Your letter of 29 October asked for advice on whether the Fountainebleau Agreement acts as a disincentive to the UK in taking full advantage of the agri-environment measures.

  I enclose a copy of a supplementary memorandum prepared for the House of Commons Agriculture Committee, paragraphs 8-17 of which describe the operation of the Fountainebleau rebate and the effect on expenditure in the UK. It shows that for every 100 million pounds of EU money spent in the UK, the UK exchequer effectively contributes 71 million pounds. This is before the cost of any fully Exchequer funded match funding is taken into account. As you say in your letter, this effect is not peculiar to agriculture as it would apply to any other area of EU expenditure in the UK.

  On the wider point, it may be the perception of some other Member States (who are net beneficiaries from the EU budget) that the Fountainebleau rebate mechanism and/or the fact that the UK is a large net contributor to the EU budget have caused the UK to take a tough line on CAP expenditure generally and discretionary expenditure in particular. Clearly these factors do influence any economic cost/benefit analysis of Exchequer funding for UK schemes. However, I think it would be difficult, if not impossible, to determine the extent to which past Governments' public expenditure decisions were affected by these factors as opposed to the wider economic and political considerations which govern the public expenditure scene generally. If you need further guidance on this, I think that you would need to address the question to the Treasury.

  On your last point, the UK has strongly supported moving away from the traditional market-based CAP support towards targeted rural development measures.

2 November 1999

The operation of the Fontainebleau abatement and its implications for the UK budget in comparison with other EU member states

  8.  The sources of revenue for the EU, or "own resources" as they are called, comprise:

(a)  levies on agricultural exports, and on sugar and isoglucose production;

(b)  customs duties collected on imports from outside the EU;

(c)  VAT resources calculated by applying a notional rate of VAT to an identical range of goods and services in each member state; since 1988 these payments have been capped in relation to member states' Gross National Product (GNP);

(d)  GNP-based Fourth Resource, introduced from 1988 and calculated by taking the same proportion of each member state's GNP. This covers the difference between total expenditure in the budget and the revenue from the other three resources.

  Each member state's contribution to the EU therefore depends on its trade and spending patterns and economic trends, only partially evened out by the balancing mechanisms adopted in 1988. In 1997, a fairly typical year, the UK contributed around 15 per cent of EU revenues.

  9.  The bulk of EU expenditure is "allocated", which means that it is paid as CAP support, structural aids and cohesion or other funds. The remainder goes on other items, such as administration and overseas aid.

  10.  Since 1984, when the Fontainebleau mechanism was introduced, the UK's contributions to the EU budget have been abated in recognition of the imbalance between the UK's receipts and the level of its contribution. The UK's abatement is broadly equal to 66 per cent of the difference between its gross(ie unabated) contribution and its receipts. The following detailed rules apply:

(i)  the abatement applies only in respect of spending within the EU; expenditure outside the EU (mainly aid), usually amounting to about 6-7 per cent of total expenditure, is excluded;

(ii)  the UK's contribution is calculated as if the EU budget were entirely financed by VAT; and

(iii)  the abatement is deducted from the UK's VAT contribution a year in arrears.

  11.  The financial cost of the abatement is borne by the other member states according to their respective shares of EU GNP. Its value to the UK varies from year to year, but is currently about £2 billion per year on average. For 1997, the abatement made in respect of 1996 is expected to reduce the UK's gross contribution to the EU budget from around 15 per cent to around 11 per cent.

  12.  The UK's abatement is calculated in respect of the whole of the "allocated" EU budget, so it is not strictly appropriate to award an amount for its effect on individual items of expenditure. However, for new expenditure which increases the overall budget (and for savings which reduce the overall budget), the effects of the abatement are that the UK contributes (or in the case of savings, recovers):

—  around 71 per cent of EU expenditure in the UK

—  around 5 per cent of EU expenditure in other member states.

  The calculations are set out below.

  13.  Assuming the UK's gross contribution to new expenditure is 15 per cent, the effect on our net contribution will be neutral if UK receipts from that expenditure are also 15 per cent. In that event the Fontainebleau mechanism will not have an effect. If however, new EU expenditure of, say, 100 mecu is incurred, all of it in the UK, the effects will be as follows:

  14.  By contrast, if all the new expenditure is in other member states, the effect will be as follows:

  15.  Any increase or decrease in the abatement arising from changes in expenditure will apply one year in arrears.

  16.  The abatement mechanism applies to the EU-funded elements of agrimonetary compensation and decommissioning of fishing vessels in the same way as it applies to other "allocated" EU expenditure. EU funding of agrimonetary compensation is available at the rate of 100 per cent for up to half the maximum allowed (and zero for the remainder). Therefore the UK would pay 71 per cent of the cost of any EU funded agrimonetary compensation paid in the UK and 5 per cent claimed elsewhere.

  17.  In the case of EU funding for decommissioning of fishing vessels in Objective 1 areas where expenditure is 75 per cent funded by the EU, the impact of the Fontainebleau abatement means that the UK would fund about 78 per cent (25 per cent + (71 per cent × 75 per cent)) of the costs in the UK and about 4 per cent(5 per cent × 75 per cent) of the costs elsewhere. In the case of schemes where expenditure is co-funded by the EU at a lower rate (normally 50 per cent outside Objective 1 areas), the UK pays a higher proportion of total costs falling in the UK and a lower percentage elsewhere. Thus co-funding at a rate of 50 per cent means that the UK funds about 85 per cent (50 per cent + (71 per cent × 50 per cent)) of the total cost in the UK and about 2.5 per cent (5 per cent × 50 per cent) elsewhere.

27 November 1997