CoPS/IMPACT Working Paper Number G-101

Title: Some Short-Run Implications of Fightback: A General Equilibrium Analysis

Authors: G.A. Meagher and Brian R. Parmenter


We report ORANI projections of the short-run effects on the macroeconomy and the industrial structure of the main elements of the Fightback proposals, namely the proposed abolition of the wholesale sales tax, petroleum excise and the payroll tax, proposed cuts in income taxes and government outlays, and the proposed introduction of the goods and services tax. In making the projections, we assume (with Fightback) that nominal wage rates are unaffected. We also assume that private domestic aggregate demand moves in line with changes in disposable income.

These fiscal changes fall into two main groups changes in indirect taxes which affect relative prices directly, and changes to income tax rates and government outlays which have their direct impacts on the level and commodity composition of domestic demand.

Analysis of the second group is relatively straightforward. Cuts in income taxes increase private-sector demand, crowding out exports but generating a net increase in output and employment. Cuts in government outlays reduce public and private demand, allowing exports to expand but generating a net contraction of output and employment. Because public demand is concentrated on labour-intensive commodities, the contractionary employment effect of cuts in outlays is greater, per dollar of change, than is the expansionary effect of the income tax cuts.

Differences in the macroeconomic effects of the indirect-tax components of the package depend on: (a) differences between the taxes in the effects of imposing a dollar's worth of tax on any given industry; (b) differences in the industrial incidences of the taxes; and (c) differences in the sizes of the tax changes.

The payroll tax affects the cost of employing labour directly. It therefore has a greater effect in any given industry on employment per dollar of tax change than does the wholesale sales tax, the petroleum excise or the goods and services tax.

The GST does not discriminate between imports and domestic commodities and affects exports in only a minor indirect way. Hence, its impact on cost-sensitive industries exposed to international competition is smaller than the impacts of the other taxes, especially the payroll tax. Hence, the implications of the GST for output and employment are relatively small.

Our translation of proposals from the Fightback document into shocks for our model is not without some difficulties. The appropriate size of the income tax cuts is one especially controversial issue. We present sufficient information in the paper to allow the reader to perform some sensitivity analysis. For example, to see the effects of assuming that income tax cuts are worth $10billion rather than the $13billion which we impose, the income tax columns in our tables should be scaled down by a factor of 10/13.

Substitution of the goods and services tax for the wholesale sales tax, petroleum excise and the payroll tax is a major feature of the Fightback package. Because employment is less sensitive to the cost effects of the goods and services tax than it is to those of the taxes which are replaced, our major conclusion is that the package would generate increases in employment and GDP in the short run.

However, our projections also imply that, without adjustments to nominal wage rates, the package would lead to a reduction in the real value of the take-home wage rate. When nominal wage rates are adjusted to maintain the real value of disposable income per unit of employment, the expansionary effects of the package on employment and the GDP are substantially reduced, but not entirely eliminated.

JEL classification: C68, E62

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