Proposal for Recovery Eurobonds – Working Paper

A revived idea that avoids the “mutualisation problem”

    Abstract

    A possible Eurobond structure that solves the “mutualisation problem” involves a previously feared idea: the necessary security would come from the citizens of each state under the form of a tax guarantee. This idea has recently been discussed by Professors Andrea Boitani and Roberto Tamborini in a paperiii (BT) published by the Fondazione Friedrich Ebert (FES). The crux of the proposal is to offer investors (the Eurobond purchasers) a guarantee stemming from a (small) mandatory contribution by (or for) each adult citizen of the EU.

    A Proposal for the ‘Recovery Eurobonds’

    With the COVID-19 medical crisis possibly on its way out, the EU States need urgent access to inexpensive capital to fund and jumpstart the recovery and prevent a full-blown, long-lasting recession.

    All over the world the economic scars of the crisis are severe: huge losses of jobs, revenues and output; but in Europe, prospects are particularly bleak as the crisis has exacerbated the structural problems and weakness of the EU economies.

    The problem is that for almost all States, access to funds is limited and – while interest rates are historically low, right now – many of them have had to pay a high interest (“spread”) on their debt in the recent past to persuade investors to loan them money. These high rates could easily return again – particularly after the economies have been ravaged by the sanitary crisis. The unprecedented shock to both demand and supply, together with pessimism (or downright fear) about the future greatly heighten the risk of Minsky-type instability (uncontrolled runaway of interest rates when trust vanishes, as it happened in Portugal after the Greek default in 2012).

    This is a problem for ALL of the EU because if one major State (or several smaller ones) suddenly faces a huge increase in its debt burden, the risk of default (real or perceived) will cause runaway rates for every State – with extreme damage for all the EU economies.

    Three key facts must be crystal clear on everyone’s mind:

    – Extreme risk is never localized: it spreads as fast as the COVID19 virus!

    –  The saying “When Athens cries, Sparta does not laugh” is a true now as it was 2500 years ago. Solidarity isessential to save yourself.

    –  It is not so much the actual level of sovereign debt that causes a country to be risky but rather the possibility that interest rates increase so much as to cause a default. Further, while there is a consensus that many countries should over time reduce their accumulated level of debt, there is also a consensus that now is not the right time to do so and that the crisis demands substantial (but intelligent) stimulus packages. Comparatively, the US package is currently at $6 trillions and they are considering going higher!

      What is needed are mechanisms to allow ALL EU countries to access funds needed for the recovery easily and at a stable and low interest rate.Eurobonds proposals have been around for a long time and at their core is the concept that a loan made to the EU, as a whole, would cost significantly less than loans made individually to each country.

      This kind of solution would be ideal and would also avoid the risk of Minsky instability.

      Unfortunately, views are widely divergent on this subject, notably on the reciprocal guarantees by the States (“mutualisation of debt”) – firmly rejected by Germany.

      To complicate matters further, the European Quantitative Easing programs of the BCE are also contested – as exemplified in the recent decision by the German Constitutional Court.

      A calm, scientific, “ideology-free” frame of mind has been absent from the political and Economics Science discourse for too long a time – which has caused several good ideas to be “unthinkable” on purely ideological or political grounds — until recently.

      But times are changing and the extreme seriousness of the current predicament requires open minds; at last, this mental openness is beginning to surface and more ideas can now be put forth without shame and fear of a violent, knee-jerk response.

      We believe it possible to have all States enjoy a cheap and stable EU rate without making any State responsible for the borrowings of other States.

      The core idea (in some whispered form) had circulated already a few years ago – but had been quickly dismissed at the time because it involves the citizens of the States to provide the needed guarantee. This conjures the bugaboo of a (potential) EU- caused tax — the mere mention of which would have been tantamount to political suicide for the politicians proposing anything requiring it.

      Now however, as we said above, times are changing, the needs for crisis recovery funds is urgent and people are willing to think matters through. So, we believe that the moment is ripe for a well-thought reformulation of this idea to be brought to the forefront of scientific and political debate.

      To begin with, some European States are already paying significant interest on their loans right now, owing to the size of the debt rather than to the level of interest rates, and it is the citizens who bear the financial load of this through taxation. Other States are at high risk of a sharp interest rate rise, which would mechanically impact their taxation level. The specific portion of the taxes that go to pay the interest expense may be hidden from the taxpayers – but it is there! Also, citizens now understand that the “spread” is important and that reducing it would potentially lower their tax burden: Ask anyone: “would you rather pay €150/year in a hidden tax or €50/year in a visible tax?” – the answer is clear.

      Indeed, this tax-guarantee concept has recently been discussed by Professors Boitani and Tamborini (“BT”) in a document explicitly proposing a new, long-dated issuance with a €50/yr. tax guarantee on each adult resident of the EU (their paper can be found here http://library.fes.de/pdf-files/bueros/rom/16779.pdf).

      We agree with BT that the proportionality and the tax guarantee render the issuance risk-free and would achieve the goal of an ultra-low, “no-spread’ interest rate for ALL EU States while removing the issue of perceived gainers and losers among the different States. We also agree with their estimation that €1,000+ billion could be raised.

      However, in order for such a “Recovery Eurobonds” plan to be successful, it is crucial that a number of practical, financial, and political details be addressed properly.

      Specifically, we stress and recommend:

      –  Each EU State can choose whether or not to participate in the program. States that choose not to participate would not enjoy any of the benefits and would not obligate themselves to any corresponding risk or expense;

      –  The amount of the potential tax must remain small: the suggested figure of €50/year per adult citizen of each participating EU State seems reasonable.

      –  It is important that this per-capita tax only exists theoretically. In practice, the public should not see any actual tax connected to the program. Only, in the case of one of the participating EU States defaulting on this particular obligation, then, and only then, a direct imposition on the adult residents of that defaulting State would come into play – as the in ultimis guarantee.

      –  Finally, in order to get the lowest possible interest rate, the issuance would have to offer other features attractive to investors: we recommend features such as exemption from any taxes, levies of any form for transfers, inheritance or other conveyances in all EU jurisdictions at all levels. Also, anonymity/privacy protection features may also make the issue more desirable.

      For the interested readers, our paper which explains more thoroughly many of these details is available here A Proposal for Recovery Eurobonds (while more technical, this document is still readable for a non-specialist).

      We want to point out, that we are not advocating at all for a general EU taxation system (which would face considerable opposition) but only for a specific, practical ‘Recovery’ Eurobond structure that has the potential to be a quickly achievable solution to an urgent problem if intelligently implemented.

      Such a solution could gain EU-wide consensus and political support once people understand that the funds are urgently needed and that the small perceived cost could in fact lower their actual tax burden.

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