Fiscal Policy Responses to the Coronavirus Outbreak

The global crisis we are facing is one of the worst in history. The priority, obviously, is to reduce the number of coronavirus victims. At the same time, mitigating the economic impacts is vital.

Both the real economy and financial markets worldwide have already been hard hit. Layoffs are surging across the globe. Factories are being shut. In China, industrial output contracted 13.5% in the first two months of 2020 (the fastest pace on record). Urban unemployment in the country hit its highest rate ever (6.2%) in February. Global stock markets dropped by 30%. The 10% plunge last Thursday was the worst decline for the Dow Jones Industrial Average since 1987.

While the unprecedented characteristics of the crisis make every forecast of the impact highly speculative, the effects on the real economy will certainly be huge. Last week, the OECD revised its 2020 GDP growth estimate for the Euro Area from 0.8% in early March down to zero. Earlier in the month, it had already brought down its global projection and pointed to the urgent need for immediate government action to “contain the epidemic, support the health care system, protect people, shore up demand and provide a financial lifeline to households and businesses that are most affected.”

Fiscal policy stands on the frontlines for that.

Spending Now and Spending Big

Against this backdrop, fiscal response packages are being designed across the world with a strong consensus on a “spending now and spending big” strategy. In the US, Congress this week passed the “Families First Coronavirus Response Act” with provisions for sick leave, free testing and an expansion of unemployment benefits, and is now discussing further measures amounting to USD 1tn to support households and firms. The UK announced a GBP 330bn package of loan guarantees for businesses. France is mobilizing EUR 300bn in loan guarantees and further support, in particular deferred taxes and payroll charges, amounting to EUR 45bn. And the European Commission has declared that the rules for cohesion spending will be applied “with maximum flexibility, thus enabling Member States to use the funds to finance crisis-related action”.

Leaving No One Behind

The key principle that must obviously guide these policy responses is to use the impressive amount of resources that are being mobilized so that the impact of the crisis is mitigated as much as possible. The central pillar for that is that they reach the people in need. Whereas the existing high level of uncertainty makes the design of response packages a challenging task, governments must ensure that no one is left behind, particularly the worse-off, who will very likely be the most affected by the coronavirus outbreak.

Providing Support Through Direct Spending

The fiscal policy responses that are being announced and discussed mainly fall into two groups: direct spending and tax relief.

Direct spending, i.e. the government providing cash to households and firms, is high on current agendas for several reasons. One key benefit compared to tax relief measures is that its reach extends to low-income earners that do not pay taxes because their incomes lie below tax-free allowances or informal workers, as well as to businesses that do not make profits. In addition, beneficiaries can receive cash immediately rather than a tax benefit that may only accrue at a later point in time.

Many countries have already announced ambitious measures that would be channelled through direct spending. Ireland has announced an emergency unemployment payment of just over EUR 200 a week for up to six weeks for self-employees and employees whose employer is unable to keep paying. In Australia, more than six million low-income earners will receive a cash payment of AUD 750. Similarly, Italy is giving EUR 600 to self-employees on a monthly basis. The Swiss government earmarked CHF 8 billion of its initial emergency package for short-time work, a scheme funded through unemployment insurance. Similarly, Denmark has implemented a wage subsidy covering 75% of wages for companies that are in danger of cutting at least 30% of their workforce or 50 people or more.

In addition to measures already taken, several policymakers and commentators are calling for broader, universal direct spending programs. Legislation introduced yesterday in the US Senate proposes cash payments of up to USD 1,200 per person and USD 2,400 per married couple. Jason Furman, former economic adviser to President Obama, has been pushing for cash payments to each American – initially suggesting USD 1’000 per adult and USD 500 per child and most recently advocating for triple that amount.

A significant advantage of such universal income schemes is that they are simple and can be implemented immediately, features that are crucial under the current scenario. On the other hand, such payments are also made to wealthier households that do not need to be supported and will not modify their consumption behaviour.

Diligent Targeting of Tax Expenditures

In parallel to direct spending, several of the fiscal response measures that have already been announced or are currently discussed are channelled through tax expenditures, i.e. government spending through the tax system in the form of tax deductions, exemptions and deferrals. The French government announced that it will allow all companies to defer “without justification, formalities or penalties” the payment of contributions and taxes due in March 2020. Argentina introduced a payroll tax holiday for the sectors most hit by the crisis (leisure, transport, hotels and restaurants, among others). The UK abolished business rates, taxes levied on commercial premises, for all companies in the retail, hospitality, and leisure industries. And the Australian government’s response to the crisis comprises tax-related measures to support business investment, including increasing and extending the instant asset write-off and accelerating depreciation deductions.

Many countries have also introduced VAT-related tax expenditures including reduced rates, exemptions and deferrals for businesses. Norway announced a 8% reduced VAT rate on public transport, cinema, sporting and cultural events. China has cut VAT rates on medical services, catering and accommodation services, sundry personal services (e.g., hairdressing, laundry), and public transport as well as on masks and protective clothing. Spain has announced VAT (and other tax payment holidays) for small businesses – below EUR 6 million turnover and if the VAT due is below EUR 30 million.

Whereas all these measures need to be assessed on a case-by-case basis, a priori, some of them are controversial. Payroll tax holidays, for example, may fail to reach those in need and lead to significant undesired distributional side effects. Following initial proposals for a payroll tax holiday in the US, a recent report by the Institute on Taxation and Economic Policy (ITEP) shows that 65% of the benefits of such a measure would be captured by the richest 20% of taxpayers. In addition, as recently pointed out by Lawrence Kotlikoff, such a measure would not help workers that will be laid-off, but rather those that will “continue to have the luxury of paying taxes”. The payroll tax holiday in Argentina risks to be even less effective and more regressive than the one discussed in the US, since around 50% of employees in the country work in the informal sector – I discuss the important role of informality in designing crisis response measures in a companion post accessible here.

Against this background, an alternative proposal would be to provide tax credits to firms based on maintaining payroll, e.g., as suggested by Jay Shambaugh, based on the number of employees working at least 20 hours and capped at 100 employees working at least half time, up to a monthly wage of USD 4,000 so that the measure does not end-up being a windfall gain for already profitable large firms or small firms made up of highly paid professionals.

VAT tax expenditures – particularly those for non-essential goods – are likely to have a reduced impact to safeguard jobs in countries where the population is locked-in and faces high levels of uncertainty. In fact, VAT tax expenditures targeting restaurants, cinemas and other leisure-related sectors seem to be at odds with measures taken by health authorities to close such businesses in order to slow the spread of the virus. In addition, as pointed out by Rita de la Feria, VAT-related tax expenditures have repeatedly shown to be highly regressive, a feature that should not be neglected by policy makers, particularly in times when crisis measures should prioritize those most in need.[1]

Tax expenditures are used widely by policymakers worldwide and can be effective tools in times of crisis. At the same time, transparency and analysis on their effectiveness is often limited. Making sure they reach their stated goals and that they are diligently targeted is even more critical when resources are scarce and urgent effective action is vital.[2]

Thinking Outside the Box

In view of the magnitude of the current crisis and the significant level of uncertainty, calls for policy innovation and thinking outside the box have hit radar screens around the world.

One example is the proposal by Emmanuel Saéz and Gabriel Zucman which calls for “a new form of social insurance that directly targets and works through businesses”. They suggest that the government should act as payer-of-last-resort by covering the necessary costs of firms to maintain their business even if they are not operating. They estimate the costs of such a measure in the US for one quarter at 3.75% of GDP.

Ben Ritz has put forward a proposal that brings together universal cash transfers and tax-related policies. He recommends an immediate universal cash transfer designed as a pre-paid refundable tax credit (or a zero-interest loan) that would need to be repaid by the well-off next year at tax time. This policy would benefit from the advantage of universal cash transfers since it remains administratively simple and can be implemented immediately. At the same time, by imposing an ex-post eligibility condition that will be implemented through the tax system, it would also allow effective targeting of those in need and reducing the misallocation of scarce resources.

Coordinating Fiscal and Monetary Policies

While fiscal policy stands on the frontlines, its coordination with other policy levers, in particular monetary policy, is essential.  Securing the functioning and stability of financial markets, providing adequate liquidity to support public and private funding needs, and ensuring that the decisions of central banks and fiscal policymakers are aligned, is essential. The measures that central banks (e.g. the ECB) can and should take to address the crisis we are facing are discussed in a blog by CEP fellow Pierre Monnin.

[1] Rita de la Feria’s forthcoming paper (with Artur Swistak) “The Progressive VAT” discusses the (negative) distributive impact of VAT-related tax expenditures and provides an interesting approach to tackle this issue.

[2] For more details on the lack of transparency and analysis on tax expenditures, see Redonda and Neubig (2018). For an overview on the effectiveness and ineffectiveness of tax expenditures, see Redonda (2016).