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A one-off capital levy: a suitable instrument for solving national solvency crises within the current euro-area framework?

Monthly Report January 2014

In the course of the current sovereign debt crisis, strong doubts have occasionally arisen as to whether individual euro-area member states are capable of servicing their government debt or whether they are implementing the necessary measures at the political level. At times, risk premiums on the respective government bonds rose sharply and the credit assessments of the major rating agencies were downgraded considerably. This situation prompted the euro area to agree various assistance measures. While such measures were generally subject to consolidation requirements, they nevertheless imply a substantial mutualisation of sovereign solvency risks without being counterbalanced by a corresponding transfer of sovereign powers to the central level.

However, the EMU governance framework set up with the European Union treaties essentially remains in place. Under this framework the member states themselves are primarily responsible for their own national fiscal and economic policies, the assumption of liability for the debts of other member states is largely excluded, and the monetary financing of governments through the single monetary policy is prohibited. This should ensure that liability and control are interconnected inasmuch as, in the first instance, it is the taxpayers of the respective member states who bear responsibility for their national sovereign debt. If solvency problems still cannot be resolved, sovereign debt creditors should next be called on to bear the financial risks of their investment decisions themselves in line with market economy principles. Economic adjustment programmes financed by taxpayers from other member states should only be employed as an exception and a last line of defence in cases where the financial stability of the euro area as a whole would otherwise be in grave danger. Moreover, such programmes presuppose that the state in question “merely” has a liquidity problem and that its public finances are either sustainable or that sustainability has meanwhile been re-established by suitable measures. Given the Eurosystem’s stability mandate, granting (real) debt relief via higher inflation should be out of the question. Thus, a crucial principle of the current EMU governance framework is that a member state experiencing a crisis must fully utilise its own resources and capabilities available in order to restore confidence in the sustainability of its public finances and thus avert the otherwise likely scenario of a sovereign default that would surely amount to a national emergency.

The current crisis has shown that confidence in the ability of a number of states to service their own debts has been eroded even though high government liabilities are, in some cases, backed by considerable public and private assets. In fact, these assets sometimes form a greater fraction of GDP than in the countries providing assistance.[1] This being so, it would appear sensible to first lower government debt by mobilising government assets through privatisation measures. But beyond that, one may also ask whether, in the exceptional situation of a national emergency, privatisations and conventional consolidation measures aimed at the long-term generation of sizeable primary surpluses should be supplemented by a contribution from existing private assets towards averting the threat of a sovereign default.[2]

With this special context in mind, this box outlines the various aspects of a one-off levy on domestic private net wealth, in other words, a levy on assets after liabilities have been deducted. From a macroeconomic perspective, a capital levy – and even more so a permanent tax on wealth – is in principle beset with considerable problems, and the necessary administrative outlay involved as well as the associated risks for an economy’s growth path are high. In the exceptional situation of a pending sovereign default, however, a one-off capital levy could prove more favourable than the other available alternatives. Placing an additional but, compared to the capital levy, more protracted burden on the private sector through ongoing charges, primarily in the form of consumption or income-related taxes, or making more drastic cuts to government spending might no longer be sufficient or might be considered impossible to enforce. Ultimately this concerns scenarios in which potential creditors have massive doubts about the country’s debt sustainability, such that a one-off capital levy is considered as an alternative to a sovereign default.

Under favourable conditions, a net wealth levy could bring about a one-off redistribution of wealth between the private and the public sector within the country in question, thereby facilitating a relatively rapid and significant fall in the sovereign debt level and the faster restoration of confidence in the sustainability of public debt (and the country’s debt service). If the levy is referenced to wealth accumulated in the past[3] and it is believed that it will never be repeated again, it is extremely difficult for taxpayers to evade it in the short term, and its detrimental impact on employment and saving incentives will be limited – unlike that of a permanent tax on wealth. A rapid fall in sovereign debt could, in particular, have a positive effect on the risk premiums of government bonds for the country in question, and employment and saving incentives would be strengthened as a result of lower uncertainty concerning future tax burdens. The public acceptance and political enforceability of a one-off capital levy could be enhanced by deploying it as an instrument of income redistribution, complementing the retrenchment efforts, which ensures that wealthy individuals shoulder a larger share of the adjustment burden, especially as the specific redistributional effects for a given levy volume can be steered by granting tax-free allowances and tapering the tax schedule. 

As a result, the general economic outlook and public acceptance of the necessary fiscal measures in the country concerned may fare better than under the alternative scenario of a sovereign default. Not least, it would be in keeping with the principle of individual national responsibility for fiscal policy in the member states if all consolidation options were rigorously utilised, and it would simultaneously bolster the credibility of the prevailing European governance framework. The incentives for pursuing a sound fiscal policy in the future could be considerably strengthened if it were clear that, in the event of a crisis, the cost of pursuing unsound policies could not be shifted onto taxpayers in other countries.

However, in practice the collection even of a one-off net wealth levy entails considerable difficulties. One of the broad set of conditions necessary to ensure successful implementation is the credibility that the levy will indeed be imposed as a once-only measure in an extraordinary national crisis situation – which is the only way to limit the negative impact on investment and the potential for capital flight. Although the government cannot guarantee in general that the levy will be a one-off measure, it would enjoy greater credibility if, first, the requisite structural reforms were put in place, second, a verifiable outlook of sustainable public finances including safety margins were given, and, third, the political costs of a repeat levy were high. In addition, the decision to raise a levy should be made swiftly. Otherwise, those affected would be more likely to seek to evade the tax, and with a rising level of tax evasion the public acceptance of the levy could be expected to diminish. Other problems are that the valuation of non-financial assets, in particular, is likely to be relatively time-consuming and often contested, and that, in the case of illiquid assets, it would probably be necessary to spread payment of the levy over a period of time, which means that the reduction in government debt would not take place in its entirety straightaway.

In addition, once a levy had been raised, this would send a signal to other countries with very high public debt levels, and may trigger evasive responses. It would probably be a considerable challenge to limit these effects by pointing to a euro-area-wide outlook for sound public finances. The rigorous implementation of the current fiscal framework may certainly help in this respect. 

Overall, a one-off net capital levy entails considerable risks, and the conditions for successful implementation are not easy to fulfil. Therefore, a capital levy should be considered only in absolutely exceptional circumstances, such as that of a looming sovereign default. However, in comparison to a sovereign default, the imposition of a capital levy could probably take place in a more structured and orderly way. It would conform to the principle of individual national responsibility, according to which domestic taxpayers should be first in line to cover their government’s liabilities, before any appeal is made to the solidarity of other countries.

[1] This can be inferred from the ECB’s “Household Finance and Consumption Survey” (http://www.ecb.europa.eu/home/html/researcher_hfcn.en.html), the financial accounts and the national accounts.

[2] The option of introducing a capital levy has recently been discussed from various angles: see S Bach (2012), Capital Levies – A Step Towards Improving Public Finances in Europe, DIW Economic Bulletin 8; or IMF, Fiscal Monitor, “Taxing times”, October 2013, p 49. The arguments presented here expressly refer to the special case of countries experiencing a fiscal emergency where a capital levy constitutes an alternative to sovereign default.

[3] This means measuring private net wealth on a specified date in the past.

Additional information

January Monthly Report: adjustments are underway in the peripheral countries  

Photo shows a ship in a harbour

According to the Deutsche Bundesbank, there are signs of a gradual improvement in the economic situation in the countries most severely affected by the crisis. The Bundesbank’s January Monthly Report explains that current account deficits have been largely reduced and competitiveness has improved. Reducing private and public debt will remain a key challenge.

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