ࡱ> Root Entry G<@ F9"e`(-e:WordDocument=ObjectPool5 G<@;9"e9"evSummaryInformation`(vgb98  !"#$%&'()*+,-./01234567L<X;[>?@ABCD`MNOPQRSEY\]^_abcdefghiwxyz{CompObj'fObjInfo&Equation Native $xCompObj8j  "%(*+,-./0123469 FMicrosoft Word Document MSWordDocWord.Document.69qRoot Entry G<@ F9"e`(-e:WordDocumentH̟ObjectPool5 G<@;9"e9"evSummaryInformation`(vgb9  !"#$%&'()*+,-./01234567LX;[GIJKTMNOPQRSZUVWYj\]^_klmnopqrstuvFHP DeskJet 870C SeriesLPT1 ,,>>>>chSTe$$a)e),,,,----;----3333333333333====a>>>I }}), resulting in lower CAP spending in the UK. b. The UK made a proportionately larger contribution to the funding of the Community, due to the fact that the UK had a relatively higher share of the VAT harmonised base than of the total GNP of the Community. The effect of these features was that, by the mid 1980s, and in the absence of any rebate mechanism, the UK would have made a net contribution to the EC which, as a percentage of GNP, would have been the largest in the Community - despite the fact that the UK had the third lowest level of GDP per head in the Community. 2.3 To overcome this anomaly, it was agreed at Fontainebleau that the UK should be paid a rebate essentially equal to 66% of the net contribution it would have paid in the absence of a rebate mechanism: this is paid for by contributions from other member states. In fact, the actual rules for the calculation of the rebate have become progressively more complicated through time for two main reasons: a. As the own resource system has been progressively modified, with greater emphasis being put on GDP in calculating gross contributions, it has been necessary for the Commission, in calculating the UK contribution, to neutralise each of these modifications in order to work back to what the UK would have paid if the budgetary rules of 1985 were still in operation. b. Rebates on the extra amounts which other member states have to pay to fund the UK rebate have been introduced to reduce the burden on Germany, the Netherlands, Austria, and Sweden. For the purposes of the present paper, it is sufficient to describe the UK rebate as if it were still calculated in its original pure and simple form: that is, two thirds of the UKs unrebated net contribution. This assumption does not affect any of the principles involved: but greatly simplifies the presentation of the argument. 2.4 In essence, suppose that, before the rebate:- The gross contribution of the UK = G Receipts to UK from EU = E The net contribution would therefore be = G - E. The effect of the rebate is to give the UK a refund, where rebate = 0.66*(G - E) Therefore, the net contribution of UK to the EU = 0.33*(G - E) (In actual fact, the rebate is paid in arrears: however, this simplified exposition captures the essentials of the situation). 3. Performance of the Rebate Since 1985 3.1 In terms of its primary function, of reducing the UKs net annual contribution, the rebate has operated as intended. As calculated by the Commission itself, (Technical Annex as above), in the absence of any correction mechanisms, the UK would have been on average the largest net contributor over the seven years to 2003, and they estimate the UK would remain as such over the period to 2013. 3.2 What has changed significantly since 1984, however, has been the relative wealth of the UK compared to other members of the EU. Whereas in 1984 the UK was the third poorest member of the EC in terms of GDP per head, the UK is now one of the wealthier members of the Community. The UKs relative standing depends on the precise measure used: but in terms of GDP per head, (on a purchasing power parity basis), the UK was the sixth wealthiest member of the EU in 2003 (source: Eurostat Yearbook, 2004): and in terms of GNI per head, (as quoted in the Commission Technical Annex), the UK was assessed to be the wealthiest. 3.3 Chart 1 shows the net contributions per head of each member in 2003 (after the UK rebate), plotted against GDP per head: (the sources of these figures are (i) for net contributions, European DG Budget, Commission Services, and (ii) for per capita GDP, Eurostat Yearbook 2004). If the UK were not to have its rebate, the effect would be, approximately, to treble the UKs net contribution per head: which would put the UK in the position of being the highest net contributor per head. As it stands, the Chart shows that countries like Germany, Sweden and the Netherlands, which are of comparable wealth to the UK, are in fact making higher net contributions per head. These countries could argue, with some justification, that the effect of the existing rebate is now to overcompensate the UK relative to their positions. (As an aside from the main theme of this paper, it can be seen from Chart 1 that the country with the most anomalous funding position is Ireland, which receives the largest net amount per head of any country in the EU, despite now being one of the wealthiest countries on a GDP per head basis. This is relevant to the debate about the contributory factors to Irelands recent economic success.) 3.4 Looking to the future, the Commission estimate that, if the current rebate rules are not changed, the effect of the enlargement of the EU would be to increase the average UK rebate by more than 50% compared with the average over the past seven years. The effect would be that the UK would become the smallest net contributor to the EU budget along with Finland. (ref: Technical Annex as above). 3.5 To summarise, therefore: a. If the UK rebate were scrapped, the UK would become the largest net contributor over the foreseeable future. b. If the rebate were retained unchanged, the UK would become the smallest net contributor. Failing a complete overhaul of the expenditure patterns of the EU, (in particular of the CAP), the above facts in themselves present a strong argument, not for scrapping the UK rebate, but for modifications to the rebate mechanism. In fact, however, the case for reform of the rebate system is even stronger than this, once the harmful effects of the perverse incentives built into the current rebate mechanism are also taken into account - particularly the harmful effects on the UK itself. These perverse incentive effects are analysed in the next section. 4. The Perverse Incentive Effects of the Current UK Rebate 4.1 This section examines the operation of the rebate in more detail, and identifies perverse effects which the Fontainebleau mechanism has on the UKs attitudes to the EU. 4.2 Looking at the operation of the rebate from a UK viewpoint, consider the UKs likely attitude to a new EU policy proposal: (that is, we are concerned at this point in the paper with policies at the proposal stage, when they are being discussed and refined before possible implementation.) Suppose that the UK, before rebate, contributes a fraction s of any extra Community expenditure: (this fraction s is based upon the UKs share of the Communitys wealth). Suppose also that, for the particular policy proposal under consideration, the UK would attract a share e of the Community expenditure on the policy. It is also assumed that there is a requirement for a 100% matched funding for this type of expenditure: (that is, for every 1 received from the EU in support of the project, the UK must match this with a further 1 to be spent in the UK on the project). Suppose that this particular new policy will represent a cost of X on the Community budget. Consider first of all what the implications would be for the UK in the absence of the UK rebate. In these circumstances, given the above assumptions, the additional cost to the UK in terms of the increase in the UKs gross contribution would be sX, the funding received from the EU would be eX. Allowing for matched funding the total expenditure in the UK arising from the new policy would therefore be 2eX. Therefore the cost to the UK is sX +eX, (that is, the cost of the increase in gross contribution plus the requirement for matched funding): the extra expenditure in the UK is 2eX: and hence the proportion of the extra expenditure in the UK funded by the UK is  EMBED Equation.2  . .(1) Now consider what happens when there is a rebate in operation. Since it is useful to express the operation of the mechanism algebraically, it is assumed that the UK rebate factor is r: that is, that the UK is given as a rebate a proportion r of the difference between its gross contribution and the EU programme funding which it receives: (at Fontainebleau, the rebate factor r was set at 0.66) . In these circumstances, the proportion of the extra expenditure that takes place in the UK which will actually be funded by the UK is as follows: Proportion of extra expenditure in UK funded by UK = 0.5*(1+r) + 0.5*(1-r)*(s/e)..(2) (this formula is derived in the attached Annex). It should be emphasised that what this formula shows is the extra expenditure undertaken by the UK as a result of the introduction of the new programme, (which will consist of the increase in the UKs rebated gross contribution, plus matched funding in the UK), expressed as a proportion of the total expenditure on the programme on the ground in the UK, (that is, receipts from the EU for the programme, plus matched funding.) 4.3 The first thing to note is that when there is no rebate, that is when r =0, formula (2) does indeed agree with formula (1) as we would expect. Note also that the proportion given by formula (2) will fall as e gets larger. Since the maximum value of e is 1, which is when all EU expenditure for a policy is allocated to the UK, it therefore follows that the minimum value of this function will be when e=1. Plugging in the current UK values of r and s, (namely r = 0.66 and s = 0.16), then the minimum proportion of extra expenditure which will actually be funded by the UK is 0.86. That is for every 1 spent on such an EU approved and supported project in the UK, 86 pence of the expenditure will be provided by the UK. 4.4 What this shows is that, with the rebate mechanism operating, even in the most favourable case (when all of the expenditure on a proposed policy would be allocated to the UK), the UK would still end up funding over 85% of the additional expenditure in the UK from its own resources. Of course, for all real world policies the UK share of the EU budget allocation, e, will be very much less than 1, which means that the proportion of the expenditure in the UK funded by the UK will be greater than 0.86. For values of e below a certain point the proportion in formula 2 will be greater than 1: that is, the UK will pay out more as a result of the policy than is spent on the policy in the UK. This point occurs when e = s, and this is irrespective of the value of r. 4.5 We now want to use formula (2) to explore how the presence or absence of the current rebate is likely to affect UK behaviour in its approach to new EU policy proposals. This is best illustrated graphically: the relevant chart is Chart 2. One curve in Chart 2, (marked with rebate), shows how the proportion of extra UK expenditure funded by UK varies with e, assuming r is fixed at 0.66, and s takes its current value of 0.16. In the other curve, (marked without rebate), r is set at 0. Without the rebate, when confronted with a range of new policy options, one would, of course, expect a country to support strongly those options for which e is likely to be greater than s for that country: for such policies, the country gets back more than it puts in, and the proportion of the extra expenditure in the country actually funded by the country will be less than 1. For countries which are net contributors to the EU, however, most new policy proposals are likely to have e values for the country which are less than the countrys s value: so the introduction of most new policies will cost the country more than the benefit it will receive. But as can be seen from Chart 2, the slope of the without rebate curve rapidly becomes very steep for e < s: in this area of the curve, even relatively small variations in the e values between different policies will make a big difference in how expensive the policy is for the country, relative to the benefit it will receive. The country will therefore have a strong incentive to participate actively in the debate about the choice of new EU policies. In other words, when there is no rebate, net contributor countries are likely to be active participants in the policy formulation process in the EU. Contrast this with the position faced by the UK, operating on the with rebate curve in Chart 2. First of all, (unlike the case of no rebate), where e > s the with rebate curve does not go down much below 1, so there is no prospect of the UK securing (perhaps by a process of horse trading), the implementation of an occasional policy which will be highly favourable for the UK: as we have already seen, even for the most favourable policy the UK will still end up funding itself at least 86% of the extra expenditure in the UK. 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