Spain should impose fiscal devaluation to restore competitiveness, experts say

The panel of experts selected by Finance Minister Cristóbal Montoro to draw up proposals for an overhaul of the tax system has suggested that the government impose a so-called fiscal devaluation that would consist of higher indirect tax rates to offset a cut in Social Security contributions made by employers with a view to boosting competitiveness, sources close to the panel said.

This formula would drive exports by lowering the cost of producing goods in Spain because of the cut in social contributions, given that overseas shipments are exempt from value-added tax. At the same time they would make imports more expensive because of the increase in VAT, thereby helping to improve the country's trade balance. This also would have a positive impact on employment but would have little effect on overall GDP.

The report the panel -- which is headed by university professor Manuel Lagares -- is due to deliver on Friday is expected to be along the lines of recommendations by international organizations such as the International Monetary Fund, which tend to be broad with few concrete details. It will not, for example, suggest specifically that the standard VAT rate of 21 percent be raised.

The main problem facing the government in implementing fiscal devaluation is the scant room it currently has to cut social contributions despite the fact that these in Spain are among the highest in Europe, at 35.35 percent of gross salary between employers and employees. This is due to high unemployment and wage devaluation as a result of the crisis causing an imbalance in the state pension system, which is currently paying out more than it is taking in. A cut in Social Security contributions would further exacerbate the shortfall.

The Finance Ministry has said that its planned tax reforms will be phased in between 2015 and 2017 and in theory a fiscal devaluation could be delayed until economic growth has been restored to levels that would allow a cut in social contributions.

One of the studies the panel has drawn on was produced by José María Labeaga, a professor at the National Distance Education University (UNED) and former director of the Institute of Fiscal Studies (IEF) for the European Commission. Labeaga concludes that a fiscal devaluation would add a few percentage points to GDP growth, while the positive impact on employment would have run its course in four years.

Other studies conclude that a reduction in social contributions equivalent to 1 percent of GDP (about 10 billion euros), offset by an increase in consumption taxes of the same magnitude, would improve the current account balance by between 1.4 and 2.4 percentage points of GDP.

Other experts have suggested that a cut in social contributions could be balanced out with a matching increase in VAT revenues, by applying the standard rate to goods and services currently subject to reduced rates rather than by an increase in the standard rate. This would be more in keeping with the thinking of the government, which is loath to further increase VAT rates.