Università Cattolica del Sacro Cuore

The role of fiscal rules in relation with the green economy

di Carlo Cottarelli

8 settembre 2020

This paper discusses the analytical basis for facilitating green public investment under the Stability and Growth Pact fiscal rules. It concludes that additional public debt created by deficit- financed green public investment is likely to increase fiscal sustainability risks. However, such additional risks could be justified to avoid the economic damages (which would also have long run consequences for public finances) arising in the absence of sufficient green public investment. Tre trade off could be improved if green public investment were financed through EU debt.

This document was provided by the Economic Governance Support Unit and Policy Department A at the request of the ECON Committee.

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Executive summary

This paper discusses the analytical basis for facilitating green public investment under the Stability and Growth Pact fiscal rules. Green public investment could be defined as public investment in the areas considered to be “green” in the “taxonomy” included in the final report of the EU Technical Expert Group on Sustainable Finance, possibly refined in some aspects. However, it would be reasonable to give a broad definition to the term “investment”, as including other forms of public spending that have favorable environmental effects including some current spending that is beneficial to the environment.

Should SGP rules be relaxed to allow deficit-financed green public investment? While the theoretical case could be allow to exclude green public investment from the SGP ceilings, there is no evidence that green public investment that is financed by issuing public debt involves lower costs in terms of roll over risks and of potential growth rates with respect to other priority forms of public spending. Thus, the rationale for a much broad and favorable treatment under the SGP rules of green public investment, with respect to the current situation, needs to be found somewhere else.

A possible rationale relates to the “newness” of the global warming challenge. When the SGP fiscal deficit and public debt ceilings were agreed, in the early 1990s, a balance was struck between the need to avoid excessive deficits and related costs and the need to allow adequate financing for priority spending. However, at that time, the nature and the extent of the global warming challenge were certainly less appreciated than they are now. The costs arising from global warming is an additional factor that now may justify accepting a higher degree of risk arising from public debt and fiscal deficits.

There are different options in allowing a different treatment of green public investment under the SGP rules. The first would be to maintain the current approach of not differentiating between different types of spending. This would imply just relaxing the overall fiscal deficit ceilings. This would have the advantage of simplicity, but there would be no guarantee that the additional room would be used for additional spending for green public investment. A second and preferable option would be to introduce a specific flexibility clause that would allow more green public investment, up to a certain level. The third, more restrictive approach would be to tighten the existing ceilings, while allowing them to be exceeded as a result of green public investment.

If flexibility for green public investment were introduced for the deficit ceiling, some corresponding adjustments would have to be made regarding other existing SGP rules, in terms of MTOs, and the pace of convergence towards them, the expenditure benchmark and the public debt ceiling. Consideration may also be given to a temporary flexibility clause allowing additional deficit and debt for a limited number of years, so as to allow a “green public capital stock” to be built.

In light of the risk of artificial “green painting” that might be given to any public investment, it would be appropriate if decisions on excluding certain investment projects from the fiscal ceilings were taken with the involvement of independent technical experts, possibly the very Expert Group that prepared the taxonomy.

As environmental damages are not affected by national frontiers, a better alternative, or complement, to changing the SGP rules would be to finance and approve more green public investment at the European Union budget level. In light of the limited amount currently in circulation of debt issued by European institutions, this approach would allow undertaking green public investment spending without a significant increase of costs and risks related to higher public debt. The proposals put forward by the European Commission regarding the Next Generation EU go indeed in this direction.

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