Why national co-financing of CAP Pillar 1 payments is needed in the MFF

There are few things that unite Agriculture Ministers more than their rejection of the idea of national co-financing of CAP Pillar 1 (P1) spending. In their first public discussion of the Commission’s November 2017 Communication of the future of the CAP post 2020 at the AGRIFISH Council meeting on 29 January, various agriculture Ministers, including France and Poland, explicitly made clear their opposition to national co-financing (as has Spain as reported here).

In early February, the Commission circulated a Communication ahead of the forthcoming European Council meeting on 23 February outlining the implications of different choices with respect to EU expenditure and financing in the forthcoming Multiannual Financial Framework (MFF). In his press conference at the end of the AGRIFISH Council meeting on 19 February, Commissioner Hogan explicitly drew attention, in a manner indicating his approval, to the fact that there was no mention of national co-financing of CAP P1 payments in this document, as had been the case in the previous Commission Reflection Paper of the Future of EU Finances.

The political economy reason for this stance of Agriculture Ministers is clear; they hate the idea that they might have to negotiate with their national Finance Ministers for the additional resources to make direct payments to farmers, payments that often are made to relatively wealthy farmers and landowners, and which they might find difficult to justify in competition with claims for additional national spending on health services, education, higher pensions and unemployment benefits, or improved infrastructure.

However, whether national co-financing of P1 payments should be introduced or not should not depend on the sensitivities of Agriculture Ministers, but on whether it would lead to more effective spending of EU taxpayer resources. And here the case for national co-financing of Pillar 1 payments is clear. In this post, I make the case that the European Council should introduce national co-financing of CAP P1 payments as part of the next MFF agreement. I also examine some of the counter-arguments put forward by Agriculture Ministers and think tanks and find them unconvincing.

The current interest in national co-financing of P1 payments arises because of the inclusion of one sentence in the Commission’s Reflection Paper on the Future of EU Finances. The Reflection Paper noted that work was ongoing on the modernisation and simplification of the CAP. In that context, it noted that “One option to explore is the introduction of a degree of national co-financing for direct payments in order to sustain the overall levels of current support”.

An early draft of the Commission’s Communication in October 2017 responded to this suggestion by arguing: “Introducing a degree of national co-financing for direct payments, especially if made optional, would endanger the currently smooth functioning of the internal market for agricultural and food products without ensuring the balanced distribution of support we are aiming at. Therefore direct payments should continue to be financed at EU level” (bolding in the original). However, this paragraph was removed in the final Communication, presumably on the grounds that the Communication was published on the explicit understanding that it “does neither pre-empt the outcome of this debate [on the future EU budget] nor the proposals for the next multiannual financial framework (MFF)”.

I have previously called for national co-financing of all CAP expenditure in my report to the European Parliament on the future of direct payments in October 2016. Here is the relevant extract from this report.

An important element of the proposed new model for direct payments is to encourage Member States to adopt a high level of ambition in their CAP spending programmes not only through controls and sanctions but also through the provision of incentives. Requiring national co-financing of all CAP expenditure is one way to ensure that agricultural funds are more efficiently used. When local taxpayers fund 30-50% of a specific agricultural or rural development programme, they have a greater interest in ensuring value-for-money. Co-financing is an accountability mechanism which needs to be introduced across the whole CAP. The proposed model would therefore require that all CAP spending, and not only EAFRD spending, would be co-financed. The level of co-financing required would be reduced for spending with clear EU value added, and increased where mainly national interests were being served.

Co-financing of CAP spending would have a significant knock-on effect on the overall EU budgetary framework, given the importance of CAP Pillar 1 spending at present. For example, total expenditure in the adopted 2015 EU general budget was €141.2 billion, of which expenditure on CAP direct payments in Pillar 1 (Chapter 05 03) was budgeted at €40.9 billion. Assuming no change in total (EU + MS) spending on agricultural policy and if, on average, 33% of this were co-financed by Member States, this would release €13.5 billion for non-agricultural spending or, alternatively, the overall EU budget could be reduced by this amount. Returning a significant proportion of agricultural spending now financed through the EU budget to Member States would also have consequences for the net transfers from the EU budget to and from Member States. These broader consequences of co-financing the CAP budget for the overall EU budget framework are not discussed in this note.

A corollary of national co-financing is that Member States in future would also be free to increase their national agricultural spending in the form of ‘national top-ups’, as is the case today. Under the Pillar 2 RDPs, for example, national top-ups over and above Member State co-financing in the 2014-2020 period amount to €10.7 billion compared to €50.9 billion in obligatory co-financing (DG AGRI 2016a). Member States also make a variety of income support payments to farmers under risk management schemes and crisis payments as state aids governed by State Aid Guidelines rules. In 2014, agricultural state aids reported to the Commission amounted to €7.6 billion. The State Aid Guidelines ensure that national payments do not distort competition to any significant extent within the single market. Within that constraint (and subject to respecting the EU’s international obligations on agricultural support), Member States would be free to make additional payments to their farmers if they so wished.

The Commission’s Reflection Paper made the worst possible case for national co-financing of P1 payments, namely, that it would help to sustain overall levels of current support. The arguments for national co-financing are much more persuasive than that. In the rest of this post, I take the opportunity to elaborate on these arguments.

Defining co-financing

At the outset, it is important to be clear about what is meant by national co-financing to avoid talking at cross-purposes, as there are a number of different models:

The compulsory model. At its simplest, we can think of this model as taking the national ceilings for direct payments in each Member State set out on an annual basis in an Annex to the Direct Payments Regulation, and dividing the column for each into two, part to be contributed by the EU and part to be contributed by the Member State. However, this model is not legally possible, because the EU cannot oblige Member States to undertake specific items of expenditure. So this model should be taken off the table.
The ESIF voluntary model. This is the model currently used in all of the European Structural and Investment Funds (ESIFs) including the European Agricultural Fund for Rural Development (EAFRD). EU funding is made available to Member States for particular programmes, but to draw down this funding the Member State must agree to make a national contribution to the programme. The percentage contribution can vary by Member State and by the nature of the programme.
The ‘top up’ model. This model was used for direct payments in the newly-acceding Member States following the 2004, 2007 and 2013 enlargements. In these countries, direct payments were gradually phased in, increasing from 25% of the agreed level in the first year to 100% over a transition period. In order to increase the overall direct payment support above the phasing-in level, these Member States were given the possibility to apply a Complementary National Direct Payment during this period. Member States also make national top-ups for measures related to an agricultural activity falling within the scope of Article 42 of the Treaty and forming a part of the rural development programme without these top-ups being classified as state aid.

Both the voluntary and top-up models could have a role to play if national co-financing were extended to CAP P1 payments, as explained below.

CAP P1 payments are unique among the major EU spending programmes in being 100% financed from the EU budget. This is the anomaly that has to be explained and justified, rather than the case for national co-financing. The reason for the 100% financing of P1 payments is the path-dependence of CAP reform, rather than any objective argument.

Direct payments were introduced to compensate farmers for a reduction in market price supports. Farm support provided through market prices as a result of import levies and export subsidies is, by construction, fully financed by the EU. The reform Commissioners (MacSharry, Fischler, Fischer-Böel) in introducing their reforms never directly touched the distribution of resources between Member States for the good reason that otherwise they would never have got agreement on those reforms (even if arguably the shift from financing farm support by higher prices for consumers to financing it through tax revenue may have had some minor distributional effects between Member States). By financing direct payments 100% from the EU budget, these Commissioners avoided distracting from their main objective (to change the nature of farm support) by introducing issues of redistribution between Member States.

While promising 100% EU financing of direct payments may have been politically astute at the time, it has resulted in important efficiency losses for the EU as a whole. There are at least four arguments why it is now time to introduce national co-financing of these P1 payments. There is limited academic literature on the topic, but the arguments made in this post are supported, e.g. in this policy brief by Von Cramon-Taubadel and Heinemann for the Bertelsmann Stiftung and in the more technical paper by Hofreither putting forward the case for ‘progressive cofinancing’ which deserves greater attention.

Arguments in support of national co-financing P1 payments

National co-financing of P1 payments would require Member State governments to take greater ownership of agricultural policy, thus improving efficiency. National spending must be approved through a budgetary process where the national Ministries for Finance play a role. There is thus some oversight by non-agricultural interests of how agricultural funds are used. In the case of money which is 100% received from Brussels and earmarked for agriculture, decisions are made solely by Ministers for Agriculture that are principally accountable to their agricultural constituencies. Member State contributions give individual countries an incentive to maximise the value of spending compared to transfers financed 100% by Brussels.

This efficiency justification for co-financing assumes Member States have choices over how this money is spent. If the only option Member States have is to use the CAP P1 money for uniform decoupled per hectare payments, then their only real choice is to decide whether to draw down the money or not. But this is no longer the case. Greater flexibility in the design of P1 payments was introduced in the last CAP reform (greening payment, redistributive payment, small farmer payment, capping and degressivity, young farmer payment, Areas of Natural Constraint payment). Member States also have the option to shift CAP funds between Pillars, thus enlarging the scope of choice to include rural development measures.

This flexibility will be extended under the new delivery model proposed in the CAP Communication, especially where greening is concerned. Requiring Member States to contribute to these payments increases the likelihood that they will have a positive outcome on agricultural developments and environmental outcomes. With direct payments 100% financed by Brussels the sole interest of Member States (or, at least, their Ministers for Agriculture) is minimising the administrative hassle in ensuring these payments are made to farmers on time and in the simplest way possible.

National co-financing of P1 payments puts P1 and P2 spending on an equal footing. The fact that P1 payments are 100% financed by the CAP budget while P2 payments are co-financed introduces a strong bias in the allocation of CAP funds in favour of the P1 budget. This is seen both in the bargaining over the division of the CAP budget in the MFF negotiations in the European Council, and in the incentives for Member States to use the flexibility to shift resources between P1 and P2 budgets.

For any given MFF budget, if a choice must be made between raising/cutting the CAP P1 budget or the P2 budget, Member States will always tend to favour smaller increases/larger reductions in the P2 budget because of the asymmetrical co-financing requirement. As Hofreither argues in his paper, P1 payments have a zero marginal cost for individual countries assuming a fixed EU budget and this leads to a strong preference for these payments. He recommends introducing co-financing in order to introduce a positive marginal cost in order to alter this behaviour ‘at the margin’.

In terms of flexibility between Pillars, Member States have recognised that there would be no incentive to transfer funds from P1 to P2 unless, at the same time, the co-financing requirement was dropped. The way in which asymmetric co-financing requirements could potentially be used to bias the allocation of CAP resources was tellingly highlighted in the negotiations on the last CAP reform, as reported by the Institute for European Environmental Policy on its CAP2020 blog.

The Heads of State in their agreement on the Multiannual Financial Framework in February agreed that there was no necessity for national co-financing of funds switched from Pillar 1 to Pillar 2. This was welcomed by many because, although desirable in principle in that it would bring more funding into the rural development budget, the reality of the current financial situation is that such a requirement would act as a strong disincentive on Member States to use this facility. In practice, rural development funding would be very likely to shrink rather than grow. For this reason, the current call from some MEPs, principally from the EPP, to reinstate the requirement for co-financing such transfers is being backed strongly by farmers’ organisations. They see this as a way of stopping fund switching to Pillar 2.

However, eliminating the requirement to co-finance transfers from P1 to P2 still leaves the anomaly that Member States that might be under financial pressure have an artificial incentive to transfer funds from P2 (which does require co-financing) to P1 (which does not require co-financing). In the last CAP reform, Member States had the possibility to transfer up to 15% of their P2 allocations to P1, and this could be increased to 25% in the case of Member States with average direct payments/ha below 90% of the EU average. As it happens, only five Member States (HR, HU, MT, PL, SK) made use of this possibility, but this still leaves open the question whether the amounts transferred would have been as great if similar co-financing requirements had been required in both Pillars.

This issue of the potential bias in allocating Member State CAP funds due to asymmetric co-financing requirements will likely only be exacerbated by the proposals in the Commission Communication to give greater responsibility to Member States in how CAP funds can be spent. The Communication proposes to replace the current green architecture of cross-compliance/greening payments/voluntary agri-environment-climate measures (AECMs) with a new conditionality model, where Member States would have greater flexibility to choose and design the combination of mandatory and voluntary measures that will lead to environmental improvement. But at the moment, the greening payment is 100% financed from the EU budget and voluntary AECMs are nationally co-financed. Depending on whether the budget for the greening payment stays in P1 or is moved to P2, the continuation of asymmetric financing would seem to inevitably distort Member State choices on the design of their future green architecture.

National co-financing of P1 payments allows EU value added to be recognised. National co-financing allows the EU to use its budget to drive Member State expenditure in the direction of priorities with higher European value added. Co-financing rates would, as at present, be differentiated by Member States’ level of development. This ensures that poorer Member States are not at an unfair disadvantage in drawing down CAP funds. However, co-financing rates should also be adjusted to reflect European value added, as is the case at present to some extent in the differentiated rates prescribed in the Rural Development Regulation.

Voluntary coupled payments, for example, which have limited or no European value added because they support farmers in one Member State at the expense of farmers in other Member States, might be financed entirely by Member States (subject to rules set down in the CAP) whereas area payments to assist farmers to convert to more sustainable agricultural practices (e.g. organic farming) or for environmentally sensitive permanent grasslands might receive higher EU co-financing than the norm.

This could also be a way of addressing the unfair distribution of direct payments which has been identified as an issue to be tackled in the Commission Communication. It puts forward the ‘old chestnuts’ of capping, degressivity and the redistributive payment as ways to improve the distribution of payments, but the experience with the use of these instruments in the current CAP reform has not been encouraging. Comments made by agricultural Ministers at the January AGRIFISH Council public debate supported capping but only if it was left voluntary for Member States, which of course makes it meaningless.

The Commission should instead take the agricultural Ministers at their word. As I have repeatedly argued on this blog, there is no justification for EU taxpayers to make substantial transfers to better-off farmers who are usually located in the more advantaged regions in Europe (thus there is no risk that this land will go out of production) and which usually because of their size benefit from economies of scale (thus have less need for income support). In 2015, just 121,713 holdings that were paid over €50,000 (out of the 10.8 million holdings in the EU and 6.7 million beneficiaries of direct payments) shared €12.6 billion in direct payments. This was 30% of the total CAP budget for direct payments and 9.2% of the total EU budget. The average payment per holding was €103,319 which was well above the median income of ordinary EU citizens even in the wealthier Member States.

One could thus envisage in the next CAP reform that the EU budget would co-finance, say, 80% of payments under €20,000 (leaving the remaining 20% to be financed by national co-financing); 50% of payments between €20,000 and €50,000 (with the remaining 50% from national co-financing) and would provide 0% contribution to payments over €50,000 (leaving Member States to pay 100% of the amounts over this threshold if they wished). National payments could be capped to ensure that total support on a per hectare basis did not exceed thresholds decided at EU level.

The thresholds are put forward to illustrate the idea and would obviously be open to further discussion; the co-financing rates should also be adjusted for the GDP per head of Member States as argued earlier. The basic point is that national co-financing provides the opportunity for the EU to focus spending on areas of EU value added, something that is not possible if the EU budget continues to provide 100% financing for direct payments.

This would be a far more effective way of targeting the EU direct payments budget on smaller farms than playing around with mechanisms such as capping and degressivity. Under the Communication proposals, Member States would not be allowed to make high payments to farms as some of them wish to continue to do, and thus the proposal is always watered down. In this proposal, Member States could continue to make such payments, but they simply would not be financed by the EU taxpayer.

This does not mean that large farms are excluded from receiving support from the EU budget. We are discussing here payments intended for income support. Large farms would still be eligible for funding for the provision of environmental and climate sequestration services, as well as investment support and support for innovation which would be much more appropriate to their needs.

National co-financing of P1 payments would free up EU budget resources. This is not the main argument for national co-financing, but in the current EU budget context (facing the twin challenges of filling the financing gap left by the UK’s departure and covering the financing needs of new priorities) it is not unimportant. Budget Commissioner Oettinger has indicated that he intends to propose an increase in gross contributions from around 1% of Member States’ GNI to 1.1x% (so, in principle an increase of between 10 and 19%). Several net contributor Member States have expressed their opposition to such an increase, in which case the alternative is much more severe reductions in existing expenditure programmes (such as the CAP) than Oettinger currently envisages.

How much money might national co-financing of P1 direct payments make available? Suppose we assume the same differentiated pattern of co-financing set out in Article 59 ‘Fund contribution’ in the Rural Development Regulation (EU) 1305/2013 would be applied to CAP P1 payments. On average, this leads to a 33% average co-financing rate by Member States for EAFRD funding in the current MFF period (national public expenditure of €51 billion excluding national top-ups compared to EU expenditure of €96 billion (initially) or €99 billion (after transfers between direct payments and rural development envelopes). Assuming P1 expenditure of €44 billion, this would make almost €15 billion available for other priorities in the EU budget. It might be no coincidence that this is almost exactly the amount of ‘new money’ that Commissioner Oettinger proposes to raise by increasing the gross contributions of all Member States.

National co-financing of P1 payments could ensure continued transfers to farmers in the event of severe cuts in the EU CAP budget. This was the argument put forward in the Commission Reflection Paper on the Future of EU Finances. Agriculture Ministers and farm unions argue strongly that the CAP budget must be maintained at least at its current level. But suppose this did not happen and it were cut by 30%, which is one of the scenarios put forward in the Commission’s Communication to the European Council next week. In this situation, previous experience suggests there could be a willingness to accept that national contributions could make up the difference. It is not an argument I use in favour of national co-financing, but it is obvious farm unions would press for greater national support in the event that the CAP budget were reduced by 30% or so.

Criticisms of national co-financing of P1 payments

I now turn to examine criticisms made of national co-financing of P1 payments, drawing on statements by agriculture Ministers at the AGRIFISH Council meetings and the document prepared by Yves Madre of Farm Europe in response to the Commission’s Reflection Paper on the Future of EU Finances. The latter paper paints a dystopian future for the CAP if national co-financing were to be introduced based on arguments I believe are exaggerated and misleading.

Direct payments should be financed 100% by the EU as they implement EU policy. Cohesion, research and connecting Europe policies all target objectives with high European value added, but co-financing is a matter of course. As previously underlined, CAP P1 payments are the exception in that they do not require national co-financing. Apart from the efficiency gains which national co-financing would bring, requiring Member States to contribute to a policy that implements EU objectives reflects the fact that there are also benefits to these countries too.

National co-financing would lead to an unbalanced distribution of support and the renationalisation of the CAP. Or as the Farm Europe document states: “[it] risks creating a significant disparity in the treatment of MS, between those which have the resources to provide substantial co-financing and a high level of aid to farmers and those which do not.”

Von Cramon-Taubadel and Heinemann point out that the claim that co-financing of CAP would kick off a destructive race of national subsidies is based on a misunderstanding. Co-financing is merely a financing tool and does not imply any changes to the rules of the European agricultural market. If the direct payments per hectare remain at the same level in each Member State as they would be with 100% EU budget financing, then the money received by farmers is exactly the same. From the farmer’s perspective, how the payment is financed is simply irrelevant.

The concern that the level playing field inside the single market could be undermined might be more justified if Member States were permitted to ‘top up’ basic payments from their own resources, so farmers in one Member State would receive more than in a neighbouring Member State. In my European Parliament paper from which I quote above, I was relaxed about this possibility, on the grounds that national aids to farmers (unless exempted under CAP regulations) have to undergo a state aids test to show that they do not distort the single market and must be approved by the Commission on this basis. However, if it were desired ‘top ups’ could be prevented by setting a ceiling on the maximum payment per hectare in the basic CAP regulation, as is done for many other types of CAP payments at present.

In any case, this worry expressed that national co-financing would lead to the renationalisation of the CAP is often opportunistic. The same voices that oppose national co-financing often support national country-of-origin labelling, or coupled supports, that are much more detrimental to the single market. Differences in payments per hectare between Member States exist today, in part because of incomplete external convergence, but also because Member States have the flexibility to target P1 payments in various ways and the possibility to switch funds between the two CAP Pillars. The new delivery model proposed in the Commission Communication, by granting greater flexibility to Member States how to meet the specified EU objectives, will also lead to greater differentiation in the supports to farmers in the future.

Voluntary nature of national co-financing of P1 payments would mean some Member States might be unable to draw down these funds. According to the Farm Europe document “The large net contributing MS will gain from the process but the others will not be able to find the necessary resources nationally”. The fear is that co-financing would mean some Member States would be unable to draw down payments to which they were entitled. As pointed out above, co-financing rates should be differentiated according to Member States’ ability to pay, as is the case at present. Indeed, the EU lowered national co-financing rates and increased the EU contribution to the ESIFs during the economic crisis for Member States in financial difficulties precisely to take account of changes in ability to pay.

Research by the European Court of Auditors shows that, for existing programmes which require co-financing, there is no overall problem in finding matching funds. One measure of this is that commitments which are not absorbed eventually need to be decommitted. However, decommitments made by the end of 2013 were not significant. The total amount decommitted in cohesion spending up to 2013 was 0.19% of the 2012 cumulative target. For rural development spending the corresponding figure was 0.14% of the 2012 cumulative target. These are tiny amounts, and show that the argument that Member States would be unable to draw down EU funds because of national budget constraints is a red herring.

It would become impossible to pursue any significant initiative at the European level as MS that cofinance would wish to retain the ability to decide how farmers should use funding – the idea that European norms can survive without a common budget is wishful thinking”. This argument by Farm Europe sets up a straw man – the absence of a common budget – in order to criticise national co-financing. National co-financing implies the continued existence of an EU budget. As I argue above, it is precisely the flexibility that co-financing allows that would ensure that European norms are pursued by the EU budget because higher rates of co-financing can be provided for objectives with greater European value added.

The political economy of national co-financing

Whatever the merits of introducing national co-financing of CAP P1 payments as a way of incentivising better value-for-money choices in the CAP, of removing artificial biases between measures with different funding mechanisms, of using the EU budget to drive those measures with greatest European value added, and of freeing up funding in the EU budget for other priorities, it would have the effect of benefiting countries that are currently (or after Brexit, likely to be) net contributors to the CAP P1 budget while disadvantaging those countries that are currently net beneficiaries of CAP P1 funds (net contributors and net beneficiaries can be easily identified by comparing each country’s share of CAP P1 receipts with its share of EU GNI which is the marginal resource for financing the EU budget, for examples see this previous post). The consequences of this redistribution should be explicitly addressed if national co-financing of CAP P1 payments were introduced.

While Commission President Juncker and Budget Commissioner Oettinger plead that Member States should not approach the forthcoming MFF budget negotiations from a ‘juste retour’ perspective, everyone knows that this is exactly what will happen. Commissioner Oettinger’s strategy to ‘sell’ his MFF proposal to the European Council has focused on the arguments for increasing the ‘political ceiling’ on the overall gross contributions to the budget. He has also highlighted the distributional implications of different models of allocating cohesion support between regions and Member States. However, he has been silent to date on the basis he will use to allocate CAP funds to individual countries. But this distributional debate cannot be avoided, regardless whether national co-financing of P1 payments is introduced or not.

For P1 payments, the debate centres on whether there should be a movement to full equalisation of payments per eligible hectare across Member States (external convergence). The Visegrad and Baltic countries are pushing hard for full external convergence, but other Member States disagree. No objective basis for the distribution of P2 funds has ever been agreed (see this previous post for a discussion of P2 allocations in the current MFF). Keep in mind that the extent of the redistribution due to national co-financing will be mitigated by the fact that many net beneficiaries would benefit from a lower national co-financing rate on GDP per head grounds. There would seem to be plenty of scope to trade off higher P2 allocations for lower P1 allocations in order to find a new political economy equilibrium.

The political economy argument should thus not be used to stand in the way of a desirable and progressive reform in the financing of the CAP. The Commission should include it in its MFF proposal in May, and the European Council should endorse it as part of its MFF conclusions in due course.

This post was written by Alan Matthews

Photo credit: Pixabay on Pexels licensed under the Creative Commons Zero (CC0) license

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One Response to “Why national co-financing of CAP Pillar 1 payments is needed in the MFF”

  1. Tone
    February 21, 2018 at 22:06 #

    Nice analysis.
    It’s intriguing that cofinancing in this way could solve Comm Oettingers “new money” conundrum. I agree that it will take Voice’s beyond the Council of Agri ministers to push something like this through. But if decision making is left to them it seems unlikely that the co funding suggestion would ever be adopted.