MACROECONOMICS, TRADE AND INVESTMENT MACROECONOMICS, TRADE AND INVESTMENT EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT The Fiscal Impact and Policy Response to COVID-19 Fiscal Policy and Sustainable Development Unit (MTI) ABSTRACT The spread and severity of the COVID-19 pandemic continues to accelerate. The outbreak was declared a pandemic by the WHO on March 11 and the epicenter of the crisis has moved from China and Korea to the US and Western Europe. Infections are also increasing at a rapid pace in WBG client countries, with large uncertainty about the extent to which many countries are affected due to the lack of testing. IDA countries, in particular, have limited resources and capacity to keep infections low and provide proper care for those with serious health problems due to COVID-19 infection as well as to address related socio-economic distress. © 2020 International Bank for Reconstruction and Development / The World Bank 1818 H Street NW, Washington DC 20433 Telephone: 202-473-1000; Internet: www.worldbank.org Some rights reserved. This work is a product of the staff of The World Bank with external contributions. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. 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The risk of claims resulting from such infringement rests solely with you. If you wish to reuse a component of the work, it is your responsibility to determine whether permission is needed for that reuse and to obtain permission from the copyright owner. Examples of components can include, but are not limited to, tables, figures, or images. All queries on rights and licenses should be addressed to World Bank Publications, The World Bank Group, 1818 H Street NW, Washington, DC 20433, USA; e-mail: pubrights@ worldbank.org. 4 >>> THE FISCAL IMPACT AND POLICY RESPONSE TO COVID-19 >>> Contents 1. Introduction 7 2. Economic Impact 8 3. Fiscal Impact 9 4. Immediate Fiscal Response 11 5. Ensuring Fiscal Sustainability and Supporting 24 Economic Recovery 6. Areas for MTI Support 28 Appendix 1 - Fiscal Impact of the Global Financial Crisis 30 Appendix 2 - Further Analysis of Country Aspects for 45 Fiscal Policy Decision Making >>> Acknowledgements This note was prepared by a team overseen by Chiara Bronchi, led by Marijn Verhoeven and Robert Utz, and comprising Anna Custers, Christian Eigen-Zucchi, Daniel Alvarez, Dialigué Ba, Dirk Heine, Eric Lacey, Francisco Vazquez Ahued, Ira Dorband, Jaffar Al Rikabi, Jan Loeprick, Joseph Massad, Massimo Mastruzzi, Miria Pigato, Raul Junquera-Varela, Roel Dom, and Se- bastian James, MTI-EMFTX. The team gratefully acknowledges inputs and comments on the first version from colleagues across EFI. THE FISCAL IMPACT AND POLICY RESPONSE TO COVID-19 <<< 5 4. MTI INSIGHT >>> The Fiscal Impact and Policy Response to COVID-19 >> INTRODUCTION The spread and severity of the COVID-19 pandemic continues to accelerate. The outbreak was declared a pandemic by the WHO on March 11 and the epicenter of the crisis has moved from China and Korea to the US and Western Europe. Infections are also increasing at a rapid pace in WBG client countries, with large uncertainty about the extent to which many countries are affected due to the lack of testing. IDA countries, in particular, have limited resources and capacity to keep infections low and provide proper care for those with serious health problems due to COVID-19 infection as well as to address related socio-economic distress. Fiscal policy in countries around the world needs to respond to be able to combat the health and economic impacts of COVID-19. As countries are ramping up efforts to slow the spread of COVID-19 and raise the capacity of health care systems to treat affected patients, the global economy is slowing down. Most countries will face an economic recession and increased fiscal deficits. Countries are implementing their initial policy responses to the on-going health and economic crisis. In advanced countries, monetary and fiscal measures taken so far have been far-reaching and costly. Client countries often operate in a different context, with less fiscal space for costly fiscal measure and lower implementation capacity. This note provides guidance to country economists and teams for assessing fiscal policy measures that fit country circumstances. Following a brief summary of the economic fallout of the COVID-19 pandemic (section 2), this note provides an overview of fiscal impacts (section 3) and the menu of fiscal responses for softening the economic downturn and protecting businesses, jobs and citizens more broadly from extreme economic hardship (section 4). This is followed by a brief discussion of longer-term aspects related to ensuring fiscal sustainability and supporting economic recovery (section 5) and an overview of MTI’s contributions to the World Bank’s support to client countries in addressing the COVID-19 crisis through fiscal instruments (section 6). Appendix 1 looks at the fiscal impact of the Global Financial Crisis and draws lessons for COVID-19 shocks by region. THE FISCAL IMPACT AND POLICY RESPONSE TO COVID-19 <<< 7 >> ECONOMIC IMPACT The outlook on the evolution of the pandemic and related ing for the virus and treatment of affected patients, and public economic impacts is highly uncertain. An aggressive health, health measures to slow down transmission of the virus. To social, and economic response has been effective in con- counteract the economic fallout from the health-related mea- trolling the spread of the pandemic at the country level. But sures, advanced economies have enacted fiscal policy mea- policies and their effectiveness vary across countries, in part sures combined with quantitative easing. These have included due to differences in the capacity for an effective response lowering of interest rates and scaling up open market opera- between more and less developed nations. Epidemiological tions, combined with a mix of revenue, expenditure, equity experience and projections also raise the specter of several and credit measures. Governments of less developed econo- waves of the pandemic, which underlines the importance of mies will be faced with multiple challenges and more limited a global approach to the pandemic, enhancing testing for the choices between fiscal policy instruments. virus, the search for a vaccine, and preparedness for eventual subsequent waves. In EMDEs, the impact of the pandemic and policy response to the COVID-19 crisis is evolving rapidly. Countries are look- Production and supply chains are disrupted as measures to ing at the experience in countries where the impact of the contain the pandemic lead to a slowdown in production and COVID-19 has been greatest (China and Korea initially and require changes in work practices.1 On the demand side, re- Western Europe and the US currently) for guidance on policy strictions on movement and activities result in a general de- options for health and economic policy. Translating these ex- cline in demand as cashflow and income of businesses and amples into policies that fit the context of specific EMDEs is households drop, in many cases dramatically. Demand and not straightforward. Health impact and options for combating supply shocks spill over to other sectors and economies via COVID-19 vary for countries with difference levels of income, trade and production linkages. These actions affect all coun- health care systems, institutional capacity, and overall gover- tries and all sectors of the economy, with an immediate global nance models. Economic impact varies further with countries’ economic slowdown that could persist in the medium term. positions in global value chains and the effect of commodity price shocks, as well as the risk of debt distress or availability The economic impact of the COVID-19 is most pronounced of fiscal buffers and specific fiscal policy features such as the in countries where infections and health measures are most presence of social safety nets that can be scaled up to protect disruptive: Western Europe, Iran, and the United States pres- individuals and households during the crisis. The next section ently, and China and South Korea earlier. But effects are in- focuses on the fiscal impact of the COVID-19 pandemic. creasingly felt across emerging markets and developing econ- omies (EMDEs). Health measures to contain the spread of COVID-19, such as social distancing and lockdowns, are im- plemented in an increasing number of EMDEs. The economic impact of these local measures compounds global COVID-19 effects. Service sectors that require direct contact between producer and consumers are especially hard hit by health measures, which trickles down to the wider economy as many businesses suspend operations and employment declines. Many countries also see an impact on trade and trade-related businesses, as global value chains are disrupted.2 Authorities in advanced economies have responded with measures aimed at protecting affected economic sectors and households, as well as strengthening their health systems to respond to the crisis. In Europe and North America, this in- cludes travel restrictions, lockdowns, efforts to speed up test- 1. This reflects two inter-related dimensions of the pandemic’s economic impact. The first arises from the direct impact on human capital though people not being able to work due to increased morbidity and mortality and the diversion of labor and other resources needed to take care of those falling sick. The second dimension arises from measures to contain the pandemic, especially social (or physical) distancing and lockdown (isolation) measures–which concurrently severely restrict demand and supply in an economy. 2. Many African countries were affected in the initial stages of the crisis by a sudden stop in certain imports from China as companies there were temporarily shut down to deal with the wave of infections in Wuhan. 8 >>> THE FISCAL IMPACT AND POLICY RESPONSE TO COVID-19 >> FISCAL IMPACT This section discusses the fiscal consequences of the globe. COVID-19 pandemic and related economic slowdown in EMDEs in terms of recent and likely impact on government • Consumption taxes (inland). Most of the goods revenues and expenditures. consumed in Africa and EMDEs are imported, or include parts, from China and other countries where production has been affected. As supply chains have been interrupted, local REVENUE >>> COLLECTION IS traders selling imported items such as textiles, electronics or EXPECTED TO DECLINE household goods are not supplied. As COVID-19 continues to spread more widely, the situation is likely to deteriorate further The COVID-19 crisis presents unprecedented challenges to and would be compounded as demand responds to supply domestic revenue mobilization (DRM) in EMDEs. From past shocks. crises we know that the effect on taxes (especially direct taxes) exceeds the economic impact in scale and duration.3 The • Direct taxes. Over the next year, revenues from unprecedented hit on cashflow and incomes of businesses Corporate Income Tax (CIP) and Personal Income Tax (PIT) and individuals puts a spotlight on the dual challenge of are likely to decrease as income generating activities slow revenue systems to provide relief for affected taxpayers and down. The most immediate effects may be felt in the collection manage a sudden large drop in collections. of payroll and wage taxes, which have a shorter lag. The COVID-19 pandemic and related economic slowdown • Revenue from natural resources. The COVID-19 will lower government revenues as a share of GDP as: (1) pandemic coincides with a major drop in the prices of oil and some tax bases are disproportionally affected by a growth other commodities as the world economy is slowing down. slowdown, including profits, capital gains, items with excises, In the case of oil, this was reinforced by the disagreement and imports; (2) commodity prices and related revenues between Russia and Saudi Arabia about cutting back oil decline; and (3) countries take steps to lower the tax burden, production in response to declining world demand. Commodity for example by lowering of tax rates or scaling up incentives, importing nations generally benefit from the drop of oil prices, in response to the crisis. Revenue performance may be further but revenue could be adversely affected to the extent that harmed by operational restrictions in revenue administrations taxes are based on the value of oil products (i.e., ad valorem due to health measures and related risk of worsened taxpayer instead of specific rates for fuel and other products). compliance. • Tax administration and compliance.4 As noted It is still too early to assess the impact on revenues in the above, health measures disrupt operations of revenue current situation, although insight can be gained from looking administrations, including enforcement and taxpayer service at specific aspects of the revenue system that are likely to activities (some tax administrations have already suspended affect collections in EMDEs: audit and collection activities, see Appendix Table 2). Reduced enforcement activity would likely increase taxpayers’ • Customs and trade taxes. In open economies, the risk tolerance for tax avoidance and evasion and thereby interruption in global value chains has a direct and immediate reduce tax compliance. Moreover, tax arrears may increase negative impact on the revenue collected by customs (excises, as taxpayers divert constrained cash flows to their business import duties, and VAT). In African countries and other EMDEs, operations. Businesses may also protect their cashflows by the slowdown in economic activity in China starting in January suspending or delaying payment of salaries, supplies, loans has already translated into a drop of manufacturing imports. and other obligations, which could further reduce taxes These problems are deepening as advanced economies have collected. entered crisis mode and COVID-19 has spread across the 3. During the global financial crisis of 2008-09, the average tax-to-GDP ratio dropped by 1.3 percentage point. Sub-Saharan Africa was the region that returned most quickly to tax-to-GDP levels from before the global financial crisis of 2008-09: 3 years. This took South Asia 7 years, while tax revenues in Eastern Europe and Central Asia and the Middle East and North Africa did not recover fully. See Appendix 1 for more detail. 4. Revenue administration aspects are only touched on in this note. A detailed assessment can be found in a companion note on Tax Administration Complications from COVID-19. THE FISCAL IMPACT AND POLICY RESPONSE TO COVID-19 <<< 9 >>> PUBLIC EXPENDITURE WILL RISE cash because of lower revenues. R A P I D LY > > > F I G U R E 1 - Social Protection by Income Categories, The COVID-19 pandemic and related economic slowdown % GDP has an immediate impact on the expenditure side though multiple channels: • Activation of automatic stabilizers in response to economic effects of the crisis on household incomes and job losses. Automatic stabilizers are mechanisms built in government systems that act as counter-cyclical measures to mitigate economic impact of crisis, including unemployment benefits and various pro-poor programs. The principal benefit of these programs is the ability to respond quickly and effectively to crisis through social protection measures for the most vulnerable and affected households. Unfortunately, the presence of these stabilizers is much less advanced and Source: BOOST Data institutionalized among developing countries, acting as a major amplifier of their vulnerability to economic shocks. This is particularly true for lowest income countries whose social protection total expenditure budgets are several times lower than in higher income countries. • Discretionary changes in expenditure policy in response to the crisis will push up spending further. This includes increased budget allocations to health systems, additional cash transfers, introduction of wage compensation schemes, and various support mechanisms for targeted business and industries (see also Section 4.2). • On the other hand, some budget allocations would be underspent due to interruptions in implementation of programs and activities. The drastic behavioral changes produced by the pandemic will likely lead to significant under- execution of public investment programs. A lack of personnel induced by social distancing and governments’ immediate focus on health crisis would slow down civil engineering works. The effect on government investment is likely most pronounced in countries that fail to spend their budgeted capital allocations in regular times. Underspending may also occur in certain per capita/formula/rule-based spending items because of social distancing and lockdowns, for example school meals (which many countries have counteracted with appropriate measures), utilities, and operational maintenance. Unavailability of supplies due to supply chain disruptions may further hamper government operations and spending. At the same time, arrears and contingent liabilities in the public sector would pile up when public entities start running out of 10 >>> THE FISCAL IMPACT AND POLICY RESPONSE TO COVID-19 > > > F I G U R E 2 - Budget Deviation in Capital Investments, 2009-2018 Average Source: BOOST Data >> I M M E D I AT E F I S C A L R E S P O N S E The overall response to the COVID-19 crisis will go through goals, both short term and long term. These aspects include phases as attention shifts from dealing with the immediate the efficiency of a specific instrument to achieve targeted crisis to getting back to a sustainable situation, which would objectives; cost and fiscal sustainability; flexibility to adjust to need to be more resilient than in the past: changing circumstances; and administrative feasibility (Box 1). • Phase 1: Immediate crisis response with an emphasis on providing adequate support for health care and supporting The relative weight of these aspects in countries’ choices businesses and households that are immediately affected will depend on circumstances. For example, countries with by health measures and the economic slowdown (see also solid fiscal buffers will be less constrained by costs. Similarly, below). countries with strong administrative capacity will be able to deploy more complex instruments than countries with limited • Phase 2: Recovery as the health situation stabilizes capacity. but the economy is yet to regain its footing. During this phase rolling back temporary measures in the initial response phase, This section focuses on fiscal responses in the first phases stepping up efforts to control cost and enforcement revenue of the crisis—immediate response. Section 5 adds thoughts on compliance, and implementing tax policy and expenditure second and third phases of the recovery. In the remainder of rationalization measures to restore revenue performance will this Section, we will discuss the various fiscal instruments that be key. are available for addressing the COVID-19 crisis, organized by revenue, expenditure, and credit and equity measures. • Phase 3: Resilience and sustainability—as the These instruments are assessed, based on the classification economic situation stabilizes, attention can turn to applying of aspects set out above. An overview of fiscal measures lessons from the crisis and the need for sustainability. planned and implemented across countries can be found in Appendix Table 2. The assessment of specific measures within the framework is presented in Appendix Table 3. The design of the fiscal responses to the COVID-19 pandemic can be assessed by considering specific aspects of individual fiscal instruments which help to understand the efficacy and efficiency of the responses in achieving their THE FISCAL IMPACT AND POLICY RESPONSE TO COVID-19 <<< 11 • Reversibility – the ease with which the response can be >>> BOX 1 - FRAMEWORK FOR ASSESSING FISCAL withdrawn, without causing economic and behavioral POLICY MEASURES IN RESPONSE TO COVID-19 distortions Fiscal policy measures in this note are assessed in a Feasibility. Measures may not have their intended effect framework that drives from the traditional timely-targeted- if they are difficult to implement because of administrative temporary model for assessing responses to crisis situations, constraints or impact is blunted by health measures, such as with a focus on the following aspects: social distancing and lockdowns. Efficiency. The efficiency of a specific fiscal instrument to • Administrative ease – the extent to which the instrument achieve particular objectives in a cost-effective way will be can be implemented within existing administrative influenced by: capabilities • Impacts of the pandemic and containment measures • Targetability – the extent to which the instrument allows – the COVID-19 pandemic has direct impacts on the to directly target specific business or population groups deployment of fiscal instruments. For example, scaling or activities up of health expenditure may be constrained by a lack • Speed – the time elapsed between the adoption of the of qualified personal; measures that involve human instrument and the desired impact contact (especially) in groups will be less desirable • Abuse resistance – the ease with which abuse by than instruments that limit such exposure; and scaling eligible beneficiaries and other parties involved with the up of consumption and investment may face supply measure can be controlled side constraints as suppliers and contractors may be in lockdown mode Cost and fiscal sustainability. Containing the cost of fiscal measures is another important aspect of the fiscal response. This will also involve consideration of costs and benefits of specific instruments and their interactions. For example, measures that aim at reducing lay-offs may generate benefits in terms of reduced unemployment and social security payments. • Affordability – the extent to which the use of the instrument impacts on fiscal stability. For example, instruments that provide support in the form of credits or through the deferral of payments will have lower cost implications than instruments in the form of outright grants and expenditure. • Predictability and control of cost – the extent to which upper limits for the cost of a program can be established and the actual cost reasonably well predicted. Flexibility. The high uncertainty regarding the duration of the pandemic and the intensity with which individual countries will be affected puts a premium on the flexibility with which an instrument can be deployed, including the ability to scale up the instrument or to stop its use as needed. • Scalability – the extent to which the instrument can be expanded or replicated for additional groups of beneficiaries in accordance with needs 12 >>> THE FISCAL IMPACT AND POLICY RESPONSE TO COVID-19 >>> REVENUE INSTRUMENTS some cases (Colombia, Korea, and Vietnam), the focus is on deferments for affected sectors (e.g., hospitality and Governments are implementing a range of tax measures aviation in Colombia). Korea has extended the due date for to address the short-term impact of the COVID-19 pandemic. income tax and VAT (both tax filing and payment) for up to 9 Measures under consideration aim to: (i) protect businesses months for affected businesses (tourism, restaurants, medical that see their cashflow and income jeopardized; (ii) provide clinics, art performance, wholesale and retailers in the area support to households and communities that are affected by where confirmed COVID-19 cases are present). Korea also measures to stem the spread of the COVID-19 virus and the suspended tax audit and any activities by tax authority to associated slowdown in economic activities, and to shore reduce outstanding tax arrears, by up to 1 year for affected up aggregate demand and consumption to moderate the business. Some countries (e.g., Austria and Costa Rica) have feedback loop between supply shocks and demand shocks. introduced temporary adjustments of advance payment rules Short-term relief measures packages are designed in terms that allow businesses to make advance payments for the CIT of tax rebates, exemptions, holidays or similar features with based on (downward adjusted) income expectations. And a direct impact on businesses and households and boost Canada has suspended client contacts for conducting audits. consumption. Measures also aim to manage longer-term Finally, speeding up of payments by revenue administrations effects, including on taxpayer compliance, business continuity, to taxpayers, such as VAT refunds, has the same effect as and fiscal sustainability. a tax deferral by enhancing taxpayers cashflow (e.g., in Australia, Bosnia and Hercegovina, China, Indonesia, Malta, The focus of revenue policy will shift over the phases of the and Thailand). crisis. During phase 1, the emphasis will be on ensuring that health care is available for those in need, providing relief to Assessment: Extended payment periods, payments in those affected most (e.g., through deferment of tax obligations installments provisions, and accelerated VAT refunds represent and cash transfers to vulnerable households) lowering useful temporary relief measures to keep taxpayers afloat advance payments), and keeping core government agencies during low profitable periods and cashflow constraints. To be operational, including revenue administrations. In phase 2, effective those need to be enacted using clear eligibility criteria rolling back the initial crisis measures, stepping up compliance under risk management. The fiscal cost of these measures enforcement, and implementing tax policy measures to can be contained by targeting affected businesses—which restore revenue performance will be key. There may be may not be feasible in all cases, especially if the economic windows of opportunity for strengthening taxes that benefit effect of the COVID-19 crisis becomes more widespread in the environment (e.g., fuel taxes) and health (e.g., taxes on EMDEs. tobacco, alcohol, and sugary drinks and food) or that reduce tax avoidance by multinational corporations (such as through An alternative approach focuses on advance CIT payments. a diverted profit rule). During stage 3, countries need to turn Typically, such advance payments are based on income for to lessons from the crisis—how to be better prepared for a the previous year. During a downturn, advance payments next adverse event and how to deepen the commitment to would be too high and cause a cashflow crunch because sustainability. A holistic and cross-country approach to green of the mismatch between (high) advance tax payments and taxes, a successful reform of the international tax system, and (lower) final liability. The fiscal impact of this measure is short a further reform of weaknesses in countries’ revenue systems lived; firms will be paying the full amount due for their CIT at would be the focus during this stage. the end of the fiscal year. >>> PROTECTING BUSINESSES Caution should be exercised with measures that may allow taxpayers to escape the tax net, such as suspension of audits • Deferral of tax obligations. and tax amnesties. Such measures risk hampering recovery of revenues in the aftermath of the crisis and would drive up Examples: A growing number of countries are deferring the fiscal cost in the short term. tax payments, including social contributions and even penalties, for businesses (e.g., Austria, Australia, Canada, Colombia, Ireland, Korea, Peru, Poland and Vietnam). In THE FISCAL IMPACT AND POLICY RESPONSE TO COVID-19 <<< 13 • Lower taxes for vulnerable businesses administration. Extending loss carry forward rules will support businesses in future years, when the tax relief becomes Examples: Vietnam is considering lowering the CIT rate operable. This may not provide immediate relief but may for SMEs from 20 to 15 percent for five years (2020-24). provide businesses with certainty that their losses during the This tax rate reduction would help this group of taxpayers crisis can be expensed against future tax payments. to have more financial resources to recover from the crisis. Korea has already implemented tax relief measures for small In order to support exporters, particularly SME exporters, to businesses. For instance, if landlords reduce rent for small stay resilient through tough economic times, it is important that businesses, 50% of reduced rents during the first semester of administrations aid in the reduction of trading costs affected by this year will be credited against income tax of landlords (tax taxes and customs duties. This can be tackled in a short-term credit measure). A two-year VAT cut is granted for individual period by granting: (i) a temporary zero rate policy to specific entrepreneurs with low annual turnover (VAT will be reduced tariff codes, (ii) limited or provisional tax/tariff exemptions to to the level of the simplified VAT regime for micro enterprises). relevant sectors; or (iii) by offering a more flexible deferral Countries are also allowing firms to accelerate depreciation or installment agreements for customs duties, etc. These of new investment (e.g., Australia, China, New Zealand, and mechanisms can help them to increase their international Singapore). competitiveness, face trade costs during global recession and to secure their participation within global value chains. Assessment: The impact on revenue of lowering the CIT rate for SMEs in Vietnam would be small. About 80 percent Tax incentives and holidays should be avoided to the extent of incorporated businesses fall below the threshold in those tend to decrease tax compliance levels in the mid/long Vietnam, and they contributed only about 4 percent of the terms. CIT revenue. The reduction of CIT rate would reduce the CIT revenue by about 1 percentage point. This reduction could >>> PROTECTING VULNERABLE HOUSEHOLDS be offset by phasing out the tax incentives for some sectors (in the aftermath of the crisis). But the measure risks creating Examples: Payments for Personal Income Tax (PIT) are some strategic sorting around the threshold and in general deferred in Indonesia (for low-income earners) and Iran. a reduction of rates is difficult to target and reverse after the Also, in mostly OECD countries, government are introducing crisis. cuts in social security contributions (e.g., Germany, Italy, Malaysia, Portugal, and Slovak Republic). These cuts may Reduction of compliance costs through simplification of tax bring substantial relief and disposable income to workers. This obligations, especially for SMEs, has widely proven to be an is expected to help companies retain workers and support effective way to increase compliance levels. During periods consumption and economic growth. of economic distress and increased non-compliance risks, tax simplification becomes particularly relevant, opening Assessment: Well-targeted tax credits and lower taxes for opportunities for tax authorities to embark on serious efforts specific vulnerable groups can provide cost-effective relief to identify complete set of regulations imposing higher quickly. But targeting tax relief measures to affected and compliance costs to taxpayers, and to prepare ad-hoc reforms vulnerable households is often challenging in EMDE contexts. aimed to tackle simplification objectives to be implemented during distressed times. Accelerated or immediate expense of fixed assets is an appropriate policy tool for providing tax relief to adversely affected taxpayers. It can also provide an incentive for bringing forward investments needed in critical economic sectors – such as health providers or pharmaceutical firms (China allows accelerated depreciation for medical firms). To be used as temporary mitigation measures those need to be designed within well-defined tax periods; using simple eligibility criteria; and closely monitored by a special task group within the tax 14 >>> THE FISCAL IMPACT AND POLICY RESPONSE TO COVID-19 >>> BOOSTING CONSUMPTION for scaling up funding, in light of fiscal space constraints, existing budget rigidities and implementation capacity. A Examples: Temporary reductions in VAT rates and other large number of developing countries simply lack the fiscal indirect taxes have been implemented in a number of space to accommodate a meaningful policy response, either countries, often focused on affected sectors such as aviation because of the effect of decreasing commodity prices and and tourism (e.g., China, Cyprus, Korea, and Norway). depleted fiscal buffers (Nigeria, Angola, Gabon), for being Korea introduced a suspension of the 70% excise tax for car on a fiscal consolidation path with little room for increased purchases during Mar-Jun 2020 to promote consumption of spending (Panama) or constrained by adherence to fiscal (in the case of Korea) largely domestically produced cars. In and/or constitutional rules (Azerbaijan, Brazil). Scaling up addition, Korea reduced the VAT payable by small businesses funding might also prove challenging in countries with low with turnover below KRW 60 million until the end of 2021. absorptive capacity and historical under-execution of budgets, as well as in those with low systems’ ability to quickly disburse Assessment: Reversing the lowering of tax rates may be funds where needed, requiring a tailored, approach based on difficult, especially if recovery after the crisis is slow, which countries’ initial conditions and PFM systems quality. would drive up the fiscal cost. The effect on consumption of such measures is also in doubt. Even with more money There is an important lesson to be learned from current and available, people may not be spending it during the COVID-19 past crisis around the long-term benefit of helping promote for precautionary reasons or because businesses are shut better fiscal preparedness in light of recurrent nature of these down and movement of people restricted. events (pandemic or natural disasters). Most low-income countries lack the appropriate financing instruments to cope >>> EXPENDITURES INSTRUMENTS with emergencies of this magnitude - such as contingent credit lines and emergency insurance schemes2, that could help The COVID-19 pandemic constitutes a serious challenge create immediate fiscal space as opposed to relying mostly for WBG client countries, particularly those with weak health on limited supplementary budgets or foreign assistance. As and social protection systems and feeble response capacities recent medical emergencies (cholera outburst) in Zambia3 overall. Governments will have to reprioritize development, demonstrated, budget rigidities might slow the process of service delivery and administrative activities, while creating extra funding allocation, undermining the pace and operational fiscal space in an environment of tight constraints and global efficiency of health providers’ response, while placing the supply shocks. entire burden on foreign assistance to fill the financing gap. During the first phase of the crisis, the fiscal policy response Assessment: It will be important to leverage the current aims at: (i) funding of the health sector response, including crisis as a catalyst for developing countries to develop increases in staffing, facilities, and supplies and materials adequate financing strategies to enhance their preparedness such as test kits and ventilators, as well as complementary vis-a-vis the recurrent nature of disaster or pandemic-related public health measures such as public information campaigns; contingent liabilities. In this respect, wider applications in (ii) protecting people from the economic fall-out of measures DPOs of Catastrophe Deferred Drawdown Options (Cat-DDO) to contain the pandemic (such as social distancing and or projects’ Contingent Emergency Response Component lockdowns), which lead to a slowdown in economic activity, (CERC) offer convenient avenues to developing countries for employment, and income; (iii) supporting the survival of quick and inexpensive access to funding, as currently taking businesses that face severe drops in activity and prevent lay- place in Romania and Kenya (CAT-DDO) and Angola (CERC) off through measures such as subsidies; and (iv) containing among others. recessionary pressures through countercyclical spending. >>> EXPANSIONARY FISCAL POLICY IN A TIGHT FISCAL ENVIRONMENT Expenditure reprioritization and new resource mobilization towards affected sectors across the developing world will be challenging. A key challenge is national readiness THE FISCAL IMPACT AND POLICY RESPONSE TO COVID-19 <<< 15 >>> INCREASED FUNDING OF THE HEALTH SECTOR should prioritize their procurement in order to enhance value for money considerations of total sector spending, ensuring Countries around the world are designing or already proper protocols and rules are in place and followed, while implementing expansionary fiscal policies to counter the maximizing efficiency (for instance through joint procurement economic and social impact of the COVID-19 pandemic. contracts). Good targeting also requires that a full costing Significant resources are allocated to strengthen health strategy has been put in place, using available instruments systems in terms of both containment and mitigation such as recent guidelines issued by WHO.5 preparedness, beyond existing basic prevention measures. In Italy alone, over 3.5 billion euros have already been allocated Ensure equitable access to facilities and medical services. to fund extraordinary hires (including bringing back retirees) Governments should to the extent possible subsidize full along with allowances and overtime, replenish the Health provision of basic prevention tools and testing which “must Emergency Fund, purchase medical devices and products be the backbone of the response in every country” (WHO) as - including by subsidizing loans or via direct contributions well as unrestrained access to medical facilities. In countries to companies producing surgical masks- and increase with high degree of private health spending, this would imply hospital beds and intensive therapy spaces, including the enhanced targeting of public financing to cover the costs of possibility of requisitioning movable property or hotels to COVID-19 related healthcare for the needy to ensure universal face the emergency. In anticipation of similar manifestations access to medical services. Focused investments in mobile across the developing world, various contingency plans are testing facilities may be desirable from both efficiency (not currently being developed in collaboration with development overloading the already strained health system) and equity partners to enhance preparedness for a full-scale epidemic perspectives, particularly to assist poorer or rural communities beyond existing prevention measures. In Nigeria for example, where medical facilities are typically ill equipped to attend the government is considering a supplementary budget that even to basic necessities. reflects funding needed for the health sector in case of a severe epidemic scenario. In some countries such as Gabon Mitigate undue diversion of resources. Re-allocation of and Cameroon, the governments have already created a health resources should not come at the expense of important fund to help and assist its citizens living abroad in case of treatments in other medical areas. Early evidence from China emergency. In Myanmar, Tajikistan and other countries, – where 42,000 doctors and nurses were sent to Wuhan to contingency plans have been fully elaborated, incorporating combat the outbreak – pointed to a sudden deterioration and funding needs towards procurement of medical supplies and de-prioritization of access to other ongoing health services equipment, training, surge capacity for service delivery and such as maternal and child care, HIV and TB treatments. outreach activities. Recognizing the likelihood of such disruption, backup plans should be elaborated, including incentivizing (through tax or Assessment: While increasing allocations to strengthen expenditure subsidies) private care givers to absorb influx of health systems is a necessary and most needed measure in non-urgent patients during the crisis. the short term to help mitigate the crisis, it is important that due considerations be applied to ensure these measures Encourage investments in country capacity and systems for are efficient, equitable, evidence-based, cost effective and long term preparedness. Historically, insufficient expenditure minimize disruptions. This includes paying close attention mobilization efforts have been devoted towards building to the following aspects, tailored to each country’s needs, adequate capacity and resilience in developing countries’ dynamics and initial conditions: health systems to cope with pandemics as these measures are systematically penalized in budget allocations in favor of more Target resources towards most under-funded areas. Limited direct and ‘visible’ interventions. Past health crises such as fiscal resources require efficient priority setting processes to Ebola, SARS and MERS witnessed a sudden upsurge of donor maximize their cost-effectiveness. For instance, in countries funding to neutralize the problem as opposed to investing in like Namibia where the majority of funding is devoted to finance long term preparedness to build permanent capacity against hospital care and relatively little for prevention (PER 2019), such risks. Proper incentives can be embedded in fiscal policy fiscal policy measures should prioritize investment in primary measures to incentivize countries to make needed capital care centers and related preventative measures. Similarly, investments to close preparedness gaps, establish/strengthen countries with chronical under-funding in medical supplies regional health institutions (such as Africa CDC) for effective 5. https://www.who.int/docs/default-source/coronaviruse/covid-19-sprp-unct-guidelines.pdf 16 >>> THE FISCAL IMPACT AND POLICY RESPONSE TO COVID-19 coordination and support diversification of appropriate these interventions. While part of these interventions should financing instruments that could help create immediate fiscal be considered temporary with subsequent reduction of hiring space in case of emergencies. surge after the epidemic wanes, it would be suitable for some structural interventions to become permanent particularly in Reversibility vs. permanent investments. While the absolute low income countries where on budget health spending has priority in the short term is to reinforce the health care system been historically low before the crisis, accounting on average with more human resources, equipment and hospital beds, for less than 1.5% of GDP. due considerations should be given to the term structure of > > > > > > F I G U R E 3 - Spending in Health is Low and Decreasing F I G U R E 4 - Spending in Health, 2009-2018 Average in Low-Income Countries Understand the inter-connectedness of health investments a significant influx of funds. Similarly, multiple administrative with other interventions. Mitigation of the health crisis by layers between the central government and health facilities “flattening the curve” goes beyond direct spending in health might slow down the provision of additional funds in addition systems. A critical component hinges on the success in to being vulnerable to leakages without proper procurement promoting desired behavioral change of global population via rules and protocols and in absence of robust monitoring and social distancing, which needs to be properly incentivized. commitment controls. Furthermore, countries with strict line While many countries have implemented measures – such as item monitoring might lack the flexibility needed to adapt direct cash transfers, employment and wage compensation to changing circumstances effectively reducing overall subsidies, and deferrals (loan payments and in some cases operational efficiency of service providers. In short, it will be utilities) - to provide short term relief to economic hardships, important for domestic and international constituencies to pay further ‘creative’ measures should be considered to incentivize close attention to existing PFM arrangements to maximize desired behavioral change of people staying home. In this accountability and value for money considerations for the respect, some countries have already introduced measures expected inflow of funds, particularly in countries with poor such as subsidized/free entertainment-related streaming quality of their financial management systems. services which carry limited fiscal implications given their time bound nature.6 Account for quality of PFM systems. Public financial management challenges can significantly affect the effectiveness of emergency funds during implementation. Historically, the health sector has exhibited some of the largest under-execution rates for low and lower middle-income countries – equivalent on average to over 0.2% of GDP or 5% of original allocations over the past decade (BOOST data) - questioning the absorptive capacity of the sector vis-a-vis 6. The private sector has also contributed towards this outcome by subsidizing home deliveries of groceries and food. THE FISCAL IMPACT AND POLICY RESPONSE TO COVID-19 <<< 17 > > > F I G U R E 5 - Under-Execution Across Main Sectors, 2009-18, % GDP >>> SAFETY NETS, EMPLOYMENT SUBSITY AND especially for vulnerable groups. In Austria and Denmark, BUSINESS SUPPORT SCHEMES temporary wage compensation measures were introduced to benefit employers who grant special leave or otherwise pledge The unprecedented, multi-faceted, disruptive nature of the to retain their workers despite experiencing financial losses pandemic undermines the feasibility of implementing traditional due to decreased demand, covering up to 75% of full salary. In fiscal policy measures when introduced in isolation. Instead this Italy, a comprehensive 25 billion Euro package of fiscal policy requires comprehensive packages that complement resources measures has been introduced targeting wage compensation allocated to health systems with proper enablers to mitigate the schemes, cash transfers and allowances, employment economic impact in terms of income and productivity losses benefits, one off firm subsidy for sanitation, alongside various while encouraging desired behavioral change. With effects of tax relief measures and regulatory measures (special leaves, demand-side fiscal policies in the form of credits, transfers or suspension of dismissals, etc.). In this respect, some allowances likely constrained by the current environment of developing countries have already designed contingency ‘social distancing’ and restrictions, more effective measures plans along similar lines. For instance, Cambodia recently require a combination of basic social safety nets strengthening introduced a $2 billion package to support tourism businesses along with support mechanisms aimed at mitigating further while pledging to pay wages of workers affected by factory economic disruption by incentivizing private sector in retaining suspension. employees and enduring the financial impact caused by the pandemic through a variety of wage compensation, loan Similarly, much like during the global financial crisis, an subsidies and deferrals and advance payment schemes, as important role for fiscal policy is to prevent loss of productive introduced in most developed countries. capacity due to potential bankruptcy of firms that would have been financially viable without the pandemic, particularly In this context, social safety nets will need to be SMEs. This is particularly compelling in some of the sectors that strengthened in order to mitigate the impact of the crisis on have been most affected by the crisis, including transportation the most vulnerable. Some countries have already introduced and hospitality, but also include cascading effects from trade a vast array of fiscal policy measures to counter the income disruption affecting supply chains globally. While the full effect of the crisis, in the form of credits for businesses extent of the economic pain will largely be dictated by the affected by the pandemic, wage compensation measures and future trajectory of the pandemic, it is reasonable to expect direct transfers. For instance, China and South Korea have a wave of request for bailouts from most affected industries – expanded and extended both cash and in-kind transfers, potentially even leading to temporary government ownership 18 >>> THE FISCAL IMPACT AND POLICY RESPONSE TO COVID-19 of critical industries as witnessed during the global financial Reversibility vs permanent changes – The risk of public crisis – including from SOEs operating in affected sectors expectation and political pressure to keep measures in place such as airlines. In this context, it is important for governments for longer than needed is non-trivial as often witnessed with to undertake proper fiscal risk analysis and scenario planning introduction of new tax incentive schemes in the developing while designing fiscal policies aimed at mitigating the world. While the priority in the short term is to mitigate at all cost economically disruptive impact of current restrictions. A good the economic impact of the pandemic, the majority of these example is the set of measures implemented in China to interventions should be considered temporary with clear and support SMEs in affected areas via a combination of deferrals transparent rules - including sunset clauses where applicable of loan payments and reduction of social security contributions. - established for their removal once pre-crisis economic levels are restored. Countries however might want to leverage the Assessment: These measures are important not only to current drive for reform to introduce permanent structural provide temporary economic relief to firms and individuals interventions to improve prospects of long-term growth such hit by the crisis to mitigate long term financial impact of the us for instance regulatory simplifications to ease the cost of pandemic but also to encourage the behavioral change doing business and investing in robust and resilient social required to mitigate spread of the virus, i.e. incentivizing safety nets to become more effective automatic stabilizers to individuals in staying home without risking losing their jobs/ help reduce procyclicality in fiscal policy of many developing income. Proper implementation of these relief schemes should countries. incorporate at a minimum the following considerations: Equity and efficiency – When compared to bailout packages > > > and broader corporate support schemes, unconditional direct F I G U R E 6 - Social Protection by Income Categories, % cash transfers to households provide the most equitable and GDP efficient channel to support distressed families and restart the economy. Bailout packages on the other hand not only raise the issue of discretion of identifying which industry or segment to be rescued but also carries widespread perception of not sufficiently benefiting ordinary people, as historically these benefits have not typically trickled down to employees and/ or consumers. >>> PURSUING OTHER EXPANSIONARY EXPENDITURE POLICIES WITH HIGH FISCAL MULTIPLIERS A growing literature recognizes that fiscal multipliers are Targeting and vulnerability to abuse - Effective implementation much higher during economic downturns than during normal of these policies requires strong administrative capacity in times (Auerbach & Gorodnichenko, 2013; Blanchard & Leigh, targeting proper beneficiaries – particularly when equity 2013b). The persistence of stimuli furthermore depends on considerations are built into these transfers - which in turn the type of spending: government consumption may only help depends on the quality of existing social protection systems, buffer current distress whereas government investment may business registration, and tax administration systems, which also raise the longer-term growth potential (Alichi et al., 2019; are typically weak in most low-income countries. Balancing Coenen et al., 2012). beneficiary validation with the need for timely disbursements and fraud prevention will likely imply a certain degree of risk to Economic crises often create a window of opportunity for be borne, particularly in countries with weak PFM systems, low economic reforms. In addition to encouraging investments quality of governance, and low transparency and accountability in country capacity and health systems for long term arrangements. Furthermore, in case of corporate support preparedness, one such opportunity revolves around green schemes, in addition to identify industries to be supported public investments in renewables, climate adaptation, clean on the basis of their criticality, governments should take clear water systems or public green transport as these would not actions to ensure that most of the subsidies trickle down to only serve as catalyst for restarting the economy but also tilt their employees as opposed to funding buybacks and other it towards green growth. A related opportunity would envision corporate needs. removing fossil fuel subsidies, as the effect of their removal THE FISCAL IMPACT AND POLICY RESPONSE TO COVID-19 <<< 19 – and particularly the elimination of ceilings – would not be felt in the current low-price environment. These mechanisms are widely used in developing countries to buffer the domestic economy against hikes in global fuel prices but also discourage investments in energy efficiency and tend to turn into a significant drag on public finances during price booms. Their removal would help improve future fiscal space along with a large built-in source of procyclicality in the fiscal policy of many developing countries. Section 5.4 further elaborates likely pathways for tilting the economic recovery green. >>> CREDIT AND EQUITY INSTRUMENTS Given the temporary nature of crises impact, countries may use credit instruments to help businesses. For example, Germany has announced that businesses will receive credit (through KfW). An initially Euro 20 billion has been allocated with guarantees up to Euro 500 billion (in comparison, during the global financial crisis,7 about Euro 200 billion were used). In addition to direct credit, countries are also working with their financial sectors on measures to defer debt service payments. In past crises, countries have also deployed equity instruments to prevent the closing or foreign takeover of businesses that are considered of strategic importance or national interest. During the global financial crisis, the automotive and financial sectors of several countries were supported by governments taking equity positions during the crisis, which were sold to investors once the businesses had stabilized and the economy recovered. In many cases, these equity interventions actually had high financial returns for governments, as their stakes in these enterprises could be sold at higher prices than what they were bought for during the crisis. > > > A S S E S S I N G T H E F I S C A L P O L I C Y RESPONSES Table 1 provides a summary classification of fiscal policy instruments described in the previous sections, related to expenditure, revenue, and credit/equity, by the key characteristics identified at the start of Section 4: efficiency, cost and fiscal sustainability, flexibility, and feasibility. This table is detailed by fiscal policy measure in Appendix Table 3. 7. Compared to the global financial crisis, lower perception of moral hazard may reduce political resistance to support of the financial sector and large companies. 20 >>> THE FISCAL IMPACT AND POLICY RESPONSE TO COVID-19 > > > T A B L E 1 - Classification of Fiscal Policy Instruments REVENUE INSTRUMENTS EXPENDITURE INSTRUMENTS CREDIT/EQUITY INSTRUMENTS Automatic targeting of corporate and income taxes. Tax incentives In principle most expenditure can be targeted to specific sectors instruments are amenable to targeting Similar to expenditure instrument and industries. For indirect taxes by location, sector etc. In practice, TARGETABILITY with the added advantage that targeting is more difficult. Loss targetability will depend on quality beneficiaries will self-select. making entities with no income tax of existing social protection systems, liabilities will also not benefit from business registration, etc. revenue measures. Temporary reductions in tax rates for Subsidies, cash transfers, and scale EFFI- indirect taxes can have immediate Funds can be made available up of recurrent spending will have effect, though potential problems relatively quickly but will depend on CIENCY SPEED immediate effect. Capital investments with pass through, especially for administrative capacity to correctly will have longer gestation and more complex taxes. Direct taxes will target the spending. implementation periods. have impacts based on tax calendars. Will depend on governance Depends on quality of governance Scope for abuse more limited as environment and strength of tax environment, risks of abuse of assessment creditworthiness and ABUSE RESIS- administration. Risk that tax subsidies and transfers, inefficiencies repayment will be required. However, incentives and exemptions are used TANCE in the use of increases in operations in weak governance environments fraudulently. Indirect tax measures and maintenance spending, and credit instruments will also be open less prone to abuse, but risk of erosion corruption in investment spending. to abuse. of tax morale. Potential to recover credits and COST AFFORDABILITY Full cost. Full cost. equity participations after crisis. AND Upper limits of expenditure can FISCAL be established to reduce risk of Upper limits can be established, PREDICTABILITY overspending. Use of increases though actual usage more uncertain SUS- Less predictably, given that a range AND CONTROL OF in spending on operations and than for expenditure instruments of factors will affect revenue impact. TAIN- maintenance and investment will as access depends on business and TOTAL COST ABILITY be subject to absorptive capacity household decisions. constraints. Most expenditure instruments easily scalable as government can choose SCALABILITY Limited by level of tax liability. the level of support and investment, Similar to expenditure instruments. but implementation/ PFM weaknesses can be a critical obstacle. FLEX- Recurrent expenditure increases more IBILITY Tax measures can have explicit time easily reversible than investment Credit programs are relatively easy expenditure, which will also have limits, but risk of undermining tax to stop when no longer needed, but REVERSIBILITY recurrent cost implications. Risk moral and political pressure to keep also risk of political pressure to keep of public expectation and political measures in place. them in place. pressure to keep measures in place for longer than needed. Broad based adjustments to rates and tax schedules that are within the The use of targeted transfers will ADMINISTRATIVE regular work of a tax administration require that adequate systems are in Will require significant capacity to may be feasible in many countries. place. Quality of public expenditure assess needs, creditworthiness, and COMPLEXITY New tax measures or specifically and investment systems will impact repayment capacity. targeted tax measures will be more on quality of spending. complex and require higher capacity. Efforts to control the health effect of COVID-19 would mute the FEASI- impact of revenue measures to Expenditure measures would be hampered to the extent that health BILITY the extent that they depend on measures impede the functioning face-to-face interaction between RESILIENCE TO of government agencies and taxpayers and revenue officials and implementation depends on face-to- Unlikely to be strongly affected by HEALTH MEA- revenue administrations struggle face interaction. Spending measures health measures. with business continuity. Revenue SURES aimed at protecting livelihoods and measures aimed at protecting supporting demand in affected sectors livelihoods and supporting demand in would be ineffective to the extent affected sectors would be ineffective health measures constrain behavior. to the extent health measures constrain behavior. THE FISCAL IMPACT AND POLICY RESPONSE TO COVID-19 <<< 21 >>> ASSESSING C O U N T RY increased expenditure requirements or reduced revenue. C I R C U M S TA N C E S : FISCAL SPACE Available fiscal reserves, capacity to adjust expenditures, AND CAPABILITY and access to loanable funds would be key elements of fiscal space. Following the earlier discussion of fiscal impact of and response to the COVID-19 pandemic, this sub-section Aside from fiscal space, countries’ and governments adds granularity by discussing country characteristics and capability to design and implement fiscal responses to an how these map to the choice of instruments. The most external shock will also affect the choice of instruments. In a fundamental determinants for the choice of instruments will broad sense, capability includes both the technical capacity be the available fiscal space and the capability of the state to implement particular fiscal measures and the institutional to design and implement specific fiscal interventions. In and political arrangements which may either facilitate or addition, the economic and fiscal structure of a country will hinder an adequate fiscal response. Capabilities of particular also influence the specific economic and fiscal impact of the subsystems will be of particular importance when specific COVIDd-19 pandemic and also shape the set of appropriate measures are being considered, including capabilities of a and feasible responses. This sub-section discusses how these country’s Ministry of Finance, revenue administration, and factors impact on the efficacy of fiscal instruments to respond social protection systems. Broader capabilities relating to to the pandemic and its economic impacts. It also shows the the quality of policy coordination and government decision variation across countries with respect to these factors, which processes will also be important. can serve to group countries into categories to facilitate the choice of fiscal instruments that is well aligned with specific These two broad sets of characteristics are key parameters country circumstances. for countries’ choices of fiscal strategies and instruments to confront the COVID-19 pandemic and its economic impacts. An effective use of fiscal measures in response to the impacts Dividing countries into those with lower or higher fiscal space of the COVID-19 pandemic requires that governments have and lower or higher government capability gives us four types the capability to design and implement quickly appropriate of countries. Table 2 shows the key elements of feasible fiscal fiscal policies and that they have sufficient fiscal space to strategies, which maps to the discussion and assessment of adopt measures on the needed scale. While countries with fiscal instruments in the previous section. high capability and fiscal space will be able to choose from the whole menu of reforms, for countries which have lower capability or lower fiscal space the set of available options will be much more limited and specific measures to deal with capability or fiscal space constraints may be needed. Fiscal space has already been narrowing prior to the onset of the COVID-19 pandemic. Kose et al (2019) define fiscal space as “the availability of budgetary resources for a government to service its financial obligations.” They discuss various concepts of fiscal sustainability and related indicators, which they group into four clusters, namely debt sustainability, balance sheet vulnerability, external and private sector debt related risks as potential causes of contingent liabilities, and market access. They also show that most countries had expanded their fiscal space prior to the global financial crisis in 2007/08, which facilitated the adoption of strong countercyclical measures. By 2019, fiscal space of many countries had eroded, leaving countries in a much weaker position to deal with an external shock before the outbreak of the Covid-19 pandemic. The massive build-up of private and public debt that took place during the last decade played an important role in narrowing fiscal space (Kose et al 2020). In the context of dealing with an external shock, fiscal space relates the ability to deal with 22 >>> THE FISCAL IMPACT AND POLICY RESPONSE TO COVID-19 > > > T A B L E 2 - Fiscal Strategies to Address COVID-19 Impacts Aligned with Country Capability and Fiscal Space LOWER CAPABILITY HIGHER CAPABILITY • Seek fiscal instruments that are most suitable to the specific country MORE FISCAL SPACE • Focus on less complex fiscal measures circumstances, including economic and fiscal structure • Focus on interventions where cost control is manageable and that are easily • Focus on cost control and reversable reversible with limited capability measures LESS FISCAL SPACE • Focus on less complex fiscal interventions • Clear prioritization of objectives • Clear prioritization of objectives • Seek to expand fiscal space • Seek to expand fiscal space For countries with limited space, focusing on interventions pandemic, for most countries higher health expenditure and with more limited cost implications that are easily reversible disrupted economic activity will result in higher fiscal deficits. will be particularly important. Credit instruments such We thus use a country’s risk of debt distress as the primary as tax deferrals and short-term loans may be particularly indicator of fiscal space, where higher risk of debt distress appropriate. Less fiscal space will also force countries to set will typically imply more limited access to and higher cost of clear priorities. In most cases, health interventions will clearly loanable funds. We group countries into three categories – have the highest priority, followed by interventions to protect those with high risk of or in debt distress, those at medium people and businesses. risk, and those at low risk. To categorize countries according to state capability, we use a country’s overall policy and Expanding fiscal space will also be important for countries institutional assessment (CPIA) rating.8 We divide countries with limited fiscal space. Limited access to funding from into two groups – those with better capabilities which have a reserves or from borrowing will force countries to seek to CPIA above the median and those with weaker capabilities – reallocate funds towards COVID-19 priorities. However, the with a CPIA below the median. disruption of programs from which resources are allocated away can have significant economic cost in terms of delayed Using these two categories simultaneously allows us to development. For developing countries, development partners classify countries into six categories ranging from countries will also have an important role in expanding fiscal space, be it with very little fiscal space and lower capacity to those with through increased development assistance, debt forgiveness wider fiscal space and higher capabilities (Table 3).Table 3 or deferral of debt service payments, or reprioritization within categorizes all IDA countries according to their fiscal space existing programs of support. and their capability for policy design and implementation. The two categories are not independent. Unsurprisingly, countries Limited state capability imposes a different set of constraints with higher capabilities tend to have more fiscal space while on the implementation of fiscal measures. The scope for countries with lower capabilities have less fiscal space, putting increasing such capacity in the short term will be very limited. them into a particularly precarious situation in confronting the However, using non-state actors in the response, especially COVID-19 pandemic. CSOs, faith-based organizations, or the private sector may help to broaden capabilities and the set of interventions that The categorization in Table 3 is illustrative. Country teams can be used. Otherwise, the focus will need to be on the will be best placed to assess into which quadrant their country selection of instruments that are administratively less complex falls, using additional information on fiscal space and state and that are within the capability of countries. capability. Appendix 1 provides further guidance on the types of contextual factors, such as public financial management, To illustrate which IDA countries might fall into which revenue structure and performance, and economic structure category, we use two specific measures of fiscal space and could be taken into account when assessing the fit of fiscal state capability. Given the massive impact of the Covid-19 policy instruments for country circumstances. 8. Using the rating of CPIA Cluster D - Public sector management and institutions – yields broadly similar groups, but we thought that the broader assessment, which also includes the assessment of social protection systems, provides a better assessment of broad state capability. THE FISCAL IMPACT AND POLICY RESPONSE TO COVID-19 <<< 23 > > > T A B L E 3 - State Capability and Fiscal Space RISK OF DEBT DISTRESS HIGH OR IN DEBT DISTRESS MODERATE LOW Honduras, Nicaragua, Dominica, Guyana, Bhutan, Cambodia, Mauritania, Samoa, Tonga, Benin, Ethiopia, Kenya, Nepal, Cameroon, Cabo Verde, Madagascar, Mali, Niger, Togo, ABOVE MEDIAN Grenada, St. Vincent & the Burkina Faso, Vanuatu, Kyrgyz Ghana, Cote d’Ivoire, Lesotho, Grenadines Rwanda, Senegal, Tanzania, Republic, Fiji, St. Lucia Uganda, Zambia, Moldova, Uzbekistan, Kosovo CPIA Haiti, Yemen, Afghanistan, Burundi, Central African Maldives, Comoros, DRC, Guinea- Republic, Chad, The Gambia, Bissau, Guinea, Liberia, Malawi, Bangladesh, Myanmar, Lao PDR, BELOW MEDIAN Mozambique, Sierra Leone, Solomon Islands, Papua New Djibouti, Congo South Sudan, Zimbabwe, Guinea Kiribati, Marshall Islands, Micronesia, Tuvalu, Tajikistan > > E N S U R I N G F I S C A L S U S TA I N A B I L I T Y A N D S U P P O RT I N G EC O N O M I C R EC OV E RY While the immediate focus of the response to the COVID-19 where government covers part of the salaries of temporarily pandemic is to manage the health impacts and soften the underemployed workers and reduces or postpones social economic impact on households and businesses, it is also security payments. For businesses, interventions include the important to look beyond the immediate impacts of the crisis establishment of credit facilities to help overcome liquidity with a view towards long-term fiscal sustainability and economic shortages, sector specific subsidies to offset significant losses recovery. Given that the COVID-19 pandemic has triggered of revenue, and also government’s equity participation in sharp drops in stock markets around the world and parallel businesses that are considered to be of systemic importance developments in the oil markets, attention to these issues is to the economy (during the global financial crisis, several even more important. In the following we discuss such broader countries took equity stakes in their automotive and financial elements which include preventing structural damages to the sectors to prevent long term damages to their economies.) economy, ensuring long-term fiscal sustainability, and taking Broader countercyclical measures to stimulate demand will action to foster economic recovery and sustained economic also be of importance to accelerate economic recovery and growth. At the same time, the current crisis may also be a ensure that impacts on households and businesses remain window of opportunity to embrace reforms that would not only temporary. support fiscal sustainability and economic recovery, but also accelerate the transition toward lower carbon emissions and > > > F I S C A L S U S TA I N A B I L I T Y enhanced resilience as well as effective taxation of the digital economy. Fiscal policy measures to deal with the COVID-19 pandemic and its economic fallout need to be taken with the importance >>> PREVENTING STRUCTURAL of long-term fiscal sustainability in mind. This will impact on DAMAGE TO THE ECONOMY the type and scale of feasible response, but also the need for external support. Countries which have adequate fiscal buf- Temporary measures to contain the COVID-19 pandemic are fers before the crisis are of course in a much stronger position resulting in significantly reduced demand for many sectors and than those that entered the crisis with higher fiscal deficits or reduced demand for labor. If this results in significant business higher levels of public debt. Cost, long-term fiscal implica- closures and unemployment, this may be difficult to reverse tions, and reversibility of measures will directly impact on long- once the temporary impacts of the COVID-19 pandemic pass. term fiscal sustainability. Measures to prevent unemployment and business closures are thus high on the agenda of many countries. With regard to preventing lay-offs and unemployment this includes measures 24 >>> THE FISCAL IMPACT AND POLICY RESPONSE TO COVID-19 From this perspective, measures that are in the form of credits the regime for resolving insolvency, facilitating employment, and guarantees rather than in the form of outright grants and and access to credit. subsidies are attractive. They hold the prospect of repayment once businesses and households recover. On the revenue >>> PAT H W AY S TO T I LT I N G THE side, tax deferrals may be preferable to outright tax exemptions. EC O N O M I C R EC OV E RY G R E E N Similarly, temporary equity participation instead of subsidies may also be appropriate, requiring, however, a credible As policymakers design and implement large stimulus commitment to disinvest once the economic situation has packages and policy measures aimed at economic stabilization improved and adequate governance arrangements to protect and recovery, pathways to green and lower carbon economic businesses from excessive government interference. growth need to be considered. The scale of stimulus programs being unveiled, $5 trillion in pledges by the G20, will have Measures that have limited long-term fiscal implications and long lasting impacts on the economic structure of the world that are easily reversible also help to reduce risks to fiscal economy, and this is a critical moment to shift to low carbon, sustainability. For example, infrastructure investment projects sustainable growth. In a context of limited fiscal space in typically have long gestation and construction periods, which many countries, key policy measures can be supported by may well exceed the time when economies will have recovered. environmental tax reforms. In addition, they also have recurrent cost implications that would add to the fiscal burden. Other measures such as targeted Stimulus measures are helped by fiscal multipliers that are subsidies that are clearly identified as being temporary will be much higher during economic downturns than during normal easier to reverse. However, measures may also differ with times (Auerbach & Gorodnichenko, 2013; Blanchard & Leigh, regard to the political feasibility of reversing them, as there 2013b). The effectiveness of stimuli furthermore depends on will often be strong pressured to keep temporary measures in the type of spending: government consumption may only help place indefinitely. buffer current distress, whereas government investment may also raise the longer-term growth potential (Alichi et al., 2019; Sustaining fiscal sustainability in the context of (temporary) Coenen et al., 2012). reduced fiscal balances should also include reviewing the scope for medium to long-term measures to enhance revenue Providing a stimulus to the economy and taking action on and rationalize expenditure. Not only will this important for climate change do not stand in opposition to each other. Large fiscal stabilization after the crisis, but also to support the stimulus packages will inevitably influence the trajectory of strengthening of buffers to be able to confront the next crisis. economic activity, and instead of reproducing the same type of Debt sustainability analysis will continue to play a central role growth and economic structure as in the past, well-designed in the assessment of the scope of debt financing, including a stimulus packages that give priority to ‘green spending’ can focus on debt transparency. help to stabilize aggregate demand in the short- and medium- term and yield large positive economic returns in the long run For low income-countries with limited fiscal buffers, external (see Box 2 for an assessment of green stimulus packages support will often be critical. Such support would allow the in response to the 2008/9 financial crisis). Green investment adoption of a minimum set of measures without jeopardizing spending has the following desirable characteristics: fiscal and macro-economic sustainability. • Triggers additional spending from the private sector, with STRUCTURAL >>> REFORM FOR a large associated multiplier effect. RESUMPTION OF S U S TA I N E D • Results in long-term climate benefits, such as a reduction ECONOMIC GROWTH in future energy consumption, lower pollution and low- carbon development. Fiscal sustainability will also depend on the trajectory of the • Boosts resilience, with investments that are climate smart. recovery and economic growth beyond the crisis period. Policy • Avoids lock-in effects that make it excessively costly to reforms that enhance countries’ international competitiveness switch to more efficient or cleaner technology pathways or should thus be an integral part of efforts to stem the crisis development patterns in the medium and long term. impacts. Reforms will need to be country specific, but “stroke • Compensates tax-payers implicitly in the form of of the pen reforms” that can be implemented quickly may be of decreased expenses on energy and lower costs of abating particular importance, especially in the areas of streamlining GHG emissions in the future. regulation to reduce the burden on businesses, strengthening THE FISCAL IMPACT AND POLICY RESPONSE TO COVID-19 <<< 25 While the ‘clean energy’ stimulus was the subject of much >>> BOX 2 - ASSESSING GREEN STIMULUS attention there have been few evaluations of the performance PROGRAMS IMPLEMENTED DURING THE 2008/9 of the policies that were promoted or introduced as a result. A FINANCIAL CRISIS recent paper9 provides a comprehensive ex-post assessment of stimulus policies on renewable energy technologies in the The 2008–2009 global financial crisis led to numerous U.S. Overall, the authors find that the stimulus programs had attempts to move economies towards a ‘green path’. Recovery a positive effect on the renewable energy sector. The stimulus packages were implemented in several countries to stimulate programs helped to boost manufacturing capacity and the green growth, create jobs and support low-carbon economies supply chain, particularly in the wind sector. Emissions (see below table. By mid-2009, governments around the from energy decreased significantly in the early 2010’s but world had allocated more than USD430bn in fiscal stimulus other factors may have played a role, notably the economic to key climate change investment themes. China and the slowdown. Estimates indicated positive employment effects US led the way. Key beneficiaries include rail transportation, and increased revenue in the renewable energy sector. On water infrastructure, grid expansion and improved building the negative side, the proliferation of many different programs, efficiency. Renewable energy received limited support, except pointed to misalignment and missed opportunities for them in the USA. In the United States, the American Recovery and to work together. The stimulus could have had even more Reinvestment Act (ARRA) included three spending objectives: significant effects if it had been accompanied - as originally it cut taxes, it extended unemployment benefits, education, intended - by a greenhouse gas ‘Cap-and-Trade’ program, and health care; and it created jobs by allocating about one which would have increased renewable investment, even after third of the US$ 840 billion package in federal contracts, short-term incentives had expired. While the program had grants, and loans, to investments in clean energy, education, positive green impacts overall, the renewable energy stimulus and health care. This amount included more than $90 billion for was not sufficient to generate a large-scale transformation to strategic clean energy investments, which – in turn - leveraged green growth. more than $100 billion in private capital for investments in manufacturing, power generation, and renewables. > > > F I G U R E 7 - A Climate of Recovery? The Climate Change Investment Dimension of Economic Stimulus Plans 9. Mundaca Luis, Jessika Luth Richter. ‘Assessing ‘green energy economy’ stimulus packages: Evidence from the U.S. programs targeting renewable energy’, Renewable and Sustainable Energy Reviews Volume 42, February 2015, Pages 1174-1186. 26 >>> THE FISCAL IMPACT AND POLICY RESPONSE TO COVID-19 The positive effects of stimulus measures are more persistent fuel subsidies, which are used in many developing countries if they combine short-term stabilization of demand with long- to buffer the domestic economy against hikes in global fuel term expansion of potential output. Hence, government prices but also discourage investments in energy efficiency spending should go to investments into durable assets such as and tend to turn into a significant drag on public finances resilient infrastructure. The World Bank’s work on cost-effective during price booms. Their removal would help improve future interventions on resilience suggests that for infrastructure, the fiscal space along with a large built-in source of procyclicality benefit-cost ratio is estimated around $4 per $1 invested. In in the fiscal policy of many developing countries. early warning system it’s even higher. There are also cost- effective investments in energy efficiency or improving the grid > > > E F F E C T I V E TA X AT I O N O F T H E to benefit from low-cost renewable energy. Governments can D I G I TA L E C O N O M Y maximize the impact of a fiscal stimulus by: (i) increasing their spending on public procurement, that is on items that show up The COVID-19 crisis is likely going to accelerate the relative directly on their balance sheets (green measures would include importance of effectively taxing e-commerce and the digital retrofitting buildings to make them more energy efficient, or economy more generally. In many economies, the digital investing in public transport and renewable energy); and (ii) economy is already a significant source of tax revenues mobilizing private sector investment and engaging in public- and its growth suggests it will become even more so in the private partnerships, including government loan guarantees or future (see below figure). While there is a clear international refundable tax credits targeted at private sector investments in consensus on how to capture revenue from indirect taxes, green recovery measures. with taxing rights allocated to the jurisdiction where the final consumption occurs, many developing economies have not Lock-in to higher carbon needs to be avoided. Green yet put adequate policies and put the administrative struc- investments provide a durable expansion of output potential tures in place to impose VAT on the direct supply to consum- whereas brown investment will temporarily expand output, ers of services and intangibles by foreign suppliers. Social which in a future carbon constrained world may become distancing is accelerating the growth of most digital delivery stranded assets, leading to significant adjustment costs when models (thus boosting online sale of goods and online trade high-carbon assets need to be retired before their physical in services such as education and banking). Incorporating wear-out, cutting short their operational lifetimes. these dynamics of expanding market shares in a contracting global economy, suggests that as opposed to most other rev- Given that many countries seek to implement stimulus enue sources, the tax base of the sector is going to continue measures in a context of limited fiscal space and elevated debt expanding in times of a global recession. Implementing rules burdens, environmental tax reforms can play an important to tax the sector is hence one potential avenue to protect role. If the stimulus needs to be fiscally neutral, one approach government revenues and should also contribute to a level is to reduce taxes which have a high fiscal multiplier during playing field for less non-digital providers. recessions (such as direct taxes), while seeking to raise revenues on tax bases that have a low fiscal multiplier (such > > > as consumption taxes). This is exactly what an environmental F I G U R E 8 - Tax Potential 2020-2025 (% GDP)10 fiscal reform does. Policymakers could also seek to capture the fall in oil prices for all by revisiting fossil fuel subsidies and taxes, and recycling any additional funds to priority spending needs. The current low fuel prices provide a selective stimulus to high- carbon, capital-intensive industries. The absolute benefit of the reduced prices accrues to more affluent households, especially in low- and middle-income countries. Taxing those fuels and recycling the revenues through spending or reduction in labor taxes improves equity and jobs (because low-carbon industries are on average more labor-intensive). Alternatively – but with similar effects – countries could phase out fossil 10. Al-Rikabi and Loeprick (forthcoming, 2020), provide estimates using a combination of macro and micro data sources for East Asian Economies. When looking at current collections and revenue potential, their findings suggest revenue in range of 0.15-0.25 of GDP is at stake now. But this was expected to increase alongside the dramatic growth of e-commerce to around 0.8% - 1.4% of GDP by 2025. With COVID-19 accelerating the transition of commerce, this share is likely to increase further. THE FISCAL IMPACT AND POLICY RESPONSE TO COVID-19 <<< 27 >> AREAS FOR MTI SUPPORT In line with the importance of a well-designed fiscal response rationalize expenditure will gain in importance. This will also and in response to country requests, MTI has already started assist countries in strengthening fiscal buffers in enhancing to scale up lending preparation and technical assistance. In resilience to future external shocks. addition to helping countries with the design and funding of adequate fiscal responses, work on ensuring the resumption As countries readjust their fiscal policies, this may also be of economic growth and fiscal sustainability will be important. an opportunity to engage on environmental tax reform which The following provides a brief overview of MTI areas of sup- would bring together improved revenue mobilization with the port to contribute to the Bank’s overall engagement on the pursuit of climate objectives and fiscal policy reforms that COVID-19 pandemic. would support the transition towards a low carbon economy. >>> A D V I C E A N D A N A LY T I C S >>> FUNDING SUPPORT AND DO- N O R C O O R D I N AT I O N • Supporting the country response to the COVID-19 pandemic • DPO and Cat/DDO support to help prioritize and fund country responses The immediate priority will be for country economists to pro- actively engage with Ministries of Finance on assessing the Many countries will require external financing support to cope economic and fiscal impact and designing the fiscal response with the fiscal impacts of the COVID-19 pandemic. The Bank, to the COVID-19 pandemic. This would include providing in close coordination with the Fund, can support these efforts information on the global experience, options for response through DPOs. (which this note aims to support), and assessment of fiscal sustainability implications. For countries that have approved DPOs, supplemental fi- nancing will be the quickest way to provide support while In many countries, such engagement will be able to draw ensuring that program implementation and macro-economic on existing analytical work, especially public expenditure re- stability remain on track. views, TADAT and DIAMOND revenue assessments, debt sustainability assessments, and economic, updates. Close For countries, without current DPO engagement which re- coordination with the health and social protection teams, the quire quick budget support, prior actions will need to be fo- IMF, and other developments will be essential. cused and achievable within a short-time period. Prior actions that support the sound design of fiscal measures in response • Supporting the post-pandemic recovery to the pandemic may be particularly attractive, while actions that are not closely related to the crisis response risk diverting MTI support will also assist countries in considering options government attention at this critical juncture. for economic recovery after the health crisis has passed. For this work, the emphasis would shift to countercyclical policies Demand for CAT/DDOs is also likely to increase. While to and institutional and structural reforms needed for a strong date the focus of many CAT/DDOs is on natural disasters, the recovery. MTI work on the drivers of economic growth such as Covid-19 pandemic highlights the urgency of including the country economic memoranda, economic growth studies, and strengthening of countries’ response capacity to pandemics country economic updates will provide important background in CAT/DDOs, requiring close collaboration with the Bank’s for such engagement. health teams. • Supporting fiscal sustainability and the building of The Bank, typically around a DPO engagement, has also an buffers important role to play in coordinating budget support by other development partners. While this will be easier where ongoing This would build on MTI’s expertise in the areas of public ex- DPO engagements are in place, it will also be important to penditure and debt management and domestic revenue mobi- support governments in donor coordination – including lization. In light of already high debt levels of many countries avoiding uncoordinated assessments and conditionality by which are likely to increase further as a result of the pandem- multiple development partners. ic, measures to strengthen domestic revenue collection and 28 >>> THE FISCAL IMPACT AND POLICY RESPONSE TO COVID-19 • TA/IPF operations to strengthen fiscal systems for in- creased resilience and preparedness are important fund- ing support. • Strengthening fiscal systems for increased crisis resil- ience and preparedness will require scaled up and re- prioritized technical assistance for many countries. Sub- stantive support for the overhaul of countries’ domestic revenue systems can be provided in the form of techni- cal assistance projects. Such strengthening of revenue systems would also be well aligned with IDA-18 commit- ments to assist countries in this area. THE FISCAL IMPACT AND POLICY RESPONSE TO COVID-19 <<< 29 >> APPENDIX 1: FISCAL IMPACT OF THE GLOBAL FINANCIAL CRISIS - LESSONS FOR THE COVID-19 CRISIS The impact of the COVID-19 on the fiscal situation of gov- Globally, revenues recovered to their pre-GFC level only ernments is difficult to predict. The closest recent parallel to a after eight years while spending spiked during the recession major global crisis has been the 2008-09 global financial crisis years and stabilized at higher than pre-crisis levels. Globally, (GFC). While the global financial crisis started in the US fi- the shock to revenue was an average of 1.3 percent of the nancial sector, resulting in a sharp drop in liquidity and quickly GDP while government spending jumped a full percentage spread globally, its effects varied by region. COVID-19 is ex- point of GDP. pected to have different impact pathways across the globe, but the impact on liquidity is likely to be of a similar nature. In a baseline scenario, the effects of COVID-19 would last un- til May-June of 2020 in the United States and Europe even while China recovers, which is a massive shock to the global economy. > > > A P P E N D I X T A B L E 1 - Revenue Shock in the 2008-09 Financial Crisis and Years to Full Recovery REGION PRE-CRISIS REVENUE (% REVENUE SHOCK (% REVENUE SHOCK (% OF YEARS TO RECOVER OF GDP) OF GDP) REVENUE) SOUTH ASIA 15.8 0.81 5.1% 7 SUB-SAHARAN AFRICA 19.45 0.86 4.4% 3 LATIN AMERICA AND THE CARIB- 21.91 0.95 4.3% 6 BEAN EAST ASIA AND THE PACIFIC 25.9 1.52 5.9% 4 EASTERN EUROPE AND CENTRAL 28.35 1.54 5.4% Did Not Recover ASIA NORTH AMERICA 31.83 2.24 7.0% Did Not Recover MIDDLE EAST & NORTH AFRICA 34.62 4.28 12.4% Did Not Recover WESTERN EUROPE 35.1 1.00 2.8% 4 Regionally, the largest shock of 4.28% of GDP was for the levels while Income tax revenues and VAT recovered in 6 countries in the Middle-East and in North America. The eco- years with revenue shocks of 0.56 and 0.53% of GDP. Trade nomic shock in these countries was compounded by the lower taxes suffered a shock of 0.44% of GDP and did not recover oil revenue as oil priced declined causing a sharp reduction to its pre-crisis levels. in fiscal revenues. In the case of Sub-Saharan Africa, the rev- enue shock was 0.86% of GDP nearly 4.4% of the pre-crisis In South Asia, income taxes were not affected by the crisis level, though these countries recovered the quickest among and continued to show an increasing trend through the crisis. all the regions. South Asia recovered its revenues to pre-crisis The most significant shock was felt in non-tax revenue which levels in 7 years. Even ten years after the financial crises, dropped by 2.57% of GDP. Apart from non-tax revenues, trade revenues for countries in the regions of North America, the taxes suffered a negative shock of 0.2% of GDP. Other taxes Middle-East and North Africa and Eastern Europe and Central suffered only marginal losses. Asia have not fully recovered. Sub-Saharan Africa too showed similar rising trend for in- Tax types most affected come taxes right through the crisis. Here too, the non-tax revenue suffered the biggest negative shock of 1.5% of GDP. Globally, non-tax revenues, income tax and VAT were most Trade taxes that were falling pre-crisis continued its downward affected by the financial crisis. Non-tax revenue which suf- trend though the fall was accelerated due to the crisis. The fered a negative shock of 0.77% did not recover to pre-crisis other negative shocks were to VAT and excises. 30 >>> THE FISCAL IMPACT AND POLICY RESPONSE TO COVID-19 Among Latin American and Caribbean countries, the biggest In North America (USA and Canada), immediately after the negative shock of 0.65% of GDP was in trade taxes followed crisis, government spending rose 4% of GDP from 19% to by 0.49% for the VAT. Income tax suffered a small negative 23% of GDP. By 2014, it settled at 20% of GDP, 1% above its shock of 0.34% of GDP. Non-tax revenue suffered a small pre-crisis levels. negative shock while excise taxes was unaffected. In MENA, government spending jumped 2% of GDP imme- Income tax suffered the biggest negative shock (1.96% of diately after the crisis from 29% to 31% of GDP. By 2011 the GDP) among East Asian and Pacific countries. Trade taxes levels were 28% of GDP and have fallen to lower levels since. had the second biggest shock among these countries (0.51% Western European countries increased government spending of GDP). VAT and excise suffered smaller negative shocks. from 33% of GDP to 39% of GDP a 6% of GDP jump. By Among Eastern European and Central Asian countries, in- 2017, its levels have dropped to 35% of GDP 2% above the come tax revenues suffered their biggest shock (1.09% of pre-crisis levels. GDP) with VAT and trade taxes following closely (0.43% of GDP and 0.40 % of GDP respectively. Conclusion North American countries (United States and Canada) suf- A study of the impact of the financial crisis on government fered their biggest shock of 2.22% of GDP for the income tax spending and revenues would provide a perspective and which did not recover to pre-crisis levels. The impact on other some estimates of the magnitude of the effects of the CO- revenue items was small. VID-19 crisis. During the financial crisis, globally, there was a 2% points government spending shock and a 1% of GDP Among Middle-Eastern and North African countries, non-tax negative revenue shock, implying a fiscal shock of nearly 3% revenues suffered a shock of 4.31% of GDP due to lower oil of global GDP. In our opinion, we should be prepared for an revenues. The next largest fall was in the VAT (0.69% of GDP) effect of at least the same magnitude for the COVID-19 crisis. followed by income tax revenues, which fell by 0.39% of GDP. Transmission through tax systems suggests that in some re- Excises and trade taxes were relatively unaffected. gions, non-tax revenues may be in for a negative shock while in other regions income tax revenues might be the most ad- Lastly among the countries of Western Europe, the negative versely affected. shock to the income tax revenues was about 1% of GDP fol- lowed by 0.34% of GDP for the VAT. Income Tax revenue did not recover to its pre-crisis levels. Government spending In South Asia, government spending 5% of GDP after the crisis from nearly 19% of GDP to 24% of GDP. By 2015, these levels dropped to nearly to its pre-crisis levels to 20% of GDP. In Sub-Saharan Africa, government spending increased by 1% of GDP after the crisis dropping back to the pre-crisis lev- els by 2012. In Latin America and the Caribbean, government spending jumped 3% of GDP after the crisis to 23% of GDP and re- mained elevated rising further to 24% of GDP. In the East Asia and the Pacific, after the crisis, government spending jumped nearly 6% of GDP from 17% of GDP to 23% of GDP. by 2011 its levels further increased and settled at 26% of GDP nearly 8% higher than its pre-crisis levels. In Eastern European and Central Asia, jumped 2% of GDP immediately after the crisis from 35% of GDP to 37% of GDP. However, these levels have since dropped to 32% of GDP. THE FISCAL IMPACT AND POLICY RESPONSE TO COVID-19 <<< 31 > > > A P P E N D I X F I G U R E 1 - Global Government Revenue Versus Spending 32 >>> THE FISCAL IMPACT AND POLICY RESPONSE TO COVID-19 > > > A P P E N D I X F I G U R E 2 - Government Revenue Versus Spending Around the Financial Crisis - Regions THE FISCAL IMPACT AND POLICY RESPONSE TO COVID-19 <<< 33 > > > A P P E N D I X F I G U R E 3 - Revenue Performance Around the Financial Crisis - World Average 34 >>> THE FISCAL IMPACT AND POLICY RESPONSE TO COVID-19 > > > A P P E N D I X F I G U R E 4 - Revenue Performance Around the Financial Crisis - South Asia THE FISCAL IMPACT AND POLICY RESPONSE TO COVID-19 <<< 35 > > > A P P E N D I X F I G U R E 5 - Revenue Performance Around the Financial Crisis - Sub-Saharan Africa 36 >>> THE FISCAL IMPACT AND POLICY RESPONSE TO COVID-19 > > > A P P E N D I X F I G U R E 6 - Revenue Performance Around the Financial Crisis - Sub-Saharan Africa THE FISCAL IMPACT AND POLICY RESPONSE TO COVID-19 <<< 37 > > > A P P E N D I X F I G U R E 5 - Revenue Performance Around the Financial Crisis - East Asia and the Pacific 38 >>> THE FISCAL IMPACT AND POLICY RESPONSE TO COVID-19 > > > A P P E N D I X F I G U R E 7 - Revenue Performance Around the Financial Crisis - Latin America & Caribbean THE FISCAL IMPACT AND POLICY RESPONSE TO COVID-19 <<< 39 > > > A P P E N D I X F I G U R E 5 - Revenue Performance Around the Financial Crisis - East Asia & Pacific 40 >>> THE FISCAL IMPACT AND POLICY RESPONSE TO COVID-19 > > > A P P E N D I X F I G U R E 8 - Revenue Performance Around the Financial Crisis - Eastern Europe & Central Asia THE FISCAL IMPACT AND POLICY RESPONSE TO COVID-19 <<< 41 > > > A P P E N D I X F I G U R E 9 - Revenue Performance Around the Financial Crisis - North America 42 >>> THE FISCAL IMPACT AND POLICY RESPONSE TO COVID-19 > > > A P P E N D I X F I G U R E 1 0 - Revenue Performance Around the Financial Crisis - Middle-East & North Africa THE FISCAL IMPACT AND POLICY RESPONSE TO COVID-19 <<< 43 > > > A P P E N D I X F I G U R E 1 1 - Revenue Performance Around the Financial Crisis - Western Europe 44 >>> THE FISCAL IMPACT AND POLICY RESPONSE TO COVID-19 > > A P P E N D I X 2 - F U R T H E R A N A LY S I S O F C O U N T R Y A S P E C T S FOR FISCAL POLICY DECISION MAKING This Appendix drills down on the categories identified > > > in Section 4 for assessing country aspects that need to be A P P E N D I X F I G U R E 1 2 - Sectoral Shares in GDP considered in the choice of fiscal policy instrument: fiscal (2018 or latest available) space and capability. Fiscal space is further examined by looking at economic structure and fiscal structure. Capability is looked at through the lens of public financial management. Economic structure Specific aspects of countries’ economic structure are of particular importance for the impact of the Covid-19 pandemic and the appropriate fiscal response. This includes: sectoral composition of GDP; economic complexity; informality; and export orientation. Countries differ widely with respect to the sectoral composition of their economies. The tertiary sector includes many activities (such as tourism, restaurants, retail trade) Note: Chart shows quartile distribution of selected indicators at the that depend on direct interaction with customers and are 25th, 50th, and 75th percentile as well as minimum and maximum value thus particular vulnerable to social distancing measures. of indicator in sample. Colored area shows 25th-75th percentile. Secondary, industrial sector activities are on the other hand more susceptible to supply chain disruptions and impacts of > > > the pandemic on the work force. Primary sector activities, A P P E N D I X F I G U R E 1 3 - Economic Complexity especially agriculture related activities tend to be more and Share of Informal Sector (2018 or latest available) dispersed than secondary activities and with less concentrated producer-customer interaction than tertiary activities. As the share of agriculture in GDP tends to be particularly high in low income economies, this may provide some degree of economic resilience to these economies. Two other structural characteristics of economies are the degree of economic complexity and informality. Higher economic complexity implies denser and more diversified economic networks among producers both domestically and with the rest of the world. As such, shocks such as COVID-19 are likely to be more disruptive in economically complex economies than in less complex economies. Another important economic characteristic is the size of the informal sector. A key characteristic of informal sector activities is there very limited integration into a countries tax system. So, for countries where Note: see previous chart the informal sector plays an important role, fiscal measures that seek to provide relief to persons and businesses will only have a very limited impact on actors in the informal sector. This will imply that in order to reach actors in the informal economy, targeted social protection measures will be more effective than revenue side measures. THE FISCAL IMPACT AND POLICY RESPONSE TO COVID-19 <<< 45 The export and import intensity of an economy is an that revenue from income tax recovers after the pandemic important indicator of its global integration, vulnerability to has passed. For many developing countries most of the external shocks and disruptions to international trade. In government revenue comes from trade and other indirect addition, trade flows are also often an important source of taxes. Temporary reductions in these taxes could have a far government revenue. reach, but studies have also shown that reductions in indirect taxes may not be passed on to the consumer. Countries with a high trade share are particularly vulnerable to COVID-19 related distortions to global trade flows and supply chains. This can be though the reduced availability of imports as an import to domestic production and reduced > > > A P P E N D I X F I G U R E 1 4 - Exports and Imports demand for exports. Government revenue of countries with as Share of GDP (2018 or latest available) well targeted fiscal measures such as the suspension of taxes on all imported medical supplies, including medical equipment such as masks, respirators and protective suits as well as medicines, disinfectants and soaps can support countries’ health response. More than 50 countries have already started to reduce tariffs and restrictions on the import of health-related goods to foster greater domestic availability. At the same time, countries have also started to impose restrictions on the export of health-related goods which, as happened during the global food crisis when countries restricted the export of grains and other food stuffs, can result in adverse impacts on domestic producers, increased smuggling, and the related loss of tax revenue. A reduction of import and export taxes as part of a broader response to support household incomes (especially tariffs Note: see previous chart on food and other necessities) and business activity could also be an important aspect of fiscal measures, especially > > > for economies that are highly import dependent and where A P P E N D I X F I G U R E 1 5 - Share of Revenue such reductions could expect to have the broadest impacts. Components in Overall Revenue (2018 or latest However, in many LDCs, while tariffs are higher, tariff available) exemptions are also high – and therefore revenue losses will be lower than anticipated on the basis of statutory tariffs. Fiscal structure The composition of government revenue and expenditure also plays an important role in determining how the COVID-19 impacts fiscal aggregates and the choice of fiscal responses. As the below charts show, the structure of tax revenue sources differs significantly across countries, which will also lead to variations on how the COVID-19 impacts on revenue and which revenue side measures will be most effective. For countries where the share of businesses and persons that pay income tax is small, use of these instruments may only reach a limited number of entities and their usefulness Note: see previous chart to achieve broader economic and social objectives may be limited. However, such measures may nonetheless be important to protect the tax base and ensure thus ensure 46 >>> THE FISCAL IMPACT AND POLICY RESPONSE TO COVID-19 > > > taxes may not be passed on to the consumer. A P P E N D I X F I G U R E 1 6 - Share of Revenue Components in GDP (2018 or latest available) Revenue performance Regression analysis can help to determine if a tax system is productive, and what its tax capacity could be, given the performance of peers with similar levels of income and trade. Tax effort is then determined by the share of actual collection to potential collection (tax capacity). The below figures show tax effort and tax capacity by risk of debt distress for IDA countries. Tax effort does not differ to a statistically significant degree among IDA groupings of low, medium, and high debt distress. However, medium-debt-distress IDAs appear to have a tax effort slightly higher than the other two categories (although this is only a point estimate). This could be a response to Note: see previous chart the onset of debt distress. Low-debt-distress IDAs have the most cases of low tax effort, with over 25% of countries in For countries where the share of businesses and persons this category collecting less than 60% of their potential tax that pay income tax is small, use of these instruments may revenue. These countries understandably are not under great only reach a limited number of entities and their usefulness pressure to mobilize more revenues. However, more than to achieve broader economic and social objectives may 50% of high-debt-distress IDAs collect less than 80% of their be limited. However, such measures may nonetheless be potential tax revenue. This indicates substantial scope for tax important to protect the tax base and ensure thus ensure reform to address the policy gaps (such as exemptions) and that revenue from income tax recovers after the pandemic administration gaps (that lead to low tax compliance) in order has passed. For many developing countries most of the to approach tax capacity and relieve debt distress. government revenue comes from trade and other indirect taxes. Temporary reductions in these taxes could have a far reach, but studies have also shown that reductions in indirect > > > A P P E N D I X F I G U R E 1 7 - Tax Effort and Capacity by Level of Debt Distress THE FISCAL IMPACT AND POLICY RESPONSE TO COVID-19 <<< 47 Tax capacity varies widely by category, most so for the high- > > > debt-distress IDAs—debt distress appears to affect countries A P P E N D I X F I G U R E 1 8 - Expenditure Flexibility with large and small tax bases. Countries with high debt distress and high tax capacity must increase tax effort to meet their revenue potential. Countries with high debt distress and low tax capacity have no choice but to rationalize expenditures in order to improve fiscal space. Medium-debt-distress countries are much more concentrated, and over 75% of them have a potential tax-to-GDP below 20%. These countries must spend in accordance with their means. Expanding tax capacity is possible over time through economic growth. In the short run, countries must take their capacity as a given, strive to meet it, and spend within their means. Country economists are encouraged to use the tax analysis tool that will circulate soon to learn the tax capacity and tax effort of their country. Note: see previous chart Expenditure flexibility For many countries, especially those with limited scope to mobilize additional resources quickly, the fiscal response will rely on countries’ ability to reallocate resources from other expenditure programs towards the crisis response. This ability will depend on the flexibility of the structure of expenditures. Some expenditure categories such as expenditure on operations and maintenance, capital expenditure, or transfers and subsidies have some scope to be deferred or reduced to free resources for the crisis response, while others such as payments for wages and salaries or debt service have typically less flexibility. In the context of the COVID-19 pandemic, some expenditures will drop automatically such as operations and maintenance expenditure for services that are not provided, while others will increase, especially unemployment payments and social security benefits. Recent calls for debt service moratoriums would also enhance the scope for fiscal reallocations in an expenditure category that typically has limited flexibility. As a simple measure of expenditure flexibility, we calculate the share of expenditure on operations and maintenance, transfers and subsidies, and capital spending as a share of total spending. A higher share of these expenditure types typically signals higher expenditure flexibility. The above chart shows how this indicator is distributed across countries by quartile. For the bottom quartile, flexible expenditure accounts for 25 to 37 percent of expenditure, for the two quartiles in the middle 37-56 percent, and for the upper quartile with the highest expenditure flexibility 57-77 percent. 48 >>> THE FISCAL IMPACT AND POLICY RESPONSE TO COVID-19