Although the effectiveness of the VAT-cut is a matter that is still disputed and two-sided, it is irrefutable that certain results can be drawn from it.
To begin with, the overall pass rate was 66%, which, although moderate, was still a partial success. However, of these 66%, only 14%42 changed the shelf price (see Table 3). The primary reason for this could be the menu costs, which, for a fairly small cut of 2.5%, may seem too large. This might have the detrimental consequence of a lack of consumer awareness, resulting in no change in their consumption levels.
Table 4: The pass-through of the VAT-cut
Method of passing on VAT reduction Percent
Shelf price changed 14
Only till pricea changed 43
Mixed - some shelf prices updated, other prices changed only at till 9
Not passing on VAT reduction 34
a The till price is the final price noted at the counter (or till). While it is usually the same as the shelf price, during such changes it might vary.
Source: Pike, R., Lewis, M. Turner, D., (2009), Impact of VAT reduction on the consumer price indices,
Econ Lab Market Rev 3, 1721, https://doi.org/10.1057/elmr.2009.139
41It must be noted that other smaller territories have adopted the US Dollar as their official currency, but the US has a far greater impact on its value.
42Pike, R., Lewis, M. Turner, D., (2009), Impact of VAT reduction on the consumer price indices, Econ Lab Market Rev 3, 1721, https://doi.org/10.1057/elmr.2009.139
Furthermore, it is clear consumers were not noticeably impacted by the policy. A survey conducted by PricewaterhouseCoopers found that 88% of the people said that the VAT-cut had not prompted them to spend more. Another 5% said they were unaware there even was a change, and only 8% said they had boosted spending as a result.43
As the policy’s primary aim was an increase in consumer expenditure, the results portray clear ineffectiveness. And while aggregate expenditure did increase by ap-proximately 0.4%44, it is important to keep in mind the opportunity cost of the
$19.4 billion lost by the Government, which could have been used for other forms of fiscal policy, such as stimulus packages, which have a more direct impact on un-employment.
In conclusion, while the pass through of the VAT-cut was regarded as a staggering success, the salience was extremely low, and the reason for both might be the fact that a cut of 2.5% was not impactful enough. As the salience was relatively small, employment was not greatly impacted, and thus, its effectiveness was low.
Predictions for 2020
In the United States, a sales tax fulfills a similar purpose to the VAT in the UK.
However, there are some key differences: the first is that in a sales tax, the tax is levied by the final retailer. This has the advantage of the possibility of a higher pass-through, as a ‘ripple effect’ might have lowered the pass-through in the VAT, particularly in a sticky-price model.
Another difference is that the sales tax in the US is set by the State, as opposed to the Central Government in the UK. The Federal Government in the US does not have the authority to change this sales tax. Hence, any changes must be made on a state level, as opposed to a national level, in the US. As other differences will not have a significant impact on the conclusion, they will not be discussed here.
The significant limitation of a possible sales tax reduction will be the general con-sumer behaviour of the majority of the population, which is currently shifting to-wards abstaining from the purchase of goods deemed ‘unnecessary’.
43PriceWaterHouseCoopers, (2009), VAT reduction has had very little impact on consumer spending so far says PricewaterhouseCoopers LLP research,
https://pwc.blogs.com/press room/2009/08/vat-reduction-has-had-very-little-impact-on-consumer-spending-so-far-says-pricewaterhousecoopers-llp.html
44Crossley, Low, Sleeman, (2016), Using a Temporary Indirect Tax Cut as a Fiscal Stimulus:
Evidence from the UK, https://www.ifs.org.uk/uploads/publications/wps/wp201416.pdf
Furthermore, as was concluded from the UK, even with a moderate pass-through, the salience was considerably low. To have a considerable effect, the reduction in sales tax must be greater than 2.5%. However, sales tax provides a large proportion of state revenue. Hence, a reduction in sales tax would have a deep effect, one which might not stimulate enough spending to make up further revenue losses.
In conclusion, a sales tax reduction will not have a high consumption effect, and the loss of state revenue will likely be higher than the boost in Aggregate Demand.
Hence, the policy will likely not be effective.
4.7 Spanish Labour Market Reforms Effectiveness in 2012-13
The Spanish labour market reforms had both positive and negative impacts. Firstly, the decentralization of collective bargaining was mostly unsuccessful in providing more trade union coverage since small firms did not have access to trade unions and employer organizations. This meant that workers’ job security was decreasing dur-ing a time of economic recession. Introducdur-ing the permanent contract showed some change, however negligible. The permanent-to-temporary worker ratio improved in the country, which resulted in more spending.
The employment protection reforms, however, had a greater impact. Dismissals on the whole increased, but they were more fair than unfair. There was a short-term rise in employment after the implementation of this change in the economy, and this turned into a continuous, long-term rise that brought Spain out of the economic re-cession.
It is clear that these policies were oriented towards shifting demand in the long run, and empirical evidence supports this. Spain’s unemployment rate began to decrease some time after these reforms were implemented, and this positive economic change is often attributed partly to this policy.
Predictions for 2020
The reforms in Spain in 2012 were a result of the country’s market imperfections en-tering into the crisis, and aimed to reduce unemployment in the long term. However, the collective bargaining reforms would be effective in little to no capacity, since the
USA has a low trade union density45 at around 10%46. If these reforms were to have an impact, it would more likely be negative than positive. In addition to the scarcity in privatized trade unions, the decentralization of collective bargaining may worsen income inequality, since coverage rates provided by unions have historically differed across the country.
When it comes to the permanence of labour contracts, the American permanent to fixed-time worker ratio is currently high. While the indefinite contract would not contribute severely to public debt, implementing it would still be impractical, and it would not have any particular economic impact.
Cutting costs for dismissals in the US economy may be more detrimental, since labour supply is continuously deteriorating. Focusing on labour demand in the USA (as Spain did in 2012) would be a mistake, as it would cause further disequilibrium in the labour market. Instead, an increase in dismissal costs would be recommended for a balance of the labour market, which is an important step towards increasing Aggregate Demand. However, dismissal procedures are not as strict in the USA as they are in Spain, and so, it would be difficult to enforce this policy. Additionally, as Lacasa (2013) suggests, reforms like this could focus more on work-time flexibility, in addition to wage flexibility.
5 Recommended Policies for 2020
In this section, we aim to formulate a final recommendation of policy actions to com-bat cyclical unemployment in the US economy following the onset of the coronavirus, on the basis of our analysis in Sections 3 and 4. While these policies would be ef-fective individually, they would certainly be more impactful if implemented together.
To begin with, Kurzarbeit, a German short-time work scheme, has proved its ef-fectiveness in the 2008 financial crisis. Through modifications addressing certain disadvantages (for example, the inclusion of the policy to temporary workers) and adjustments made following the severity of the Great Lockdown, it is likely that the policy will be made more effective in reducing the high cyclical unemployment observed currently. A particular advantage that Kurzarbeit holds over other policies is its direct impact on cyclical unemployment and income. However, one limitation that must be taken into account is its potential support for uncompetitive firms.
45The ratio of trade union member workers to non-unionized member workers.
46OECD, Collective bargaining: Levels and coverage, https://www.oecd.org/els/emp/2409993.pdf
Several different fiscal stimuli that were implemented in the 2008 financial crisis have been covered under the CARES Act. Under this $2 trillion fiscal stimulus package, both tax credits and tax rebates have been introduced.
Tax credits are an effective measure to increase disposable income, as evidenced by their effectiveness during the Great Recession. In addition to their direct effect on income, they would have the monetary effect of increasing the number of loans.
However, they must be implemented carefully due to their high risk of mass insol-vency.
Tax rebates were equally successful during the 2008 financial crisis, as depicted by the “Survey of Consumers” in Shapiro, M.D., Slemrod, J., (2009), (see Table 2).
Offered to consumers with low tax liabilities, tax rebates will increase their pur-chasing power. One restriction to be considered is that consumers might choose to save their money rather than spend it due to the high uncertainty.
Given the effectiveness of tax rebates and credits in the Great Recession, it is highly likely that they will be successful under the CARES Act.
A policy not implemented as extensively under the CARES Act is the usage of state fiscal spending, which has the primary effect of increasing liquidity. Since state banks receive loans and bailouts from the Federal Government, this would have the added impact of credit creation between state banks and the Federal Reserve.
Therefore, we recommend a portion of fiscal packages to be directed towards state fiscal spending. However, it must be ensured that this policy is balanced with Gov-ernment spending towards households and businesses.
Quantitative Easing, is currently being implemented in the USA in an unconstrained manner, as it has portrayed its effectiveness numerous times during the Great Reces-sion. Its positive influence on bank loans increases Aggregate Demand, especially when interest rates can no longer be lowered, as is currently the case. QE’s risk of high inflation makes it preferable for the policy to be implemented in stages as opposed to ‘large chunks’.
The implementation of unemployment benefits under the CARES Act will further be beneficial. They will continue to stimulate credit creation, which would assist the unemployed workforce in settling other liabilities. While in the long run they act as a good transition from a recession, in the short run, they could potentially demotivate the workforce.
A final recommendation of ours is the Medicaid reform. In the current situation, this policy will focus on making healthcare more affordable via the DSH scheme, as a result of which consumption expenditure on the whole increases. An added usage for the Medicaid reform would be to increase testing during the earlier stages of a potential second wave of the pandemic. By focusing on more testing, this would allow the US to flatten the curve, thus preventing the further spread of the virus, which would protect the country economically. A potential disadvantage is its effect of crowding out, which might demotivate private spending in the health sector.
6 Conclusion
In this paper, we aimed to formulate an ideal strategy for a post-Q3-2020 US econ-omy. After a thorough examination of certain policies used by a group of selected countries in the Great Recession, we constructed a set of recommended policies whose effectiveness in 2008 reflect their potential effectiveness in 2020. These poli-cies, together, focus on cyclical unemployment and address the issue through various angles, such as lending, income, and fiscal spending.
However, there do exist certain caveats that may hinder the practical effectiveness of these policies, the primary ones being the dynamic situation as a result of the pandemic, and any political opposition that may have not been considered.
The Great Lockdown has had severe impacts on the United States economy, to which our paper hopes to provide an insightful recommendation for ideal policies to be implemented in the country in order to reduce the currently high levels of cyclical unemployment.
7 References
111th Congress, (2009), American Recovery and Reinvestment Act of 2009, https://www.govinfo.gov/content/pkg/PLAW-111publ5/pdf/PLAW-111publ5.pdf Accounting Today, (December 2010), Tax Cut Extension Bill Wends Its Way to White House, https://www.accountingtoday.com/news/tax-cut-extension-bill-wends-its-way-to-white-house
Atauri, P.G.D., (September 2015), The cost of dismissals in Spain before and after the labor reforms, https://e-revistas.uc3m.es/index.php/SLLERJ/article/view/2883 Blundell, R. (2009), Assessing the Temporary VAT Cut Policy in the UK. Fiscal Studies, 30(1), 31-38, www.jstor.org/stable/24440144
Broda, C., Parker, J. (2008), The impact of the 2008 tax rebates on consumer spending: Preliminary evidence, Northwestern University, July 29.
http://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.188.9572rep=rep1 type=pdf
Carter, A. (October 2019), Increase in social contributions for 2020: high earners will pay much more, https://www.iamexpat.de/expat-info/german-expat-news/increase-social-contributions-2020-high-earners-will-pay-much-more
Carter, A. (2019), German unemployment benefit Hartz IV to go up from 2020, https://www.iamexpat.de/expat-info/german-expat-news/hartz-iv-german
-unemployment-benefits-go-2020
Ceicdata, United States Unemployment Rate, 1948-2020,
https://www.ceicdata.com/en/indicator/united-states/unemployment-rate
Center on Budget and Policy Priorities, (2019), Trump Administration’s Harm-ful Changes to Medicaid, https://www.cbpp.org/sites/default/files/atoms/files/6-12-19health.pdf
Chirakijja, J. et al, (2009). The Stimulus Effect of the 2008 U.K. Temporary VAT Cut. Proceedings. Annual Conference on Taxation and Minutes of the Annual Meet-ing of the National Tax Association, 102, 15-21.,
www.jstor.org/stable/prancotamamnta.102.15
Chodorow-Reich, G. et al. (August 2012), Does State Fiscal Relief During Reces-sions Increase Employment? Evidence from the American Recovery and Reinvest-ment Act, https://www.jstor.org/stable/23249923
Congressional Budget Office, (June 2020), Monthly Budget Review for May 2020, https://www.cbo.gov/publication/56458
Cox, J., (June 2020), Fed sees interest rates staying near zero through 2022, https://www.cnbc.com/2020/06/10/fed-meeting-decision-interest-rates.html
Crossley, Low, Sleeman; (2016), Using a Temporary Indirect Tax Cut as a Fiscal Stimulus: Evidence from the UK, https://www.ifs.org.uk/uploads/publictions/wps/
wp201416.pdf
Crossley, T., Low, H., Wakefield, M. (2009). The Economics of a Temporary VAT Cut. Fiscal Studies, 30(1), 3-16, www.jstor.org/stable/2444014
Domenech, R. et al, (November 2016), The effects of wage flexibility on activ-ity and employment in the Spanish economy, https://www.bbvaresearch.com/wp-content/uploads/2016/11/WP 16-17.pdf
European Automobile Manufacturers Association, (June 2009), Vehicle Scrapping Schemes in the European Union, https://web.archive.org/web/20090419033114/
http://www.acea.be/images/uploads/files/20090406 Scrapping schemes.pdf
European Central Bank, (October 2009), The Effects of Vehicle Scrapping Schemes Across Euro Area Countries, https://www.ecb.europa.eu/pub/pdf/other/mb200910 foc-us04.en.pdf
Ferreiro, J. et al, (July 2013), Mistakes in the Fiscal Policy in Spain before the Cri-sis, from https://panoeconomicus.org/index.php/jorunal/article/view/85
Gopinath, G. (April 2020) The Great Lockdown: Worst Economic Downturn Since The Great Depression, https://blogs.imf.org/2020/04/14/the-great-lockdown-worst-economic-downturn-since-the-great-depression/
Haldane, A., et al., (2011), QE: the story so far, https://ideas.repec.org/p/boe/
boeewp/0624.html
HM Treasury, (2008), HM Treasury Annual Report 2007-2008,
https://assets.publishing.service.gov.uk/government/uploads/system/uploads/
attachment data/file/243389/7408.pdf
Horwitz, L. Myant, M., (March 2015), Spain’s market reforms: On the road to em-ployment - or the road to unemem-ployment?, https://www.etui.org/publications/working-papers/spain-s-labour-market-reforms-the-road-to-employment-or-to-unemployment
House of Commons Treasury Committee (Jan 2009), Pre-Budget Report 2008, Sec-ond Report of Session 2008-09, the publications.parliament.uk website
International Monetary Fund, (2020), Kurzarbeit: Short-time Work benefit,
https://www.imf.org/en/News/Articles/2020/06/11/na061120-kurzarbeit-germanys-short-time-work-benefit
International Monetary Fund, (June 2020), World Economic Outlook Update: A crisis like no other, an uncertain recovery, https://www.imf.org/en/Publications /WEO/Issues/2020/06/24/
WEOUpdateJune2020
Jahan, S. et al, (2014). What is Keynesian Economics? - Back to Basics - FI-NANCE AND DEVELOPMENT, https://www.imf.org/external/pubs/ft/fandd/2014/
09/pdf/basics.pdf
Keynes (1943), The Maintenance of Full Employment, page 319
Kopecki, Dawn (2008), “Bernanke Backs Calls for Quick Action”, Bloomberg News, https://www.bloomberg.com/news/articles/2008-01-17/bernanke-backs-calls-for-quick-actionbusinessweek-business-news-stock-market-and-financial-advice
Kose, et al. (2017), The Global Role of the US economy,
http://documents1.worldbank.org/curated/en/649771486479478785/pdf/
WPS7962.pdf
Lacasa, J.M., (2013), The Labour Reform from a Business Point of View, https://contenidos.ceoe.es/resources/image/bee20902.pdf
Oda, N., Ueda, K. (2005), The Effects of the Bank of Japan’s Zero Interest Rate, https://www.boj.or.jp/en/research/wps rev/wps 2005/data/wp05e06.pdf
OECD, Spain - OECD Data, https://data.oecd.org/spain.htm
OECD (2009), Employment Outlook 2009 - How does Germany Compare, http://www.oecd.org/employment/emp/43707146.pdf
OECD (2012), Structural reforms in times of crisis, http://www.oecd.org/economy/
growth/49711014.pdf
OECD, (2015), OECD Economic Surveys: United Kingdom 2015, from
https://www.oecd-ilibrary.org/economics/oecd-economic-surveys-united-kingdom-2015 eco surveys-gbr-2015-en
OECD, Collective bargaining: Levels and coverage, https://www.oecd.org/els/emp/
2409993.pdf
Office of National Statistics, Unemployment - ONS, https://www.ons.gov.uk/
employmentandlabourmarket/peoplenotinwork/
unemployment
Pike, R., Lewis, M. Turner, D., (2009), Impact of VAT reduction on the consumer price indices, Econ Lab Market Rev 3, 1721, https://doi.org/10.1057/elmr.2009.139
PriceWaterHouseCoopers, (2009), VAT reduction has had very little impact on con-sumer spending so far says PricewaterhouseCoopers LLP research,
https://pwc.blogs.com/press room/2009/08/vat-reduction-has-had-very-little-impact-on-consumer-spending-so-far-says-pricewaterhousecoopers-llp.html
Rinne, U., Zimmerman, K.F., (2012), Another economic miracle? The German labor market and the Great Recession, https://link.springer.com/content/pdf/10.1186/
2193-9004-1-3.pdf
Rodnyansky, A., Darmouni, O. (2016), The Effects of Quantitative Easing on Bank Lending Behaviour, https://www0.gsb.columbia.edu/mygsb/faculty/research/
pubfiles/19250/Darmouni quantitative easing.pdf
Schenkelberg, H., Watzka, S. (2011), CESifo Working Paper no. 3486 - EconStor, https://www.econstor.eu/bitstream/10419/46297/1/661904342.pdf
Serrano, F., (August 2010), The Spanish fiscal policy during the recent ‘great reces-sion’, The Journal of Post Keynesian Economics, www.jstor.org/stable/40599727 Shapiro, M.D., Slemrod, J. (2009), Did the 2008 Tax Rebates Stimulate Spending?, https://www.ncbi.nlm.nih.gov/pmc/articles/PMC3522430/
Statista, Car industry employment numbers in Germany 2005-2019,
https://www.statista.com/statistics/587576/number-employees-german-car- industry/
Statista, Japan - Inflation Rate, https://www.statista.com/statistics/270095/
inflation-rate-in-japan/
Statista, US Unemployment Rate, Adjusted, July 2020,
https://www.statista.com/statistics/273909/seasonally-adjusted-monthly-unemployment-rate-in-the-us
Thomas, R; Bridges, J; (2012), Working Paper No. 442: The Impact of QE on the UK economy some supportive monetarist arithmetic,
http://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.231.4153
Trading Economics, Germany Unemployment Rate,
https://tradingeconomics.com/germany/unemployment-rate
Verick, S., Islam, I., (May 2010), The Great Recession of 2008-2009: Causes,
Verick, S., Islam, I., (May 2010), The Great Recession of 2008-2009: Causes,