A fiscal shock to Italy
Recently on this blog, Brunello Rosa had submitted an interesting policy proposal to boost Italy’s GDP.
Brunello’s proposal shares many analytical premises with the one we have articulated in a public appeal published at the end of last year, concerning the issuance of tax credit certificates as a means to inject new purchasing power in the economy without creating new debt. 
We set out to compare the two proposals in today’s comment. This will offer readers a better understanding of their relative pros and cons but even more importantly to our purpose, it will give us an opportunity to discuss key elements of Brunello’s idea, which we think can be usefully incorporated into ours leading to a new much more powerful proposal.
Brunello starts from two premises that we fully share. The first is that Italy’s macroeconomic policy space is heavily limited by institutional constraints and market risks. Not only may Italy no longer use the monetary lever or devalue the exchange rate to pursue macroeconomic adjustment in the face of demand shocks, like any other Eurozone member; it also lacks sufficient fiscal headroom to exercise strong enough stimuli in the event of recession, stagnation or sluggish growth. Even the flexibility granted to Italy by its EU partners under the fiscal compact gives the country margins that are far too inadequate for its needs. .
The second premise is that the Italian government cannot be satisfied with a state of affairs where the country’s output growth is wholly exogenously determined as well as utterly disappointing, notwithstanding the very favorable current international market conditions, with the cost of oil at its record low; the spread on national debt under Mario Draghi’s check; and the exchange rate on a sliding path, still thanks to Uncle Mario.
According to the forecasts of the major policy institutions, market participants and independent research houses (including RGE), Italy’s GDP in 2015 is expected to grow by only 0.7% (median forecast), that is, about half the pace of the Eurozone as a whole (which is not great on its own, to be sure), and expectations for 2016 are that, with all the above favorable conditions in place, Italy could achieve a slightly higher growth rate than in 2015, perhaps north of 1% (net of the positive boost to the economy potentially deriving from the extraordinary Jubilee, as Brunello correctly indicates).
Mr. Renzi, his government, and the Italians do not have reasons to rejoice about this.
As the so much recommended structural reforms are being put into place by the government, in the belief that they will raise Italy’s potential output in the medium-term, a strong and persistent fiscal boost to the economy remains the only way to change people’s expectations radically and swiftly, so as to literally pull Italy’s out of stagnation and help it traverse to a higher, better equilibrium.
But how to do so, and above all, how to pay for it?
While Brunello does answer the former question head on, in our view it does not address the latter as satisfactorily. Combining his proposal with ours, though, we think would improve both and would result in a very powerful policy program.
Stimulate spending, not saving, with the Fiscal Debit Card
From a very Keynesian perspective, Brunello correctly notes that a critical element of any measure of fiscal support is to make sure that the additional money given to the people is spent, not saved, so that it enters the economic circuit. Granted that increasing household savings may contribute to repair the balance sheet of indebted families or to re-constitute the stock of savings that were depleted during the harshest years of the crisis. Yet increasing savings do not increase consumption and, hence, output.
How then to ensure that the additional money is actually spent?
Brunello proposes that the government issues a Fiscal Debit Card (FDC) bearing an expiry date. In other words, the government puts new money into the FDC but tells cardholders that either they spend it or lose it: it’s an extreme version of the negative interest rate theory originated by Silvio Gesell, which has resurfaced during the crisis. Cardholders may therefore choose how to spend the new money, but not whether to spend it or not. This would ensure that the economy’s multiplier effects kick in, new incomes get generated, and additional tax revenues are raised (from VAT and income taxes).
Brunello’s proposal would be an implementation of fiscal measures already approved by the EU, and therefore does not imply any use of additional resources. This explains why the public deficit to GDP ratio is expected to remain below 3%. The weak point of this proposal is that it would not give additional money to be spent: the money credited on the card would be associated with new compensative taxes or lower public expenditure in order to avoid public deficit growth. In this case the social card would work as a mechanism to force spending the euros credited on the card but with the risk that households might save other money in order to pay tax rises or higher costs of public services. Brunello, however, is also open to the possibility that the coverage of the operation might initially come from a higher deficit, rather than from a cut in spending, in particular at a time when the ECB is buying government bonds, since, as he argues, this amounts to the central bank de-facto monetizing the public debt purchased.
We take a much more aggressive and yet cautious view. A significant fiscal boost – much more significant than what Brunello proposes – would in fact be needed to make a real difference. This would involve a large initial fiscal deficit, which would not be tolerated by Italy’s EU partners and would further increase Italy’s debt. Using the FDC approach, the government would have to raise the money first. Now, in order for the stimulus not to be counteracted by higher taxation and/or lower spending, the government could raise the money only by issuing debt. Contrary to Brunello’s argument, the ECB purchases of government securities on the secondary market do not constitute permanent monetization of public debt: the securities purchased are, and remain, a liability of the issuing governments (even though the related cost of servicing them is abated). They will have to be repaid at maturity, unless the ECB and the government commit to rolling over forever the securities reaching maturity, which clearly is not the case. Also, the ECB could at any point in the future resell to the market the debt purchased under QE or slow down its pace of debt absorption through QE, even though it does not envisage doing so at this stage.
In this respect, we stick to the fundamentals of our proposal, while we are ready to incorporate in it some key aspects of Brunello’s idea, as discussed next.
Not money, but Tax Credit Certificates
First of all, we appreciate the practical advantages of using the FDC as a channel to distribute fiscal money to households and enterprises. We also particularly like the ‘spend it, or lose it’ constraint on the money credited on FDC, which virtually eliminates the risk of hoarding the new money and its negative implications for output growth and fiscal revenues.
With a view to further reducing the risk of the government incurring higher deficits, however, we believe that FDCs should be credited with Tax Credit Certificates (TCCs), rather than money, in line with our proposal. TCCs are government-issued rights to reduce future tax obligations. More precisely, they are (non-debt) bonds that commit the government to reduce the tax burden of their bearers by an amount equivalent to their nominal value, two years after they have been issued. The reasons of the two-year deferral are clarified below.
TCCs are transferable, can be sold in exchange for euros (at a discount that should be comparable to that on a two-year coupon bond) or used directly as means of payment as discussed below, and may therefore be used to finance immediate spending. As people sell TCCs to get euros, others may want to buy TCCs to acquire rights to future tax rebates (which means more future savings). Financial intermediaries may want to buy TCCs from sellers at a discount and use them for future tax saving purposes or resell them at a lower discount and make a profit.
In our modified proposal, the government would distribute FDCs to households and enterprises, and would credit the FDCs with newly issued TCCs.
The TCCs assigned to households would be credited to their accounts under the spend-it-or-lose-it constraint: if within a year the TCCs are not spent, they will be canceled. The TCCs would be allocated to households in inverse proportion to their income. The TCCs would then be ‘activated’ as soon as households debit their FDCs to pay for goods and services sold by enterprises, and enterprise FDCs will correspondingly be credited with TCCs. Expenditures from the cards, therefore, would not involve conversion in euros, and all goods and services would have to bear a double price (in TCCs and in euro), since prices expressed in TCCs would reflect the discount at which the TCCs trade against the euro. Once activated, the TCCs would no longer subject to the spend-it-or-lose-it constraint and could be used for any purpose (i.e., they might be converted in euros, used for tax rebates at maturity, sold to people who want to use them for future tax rebates, or still used for payments).
In the case of enterprises, the TCCs would be assigned without constraints primarily to those that are exposed to international competition. Such assignments would be credited on the enterprises’ FDC accounts in order to reduce their wage bill. In this way the enterprises will be able to recover competitiveness, a crucial step to expand domestic production and exports and to reduce imports. The goal of this measure is to safeguard the external trade balance, which would undergo strong pressure by the increase in aggregate demand following higher consumption induced by TCC assignments to households.
In a depressed or slow growing economy, the new spending triggered by TCC issuances will have multiplier effects on output and employment. Credit prospects will improve and banks will have an incentive to start lending again to finance production and investment. The new output will raise fiscal revenues. The two-year deferral on the TCCs would give enough time for output and fiscal revenue to grow and finance the cost of the TCC-induced tax cuts. As projections show, a relatively small multiplier of 0.8 would assure no deterioration of the deficit-to-GDP ratio.
It is critical to notice that the TCCs would not be issued by the government as a new currency and would not have the purpose of replacing the euro, even though the public and the market might use them any way they wish, including as a means of payment (as for any bonds or assets). Also, being rights to future tax reductions, TCCs would not constitute social transfers and, therefore, would not enter deficit definition and calculations. As negotiable and transferable rights to reductions of future tax obligations, the TCCs would make possible for the government to engineer a huge tax cut in a situation where no other policy lever is available to stimulate the economy. The TCCs would allow for a Keynesian deficit spending program, where
- The deficit would occur, ceteris paribus, in the future, after TCCs reach maturity and are used for tax reductions purposes
- Spending from the private sector would be immediate
- The future deficit would be self-financing thanks to the income multiplier effect on output and fiscal revenue, as reinforced by the spend-it-or-lose-it constraint, and the two-year deferral that gives enough time to output and fiscal revenues to grow.
Safeguarding fiscal performance
Much as we are persuaded of the need to introduce Brunello’s spend-it-or-lose-it constraint in our proposal as a spending clause that reinforces the effective operation of the income multiplier effects set in by the fiscal stimulus, we remain strongly persuaded of the need to maintain our proposed fiscal safeguard clauses to make sure that the government’s fiscal performance is guaranteed even in the event that the TCC maneuver generates less budget revenues than anticipated.
The safeguard clauses we have proposed are the following:
- First, the government could announce a commitment to pay a fraction (presumably, just a small one) of its public expenditures with TCCs
- Second, taxpayers could be entitled to receive TCCs as compensation for additional euro tax payments: this would be equivalent to replacing tax raises with compulsory TCC-for-euro swaps
- Third, TCC holders could be incentivized to postpone the use of TCCs for tax reductions by receiving an increase in their face value (equivalent to interest income being paid in the form of TCCs), and
- Fourth, the government could raise euros in the market by placing TCCs with longer maturities instead of debt bonds.
It should be noticed that these safeguards would be significantly less pro-cyclical than those imposed by the EU to secure budget targets through spending cuts or tax hikes in the event of fiscal underperformance. In fact, one or more of these clauses used in combination would easily accommodate for even significant shortfalls in primary budget surplus targets.
We conclude by emphasizing that a combination of our Tax Credit Certificates and Brunello Rosa’s Fiscal Debit Card could provide the government of Italy (or for that matter, the government of every Eurozone crisis country) with a very powerful fiscal weapon featuring a remarkably high degree of potential success as well as considerably watertight safeguard clauses that would protect the budget from risks of fiscal underperformance, however remote we believe those may be.
We see no reason why the government and social parties should not consider adopting the proposal with the utmost interest as the only way out of the current economic stagnation and an indefinite prospect of sluggish growth at best looking forward.
See “Free fiscal money: exiting austerity without breaking up the euro”, by B. Bossone, M. Cattaneo, L. Gallino, E. Grazzini, and S. Sylos Labini, Associazione Paolo Sylos Labini, 26 November, 2014
http://www.syloslabini.info/online/wp-content/uploads/2014/11/Appello-Inglese-rivisto_9-03-2015.pdf. The same authors have recently published in e-book format “Per una moneta fiscale gratuita. Come uscire dall’austerità senza spaccare l’euro”, MicroMega, 2015 (to be translated in English).
http://temi.repubblica.it/micromega-online/“per-una-moneta-fiscale-gratuita-come-uscire-dallausterita-senza-spaccare-leuro”-online-il-nuovo-ebook-gratuito-di-micromega/?printpage=undefined. We have repeatedly articulated the proposal in subsequent articles and comments, including on EconoMonitor; see ,for instance, the recent post by Bossone and Cattaneo here [please insert following] http://www.economonitor.com/blog/2015/07/from-grexit-to-exitaly-lets-stop-this-madness/), here http://www.economonitor.com/blog/2015/05/greece-still-has-a-fighting-chance/, here http://www.economonitor.com/blog/2015/04/greek-parallel-currency-how-to-do-it-properly/
 For an illustration of Gesell’s theory see Chapter 23 of Keynes’ General Theory. For a discussion, and useful references, of negative interest rate policy in the context of the unconventional monetary policies adopted by central banks during the crisis, see Bossone B, Unconventional monetary policies revisited (Part I & II), VoxEu, 4-5 October, 2013.
 On the relevance of the central bank (not) committing to hold permanently the debt purchased under QE, see here [please insert link] (http://blogs.worldbank.org/allaboutfinance/qe-permanent-debt-purchases-fiscal-expansion-helicopter-money-recipes-eurozone
 A centralized system would be set up at the Treasury (or at the central bank acting on the behalf of the treasury), where all economic agents (i.e., households, enterprises, financial institutions, etc.) would hold transaction accounts denominated in TCCs. The system would allow TCC values to be transferred in real time across accounts in execution of payments by simultaneously debiting and crediting individual accounts. Households and enterprises would have their FDCs linked to their respective TCC accounts, so that they can effect payments of TCCs using their cards. A settlement facility should link the centralized TCC system with the central bank’s TARGET system so as to ensure that TCCs vs. euros transactions can take place in real time and on a payment-versus-payment basis.