds the EU's ability to enforce fiscal rules on errant member states. The focus of the ruling by Europe's highest court was the EU's new "general regime of conditionality for the protection of the Union budget," which expanded the European Commission's powers to withhold EU budget funds from a member state it deems to have breached budgetary rules. It comes just as the EU has been debating reform of its rules for imposing limits on fiscal deficits of member countries.
Separately, the EU is authoring up to €750 billion in a regional pandemic recovery plan, NextGenerationEU. The combination of expanded common fiscal resources and increased political conditionality are signs of further EU fiscal and economic integration.
The Commission's new powers enable it to act if a breach of the principles of the rule of law "affect or seriously risk affecting the sound financial management of the Union budget or the protection of the financial interests of the Union in a sufficiently direct way." The wording provides a potent weapon against government corruption. It is too soon to tell if it will be used against Hungary if it fails to conduct free and fair parliamentary elections in April.
The EU budget process has long guarded against financial fraud, at least in theory. In practice, EU regulations of member states' budgets have been toothless. The "Copenhagen Criteria," dating from the 1992 Maastricht Treaty, defines requirements for member states, including adherence to democracy, rule of law, human rights, and minority protections. Members must also be market economies with the administrative capacity to implement EU laws. But EU members have been consistently reluctant to interfere in each other's affairs. No ongoing centralized oversight of how EU funds are spent by members has been established. Until now, the only provision for oversight has been the so-called "Article 7 procedure," which states that a member state can be sanctioned if all other EU members think it is in "serious breach" of EU values. This tool has never been used.
Member states must also adhere to commonly agreed administrative and political priorities in their use of EU funding. But such conditionality is limited in scope to avoid Brussels being accused of red tape or overreaching against member states. Disbursement of funds is also, theoretically, linked to members' adherence to the Stability and Growth Pact (SGP), the EU rules that a country's budget deficit cannot exceed 3 percent of GDP and national debt cannot exceed 60 percent of GDP. The EU has suspended the SGP since the beginning of the pandemic, but it has imposed penalties (in the form of funding cutbacks) for violating these rules only once, against Hungary. In 2012, it suspended €495 million from the EU budget for that country.
Much of the immediate focus on the Court's ruling will be on whether the Commission will deploy the new enforcement tool against Hungary before the elections in April. But even if the Commission does not, the new procedure increases the likelihood that it will use budget sanctions against a member if approved by a qualified majority of 55 percent of member states (15) representing 65 percent of the EU population. Such a step would greatly expand the Commission's "integrating budget power."
The importance of the EU's embrace of budget conditionality becomes clear when considered in conjunction with other economic developments in Europe. First, the de facto non-enforcement of the SGP since its inception and outright suspension of it during the pandemic has made it clear that the threat of economic sanctions has not worked in compelling fiscal discipline on member states. As the SGP suspension expires, the EU must choose between continued non-enforcement of its rules or undertake fundamental reform of the entire SGP framework. The Commission has already signaled that it will not continue to enforce existing unreformed SGP rules in 2023 or beyond.
Whatever decision they make, the reality of the pandemic will be hard to discard. The €750 billion recovery and resilience facility (RRF), comprising conditional grants and loans, has changed the dynamics. Member states are obliged to commit the majority of these grants toward climate and digital infrastructure investments to get the money. Access to that funding thus goes beyond the new terms of conditionality, representing more of an incentive than a threatened punishment to get member states to act in the commonly desired manner.
The EU's new rules increasingly replicate the US approach to federal funding, supported by the US Constitution's "Spending Clause" (Article I, Section 8, Clause 1) that provides the federal government with the legal authority to offer federal grant funds to states and localities contingent on their engaging in, or refraining from, certain activities (see a detailed discussion in Yeh 2017). As discussed in 2018, such federal government conditional grants make up around 30 percent of US states' budgets today, a level beyond anything contemplated in Europe. Still, despite doubts in many quarters, Europe's economic and political integration is being materially strengthened.