The European Commission will propose on Wednesday a short, sharp boost to the recession-hit European economy including value-added tax cuts and a call for lower ECB interest rates, a draft document showed.
The draft proposal, obtained by Reuters, did not specify the size of the stimulus plan, which Germany said last week could be worth some 1 percent of the European Union's gross domestic product (GDP), or 130 billion euros ($164 billion).
With differences among the bloc's 27 states on how to counter a slowdown after the worst financial crisis since the Great Depression, the document is formulated in such a way as to give them leeway on which exact policies they finally adopt.
"Only through a significant stimulus package can Europe counter the expected downward trend in demand, with its negative knock-on effects on investment and employment," the draft said.
"Most of the economic policy levers, and in particular those which can stimulate consumer demand in the short-term, are in the hands of the member states," it said.
The Commission said the budgetary stimulus had to be timely, targeted and temporary, mix revenue and spending instruments, be accompanied by structural reforms and comply with EU budget rules — the Stability and Growth Pact.
The text, which will be debated by EU leaders at a summit in December, contained a strong caveat that the deterioration in budget deficits resulting from the stimulus should be repaired as soon as the economy picks up.
"This budgetary stimulus should be foreseen for a maximum period of two years (2009-2010) following which member states' budgets should commit to reverse the budgetary deterioration and return to the aim set out in the medium-term objectives," it said of the goal of balanced budgets for most countries.
The fiscal stimulus, along with the fall in revenue and rise in spending that accompany an economic slowdown, is likely to boost deficits in France, Britain, Ireland, Italy, Greece and Portugal well beyond the EU ceiling of 3 percent of GDP.
"Member States may be obliged to break the 3 percent reference value in 2009 and 2010 because of the extraordinary circumstances," the draft said.
"However, such excessive deficits will have to be corrected in time frames consistent with the recovery of the economy."
Apart from fiscal stimulus, there was room for the European Central Bank to cut interest rates further, the Commission said. The ECB has signalled it may cut rates on Dec. 4 and markets expect a reduction of 50 to 75 basis points to 2.5-2.75 percent.
"Emerging evidence of lower inflationary pressures in the face of slumping demand provides scope for further reductions in interest rates," the draft said.
The final size of the proposed programme will be decided on Wednesday after consultations with governments by Commission President Jose Manuel Barroso.
BRIDGING DIFFERENCES
The paper attempts to bridge differences of opinion among bloc leaders on how to kickstart the European economy, notably on whether cuts in value-added tax (VAT) are an appropriate way to boost the economy, and the overall size of the package.
"Barroso is currently engaged in shuttle diplomacy between the various capitals to try and reach a consensus before Wednesday on the burden-sharing," one EU source told Reuters.
"It is not just the big states whom he has to satisfy. The smaller and eastern states for example say they cannot afford to pay 1 percent of GDP. So it will not be as simple as just saying 1 percent of GDP," the source said.
Britain on Monday announced a 2.5 percentage point cut in VAT to 15 percent in a 12.5-billion-pound ($18.9 billion) move aimed at kickstarting the economy. Germany and France ruled out copying the British plan.
The Commission draft proposal, which lists a menu of actions that EU members can take, said discretionary public spending would give demand a short-term stronger boost than tax cuts.
As examples of possible measures, it suggested temporarily increased benefits to low-income households and the unemployed, or a temporary lengthening of benefit pay-outs.
It said an across-the-board, temporary VAT cut could also provide strong impulse for consumption, but stopped short of proposing a concrete, single move for the whole 27-nation bloc.
The draft also said government guarantees and loan subsidies for companies would work well at a time when credit is more difficult to obtain and proposed cutting taxes on labour, especially for low-wage earners.
