Tax-backed Bonds—a National solution To The Europeandebt Crisis

Discussion in 'Economics' started by Andromeda, Mar 30, 2012.

  1. PHILIP PILKINGTON AND WARREN MOSLER

    Introduction
    The purpose of this paper is to offer a brief introduction to a new approach to the burgeoningEuropean debt crisis: tax-backed bonds.Tax-backed bonds would be similar to standard government bonds except that they wouldcontain 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 maketax payments within the country in question, and would continue to earn interest.
    Background
    The key problem facing Europe is the sovereign debt crisis. The crisis has caused enormous dam-age to Europe, politically, socially, and economically. As recent polls have shown, confidence in theEuropean Union and its institutions is at its lowest point, with many citizens questioning thedirection that the European project is taking.The key issues raised on both sides of the debate are those of sovereignty and responsibility.The populations of the wealthier European countries insist that distressed peripheral countries

    must take responsibility for their debt burdens and stop relyingon bailouts from Europe as a whole.Meanwhile, citizens in the periphery are growing distressedat the loss of fiscal sovereignty that has resulted from thebailouts and subsequent austerity measures. In more extremecases, this has manifested itself in calls for countries to exit thesingle currency, an action that would be catastrophic for theEuropean project as a whole.The ideal solution would satisfy both parties. Such a solu-tion would allow individual countries to maintain their sover-eignty and return to the markets so that they no longer have torely on the rest of Europe for bailouts. At the same time, wemust also ensure that the single currency remains intact. Inwhat follows, we introduce a financial innovation that couldprovide such a solution.
    Cause of the Present Crisis
    The root of the debt crisis can be found in the fact that investorsare currently concerned about the government debt of countriesin the eurozone periphery. They are concerned that these coun-tries might default and that investors would consequentlylosetheir money. This causes investors to demand a higher “yield,”or interest rate, on such government bonds. But when interestrates rise too high, the country in question suffers under the bur-den of hefty interest payments, which may push that country intoa situation in which it is unable to repay its creditors. In such acase, the debtor country may then ask its neighbors for a bailout,either through a fund set up especially for such a bailout or by requesting that the central bank buy up some of their debt in thesecondary market. Both of the above scenarios have already occurred and have caused tension and strife across Europe.We wish to call attention to the fact that member-nationsare not issuers of the euro, and that countries that issue theirown currency do not have such problems. Japan, whose debt-to-GDP ratio is the highest in the developed world at over 220percent yet whose interest payments on that debt are among thelowest in the world (1.04 percent on 10-year bonds, at time of writing), is a good example.As prominent figures such as Alan Greenspan and PaulKrugman have noted, the reason countries that issue their owncurrency have such low debt-servicing costs is that these coun-tries can always make debt repayments; they can always createmoney to meet contractual obligations. And the fact that they have this option on the table allows their bond yields to remainlow even as their debt burden reaches relatively high levels.The problem, of course, is that if any of the peripheralcountries wished to issue their own currency they would haveto exit the euro, a policy option for which there is no politicalsupport.
    The Key Elements of the Tax-backed Bond Approach
    What investors seek is assurance that they will be paid back.In the markets, this is referred to as “creditworthiness.” Investorsseek out safe assets that they believe to be “money good.”Therefore, what we must do is give peripheral debt a highdegree of safety while (1) allowing peripheral countries to remainusers of the euro and (2) ensuring that the European CentralBank does not need to step in as lender of last resort.We propose that a simple solution to this problem wouldbe to have the peripheral countries begin issuing a new type of government debt. We call this type of debt a “tax-backed bond.”Tax-backed bonds would be similar to current governmentbonds except that they would contain a clause stating that if thecountry failed to make its payments when due—and
    only if this happens
    —the tax-backed bonds would be acceptable to maketax payments within the country in question

    How the Tax-backed Bond Would Work

    If an investor holds an Irish government bond, for example,worth 1,000 euros and the Irish government misses a paymentof interest or principal, the investor can simply use the bond tomake tax payments to the Irish government in the amount of 1,000 euros.If the investor is a foreign holder of debt and the govern-ment misses a payment, he or she may simply sell the defaulted-on debt to an Irish bank (perhaps at a tiny markdown; say, 5euros) that could then use the bonds to pay the taxes of theircustomers in exchange for their customers’ euros.The key point here, however, is that since this tax backingwould set an absolute floor below which the value of the assetcould not fall, and because the bonds pay a fair rate of interest,there would be no risk of actual loss and no reason to part withthem—and, hence, the bonds might never be used to repay taxes

    If an investor holds an Irish government bond, for example,worth 1,000 euros and the Irish government misses a paymentof interest or principal, the investor can simply use the bond tomake tax payments to the Irish government in the amount of 1,000 euros.If the investor is a foreign holder of debt and the govern-ment misses a payment, he or she may simply sell the defaulted-on debt to an Irish bank (perhaps at a tiny markdown; say, 5euros) that could then use the bonds to pay the taxes of theircustomers in exchange for their customers’ euros.The key point here, however, is that since this tax backingwould set an absolute floor below which the value of the assetcould not fall, and because the bonds pay a fair rate of interest,there would be no risk of actual loss and no reason to part withthem—and, hence, the bonds might never be used to repay taxes

    http://www.scribd.com/webber3292/d/87105577-Pilkington-Mosler-Tax-Backed-Bonds
     
  2. I don't really understand how this would work. Do you think they are good for paying it?

    From what I can tell the debt is bought by a tax payer who then gets a tax reduction relating to the amount they bought. Surely this will create a net loss to the government because the tax not paid will be equivalent to the payment not made. It would just pass it down the road. The reduction in tax revenue would prevent future debt repayments and create more defaults creating more tax cut buy outs.

    Or the way of looking at it is they are buying the tax revenue of the individual of insititution so it bypasses the government. In any event that would have the same effect. If the government revenue falls the ability to pay debt off will fall and this will create more defaults and more tax buy outs.
     

  3. Is Philip related to this guy?

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