France, Germany have a plan for Europe

The deal struck between German Chancellor Angela Merkel and French President Emmanuel Macron might one day be remembered as the European Union's 'Hamiltonian moment'

The new Franco-German proposal for a $547 billion European recovery fund could turn out to be the most important historic consequence of the coronavirus. It is even conceivable that the deal struck between German Chancellor Angela Merkel and French President Emmanuel Macron might one day be remembered as the European Union's "Hamiltonian moment," comparable to the 1790 agreement between Alexander Hamilton and Thomas Jefferson on public borrowing, which helped to turn the United States, a confederation with little central government, into a genuine political federation.
Admittedly, this sounds hyperbolic. The proposed sum for the recovery fund is small change in an era when politicians and central bankers conjure up trillions almost daily. And what about the gulf between words and action throughout the EU's history? Skepticism about the Franco-German proposal is certainly understandable and may prove justified.
The plan amounts to only 3 per cent of the EU's GDP, compared with the 15 per cent of GDP already committed by Germany to industrial support. Creating any EU recovery plan will require unanimous support from the EU's 27 member countries - and this will involve unseemly late-night squabbles between the self-styled "Frugal Four" northern governments (the Netherlands, Austria, Finland, and Sweden), which have vehemently opposed funding for Mediterranean EU members which, according to Wopke Hoekstra, the Dutch Finance Minister, have mainly themselves to blame for "failing to reform."
But to focus on these drawbacks is to miss the potential significance of the plan. What makes the Merkel-Macron deal a potential game changer is not the sum of money or their apparent backing for grants over loans; it is the financial mechanism to which both Merkel and Macron are now publicly committed and must now deliver or suffer enormous loss of face.
The Merkel-Macron proposal involves three crucial innovations, which may sound tediously technical but will vastly increase the flexibility of EU fiscal policy and could ultimately transform European politics in a way that really proves comparable to the Hamilton-Jefferson deal.
The key innovation is financing the recovery fund with bonds issued directly by the EU in its own name and guaranteed by its own revenues, instead of using funds raised by national governments, whether acting together or separately. Merkel presumably insisted on this mechanism to avoid the vexations of jointly guaranteed "Eurobonds," which German public opinion deems politically toxic and possibly unconstitutional, because German taxes could end up paying for Italian or Spanish debts.
But by relying on the EU, instead of national governments, to issue bonds, the Merkel-Macron plan implies a second, more controversial, innovation, which is clearly necessary to create a fiscal federation, but which European politicians have always tried to avoid.
To guarantee and service hundreds of billions of euros of new borrowing on its own account, the EU will require more tax revenue than it now receives. Merkel and Macron have therefore proposed increasing the European Commission's budget from 1.2 per cent to 2 per cent of EU gross national income, yielding about ?180 billion per year in extra revenue.
To raise this amount, the EU will need to levy new taxes on its own account, in addition to the customs duties and small share of national VAT revenues which already flow automatically to Brussels. The exact nature of the EU's new taxes will presumably be the subject of fierce debate and fiercer lobbying.
But a broad consensus seems to be emerging that pan-European taxes should be based on economic activities that transcend national boundaries, such as carbon dioxide emissions, financial transactions, and digital transactions. Some of this extra tax revenue will flow into recovery projects, but most will be needed for other EU spending, such as the "cohesion funds," which subsidise the poorer eastern countries (and help to buy off governments that might otherwise block the recovery fund and other EU initiatives and reforms) - and also to replace the United Kingdom's net contributions of roughly ?10 billion per year.
That leads to the third game-changing innovation in the Merkel-Macron plan: permitting the EU to leverage its activities with borrowing, instead of just using the EU budget as a pass-through mechanism from pan-European taxes to current spending. 
If the EU issued ten-year bonds, it would probably pay interest of zero or below, potentially allowing almost unlimited borrowing, albeit with sinking funds to redeem the debts at maturity. But even a 50-year bond could probably be issued with a coupon no higher than the 0.5% yield on Austria's 50-year bond.
Better still, the EU could issue perpetual bonds with no redemption date, similar to the now-retired British and US "consols," as proposed by the Spanish government and George Soros. This would allow the EU to borrow ?500 billion at an interest cost of just ?2.5 billion per year.
Such simple calculations show why European economic and political conditions could be completely transformed by the Merkel-Macron plan's financial innovations.
Anatole Kaletsky is Chief Economist and Co-Chairman of Gavekal Dragonomics.-Project Syndicate