Wednesday, 17 February 2021

Wage subsidies vs. income-contingent loans to reduce the economic impact of coronavirus

The economic disruption/s caused by the coronavirus pandemic have put pressures on government social support systems. Many countries have responded with wage subsidies for workers who have faced job loss or a reduction in work hours. In a new article in The Conversation yesterday, Richard Meade (Auckland University of Technology) presents an alternative:

For many countries, targeted wage subsidies of some form have been the principal tool for maintaining employment and economic confidence, often complemented by small business loans. While these have clearly been useful, they also have clear limitations — not least their cost.

This raises questions about the ongoing viability of wage subsidies and small business loans as the economic response measures of choice.

My recently published policy paper proposes an alternative approach, modelled on student loans schemes such as those operating in New Zealand, Australia and the UK.

Rather than attempting to support firms and households to pay wages, rents and other expenses, this alternative enables firms and households whose incomes have fallen due to the pandemic to take out government-supported “COVID loans” to restore their pre-pandemic income levels — a form of “revenue insurance”.

I argue this alternative approach will be not just more affordable and sustainable, but will also be more effective and more equitable.

Meade summarises his proposal in The Conversation, with additional detail in this forthcoming article in the journal New Zealand Economic Papers. He argues that:

In terms of affordability, loans to make up drops in income would be repaid via tax surcharges on those taking out loans, as and when their future incomes allow. This means would-be borrowers need not be deterred by fixed repayment deadlines in times of ongoing economic uncertainty.

Furthermore, since any firms and households borrowing against their own future incomes will ultimately be repaying their debt, COVID loans represent an asset on government balance sheets.

This offsets the extra liabilities governments take on by borrowing to finance these loans — something wage subsidies do not do. This increases the affordability of a loans-based approach from a government perspective (even allowing for defaults and subsidies implicit in student loan schemes).

Using illustrative data for New Zealand, my paper shows COVID loans are 14% cheaper than wage subsidies (and small business loans) in terms of their impact on net government debt.

The problem with Meade's analysis is that it adopts a purely fiscal approach, and ignores the distributional consequences. With a wage subsidy, affected households receive an immediate income boost, and the costs are shared across all taxpayers, current and future. Current taxpayers face a burden if taxes increase, or if government services are reduced (in quantity or quality) to offset the cost of the subsidy. If instead the wage subsidy if funded by government borrowing, future taxpayers will face the burden of paying the debt back (through higher taxes or reduced government services in the future). If instead of a wage subsidy, the government provides income-contingent loans, affected households receive an immediate income boost (just like the wage subsidy), but it is those households, and not all taxpayers, that face the burden of paying for the loans (in the future).

We need to consider who is likely to receive the government assistance (whether wage subsidy or loan). According to this article by Michael Fletcher, Kate Prickett and Simon Chapple (all Victoria University of Wellington), also forthcoming in New Zealand Economic Papers, lockdown-related job losses were concentrated among the lowest income households:

Respondents with low annual household incomes (under $30,000pa) were substantially more likely to have lost jobs (24%) or not working due to the lockdown (36%), and less likely to be working from home (13%). Respondents with high household incomes (over $100,000) were less like to have lost jobs (3%) or to be unable to work (18%) and more likely to be working from home (45%).

Although, Fletcher et al. find that in terms of income losses:

Higher-income households were more likely to report at least one adult had experienced job or income loss, compared to households with lower incomes (52% among those earning over $100,000pa compared to 33% among homes living on less than $30,000pa). This result is driven by higher rates of income loss, not job loss, among the high income households and job loss more than income loss among lower-income households.

So, then it probably comes down to who would accept an income-contingent loan from the government. Higher-income households face fewer credit constraints, likely have higher net wealth, and may be more able to self-insure. In other words, while they would gladly accept a wage subsidy from the government (who doesn't love free money?), they would be less likely to accept an income-contingent loan. Lower-income households face credit constraints, and a loss of income is a more serious proposition for many lower-income households, so an income-contingent loan wouldn't so easily be passed up.

I think it's pretty clear, even in the absence of a thorough distributional analysis, that the wage subsidy scheme is progressive (to the extent that low-income households benefited to a greater extent in relative terms than high-income households). In contrast, Meade's income-contingent loan scheme is likely to be more regressive.

So, while the loan-based scheme may save the government 14 percent in terms of the total cost, that has to be weighed up against the potential for higher future poverty and inequality as the loan repayments impact low-income households relatively more than high-income households. Some governments may think that is an acceptable trade-off. I suspect that the current New Zealand government is not among them.

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