Taxes are the Swiss Army Knife of economic and social policy. With enough ingenuity, you can attempt almost any policy goal, from encouraging health insurance to discouraging pollution to stimulating the economy, to name just three. Over at Bloomberg Businessweek, Rina Chandran explains yet another use: helping a troubled economy achieve the moral and economic equivalent of a currency devaluation, without actually devaluing. That’s particularly intriguing for countries in the Euro zone:
The idea of fiscal devaluation originates with John Maynard Keynes. [Harvard Professor Gita] Gopinath’s insight was to advocate fiscal devaluation for Europe’s beleaguered currency union in a 2011 paper she co-authored with her colleague Emmanuel Farhi and former student Oleg Itskhoki, now an assistant professor at Princeton. …
The paper examines a “remarkably simple alternative” that doesn’t require countries to abandon the euro and devalue their currencies to revive growth through exports, Gopinath says. By increasing value-added taxes while cutting payroll taxes, a government can affect gross domestic product, consumption, employment, and inflation much as a currency devaluation would.
The higher VAT raises the price of imported goods as foreign companies pay the levy on the products and services they export to that country. The lower payroll tax helps offset the extra sales tax for domestic companies, reducing the need for them to raise prices. Since exports are VAT-exempt, the payroll cost saving allows producers to sell goods more cheaply overseas, simulating the effect of a weaker currency, according to the paper. The policy also can help on the fiscal front, as increased competitiveness can lead to higher tax revenue, Gopinath says.