Fighting COVID-19 is expensive. Medical costs for testing, medicines, and delivery of care are just the beginning. Social distancing, self-isolation, and quarantines, which collectively imply shutting down large segments of the economy, constitute by far the largest cost.
Restaurants and other entertainment venues are closed; airlines, hotels, and mass transit systems are operating well below capacity; and professional sports teams are not playing. In many states, most businesses are now physically shuttered, and many people are furloughed (on leave from their jobs without pay while retaining benefits) or unemployed. We’ll never recover this lost economic output. US GDP is about $22T, just less than $2T per month. Very rough estimates of COVID-19 economic losses range as high as $1T per month.
A recession is “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.” “Recession” is an impersonal word summarizing very personal losses. A more detailed assessment recognizes that specific individuals and companies suffer.
There are several broad categories of losses – direct, indirect, and disruption.
· Direct losses include lost revenue for businesses that must stop operations and lost personal income for their employees.
· Indirect losses occur because those businesses and employees spend less on goods and services for themselves.
· Disruption means that valuable relationships are broken. These relationships include those between closed businesses and their employees, closed businesses and their partners, and the unemployed and the businesses they patronized. Companies dismiss workers and abrogate contracts. Families may default on mortgages or fail to pay rent, and so on. Replacing and repairing these relationships is expensive and takes time.
Larger direct and indirect losses make a recession deeper. Disruption can make a recession longer.
Who bears these losses? In earlier eras, the chips were left to fall where they might. Each economic actor – worker, company, association – bore its own losses. In a situation like today’s, this approach would make social distancing and economic slowing extremely difficult to sustain. There would be strong incentives to disobey the rules, both because the economic costs are so high and because they are not distributed evenly across the population.
How do we mitigate these losses?
Modern economies have a more highly developed (albeit far from perfect) understanding of how to mitigate the economic and social consequences of the sorts of restrictions required to combat the virus. Congress recently passed the $2.3T CARES Act, authorizing multiple financial supports like the ones in this Wall Street Journal summary (paywall). Or see the bill’s full text (warning, nearly 900 pages!) designed to limit the size and duration of the economic slowdown.
The CARES Act includes:
· Loans to small businesses [$349B] (forgiveness for payroll, rent and utilities, effectively turning into grants). Small businesses will be better able to
o Continue paying employees despite lower (even zero) revenue
o Maintain good commercial relations with landlords and energy suppliers; and therefore
o Reopen when social distancing and gathering restrictions are relaxed.
· Loans to large companies [$454B] focused on businesses hit especially hard by the economic slowdown and designed to have the same benefits as the small business support. Some economists (behind Wall Street Journal paywall) are concerned about the precedent this may set.
· Support to state unemployment insurance programs [$250B] extending benefits from 26 to 39 weeks, increasing benefits by $600 per week for 4 months, including coverage for freelance and “gig” workers. For many workers, the increased benefits will exceed their regular earnings. Workers unemployed due to the coronavirus crisis will be able to:
o Buy food
o Pay rent and make mortgage payments
o Afford to comply with social distancing requirements
o Note: the generosity of this program may encourage workers to stay unemployed rather than go back to “work” with their employers who have taken the loans summarized above. So long as the connections between workers and employers are maintained, the objective of limiting disruption is achieved.
· Direct payments [$301B] to households ($1,200 to each adult with income under $75,000 apiece, plus $500 per child). This should make it easier for families (especially those under- or unemployed) to:
o Buy food
o Pay rent and make mortgage payments
o Afford to comply with social distancing requirements
o Note: this one-time direct payment appears to duplicate support to unemployment insurance and to businesses. Some economists have pointed out this inefficiency.
· Grants and loans to airlines and air cargo companies [$61B] – (grants to cover salaries and benefits). Despite the dramatic decline in the demand for their services, these companies will be able to:
o Keep paying their employees
o Make payments to airports
o Maintain skeleton operations
o Be ready to operate again when the restrictions are relaxed
· Supplemental support for hospitals and veterans care [$117B]. Hospitals will be better able to:
o Cover the costs of COVID-19 care for the uninsured
o Pay staff idled by the pandemic (e.g., providers of elective hospital care)
o Resume regular operations when the pandemic wanes
· Aid to states [$150B] – state tax revenues will be much lower for the duration
These grants, loans and unemployment insurance supplements can’t prevent the recession, but they do change who bears the losses.
Who will bear the losses?
First, anyone who receives benefits will have smaller net losses than they would have otherwise. For example, a restaurant worker who might otherwise have completely lost their job and all of their earnings for the duration of the shutdown may be able to receive earnings for some of the shutdown, and then enhanced unemployment benefits for the following four months. A restaurant owner who might have had to pay rent and other costs for an empty restaurant out of their own pocket (or file for bankruptcy) will have smaller net losses. Importantly, though, the stimulus payments won’t fully offset the losses. The restaurant owner’s profits are lost forever, and the restaurant worker won’t be able to replace their tips.
The provider of the stimulus, the Federal government, makes up the difference between the full economic losses of the recession and the now smaller net losses that affected companies and employees bear.
The Federal government, however, has no independent economic resources. Who funds Federal government spending? Do you have a mirror?
How much the stimulus will cost you depends both on your economic situation and on the funding mechanism.
How will we pay for the CARES Act?
First, the Treasury could authorize the Federal Reserve to print money to fund the stimulus. This is likely to reduce the value of the US dollar – inflation is likely to increase for an indeterminate time. In this scenario all money in circulation would lose value, as would all bonds and interest payments denominated in US dollars.
Everyone who holds US dollars and dollar-denominated bonds and loans would have less purchasing power – and would bear the losses absorbed by the Federal government – in proportion to their holdings. The “everyone” in the previous sentence is a huge group, including US individuals who hold cash and Treasury bonds, mortgage and credit card companies who will receive interest and principal payments in depreciating dollars, and pensioners whose benefits will now buy less. There are also non-US individuals and governments who hold dollars and Treasury bonds (40%-60% of US currency is held overseas, as is roughly 40% of US government debt).
Among US individuals, the wealthy are likely to bear a higher share of the cost. The wealthy hold more dollars in bank accounts, and they are also more likely to be lenders (bondholders) and shareholders in banks and other financial institutions whose loans would decline in purchasing power. Non-US individuals and governments would also bear a significant share of the cost.
There is a wrinkle – borrowers whose debts are denominated in dollars would owe less – their future payments would be worth less. They will be indirect beneficiaries of the stimulus. This is just one example of the many unintended consequences of this financing method.
Alternatively, the Treasury could issue debt (sell bonds) to fund the payments and loans. In this case, taxpayers would be on the hook, as they are for all Treasury debt. The direct answer to who pays taxes and how much they pay is relatively straightforward. Individual income taxes represent 48% of tax revenue, corporations 9%, payroll taxes 35%, and 8% is excise taxes and other. However, upon more careful analysis, individuals pay all taxes. Economists believe that workers bear the entire burden of the payroll tax, including the employer’s share, and individuals are the ultimate owners of all corporations, either directly as shareholders or indirectly through mutual funds, pensions, life insurance policies, etc. With this approach, individuals with high incomes will bear more of the losses; they have higher incomes and pay larger percentages of those incomes in taxes.
No matter which financing method is used, there are two broad effects. First, the losses will be shared with others who are not directly affected. We will all have lower lifetime resources (by paying more taxes or having less purchasing power) instead of the loss being concentrated on those directly affected through no fault of their own. Second, we will be able to spread the losses over time. Whether due to reduced purchasing power or higher taxes, lifetime net resources will be lower. It is much easier, however, to cope with the loss of, say, 3 months’ income spread over a 20 year working career (1.25% reduction) than all at once (100% reduction) as would occur in the absence of the CARES Act.
This article originally appeared in Forbes.com.
For more information on the CARES Act, please read this article by Chris Andrysiak.