国家经济和社会研究所-挑战时代-英国春季预算前的经济（英）

ChallengingTimes:

oftheSpringBudget

TheEconomyAhead

9March2023

1

NIESRPre-Budget2023Analysis

ArnabBhattacharjee,PaulaBejaranoCarbo,EdCornforth,HuwDixon,HaileyLow,StephenMillard,MaxMosleyandAdrianPabst

9March2023

Contents

MainPoints 2

MacroeconomicBackgroundandFiscalSpace 3

InflationandthePublicFinances 6

TaxPolicy 10

Public-PrivateWageSpilloversandtheCaseforHigherPublic-SectorWages 13

HouseholdFinanceandLivingStandards 16

NIESR’sPlanforHouseholdEnergyBills 20

References 25

2

MainPoints

•Acombinationofhigherrevenueandlowerspending,togetherwiththemorefavourableoutlookforGDPandinterestrates,meansthattheChancellorhasalargeamountoffiscalspaceaheadofhisbudgeton15March.Weestimatethistobe£166.0billion(5.1percentofGDP)forhisdeficittargetand£97.5billion(2.9percentofGDP)forhisdebttarget.

•Persistentinflationaddstothatspace:onceweadjustfortheinflationtax,whichisanadjustmentfornominalgovernmentliabilitiesforinflation,weexpectthegovernmenttoberunningasurplusinrealtermsthroughoutthe2023-24fiscalyearandthedebt-to-GDPratiotofallover2023-24.

•Atthemacroeconomiclevel,wewouldarguethatsomeofthisfiscalspacebeusedtoreducetheplannedriseincorporationtax,whichwouldotherwiselowerinvestmentandGDPinboththeshortrunandlongrun,andtoincreasetheamountofpublicinvestment.Lowereffectivecorporationtaxandincreasedpublicinvestmentarebothgrowth-enhancing.

•WearguethattheChancellorshouldallowpublic-sectorwagestorisetocatchupwiththeprivatesector,giventhepublic-privatewagegaphasdeviatedfromequilibrium.Wecanexpectsomespilloversfrompublic-sectorwagegrowthtotheprivatesector,butanyadversemacroeconomiceffectsneedtobeassessedagainstpotentialoutputlossesifthepublicsectorlostskilledworkers.

•Finally,weproposeamoretargetedapproachtoprovidingsupportforhouseholdstodealwiththehighfoodandenergyprices:specifically,acombinationofanopt-inSocialTariffsystemandaVariablePriceCap.Thisispreferableinfiscalterms(asauniversalEPGmightcostasmuchas£29billionfor2023/24),providesincentivestousersofenergytolimitdemandbutalsoprovidesmoresupporttothosewhoneeditmost.

3

MacroeconomicBackgroundandFiscalSpace

•IntheirNovember2022

EconomicandFiscalOutlook

,theOfficeforBudgetResponsibilityassessedtheChancellortobeabletomeethisnewdeficit-to-GDPtargetwith£18.6billion(0.6percentofGDP)tospareandhisnewdebt-to-GDPtargetwith£9.2billion(0.3percentofGDP)tospare.

•SinceNovember,thedeficitonalike-for-likebasishascomein£30.6billionandthedebt1percentofGDPlowerthanexpectedinNovember,addingdirectlytothefiscalspaceavailablefortheChancellorinhisMarchBudget.

•WebelievethatinflationwillbemuchmorepersistentthanintheOBRforecast,withtheresultthatnominalGDPin2027-28willbe11.4percenthigherthanforecastbytheOBR.Inaddition,interestratesoverthecomingyeararenowlowerthanwereexpectedinNovember.

•Withoutanychangeinspendingortaxrates,wenowexpecttheChancellortomeethisdeficitanddebttargetswithatotalof£166.0billion(5.1percentofGDP)and£97.5billion(2.9percentofGDP)tospare,respectively.

TheChancellorwilldelivernextweek’sbudgetagainstabackgroundofweakGDPgrowth,highinflationandrisinginterestrates.Thatsaid,theGDPoutlookappearsslightlybrighterthanwasexpectedbackinNovemberandthepeakininterestratesnowlookstobelowerthanexpectedbackinNovemberandthismeansabetteroutlookforthepublicfinances,otherthingsequal.Weshouldrecallthat,intheAutumnStatementinNovember,JeremyHuntannouncednewfiscaltargets:

•Togetborrowingbelow3percentofGDPinfiveyears’time

•Forunderlyingdebttobefallinginfiveyears’time

NIESRhaslongargued–particularlyin

thisOccasionalPaper

–thatthereisaneedforanewfiscalframeworkthatrecognisestheneedforfiscalpolicytoimprovethewelfareofUKhouseholdsbydealingwithmarketimperfections,redistributingfromrichertopoorerhouseholds,andencouragingproductivitygrowthacrossthewholeoftheUnitedKingdomviawell-targetedinvestmentinpublicinfrastructure,withoutsettingborrowingoffonanunsustainablepath.Debtanddeficittargetsareusefulwaysofhelpingconvincethemarketsthatitissafetolendtothegovernment,butfiscalpolicyshouldnotbesetpurelyonthebasisofsatisfyingsuchtargetswhichare,essentially,arbitrary.Allthatsaid,itisstillworthexaminingwhether–giventheslightlypositiveeconomicnewssinceNovember–thereisanyfiscalspaceagainsttheChancellor’scurrenttargetsthatwouldallowhimtoincreasespendingand/orcuttaxesintheforthcomingbudget.

4

BorrowingintheyeartoJanuary2023was£22billionlessthanforecastbytheOfficeforBudgetResponsibility(OBR)intheirNovember2022

EconomicandFiscalOutlook

.Thiswasdrivenbyreceiptsbeing£9.7billionmorethanexpected,spendingbeing£2.9billionlessthanexpected,andborrowingbypubliccorporationsandlocalauthoritiesbeing£9.5billionlessthanexpected.Inaddition,giventhattheOBRforecastaccountedfora£8.6billioninpublicinvestmentduetochangesinstudentloansthathasnotappearedintheONSdataasyet,onalike-for-likebasisborrowingis£30.6billionbelowtheNovemberOBRforecast.Public-sectornetdebtnowstandsat98.9%ofGDP,1percentagepointlowerthanexpectedinNovember.

IntheirNovemberforecast,theOBRcalculatedthattheChancellorcouldmeethisnewtargetofreducingborrowingtounder3percentofGDPby2027-28with£18.6billiontospareandhisnewdebttargetwith£9.2billiontospare.Giventheoutturnsinthepublicfinancesdiscussedabove,itislikelythattheChancellornowhasmorefiscalspacethanthoughtatthattime.But,importantly,withtheshareofrevenuetakenuppayinginterestrisingfrom5percentin2019-20to8½percentin2027-28,changesinmarketsentimentcouldswiftlywipeoutthisfiscalspace.

Ofcourse,theOBRestimatesoffiscalspacewillbebuiltonparticularassumptionsaboutGDPgrowth,inflationandinterestratesmovingforward.TheOBRforecastsnominalGDPin2027-28tobe£2,927billion.ThisresultsfromrealGDPgrowthof9.8percentovertheforecastandanincreaseintheGDPdeflatorof13.6percent.Bythetimeofour

WinterUKEconomicOutlook

,theprospectsforUKGDPgrowthintheneartermwerelookingabitbetter.But,beyond2024ourviewofrealGDPgrowthismorepessimisticthantheOBR’s.Asaresult,weforecastrealGDPtogrowbyonly8.6percentby2027-28.Ontheotherhand,wearemuchmorepessimisticthantheOBRaboutthechancesofinflationcomingdownsoon.(Indeed,intheirforecastCPIinflationfellto0percentin2024-25and-1.0percentin2025-26.)Asaresult,weforecasttheGDPdeflatortogrowby30.8percentovertheyearsto2027-28.PuttingthistogethergivesaforecastfornominalGDPof£3,261billionin2027-28.TheOBRforecastpublic-sectornetborrowingin2027-28tobe£69.2billion.Givenourforecast,thatsuggestsanextra£10.0billionoffiscalspaceagainstthedeficittarget.Ofcourse,wemightexpecttaxrevenuetobehigherthanassumedbytheOBRgivenourforecastforhighernominalGDPgrowth.IfweassumethattheshareoftaxesinGDPisthesameinourforecastasintheOBR’sforecast,thentheamountoffiscalspaceagainstthedeficittargetincreasesbyafurther£139.2billion.

InordertoexaminetheamountoffiscalspacethattheChancellormayhaveagainsthisdebt-to-GDPtarget,TableAlaysouttheOBR’scalculationsandTableBlaysoutours.WehaveassumedthatgovernmentspendingandtheimplicitrateoftaxationisthesameinbothcalculationsbutwehaveappliedNIESR’sforecastsfornominalGDPandthelong-terminterestrate.

5

TableA:OBRforecast(November2022)

2021-22

2022-23

2023-24

2024-25

2025-26

2026-27

2027-28

GovernmentSpending(£billion)

1047

1182

1199

1180

1199

1240

1271

Taxes(£billion)

914

1005

1059

1096

1122

1159

1202

Interest(£billion)

49

109

88

64

64

85

89

Deficit(£billion)

133

177

140

84

77

81

69

Debt(£billion)

2054

2270

2473

2595

2695

2802

2903

Impliedinterestrate(percent)

5.30

3.87

2.58

2.47

3.16

3.17

Bondrate(percent)

0.96

3.03

3.66

3.7

3.72

3.73

3.74

Impliedtaxrate(percent)

39.01

40.25

41.66

41.70

41.36

41.14

41.07

GDP(£billion)

2343

2497

2542

2628

2713

2817

2927

GDP(centredendMarch£billion)

2435

2524

2579

2671

2762

2872

2985

DeficittoGDPratio(percent)

5.68

7.09

5.51

3.20

2.84

2.88

2.36

DebttoGDPRatio(percent)

84.35

89.94

95.89

97.15

97.57

97.56

97.25

Source:OBREconomicandFiscalOutlook,November2022

TableB:NIESRforecast(February2023)

2021-22

2022-23

2023-24

2024-25

2025-26

2026-27

2027-28

GovernmentSpending(£billion)

1047

1182

1199

1180

1199

1240

1271

Taxes(£billion)

912

1030

1148

1204

1239

1284

1339

Interest(£billion)

49

109

67

83

83

83

84

Deficit(£billion)

135

152

51

-24

-40

-44

-68

Debt(£billion)

2054

2315

2434

2493

2535

2575

2591

Impliedinterestrate(percent)

4.58

Bondrate(percent)

0.96

2.91

3.43

3.32

3.29

3.28

3.27

Impliedtaxrate(percent)

GDP(£billion)

2339

2558

2756

2888

2996

3121

3261

GDP(centredendMarch£billion)

2426

2653

2810

2928

3040

3172

3312

DeficittoGDPratio(percent)

5.75

5.96

1.84

-0.85

-1.34

-1.41

-2.09

DebttoGDPRatio(percent)

84.67

87.28

86.61

85.13

83.40

81.17

78.22

ThefirstthingtonoticefromacomparisonofTablesAandBisthelowerbondratesthatweareforecasting.ThispartlyreflectsthefactthattheOBRweremakingtheirforecastinthewakeofthelargeincreaseinbondratesbroughtaboutbytheminibudgetinSeptember.Thisimplieslowerinterestpaymentsforthegovernmentgoingforward,addingtotheamountofspacetheChancellorhasagainsthisdebt-to-GDPtarget.AddingthistoourmuchstrongerforecastfornominalGDP–resultingfromahigherforecastforinflation–resultsinalargeincreaseintheamountoffiscalspaceavailabletotheChancellor.Indeed,ascanbeseenfromTableB,ifourforecastsfornominalGDPandtheinterestrateongovernmentdebtcometopass,thenthegovernmentwillachievebothitsdebtanddeficittargetsasearlyasthenextfiscalyear(ie,2023-24).

6

Aswesaidupfront,wehavelongarguedthatgovernmentsshouldnotsetfiscalpolicyonthebasisofarbitrarytargetsbutrathertoimprovethewelfareofUKhouseholdsbydealingwithmarketimperfections,redistributingfromrichertopoorerhouseholds,andencouragingproductivitygrowthacrossthewholeoftheUnitedKingdomviawell-targetedinvestmentinpublicinfrastructure,withoutsettingborrowingoffonanunsustainablepath.OurforecastsfornominalGDPandbondratessuggestthattheChancellorhasroomtoincreasespendingandreducetaxes,evengivenhisownfiscalrules.Therestofthisdocumentputsforwardoursuggestionsastohowhemightmakeuseofthisadditionalfiscalspace.Beforewedothis,however,wefirstupdatetheanalysisinour

Autumn2022UKEconomicOutlook

ofhowthecurrenthighinflationisresultingina‘real’(ie,inflation-adjusted)improvementinthepublicfinances.

InflationandthePublicFinances

•Thecurrenthighinflationactsasa‘tax’onhouseholds,makingthetruefiscalpositionbetterthanitlooksonpaper.

•Onceweadjustfortheinflationtax,weexpectthegovernmenttoberunningasurplusinrealtermsthroughoutthe2023-24fiscalyear.

•Thisexplainsourforecastforadecliningdebt-to-GDPratioin2023-24.

Economistsfocuson‘real’magnitudes,magnitudesthataremeasuredinawaythattakesouttheeffectsofinflation.Standardnationalaccountingproceduresaredesignedtocapturebothrealvolumemeasuresand‘currentprice’measuresbydeflatingnominalvaluesbyanappropriatepriceindex.However,intherealmofpublicfinances,therehasbeensomethingofablindspotwhenitcomestoinflationadjustmentandstandardstatisticsdonottakeintoaccounttheeffectofinflation.However,theimpactofinflationcanbeconsiderablesincethebulkofgovernmentliabilitiesaredenominatedinnominalterms.Thereisthusan‘inflationtax’reflectedinthereductioningovernmentliabilitiesinrealterms(andcorrespondingreductionintherealvalueoftheassetsofthebondholders).

Inour

earlieranalysis

weconstructedtheinflationtaxusingmonthlydata,andyoucanfindadetaileddescriptionofthemethodthere.Here,instead,weusequarterlydata,whichenablesustolinkthequarterlydataongovernmentdebtandinflationtocalculatetheinflationtaxandfeeditintoPublicSectorNetBorrowing(PSNB)toobtainan‘inflationadjusted’PSNB,whichweshowinFigure1andTableC.OurfiguresaretakenfromtheONSquarterlystatement

UKgovernmentdebtanddeficit

publishedinJanuary2023.Wealsousethe

Winter2023UKeconomicoutlook

toforecastthedatauptothefirstquarterof2024.

7

£bn

50

0

-50

-100

Figure1:QuarterlyInflationTaxandPSNB

InflationAdjustedPSNB2020-2022

100

-150

InflationTax(£bn)GovernmentDeficit(£bn)InflationTaxAdjustedDeficit(£bn)

Source:NIESRcalculations

TableC:TheImpactoftheInflationTaxontheBudgetDeficit

InflationTax

(£bn)

Government

Deficit(£bn)

InflationTax

Adjusted

Deficit(£bn)

2020Q1

1.3

-0.4

0.9

2020Q2

-0.7

-132.8

-133.4

2020Q3

6.6

-74.2

-67.7

2020Q4

1.6

-63.6

-61.9

2021Q1

3.4

-42.1

-38.7

2021Q2

28.2

-59.3

-31.1

2021Q3

16.3

-36.0

-19.7

2021Q4

39.5

-27.2

12.3

2022Q1

29.7

0.1

29.8

2022Q2

68.4

-42.0

26.4

2022Q3

27.7

-26.8

0.9

2022Q4

47.4

-53.6

-6.1

2023Q1

51.2

-41.1

10.2

2023Q2

47.4

-39.2

8.2

2023Q3

42.8

-37.7

5.1

2023Q4

38.4

-35.0

3.4

2024Q1

34.0

-25.7

8.3

Source:ONSandNIESR

8

£bn

80

60

40

20

0

-20

-40

-60

-80

Thisanalysissuggeststhathighinflationcanbepositiveforthegovernment’sfiscalposition.Thegovernment’sfiscalbudgetdeficitforthethirdquarterof2022was£26.8billion;howeverthe£27.7billioninflationtaxmorethanoffsetsthedeficit,creatingasurplusof£0.9billion.Notethattheinflationtaxvariesgreatlyfromquartertoquarter:thatisbecauseinflationvariesfromquartertoquarter–thelargeinflationtaxinthesecondandfourthquartersof2022reflectsthebigmonthlyincreasesinAprilandOctobercapturedintherespectivequarters.UsingtheNIESRforecast,wecanseethattheinflationtaxexceedsthedeficitthroughout2023andintothefirstquarterof2024.ThisisdepictedinFigure2.Whilstinflationissettofallin2023,therewillstillbeaconsiderableinflationtaxeffectinthefirsttwoquarters.ThisimpliesthattherewillbemorefiscalroomforthegovernmentthanmightbesuggestedbythesizeofthePSNB.

Figure2:TheInflationTaxandPSNBForecastfromtheWinterUKEconomicOutlook

InflationAdjustedPSNB2020-2022

Forecast

Forecast

InflationTax(£bn)GovernmentDeficit(£bn)

InflationTaxAdjustedDeficit(£bn)

Source:ONSandNIESR

Thisinflationeffectistheflipsideofthedeclineinthebehaviourofthedebt-to-GDPratioasshowninTableB.Giventhatthereislittleeconomicgrowthprojectedfor2023,thefallingdebt-to-GDPratioisalmostentirelydrivenbyrisingpricesliftingnominalGDPgrowth.Giventhis,mightitnotbebettertomeasurethe‘inflationtax’intermsoftheGDPdeflator?TheGDPdeflatorisaderivedpriceindex:itisimpliedbythebehaviourofrealGDP(theChainvolumemeasure)andnominalGDP.ItisthereforeavariablethatcanonlybedeterminedwithaccuracyoncerealGDPhasbeenfinalised(whilstnominalGDPcanbeestimatedrelativelyrapidly,realGDPisamoreprolongedprocessthatisonlyfinalisedwhenaccountsarebalancedintheBlue

9

£bn

Book).Italsoreflectsthebehaviourofthe30percentormoreofGDPthatisnon-market:fromtheNHSandgovernmentdeliverededucationtotheimputedrentofowner-occupiedhousing.

However,wecanusethisasapotentialmeasureofinflationthatlinksmoredirectlytothesustainabilityofgovernmentfinancesintermsoftheevolutionofthedebttoGDPratio.Oneofthemaindifferencesoccursinthesecondquarterof2020:whilstCPIinflationfell,theGDPdeflatorincreased.ThiswasbecauseofthebigfallintherealoutputoftheHealthandEducationsectorsduringthefirstlockdown.Thereisadebateabouthowappropriatethemeasuresofrealoutputare,particularlyinHealth.Thecomparativefiguresfortheinflation-adjustedPSNBusingCPIandGDPdeflatorinflationaregiveninFigure3.Thefiguresdodifferquartertoquarter,buttheoverallpictureislargelythesame,withamuchsmallerdeficitin2022thantheunadjusted

PSNB.

Figure3:GDPDeflatorandCPIinflationAdjustedPSNBCompared.

InflationAdjustedPSNB2020-2022:GDPDeflatorandCPICompared.

40

20

0

-20

-40

-60

-80

-100

-120

-140

-160

2020Q12020Q22020Q32020Q42021Q12021Q22021Q32021Q42022Q12022Q22022Q32022Q4

InflationTaxAdjustedDeficit(£bn)GDPDeflator

10

Fromtheperspectiveofthehousehold,the‘inflationtax’iscapturedbetterbyCPIinflation,sincethismeasuresthedeclineinpurchasingpowerimpliedbythefallingvalueofmoneyandbonds.Also,thedataforCPIinflationisatimeliermeasurewhichissubjecttonorevision,unliketheGDPdeflator.Inthelongrun,theGDPdeflatorandCPIinflationarethesame(bothhaverisenby61%overtheperiod2000Q1to2022

Q2),sothereisnosystematicdivergencebetweenthetwomeasuresofinflationandhencetheinflationtax.Therefore,webelievethattheCPIinflationlevelisthemoreusefulmeasure.

TaxPolicy

•Apersistentriseinlabourincometaxesleadstoapersistentfallinhouseholdincomeand,so,consumptionandGDP.

•ApersistentriseintherateofVATleadstoaninitialsurgeininflationandpersistentfallsinhouseholdincome,consumptionandGDP.

•ApersistentriseincorporatetaxesleadstoafallininvestmentandGDPinboththeshortrunand–giventhenegativeeffectoflowerinvestmentonthecapitalstockandpotentialoutput–willfallinthelongrun.

•TheoveralleffectofanytaxchangeonGDPwilldependonhowthegovernmentusestheextrarevenue.Inparticular,iftheriseincorporatetaxesismatchedwithanincreaseinpublicinvestment,trendandactualGDPwillriseovertime.

Inhisstatementon17October,2022,theChancellorconfirmedthatCorporationTaxwouldbeincreasedfrom19percentto25percentinAprilofthisyear.Leavingasidetheincreasedfiscalspacethatcouldenablehimtoreversethischange,thereisaquestionastowhetherariseincorporationtaxisthemostefficient(ie,leastharmfultotheeconomyasawhole)wayofraisingtaxrevenue.Thegovernmenthasthreemainformsoftaxationatitsdisposal:corporationtax,indirecttax(VAT),orlabourincometax.Eachtaxtargetsdifferentsectionsofsocietyandhasdifferentdistortionaryeffectsontheeconomy.Toexplorethisissue,NIESR’sglobaleconometricmodel,NiGEM,wasruntosimulatetheeffectsofariseineachofthesetaxesontheeconomy.Thesesimulationswerecalibratedforcomparabilitytoprovideadditionalgovernmentrevenueof£2billionperquarteroverthefirsttwoyears.Toachievethistarget,eitherVAThadtobeincreasedby1.2percentagepoints,corporationtaxhadtobeincreasedby1.25percentagepoints,orincometaxby0.4percentagepoints.Therateincreasewassettolastfor10yearswithmonetarypolicyendogenizedtoreacttoeconomicdevelopments.

11

Percentagepoint

differencefrombase

Absolutechangefrom

foreecast(percent)

per

Figure4showstheimpulseresponsefunctions,whichenableustocomparetheeffectsofthesetaxes.

Asincometaxesrise,RealPersonalDisposableIncome(RPDI)falls,leadingtoafallinconsumption.ThisleadstoanimmediateandsustainedfallinGDP,andhigherunemploymentthatremainsinthelongrunasconsumershavepermanentlylowerincome.Risesinindirecttaxespassthroughdirectlyintothepriceofgoodsandservices,thusleadingtoasuddenanddramaticincreaseininflation.ThispushesRPDI

downtoalowerlevelimmediately,subsequentlyaffectingGDPthroughdecreasedconsumption.Higherinflationexpectationsleadtolowerexpectationsoffuturewealth,pushingconsumptiondownfurther.However,astheinflationarysurgeinpricespassesthrough,inflationexpectationsreturntonormal,andGDPbeginstosomewhatrecover.Finally,corporationtaxesaffectdemandintheshortrunandsupplyinthelongrun.Highercorporatetaxesleadtoahighereffectiveusercostofcapital;thisleadstolowerbusinessinvestment,affectingdemandintheshortrunasbusinessesholdbackoninvestmentsthatarenolongerprofitable.Furthermore,householddividendincomeforhouseholdsandthevalueoftheirequityholdingsbothfall,affectingpresentconsumption.ThesefactorsleadtoanimmediatedeclineinGDP.

Figure4:Effectsofa10-YearTaxIncrease

UnemploymentRate

0.20%

0.15%

0.10%

0.05%

0.00%

CorporateTaxIndirectTaxIncomeTax

ConsumerPriceInflation

0.80%

0.60%

0.40%

0.20%

0.00%

-0.20%

IncomeTaxCorporateTaxIndirectTax

Source:NIESRcalculations

RPDI

centdifferencefrom

base

0.00%

-0.20%

-0.40%

-0.60%

-0.80%

-1.00%

2023Q12024Q12025Q12026Q12027Q12028Q1

CorporateTaxIndirectTaxIncomeTax

GDP

percentdifferencefrombase

0.00%

-0.05%

-0.10%

-0.15%

-0.20%

-0.25%

2023Q12024Q12025Q12026Q12027Q12028Q1

CorporateTaxIndirectTaxIncomeTax

12

Absolutedifferencefrombase(£mn)

Furthermore,thelowerinvestmentleadsthecapitalstocktodecreaseovertime,hittinglongrunsupplycapacity.ThismeansthattheinitialGDPhitbecomespermanent.Thissupply-sidedeclineisnotpresentineitheroftheothertwoshocks,ascanbeseeninfigure5.Infact,supplyslightlyincreases;thisislargelyduetothefactthattheusercostofcapitalfallsinthesescenarios,giventheendogenousresponseofthecentralbank,whichcutsinterestratesinresponsetothedemandshock,andtheinvestmentpremiumfallsasaresultofchangesinbankbalancesheetsasaresultoftheshock.

Bothoftheseeffectsencourageinvestment;withoutthem,potentialoutputinthesescenarioswouldbelowerduetoadecreaseinemploymentasaresultofafallinthenominalwage.

Figure5:Effectsofa10-YearTaxIncrease

TrendOutput

500

0

-500

-1000

-1500

-2000

2023Q12024Q12025Q12026Q12027Q12028Q1

IncomeTaxCorporateTaxIndirectTax

Source:NIESRcalculations

Ascanbeseenfromthesesimulations,thesethreetaxeshaveavarietyofimpactsontheeconomy,hittingdemandandsupply,thelongrunandtheshortrun,insubtlydifferentways.VATisthemostdisruptiveintheshortrun,hittingGDP,incomes,andunemploymentthehardest;however,inthelongerruntotheeconomystabilisesaftertheinitialhit.Incometaxhasanimmediatenegativeimpactonincomes;inthelongrun,permanentlylowerincomeleadstopermanentlylowerconsumptionandGDP.Corporationtaxisdisruptiveintheshortrunthroughthedemandside.However,astheeconomyevolves,supply-sidedepletionthroughreducedbusinessinvestmentleadstoapermanentdecreaseinthecapitalstockandthereforeapermanentlylowerlevelofoutputcapacityandGDP.Thiswouldsuggestthatforminimumvolatilityandeconomicdisturbance,incometaxisthebestoptionavailable.

13

However,thisisjustonesideofthestory.Itisalsoimportanttoconsiderwhatthegovernmentdoeswiththemoneyraisedbyhighertaxes.Forexample,whathappensifthegovernmenttaxescorporationsbutsimultaneouslyincentivisesinvestment?Toexplorethiscounterfactual,thecorporationtaxscenariowasrunagainwiththenewassumptionth