For Greece, a "fiscal devaluation" is a better solution than a "temporary holiday" from the Eurozone

Martin Feldstein (Martin Feldstein) last week argued that Greece should "take a temporary leave from the right and duty to return with a more competitive exchange rate." In this article, a former economy minister of Argentina and one of its authors claimed that this idea will not work. The best solution would be to adjust the Greek tax system.

Martin Feldstein argues that in order to reduce the costs of financial restructuring, Greece should ask its European partners on a "temporary leave from the right and obligation to go back to a more competitive exchange rate" (Feldstein, 2010). In particular, he proposes to re-enter the Greek drachma, at par with the euro, it depreciated by 23%, and then return to the euro a few years later with a more competitive exchange rate is 1.3 drachmas per euro. His proposal does not include the denomination of financial contracts of the euro in drachmas (this will mean the same thing that a default on these contracts), he proposes to temporarily change the unit of measure used for pricing and payroll in the economy.

The aim of these measures is to reduce labor costs to increase exports and reduce imports (assuming that the carryover effect from devaluation to domestic prices close to zero), and thus stimulate the economy, to compensate for the reduction because of the inevitable financial adjustments needed to improve the creditworthiness of Greece (this, in turn, implies that the consequences of relying on the cost impact of the devaluation outweigh all other deterrent effect).

Eurozone as the Bretton Woods?
In fact, Marty offers to re-establish within the eurozone is the same mechanism that had existed under the Bretton Woods system that would allow countries facing severe internal and fiscal imbalances, to adjust its fixed exchange rates, after consultation with the IMF and other countries who took participation in this agreement.

In this sense, this proposal has a certain logic, but, unfortunately, it gives a course on the creditworthiness of other eurozone countries, which poses a political challenge for its adoption.

We, however, fully agree with Marty, until something is done to enhance competitiveness in foreign markets, unilateral measures on fiscal adjustment does not put Greek economy on its feet. In Greece now operates monetary agreement similar to what happened in Argentina, it prevented the country's economy to adjust more smoothly in 2001 when the country faces a crisis of confidence and scant international support, eventually, the government was forced to implement a tough program of fiscal adjustment . Social tensions caused by this and other measures (one of them was the temporary capital controls) led to the resignation of the government, the administration chose a new error rate policies, for which the country is paying to this day. One of the erroneous action has forced transfer to the peso financial contracts denominated in U.S. dollars, thus (as correctly believes Marty) Greece ought not to do it.

Will improve the competitiveness of the devaluation?
Point of contact, in which we allow ourselves not to agree with Marty - is the idea that devaluation needed to restore competitiveness. In fact, this effect could be reached by other means, which, at least in the case of today's Greece, are less disruptive, for example, by changing the tax structure, without prejudice to the collection of taxes.

In our opinion, one of the reasons for the high cost of labor in Greece is a tax on social security. It is 44% of the nominal wage, 28% of which is paid by the employer and 16% of the employee. Taken together, taxes for social security collected € 33 billion, or slightly less than 14% of GDP. Unlike the VAT, which has collected less than € 32 billion, and whose application is much broader. And all this despite the fact that the evasion of tax on wages (especially self-employed) in Greece sadly common that it is not surprising, given the high level of this tax.

Of course, there is a reason why the VAT collected less than the social deductions, despite the more widespread use and relatively low level of tax evasion (usually much harder to evade payment of VAT than from payroll tax), in addition, VAT rate is relatively lower. With reference to the fact that in Greece there is not one, but several VAT rates, which vary by product and region. Although the overall rate is 19%, on those goods which are basic necessities such as food and medicines, VAT is imposed at a rate of 9%, for books and newspapers - 4,5%. In addition, some Greek islands are subject to lower VAT than the rest of the country. Introducing economic distortions at the microeconomic level, we see that the non-uniform tax rate reduces the tax collection for a given level of average tax rate, and encourages tax arbitrage. By the most conservative estimates suggest, if the Greek government to adopt a uniform tax rate of 15% in all sectors, it will collect the same amount of money that it collects today, according to the differentiated system of rates to the maximum level of 19%.

Using a system of taxation
Given this information, in principle, be possible to reconstruct the Greek tax system so as to achieve a similar reduction of labor costs in euros, that Marty had in mind, without requiring the withdrawal of Greece from the euro zone, or damage to Revenue. This can be done as follows:
- Increasing VAT to 25%;
- Introduce an equal rate for all goods and services in the economy;
- Completely eliminating the payroll tax, or allowing firms to completely write off the cost of VAT returns (of the two options we prefer the latter because it ensures the continuation of the welfare system, while rewarding companies that met their obligation to pay payroll tax ).

The table below shows how we came to this conclusion. The increase in VAT to 25% and the introduction of equal rates would increase the charges VAT on € 21 billion (from € 31.5 billion to € 52.5 billion). This is the same amount of money that will be lost because of the permit firms to defer taxes on wages (ie, 28% of W / n, which the employer deducts social security), thereby compensating for the VAT. Although it will be almost neutral in respect of tax collection, but it will affect the economy. According to our assumption, the total labor costs (the sum of nominal wages and tax deductions) should be reduced to € 96 billion to € 75 billion. The difference in the amount of € 21 billion as a percentage similar to that meant Marty. However, in the absence of transitional or deterrent effects of the devaluation, the impact on competitiveness should be higher. Naturally, some firms will benefit more than others. But if someone wanted to encourage evading taxes, in this case nothing happens.

In conclusion, this measure, along with several others, including a 13% decline in nominal wages in the public sector and accurate debt restructuring carried out by domestic lenders, have been successfully implemented in Argentina in 2001.

Yet this was not enough to prevent a monetary and debt crisis, which occurred at the end of the year after it was promised financial aid in exchange for the implementation of these measures, the IMF suddenly decided to pull the plug on Argentina, announced in November 2001 that would not allocate funds, which promised, which caused a massive outflow of bank deposits and sovereign bonds, accelerating the development of the crisis. We hope that Germany, France and other countries in the eurozone will not allow the same mistake with Greece, which allowed the IMF to Argentina.

VOX EU