Fiscal Devaluation: Efficiency and Equity

Whilst it is generally accepted that a shift of taxation from labour to consumption has positive effects on employment and is growth enhancing, such a policy reform is often not pursued due to equity considerations. In this paper we challenge these considerations by arguing that a fiscal devaluation is a means to shift taxes from labour to all sources of income including income from financial and non-financial wealth. Approaching income from a functional income distribution angle, we focus on the impact that a fiscal devaluation has on income from financial and non-financial wealth, from labour and from social transfers. We simulate tax shifts in the European Commission's QUEST3 model and show that a tax shift redistributes real consumption income from capital owners to wage earners. Concerning the ratio of net wage income to income from financial and non-financial assets specifically, we find that the tax shift is regressive in the short run, but progressive in the long run, if it is enacted by reducing employers' social security contributions, and is progressive already in the short run if it is enacted by reducing personal income taxes. Concerning the ratio between net wage income and social transfer income, the tax shift is regressive, especially in a situation in which transfer income recipients are not compensated for the increase in the VAT. This adverse effect on benefit recipients is partly alleviated by a positive employment effect which allows unemployed workers into employment.