Presentation on theme: "Fiscal Policy to Fine-Tune the Economy"— Presentation transcript:
1 Fiscal Policy to Fine-Tune the Economy Economic ModellingLecture 10Fiscal Policy to Fine-Tune the Economy
2 Objectives of Fiscal Policy Macroeconomic stabilisationHigher growth rate of outputFull employmentStable prices:low rate of inflationstable interest rate and exchange ratesEquity: horizontal and verticalEfficiency in resource allocationProvision of public goodsExternalityMarket failurePublic private partnership
3 Instruments of Fiscal Policy TaxesDirect (income, wealth)Indirect (VAT, Excise, Tariff and duties)Subsidies (consumption and production)SpendingPure Public goods ( defence, law and order, roads)Semi-public goods (education, health, sanitation)DebtBorrowing from the private sector -Crowding OutFrom the central banks -inflationary tax
4 Who Bears the Burden of Taxes and How does tax-spending affect the economy? Stabilisation roleEconomic certainty, growth dividendProducersLabour supply (work hours, leaves, retirement)Production: taxed sectors vs. subsidised sectorTrade: domestic vs. foreign goodsExcise dutiesConsumersCurrent vs. future consumptionComposition of consumption(VAT and market prices, Sin goods)Traders and investorsChoice of trading partnersLocation investment
5 Golden Rule of Fiscal Policy in the UK Over Economic CyclesGovernment 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.
6 Macroeconomic Stabilisation Role of Tax and Spending T = tYT > GSurplus in boomG = TTaxandSpendingGGT < GDeficit inrecessionYFIncomeT
7 Balanced Budget Multiplier with Lump-Sum Taxes The real national income is given by the IS Curve:Positive Government expenditure multiplier:.Negative tax multiplier:The balanced budget multiplier:=1/(1-c1) - c1/(1- c1) = 1A change of 100 in both G and T also raised income by 100.Balanced change in G and T is not macro economically neutral.
8 Automatic Stabiliser with Proportional Taxes Consumption:Disposable income:Tax RevenueIncome (IS curve):Y = c0 + c1YD + I + GHigh T when Y is high.Low T when Y is low.The multiplier = 1/(1-c1+c1t1) <1/(1- c1),so the economy responds less to changes inautonomous spending when t1 is positive.
9 How much should be the tax rate to maximise the government revenue ? Tax complianceR-maxRevenueTax avoidanceTax evasionR-lowRevenue=F(t)Tax ratetHt-Lowt-Rmax
14 How High Should be Public Spending? Costs of public spendingCost andBenefitOf spendingC = BBenefits of spendingG*Size of spending
15 (www.HM-Treasury.gov.UK/Economic Data and Tools)
16 (www.HM-Treasury.gov.UK/Economic Data and Tools)
17 (www.HM-Treasury.gov.UK/Economic Data and Tools)
18 References http:/www.hull.ac.uk/php/ecskrb Blanchard (5, 7, 26) ,Aghevli B B (1977), Inflationary Finance and Growth, Journal of Political Economy, vol. 85, no.6 ppBarro, R. J. (19740, "Are Government Bonds Net Wealth?," Journal of Political Economy ppBhattarai (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, ppBhattarai 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,
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