Categorized | Currency, Tax

French increase VAT rather than devalue currency


From Business Week

Harvard Economist Gita Gopinath Offers a Euro Cure

By  on February 14, 2013

When French President François Hollande unveiled a plan in November for a business tax credit and higher sales taxes as a way to revive the economy, he was implementing an idea championed by economist Gita Gopinath. A 41-year-old professor at Harvard University, Gopinath has pushed for tax intervention as a way forward for euro-area countries that can’t devalue their exchange rates. This so-called fiscal devaluation is helping France turn the corner at a time of extreme budget constraints, former Airbus chief Louis Gallois said in a report on France’s business competitiveness commissioned by Hollande.

Gopinath’s understanding of the theory took shape through her years teaching at Harvard and the University of Chicago, and particularly as a Ph.D. student at Princeton under the guidance of economists Kenneth Rogoff, Pierre-Olivier Gourinchas, and Ben Bernanke, now chairman of the Federal Reserve. While her earlier work on current accounts and balance of payments garnered praise, it’s her recent focus on the 17 euro-zone nations that has national leaders paying attention. “Gita is already a major star, at the top of her cohort in international macroeconomics and still rapidly growing as a scholar,” Rogoff says in an e-mail. He calls her internal devaluation strategy for the euro region “very influential.”

Gopinath, the first Indian woman to receive tenure at Harvard, grew up in the South Indian city of Mysore. Like many Indian high school students, she sought her parents’ advice on what to study after graduation; the Gopinaths wanted their daughter to land a respectable job as a government official in the Indian Administrative Service. The best way to achieve that, friends told them, was a bachelor’s degree in economics from the University of Delhi. “It was purely accidental,” Gopinath says. “Luckily, I found out fairly quickly that I had more of an academic leaning and little aptitude for administration.”

Her bachelor’s degree in economics from the university’s Lady Shri Ram College for Women in 1992 was followed by two master’s degrees, and a doctorate from Princeton in 2001. She taught at the University of Chicago from 2001 to 2005 before moving to Harvard.

The idea of fiscal devaluation originates with John Maynard Keynes. 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. “Despite discussions in policy circles, there is little formal analysis of the equivalence between fiscal devaluations and exchange-rate devaluations,” they wrote. “This paper is intended to bridge this gap.”

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.

As part of France’s fiscal devaluation, Hollande has offered French companies a €20 billion ($27 billion) tax cut on some salaries as he attempts to turn around an economy that has barely grown in more than a year. He’ll also lift the two highest VAT rates.

The plan was inspired partly by Gopinath’s paper, says Harvard professor Philippe Aghion, an informal campaign adviser to Hollande, who was elected president in May. Aghion co-wrote a column in Le Monde last October urging fiscal devaluation. Airbus’s Gallois then proposed the strategy to Hollande. “We contributed to the adoption of the policy by Hollande, and Gallois called to thank me,” Aghion says. “There is wider interest in the policy. Italy, Spain, Greece—they should all be interested. It’s an idea that would work.”


The bottom line: Gopinath’s theory has so impressed the French that Hollande has proposed a $27 billion tax cut for French companies.


11 Responses to “French increase VAT rather than devalue currency”

  1. W. Raymond Mills says:

    This academic study was limited in scope. She showed only that Value-added tax was equivalent to currency devaluation. The suggestion for a reduction in payroll tax was added in the hopes to compensate for the fact that French consumers would pay more than foreign consumers for French produced goods.

    Both or either of a value-added tax or currency devaluation will increase exports and/or reduce imports so long as other nations fail to use the same tactics. Mercantilism, in any form, works only as long as other nations refuse to respond in kind. When everybody devalues their currency or uses valued added tax to increase exports, the benefits of these actions disappear. That said, each nation should protect its own interests. I have long advocated additional tariffs on imports from China, Japan and Germany as a necessary response to their mercantile behavior.

    There is a way out of this mess. All nations should embrace balanced trade. Once that goal is accepted, it is clear that currency devaluation, tariffs or Valued added taxes should be acceptable only from nations who have a trade deficit to overcome. Why economists do not embraced this perspective is a mystery to me.

    France should use the value added route because they had a trade deficit of 2.1% of GDP in 2012. Three other large countries also should use some kind of mercantile actions because they each had a trade deficit of 3% or more in 2012 (Great Britain, Canada and the U.S.)

    One other point. This article implies that a value added tax is equivalent to a subsidy - using governmental power to increase exports and reduce imports.

  2. Shinichiro Takizawa says:

    Dear Sir:

    Please forgive me Sir for my discourtesy.

    Why no one points out the existence of state-sales-taxes?
    (I donot know the exact name of this state-tax.)
    (I am not a specialist of any field.)

    For example,

    California State: about 9.5%
    New York State: about 9%
    Florida State: 6.5%

    are taxed when you buy something in there.

    And, besides, there is use tax in the U.S.
    Are you talking about transfer of taxes from States to Federal?
    What is the difference of effects between state-sales-taxes and VAT?

    Very sincerely yours,
    Shinichiro Takizawa

    • W. Raymond Mills says:

      VAT tax is collected on imports; rebated on exports. Gives a financial advantage to exports. Researcher claims same advantage to exports and penalty to imports as a devaluation of currency.

      Sales tax is collected on all sales, ignoring whether imports or exports. Sales tax has no impact on size of trade deficit. VAT does. It increases trade deficits in country like U.S. and increases trade surplus in country like Germany.


      • Mo says:

        Raymond many countries with VAT taxes have trade deficits. Any increase in VAT taxes will not only increase the price of exports but also goods produced in that country. The countries with VAT taxes that have high trade surpluses either have higher savings than the US or have tariffs on top of the VAT that get applied to US exports.

        The VAT tax is not the problem because the VAT puts domestic and foreign producers on a level tax playing field. If you look at a country like China, they have the following other taxes that may be added on top of the VAT for certain imports:

        Import Duties 0-35% (motor vehicles 34.2%)
        VAT 17%
        Consumption Tax 5-10%

        Check out link below to see what taxes are applied on top of the VAT when exporting to many countries.

        Duties and Value Added Taxes

        • W. Raymond Mills says:

          Tom - if you agree that VA taxes get rebated to the companies that produced the product, how can you say that those taxes increase the price of exports? And imports pay the VA tax when entering the country with no rebate to anyone. You say “VAT puts domestic and foreign producers on a level playing field”. Not so with rebates provided to exporters and overseas producers must pay a VAT that is not rebated.

          Please deal only with VAT. Other issues such as other taxes, etc. only cloud the subject.

          The issue is what impact does VA taxes have on the ability of a country to sell more exports and discourage more imports. Whether other taxes are added or whether a country does or does not have a trade deficit is irrelevant to the question of the consequences on exports sent out and sold overseas and consequences on imports sold in Germany or any other nation that used VA taxes.

          If the exporter from Germany can sell the product overseas for the same price as sold in Germany, the rebate just adds to his profit. But if competition requires a price reduction to sell the product overseas, the rebate provides the opportunity for the exporter to reduce the price overseas and still get the same profit as he would get selling in Germany.

          Also, the comparison with a sales tax is irrelevant. A sales tax is collected on all goods, whether produced domestically or imported. It provides no advantage to exports nor no disadvantage to imports.

          • Tom T says:

            Raymond, it seems to me that the VAT tax is a tax on value added. That means that any products that have value added are taxed more than raw materials. All countries want raw materials cheap and for their labor force to use those raw materials to add value (and add employment).

            This is how VAT taxes differ from sales taxes which don’t care about the value added but the only the purchase price.

            If your tax system is not taxing items like raw materials as much and are taxing value added materials more, then the tax system is basically like an import tax on value added items more than raw commodities for instance.

            From a practical note, I could care less if the tax is a level playing field. If a country is hemorrhaging economic activity because they have a continual higher value on their currency, that country’s value added (employment) will decrease over time. When every country in the world runs to the U.S. dollar in times of crisis, for instance, because we have a strong dollar based on our strong military, it makes the dollar strong. The strength of this dollar in this way makes manufacturing or value added work less valuable in that country.

            To me, all of these issues have caused the U.S. manufacturing and value added work in the U.S. to be worth less. That means pressures on wages. At this point in time in our economic history, this is the main problem we are having and will continue to have because of the above factors.

            One can not compare China’s VAT to taxation in the U.S. but we can see that there are problems when we have perennial trade deficits and subsequent lower labor (wage) values over longer periods of time. In the case of China, the government has captured the value of economic activity because they have by dictate, not free markets, been allowed to capture that value via currency manipulation and a whole host of limitations. Comparing a VAT to China (put in country X) is, because of this, pretty ridiculous.

            In the case of VAT taxes of the U.S. vs. Germany, the U.S. is losing its ability to tax economic activity that the Germans capture with their system. This is not included in the VAT analysis. This goes to show that the outcomes are better data than the assumptions to those outcomes. With huge continual trade deficits, one would think that this would become apparent to our plutocrats. Perhaps it is but they are just using this as an excuse to continue trade agreements that don’t fix the underlying problems. They must want U.S. labor to be pushed to the world’s labor standards since there is so much money to be made by those who control the benefits of those differences regardless of what it doing to the U.S. economy through their labor force.

            Tom T.

  3. China Watcher says:

    It’s no mystery, Raymond. Scratch a “free trader” and you discover a mercantilist. Surplus countries love their surpluses and espouse “free trade”; deficit countries hate their deficits and preach “balanced trade.” Unless the deficit countries take all appropriate steps — in the domestic as well as the international economic realm — to end their deficits, the surpluses will go on until the entire system falls from the weight of the accumulated imbalances.

  4. Tom T says:

    The way this VAT works smells suspiciously like a tariff by another name, I think Shakespeare would say.

    Countries with trade imbalances should have the ability to collect tariffs until they fix the structure of their internal economy so they don’t hemorrhage their wealth. We have this ideological idea that tariffs are a no no unless they become wrapped in another form like this lady’s solution.

  5. W. Raymond Mills says:

    Tom T. Where do you settle after all the discussion? What should we do next? Persuasion. But who of what?

    1. General public. Can recognize that store shelves filled with products made overseas is not good. But do not recognize that lots of imports would be OK if we had an equal number of exports. It is the difference in two numbers that is important. Apparently that abstraction is too complex for general understanding. Or is it? Maybe we need to keep saying “It is the size of the trade deficit” - dare we add “Stupid”?

    2. Economists. This is the harder nut to crack. No one wants to say that the emperor has no clothes. Paul Krugman is the ideal person to lead a revolution among economist. He has said in passing that the trade deficit plays a part in our slow economic growth. But only one sentence, so far as I know. If a person with his stature cannot bring himself to speak truth to power, who can? I am still waiting for a serious discussion among economists of the impact (or lack of impact) of 36 years of a continuous trade deficit on the ability of the U.S. economy to produce goods and services that will sell on the global market. The miracle (in my mind) is that we still have some manufacturing firms in the U.S. that can sell on the global market despite years of headwinds created by both domestic and foreign governments.

    3. Solutions. Those of us who think we know which solutions should be advocated are hard headed, stubborn and unwilling to compromise. Each of us seems to have settled on THE ONE solution.
    I am among the worst. I think any solution other than a U.S. law that gradually increases tariffs of all imports manufactured in China, Germany and Japan has not sufficiently considered current realities - sunk investments, many by U. S. firms, the need for saving face among national leaders of China, Japan and Germany, the need for support among other nations for any action we take.

    4. Input. Many minds need to get involved in brainstorming - how to persuade the general public, how to persuade economists, how to agree on the best solution.

  6. Milt Heft says:

    All the above conversations are built on the assumption that our predicament is a result of open, competitive trading. That the deficit is due to the low price of foreign competitors and that Americans are simply buying the cheapest goods. RUBBISH! Have we forgotten that 50,000 AMERICAN companies have voluntarily closed their business here and moved to China, et al? Leaving 5 million productive Americans unemployed? Have we forgotten the word OUTSOURCING? We are not the victims of a competitive game - we are victims of American OUTSOURCERS who want more. We are doing this to ourselves. Yes, we can raise tariffs and thus reduce imports to achieve a better balance. We might also consider shaking the outsourcers by the neck and reminding them that they are also American citizens.

    • Tom T says:

      Milt, you hit the nail on the head. The outsourcers were able to keep their markets here and move the economic activity off shore where they made larger margins. Countries like China that were manipulating their currency to make this happen (buying U.S. jobs) and other countries using other methods that gamed the supposed “free market” system became the winners while the U.S. economic activity was a loser. Free trade is beneficial when the nations have balanced trade surplus/deficits on average. A year off here or there is fine as long as it is not a long term problem. I say devalue all of the outsourcer’s investments by tariffs or some sort of Buffet plan. The hemorrhage of jobs and economic activity has been too costly to the general welfare of the country and its economic activity. We have allowed outsourcers to arbitrage mercantilst policy differences between world economies to the detriment of our economy. In return, the capture of dollars by the Chinese govt. has put us at a huge strategic disadvantage— as much as a huge military advantage (which we learned from the cold war was highly correlated). In so doing, we have created a class of investors here in the U.S. who have profited by selling the country out. We owe them nothing, despite the economic power they hold.

      Raymond, I guess my solution would be to recognize the above first and that the continuance of such policies only puts us further in trouble. Second, do SOMETHING NOW. ANYTHING is better than allowing the cart to coast towards the proverbial cliff.

      Our budget deficits could be solved if people in the economy were able to get adequate income from the economy instead of being sold out by outsourcer investors and globalists. It seems that those who have the VAT taxes understand this and implement it in their trade tax policy. We do not. We allow those who are undermining the economy to benefit from their arbitrage and somehow we call that “good business” by allowing them to profit from it.

      I think our political leaders should be graded on their results, not on their action, as we currently judge them. In trade, it is the balance of payments, not some new free trade agreement. They have to see that it is unsustainable to rely on foreign investment to fund our government as the above process undermines the economy domestically.

      Tom T.


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