In sports, games are often won by the team that deploys multiple layers of defense. ESPN’s recent documentary series The Last Dance, which chronicles the Chicago Bulls’ dominance of the NBA in the 1990s, shows how the team’s seamless offensive strategy was a key to its success. But perhaps most important, the Bulls triumphed over virtually any opponent through the layered defensive forces of its three key players. The multiple ways in which the Bulls smothered teams defensively led them to six NBA championship titles in eight years.
Today, Congress and the Federal Reserve are battling a formidable opponent in COVID-19. Policymakers have formed two critical lines of economic defense against the deepening U.S. recession as social distancing measures have created an acute “cash-flow vacuum” for Main Street businesses and an unprecedented unemployment crisis. The $2 trillion CARES Act and aggressive Fed actions have been important policy responses, extending credit to shuttered businesses and unemployment assistance to millions of struggling Americans.
These two lines of economic defense may prove sufficient now that the arc of the virus’s spread appears to be trending down. Vanguard’s economic forecast calls for one of the deepest U.S. recessions on record, but one that is short in duration. We expect the economy to grow in the second half of 2020, even if the probable U-shaped recovery delays our return to the level of economic output that prevailed before the pandemic. But there are risks to our outlook that are difficult to quantify, including a second wave of COVID-19 that could require economic lockdowns similar to those of the past several months.
Now is the time to layer our defense
If those unfortunate risks to our economic outlook materialize, we advocate for employing an existing mechanism to provide impaired businesses with cash, not credit. With only slight amendments to the employment retention tax credit (ERTC) in the CARES Act, Congress could enable the Treasury Department to provide full-employment cash grants to employers, should economic conditions warrant. An enhanced ERTC would quickly deliver cash grants to millions of small and medium-sized businesses at scale by “reversing the flow” of quarterly tax withholding funds typically sent through the “plumbing” of the Treasury.
How it would work within the existing process
Every employer lists the number of its employees and total wages paid in their tax filings. More than 13 million of these forms are filed electronically. Congress could use these filings to make the size of a cash grant contingent on the number of workers a firm intends to employ in the future, incentivizing—indeed, enabling—businesses to bring back workers who are unemployed or on furlough. And because the grant size would be based on tax filings, a natural “clawback” provision could be easily embedded for compliance.
The ERTC mechanism stands on its own and offers streamlined relief without requiring employers to apply to a bank. It could significantly and cost-effectively reduce unemployment in a potential downside scenario (such as a second wave of the pandemic) while taking pressure off unemployment insurance and the Paycheck Protection Program. If only one in five businesses with 2,000 or fewer workers opted for full-employment cash grants, this mechanism would move as many as 12 million workers from the unemployment rolls to the workforce, saving nearly $180 billion in federal and state unemployment insurance costs.
A knock-on effect for the economy
Individuals earning a paycheck have the ability to spend, which could help keep other businesses afloat and accelerate an eventual rebound.
The ERTC currently offers businesses an advanced credit (or tax refund) if their revenues have declined materially because of COVID-19. But unlike the Small Business Administration’s Paycheck Protection Program, the complementary ERTC has seen limited uptake because the tax credit covers only about 30% of the average business’s core operating expenses for payroll, benefits, leases, and utilities.
However, the ERTC could be modified to include an “escalation clause” for businesses to receive more than 100% credit (rather than the current 50%) on their quarterly qualified wages if—and only if—they bring their number of workers back to year-ago levels. A credit that exceeds 100% is critical to help impaired businesses meet some basic operating costs beyond worker salaries, enabling more workers to receive their original paycheck amount.
The escalation clause would be activated only if the U.S. was still in recession later this year. The clause could be tied to economic conditions, such as an unemployment rate exceeding 10%, becoming a new automatic stabilizer. If business conditions improve, the mechanism’s future costs would be zero, because the extraordinary business support would not be available.
On the other hand, should the health crisis evolve in a way that leads to a prolonged recession or additional rolling shutdowns, the automatic mechanism would kick in, as national disaster-relief programs are intended to do. In a downside scenario where 20% of small and medium-sized businesses opt in to the program, the grants would cost the federal government less than $200 billion over three months after accounting for the savings from unemployment insurance.
We applaud Congress and the Fed for their collective and meaningful efforts to date and encourage them to seriously consider ERTC modifications as a third, and automatic, line of defense. This would buy time for vaccines to be developed while protecting the flank of current economic responses. Similar to the Chicago Bulls, the adoption of a multipronged defensive approach would help ensure a decisive victory—for workers, businesses, and the American economy.
Note: All investing is subject to risk, including the possible loss of the money you invest.