Transcript Tax Policy Analysis Using a General Equilibrium Model

Tax Policy Analysis Using a General Equilibrium
Model
What is a General
Equilibrium Model?
A. Model Elements
 Technology – Firms maximize
profits
 Preferences – Households
maximize utility (demands)
 Endowments –Ownership of
factors
B. Equilibrium/Model Solution
Macroeconomic Themes:8
1
How Do Taxes or Subsidies affect Affect Production in the Economy- A
Look at the Sectoral Supply in the UK 1999
Structure of value added in the UK
5
1
6
2
25
3
4
8
9
11
12
24
1 Agriculture, hunting, forestry & fishing [1,2,3]
14 Basic metals and metal products [54-61]
2
2 Mining of coal and nuclear fuel [4]
15 Machinery and equipment [62-68]
3
4
3 Extraction of mineral oil and natural gas [5]
16 Electrical and optical equipment [69-76]
5
6
4 Other mining and quarrying [6-7]
17 Transport equipment [77-80]
7
8
5 Food and beverages [8-19]
18 Other manufacturing [81-84]
6 Tobacco products [20]
19 Electricity, gas & water supply [85-87]
7 Textiles and textile products [21-30]
20 Construction [88]
8 Wood and wood products [31]
21 Wholesale & retail trade; repairs; hotels, restaurants [89-92]
1
10
7
13
14
15
16
17
18
19
9
10
11
12
13
14
9 Pulp, paper and products, printing and publishing
[32-34]
10 Solid and nuclear fuels, oil refining [35]
22 Transport, storage & communication [93-99]
11 Chemicals and man-made fibres [36-46]
24 Public admin., national defence & social security [115]
19
12 Rubber and plastic products [47-48]
25 Education, health & social work [116-118]
20
13 Non-metallic mineral products [49-53]
26 Other services including sewage & refuse disposal [119-123]
15
16
17
18
22
20
21
23 Financial int, real estate, rent & business activities [100-114]
22
21
23
24
25
Macroeconomic Themes:8
2
Use
TOTAL OUTPUT
Total intermediate consumption
Taxes less subsidies on production
Compensation of employees
Gross operating surplus
}
GVA
(Primary Inputs)
TOTAL OUTPUT
Macroeconomic Themes:8
3
Change in inventories
Valuables
INTERMEDIATE
DEMAND
at purchasers' prices
Gross Fixed Capital formation
S
U
P
P
L
Y
P
R
O
D
U
C
T
General Government
T
O
T
A
L
FINAL DEMAND at
purchasers' prices
NPISHs
Note: Supply table
industry / product detail is
not available due to
disclosure rules
Taxes less subsidies - products
DOMESTIC
SUPPLY
at basic prices
Distributors' trading margins
P
R
O
D
U
C
T
INDUSTRY
Imports - goods and services
INDUSTRY
Total intermediate consumption
Households
Supply
Income, Cash and In-kind Benefits and
Transfers and tax rates, Leisure and Labour
Supply by Household Categories in the UK
Or-incm
NcBen
DirCash Dirtax
Indirtax
InkindBe PWn
earng
2648
177
Work Leisure
wk
13
16107
totol
income
17380
consump net transf Tax
tion
Rates
4962
-3689
0.1354
H1
1273
256
3138
657
1696
H2
2325
2331
2780
739
1524
2834
200
23
16200
18525
8007
-5682
0.1222
H3
4371
2921
2748
1164
2179
3286
223
41
14049
18420
9983
-5612
0.1815
H4
7964
2678
2529
1916
2790
3258
247
55
12103
20067
11723
-3759
0.2345
H5
12799
2152
2016
2914
3427
3461
269
64
10760
23559
14087
-1288
0.2692
H6
18449
1598
1708
4194
4179
3456
294
70
9996
28445
16838
1611
0.2944
H7
24700
1196
1206
5703
4828
3388
354
69
12390
37090
19959
4741
0.2839
H8
31677
931
963
7256
5552
3620
413
70
14042
45719
24383
7294
0.2801
H9
40931
999
765
9558
6535
3726
475
84
9500
50431
30328
10603
0.3191
H10
75548
713
563
17874
8199
3674
537
91
6981
82529
54425
21123
0.3159
Source: Based on Table 9 (Appendix 1) of Economic Trends, 2000/01, p. 63, and authors’ own
calculations. Further explanatory notes are given over.
Macroeconomic Themes:8
4
Household
Preference, Budget and Demand
and demand
Utility
U
h

  

 i

 i,hC h  
i,h


L h 
h h 
1
h

(1)
Budget
I  r (1 t ) K  (1 t h )wL  TR
h
k h
h
h
l
(2)
Consumption demand
C 
i,h











 i,h I h


 
 
 h


 h
 h


v
v
h
Pi (1 t )     Pi 1 t      w1 t  
i   i i,h   i  
h   l 






 


 

(3)
Leisure demand
L 
h








 









 h .I h
v  


 

w1 t h   h   Pi 1 tt   h    w1 tth   h

h 
l 


i i,h  
Macroeconomic Themes:8





 


 

(4)
5
Labour Supply Production and Revenue
Labour supply
LS  L  L
h
h h
(5)
Production
Yi  i ((1  i )(K )
i
i
1
 
  i (Li ) i ) i
(i  1.. N )
max  i  Pi X i  wLi  rK i   P j M j,i
j
(6)
(7)
Revenue
 TRh  t k rK i   tiv Pi Ci,h   tlh wLS h
i
h
h
h
Macroeconomic Themes:8
(8)
6
Definition of a Competitive Equilibrium
In this model a competitive equilibrium is given by prices of consumption
goods, Pi ; the rental rate of capital r ; a wage rate for labour,w ; and levels
of gross output,Yi ; capital use,K i ; and sectoral use of labour, Li ; such
that,
i)
markets for goods and services, labour and capital clear; and
ii)
the government budget constraint is satisfied
iii)
households and firms optimise subject to the budget and technology
constraints.
Macroeconomic Themes:8
7
Market Clearing Conditions
Goods market
N
X i  Ci   aij X j
j 1
(9)
where Ci   Ci,h is household final consumption, and  aij X j the
j
h
intermediate demand.
The capital market clearing condition implies
 K h   Ki
i
h
(10)
and labour market clearing implies:
 LSh   LSi
i
h
(11)
Government budget balance is given by (8). When there are n
different markets in the economy, relative prices that clear n-1 markets
Macroeconomic Themes:8
clears the nth market as well.
8
Evaluation of Efficiency Impacts








U h U h 
B Ih
EV h  C

h
 C
U
B 







(12)

U h U h 
C Ih
CV h  B

h
 B
U
C 
Macroeconomic Themes:8
(13)
9
Compensating and Equivalent variation in money metric
utility after tax changes: Continuous Case
C
EV
A
CV
B
O
Macroeconomic Themes:8
10
Types of General Equilibrium
Models
 Goods /Factors (22)
 Dynamic /Static
 Open (goods/factor flows)
/closed
 Perfect Competition /Market
structure
 With government expenditures
(Lindahl equilibrium)
 Multiple households
/individuals
Macroeconomic Themes:8
11
Reasons for Using General
Equilibrium
 Capture economywide effects
of policy and other changes on
resource allocation and
distribution
 Theoretical approach is the
most widely used in key
applied fields in economics
(public finance, trade,
environment, and others)
 Resource allocation and
distributional effects not
captured in econometric or
other approaches
Macroeconomic Themes:8
12
Normative Content of General
Equilibrium Models
 Two Fundamental Theorems of
Welfare Economics
- Any competitive
equilibrium is
Pareto
Optimal
- Any Pareto Optimal
allocation can be supported
as a competitive equilibrium
with appropriate lump sum
transfers
 Any no tax equilibrium is
Pareto Optimal; any with tax
equilibrium reduces welfare
(unless, for example, tax offsets
externality (petrol tax))
Macroeconomic Themes:8
13
Computing General Equilibrium
 In simple goods/factor model,
task is to find prices which
clear goods and factor markets
 Equilibrium involves consistent
optimization by consumers
(maximize utility) and
producers (maximize profits)
at the same set of prices; with
market clearing
 We use GAMS (Generalized
Algebraic Modelling System)
software; optimization code, in
which equilibrium conditions
enter as constraints
Macroeconomic Themes:8
14
Designing an applied general
equilibrium model
1. Identify problem/focus of
analysis
 In this case, what are resource
allocation effects of various
changes in tax treatment of
various types of capital assets
(structures, long lived assets,
short lived assets, vehicles) by
industry?
 General purpose versus issue
specific modelling
Macroeconomic Themes:8
15
2. Choose structure of the
model, given problem
definition
Broad Issues of Design
 Static /Dynamic
 Open /Closed
 Treatment of policy
variables (taxes)
 Treatment of
government
More Specific Design Issues
Macroeconomic Themes:8
16
3. Assemble data for base case
equilibrium to which the
model is to be calibrated
 Characteristics of
benchmark equilibrium
data set for base case
(Model equilibrium
conditions satisfied)
 Initial input data from
which the benchmark
equilibrium data
constructed (National
Accounts,
I-O, Tax data, trade data,
household survey data)
Macroeconomic Themes:8
17
4. Model Comparisons /Results
 % changes in factor use by industry
Commodity demands
Household income
Trade volumes
 Measures of improvement or worsening in resource allocation
Money metric measures of change in welfare (Hicksian Equivalent or
Compensating variations)
Arithmetic sum of EVs or CVs
 Measures of distributional impact
 Gini coefficient
 Percentile shares
 Gross or net of tax
 Effects of capital taxes in the UK by asset and by industry
Macroeconomic Themes:8
18
Flow Chart of Model Use
Raw Data
(National Accounts, IO, tax,
trade, household survey)
Adjustments to yield benchmark
(micro consistent) data set
Model Structure,
Functional forms,
Elasticities
check
Calibration
Replication
Policy change
(Tax)
specified
Macroeconomic Themes:8
Compute New
Equilibrium
19
References
1. Aghevli B B (1977), Inflationary Finance and Growth, Journal of Political Economy, vol. 85, no.6 pp.
1295-1307.
2. Barro, R. J. (19740, "Are Government Bonds Net Wealth?," Journal of Political
Economy pp.
1095-1117.
3. Bhattarai K. (2002) Welfare Impacts of Equal-yield Tax Reforms in the UK Economy, mimio,
University of Hull.
4. Bhattarai K. (2001) A Prototype Multi-Sectoral Multi-household General equilibrium Tax Model, Hull
Advances in Policy Economics Working paper no. 9.
5. Bhattarai K. and J. Whalley (1999) “Role of labour demand elasticities in tax incidence analysis with
hetorogeneous labour” Empirical Economics, 24:4, pp.599-620.
6.
7.
8.
9.
Bhattarai and J Whalley (2000) “General Equilibrium Modelling of UK Tax Policy” in S. Holly and M Weale
(Eds.) Econometric Modelling: Techniques and Applications, pp.69-93, the Cambridge University Press, 2000.
Clark Tom , M Elsby and S Love (2001) Twenty Five Years of Falling Investment? Trends in Capital Spending on
Public Services, Institute of Fiscal Studies.
Dilnot A, C.Emmerson and H.Simpson (2002) The IFS Green Budget: January 2002, Institute of Fiscal Studies,
Commentary 87, 7 Ridgemount Street, London WC1E 7AE.
Emmerson C. and C Frayne (2002) Challenges for the July 2002 Spending Review,
http://www.ifs.org.uk/budgetindex.shtml; http://www.ifs.org.uk/public/bn20.pdf.
10. HM Treasury (2002) Reforming Britain’s Economic and Financial Policy, Palgrave.
11. Institute for Fiscal Studies (2002), The IFS Green Budget, Janaury.
12. Shoven, J.B. and J. Whalley (1984) “Applied General-Equilibrium Models of Taxation and
International Trade: An Introduction and Survey,” Journal of Economic Literature 22, 1007-1051.
Macroeconomic Themes:8
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