Fiscal policy: tax and spending
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Transcript Fiscal policy: tax and spending
Economic Modelling
Lecture 10
Fiscal Policy to Fine-Tune the Economy
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Objectives of Fiscal Policy
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Macroeconomic stabilisation
Higher growth rate of output
Full employment
Stable prices:
low rate of inflation
stable interest rate and exchange rates
Equity: horizontal and vertical
Efficiency in resource allocation
Provision of public goods
Externality
Market failure
Public private partnership
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Instruments of Fiscal Policy
• Taxes
Direct (income, wealth)
Indirect (VAT, Excise, Tariff and duties)
Subsidies (consumption and production)
• Spending
Pure Public goods ( defence, law and order, roads)
Semi-public goods (education, health, sanitation)
• Debt
Borrowing from the private sector -Crowding Out
From the central banks -inflationary tax
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Who Bears the Burden of Taxes and How does tax-spending affect
the economy?
• Stabilisation role
• Economic certainty, growth dividend
• Producers
Labour supply (work hours, leaves, retirement)
Production: taxed sectors vs. subsidised sector
Trade: domestic vs. foreign goods
Excise duties
• Consumers
Current vs. future consumption
Composition of consumption
(VAT and market prices, Sin goods)
• Traders and investors
Choice of trading partners
Location investment
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Golden Rule of Fiscal Policy in the UK
• Over Economic Cycles
Government will borrow only to invest and
not to fund current spending.
Ratio of public debt to GDP will be held at
stable and prudent levels.
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Macroeconomic Stabilisation Role of Tax and Spending
T = tY
G=T
Tax
and
G
Spending
T>G
Surplus in boom
G
T<G
Deficit in
recession
0
YF
Income
T
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Balanced Budget Multiplier with Lump-Sum Taxes
The real national income is given by the IS Curve:
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Y
c0 I G c1T
1 c1
Positive Government expenditure multiplier:
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Negative tax multiplier:
Y
1
G 1 c1
c1
Y
T
1 c1
Y Y
=1/(1-c1) - c1/(1- c1) = 1
G T
A change of 100 in both G and T also raised income by 100.
Balanced change in G and T is not macro economically neutral. 7
The balanced budget multiplier:
Automatic Stabiliser with Proportional Taxes
C c0 c1YD
Consumption:
Disposable income:
YD Y T
T t 0 t1Y
Tax Revenue
Income (IS curve):
0 c1 1
0 t1 1
Y = c0 + c1YD + I + G
1
Y
* [c0 - c1 t 0 I G]
(1 - c1 c1 t 1 )
The multiplier = 1/(1-c1+c1t1) <1/(1- c1),
so the economy responds less to changes in
autonomous spending when t1 is positive.
High T when Y is high.
Low T when Y is low.
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How much should be the tax rate to maximise the government revenue ?
Tax compliance
R-max
Tax avoidance
Tax evasion
Revenue
R-low
Revenue=F(t)
t-Low
t-Rmax
tH
Tax rate
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Laffer Curve Model:A Numerical Example
Rt 50t 2t 2
Where R is revenue in billion of pounds, t is the tax rate.
The tax rate that maximises the revenue is given by
Rt
50 4t 0 t = 12.5
t
There are two tax rates that can raise the same revenue.
200 50t 2t 2
2 4(100)
(
25
)
(
25
)
t 2 25t 100 0 ; t1
=
2
t 2515 5,20
1
2
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Tax Brackets and Effective Rates of Taxes for three Individuals
Individuals
Gross income
Personal Allowances
Taxable income
At starting rate
At basic rate
At higher rate
Total tax payment
Effective tax rate
Starting rate
Basic rate
A
B
12000
27000
4615
4615
7385
22385
Calculation tax
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192
1202.3
4502.3
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1394.3
4694.3
0.116192 0.173863
Higher rate
1920
27980
29,900
or above
Allawances
4615
C
53000
4615
48385
192
6153.4
7394
13739.4
0.259234
0.1
0.22
0.4
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Structure of Public Revenue in the UK (www.HMTreasury.gov.UK/Economic Data and Tools)
C3: GOVERNMENT RECEIPTS
Business rates
5%
Other
13%
Council tax
4%
VAT
16%
Corporation tax
8%
Excise duties
9%
Income tax
29%
National insurance
16%
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Why Does the Tax Ratio Go Up and Down?
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How High Should be Public Spending?
Costs of public spending
Cost and
Benefit
Of spending
C=B
Benefits of spendin
0
G*
Size of spending
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B4: GOVERNMENT SPENDING BY FUNCTION
Social security
27%
Other expenditure
12%
Housing & environment
5%
Law & order
6%
Defence
Industry, agriculture &
6%
employment Debt interest
5%
4%
Other health and
personal social
services
4%
NHS
15%
Transport
3%
Education
13%
(www.HM-Treasury.gov.UK/Economic Data and Tools)
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(www.HM-Treasury.gov.UK/Economic Data and Tools)
(www.HM-Treasury.gov.UK/Economic Data and Tools)
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References
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Blanchard (5, 7, 26)
http://www.statistics.gov.uk/themes/economy/default.asp
http://www.ifs.org.uk/public/bn20.pdf, http://www.hm-treasury.gov.uk ,
Aghevli B B (1977), Inflationary Finance and Growth, Journal of Political Economy, vol. 85, no.6
pp. 1295-1307.
Barro, R. J. (19740, "Are Government Bonds Net Wealth?," Journal of Political
Economy pp.
1095-1117.
Bhattarai (2003) Macroeconomic Impacts of Taxes: A General Equilibrium Analysis, University of
Hull.
Bhattarai K. (2001) A Prototype Multi-Sectoral Multi-household General equilibrium Tax Model,
Hull Advances in Policy Economics Working paper no. 9 forthcoming in Problems and Perspective
Management, Spring 2004.
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.
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, Institute of Fiscal
Studies, Commentary 87, 7 Ridgemount Street, London WC1E 7AE.
Emmerson C. and C Frayne (2002) Challenges for the July Spending Review,
HM Treasury (2002) Reforming Britain’s Economic and Financial Policy, Palgrave.
Institute for Fiscal Studies (2002), The IFS Green Budget, Janaury.
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
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•http:/www.hull.ac.uk/php/ecskrb