Discretionary fiscal responses to the COVID-19 pandemic

This paper analyses discretionary fiscal responses to the COVID-19 pandemic. It begins by distinguishing three phases of the pandemic: (1) acute overall disruption, (2) initial recovery phase and (3) the longer term. It then goes on to consider measures that could be used – especially focusing on the immediate issues in phases (1) and (2). We distinguish measures that aim to create incentives to change behaviour from those that simply provide a cash benefit. 

The most important of the former group are schemes to support short-time work, when an employee works for reduced hours or does not work at all. These schemes typically subsidise the wage costs for workers whose working hours have been reduced or who have been furloughed and thus create an incentive for businesses to maintain employment levels. The UK Coronavirus Job Retention Scheme is a generous example of such a scheme. 

Such policies are particularly useful in phases 1 and 2. They help businesses maintain their workers and thus their firm-specific human capital, which allows them to recover more quickly after temporary shocks. They also save firms’ firing and re-hiring costs. These factors ultimately reduce the probability that the business has to close. They also reduce the monetary and physical costs for workers who would otherwise be laid off. 

The second main group of measures are designed to boost business cash flow, for example, by deferring or cancelling tax payments, and government guarantees for business loans. For example, many countries have introduced measures which have deferred payment of VAT and corporation taxes. A one-year holiday of business rates for the retail, hospitality and leisure sectors was also introduced in England.  These measures are clearly beneficial for businesses in phase 1 but deferring tax may create potential problems for phase 2. If a tax is deferred until the end of phase 1, then it may become due just at the moment at which governments will be hoping for a speedy recovery, with business rehiring workers and undertaking new investment. 

Identifying appropriate policies for phase 2 is more difficult. The paper considers extensions to the relief for short-time work, as well as relief from corporation tax, VAT and business rates. The priority must be to support a speedy recovery; how that is done should depend on whether there are primarily supply or demand shocks to the economy. Extending the Job Retention Scheme to workers working less than full hours would be important. In addition, governments should consider subsidising employment – for example, in the UK by reducing or halting employers’ national insurance contributions. This would clearly entail substantial costs, but the costs of much greater unemployment may be larger still.  

 

Michael P. Devereux, Irem Güçeri, Martin Simmler and Eddy H.F Tam (2020). Discretionary Fiscal Responses to the Covid-19 Pandemic, Oxford Review of Economic Policy, 36 (1), pp.225-241