The battle-lines are already drawn up over when to begin withdrawing the stimulus measures that appear, for the moment, to have averted the widely feared global economic meltdown: on the one hand the inflation and deficit hawks who cannot wait for monetary policy to return to normal, and for fiscal policy to reign in the ballooning deficits; on the other those concerned about the fragility of the incipient upturn and the perspective of a continued and substantial rise in unemployment. The wait-and-see-sayers are still in the majority, but Ireland has already raised taxes and Spain announced fiscal contraction for as early as 2010. Yet, as important as this debate is, there is a more important fight: how will policy be tightened?
Given both the origins of the crisis (amongst them widening inequality) and the massive support given to the financial sector (an abstraction behind which hide largely wealthy individuals), ensuring that the needed consolidation is achieved by way of a fair sharing of the burden is vital not only for ethical but also for economic reasons. The impact of the crisis on the labour market will substantially increase the degree of inequality, especially at the bottom of the distribution (even if initially it somewhat compressed it at the top).
When policy is tightened there are three main qualitative policy questions. The first concerns the balance or sequencing between monetary and fiscal policy, the second is whether fiscal policy tightening should focus on the spending or the revenue side, and the third is the type of measures to be preferred.
There are widely accepted arguments for keeping interest rates at current low levels for as long as possible and to begin exiting by tightening the fiscal stance: low interest rates accelerate the process of fiscal consolidation, as they influence positively both the key determinants of government debt dynamics (the interest rate on government bonds and the rate of nominal GDP growth). Indeed the ECB still has scope to cut rates, and given its mandate and the steadily appreciating euro it should do so. Europe’s banks are still wobbly and central banks must continue to make credit available at virtually zero cost. Fiscal policymakers, meanwhile, can and should assuage monetary hawks by preparing and announcing fiscal packages that have an economically sensible trigger mechanism (such as a given fall in unemployment). In short fiscal policy must take the lead.
The conventional view is wrong on the second question, though: the growing calls for a focus on cuts on the spending side should be resisted for four main reasons. First, substantial cuts cannot be achieved as quickly and flexibly as changes on the revenue side; second, the crisis has shown the importance of maintaining and even expanding the public sphere; third, the imperative of addressing climate change calls for greater public investment, not less; and fourth, the substantial cuts needed – given projected deficits of above 10% and debt ratios around 100% of GDP – will have negative effects on income distribution and hit the weakest in society hardest.
This is not to say that some spending could not usefully be cut. Support for home ownership and the subsidisation of private pension saving have helped to exacerbate the crisis; cutting these measures would reduce deficits while hardly curtailing demand – in the case of pension-saving subsidies the effect on demand might even be positive – while promoting more equitable income distribution.
But the heavy lifting has to be done on the revenue side. There are innumerable possibilities, but here are my top four. The ideal tax measure is surely obvious. A small tax on financial transactions – as little as 0.05% – would raise substantial revenue, make the sector pay its share of the clean-up costs it incurred, would be highly progressive, and would shift financial resources from short-term speculation to uses with a longer time horizon. Technical details (rates, coverage) need to be clarified, but national taxes of this type already exist (notably stamp duty on share trading in the UK), and electronic trading makes it technically feasible.
Second, an increase in the top rate of income tax would go some way to reverse the substantial increase in inequality in most European countries. I propose a temporary surcharge of, say, 10 percentage points to be introduced on the top rate once unemployment falls and maintained until budget deficits fall below 3%.
Third, energetic measures are needed to fight tax evasion and recourse to offshore tax havens and limit intra-European competition for mobile tax revenues.
And finally, a carbon tax could raise substantial revenue and, as a bonus, is probably the only way to avoid frying the one planet we have.
Common to all proposals is that they would be more effective with some degree of coordination, at least within Europe. This will be used by nationalists and eurosceptics, but also by opponents of progressive income redistribution and climate-change deniers, as a reason to rule them out. But the European treaty requires national policymakers to see economic policy as a matter of common interest. Such policy coordination is what meetings of the ECOFIN Council (of finance ministers) and the European Council (of heads of government), guided by a Commission that watches over the wider European interest, are supposed to deliver.
ECOFIN meets as I write, the European Council at the end of this month. Europe’s citizens are watching and expecting policy decisions that are economically rational and, at the same time, embark on the task of redressing the social imbalances of the previous, failed growth model. Working families have already paid a high price for the failings of others. It is high time that a signal is sent that the ‘high net worth individuals’ that benefited from the previous skewed growth regime and then from taxpayer-financed bail-outs and support measures will be made to foot their fair share of the bill.