Saturday 10 September 2011

Fiscal devaluations

Today's "Dinheiro Vivo" supplemento to Jornal de Noticias e Diario de Noticias had an essay by me on fiscal devaluations. (It is here, but a better version is here.)

There are some pros and cons to this measure, but many of the arguments that have dominated the public debate in the last month are, in my view, not valid. In particular:

1) Fiscal devaluations have nothing to add to our deficit target, positive or negative. They are budget neutral. They are a growth measure.

2) Devaluations are not some funky idea by esoteric or disreputable economists or crazy wonks. They are part of almost every IMF plan, including those in Portugal in the early 80s.

3) The price of Portuguese non-tradables does not change with the measure. The price of imports rises, the price of exports falls, and that is it.

4) Profits are likewise unchanged.

5) Fiscal devaluation is not the same as lowering payroll taxes. Raising VAT is as important as lowering the payroll tax in the measure.

6) One feature that hasn't been given its due attention is that you have to raise the consumption tax on sectors exempt from VAT, especially real estate.

7) According to the study put out by the Bank of Portugal and several Ministries, lowering payroll taxes by 3.7% as part of a fiscal devaluation leads to a fall in the real exchange rate of about 2.2%. That is a lot. The measure has a lot of bite on competitiveness, in spite of what a naive look at the labor content of exports may show.

8) Contrary to what the press reported, that official study, in my view, supports the use of a fiscal devaluation. The study spent (too) much of its time talking about lowering payroll taxes, which is not the same as a fiscal devaluation (point 5 above). Also, its more reliable estimates show a positive impact of 0.5% of GDP to a 3.7% lower TSU plus 2.2% higher VAT combination. That's a big impact. Extrapolating, it says that if you doubled or quadrupled the measure (like I have defended, and the IMF has supported) you could get a huge impact, likely well above 1% of GDP. Show me any other measure that has that short-run impact on output.

This the summary of the essay in English, for those who do not speak Portuguese.


  1. Ricardo, não estarás a confundir o IMI (um impostos municipal anual), com o IMT, o imposto que se verifica quando há TRANSACÇÃO de imóveis?

  2. Luis,
    No meu artigo que introduziu este tópico já lá vão 18 meses, falava no IMT, mas entretanto convenci-me que o IMI será mais adequado. Porquê? Para taxar o fluxo de rendas, ou seja o serviço que vem com a habitação todos os anos.
    Num mundo perfeito seriam os dois equivalentes: aumentando o IMT, o comprador original cobraria mais por renda no futuro; aumentando o IMI, estás a taxar o comprador mas no futuro uso que ele dá à casa, o que vai afectar a sua procura pela casa inicial exactamente da mesma forma. Num mundo imperfeito, tive a impressão que era melhor ir pelo IMI para não penalizar a nova habitação e favorecer as casas já construídas. Mas, era preciso estudar as imperfeições no mercado imobiliário mais a fundo para decidir com mais certeza. Por isso, continuo de mente aberta.

  3. Não me parece boa ideia misturares neste argumento impostos sobre transacções com impostos sobre a propriedade. Gera confusão num assunto já de si difícil e pouco cristalino. E ainda mais com vantagens que não são de todo óbvias.

  4. Ricardo, thanks for the article.
    I’m also convinced we need to think about economic growth and go beyond simple fiscal adjustment otherwise we’ll never really change the country’s economic structure and move it towards a sustainable development path (including debt sustainability). In this sense, a fiscal devaluation or something of the kind given our policy constraints (namely currency) will be needed. Still I’m wondering if other complementary options have been considered seriously to distort prices in favor of exports. This would involve fiscal measures to benefit exporters in relative terms. I wonder how much can be done in EU context and whether it has been researched carefully. Maybe we could also consider a special temporary trade autonomy within EU as part of adjustment even without leaving the euro. This can be argued given all the question marks on the ability of simply reducing state involvement in the economy and other measures in the adjustment plan really boosting our growth potential.

  5. Finally, just a technicality having read the portuguese version of your article: while the move will have a clear impact on tradables, for non-tradables your conclusion that the final price will be the same is possibly debatable. Even assuming perfect competition, it will still depend on the labour content of a given commodity and the specific VAT rate. Maybe the study by the Central Bank mentions this...

  6. When Ricardo says a growth measure, he means a short run growth measure (Ricardo correct me if I am wrong): a devaluation, namely an expansionary policy to counterbalance the fiscal consolidation and reduce external deficit. Obviously Portugal also need structural changes to reallocate more efficiently resources and rebalance the external deficit.

    Regarding the allocation between tradables and non-tradables: I mentioned in my last post that PT telecom pays a social security tax of 7.8%. This is very low relative to the "general" rate of 23.4%. I wonder if other non-tradables industries also pay a reduced social security tax rate (apparently CTT also pays 7.8%).

    Basically until last year non-tradables were having
    or 1. a lower social security tax
    or 2. their products were taxed with a very reduced VAT rate (Gas and Electricity were at 6%).

  7. Dear Nuno,
    Most other measures to promote exports are forbidden by our trade union with the rest of Europe. I don't have the political/legal knowledge to know if they can be temporarily halted, but I would think the answer is a strict no.
    On your second question, for each individual good, yes, it may change slightly, as the calculations are always for averages.

    Dear Francesco,
    Yes, absolutely, short-run growth only. Stimulus may be the right word.

  8. The suggestion that "the [average] price of Portuguese non-tradables does not change with the measure" fails to allow for the increase in employment and the consequent reduction in welfare spending. When these are taken into account, we need less revenue from a larger consumption base. That allows for a fall in domestic prices of domestic products, and a smaller rise in import prices.

    The advantage of "fiscal devaluation" is not limited to trade. A VAT, unlike a tax on labour, exempts the value added by labour in the formation of capital, and therefore encourages net investment. Not all countries can be net exporters; but all countries CAN be net investors.

    One method by which the measure can be "doubled or quadrupled" is to replace or offset not only payroll tax but also pay-as-you-go personal income tax; see "Maximalist 'fiscal devaluations' for Greece and Australia".