Tax Increases and Spending Cuts Loom as Defense Budgets Surge – ECB Warnings on Public Debt

The European Central Bank (ECB) has tempered expectations regarding the developmental impact of increased defense spending, warning that future tax hikes or cuts in other public expenditures may be necessary to ensure the sustainability of public debt. Specifically, while acknowledging that strengthening European defense is essential for geopolitical challenges and strategic autonomy, the ECB highlights risks associated with excluding defense expenditures from fiscal rules. Countries like Greece, among others, have requested exemptions under the escape clause proposed by the EU for defense spending increases between 2025-2028. The ECB outlines several negative aspects: potential displacement of private consumption and investment due to expected future tax increases, short-term inflationary pressures, possible tax increases, and constraints on real GDP growth. Additionally, financing these increases through borrowing poses significant risks to debt sustainability without corresponding cost-saving measures. The role of the Shared Financing Mechanism (SAFE) is critical in supporting countries facing debt sustainability challenges by offering favorable financing terms for armament programs.