Burgeoning EU takes annual tilt at UK rebate

London Briefing: It's European budget time again, which means the EU will begin its annual exercise in futility and ask Britain to forgo its rebate, famously negotiated by Margaret Thatcher in 1984.

UK foreign secretary Jack Straw has been joined by chancellor of the exchequer Gordon Brown in threatening the rest of the EU with a veto of the entire budgetary process if Brussels persists in its attempts to squeeze more money from the British treasury.

This pantomime begins around this time every year and has acquired fresh resonance as the EU's demands for funds show signs of growing at an exponential pace and the traditional paymaster, Germany, becomes less able to subsidise inefficient farmers in 25 countries.

The European Commission is demanding a 35 per cent increase in its budget - which was branded as "utterly unacceptable" by Straw. He argues that no government would seek such an increase.

In turn, the commission has proposed a cap for the rebate in 2007, to be followed by annual reductions.

The rebate is worth around £3 billion (€4.36 billion) a year - not a lot when you consider British public spending will total around £500 billion this year. But the issue is redolent with symbolism and the Blair government is terrified of the consequences of being seen to hand money back to Brussels.

Commission president José Barroso has recently joined the fray, arguing that the UK is now much more prosperous than when the rebate was negotiated 21 years ago and that it is no longer justified. Jacques Chirac, as well as many others, has added to the growing chorus of European politicians who want Britain to contribute more to the running of the EU.

Brown has argued that the rebate is completely justified, claiming that, if it didn't exist, Britain would pay more than any other member state. As things stand, with the rebate, only Germany pays more.

One of the reasons for this is that the UK receives relatively little by way of agricultural subsidies and infrastructure grants compared to other countries, so its net position is already that of a large donor.

Downing Street is clearly weary of all of this. The prime minister's official spokesman recently suggested that if anyone typed in "Chirac", "summit" and "rebate" into Google, they would find that we have been here before.

The EU's budgetary problems are being made worse by the hopeless economic performance of Europe's larger economies. Germany's problems are well known and have led to an early general election but Italy's economic difficulties are much worse.

A recent report by the commission argues that the Italian economy has not changed in decades and does very little that China doesn't do better. Italian exports have shrunk over the past four years, a truly appalling vista when we note the massive expansion in world trade over that time.

Germany's pace of structural reform might be glacial but Italy's has been next to non-existent. The economy is, once again, in recession.

The accession of a lot of poor countries to the EU could not have come at a worse time for Brussels' finances. Even to meet existing commitments to the newly arrived poor farmers will require fresh sources of revenue. Hence the need for an overall budget increase and more attention than usual on the UK's rebate.

Prime minister Tony Blair probably agrees that the UK could afford to pay a bit more. But he also knows that the media will portray any concessions on this issue as handing over money to an inefficient and occasionally corrupt bureaucracy. While the relevance of Britain's 2006 constitutional referendum may be somewhat reduced by the outcome of the forthcoming French or Dutch votes, Blair will not want to antagonise an anti-EU electorate any more than is necessary.

It was truly astonishing just how little the issue of Europe figured in the recent election. The trouble for the government is that the debate, for many people, has now been settled. The only way it can be re-ignited is in a negative sense.

Blair will be hoping for rescue from a French "No". Brussels must realise that asking Britain for more money will only push the country further to the European fringe.

Chris Johns is an investment strategist with Collins Stewart. All opinions are personal.