The recent crisis has revealed large differences in external competitiveness between euro area member
countries. Since nominal exchange rate devaluation is not an option for members of a currency area,
governments in troubled member countries have been considering so-called fiscal devaluation, i.e. a
shift from employers’ social security contribution to value added tax, as an alternative means to restore
competitiveness. This paper discusses the potential benefits and drawbacks of such a reform and
investigates under which circumstances it would have the intended effects. It argues that a fiscal
devaluation can have transitory effects, but that any permanent real effects are likely to be small in
size. The policy tool can thus not be a substitute for deeper structural reforms of labour, product and
financial markets. However, it may be helpful as part of a broader package of reforms.
