Tax-Backed Bonds: Update and Response to Critics

Last year, Philip Pilkington and Warren Mosler argued that they had come up with a financial innovation that had the potential to help control the crippling borrowing costs faced by many member-states on the eurozone periphery. Their “tax-backed bond” proposal worked like this: if a member-state issuing these bonds defaulted on a payment, the bonds could, under such circumstances (and only under such circumstances), be used to make tax payments in the country in question (and would continue to earn interest).

This financial innovation attempts to address, obliquely, one of the critical design flaws of the eurozone setup: that member-states remain responsible for their own fiscal policy after having given up control over their own currency. (Dimitri Papadimitriou and Randall Wray explain here why separating fiscal policy from a sovereign currency was such a fatal mistake.)

Part of the idea behind the tax-backed bond proposal is that it would allow a member-state to enjoy borrowing costs that would be more comparable to those of a currency issuer (countries that issue their own currency have lower debt-servicing costs, even when their government debt-to-GDP ratios soar above some of the ratios seen on the eurozone periphery, because they can always make payments when due). Tax-backing is meant to assure investors that these bonds are always “money good.”

Since they first published their proposal, ECB President Mario Draghi had his “whatever it takes” moment, which contributed to a fall in sovereign debt yields on the periphery. Does this make the tax-backed bond moot?

Pilkington has just published an update on the proposal, and he explains why the idea is still relevant in a post-OMT eurozone. In addition to being able to further reduce borrowing costs, Pilkington argues that implementing this plan would enable troubled member-states to minimize or avoid the fiscal austerity imposed as a condition of the troika’s bailouts and backstops; it would “give eurozone member countries back their fiscal independence,” as he puts it.

Pilkington also responds to some objections that have been raised since the proposal was first published, including most notably those of Ireland’s Minister for Finance, Michael Noonan (the proposal was raised, and ultimately rejected, in the Irish parliament). Finally, Pilkington explains how the tax-backed bond could be used in non-eurozone context, referencing recent debates over Scottish independence.

Download Pilkington’s latest policy note: “The Continued Relevance of Tax-backed Bonds in a Post-OMT Eurozone”

(The original tax-backed bond proposal, by Pilkington and Mosler, is here.)