February 6, 2007
Beggar thy neighbor: France might just join the scheme
With the French presidential election campaign heating up, we get more and more of an idea what the leading candidates actually stand for. From an EMU point of view, especially a recently voiced idea by the conservatives’ candidate Nicolas Sarkozy is quite interesting: “Le TVA social” – a “social” value added tax. (In fact, Sarkozy had referred to this idea already in 2004, when he was Minister of Finance, but has come back to that proposal a couple of weeks ago.) This term refers to a plan according to which the VAT will be increased and the revenue be used to lower the employers’ contributions to the social security system, effectively lowering payroll taxes.
While Sarkozy’s current remarks were rather vague, he had mentioned some detailed figures in 2004: At that time he referred to a scheme that would cut the employers’ contributions by one percent of GDP, roughly € 16 bn, while increasing the standard VAT rate by 4 percentage points (in France, the standard VAT rate at the moment stands at 19.6 percent, which is close to the average for the European Union).
Lars Calmfors has dubbed this kind of economic policy “internal devaluation” as it is a real devaluation without a change in the nominal exchange rate: The companies’ domestic labour costs fall which makes their products more competitive relative to those of foreign competitiors. At the same time, imports become more expensive as the higher VAT is levied upon them.
Interestingly, this is exactly what the Germans have done this January: Part of the increase of the German VAT by three percentage points was used to lower the contribution to the national unemployment insurance, thus making German products even more competitive at a point where German price competitiveness is already at their highest at least since the early 1980s.
It is however, some kind of irony that especially France might be set to also embark in this kind of policy: French economists, businesses and media have just been bashing Germany for “beggar-thy-neighbor”-policies. And in fact the scheme of a VAT increase and a cut in the unemployment insurance contribution in Germany has exactly been such a beggar-thy-neigbor-policy: As the after-tax-price of labour (which is charged in the domestic market) remains widely unchanged because the lower labour costs are offset by higher sales taxes, domestic demand for labor can also be expected to remain unaltered. Only because the international price of labour (that is the pre-tax price, since VAT is not charged on exports) falls, there can be expected to be some additional export demand. At the same time, foreign goods become more expensive because of the higher VAT, dampening imports. This is a classical scheme to improve one’s own demand at the cost of the trading partners, much like the competitive nominal devaluation that have ravaged Europe earlier last century.
So, Sarkozy’s idea might just show that the Germans have started a round of competitive internal devaluations in Europe by refinancing their unemployment insurance with higher VAT rates. Soon other countries battling with their competitiveness might follow, with Italy or Portugal prime suspects. At the end, Europe will just have lower payroll taxes and higher VAT rates – without having improved on any fundamental economic problems.
Comments(6)
Thanks, another well-argued piece. However, I would like to point to something that the two of us have discussed over and over again.
From my point of view, there is absolutely nothing wrong with the proposition of hiking VAT in order to reduce social insurance contributions. Rather you switch from one of the most regressive and employment-unfriendly forms of financing towards a much more neutral one. Furthermore you can cope with competitive pressures (which is what the doctor will order in case of France) in a different way than just going for wage restraint, which is likely to be more harmful. While you have rightly argued in case of Germany that it should be workers not companies that should see the benefit of the reduction in the contribution rate, in the case of France it is definitely the companies that need some relief from German competition (had some nice numbers recently shared with Marc Schroers on that subject).
If at the end of the day Europe is more reliant on (indirect) taxes rather than contributions to finance its welfare state, it will be one of the most benign outcomes of european tax competition I can imagine. (With probably zero percent tax rates on the corporate tax being the most malign).
Dear David Milleker,
you are right that a shift away from payroll taxes towards other taxation might fundamentally a sensible idea. The problem, however, is, as you correctly pointed out that Germany has started the round of “internal devaluation”, a country which needs the devaluation least. I am also not quite sure whether France needs the devaluation most (although it undeniably has some problems with its competitiveness) or whether it should have been Italy or Spain which should use this path to improve their competitiveness.
The problem is that one can only do this trick so often, as from a certain level of VAT on, tax evasion especially in small craft (house repairs etc.) becomes a major problem.
Best,
Substituting the reduction in payroll taxes with higher VAT risks exacerbating the gap between the workers and the capital (in Marxian sense) and invariably tilts the balance in favour of the latter. VAT is a regressive tax if measured as a ratio of consumption tax to income. Because workers rely on income as a primary source of their wealth and do not participate in profits in the same way as capital owners do, the mechanism of tax competition you described is effectively a race to the bottom as far as poorer workers are concerned.
[...] To judge these measures, the important question is: What does France really need at the moment? Our regular guest contributor David Milleker, chief economist of Union Investment, has long argued that France needs some supply side reforms bolstering the profitability of the French corporate sector (see his contribution for the Financial Times Deutschland’s website here or his comment to our post on the “TVA sociale” here). David used to argue that the profitability of the French corporate sector is low in international comparison and that thus investment is low. Since supply side reforms tend to suppress demand in the short run, David has been in favour of a combined approach of supply and demand policies for France. [...]
[fussiness mode]
It’s ‘La TVA sociale’ not ‘Le TVA social’.
[/fussiness mode]
Yann,
you are of course right. Somehow I must have assumed that the “T” in “TVA” stands for “taux” and not for “taxe” (which of course is nonsense)…
Best,