Catalonia Crisis Casts Shadow over Potential European Fiscal Union

In the aftermath of the independence referendum in Catalonia, supporters and opponents of Catalan secession remain bitterly divided. The chaotic conflict surrounding the referendum represents a severe test to Spanish unity. Professor Friedrich Heinemann, head of the Research Department “Corporate Taxation and Public Finance” at the Centre for European Economic Research (ZEW) in Mannheim, offers his view on the referendum and its implications for a potential European fiscal union.

“Spanish cohesion is currently facing a severe test in the chaotic conflict surrounding the referendum on Catalan independence. The desire for independence shared by many Catalans has its roots in numerous and complex historical, cultural and political factors. Of particular importance, however, is the fiscal dimension of the issue. A highly influential argument put forward by the independence movement has pointed to the financial burden placed on the region combined with Catalonia’s limited budgetary autonomy. This is an experience that Europe should pay close attention to, given the ambitious reform proposals for the EU and the euro area currently being discussed, many of which point to greater centralisation. Some of the blueprints for a future European Fiscal Union run the risk of making leaving the European federal system seem like an attractive option – just as it is for many Catalans in Spain today.

The fiscal relationship between Catalonia and the Spanish state is characterised by the following features. There is a considerable gap between the tax revenue collected by the central government in the region and the amount of public funds that flow back. According to the Spanish government’s own calculations, the net payments made by the autonomous region amount to the approximate yearly sum of €10 billion. This corresponds to five per cent of Catalonia’s economic output. Calculations carried out by the Catalan government using a different method point to an even higher deficit of 7.5 per cent of Catalonia’s GDP. Depending on the method of calculation used, the per capita financial burden on Catalans amounts to somewhere between €1,300 and €1,900 a year.

Spain faces losing one fifth of its economy

The dominance of the central government and Catalonia’s limited budgetary autonomy are also reflected in the distribution of government debt. In 2017, Spain’s public debt across all levels of government reached a level of €1,150 billion, almost 100 per cent of the country’s GDP. The Spanish central government is to a large extent directly liable for this debt. Catalonia also has its own debts, but these amount to a mere €75 billion, a moderate 35 per cent of the region’s total economic output. The regions’ comparably low direct liability for Spain’s public debt is a highly controversial issue. If Catalonia were to secede, Spain would lose one fifth of its economy, but would see only a slight reduction in central government debt. This would be enough to throw the country already deep in debt completely off course financially. The need for an independent Catalonia to assume at least some of Spain’s debt would therefore be a key issue in any negotiation surrounding the region’s independence.

Attempts in recent years to strengthen Catalonia’s fiscal autonomy and to cap the net financial burden on the region have all failed. Back in 2006, after complex negotiations, the Spanish parliament passed a new Statute of Autonomy of Catalonia which would have increased the fiscal independence of the region and set upper limits for the financial burden placed on Catalans. These fiscal protective rights were nullified by the Spanish Constitutional Court in 2010. This effective failure to decentralise the Spanish federal system in the nation’s highest court helped to fuel the Catalan independence movement considerably.

These events happening in Spain are highly relevant for the current debate on a European Fiscal Union. Many of the suggested reforms propose new centralisation instruments like a new Eurozone budget, centralised EU taxes and new shared debt and transfer instruments. Supporters of these idea point time and time again to existing federal states that are supposedly only as successful as they are thanks to highly developed revenue sharing, big centralised budgets and centralised debt.

European financial solidarity hinges on the outcome of the vote

The current conflict over Catalonia suggests the opposite. Too much fiscal centralisation can undermine the political unity of a federation to the point of collapse. What is happening in Spain demonstrates that not even centuries of shared history as a nation state are a guarantee that a federation will survive as a single political entity. The danger of this happening is, of course, particularly great in federations like Spain where there are strong regional identities with their own languages and sense of nationhood. However, this is exactly what defines the EU. This is why the current threats to Spain’s federal system are far more relevant to the EU than for example the stability of the German Federal Republic with its linguistic and cultural homogeneity. The fact that large-scale transfers of funds from South Germany to North and East Germany have been taking place for decades without triggering any serious secessionist movements has no bearing on how a Europe-wide transfer system might be received. Brexit proves that European nation states can turn their backs on the EU even when faced with a very low fiscal burden. What’s more, the right to exit the union is explicitly defined in Art. 50 of the Treaty on European Union and Brexit will set a precedent. While many Spanish politicians and judges rigorously deny regions the right to leave, this strategy is not open to the EU.

There are three central lessons to be learned from the Catalan crisis that should be kept in mind in the further reflections on a European Fiscal Union. First, ambitious fiscal insurance and transfer systems are risky both in terms of political acceptance and for the survival of the EU. If these plans result in Member States being confronted with permanent unilateral financial burdens, this will nurture anti-EU movements in these countries and possibly lead them to victory. Secondly, a centralisation of government debt in the EU is a further risk factor for another Member State potentially leaving, since collective debt creates unclear liabilities and therefore increases the risk of new debt crises. Thirdly, rulings from centralised constitutional courts do little to compensate for a lack of public acceptance of far-reaching redistribution systems. An EU-friendly ruling from the European Court of Justice would be just as ineffective at lending legitimacy to fiscal redistribution as the ruling of the Spanish Constitutional Court was at deescalating the situation back in 2010. There can be no future financial solidarity between the European nations unless it is supported by the majority of people living in those states that will bear the financial burden.”

This piece initially appeared on 6 October 2017 in the “Süddeutsche Zeitung”.