In a policy note published last year by the Levy Institute, Philip Pilkington and Warren Mosler argued that the eurozone sovereign debt crisis could be solved by national governments without the assistance of the European Central Bank (ECB) and without their leaving the currency union, through the issuance of a proposed financial innovation called “tax-backed bonds.” These bonds would be similar to standard government bonds except that, should the country issuing the bonds not make its payments, the tax-backed bonds would be acceptable to make tax payments within the country in question, and would continue to earn interest.
In the current policy note, Pilkington examines the continued relevance of the bond proposal in light of changes that have taken place with respect to ECB policy since the original proposal was made, as well as the case made by Ireland’s finance minister that tax-backed bonds would violate current Irish law (and, by implication, the law in other eurozone countries). He also outlines some changes made to the initial proposal in response to constructive criticisms received since its publication, and briefly notes another area in which the proposal might be utilized—outside the eurozone. His conclusion? That tax-backed bonds remain a valid policy tool, one that can be implemented at the national rather than at the federal level, and a stepping stone to solving the eurozone’s economic problems.The Levy Institute
The Continued Relevance of Tax-backed Bonds in a Post-OMT Eurozone
Philip Pilkington
Tax-backed bond of country x:
ReplyDelete"We, the government of country x hereby solemnly promise to make regular payments of euros on our bonds (Promise number one).
However, if we for some reason break this first promise we hereby solemnly promise to accept the same bonds in payment of taxes (Promise number two)."
Question: if a government starts by admitting it may break a promise number one, what is the value of a "guarantee" by the very same government to honor a promise number two?
I'd say very close to zero. The government could easily default on the second commitment, just like it did on the first one.
It's hard to believe rational investors could be swayed into backing such bonds, issued by a government already lacking in credibility by publicly announcing the possibility - nay, the likelihood - of defaulting on a solemn commitment.
Jose, isn't the promise to accept in payment of taxes a bit like collateral?
ReplyDeletefor example you borrow money and post collateral. This doesn't mean you intend to default on the loan, it just means the lender has some sort of guarantee.
ReplyDeleteWhat's the difference? Seems to me that:
ReplyDelete"We promise to pay you $10,000"
is functionally equivalent to:
"We promise to reduce what you owe us by $10,000".
It's not collateral because the lender does not receive an asset.
ReplyDeleteThe lender receives a promise - given by a government that pre-announces its intention to break a previous promise.
That announcement, by itself, destroys the credibility of the government.
The imaginary dialogue runs like this:
We, the government promise to pay you euros.
But we may break that promise.
In that case, we promise to waive your taxes, owed to us in euros.
The investor will reason that if the government admits an intention to default because it may not have the euros (a currency the government does not issue, remember) it will likely default as well on the promise to receive payment of taxes in bonds - instead of in the euros it so desperately needs to pay its bills.
Only a mad government would issue such "tax-backed bonds".
The main problem with the Eurozone arrangement is that every euro in existence is accruing interest...a massive redistribution of wealth towards the top...towards bankers and bond-holders.
ReplyDeleteThese parasites gain by distributing a product as necessary as the air we breath that costs nothing to make and maintain a choke-hold on the distribution of it.
What could possibly go wrong?
Since I first heard of this idea of Warren Mosler's I have considered it clever and, in theory, workable.
ReplyDeleteIn practice, it seems to me that any country that is able to understand how and why this type of bond would work, is a country that would exit the euro anyway.
"It's not collateral because the lender does not receive an asset."
ReplyDeleteIt'[s what Warren calls a 'tax credit'
"The lender receives a promise - given by a government that pre-announces its intention to break a previous promise."
It has't announced its intention to break a previous promise. Plus them promise to accept it in payment is a promise that is easy to keep.
"The investor will reason that if the government admits an intention to default"
In your sentence the government hasn't announced an intention to default.
If you borrow money there is always the risk that you might default. That doesn't mean you intend to default.
However I agree that the concept seems a little shaky. It would be very interesting to see whether it works in practice though.
From the proposal
ReplyDeletethe bonds...would contain a clause stating that if the country issuing the bonds does not make its payments—and only if the country does not make its payments—the tax-backed bonds would be acceptable to make tax payments within the country in question
No country ever admits (in a formal clause!) to the possibility of not honoring its promises.
If it does, its credibilibity takes a hit - a very serious one. Such a government has just given away its most precious asset from the POV of investors: trust.
Investors will take note by requiring an even higher compensation for the risk of default - on both the promise to pay euros and the promise to waive taxes.
And that would defeat the whole purpose of the bonds: making it easier and cheaper for non monetarily sovereign euro governments to get access to funding.
@Jose Guilherme,
ReplyDelete"Only a mad government would issue such 'tax-backed bonds'."
Nope, only foolish investors would put their money in those bonds: in practice, cash-flow wise, from the point of view of the investor, it's equivalent to paying taxes in advance:
Investor's cash goes out now (say EUR100, January 01)
Later (say June 30) Government says: "Sorry, can't pay you back; but don't worry, consider the EUR100 taxes you would have paid today as already paid (in advance)".
----
On top, imagine the investor comes back: "That's kind of crappy, but here's the thing: I owe you no taxes".
Magpie, the idea is it doesn't matter if the purchaser of the bond doesn't have to pay taxes. The fact that others do means they can sell the bond to others if they want to. That's the idea anyway.
ReplyDelete"Magpie, the idea is it doesn't matter if the purchaser of the bond doesn't have to pay taxes. The fact that others do means they can sell the bond to others if they want to. That's the idea anyway."
ReplyDeleteThat's clear. Unlike it was said above, those pre-paid taxes certificates (which is what the bonds actually are) are assets and one can always turn assets into cash.
The thing is not all assets are equally liquid and not all assets are equally profitable.
The original investor may well be stuck with those pre-paid taxes when he needs liquidity: there's a good chance he'll need to offer a discount to get rid of them.
@y
ReplyDeleteLet me put things this way. The following are two descriptions. The first one is how a normal bond works and the second is how this bond would work. Compare their relative complexities, which you can roughly judge by the length of the descriptions:
Normal, garden variety, bond:
BEGINNING of DESCRIPTION 1:
You have cash available now and decide to put it in the bond, **KNOWING** that at a future date you'll have your investment plus an excedent (i.e. interest) in cash, which you can calculate now.
END of DESCRIPTION 1
Super-duper bond:
BEGINNING of DESCRIPTION 2:
You have cash available now and decide to put it in the bond, **HOPING** that at a future date you'll have your investment plus an excedent (i.e. interest) in cash, which you can calculate now.
Maybe you are lucky and things go just this way; or maybe you are unlucky and you get some pre-paid tax vouchers instead, which perhaps you can use yourself then, or which you can sell to someone else, maybe at a loss, maybe at a profit. Or which perhaps you can keep until you need at a future date.
END of DESCRIPTION 2
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Me? I like simple things. You know, Murphy's Law and all. So, there's little chance I'd take the second bond. But that's me.
They're not "pre-paid taxes certificates" at all.
ReplyDeleteUntil there is a default on the promise to pay in euros, they're just normal bonds.
If the government breaks its promise to pay in euros, it promises (underline "promises" - the promise is supposed to hold in case there is an uncertain future event determined by government bankruptcy, aka a desperate need to receive taxes in euros...) to accept the certificates in lieu of taxes. Not a very credible promise, IMO.
Instead of this, a true "pre-paid taxes certificate" would have to be a token immediately accepted in payment of taxes.
In other words, a new currency.
Which is definitely not the case with this kind of "tax-backed" bonds.
In a policy note published last year by the Levy Institute, Philip Pilkington and Warren Mosler argued that the eurozone sovereign debt crisis could be solved by national governments without the assistance of the European Central Bank. studio commercialistico milano
ReplyDelete