EU Treasury Bond Proposal

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In the Euro area, many countries have large debt stocks beyond 60% of GDP, which caused the Euro crisis and doubts on the debt sustainability in certain countries. To avoid similar events in the future, this paper proposes to change the EU treaties so the EU is allowed to raise 4% of VAT in Euro area countries. In return, it assumes debt of up to 60% of GDP for each Euro area country by issuing EU Treasury Bonds. Countries with less debt get cash, so all countries benefit by a similar amount. In addition, article 125 of the Treaty on the Functioning of the European Union is strengthened by explicitly stating the possibility of default. Because the tax is controlled centrally and only used for repayment of debt, the new Treasury Bonds are as secure as the safest asset in the Euro area and expected to pay no higher interest rate. But since there are no additional liabilities for member states themselves, which lowers potential conflict with the German Grundgesetz, their interest rates should not increase either. With this proposal, little sovereignty is lost; VAT fraud should be reduced and tax collection improved; and it maintains pressure to keep finances in order.
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  EU Treasury Bond Proposal   Johann Müller   Nov 2013   eutreasuryproposal(at)gmail.com   1   EU Treasury Bond Proposal    Abstract   In the Euro area, many countries have large debt stocks exceeding 60% of GDP, which lead to the Euro crisis and fuelled doubts on the debt sustainability in certain countries. To avoid similar events in the future, this paper proposes to change the EU treaes allowing EU to raise a 4% VAT in Euro area countries. In return, the EU assumes debt of up to 60% of GDP for each Euro area country by issuing EU Treasury Bonds. Countries with less debt get cash, so all countries benet by a similar amount. In addion, arcle 125 of the Treaty on the Funconing of the European Union is strengthened by explicitly stang the possibility of default. Because the tax is controlled centrally and only used for repayment of debt, the new Treasury Bonds are as secure as the safest asset in the Euro area and expected to pay no higher interest rate. Also since member states themselves are not burdened by any addional liabilies, the potenal conict with the German Grundgesetz is likely to be small. Some posive externalies of this proposal are reduced VAT fraud and improved tax collecon; potenally lower borrowing cost by creang a new safe reserve asset; addional incenves for non - Euro EU countries to enter the Euro area; lower tax collecon cost for countries; together with banking union, issues in individual countries become less important, hence Maastricht criterion become less relevant for joining the Euro; connued pressure to keep nances in order; sets example for future integraon; lile sovereignty lost by countries.   Introducon   There have been numerous proposals for the creaon of Eurobonds during the height of the Eurocrisis. However, the debate quickly abated despite persistent debt overhang 1  in many countries. At the same me, a reopening of the EU treaes is discussed to enshrine the banking union, and other changes pushed by the larger EU countries. In this seng, this proposal intends, by making explicit treaty changes, to circumvent some of the shortcomings of previous proposals like the potenal vicious circle issues that most previous proposals shared. Moreover, 1  Debt above 60% of GDP, the maximum level of debt allowed under the Maastricht Treaty    EU Treasury Bond Proposal   Johann Müller   Nov 2013   eutreasuryproposal(at)gmail.com   2   the proposal intends to resolve other issues regarding tax collecon or tax fraud due to the current legal fragmentaon or issues enforcing laws. These large benets are achieved without signicant loss of sovereignty for member states and maintain market pressure to promote budget discipline and draw in part from exisng proposals. Exisng proposals Some of the most prominent previous proposals include the EU Commission Stability Bond Proposal, the Blue Bond Proposal by Bruegel and the Redempon Fund Proposal by the German Council of Economic Experts. A more complete comparison can be found in Claessens et al. (2012).   The Blue Bond Proposal   wants to split current debt into two categories. Blue bonds up to 60% of GDP are jointly and several guaranteed 2  within the Euro area, while red bonds for amounts exceeding 60% are only guaranteed by individual member states. As up to 60% is jointly guaranteed, interest rates on this part should be equal for all countries and considerably lower for some and moderately higher for other countries. This creates a large joint bond market, which can be used as a reserve asset. At the same me, countries with debt exceeding 60% are likely to pay higher interest on their red bonds, encouraging them to keep their budget in check. While this proposal alleviates some of the pressure for the highly indebted countries, there are shortcomings to this approach. In addion to the treaty change to allow member states to become liable for the joint issuance there are addional naonal hurdles, in parcular in Germany with the Grundgesetz. There are some potenal implementaon dicules regarding the GDP threshold during recessions, as the blue bond might become more than 60%. A larger issue with this proposal is the potenal vicious circle that is not broken: Assuming that one country is not able to pay any debt, then the blue bond liabilies of all remaining Euro area countries increase -  this increase could repeatedly cause the next weakest member state to default as well unl only one country is le. Assuming the last country was Germany, the largest country in the Euro area, with a GDP share of around 30%, it would have to stem blue bonds of 2  Every member state is liable for all the debt.    EU Treasury Bond Proposal   Johann Müller   Nov 2013   eutreasuryproposal(at)gmail.com   3   200% of GDP in addion to its red bonds. If any other country was the last country, much worse raos would be obtained.   The Redempon Fund Proposal   wants to take all the debt exceeding 60% of GDP and create a redempon fund that pays the debt o over 20 - 25 years. Each country sll has to pay the interest on its share, but there is joint and several guarantee to lower the interest rate. Due to its one o nature, this proposal should maintain the incenve to keep the budget in check in each country. Compared with the previous proposal, the impact on interest rates should be smaller, as less debt is mutualized, but sll relieve the highly indebted countries. Similar to the previous proposal, the potenal vicious circle remains, even though the risk became much smaller, as the outstanding debt exceeding 60% is much smaller than the amount below. Also, the addional liability might have the same addional naonal hurdles as the previous proposal. These hurdles might even be higher, as countries with higher debt can mutualize more debt relave to their GDP level.   The EU Commission Stability Bond Proposal   outlines three cases with dierent degrees of common issuance in the Euro area. The rst case assumes joint and several guarantee for all bonds (but each country sll pays interest on its share of bonds). As all bonds become the same, member states pay the same interest rate, where highly indebted countries benet more from this proposal. While this creates an even larger bond market than the Blue Bond Proposal and hence more liquidity, there is no more incenve for countries to keep their budget in check. In addion, this does not break the potenal vicious circle described above and creates the stronger naonal hurdles due to asymmetry. The second case is essenally the same as the Blue Bond proposal, except that the threshold for joint and several liability is le open. The third case is very similar to the second case, except that member states are only several liable 3 , but there is collateral. The only interest relief several liability with collateral might give to countries is due to higher liquidity. However, this relief might be small which puts the ability to deal with the debt overhang into queson. Due to the several guarantee, there is no potenal vicious circle. 3  Liable up to their share    EU Treasury Bond Proposal   Johann Müller   Nov 2013   eutreasuryproposal(at)gmail.com   4   As can be seen from the crical descripon of the previous proposals, either there is a potenal vicious circle due to joint and several guarantee (which likely requires a treaty change) and naonal hurdles or the eect on the debt overhang is not clear. The EU Treasury Bond Proposal   My proposal suggests that the EU assumes 60% of GDP of its Euro area member state’s debt as a one o measure. Member states with less government debt than 60% of GDP get a nominal credit amount for the dierence that they can use as they like. It needs to be taken into account that some member states were in a recession for some me and hence their debt to GDP rao mechanically increased. Hence 60% of the highest GDP value since 2007 or some cyclically adjusted GDP value should be used. Over the next two decades, the EU is bound to reduce this debt to 40% of Euro area GDP.   In return for assuming this debt, the EU is allowed to levy and control a 4% VAT. If member states collect the tax on behalf of the EU, the EU must at least be allowed to send its own ocers to check that the tax is collected correctly. To calculate what this implies in terms of income, Germany is used. In 2012 it collected € 194.6bn in VAT at 19% (destas) on total nal consumpon expenditure in 2012 of € 1490.5bn. Neglecng the lower VAT rate for certain goods in Germany, a 4% VAT tax corresponds to a revenue of € 146.2bn for the enre Euro area with total nal consumpon expenditure of € 5320.3bn in 2012 (Eurostat). Euro area GDP was at € 9483.8bn, hence this tax could pay 2.57% interest on bonds 4 . Given that the bonds are a nominal amount and VAT returns grow with nominal consumpon growth, the increases in revenue over me can be used to repay some of the debt unl a debt to GDP rao around 40% is achieved. If there are addional revenues at this point (up to 3.85% interest could be paid then), they can be used to reduce the payments made to the EU budget by Euro area member states. If the required payments are exceeded, addional revenues ow back to member states. As member states would have to pay interest on their bonds and an amount to the EU budget anyway, this should be a very small loss in sovereignty. 4  This does not include administrave cost or the reducon of VAT fraud  
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