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State aid in times of COVID-19. Competition, moral hazard and public policy

Jul 14, 2020

The legal and non-legal definition of EU State aid

As time passes, more companies large and small are considering their options in applying for State aid with their governments. In the EU, State aid that distorts competition in the internal market is prohibited under Article 107 TFEU. Such State aid is considered to be incompatible with the principles of the internal market. However, there are ample “State aid” tools that fall outside the scope of Article 107. 

Many Member States have implemented wage subsidies, tax payment deferrals and/or reliefs. Where such relief is selective (e.g. only for the tourism sector) it does fall under Article 107 and needs to be notified to the Commission.

Within the scope of State aid, there exists a vast body of rules and regulations under which, even without the COVID-19 outbreak, State aid can be granted to companies (De minimis, GBER, Rescue and Restructuring Guidelines). Given the effects that the COVID-19 outbreak has and will have on companies, sectors and countries, additional measures can be allowed under Article 107 TFEU. Article 107(2)(b) is mainly employed with local occurrences, while Article 107(3)(b) is intended for world systemic crises such as the 2008 financial crisis, and now the COVID-19 outbreak.

By far the most popular of the measures is the guarantee scheme. 49 of the 98 measures that have been approved contain a loan guarantee scheme. Measures can be focussed at SMEs and/or specific sectors (e.g. airlines, tourism, events) or can be offered to all companies that are suffering a loss in revenues since the outbreak of Covid-19.

Competition

The central concern of State aid is that it distorts competition. A firm that receives a financial advantage from the State is at a competitive advantage against a firm that does not. While the Commission has set out rules under which it finds that certain State aid measures are “necessary, appropriate and proportionate” to remedy to remedy the impact of the Covid-19 outbreak on the economy, there will still be an impact on competition between firms.

First, as can be seen from the vast diversity of State aid programmes that have been notified by Member States, some companies will be eligible for more aid than others, while their exposure to the Covid-19 outbreak might be similar. The ambition of the Commission for a “coordinated response” is only partially found in the published measures. While it is true that similar types of measures are rolled out, and that the Commission has quantified boundaries for specific measures, the actual measures implemented and their requirements for eligibility differ.

As a result, within the framework specified by the Commission, there is still room for one company to be favoured more than another within the EU internal market.

For example, Dutch firms (SA.56914) are expressly allowed a 6 month moratorium when their loan has a state guarantee, while firms in for instance France (SA.56985), Germany (SA.56787), Spain (SA.56851), and Poland (SA.57065) are not offered this leniency. This will improve the competitive position of Dutch firms. Italian firms, however, are disadvantaged by the requirements set out by the Italian State (SA. 56963); they are not allowed to pay dividends in the first 12 months after issuance of a state guarantee. This puts them in a competitive disadvantage for attracting investors in the 12 months following the State guarantee, compared to EU companies who have a state guaranteed loan from another Member State.

The conditions set out for subsidised loans is also not uniform throughout the EU. For example, the Dutch State has set up a scheme only for SMEs, with a cap of EUR 2 million per applicant. Furthermore, loans over EUR 250,000 need to be co-financed by the firm’s shareholders for at least 25% (SA.57107). The subsidised loans provided by France (SA.56985), Germany (SA.56863), Spain (SA.56851) and Poland (SA. 57065) are for all size companies and do not speak of co-financing limitations. As a result, Dutch SMEs are put at a competitive disadvantage by the Dutch State’s additional requirements.

Taxation relief is a State aid measure that falls outside the scope of the European Commission, as long as it is not selective in nature. While non-selective measures are not considered State aid in a legal sense, they also impact competition in the internal market. There is no European coordination on what tax breaks should be considered reasonable in the current crisis.

Taxation is still very much a domestic affair in the EU, with unofficial tax havens being amongst its Member States. As a result, tax laws in Member States affect competition in the internal market regardless of the Covid-19 crisis. The alleviation offered during this crisis differs between Member States and in that respect affect the competition between firms on the internal market.

Some Member States have notified selective tax relief schemes to the Commission. France, for example has implemented a relief for airlines in the form of deferred payment of certain taxes, calculated in proportion to their loss of traffic (SA.56765).

Poland has launched a scheme containing 11 measures (SA.56922). Among it are a selective tax break to SMEs and NGOs on property taxes, where they do not have to pay taxes for April May and June, and only have to pay these by September. A similar extension is given to all firms in all sectors for rent or lease payments on public real estate, civil law claims, social security and health insurance contribution. Wage subsidies are also available for all companies in all sectors for maximum of 3 months, for companies that have seen more than a 30% revenue drop. The wage subsidy ranges from 50 to 90%, increasing with the proportion of revenues lost.

Moral hazard

A second major concern for the efficiency of State aid is moral hazard. The most recent example for such a threat was seen during the financial crisis where some financial institutions considered themselves and/or were considered by regulators as “too big to fail”. As a result, these financial institutions had a reduced incentive to manage their risk effectively, as they reaped the profits when their gamble paid off but not expect to bear the costs when their decisions would lead to bankruptcy.

A similar concern arises now. Member States are setting out the rules under which they are willing and/or able to grant aid to firms. In setting these rules, Member States want to ensure that firms now and in future have an incentive for efficiency.

An inefficient firm can be failing, generating negative profits; or it might be a highly profitable firm, but cash is re-invested at a rapid rate, or flushed from the firm by its owners through dividend pay-outs or share buy-backs. Both types of inefficiently run companies should not be kept in the market through the granting of State aid in crises.

Rescuing the failing firm will lessen the incentive of the owners to improve the efficiency of the performance of the firm. Rescuing the firm with high re-investment rate will lessen the incentive for owners to consider the risks taken in entrepreneurial decision. Rescuing the firm with greedy owners will lessen the incentive of owners to keep some reserves in the firm. While in the latter two situations State aid would serve to keep a profitable firm in operation, the owners of such a company have not run this company efficiently and should therefore not be supported. The competitive process should have its course in disciplining the market behaviour.

In this context, the Commission is currently considering including recapitalisation measures in the Temporary Framework. Documents leaked to The Guardian newspaper suggest that these measures would include stipulations that prohibit pay-out of dividends and repurchasing of shares. Such stipulations would help curb the moral hazard of the recapitalisation measures.

Public policy

As time passes, public debate is turning towards the possibility of using the current crisis to attain certain public policy objectives.

In this context, Poland and Denmark have introduced the eligibility requirement that State aid applicants should have paid taxes domestically and not be headquartered in a tax haven, i.e. a so-called non-cooperative jurisdiction. While such a requirement will score high on solidarity symbolism, neither country has made a reference or implication for firms that make use of the various unofficial EU Member State tax havens. In that sense, the impact of such requirements will be rather limited.

Furthermore, public debate is rising to introduce sustainability demands in the eligibility criteria, especially in the air travel industry. For example, the French State has appended some non-binding CO2 reduction stipulations to their aid of EUR 7 billion To Air France. The Dutch government is still negotiation with KLM regarding the amount and conditions of aid, the aid amount is expected to be in the range of EUR 2-4 billion.

Any opinions expressed in this communication are personal and are not attributable to Competition Economists Group (CEG)