Covid,taxesandLaffer'scurve

In India the total increase in new covid cases was close to 314k. The daily death toll also crossed the figure of 2000 for the first time. As the supply of oxygen and other medical necessities dwindles the situation becomes ever more delicate. The policy makers now face the famous Cornellian dilemma where all the options in front of them appear equally bad. In case they put down a strict and complete lockdown, the economy goes for a spin and in case they allow it to function normally the virus goes for a free ride. The only hope remains that supply chains for a universal and efficient vaccine rollout are put in place quickly. The Indian markets continued to bake in the optimistic scenario as stock markets ended in green yesterday and the bond yield softened. 10-year bond improved by 3bps.

In other global market news, the ECB came out with its policy statement. On expected lines the ECB policy rate remains same at negative 50 bps and the bond buying also continue at the existing speed. The ECB Chief however added in her statement that there are clearly signs of improvement and she sees a firm rebound in economic activity in 2021 on the back of vaccine campaigns and relaxation of containment measures. The word “firm” as used by her is an adjective, some of its other cousins being “great, significant, solid” etc. The different adjectives however differ in the quantity of conviction which they convey. Firm is somewhere midway. The markets hence lap on to all these small wordplays and put their bets accordingly. However, it is still uncertain that whether firm will graduate to great by the time of next ECB meeting in June. The very fact that some of the central banks have already started signalling that they might start the unwinding process sooner than later has made markets hunt for any small clue. The Bank of Canada in the recent policy announcement stated that they can start hiking rates by late 2022.  The Euro currently trades around 1.2020 and the German 10-year bond yield trade at negative 0.25 mostly unchanged.

From the US there came two sets of important news items. First was the jobless claims data which comes out every Thursday. The recent report indicated that the new claims fell to the pandemic era low of 547k. Initial jobless claims measures the number of people who are filing for unemployment insurance for the first time. The now almost secular trend of weekly decline in these claim numbers portends well for the US. Markets would love a steady decline but as soon as it will start hitting the pre pandemic level it would increase the probability of rate hikes and possible normalization. Hence it would help if the number is good but not too good.

Other important news from the US was when some reports suggested that the Biden administration is planning to hike capital gains tax rates to very high levels for a certain set of investor class. Dow Jones ended in red. Now the optimal tax rate is always a tricky topic. There is a concept called Laffer’s curve which is generally quoted whenever such discussions come up. Formulated by the economist Arthur Laffer the idea describes the relationship between the tax rates and the amount of tax revenues collected. It says that a parabolic kind of relationship exists between the two as the tax revenues start to decline if the rates are raised too high. The logical explanation behind the same is not difficult to fathom. Higher taxes disincentivizes as well as some pilferage also comes in. But with all thing’s economics, the point of inflection on Laffer’s curve is subjective and no one knows where it exists. Just that it exists for sure. Readers would do well to employ the insight of Laffer’s optimality in our discussion regarding initial jobless claims too.