Tax the rich harder to help victims of the energy crisis, says the ECB

The European Central Bank’s chief economist has urged eurozone governments to tax wealthy people and businesses to fund support for those hardest hit by the region’s energy crisis.

Philip Lane said that funding for measures to support the most vulnerable groups in society “could take the form of higher taxes for higher earners or for industries and businesses that are highly profitable despite the energy shock”.

Lane’s comments come after the UK government’s latest budget, which includes a tax cut for the highest earners, triggered a sell-off in bond markets and a sharp depreciation in sterling.

The UK and EU member states have both announced fiscal support for households and businesses to cope with soaring energy prices. However, after the UK plans a €150bn energy price cap

Investors around the world are increasingly concerned that monetary policy and fiscal policy are out of sync. Central banks fear that expensive government support measures will lead to higher inflation and force them to hike higher interest rates.

According to Lane, governments faced a clear choice on how to fund measures to help those hardest hit by the energy crisis caused by Russia’s invasion of Ukraine, which has drastically reduced Moscow’s supplies of natural gas and oil to Europe .

“If you support those in need through higher taxes, it has less of an impact on inflation than if you increase deficits,” he told the Austrian newspaper Der Standard in an interview, giving more detailed advice than is usual for central bank politicians to give tax policy.

Lane’s comments support the EU’s plan to siphon off €140 billion from a levy on excess profits in the energy sector to spend on measures to cushion the blow of high prices, to be discussed by policymakers on Friday. Bruegel, the Brussels-based think tank, estimates that 10 EU countries have already announced or introduced such windfall tax measures. However, the EU has not advocated higher taxes for wealthier citizens.

“From a fairness standpoint, but also from a macroeconomic perspective, governments should support the income and consumption of households and businesses that suffer the most,” said Lane, a key architect of monetary policy for the eurozone. “The big question is whether some of that support should be funded through tax increases for the better off.”

In the eurozone, where fiscal policy is managed by 19 different governments, the ECB has additional concerns. Higher government debt can raise the specter of a debt crisis in individual member states and make it more difficult for the central bank to raise interest rates as high as needed to fight inflation.

Concerns about the far-right government set to take power in Italy after the weekend’s election have pushed the gap, or spread, between Italy’s 10-year bond rates and Germany’s to over 2.5 percentage points, the widest since Die Pandemic caused a sell-off in bond markets in April 2020.

Lane said that while it “won’t be possible to avoid slightly higher deficits” in the short term, “there has to be a clear time limit”. Stressing the importance of lower deficits next year to combat inflation, he said: “This does not mean moving towards austerity, just moving away from expansionary policies.”

Inflation is expected to hit a new euro-zone record of 9.7 percent when September data is released on Friday. Lane forecast energy prices would stabilize by the middle of next year and said inflationary pressures should ease as supply chain congestion eases and higher interest rates dampen demand.

He also warned that workers and businesses are facing lower incomes due to higher energy costs, which he estimates have risen from about 1 percent of euro-zone gross domestic product to 5 percent.

“To return to lower inflation, we need to be aware that corporate profitability will fall for a while and wages will not fully keep up with inflation for a while either,” he said.