Welfare impacts of equal-yield tax reforms in the UK economy

Abstract

A multisectoral dynamic general equilibrium tax model with and without announcement effects for open and closed capital markets is used to evaluate efficiency gains and transitional effects from equal-yield tax reforms for seven different taxes in the UK economy. Impacts of an unanticipated tax reform on investment, capital accumulation, output and employment are compared to those of anticipated tax reforms. Households, producers, traders, investors and the government are found to be more capable of adjusting their economic behaviour when tax announcements are made in advance. In equal-yield tax experiments welfare gains up to 1.4% of base year GDP can occur by removing distortions in taxes. Welfare loss of up to 2.05% of it can happen if a less distortionary tax, such as the labour income tax is replaced by more distortionary taxes. These simulation results hold whether the capital markets are closed or open.

¹ This article builds on research undertaken as part of the ESRC project on General Equilibrium and Dynamic Modelling for the Analysis of UK Policy Issues.

Acknowledgements

I am grateful to Professors John Whalley, Carlo Perroni and Thomas F. Rutherford for guidance, to Graham Siddorn and Bill McNie who were at the Economics Unit of the Inland Revenue at the time of study for data support. I acknowledge suggestions made by Professor Richard Green, Tobi Kendall and a seminar group in the University of Hull and by two anonymous referees in the earlier working article version of this article.

Notes

¹ This article builds on research undertaken as part of the ESRC project on General Equilibrium and Dynamic Modelling for the Analysis of UK Policy Issues.

² When σ = 1, we have U(C_t ) = ln U_t .

³ Disaggregation of assets into five different capital assets—long-lived plant and machinery, short-lived plant and machinery, vehicles, buildings and dwellings, as in our static model, is left for a future version of the model.

⁴ I appreciate very useful and extensive comments made by the editor of the Economic Issues for this section.

⁵ This model assumes a uniform growth path across the sectors in the steady state. There may be a set of dynamic paths in which some sectors might be expanding and some others remain contracting or even eliminated over time. Analysis of this sort of economy requires a more complicated model left as an open question for further research.

⁶ The main excise duties on tobacco, alcohol and fuel were included in ‘Production Taxes’ here in line with ONS Input-Output definitions; although in a later tax aggregation provided by the Inland Revenue and used in our Static Model (Bhattarai, 1999) such excise taxes were incorporated within consumption taxes (see also Siddorn 1999).