Tax-Backed Bonds - A national solution to the European Debt Crisis

Philip Pilkington and Warren Mosler – 2012/4

Levy Economics Institute of Bard College - Policy Note


The purpose of this paper is to offer a brief introduction to a new approach to the burgeoning European debt crisis: tax-backed bonds.

Tax-backed bonds would be similar to standard government bonds except that they would contain a clause stating that if the country issuing the bonds does not make its payments—and only if the country does not make its payments—the tax-backed bonds would be acceptable to make tax payments within the country in question, and would continue to earn interest.


The key problem facing Europe is the sovereign debt crisis. The crisis has caused enormous damage to Europe, politically, socially, and economically. As recent polls have shown, confidence in the European Union and its institutions is at its lowest point, with many citizens questioning the direction that the European project is taking.

The key issues raised on both sides of the debate are those of sovereignty and responsibility. The populations of the wealthier European countries insist that distressed peripheral countries must take responsibility for their debt burdens and stop relying on bailouts from Europe as a whole.

Meanwhile, citizens in the periphery are growing distressed at the loss of fiscal sovereignty that has resulted from the bailouts and subsequent austerity measures. In more extreme cases, this has manifested itself in calls for countries to exit the single currency, an action that would be catastrophic for the European project as a whole.

The ideal solution would satisfy both parties. Such a solution would allow individual countries to maintain their sovereignty and return to the markets so that they no longer have to rely on the rest of Europe for bailouts. At the same time, we must also ensure that the single currency remains intact. In what follows, we introduce a financial innovation that could provide such a solution.

Cause of the Present Crisis

The root of the debt crisis can be found in the fact that investors are currently concerned about the government debt of countries in the eurozone periphery. They are concerned that these countries might default and that investors would consequently lose their money. This causes investors to demand a higher “yield,” or interest rate, on such government bonds. But when interest rates rise too high, the country in question suffers under the burden of hefty interest payments, which may push that country into a situation in which it is unable to repay its creditors. In such a case, the debtor country may then ask its neighbors for a bailout, either through a fund set up especially for such a bailout or by requesting that the central bank buy up some of their debt in the secondary market. Both of the above scenarios have already occurred and have caused tension and strife across Europe.

The inherent instability can be expressed as a series of questions:

*Will the euro-12 economy slow sufficiently to automatically increase national deficits via the reduction of tax revenues and increased transfer payments?

*Will such a slowdown cause the markets to dictate terms of credit to the credit sensitive national governments, and force procyclical responses?

*Will the slowdown lead to local bank failures?

*Will the markets allow national governments with heavy debt burdens, falling revenues and rising expenses the finance required to support troubled banks?

*Will depositors lose confidence in the banking system and test the new euro-12 support mechanism?

*Can the entire payments system avoid a shutdown when faced with this need to reorganize?


Water freezes at 0 degrees C. But very still water can be cooled well below that and stay liquid until a catalyst, such as a sudden breeze, causes it to instantly solidify. Likewise, the conditions for a national liquidity crisis that will shut down the euro-12’s monetary system are firmly in place. All that is required is an economic slowdown that threatens either tax revenues or the capital of the banking system.

A prosperous financial future belongs to those who respect the dynamics and are prepared for the day of reckoning. History and logic dictate that the credit sensitive euro-12 national governments and banking system will be tested. The market’s arrows will inflict an initially narrow liquidity crisis, which will immediately infect and rapidly arrest the entire euro payments system. Only the inevitable, currently prohibited, direct intervention of the ECB will be capable of performing the resurrection, and from the ashes of that fallen flaming star an immortal sovereign currency will no doubt emerge.