Menu
Tax Notes logo

The Billion-Dollar Question: How to Pay for the Pandemic?

Posted on Apr. 8, 2020

The most critical question confronting the world today is how to contain COVID-19, but perhaps equally uncertain is how the trillions being spent on mitigating its economic impact will be financed.

COVID-19 has delivered a shock the likes of which has never been experienced in so short a time by so many people. Considering the dizzying array of measures being announced by governments around the world to deal with the unrelenting threat to the global economy, there is no crystal ball to reveal how the crisis will be sorted out, and certainly not how it will be paid for. “Given that we are living in unprecedented times, it would be very difficult for any economist to confidently suggest what the future holds for the global economy,” said Constantinos Alexiou, a professor of macroeconomics and policy at Cranfield University in the United Kingdom. 

While it is unclear how economies can eventually be put right, Alexiou said the old saw that there is no free lunch still holds true. “Given the current economic system, taxpayers in all likelihood will have to foot the bill at the end of the day,” he said. 

Simon MacAdam, a global economist with Capital Economics in London, said governments are resorting to unconventional tactics to deal with the economic consequences of the pandemic. “Fiscal orthodoxy has been chucked out the window as governments commit to doing whatever it takes to prevent this crisis snowballing into a protracted economic depression,” he said. “For now, preventing depression and mass deprivation is the immediate concern.” 

Fiscal consolidation won’t happen during the remainder of the year and is unlikely in 2021 as well, because governments won’t want to jeopardize economic recovery, MacAdam said. “Further ahead, tax rises are possible. Given the patriotic and [solidarity] narratives being adopted to fight the virus, I wouldn’t be surprised if, in many cases, the higher tax burden ends up resting mainly on the shoulders of richer households and corporations,” he said. 

Bev Dahlby, a professor of economics at the University of Calgary, said he doesn’t expect the Canadian government to enact any significant tax increases soon. “But with the increase in the public debt, there will have to be higher taxes, cuts in spending, or an increase in the rate of inflation,” he said. “The latter would reduce the real value of the public debt.” 

One country that shouldn’t resort to taxation to fund its efforts to rebound from the impact of COVID-19 is the one where the disease originated, said Derek Scissors, a resident scholar at the American Enterprise Institute specializing in the Chinese economy. “The Chinese have never taxed individuals effectively,” he said. “They don't know how . . . sizable tax increases risk capital flight. On the corporate side, they've started in the last few years to switch from monetary to fiscal leveraging as a risk-control measure. That was the easy part; deciding who faces additional taxation would be another political burden" for President Xi Jinping.

Scissors said he suspects that China will react like most other countries, “and just borrow, killing future growth for the sake of [the] present.” The country’s domestic savings pool will be large enough for at least another decade, he said. “What they should do is tax clearly oversized sectors, with nearly all building materials as the start,” Scissors said. “This is possible, as is a carbon tax. But they won't do it this year due to job fears.” 

Wealth Tax

Only one of the economists interviewed by Tax Notes responded to a question about whether governments will be more likely to propose wealth taxes to finance a post-coronavirus recovery.

Dahlby said that while he expects Canada’s federal government and some of its provinces to increase personal income taxes and general sales taxes, the introduction of a wealth tax is unlikely. 

Some other economists, however, think a wealth tax is the ideal tool to pay for the pandemic. Economics professors Camille Landais of the London School of Economics and Emmanuel Saez and Gabriel Zucman of the University of California, Berkeley published a paper April 3 proposing an EU-wide, progressive wealth tax on the net worth of the richest 1 percent of Europeans. “If fighting COVID-19 requires issuing 10 [percentage] points of EU GDP in Eurobonds (or a rescue fund worth 10 points of EU GDP), a progressive wealth tax would be enough to repay all this extra debt after 10 years,” the authors said. The tax envisaged by the trio would kick in at a rate of 1 percent for net assets above €2 million before rising to 2 percent for assets above €8 million and then topping out at 3 percent for assets over €1 billion. 

The economists supported their proposal by saying that while France and the United Kingdom inflated away their massive public debts accumulated during the first half of the last century, Germany resorted to highly progressive wealth taxes to more responsibly deal with the problem, paving the way for the country’s post-war economic miracle. “A wealth tax is preferable to inflation because it would provide clarity on the allocation of costs, while inflation redistributes wealth in an opaque and chaotic manner,” they said. 

Landais, Saez, and Zucman said the individuals who would be subject to the tax own between 20 and 25 percent of the total net assets in France, Germany, Spain, and Scandinavia. “This means that a wealth tax levied only on the top 1 percent wealthiest Europeans would generate a large amount of tax revenue while preserving wealth for the bottom 99 percent. With a European wealth tax, migration of wealthy taxpayers within the European Union becomes irrelevant; enforcement is facilitated by cross-border bank and tax administration cooperation," they said.

"Most importantly, a tax at the European level would be a concrete embodiment of European solidarity in the fight against the COVID[-19] epidemic," the economists added. "It would shift the discussion about how to pay for the costs of the crisis away from a question of international transfers (across European countries) and instead focus the discussion on transfers across individuals according to their means (irrespective of their nationality). This would overcome oppositions based on selfish national self-interest and contribute to creating a sense that Europe can indeed work for everyone.” 

Anticipating arguments that there is no legal basis for an EU wealth tax, the economists said the bloc’s treaties can be amended. “There is no reason to believe that the arguments that justify the need to coordinate our response to the virus cannot similarly apply to justify coordination in the payment of its costs,” they said. “Should an EU-wide agreement fail to materialize, a smaller group of countries could choose to create a common wealth tax, eventually paving the way for an EU-wide tax.” 

The economists concluded by saying that a time-limited wealth tax is less likely to retard future growth than other forms of fiscal consolidation or public expenditure contraction that might be used to repay “coronabonds” — which have been proposed as an EU-wide mechanism to finance relief efforts — because it would operate like a capital levy. “You tax past accumulation, but the returns to current investment and innovation are unaffected,” they said. “[The rates] are in line with the rates applied by the many European countries that had wealth taxes until recently — such as France, Germany, Denmark, and Sweden — and as in recent proposals, [with] a federal wealth tax . . . in the U.S.” 

The U.S. wealth tax proposals referred to in the economists’ paper were made by a pair of Democratic presidential candidates, Sens. Elizabeth Warren, D-Mass., and Bernie Sanders, I-Vt., based on earlier academic work done by Saez and Zucman.

According to a 2018 OECD report, only three of the group’s 35 member states — Norway, Spain, and Switzerland — still have net wealth taxes. “Decisions to repeal net wealth taxes have often been justified by efficiency and administrative concerns and by the observation that net wealth taxes have frequently failed to meet their redistributive goals,” the OECD said in the report. 

The debate over the constitutionality of a U.S. wealth tax kicked into high gear last year after the Sanders and Warren campaigns said they would implement one to pay for a large part of their ambitious spending plans. Daniel Shaviro, Wayne Perry Professor of Taxation at New York University, said the conservative majority on the U.S. Supreme Court would “undoubtedly” strike down a wealth tax as unconstitutional. “Although it's certainly possible that they will also strike down anything else at all that they don't happen to like,” he added. “Certainly, using a wealth tax rather than something else would make their job in that regard easier than it would otherwise be, although possibly they no longer feel they need much of a fig leaf.” 

Wealth taxes also raise administrative and efficiency issues that are much disputed, even among those who are comfortable with the underlying policy aims, Shaviro said. “I tend to think that they are probably not the best choice if one has sufficient flexibility, but a world in which they are politically possible is too counterfactual at present for me to feel able to assess what the realistic alternatives would be,” he said. 

VAT

Many countries have cut VAT rates and delayed payment deadlines to provide relief to cash-starved companies and encourage consumption as their economies reel from business shutdowns and mass layoffs. 

On April 2 the OECD published a working paper saying that while expanding VAT bases and harmonizing VAT rates might help stabilize consumption tax revenues in an economic downturn, countries should exercise caution when deciding on a course of action. The report, which was based on an analysis of the 2007-2009 financial crisis, said VAT revenues — especially in countries with low VAT efficiency and high proportions of government consumption — are at higher risk of exposure to economic shocks because of post-crisis changes in consumption patterns, since the parts of those tax bases that are subject to standard VAT rates have shrunk compared with pre-crisis levels. 

Among developed countries — in fact, compared with the whole of the rest of the world — the United States is an outlier when it comes to VAT. While almost all U.S. states impose sales taxes payable by the final consumer, those taxes lack a VAT's key feature of being levied at each stage of production with refunds or credits allowed for business-to-business transactions, which makes the tax harder to avoid. 

There has been little, if any, discussion about whether the United States might be more willing to consider a national VAT to pay for pandemic relief. Shaviro said that even before the outbreak of COVID-19, he believed that VAT should be part of a well-designed, modern fiscal system. “The distributional issues it raises (e.g., higher burden on the poor and lower burden on the rich than under a well-functioning income tax) are best addressed through other components of the fiscal system, on both the tax and spending sides,” he said in an email. “The concern that it will fuel runaway government spending is largely bogus, although clearly it is an issue to direct government expenditure towards good rather than bad things in the face of our highly defective political system.” 

Trade and Tariffs

One thing the pandemic has made clear is the vulnerability of global supply chains, which have increasingly relied on China in recent years. Concern about being cut off from key products will likely result in countries imposing tariffs, both to raise revenues and to encourage domestic companies to manufacture critical supplies locally, economists say. 

“Regardless of government measures, companies themselves are likely to shorten their supply chains as a result of all this,” said Vicky Redwood, senior economic adviser at Capital Economics in London. 

Dahlby said governments will start stockpiling critical medical supplies and equipment. “Requiring domestic companies to produce critical goods would be very costly for small economies such as Canada’s,” he said. “That said, they might introduce short-term subsidies while relevant industries have spare capacity.” 

“Unfortunately, the [French] government will raise some new barriers to limit foreign production, out[side] of Europe of what they will call ‘strategic products,’” said Jean-Philippe Delsol, a tax lawyer with Delsol Avocats and chair of the Institute for Research in Economic and Fiscal Issues in Paris. “We are afraid that a lot of products will be designed as strategic. It will be more difficult for the government to raise tariffs because of WTO rules and European rules, even [though] it will try to modify such rules or to get exemptions. It will probably use new regulations to oblige producers to repatriate goods production to France.” 

Before the pandemic, the European Commission vigorously enforced state aid rules prohibiting member states from conferring selective advantages on businesses that distort trade and competition within the EU. Once the magnitude of the crisis became clear, the commission quickly relaxed its policy. On March 17 it proposed that businesses affected by the coronavirus pandemic be allowed to receive direct grants and selective tax advantages of up to €500,000 to address urgent liquidity issues. On March 27 it proposed additional support measures, including allowing member states to defer tax payments and suspend social security contributions for specific regions or sectors to prevent layoffs. 

Since free and open trade between member states is one of the pillars on which the EU is based, concerns about actions taken by France and other European countries to control and restrict commerce within their borders “are not overstating the danger” to the bloc, Delsol said. 

Scissors, who is based in Washington, said tariffs are a poor source of revenue for large economies because they result in trade substitution, and for small economies because they invite retaliation and suffer foreign exchange shortages. “It's more likely countries will simply mandate relocation of production of certain goods away from China — for example, active pharmaceutical ingredients,” he said. “There are going to be very important global debates — obviously about what constitutes critical [products] — but also about what constitutes a trusted supplier. The U.S. can choose to make everything here. Very few [others] have that option. If the WTO is to remain relevant, it will have to adapt to unequal treatment of partners for select products.” 

MacAdam said he doubts that the world will turn protectionist overnight. “That said, when the dust settles, recent experience will help the arguments of the economic nationalists,” he said. “We had warned about a gradual move toward deglobalization even before the virus outbreak. Recent developments only make that scenario more likely.”

Debt and Inflation

To the extent governments don’t raise taxes to finance their pandemic relief efforts, they might rely on debt and possibly inflation. “Countries such as the U.S. or the U.K., given the . . . interest rate environment and their credibility, might find it easier to increase their debt with some degree of coordination with the central banks,” Alexiou said. “But for the bulk of the European economies, this might not be the case. So, at a European level, there are a few options such as Eurobonds, coronavirus bonds, or even helicopter money,” extreme monetary stimulus used as a last resort to boost both inflation and economic output.

“Central banks are already effectively financing government spending by buying government bonds,” Redwood said. “The next step might well be doing that permanently — a helicopter drop — with no rise in government debt. If done moderately, then inflation is not a major risk. The concern is that governments come to rely on it in the good times, which is how high inflation and hyperinflation might result.” 

Scissors said there is no consumer inflation in China because the country overproduces consumer goods. “China's broad money stock is already larger than the U.S., Japan, and the U.K. combined,” he said. “But expanding the money supply rapidly from here would cause asset bubbles — certainly in property, probably in securities, and possibly [in] other major sectors. This may be seen as an acceptable risk in many countries, but China has repeatedly struggled with asset bubbles. They will be more cautious on this.” 

MacAdam said creating new money is a reasonable way to finance deficits under the current circumstances. “The massive asset purchase programs that have been undertaken by central banks in recent weeks aim to hoover up most of the bonds being issued by the government in order to inject liquidity into the financial system and to ensure that governments get the capital they need while keeping borrowing costs low,” he said. “So far, the bond buying is taking the form of quantitative easing — money will need to be repaid — rather than outright monetary financing or a so-called helicopter drop [in which] debt is effectively canceled by the central bank.” 

Problems will set in if fiscal measures to support the economy come too late to prevent mass unemployment and prolonged financial distress, MacAdam said. “Central bankers could find themselves having to resort to the latter approach in order to encourage governments to [start] spending like there is no tomorrow, which they will be able to do if the fiscal constraint of having to repay debt is removed entirely,” he said. “Against this recessionary backdrop, the bigger risk is deflation, not inflation.” 

Martin Krause, a professor of economics at the University of Buenos Aires, said creating new money is not a reasonable way to pay for stimulus programs. “It never is,” he said. “Only if a central bank wants to accommodate an increase in money demand — say, because people go mad and want more money in their hands — but not to finance expenditures. In case of more specific expenditures, it should place debt.” 

Delsol said the European Central Bank will issue a lot of new money. “It can be done without immediate cost, but it is very dangerous because it destroys the true economic relations between people and the true value of products and services,” he said. “It will encourage the government to spend more and to become more indebted. It will induce entrepreneurs to initiate or carry on nonprofitable enterprises at the cost of the others. At the end of the story it will damage, maybe seriously, the European economy.” 

Money creation hasn’t resulted in significant inflation over the last 30 years because of higher productivity, excess savings, globalization, and the digital economy, Delsol said. “To tell the truth, we don’t know exactly why,” he said, adding that it is possible that inflation will return after the crisis because of nationalist isolation and reduced international trade. 

Like taxes, inflation can have a disproportionate impact on some groups, Delsol said. “Inflation is always a way to steal [from] some people to the advantage of some others,” he said. 

Dahlby said that because inflation is a distortionary tax on financial assets, it would be better to increase personal income taxes and general sales taxes. A sudden, unanticipated increase in the rate of inflation hits those who receive their incomes from financial assets that are not indexed to the price level, he said. “The 60-plus age group may be affected, especially if they do not have indexed pensions. Note, however, a recent study suggests that about half of the benefits from the economic interventions to slow the spread of the virus accrue to those over the age of 60 in the United States,” Dahlby said. “That might provide a rationale for using inflation and a sales tax increase to pay the interest on the public debt.“ 

If the stimulus measures — at least in the United States — disproportionately favor senior citizens, inflation resulting from efforts to pay for the pandemic could help spread the cost. “In general, inflation hurts creditors and asset owners by eroding the real value of their income and wealth, while it reduces the real burden of debt for borrowers,” MacAdam said. “So, relatively speaking, younger people benefit from higher inflation while older people lose out.” 

The controversial issue of who will foot the bill for coronavirus relief efforts even resulted in the filing of a criminal complaint by the president of one country. After Turkish President Recep Tayyip Erdogan referred April 6 to dated tax laws that give the government authority to confiscate 40 percent of all clothing, food, and medicine, Fox News reporter Fatih Portakal posted a tweet asking rhetorically whether the government might use it to seize bank accounts to finance the recovery. 

Erdogan’s lawyer, Ahmet Ozel, promptly denied that the president had any such intentions. “These are statements that are completely about lies and manipulating the public,” Ozel said, adding that the president has filed a criminal complaint against Portakal. 

Pre-Pandemic Roots

At least one of the economists interviewed by Tax Notes said the coronavirus might not be the only culprit in the current economic chaos. “Mainstream economists have been swift to attribute this imminent crisis to exogenous factors such as the COVID-19 pandemic,” Alexiou said in an email. “This comes as no surprise, given that, for the ills of capitalism, the culprit is always an ‘alien invader’ that destabilizes the market economy. An alternative explanation, however, for the unprecedented unfolding crisis is sought in the realms of capitalist accumulation. In this context, the 2008 global financial crisis is thought to have been caused by the over-accumulation of capital and the ensuing declining profitability.” 

The devastating effects of the 21st century’s first financial crisis were countered by more state intervention, as manifested in the expansionary nature of both monetary and fiscal policies, Alexiou said. “These expansionary policies caused global stock markets to rally. The real sector of the economy, however, exhibited signs of stagnation — which some economists named ‘secular’ to indicate that the pre-crisis levels of economic activity were difficult to attain — and as a result, a new recession is lurking around the corner, which, by the way, started setting in long before the pandemic broke out,” he said. 

Shaviro said that while he doesn’t think the pandemic has fundamentally changed the character of the long-term financing issues for the United States, it has made them much worse in quantitative terms. “The shock does, of course, help to show why it was so vital to pivot toward fiscal responsibility and sustainability before things took their current course,” he said in an email. “A number of commentators were noting the insanity of running $1 trillion full employment deficits — and not using the deficit spending to fund long-term investment and growth — because it was entirely predictable that something bad and unpredictable would happen at some point, even if we didn't know that it would be this bad (or exactly this).”

Copy RID