The coronavirus pandemic poses an immense challenge to society and citizens in terms of health and the economy. Currently, decision makers are focusing on public health and the performance of healthcare systems. At the same time, it is important to minimise the damage to businesses and wage-earners, as summarised in Baldwin and Weder di Mauro (2020). Next, we will have to think about how to pay the bill.
In Europe, the measures taken by the public sector enjoy broad-based support. Central banks have been quick in their responses and offered financing for those who need it. Governments have done their part by extending loans and offering financial support. Part of the assistance provided by the public sector is in the form of loans that are expected to be repaid, while part consists of financial support which will not be repaid. Financial support refers to measures whose cost impact will be spread over the coming years, with the public sector becoming increasingly indebted. While estimates vary from one country to the next, sovereign debt is expected to grow by 10–30 percentage points relative to GDP as a result of the rescue operations triggered by the Covid-19 crisis.
Public debt has been growing for a long time
So far, the increase in public debt has been manageable because the ECB has been purchasing government bonds, thereby keeping the interest rate at a moderate level. The central bank may be expected to continue doing so, but the public debt will have to be repaid over time and further growth of debt brought under control. This can only be achieved through taxation.
Taxation is a tricky issue in a democracy. Irrespective of the country involved or the political party in power, tax rates and debt ratios have increased in most European countries, as well as in the US, over the past decades. Indebtedness has grown as a result of tax cuts or increased benefits. It is only fair to ask how we expect things to get better in the future when we have failed to fix the problem in the past?
Understandably, concerns over a disproportionate public deficit and national debt are increasing, and efforts are being made to find a way out, preferably other than taxation. Before taking a closer look at taxation, we need to consider two other potential solutions to servicing the debts incurred as a result of the corona crisis.
Coronabonds increase debt levels
One proposed solution is Coronabonds, or Eurobonds as they could be called for simplicity. These are bonds issued indirectly by euro area countries, which would make it possible to target support to countries most impacted by the corona crisis. For many of the impacted countries, this joint liability would mean cheaper financing costs. However, in the current situation the cost of financing the debt is not a problem, thanks to the ECB. It has kept, and will keep, interest rates low. Shared liability would mean that the costs would be spread widely. But the problem with Coronabonds is that liability for one’s own debt would be shouldered by others. In the absence of stringent conditions, this solution would, with time, lead to new problems and would, most likely, increase total debt. The scheme would not reduce the amount of debt, which should be one of cornerstones of sound financial management policy in a situation in which the level of debt is already excessively high. Efforts must be made to reduce debt levels because buffers should be created to cushion the impact of new crises that will inevitably emerge in the future. According to estimates by Reinhart and Rogoff (2010), a national debt of 90% relative to the GDP can be regarded as a sort of critical limit. If this is exceeded, the necessary preconditions for economic growth will suffer, paving the way for a range of financial crises. This level has been exceeded by some countries and may potentially be exceeded by number of more countries if the crisis continues.
Central bank-generated stable inflation is hard to engineer
Another proposal calls for various schemes by which the central bank could induce inflation or otherwise create room for additional government borrowing. Gali (2020) calls for the use helicopter money as this emergency situation calls for emergency action whereby money-financed fiscal intervention would be the solution. Vihriälä (2020) suggests a big enough debt relief by the ECB for euro area government debt. This could take the form of conversion of ECB-held sovereign debt into perpetuity with zero coupon. Blanchard and Pisani-Ferry (2020) have stated that the current central bank policies have not provided evidence that the central banks would be giving up their price stability mandates. Even the current public bond purchases should not be regarded as indicative of future excess monetisation.
With time, a higher inflation rate would reduce the amount of debt in real terms. While the goal is extremely simple, a simple solution may be difficult to find. Market interest rates could easily jump and cause problems for indebted countries in the short term. To be successful, inflation should be generated over the medium term and remain steady and controlled. One potential way of making it work would be to raise the inflation target to 4% for a period of 10–15 years. The practical implementation of this would call for helicopter money in various forms. This approach might be termed ‘generated stable inflation’. Considering that the current rate of inflation in the euro area is hardly one percent, the mechanism described above would reduce the amount of debt by 35–55% over the years. Whether it could be achieved without close regulation remains to be seen. At least for the transition period, low-interest government bonds should be issued, which would only be purchased by the central bank. On the drawing board the solution looks simple enough, but market forces would make it bumpy and painful.
The solutions outlined above would provide no easy way out and would expose the economic system and the euro to elevated risks. Hence, they should only be resorted to if nothing else works and no other option remains.
Coronataxes as a solution to the debt problem
Before anything else, we should take a closer look at taxation as a solution to the growing amount of debt. Taxation is mostly national. It would be advisable to think how the cost of countering the coronavirus could be financed through coronataxes. Corona taxation could be accomplished at the national level, and possibly even supported at the EU level, through joint coordination, declaration or even payments.
For example, coronataxes could be collected by raising overall taxes temporarily for 5–10 years, the objective being to repay the extra 10–30% of public debt incurred as a result of the corona crisis. The increase would apply to all forms of taxation. Income taxes should be increased by 1–5 percentage points for all wage-earners. Corporate taxes should be increased by 1–5 percentage points for all tax-paying businesses. Value added taxes should be increased by 1–5 percentage points across the board. The simplest and easiest solution would be to increase all forms of taxes by an annual 3-percentage point coronatax for the next 5–10 years.
Unfortunately, it is impossible to make the culprit of the corona crisis pay for the cost. In the financial crisis, the blame could be placed squarely on the banking sector, as its high indebtedness was one of the reasons for the problems. In addition, the financial support, in its various forms, had to be channelled to the banks. After the financial crisis, the EU saw the establishment of the Single Resolution Board that raised, in just four years, €33 billion euros from over 3,000 euro area banks and is set to collect a total of €60 billion by 2023. The funds were collected according to a formula worked out by member states under which large banks and those perceived most at risk contributed more than others.
With the corona crisis, it is hard to name the culprit. The number of those who benefit from the support measures, directly or indirectly, is high and difficult to tell apart. The fact is that everyone will benefit. The schemes help sustain society and the existing economic system. Consequently, it is probably necessary to spread the cost among the maximum number of payers.
Support for EU-wide coronataxes
The tax schemes discussed above are still fairly straightforward. If we wish to set our sights a little bit higher, we could contemplate a European-wide decision or guidance on said temporary national taxes and tax rates. After all, it would be easier to sell the idea at home if all EU countries were involved. Maybe even a recommendation could be enough if decision-making within the EU proves too complicated.
Recently, the EU presidents published a joint roadmap for easing the restrictions imposed to combat the coronavirus. A similar roadmap for taxation could help with tax solutions at the national level. It could make national decision-making easier. Moreover, a uniform, coordinated temporary tax increase would tone down cross-border tax competition.
If we want to set the sights even higher and invoke nobler ideals of sustainability, we could consider an EU-wide carbon tax, emission trading pricing as well as carbon duties. That way, we could shift to taxing natural resources and environmental impacts, such as harmful externalities that accelerate climate change. While much progress has been made in these areas in recent years, we are just taking the first steps.
Perhaps EU-wide decisions are now conceivable, as we are compelled to collect taxes anyway. If it proves to be necessary to issue Eurobonds and there is sufficient innovativeness, the bonds could be tied to revenues from carbon taxes, emissions trading and carbon duties at the EU level. Emissions and air quality are supranational phenomena without national borders.
No viable alternatives to coronataxes
Even though taxation undermines economic growth, there are, unfortunately, no sound alternatives. Taxes generate protests because few people love to pay them. Those who demand substantial subsidies and quick action on the part of the governments and central bank are presumably willing to accept coronataxes in exchange. The coronatax would be a natural solution, in preference to complicated schemes that would anyway fail to address the core problem. Coronabonds and central bank-generated stable inflation would only be conceivable when all other options are exhausted. Strong economic growth will hardly rescue us because the challenges of an ageing population will only grow and erode the basis for growth across Europe.
Baldwin, R and B Weder di Mauro (eds) (2020), Mitigating the COVID Economic Crisis: Act Fast and Do Whatever It Takes, VoxEU.org Book, CEPR Press.
Blanchard, O and J Pisani-Ferry (2020), “Monetisation: Do not panic”, VoxEU.org, 10 April.
Gali, J (2020), “Helicopter money: The time is now”, VoxEU.org, 17 March.
Reinhart, C and K Rogoff (2010), “Growth in the time of debt”, American Economic Review, 100, May.
Vihriälä, V (2020), “Make room for fiscal action through debt conversion”, VoxEU.org, 15 April.
1 They see, however, that the ECB bond-buying purchase program can include some risk sharing elements which should rather take place in a more transparent way through budgetary or fiscal channels.