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EU Budget Reform Options and the Common Pool Problem

PFM, Vol. 9 No. 4, (2009)

There is a consensus in the literature that the expenditure structure of the EU budget is not in line with normative criteria based e.g. on the theory of fiscal federalism. While transfer policies have a large weight, policies of a European public good type are neglected. Our contribution explains this inefficient outcome within the framework of a political-economic two-country model adapted from Besley and Coate (2003). The model's modifications integrate crucial features of the EU setting such as income heterogeneity of countries, a GNI dependent revenue formula and the existence of transfer policies in the EU budget besides both local and European public goods. We show that the common pool problem in combination with a budget cap is at the heart of overspending on transfers and under-spending on European public goods. On the base of this model we assess different reform options related to the revenue side. We show that the effects of an EU tax depend crucially on the deviation of the specific tax base's redistributive effects from income proportionality. Furthermore, our results point to the advantages of a general but limited correction mechanism.

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