- During the Global Financial Crisis of 2008-2009, how did governments use such tax breaks for stimulus?
- Do you think these policies worked to generate investment, employment and output?
- How about monetary policy instruments? Which countries reduced their interest rates? Do you think this helped alleviate the effects of the crisis, and if so, how?
Tax Breaks for stimulus –
Corporate tax rates have been largely coming down across the world. Between 2000 and 2021, globally, the Statutory Corporate Income Tax rate fell by roughly 8.3 percentage points from 28.3% to 20%. However, the average corporate tax revenues as a share of total tax revenues has grown from 12.3% in 2000 to 15.3% in 2018. Average corporate tax revenues as percentage of GDP has also grown from 2.7% to 3.4% in the same period. So governments across the world have been in the corporate tax reduction race for quite some time.
The 2008-2009 financial crisis may have necessitated further and faster reduction but it was not realized until only 3-5 years after the crisis broke out. I shall compare the US, UK and OECD during this period to present how governments intervened and the effect such interventions had.
US –
The corporate taxes in US were around 50% in 1950s and since then have dropped considerably to around 20% by 2018. However, the statutory tax rates had pretty much plateaued since the Raegan years until 2017. Therefore, there were no reductions in the Statutory Corporate Tax rate during the 2008-2009 crisis. The average effective tax rate in the US has pretty much remained flat since 1992 until 2008 when it dropped to around 23-25% levels by 2010. The Biden administration proposed some increases in 2021.
UK –
Corporate tax rates in the UK were at 52% in 1980 and since then have been coming down steadily. The rates in 2008 were around 28% (still higher than some European countries) and have been further brought down to below 20% by 2022. There has been an increase to 23% in 2023.
OECD –
The rates were dropped a bit in UK and OECD during the crisis but not by much. Significant reductions were made 3-4 years into the crisis around 2013. US dropped rates only after 2017.
Monetary policy instruments by governments during the crisis –
Now let us look at the monetary policy instruments –
US –
Initially, the Fed used “traditional” policy actions by reducing the federal funds rate from 5.25 percent in September 2007 to a range of 0-0.25 percent in December 2008, with much of the reduction occurring in January to March 2008 and in September to December 2008. US also used large scale asset purchases and credit easing programs to stimulate the economy.
UK –
Decrease of the short-term rate of interest from 5% to 0.5% between September 2008 and March 2009. As this policy was ineffective in boosting the economy, Quantitative Easing (QE) was introduced by the Bank of England (BoE).
EU –
Decrease of the short-term rate of interest from 5% to 0.5% between September 2008 and March 2009. They also enhanced credit support and focused primarily on commercial banks, as these are the main source of funding for households and businesses in the euro area.
Did it work?
Corporate tax reductions –
Corporate taxes were reduced although marginally because, most likely, such breaks are probably not designed to provide an immediate stimulus. Tax rates have been on gradual downward trend for the last 30-40 years now in UK, OECD, EU.
Countries where these rates are high observed inversion i.e. companies leaving the country or moving bulk of the operations outside. These reductions have offered incentives to return and reduce inversions thereby increasing the overall tax base. Other than reducing inversion, reduction in corporate taxes contribute to wage growth and higher productivity.
Some observations in UK –
- Corporate tax rates were brought down from 30% to 28% in 2007-08 and it remained at 28% until 2010. From 2011, the rates were reduced by 7% in the next 5 years.
- Unemployment increased in 2008 at the beginning of recession and peaked in 2011. But it really started dropping significantly since 2013. Perhaps an indicator that the multiplier effect of the marginal propensity to consume (MPC) has a lead time associated with it.
- In the post-recession era corporate tax revenues stabilized and the number of corporations grew possibly contributing to investment, employment and output.
Corporate tax rates in the US have been brought down from 35% to 21% post the Tax Cut and Jobs Act of 2017. During the recession, the rates remained pretty much flat.
Monetary policy instruments –
Conventional monetary policy instruments were almost immediately deployed in reducing the interest rates by 300-400 percentage points across US, UK and EU. Reducing the rates should improve liquidity in the market, stimulate aggregate demand and thereby boost employment, productivity and output. As mentioned in the module earlier, central banks should pull back the liquidity to reduce inflationary pressures. However both US and UK kept their interest rates very low close to the low bound for a decade before Covid kicked in. US did start increasing since 2016 but had to bring it down to pre-2016 levels during Covid.
So clearly, a very low interest rate was deemed to be essential to getting out of recession, increasing employment and output. In fact, both US and UK were only able to reach the 2005 levels of unemployment only by 2017. In order to provide these low interest rates for such a long period, the US used government spending or large-scale asset purchases (in trillions of USD) to help push down longer-term public and private borrowing rates. For example –
- In November 2008, the Fed announced that it would purchase US agency mortgage-backed securities (MBS) and the debt of housing related US government agencies. The choice of assets was partly aimed at reducing the cost and increasing the availability of credit for home purchases.
- In UK that deployed QE in March 2009, involved the purchase of financial assets – the majority being UK government bonds (gilts) – on the secondary market by the BoE via money creation.
Comparing US and UK, it can be observed that it was more of government spending that actually improved aggregate demand over a period. Just providing lower rates did not seem to work on its own as it may be a significant driver for household borrowers but not for companies / firms who tend to look at aggregate demand and future demand.
In summary, government intervention in the form of fiscal and monetary stimulus did work but it was large government spending that really stimulated aggregate demand and lead to alleviation of the crisis. The European sovereign debt crisis, sluggishness in aggregate demand and lead time for multiplier effects could be reasons for the longer time required to reduce unemployment, generate investments from firms and not just households.