EU Fiscal Rules and Public Investment in the Green and Digital Transitions –

Policymakers in the EU must substantially increase public investment to achieve ambitious green and digital objectives, even as many member states face fiscal consolidation, rising ageing-related expenditure and higher defence spending. This article examines how the reformed EU fiscal framework treats public investment and whether it provides sufficient fiscal space for the green and digital transitions. Investment and reform commitments can justify extending national adjustment periods, provided that public investment ratios are at least maintained. However, most nationally financed investment counts towards net expenditure and therefore remains constrained by agreed net expenditure paths, while the framework takes no account of the public assets created through such spending. Medium-term fiscal-structural plans suggest that downward pressure on public investment is stronger in countries facing larger adjustment requirements. Merely safeguarding current investment levels will be insufficient to deliver the green and digital transitions. The article assesses five options for expanding fiscal space. It argues that technical adjustments within the existing framework could provide meaningful, but largely temporary, relief. More ambitious reforms will be necessary to create durable fiscal space and sustain political support for higher public investment.

Investment in the European Union must rise substantially to deliver the green and digital transitions, which will require a major renewal and expansion of the capital stock over the coming decades. The Draghi report estimates the EU’s annual investment gap at €750-€800 billion, or around 4.5% of GDP, across areas including energy security, decarbonisation and digital infrastructure (Draghi, 2024). Much of this investment will need to be initiated by the public sector because essential projects such as electricity grids or transport infrastructure have great social benefits but often provide private investors with returns that are too low, uncertain or long-dated to justify investment on a sufficient scale. Public investment can also crowd in private capital, particularly when it forms part of a credible and coherent long-term strategy that raises investment in support of strategic green and digital objectives and sustains it at a sufficiently high level. This points to the need to increase public investment by at least 1% of EU GDP annually and maintain that effort over time (Heimberger & Lichtenberger, 2024).

After several years of suspension under the general escape clause in response to the COVID-19 pandemic, the reformed EU fiscal framework entered into force in April 2024. At the same time, many member states face growing public spending pressures from population ageing and higher defence commitments (e.g. IMF, 2025). With fiscal deficits and public debt ratios often still above levels recorded before the pandemic and subsequent energy crises, governments face pressure to consolidate public finances while addressing substantial long-term spending needs.

Against this background, I assess whether the EU fiscal framework provides sufficient scope for strategic investment in the green and digital transitions and discuss options for expanding fiscal space for these priorities.

Public investment in the EU fiscal framework

The reformed EU fiscal framework is built around country-specific multi-year fiscal-structural plans negotiated between national governments and the European Commission. Its overarching objective is to place public debt ratios on a plausibly downward path while ensuring that fiscal deficits remain below 3% of GDP. Country-specific adjustment requirements are translated into multi-year paths for net expenditure growth, defined as government expenditure net of interest payments, cyclical unemployment spending, temporary measures, discretionary revenue changes and national funds for co-financing EU expenditure (Heimberger, 2026).

Public investment is generally included in net expenditure and is therefore subject to the same constraints as most nationally financed spending. The main exceptions relevant to public investment are expenditure on EU programmes fully matched by revenue from EU funds and national expenditure on the co-financing of EU-funded programmes. Member states may obtain an extension of the fiscal adjustment period from four to a maximum of seven years if they submit an investment and reform package that supports growth and debt sustainability, addresses common EU priorities and country-specific recommendations, and maintains nationally financed public investment at least at its previous level. Eight member states received such an extension in the first application round in 2024–2025: Austria, Belgium, Finland, France, Germany, Italy, Romania and Spain.

An extension of the adjustment period to seven years reduces the required annual consolidation; however, it neither exempts (strategic) public investment from the net expenditure path nor necessarily lowers the total adjustment requirement substantially (Darvas et al., 2024). Governments seeking to increase green and digital investment must therefore generally create room within their net expenditure paths by hiking taxes or restraining other spending. The fiscal framework may help preserve existing investment in countries granted an extension, but it does not ensure the additional fiscal space required for the green and digital transitions.

A further weakness is the framework’s narrow focus on bringing down public liabilities over the medium run. It disregards the accumulation of public assets through investment, even though stronger government net worth, i.e. the value of public assets minus liabilities, can support economic growth and the long-term sustainability of public finances (Ball et al., 2021; Chai et al., 2024). By focusing on public debt while ignoring the assets created by public investment, the rules fail to provide incentives for financing projects that strengthen future productive capacity.

Maintaining current investment levels will in any case be insufficient to meet the EU’s climate and digital objectives. Boivin and Darvas (2025) find that nationally financed public investment is projected to decline in around one-third of member states over the period 2025–2028. Public investment is particularly vulnerable during consolidation because projects can often be postponed or cancelled more easily than current expenditure (Jacques, 2021). Consistent with this, stronger adjustment requirements are associated with greater downward pressure on public investment (Boivin & Darvas, 2025).

These constraints are becoming more binding as governments face mounting pressure not only to increase military expenditure, but also to sustain it at a structurally higher level over the longer term (Heimberger et al., 2026). Financing higher green and digital investment through tax increases or cuts to social protection, health, education or other spending may prove contentious, potentially increasing the risk of political instability (Heimberger & Matzner, 2026).

Options for expanding the fiscal space for public investment

This section discusses five options for creating additional fiscal space for public investment in support of the green and digital transitions. Three could be implemented largely within the existing EU fiscal framework: using the national escape clause, revising the Debt Sustainability Analysis (DSA) underlying the EU fiscal rules, and making greater use of national co-financing of EU funds. Two others would require more far-reaching institutional reform: a legislated exemption for public investment and a permanent EU investment fund.

Using the national escape clause for energy security investment

The European Commission initially invited all EU member states to activate the national escape clause for additional defence expenditure. Participating member states may temporarily deviate from their net expenditure paths during 2025–2028 by up to 1.5% of GDP per year, measured relative to defence spending in the 2021 base year (e.g. Heimberger et al., 2026). In its 2026 European Semester Spring Package, the European Commission (2026) communicated that, upon request, this flexibility could also cover measures undertaken since February 2026 to reduce dependence on imported fossil fuels.

Eligible measures include investment in electrification, electricity grids and storage, energy efficiency and clean-energy capacity. This could allow governments to finance projects that strengthen energy security and decarbonisation without worsening compliance with their agreed expenditure paths.

However, the additional fiscal space is both limited and temporary. Energy-related measures are capped at 0.3% of GDP per year and 0.6% cumulatively over 2026–2028, while the escape clause’s overall ceiling remains unchanged. The measure may therefore offer targeted short-term flexibility; however, it does not provide a structural solution to existing investment gaps.

Adjusting the European Commission’s framework for debt sustainability analysis

The DSA plays a central role in determining country-specific adjustment requirements under the new fiscal rules, as it is used to assess how much fiscal consolidation is needed to put the public debt ratio on a plausibly downward trajectory. Relatively small changes in DSA assumptions can substantially affect the required fiscal adjustment (Heimberger et al., 2024). Changing the treatment of public investment in the DSA could therefore create extra fiscal space.

The current framework encourages investment and reform plans by allowing the adjustment period to be extended from four to seven years. Yet the DSA does not systematically recognise that these measures raise potential growth (Fournier, 2016). This creates an inconsistency between the incentives built into the rules and the technical framework used to assess debt sustainability.

A more coherent approach would incorporate potential growth effects into the DSA. Investment multipliers could be used to translate additional public investment into higher potential growth (e.g. Suresh et al., 2024). Where the DSA-based constraint is binding, stronger projected growth would reduce adjustment requirements.

Such changes would not require legislative reform, as the legal framework does not prescribe the DSA’s detailed assumptions. Nevertheless, the fiscal space generated would remain constrained by the safeguards stipulating minimum fiscal consolidation requirements¹ and, for countries in an Excessive Deficit Procedure (EDP), the general requirement to improve the structural balance by at least 0.5% of GDP annually. Any additional room would also not automatically be allocated to green or digital investment. In any case, recognising that public investment can raise potential growth would make the framework more internally consistent (Gottschalk et al., 2025).

Using national co-financing of EU programmes

National co-financing of EU-funded programmes is excluded from the net expenditure indicator used to assess compliance with national fiscal plans. Although the immediate effect is likely to be modest, this provision could eventually encourage governments to channel more investment through EU programmes.

Its importance will depend on the design of the next Multiannual Financial Framework (MFF) for 2028–2034 and the extent to which future programmes permit or require national co-financing (Hansum et al., 2025). The Commission’s proposal to replace narrowly defined programmes with a more flexible envelope linked to EU objectives could strengthen this channel.

The EU budget could also be reoriented more strongly towards climate investment. Cohesion and agricultural expenditure could become more climate-friendly, while a more ambitious climate spending target could be set for the next MFF (Heimberger & Schratzenstaller, 2024). New green own resources such as levies on aviation and cryptocurrency transactions, could further reduce pressure on national budgets (Schütz & Heimberger, 2026).

Introducing a legislated investment carve-out

A substantial reform would be a legislated carve-out, or “green golden rule”, allowing governments to borrow for eligible public investment without the expenditure counting against the net expenditure indicator used to assess compliance. The rationale is that public investment creates assets and benefits over many years. Charging its entire cost to the year in which it is undertaken can bias fiscal policy against investment, particularly during consolidation. A broad rule could exclude total net public investment (Truger, 2016), while a narrower version could focus on climate, energy and digitalisation investment priorities (e.g. Darvas & Wolff, 2023; Pekanov & Schratzenstaller, 2023).

Such a rule could protect investment from the cuts it often experiences during fiscal consolidation. It would also make the fiscal framework more consistent with the EU’s strategic objectives by preventing the rules from discouraging nationally financed investment in areas where substantial additional spending is required.

However, a legislated carve-out would require careful design. There are concerns that a broad exemption would weaken fiscal discipline, encourage the relabelling of current expenditure and favour physical infrastructure over education or R&D spending. Eligibility therefore needs to be defined, linked to EU priorities and subject to transparent accounting and independent monitoring (e.g. Blesse et al., 2023).

A legislated carve-out would represent a more significant political and legal change than DSA reform or using more national co-financing of EU funds; it would also need to account for debt sustainability risks in high-debt countries. Nevertheless, it represents an option for directly addressing the absence of systematic support for nationally financed public investment for the green and digital transitions.

Creating a permanent EU investment fund

An ambitious option is a permanent EU fund for climate, energy and digital investment. National budgets alone are unlikely to meet the scale of investment required, particularly where member states face tight constraints under the fiscal rules (Heimberger & Lichtenberger, 2024).

A permanent EU investment fund could build on the experience of the Recovery and Resilience Facility (RRF), the central component of NextGenerationEU, which was established in response to the COVID-19 crisis. The RRF provides grants and loans to member states based on agreed investments and reforms, with substantial resources allocated to climate and digital objectives. It is financed through borrowing by the European Commission on behalf of the EU.

The RRF demonstrated that common EU borrowing can be used to support national investment while advancing shared policy priorities. However, it is temporary and too limited to meet the EU’s longer-term investment needs, with payments scheduled to end in 2026. Cornago and Springford (2021) show that achieving the EU’s 2030 climate target would require green public investment several times larger than the green component of the RRF.

Following this model, the European Commission could issue EU bonds and use the proceeds to finance climate, energy and digital investment. The debt would be issued at the EU level rather than becoming the direct liability of individual member states. Its servicing would nevertheless need to be accounted for. This could be achieved by introducing new own resources that generate a dedicated revenue stream in the MFF or by refinancing maturing bonds and gradually establishing a permanent stock of common EU debt (Heimberger & Lichtenberger, 2024; Schütz & Heimberger, 2026).

A permanent EU investment fund could concentrate on projects with clear European added value and substantial cross-border benefits. These could include European public goods in energy, transport and digital infrastructure (Beetsma & Buti, 2024). In transport, an integrated high-speed rail network could help reduce emissions and improve cross-border connectivity (Creel et al., 2020; Angers et al., 2023). In energy, priorities could include stronger cross-border electricity grids, storage capacity and infrastructure for green hydrogen. Digital projects could include ultra-fast broadband, cross-border 5G networks, European cloud capacity and high-speed data networks (Heimberger, 2026).

By financing projects that are difficult to organise efficiently at the national level, a permanent EU investment fund could accelerate the green and digital transitions, and reduce pressure on national budgets under the EU fiscal rules.

Conclusions

National fiscal policy is becoming increasingly constrained in many EU member states just as public investment needs to rise to meet ambitious climate and digital objectives. The Draghi report and related studies call for a significant expansion of investment to advance the green and digital transitions. At the same time, ageing-related expenditure, rising defence spending and the reformed EU fiscal framework are narrowing governments’ room for manoeuvre. Many member states must therefore reduce fiscal deficits and debt ratios over multi-year adjustment periods while simultaneously financing investment in decarbonisation, digitalisation and energy security.

Safeguarding current investment levels will not be enough. Meeting the EU’s strategic objectives will require additional public investment of at least 1% of EU GDP annually and credible long-term financing arrangements. The tension between fiscal consolidation and the EU’s investment agenda is therefore real, but not unavoidable. Much will depend on the willingness of national governments and EU institutions to create additional fiscal space.

The national escape clause, adjustments to debt sustainability analysis and greater use of national co-financing for EU programmes could provide limited and temporary relief within the existing framework. More far-reaching reforms – such as a targeted exemption of strategic investment from net expenditure or the creation of a permanent EU investment fund – would address the investment constraint more directly.

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