Myopic Fiscal Policy During the COVID-19 Pandemic and its Intergenerational Burden

ABSTRACT

The COVID-19 pandemic has greatly affected global social and economic activities. While German economic output has declined dramatically, the German federal government’s reactions to the direct and indirect effects of the pandemic have resulted in an unprecedented public deficit. Leading politicians urge repaying the debts induced by the pandemic, as this rather myopic fiscal policy raises questions regarding fiscal sustainability. This study addresses policymakers who are designing amortisation solutions; employing the method of generational accounting provides fundamental insights into the effects of diverse amortisation scenarios on intergenerational burden sharing. The results demonstrate that current and future generations are unequally burdened depending on the period, instrument and amortisation target. These findings indicate that a long-term amortisation process initiated promptly after the COVID-19 crisis is crucial for intergenerational equity.

Acknowledgements

We are grateful to the two anonymous referees of German Politics and Professor Kai Oppermann, the editor of this journal, for their constructive and valuable comments. We are also grateful to Professor Bernd Raffelhüschen, and Tobias Kohlstruck who also provided very useful suggestions.

Disclosure Statement

No potential conflict of interest was reported by the author(s).

Correction Statement

This article has been republished with minor changes. These changes do not impact the academic content of the article.

Notes

1 Brodeur et al. (2021) have provided a literature review on the economic consequences of the COVID-19 pandemic in various countries.

2 The German Council of Economic Experts (2019) discussed the economic justification of the debt brake. Moreover, the authors classified each position according to the consequences for (German) fiscal policy. Moreover, Werding et al. (2020, 124) have described this issue in an excursus.

3 For a further discussion of the term fiscal sustainability and possible measures, see Balassone and Franco (2000).

4 For a comparison of the OECD-method and the method of generational accounting, see Fetzer and Benz (2006).

5 Gokhale and Raffelhüschen (2000) have argued that this indicator is also called the ‘generational gap’ or true debt, which Raffelhüschen (1999) went on to discuss in further detail.

6 Reference year (current year - 1) and base year (current year - 2) are distinguished from each other. The latter is the first year of the available data basis, while the calculations of the present value, as well as the IPL, refer to the former.

7 It is worth mentioning that the official tax estimates remain uncertain due to the underlying growth assumptions and thus could change in coming forecasts. The estimates by the German Working Party on Tax Revenue Estimates are based on key macroeconomic data supplied by the German Federal Government. Although the German Federal Government bases its forecasts on estimates by the Joint Economic Forecast (JEF), Lehmann and Wollmershäuser (2020) have shown that their estimates deviate from the JEF and that they ‘found evidence for political motives underlying these deviations’ (Lehmann and Wollmershäuser 2020, p. 265).

8 These assumptions match the values in numerous publications on generational accounting (see Raffelhüschen (2021), Manthei (2020) and Bahnsen et al. (2020)) and are to be considered as standard values. Concerning this matter, it should be emphasised that the long-term growth assumptions are not crucial for the qualitative findings of the present work. (Auerbach, Gokhale, and Kotlikoff 1994; Leibfritz 1996; Bonin 2001) discuss the choice of an appropriate discount rate. According to the authors, the government receipts, and expenditures as well as the return on capital are uncertain and volatile, which must be considered. The use of the government’s borrowing rate would thus not be appropriate.

9 For a more detailed methodological description, see Bahnsen et al. (2020).

10 Please note that this approach applies a sample survey of income and expenditure by the Federal Statistical Office. Therefore, especially high-income earners might be underrepresented. For a more detailed analysis on the effect of an increase in the top income tax rate a special statistical evaluation of the Federal Statistical Office concerning the income tax revenue by age and sex would be necessary.

11 The intergenerational burden sharing in case of amortisation of the total debt due to the COVID-19-pandemic is analysed in Bahnsen et al. (2020).

12 In the light of the current negative nominal interest rates on German sovereign bonds, this represents a conservative assumption. In the past ten years, a negative real interest rate in the range of 0.5 to 1 per cent would be reasonable as well. Sensitivity analyses have shown that it has no significant impact on the present results.

13 Regarding the high level of the pandemic induced implicit debt it should be noted that the modelling of the COVID-19 pandemic fiscal effects is not implemented through a simple continuation of the base year. On the contrary, relevant fiscal and economic recovery effects are taken into account. If the standard approach of generational accounting were implemented, implicit debt due to the COVID-19 pandemic would amount to 315.4 per cent of GDP. The COVID-19 debt that results according to the baseline scenario of this paper is 96.5 per cent of GDP lower, and thus amounts only to two-thirds of the pandemic-induced debt based on the standard generational accounting approach. The overall lower level is due to the fact that special Corona measures are taken into account for the statutory period of validity and the growth assumptions are applied according to the tax estimates from the Federal Ministry of Finance. Moreover, labour market-specific supporting measures, such as the short-time allowance (German: Kurzarbeitergeld), are considered based on statistics from the Federal Employment Office. (cf. Data and assumptions) If, on the other hand, one was to assume that no impact of the pandemic on public finances remained from 2023 onwards, total pandemic-induced debt would amount to only 24.3 per cent of GDP. The main reason for the comparatively high level of implicit debt in the baseline scenario is the permanent growth effect according to the official tax estimates and the likely permanent reduction in the level of government revenue without a corresponding reduction in expenditure. Of course, it is to be expected that in the medium- and long-term expenditure and revenues will be adjusted through political measures. Therefore, this paper investigates on the intergenerational impact of the choice of timing and instruments of such adjustments.

14 For a detailed examination of COVID-19 induced public debt see Bahnsen et al. (2020).

15 The generational account of a ’–1-year-old’ individual represents another indicator for fiscal sustainability. If only the future generations have to bear the necessary tax increase/ decrease of social security benefits to retiring the IPL, the generational account of individuals born after the base year would amount to this notional generational account of a ’–1-year-old’ individual.

16 This scenario would result in a maximum VAT rate of around 35% in Germany, significantly higher than the VAT rate of 27% in Hungary, which is currently the highest in the European Union (European Commission 2021).

17 Please note that the amortisation through the use of TIT does not consider a certain amortisation period or a certain amortisation target but rather represents the age-specific burden due to amortisation through the introduction of an increased TIT from year 2023.

18 To analyse the impact of a top income tax, which also considers investment income, a special statistical evaluation of the Federal Statistical Office would be necessary. Moreover, the described effects represent a partial analysis such that feedback effects of a tax increase (e.g. on labour supply) are not considered. Please see Blundell (1992), Meghir and Phillips (2008) and Biswas, Chakraborty, and Hai (2017) for a general analysis of this topic. Future research could address this aspect with respect to this specific reform proposal by the German Green Party.

19 For a discussion of structural reforms concerning the German social security systems, please see Raffelhüschen (2021), Bahnsen and Raffelhüschen (2021; 2019), Raffelhüschen and Seuffert (2020), and Raffelhüschen et al. (2021).

Additional information

Notes on contributors

Florian Maximilian Wimmesberger

Florian Maximilian Wimmesberger is Research Associate at the Research Centre for Generational Contracts and Academic Lecturers at the Institute for Public Finance and Social Policy at the University of Freiburg, Germany.

Stefan Seuffert

Stefan Seuffert is Research Associate at the Research Centre for Generational Contracts and Academic Lecturers at the Institute for Public Finance and Social Policy at the University of Freiburg, Germany.