I am viewed as being an opponent of fiscal stimulus, but I’ve always argued that an employer-side payroll tax cut would “work.” It just seems kind of pointless. If it’s a lower W/NGDP ratio that you need, just boost NGDP! Christina Romer has also advocated this sort of payroll tax cut. It lowers a country’s labor costs in much the same way as a currency devaluation. If you add on a VAT increase it can even be revenue neutral, which keeps the Very Serious People on board. Since it’s supply-side, no monetary offset problem. What’s not to like? Larry sent me the following.
When French President Francois 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.
Gopinath, 41, a professor at Harvard University in Cambridge, Massachusetts, has pushed for tax intervention as a way forward for euro-area countries that cannot devalue their exchange rates. “Fiscal devaluation” is helping France turn the corner during a period of extreme budget constraints, former Airbus SAS chief Louis Gallois said in a business-competitiveness report Hollande commissioned. . . .
“Gita is already a major star, at the top of her cohort in international macroeconomics and still rapidly growing as a scholar,” Rogoff said in an e-mail. “Her empirical work on price rigidities is simply stunning and has had everyone going back to the drawing boards. Her theoretical work on international debt and default defines the state of the art in the field,” he said, calling her strategies for the euro zone to achieve internal devaluations “very influential.” . . .
The paper examines a “remarkably simple alternative” that doesn’t require countries to abandon the euro and devalue their currencies, Gopinath said. By increasing value-added taxes while cutting payroll taxes, a government can create very similar effects on gross domestic product, consumption, employment and inflation.
The higher VAT raises the price of imported goods as foreign companies pay the levy. 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 cheaper 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 said.
I’m glad her ideas are getting attention, but I can’t help wondering why this took so long. If it’s higher inflation they want why not just do monetary stimulus? The ECB was raising interest rates as late as 2011 in an attempt to reduce inflation. When I recommended easy money for the eurozone all sorts of European commenters would come over here an insist that Europe doesn’t need inflation, their problem are “structural.” ”Mind your own business.” Now we learn that they do need higher inflation.
Unless I’m mistaken this is the sort of policy that only makes sense if you have a dysfunctional central bank that refuses to do the right thing, and hence you must do an end run around that institution.
PS. I suppose some will cite the “one-size-fits-all problem,” but that doesn’t apply to the eurozone, as even German inflation is down to 1.0%. They all need higher inflation. (Actually higher NGDP growth.)
PPS. The article might be difficult for non-economists. Just to be clear, the higher VAT approach doesn’t give you any permanent boost to trade, just a boost until nominal wages adjust. VAT does NOT favor exports over imports.
PPPS. I see Krugman’s going from Princeton to CUNY. Bernanke’s joining Brookings. Woodford left Princeton for Columbia. I’d say losing Woodford, Bernanke, and Krugman slightly weakens their monetary econ program. But they still have Lars Svensson. And Svensson is still writing great posts. I love the way Britmouse describes the Svensson post:
Via Mr. Svensson, still methodically attacking the madness.