War in Ukraine: How to finance higher fiscal spending? through taxes or public debt?

Report published by the Peterson Institute for International Economics analyzing the economic effects of the war in Europe and the responses from the perspective of fiscal and monetary policy in the different EU countries in the form of direct aid, tax cuts on energy prices, subsidies... The report analyses what would be the best way to finance this increase in public spending, opting for public debt at a time when uncertainty can take its toll on domestic demand and there is substantial room to run temporary larger deficits if needed.

Report Highlights:

• Fiscal policy measures: The war in Europe is going to lead to an increase in public spending due to higher expenditure on defence, refugees, the need to invest in infrastructure and energy autonomy, and the support to the corporates and households most affected by the war and the rise in energy prices. So far, these public support measures could be grouped into the following categories:

- Temporary reduction of taxes on energy consumption: This measure has been the most widespread to date, and for example has led to reductions from 15 cents per litre of gasoline in France to 30 cents in Germany.

- Direct grants: Cash transfers of a fixed amount to individuals or companies to deal with the effects of inflation and war. They can be universal regardless of their consumption of food, fuel or gas, or more specific aimed at the most vulnerable and affected by price increases.

- Price regulations: For example, the plan of Spain and Portugal proposing a method to decouple gas from the calculation of the electricity price, or France requesting the country's main electricity company to limit the increase in the bill to 4% in 2022. According to the authors, these are not efficient measures in the long term, but they do protect the welfare state.

• Perverse effects of subsidies: The authors' main criticism of these public subsidies is that they would be encouraging energy consumption, transferring aid to producers ( i.e Russia).
  
  
• How to finance this public support? According to the authors, there are arguments in favour of creating a special tax on war “Putin tax”: it would not be as unpopular as in other circumstances and it would also underline the fact that war is not free. However, they are more favourable to financing through public debt as it is a more efficient mechanism to compensate for the weakness in consumption and investment expected in the EU due to the uncertainty and loss of income and purchasing power that is taking place. This measure should not call into question the sustainability of public debt in the future for various reasons: the 10-year benchmark bond rates have increased by 50 basis points only since the start of the war, an affordable cost, it is a temporary crisis, and public debt levels in a scenario of high inflation will likely fall in the next two years.