19.  The proposed Financial Perspective for 2007-2013 allocates significantly more funds to Pillar 1 than Pillar 2 (see Table 1). However, whereas Pillar 2 funding levels are set to increase from €10.5 billion in 2006 to €13.2 billion in 2013, Pillar 1 levels will stay the same as 2000-2006 allocations. Market support and direct subsidy expenditure (Pillar 1) will remain static at around €42-43 billion per year. This represents the 2002 Council agreement—the so-called "Brussels Ceiling"—to freeze Pillar 1 spending.

European Commission's spending projections for the CAP 2006-2013

Breakdown of Pillars 1 and 2 compared to Brussels Ceiling

20.  Our evidence highlighted that Pillar 1 will face increasing strain during the 2007-2013 budgetary period[14]. It must cover the cost of direct aid payments and market support to the EU-15 as well as the new Member States; the cost of incorporating Romania and Bulgaria into the European agricultural market from 2007; and meet the cost of additional reforms of the sugar, fruit and vegetable and wine market regimes which are likely to take place in 2006-2007. The pressures on Pillar 1 will increase even as the budgetary ceiling remains static. This will place a tremendous strain on the Pillar 1 funds allocated for 2007-2013.

Implications of a 1% budget

21.  An initial stress which has been placed on a ceiling which is, as the Commission told us, "already very tight" (Q 366)[15] is the ongoing political negotiations on the overall EU budget. The six net contributor Member States are suggesting that the overall EU budget be reduced. The United Kingdom Government, together with those of Austria, France, Germany, the Netherlands and Sweden, considers the Commission's overall proposals for a 35% real terms increase in the EU budget to be unrealistic and unacceptable. Of course, the prime reason for the increase is the accession of ten (soon to be twelve) countries. They argue that the Commission's requirement of an annual budget equivalent to 1.14% GNI is too high and instead have called for the total budget to be limited to only 1% of GNI[16]. Such an adjustment would reduce the overall EU budget by 12.3% from €158,450 million in 2013 to €138,960 million.

22.  Were such a reduction to be agreed, it is highly unlikely that those responsible for the reduction would be prepared to accept that the necessary cuts in spending should fall only on the non-agricultural sections of the budget. Since agriculture is likely to remain the most significant expenditure item, they would be likely to argue that cuts should also be applied pro rata to agricultural spending. If this occurred, the total available for Pillar 1 would be reduced from the Commission's estimate of €43.5 billion for 2007 down to €38.15 billion; and of €48.57 billion for 2013 down to €37.1 billion. The total available for Pillar 1 in the 2007-13 period would be reduced from €302 billion to €265 billion. Assuming that the 12.3% cut were applied to the whole agricultural budget, the total for both Pillars would be reduced from €390 billion to €342 billion.

23.  The British Government maintain that a 1% GNI budget is feasible and told us that with "growth and reprioritisation on those policy areas with significant EU value added", a reduced EU budget would still be sufficient to support the Union's agriculture priorities. However, Mr Stefan Lehner, Head of CAP and Structural Policies Unit of the Commission's Budget Directorate-General, told us that "one per cent financial perspectives are not imaginable without reopening the 2002 ceiling for the first Pillar" (Q 458).

24.  It is unlikely that the political will would exist to renegotiate the Pillar 1 ceilings, given that they were agreed as part of the 2002 Brussels agreement to act as "compensation" to EU farmers for the 2003 scaling down of market support. To re-open the Brussels ceiling now would be to create further instability in an already complex negotiation. We therefore do not recommend that the agreement be re-opened.

25.  On the other hand, we acknowledge the overwhelming evidence we received that spending on the single farm payment and market support measures within the enlarged EU has the potential to exceed the Pillar 1 Brussels Ceiling. Even the British Government believe expenditure will exceed the budgetary ceiling by as early as 2008. Lord Whitty, the Parliamentary Under-Secretary of State for Environment, Food and Rural Affairs, told the 2005 Oxford Farming Conference[17], that "irrespective of wider financial reform the cap set on Pillar 1 expenditure by the Brussels Ceiling will be hit by 2008 as direct [Pillar 1] payments to the 10 accession countries increase—earlier if Bulgaria and Romania are members."

26.  It is not generally realised that the reforms of 2003 did not eliminate the traditional market support measures of the CAP. Market intervention and export subsidies continue to be used, in combination with high import tariffs, to maintain high market prices within the common EU market. This means that, particularly for cereals, dairy products, sugar and Mediterranean commodities (mainly olive oil and wine), this official market manipulation will continue to operate until the end of the 2007-2013 budgetary period. Because this system guarantees prices for EU farmers which are frequently greater than international prices, expenditure on these market measures is still, and will remain, significant.

27.  Evidence to us indicates such expenditure will be greater than currently estimated by the European Commission. Mr Séan Rickard, Senior Lecturer in Business Economics at Cranfield School of Management, told us that, "all the evidence to date is that production will keep growing. There will be more milk or milk products to dispose of; there will certainly be more cereals to dispose of; and I very much doubt if we will see much in the way of a reduction in beef production" (Q 19) [18].

28.  Enlargement will be the main pressure facing the 2007-2013 CAP budget. The Financial Perspective of 2000-2006 addressed the budgetary needs of 15 Member States. The next Financial Perspective will have to respond to the needs of at least 25 Member States, planned to increase to 27 in 2007. The number of farmers eligible to receive CAP funding has therefore increased significantly even as Pillar 1 funding remains static.

29.  However the 2004 wave of enlargement has changed the needs as well as the number of EU farmers. The inclusion of eight Central and Eastern European Countries[19] (CEECs) into the Union has introduced particular agricultural issues and needs which did not exist in the pre-accession Union of 15 countries. A pre-accession Commission report[20] found that 21% of the CEEC population worked in agriculture which compares to only 4.3% of the active work force in the EU-15. If Bulgaria and Romania accede as planned in 2007 the agricultural needs will change even more dramatically—the same report found 42% of the Romanian population was engaged in agriculture in 2002. This highlights the problem of developing a CAP which will satisfy a diverse range of expectations within an enlarged Union.

30.  Those countries which are primarily focussed on agriculture will inevitably require significant CAP funding which, like the EU-15, they are entitled to receive (see Box 7). This will place huge demands on a Pillar 1 budget which is essentially the same as the 2000-2006 Pillar 1 budget for a 15 Member EU. €1.8 billion has been allocated for direct payments to farmers in the new Member States in 2005[21]. At the eventual full rate of payments, this suggests that the annual cost of direct payments to the new Member States will be just over €7 billion.

31.  With the addition of Bulgaria and Romania, the total cost of applying policies provided by Pillar 1 (direct payments plus market support) is likely to total in excess of €10 billion by the end of the 2007-2013 period. This figure includes the annual €1.6 billion estimated by the European Commission for Pillar 1 expenditure to Bulgaria and Romania by 2013[22].

32.  Enlargement will also result in increased levels of EU agricultural production, leading to further pressures on the CAP budget. Pillar 1 funds market support and intervention measures. The level of funding required is dependent in part on the volume of commodities the EU produces and the fluctuations in the price of major commodities on international markets (the lower the world price the greater the need for export subsidies and other market intervention).

33.  Eurostat recently reported that the new Member States registered a rise in their cereal production of on average more than 40% between 2003 and 2004, a rise twice that recorded for the EU-15[23]. Significantly, additional EU measures and expenditure were needed to deal with a substantial cereal surplus in the new Member States during the 2004-05 marketing year[24]. The demands placed on Pillar 1 market support and intervention measures seem likely to grow significantly following accession of the CEECs.

Operation of the financial discipline mechanism

34.  A mechanism to cope with these strains of possible further enlargement, over-production and cuts in the overall budget has already been foreseen by EU policy-makers. The CAP reforms of 2003 made provision for the operation of a so-called "financial discipline mechanism" from 2007. The financial discipline mechanism reduces the single farm payments by the percentage necessary to keep total Pillar 1 expenditure below the agreed Brussels ceiling.

35.  The European Commission estimates any likely overrun in any given budget year at the beginning of the previous year. The expected excess will then be deducted from the single farm payment in the following year. The financial discipline mechanism applies only to payments in the EU-15 until 2013. It will not operate in the new Member States until they reach their full entitlement to direct payments in 2013.

Bulgaria and Romania

37.  The financial discipline mechanism's purpose is to "recycle" funds within Pillar 1. The most foreseeable reason for the financial discipline mechanism's use will be the planned accession of Bulgaria and Romania in 2007. There has been much confusion over whether or not expenditure for supporting Bulgarian and Romanian agriculture has been allocated within the Brussels Ceiling. The majority of our witnesses were clear that the cost of direct payments and other CAP support measures to Romania and Bulgaria is not covered by the Commission's current budget proposals. If extra funding is not provided, the cost would therefore have to be financed through cutting direct payments to the EU-15 via use of the financial discipline mechanism.

38.  Our witnesses were clear that the financial discipline mechanism would have to be used from its inception in 2007. In addition to the automatic 5% "modulation" or movement of funds away from EU-15 direct payments to Pillar 2[25], Mr Jean-Luc Demarty, Deputy Director General for Agriculture at the European Commission, suggested direct payments may experience a reduction of another 5% in order to cover i) extra CAP costs associated with the recent accession of ten new Member States, and ii) higher than currently estimated spending on market support (QQ 354-358).

39.  If separate funding is not made available for the accession of Bulgaria and Romania, there would have to be a further reduction of the direct payments, beginning at 4% at accession and rising to 8% by 2013. The total reduction in direct payments through use of the financial discipline mechanism could therefore be as much as 18-20% by 2013 (QQ 361-363).

40.  Dr Franz Fischler, former Commissioner for Agriculture and Rural Development, also confirmed unequivocally to us that the additional modulation figure from 2007 (excluding the automatic 5% modulation) would have to be 8%; without even including the cost of applying the CAP to Bulgaria and Romania (QQ 544-545).

41.  Additional funds will not be provided for the agricultural cost of the accession of Bulgaria and Romania. The financial discipline mechanism will divert funds from direct payments to farmers in the EU-15 to farmers in the new and future Member States. This should not necessarily preclude a move to increase the proportion of funding on rural development measures which are more likely to benefit farmers in the new Member States.

42.  This use of the financial discipline mechanism will encourage the Brussels ceiling to be treated as a limit on spending rather than an allocation. It will also encourage moderation of the single farm payment in the short term, in advance of long term reforms. For the reasons stated above, it is clear to us that farmers in the EU-15 are likely, from 2007 onwards, to receive reduced single farm payments, and these will dwindle further to 2013. The European Commission must make this clear to the Council of Agriculture Ministers.

The Brussels Ceiling

43.  We understand the 2002 Brussels Ceiling was agreed within the CAP reform negotiations occurring at that time. It provided stability by allowing EU farmers to know exactly how much money would be allocated for direct payments until 2013 at a time of considerable change in agricultural financing. However it is clear to us that ceilings have been set which do not fully anticipate the demands on the 2007-2013 Pillar 1. As Mr Rickard remarked, "given the scale and importance of the Union's policy objectives" the Commission's proposals as based on the Brussels ceiling are "conservative" (p 1).

44.  We believe the Brussels ceiling represents a missed opportunity to plan fully for the enlargement of the EU. In particular, as we have shown, due thought has not been given to the future financing of the EU agriculture sector following accession of Bulgaria and Romania. Future enlargement should be planned for much more carefully when preparing the Financial Perspective for the period beyond 2013.

45.  The Brussels ceiling has also created a situation whereby future Pillar 2 funding may be held hostage to negotiations over Pillar 1 funding. If, as we have recommended, the Brussels ceiling is not re-opened, it is likely that any reduction in the overall CAP budget resulting from negotiations on a 1% GNI budget would fall on Pillar 2. Calculations based on a 1% budget suggest this could reduce Pillar 2 funding by 55% if no cuts were made to Pillar 1. This would be highly regrettable as the setting of the first Pillar ceiling should not prejudice the setting of the second Pillar. We reiterate our previous recommendation[26] that the Council should never again seek to pre-empt negotiations on the Financial Perspective by agreeing certain ceiling limits beforehand.

15   All references to evidence refer to volume II of this Report Back

16   Austria, France, Germany, the Netherlands, Sweden and the United Kingdom: letter to President Prodi, 15 December 2003.  Back

17   Speech to the Oxford Farming Conference, 5 January 2005: http://www.defra.gov.uk/corporate/ministers/speeches/1w050105.htm Back

18   Recent figures produced by Eurostat support this view. During 2004 large increases in EU output volumes were reported for crops: cereal (+24%), wine (+21.1%), olive oil (+25.3%) and oilseeds (+25.4%) EU25 real agricultural income per worker up by 3.3% (Eurostat news release, 17 December 2004). Back

19   The Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Slovenia and the Slovak Republic. Back

20   Executive Summary, Analysis of the Impact on Agricultural Markets and Incomes of EU Enlargement to the CEECs, March 2002, European Commission Directorate General for Agriculture. Back

21   Under Regulation 118/2005, published in Official Journal L24, 27 January 2005. Back

22   See Appendix 1. Back

23   EU25 cereals production increased by nearly a quarter in 2004 (Eurostat news release, 8 March 2005). Back

24   No 6206/05 Proposed Regulation amending Regulation (EEC) No 1883/78 laying down general rules for the financing of interventions by the European Agricultural Guidance and Guarantee Fund, Guarantee Section Back

25   As part of the reformed CAP's objective to reduce direct payments, automatic modulation is in place to move funds from Pillar 1 to Pillar 2. Member States can opt to modulate up to 20% of Pillar 1 funds. See Box 3 for further explanation. Back

26   European Union Select Committee, 6th Report (2004-05): Future Financing of the European Union (HL 62), paragraph 19. Back