Raise military spending – that's easy to say. Three ideas on how to finance it

Allianz Research analysts note that so far, in the face of aging societies and the enormous needs related to the green transformation, governments have been reluctant to specify how exactly they will increase defense spending. “To put this into perspective, it would require:

• spending cuts by -8.6 percent in Spain, -7.7 percent in Germany, -6.5 percent in Italy and -4.8 percent in France; or

• an additional interest burden of approximately EUR 12.1 billion in 2028 if based solely on debt financing; or

• If the focus was solely on increasing tax revenues, for example VAT rates, they would increase by 0.6 percentage points across the EU,” we read in the latest study.

Rising defense spending

Allianz Trade analyzes show that since 1995, overall government spending on defense in today's EU27 has increased from EUR 104 billion to EUR 204 billion in 2022. However, they have not kept pace with overall growth in GDP and total spending: In 1995, defense spending accounted for 1.6 percent. GDP compared to 1.3 percent GDP in 2022, ranging from 0.2 percent GDP in Ireland to over 2%. in Greece, Latvia, Estonia and Lithuania (Poland 1.6% according to COFOG, i.e. the classification used to determine individual consumption and general social consumption in the general government sector).

Gradual increase in the share of defense spending to 2%. GDP in all EU Member States by 2028 would require a total of €470 billion in additional government spending compared to a scenario assuming current levels. This would include €150 billion in Germany, €55 billion in Italy, €48 billion in Spain, €17 billion in France and €11.9 billion in Poland. Reaching a share of 3%. The GDP currently spent by the US (and also requested by Polish President A. Duda) would require additional defense spending of EUR 1,110 billion (EU scale) over the next five years.

The question is how will these spending increases be financed? Allianz Trade analyzes show that there are three options for financing increased defense spending: cutting spending on other functions, debt financing or increasing taxes.

How to finance the increase in defense spending?

Maintaining the overall level of spending stable (in the scenario of increasing defense spending to 2% of GDP) would require cuts in public spending by -8.6%. in Spain, -7.7 percent in Germany, -6.5 percent in Italy and -4.8 percent in France. The single largest item of spending in EU countries' budgets is social protection spending. In 2022, they accounted for 39%. total expenditure of the general government sector in the EU-27 (in Poland 38%), with 54% social protection spending in the EU was pension spending; 15 percent of total expenditure was allocated to health (12% in Poland), and 12% each for general public services and economic policy (in Poland, 10% for public services and 15% for economic policy, respectively).

Another option would be to raise taxes to cover additional defense spending. Assuming no change in the structure of tax revenues, according to our calculations, the VAT rate would need to increase by an average of 0.6 percentage points in the EU-27 in 2028, from 0.1 percentage points in France, 0.5 percentage points in Italy and 0 .7 percentage points in Germany and Spain to 2.4 percentage points in Ireland (for Poland, an increase of 0.4% from 23%).