in marginal firms; i.e. firms that lay off workers in the absence of the wage subsidy but retain them when receiving the subsidy. Firms are marginal if their losses can be compensated by a reduction in their labor costs. But labor costs only represent 21% of all costs on average, and an even smaller share in poorer countries, presumably due to the high level of informal employment within formal firms. For many firms, fixed costs are so high that the revenue shock pushes firms into loss-making territory even if wages are subsidized. As a result, wage subsidies are largely inefficient for countries in Sub-Saharan Africa, and are useful to protect employment only in moderately impacted sectors in middle-income countries.

Finally, we estimate the budgetary impact of the shock, which reduces the tax revenue collected from the corporate sector and increases the private sector’s financing needs. Summing up the reduction in tax revenue for the three main taxes remitted by firms (the Corporate Income Tax (CIT), payroll tax and ValueAdded Tax (VAT)) we predict that tax revenue from corporations will drop by 1.5% (2.5%) of GDP in 2020 under the three-month revenue shock (five-month shock). Our estimates constitute a lower bound as we do not account for large expected losses in other taxes such as import tariffs. We also predict that firms accumulate excess losses equal to 2.9% (5.8%) of GDP. Thus, to avoid massive bankruptcies, governments need to provide additional loans and credit guarantees to firms. A government with a balanced budget at baseline would need to borrow 4.4% (8.3%) of its baseline GDP, on average, to fully cushion the formal corporate sector and its workers from this unexpected shock.

Overall, our estimates imply very large increases in borrowing needs to cover tax revenue shortfalls and to guarantee loans to the corporate sector – a challenge for developing countries with limited fiscal space (Loayza and Pennings 2020, Benmelech and Tzur-Ilan 2020, and Abraham et al. 2020). Countries with limited access to international capital markets will require a substantial increase in budget support from donors. A silver lining is that poorer countries seem relatively less impacted on the dimensions we examine: the average loss in tax revenue from corporations in our five Sub-Saharan African countries is 1.0% (1.7%) of baseline GDP in the three-month (five-month) shock scenario, while it is 1.9% (3.0%) in the middle-income countries. This is because middle-income countries have larger formal sectors, higher effective tax rates and sectoral compositions which produce a slightly stronger revenue shock.

Our analysis faces several limitations. First, it only considers a demand shock— arguably the key direct impact of COVID-19 (Coibion et al. 2020)— and assumes that firms have no problems sourcing inputs; in practice the pandemic also induces a supply shock which can amplify the demand shock (Guerrieri et al. 2020). Second, we do not account for the indirect impacts of the shock through firms’ trade linkages which are potentially important (Baqaee and Farhi 2020, Bonadio et al. 2020). Third, in our framework firms do not adapt to the crisis (for example by changing products, selling online etc.). Fourth, profits in administrative tax data could be under-reported for tax minimization purposes, so that firms in our data might exhibit artificially low profitability in the pre-Covid baseline. Taking into account caveats (i)-(iii), the numbers in this paper could be considered as plausible lower bounds arising from direct effects, in partial equilibrium, without taking into account the full set of government support policies. Dynamic general 4