Macroeconomic Themes:6 1

Taxing and Spending

Goals of Public spending: Provision of public goods Externality Market failure Public private partnership Role of public sector spending in productivity (Railways,

R&D)

Principles of taxation Equity Efficiency

Macroeconomic Themes:6 2

VAT16%

Corporation tax8%

Excise duties9%

National insurance16%

Income tax29%

Council tax4%

Other13%

Business rates5%

C3: GOVERNMENT RECEIPTS

Macroeconomic Themes:6 3

32.5

33

33.5

34

34.5

35

35.5

36

36.5

37

37.5

38

38.5

39

39.5

1980-81

1982-83

1984-85

1986-87

1988-89

1990-91

1992-93

1994-95

1996-97

1998-99

2000-01

2002-03

2004-05

2006-07

%

C2: Tax-GDP ratioForecast

Why Does the Tax Ratio Go Up and Down?

Macroeconomic Themes:6 4

Social security27%

Other health and personal social

services4%

NHS15%

Transport3%

Education13%Defence

6%

Law & order6%

Other expenditure12%

Housing & environment5%

Industry, agriculture & employment

4%

Debt interest5%

B4: GOVERNMENT SPENDING BY FUNCTION

Macroeconomic Themes:6 5

B3: Total managed expenditure

37

39

41

43

45

47

49

1980-81 1982-83 1984-85 1986-87 1988-89 1990-91 1992-93 1994-95 1996-97 1998-99 2000-01 2002-03

% o

f G

DP

Forecast

Macroeconomic Themes:6 6

P3: IDENTIFIABLE GENERAL GOVERNMENT EXPENDITURE PER HEAD, BY REGION AND FUNCTION, 2000-01

£ per head

Agriculture, Trade, industry, Roads Housing Other Law, order,fisheries energy and and environmenta

lProtective

and food employment transport services Services

North East 44 113 172 51 199 331North West 48 106 128 68 182 338Yorkshire and Humberside 86 120 118 48 154 314East Midlands 91 109 141 26 141 285West Midlands 72 111 127 21 144 306South West 72 104 149 21 136 293Eastern 108 109 159 11 119 285London 33 111 189 155 171 454South East 58 109 146 6 130 286

Total of all England 66 110 148 48 151 326

Education Culture, Health and Social Central Totalmedia and personal security Admin

sport services

North East 746 109 1196 2126 61 5148North West 747 76 1190 1960 46 4888Yorkshire and Humberside 742 145 1139 1764 39 4669East Midlands 700 72 1024 1648 44 4280West Midlands 744 93 1077 1755 41 4491South West 674 84 1081 1658 42 4312Eastern 696 76 1014 1518 47 4142London 767 102 1384 1636 65 5067South East 668 72 1031 1450 44 4000

Total of all England 719 90 1132 1692 47 4529

Source: Public Expenditure Statistical Analyses 2002-2003, table 8.12b

Macroeconomic Themes:6 7

-8

-6

-4

-2

0

2

4

6

8

10

1980-81 1982-83 1984-85 1986-87 1988-89 1990-91 1992-93 1994-95 1996-97 1998-99 2000-01 2002-03 2004-05 2006-07

% o

f G

DP

Public sector net borrow ing Surplus on current budget

ForecastA4: BUDGET BALANCES

Macroeconomic Themes:6 8

Why There is a Deficit or Surplus Cycle in the Current Budget?

Macroeconomic Themes:6 9

Why is the Net Public Sector Investment Declining in the UK? (Source Navidata3)

Macroeconomic Themes:6 10

How much should be the tax rate to maximise the government revenue ?

Revenue

Tax rates Tax rates

Macroeconomic Themes:6 11

A Simple Laffer Curve Model:A Numerical Example

2250 tttR W h e r e R i s r e v e n u e i n b i l l i o n o f p o u n d s , t i s t h e t a x r a t e .T h e t a x r a t e t h a t m a x i m i s e s t h e r e v e n u e i s g i v e n b y

0450

t

ttR

t = 1 2 . 5

T h e r e a r e t w o t a x r a t e s t h a t c a n r a i s e t h e s a m e r e v e n u e .2250200 tt

0100252 tt ;2

)100(42)25()25(1

t =

20,52

15251 t

Macroeconomic Themes:6 12

How much should a government spend and how should tax revenue and government expenditure

behave over the cycle?

Social Revenue Benefit and exp

Social cost Income level

Macroeconomic Themes:6 13

Keynesian Balanced budget multiplier argumentT h e n a t io n a l in c o m e in e q u i l ib r iu m .

TcGIcc

Y 1011

1

G o v e r n m e n t e x p e n d i tu r e m u l t ip l ie r g iv e s th e c h a n g e in in c o m e d u eto c h a n g e in o n e u n i t o f g o v e r n m e n t e x p e n d i tu r e . I n th i s c a s e th i s

i s g iv e n b y 1 / ( 1 - c 1 ) ,

111cG

Y

. O n e u n i t in c r e a s e in ta x e s

r e d u c e s th e in c o m e b y c 1 / ( 1 - c 1 ) u n i t s ,

111c

c

TY

.

O n b a la n c e i f b o th T a n d G in c r e a s e b y th e s a m e a m o u n t , th eb a la n c e d b u d g e t m u l t ip l ie r i s

TY

GY

= 1 / ( 1 - c 1 ) - c 1 / ( 1 - c 1 ) = 1 . B a la n c e d c h a n g e s in G a n d T

a r e n o t m a c r o e c o n o m ic a l ly n e u t r a l .

Macroeconomic Themes:6 14

Keynesian Built in stabiliser approach

E q u i l i b r i u m N a t i o n a l I n c o m e

]0t1c-0[c*)1t1c1c-(1

1 GIY

T h e m u l t i p l i e r = 1 / ( 1 - c 1 + c 1 t 1 ) < 1 / ( 1 - c 1 ) .S o t h e e c o n o m y r e s p o n d s l e s s t o c h a n g e s i n a u t o n o m o u ss p e n d i n g w h e n t 1 i s p o s i t i v e .

B e c a u s e o f t h e a u t o m a t i c e f f e c t o f t a x e s o n t h e e c o n o m y ,t h e e c o n o m y r e s p o n d s l e s s t o c h a n g e s i n a u t o n o m o u ss p e n d i n g t h a n i n t h e c a s e w h e r e t a x e s a r e i n d e p e n d e n t o fi n c o m e .

Macroeconomic Themes:6 15

Macreoconomic controversy: Crowding-Out or Not?

IS2 LM3 LM1 LM1

Interestrate, i

Models I, II, IIIA IIIB

IS1

Macroeconomic Themes:6 16

Financing budget deficit by an inflation tax

T h e g o v e r n m e n t c a n b o r r o w f r o m t h e c e n t r a l b a n kt o f i n a n c e i t s d e f i c i t .

T h e b a s i c r e l a t i o n b e t w e e n n o m i n a l v a l u e s o fp r i m a r y d e f i c i t , d e b t s e r v i c i n g , n e w d e b t a n ds e i g n i o r a g e ( p r i n t i n g o f m o n e y ) i s g i v e n b y t h ef o l l o w i n g i d e n t i t y i n n o m i n a l t e r m s :

PYPBi

PYPT

PYPG

PYM

PYPB

( 1 )

Macroeconomic Themes:6 17

Financing budget deficit by an inflation tax

g

PYPB

PYPB

PYPYYP

PYPB

PYPB

PYPB ( 2 )

PY

MPYPBi

PYPT

PYPGg

PYPB

PYPB

( 3 )

PYM

YBgi

YTG

YB

. ( 4 )

T h e r e f o r e i n o r d e r t o m a k e d e b t / G D P r a t i o YB

c o n s t a n t PY

MYBgi

YTG

YB

0 o r ,

YBgi

PYM

YTG

( 5 )

E i t h e r p r i m a r y s u r p l u s o r t h e m o n e y c r e a t i o n c a nf i n a n c e t h e d e b t s e r v i c i n g .

Macroeconomic Themes:6 18

Sources of Revenue in the UK

0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

0.4

0.45

0.5

1993

1994

1995

1996

1997

1998

1999

2000

2001

Pe

rce

nt o

f to

tal r

eve

nu

eCorp Tax

Soc Sec

Inc Tax

Prod+imp

Other

Macroeconomic Themes:6 19

Debt GDP Ratio in the UK

0

5

10

15

20

25

30

35

40

45

50

1993

1994

1995

1996

1997

1998

1999

2000

2001

Quarters

Pe

rce

nt o

f GD

P

Debt

Macroeconomic Themes:6 20

ReferencesBroad Trendshttp://www.statistics.gov.uk/themes/economy/default.asphttp://www.ifs.org.uk/budgetindex.shtml; http://www.ifs.org.uk/public/bn20.pdfhttp://www.statistics.gov.uk/themes/economy/Articles/NationalAccounts/downloads/1995_UK_Analytical_Input_Output_Tables_article.pdf; www.hm-treasury.gov.uk/Economic Data and Tools

1. Aghevli B B (1977), Inflationary Finance and Growth, Journal of Political Economy, vol. 85, no.6pp. 1295-1307.

2. Barro, R. J. (19740, "Are Government Bonds Net Wealth?," Journal of Political Economypp. 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 analysiswith hetorogeneous labour” Empirical Economics, 24:4, pp.599-620.

6. 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.

7. Clark Tom , M Elsby and S Love (2001) Twenty Five Years of Falling Investment? Trends in CapitalSpending on Public Services, Institute of Fiscal Studies.

8. Dilnot A, C.Emmerson and H.Simpson (2002) The IFS Green Budget: January 2002, Institute of FiscalStudies, Commentary 87, 7 Ridgemount Street, London WC1E 7AE.

9. 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