ABSTRACT
This paper presents the argument for a fiscal devaluation as a policy to adjust to external imbalances within the eurozone applied to the case of Portugal. From 1995 to 2010 Portugal has accumulated a negative international asset position of 110 percent of GDP. In a developed and aging economy the num- ber is astonishing and any argument to consider it sustainable must have relied on extremely favorable growth forecasts. Portuguese policy options are reduced in number: no autonomous monetary policy, no currency to devaluate, and limited discretion in changing fiscal deficits and government debt. To start the necessary deleveraging, a remaining possible policy is a budget-neutral change of the tax structure that increases private saving and net exports. An increase in the value added tax (VAT) and a decrease in the employer’s social security contribution tax (ESSC) can achieve the desired outcome in the short run if they are complemented with wage moderation or if nominal wages are sticky. To obtain a substantial improvement in compet- itiveness and a large decrease in consumption, the changes in the tax rates have to be substantial: a swap of 1 percentage point of GDP from social security contributions to VAT revenues achieves a decrease in real imports of 13.6 percent within 8 quarters and an improvement of real exports of 8.4 percent within 5 quarters without significantly affecting the fiscal budget. The increase in the effective VAT rate could be obtained by raising part of the reduced VAT rates to the general VAT rate. Finally, in theory, coordi- nated fiscal devaluations could be the basis for competitiveness realignments within the monetary union.
