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The devastation wrought by coronavirus is, above all, a matter of human suffering to be lamented. But we must also note another casualty of the pandemic: it puts the final nail in the coffin of an economic philosophy that has dominated policymaking for over three decades.
The experience of “stagflation” of the 1970s, and public debt spikes in the 1980s, produced a reaction in the form of a particular set of ideals of fiscal responsibility. Aiming to keep public deficits and debt to moderate levels became a mark of politicians’ seriousness; so did forswearing an increase in the state’s tax take to fund ever larger public spending as a share of national income. Bien pensants looked askance at “tax and spend” and “borrow to spend” alike.
Before the pandemic, this perspective had already been losing its grip, as expert opinion was becoming more tolerant of debt and more concerned about the damage of public spending cuts in the aftermath of the 2008 global financial crisis. With the economic fallout from Covid-19, received truths about fiscal responsibility will become impossible to hold on to.
Since March, governments have rightly embraced enormous deficits to limit the collapse in economic activity, protect incomes and sustain employer-employee relationships. As a result, public debt burdens are rising everywhere to levels not seen for many decades, or even ever before. According to the OECD, many of its member governments could add debt worth 20 to 30 percentage points of gross domestic product this year and next.
This is going to force a simple choice on just about every government. They can tolerate the high debt burdens indefinitely, rather than try to bring them back down to moderate levels. Alternatively, they can permanently increase the state’s tax take to balance the books and start whittling down the debt. Either way, combining “responsible” policies on both debt and tax burdens is no longer an option.
And even this choice — whether to be “fiscally responsible” with debt or with taxes — is only available in a best-case scenario. We may have to jettison both and learn to live with permanently higher public debt and permanently higher taxes. This will be true if economies never recover to their pre-pandemic growth trend, which seems almost certain if another wave of infections forces a new round of nationwide lockdowns. The resulting permanent shortfall in government revenues would mean taxes having to be raised not to reduce debt ratios, but simply to prevent them from growing ever bigger.
Some express the hope — or the fear — that governments could coax their central banks into inflating away the debt instead. That is theoretically possible. But it would, of course, only mean the crumbling of another pillar of the conventional wisdom on what constitutes “serious” economic policy, namely the inflation-stabilising central bank.
The evidence, however, is that central banks struggle to push inflation up even to their own targets, let alone enough to erode public debt meaningfully. Japan’s case is instructive: decades of loose and often pioneering monetary policy has failed to inflate away public debt.
Equally enlightening is that Japan’s tax take, which used to be well below the rich-country average, has gone up markedly. According to the OECD, Tokyo took in 25.8 per cent of gross domestic output in taxes broadly defined in 2000, or 8 percentage points below the OECD average. Before the pandemic that had converged to 31.4 per cent of GDP, within 3 percentage points of the OECD average. If Japan is a harbinger of the future for all rich economies, then, expect public debt to stay high and taxes to move higher.
It is hard to imagine such a shift in governing ideas without a change in politics, too. Bear in mind whose interests were best served by prevailing ideas of fiscal responsibility. Public borrowing, it was long thought, crowds out private investment by making financing costlier for the private sector. Higher taxes, naturally, have been seen as reducing the profitability of private enterprise.
The old orthodoxy, in other words, has suited the asset rich and those enjoying income from owning or controlling capital. The power of those interests — in terms of defining the reigning ideas of what counts as serious policy, if not also by lobbying directly — can be seen in the response by most countries to the previous jump in public debt, caused by the global financial crisis. Fiscal orthodoxy was behind the drive to cut public spending in many countries.
It is much harder to imagine significant cuts to public budgets today. Partly because the damage from past cuts is now visible and further ones are more difficult to justify. Partly because the pandemic itself focuses the political spotlight on inadequate public services and underpaid public sector and other key workers. Much more than a decade ago, budget shortfalls will now have to be covered by tax raises.
There is no reason to expect those who benefited from the “fiscal responsibility” of the past to give up the fight for their interests. If significant tax rises are indeed inevitable, the fight will move to where the heavier tax burden falls: which taxes go up and by how much. Expect this to be the fiercest battle over economic policy if, and when, we return to some semblance of normality.