https://cpes.org.uk/om/files/original/70b6c136bf4289e2a404fbbbf5a3b1f5.pdf f3cee251e1523090ed52ac6eeaf1db76 Dublin Core The Dublin Core metadata element set is common to all Omeka records, including items, files, and collections. For more information see, http://dublincore.org/documents/dces/. Title A name given to the resource Problems in the Management of the Economy 1971 - 75 Text A resource consisting primarily of words for reading. Examples include books, letters, dissertations, poems, newspapers, articles, archives of mailing lists. Note that facsimiles or images of texts are still of the genre Text. Text Any textual data included in the document Chapter VII Private consumption The preceding chapters have provided estimates of total resources available, as measured by GDP at factor cost, and of resources required for fo.teign tradE:, public expenditure on goods and services, private Investment, and stockbui ld.tnf.' This chapter starts by estimating the level of private consumption requi reel to balance aggregate demand with the assurr,ed level of COP, h<'L h in the 11ar ccon·lll:v for the period 1962-75, and under the assumptions of our hypothetical project ions for 1972-5. In the later part of the chapter we estimate the levels of consumption which would be generated by the flow of incomes, given various assumptions about the real burden of taxation The difference between these latter estimates and the earlier estimates of required consumption may be regarded as a demand gap which would need to be closed by flscal action if. the level of aggregate demand were to be regulated so as to achieve the assumed level of GDP Conclusions 2 Table VII-1 below summanzes the changing composition of expenditure 111 t)l, past and into the future under our various assumptions From 1961 lo 1969 p11 \.t'' consumption declined in relation to GDP from 74 0% to 71.5%, ma1nly because of the relat1 ve Increase in resources devoted to investment and the balance of payments. By 1971 the ratio of private consumption to GDP appears to have recovered to 73 8%; but this largely reflects a substantial increase in the estimated factor cost adjustment (see paragraph 12 ). 3. In the par economy private consumption tn 197f shows a slightly higher rat IP to GDP than the actual figure, but the ratio is required to decline to 7YZ by l <~7' because of the increasing share of resources devoted to investment and the ba '·' '· of trade. Under the hypothetical projections assuming 4 5% per year growth ol Lii. consumptt_on is required to rtse as a share of GDP by 1973 because of the deteriur~· t1on of the trade balance; without devaluatton very fast growth of consumption ·would be required to maintain the 4 5% per year growth rate up to 1975; .but givcu the devaluation end-1973 assumed under projection Il, private consumption would VII-2 need to fall back to 72.4"1. of GDP. Details of the estimates of private consumption are given in Appendix Table 9 and the composition of expenditure on GDP is shown in detAil in Appendix Tables 10 - 12. Table Vll-1 The composition of expenditure on GDP (expenditures as per cent of GDP at factor cost, 1963 prices) Actual Private consumption Public I Private Stock Balance(!) Adjustment Residual expenditure investment building of trade to factor cost error(2) ·- 1961 74.0 27. 1 11.3 1.3 -o.6 -13.1 -0.1 1965 72 9 27.5 11 6 1 3 -o.a . 12.8 0.3 1969 71 .5 27.6 12.0 1.1 o. 7 -13.3 o.s 1971 73.8 27.7 12.0 0.0 0.4 -14.4 o.s ------- Par 1971 1975 74.2 73.0 Projection I (3) 1975 78.1 26.9 26.5 .12.1 13.4 1.1 -0.4 1.0 0.4 25.8 13.4 1.5 -4.5 -13.9 -14.3 -14.9 ··· ··· - o.s t--·--- · - Projection Il (3) I - · -1975 72.4 25.8 13.4 1.5 o.s -14.1 o.s {1) Exports less imports of goods and services . (2) Discrepancy between expenditure and comproMise estimates of GOP (see paragraph 10) (3) Hypothetical projections assuming 4.5% per year growth of actual COP, 1971-5, and either (I) no devaluation or (ll) devaluation at end-1')73. 4. The calculations of private consumption which would be generated by the flow of incomes described in the later part of the chapter assume the real burden of taxation on the personal sector expected, under present policies, for 1~72 (see paragraphs 15-16 below). Table VII-2 below shows the 'tax gaps' i1uplied, under this initial assumption, for the par economy ~d for out hypothetical projection·; to 1975. - VII-3 Table VII-2 The real burden of taxat~on, 1971-5 Par 1971 1973 19 75 Required {J.) Generated(2) consumpt1on consumpt1on lnitia10) tax gap Terms of(4) trade --------·· ..'" """ Rents and Final food tax gap -- £ million. 1963 prices - - £ mtllion, 19 71 pr1ces - 24744 26206 2 75 31 24491 26098 2 7728 - 395 -168 + 307 -516 -468 -1103 0 -225 -450 -911 -861 -1246 Project1on II (5) I1971 24136 1973 26625 1975 28229 24055 26229 28385 -·126 -618 i li +243 I -66 +41 ·1 J 39 0 -225 -450 - 192 -802 ·-1546 Private consumption required to ach1eve the assumEd level of GDP For .:ompatability with projection II (including the actual figure for 1971), a res1dual error has been introduced 1nto the par estimate, bearing the same r<>tio to GDP in each ye<>r <>S that assumed 1n proJection l i ( 2) Private consumption generated by the flow of 1.ncomes, assuming the.· current real burden of taxation and the ratio of import prices to horn~ C<Jsts expected for 1972 (3) Difference between the above estimates. exr:ressc.d at 1971 pr~~~· and divided by the ratio ot consumpt1ot: to p~s-'"-~~;;··;-nccmc to sho\v tlw required change in taxation of personal 1ncome compared \vith the assumpt1ons of 12) above 14) The effects on consumption of changes 1n import prices relative to home costs, expressed in terms of personal income at 1971 pr1ces, as for (3) above (5) Assumes 4.5% per year growth of GDp and devaluat1on at end-1973 5 The 1nit1al tax gap shown in the table makes no allowance for the effects on real personal 1ncomes of changes in 1mport pricc:s relative to home costs, and 1s based on the expected prices of 1972 On this basis consumpt1on generated in the par economy 1s too low in 1971, but rises above the required level by 1975. S1nce the- terms of trade assumed for the par economy are lower than those expected 111 1972. import prices are expected to be higher in relation to home cost~, therefore introducing a deflationary effect on real persona~ income which r1ses VII-4 from about £500 million (at 1971 pnces) in 1971··3 to over £1,000 million in 1')75 as the par terms of trade are required to deter1orate further in order to achieve the target balance of trade When we allow also for higher food prices (due to the movement to the Common Agricultural Policy) and for h1gher rents to be charged for local authority housing, the total deflationary gap wh1ch would need to be made up by a lower real burden of taxation (as compared w1th our init1al assumption) of £900 - £1250 million (~t 1971 prices) throughout the period But from the point of view of the personal sector the initial tax gap is most relevant; this shows an increasing required deflation of real incomes from 1971 to 1975. Whether this was the result of higher import prices or more stringent fiscal policy would be a secondary matter. 6. Under projection II, the initial tax gap becomes increasingly negative to 197} as reductions in the burden of taxation are required to offset the leakage of demand in the deteriorating trade balance, in order to maintain the assumed 4.5% per year growth of GDP After the devaluation at the end of 1973 more demand is generated by the turnround on the balance of trade and a positive tax gap' appears But our estimates suggest that the effect on real personal income of the rise in import prices following on the devaluation required to force down the terms of trade would be strongly deflationary. Some fiscal compensation for the terms of trade effect would be required to sustain the postulated growth of demand at 4.5Z per year. 7. It should be emphasised that these calculations do not relate to the taxation of the personal sect or in money terms. An increase or reduction in real taxati·'n 1s defined in our analysis simply as a change 1n the ratio of net taxation (including indirect taxes and current grants) of the personal sector to gross personal income An increase of'taxation in this sense is generally expected as real or money incomes rise because of the 'fiscal drag' inherent in a progressive tax system (see paragraph 19 below) without any changes in fiscal policy defined in terms of money tax rates. Vll-5 8 Our calculations also abstract from various short-term effects which may influence the level of consumption such as changes in the personal savings ratio and time-lags in the adjustment of prices when the pace of inflation accelerates or slackens The purpose of the calculations is to estimate the pressur~ on real personal income resulting, on average, either from fiscal policy or from changes in the terms of trade, in the par situation or under the assumptions of the hypothetical projections. - VII - 6. The required level of consumers' expenditure 9. The following paragraphs describe estimates of the level of consumers' expenditure required to equate total expenditure with the assumed level of G.D.P., both in the par economy and under the two hypothetical projections. All other categories of expenditure have already been estimated in previous chapters, measured at market prices. These expenditures are adjusted to a factor cost basis and subtracted from the assumed level of G.D.P. to obtain consumers' expenditure at factor cost. This latter is then adjusted to a market price basis. The analysis of the following paragraphs shows that the adJustment to factor cost, at 1963 prices, presents surprisingly difficul problems because, for past actual data, the only figure published in the national income accounts is the adjustment 1n aggregate. 10. Before descnbing the calculation of adjustments to factor cost the treatment of the residual error must be descr1bed. We have measured G.D.P. by the compromise index l1nked to the expenditure estimate for 1963 and this means that we have generated a discrepancy 1n other years between our estimat of G.D.P. and that derived from expenditure data alone. In the last few years the residual error has continuously been substantially positive, at about 0.5% of the level of G.D.P., the expenditure estimate ot G.D.P. having fallen behind the output estimate. We have not introduced any residual into our par estimates because there is no strong presumption about the likely magnitude and sign of the residual error under the assumptions which define the par economy. But for our hypothetical projections to 1975, starting at the actual position in 1971, we have retatned a residual error which bears the same ratio to G.D.P. in each year as the average residual error in 1969-71. This procedure avoids any discontinuity in the hypotheti< projections. 11. In esttmating adjustments to factor cost we have assumed that the tota: adjustment can be decoffiposed into net indirect taxes falling respectively on consumers' expenditure, public current expenditure, gross fixed capital I VII- 7. ,/ formation and exports (by convention imports are always shown exclusive of / U.K. indirect taxe~). Estimates of the actual adjustment, divided into the above categories, are available for 1963. For expenditures other than private consumption we assume that the ratio of factor cost adjustment at 1963 rates to expenditure at 1963 prices is constant; the ratios used are 2.99% for public current expenditure, 5.37% for fixed investment, and 2.65% for exports of goods and services. These are estimated actual ratios in 1963. 12. For past actual series, 1960-71, it is possible to estimate the factor cost adjustment for private consumption as a residual, since the total adjustment at 1963 rates is published for each year. The implied ratio of adjustment to consumers' expenditure shows a rising trend through the period and abnormally high values in one or two years, particularly 1964 and 1971. We have not been able to find any satisfactory explanation for the high values in these two years, and therefore assume that in the future, 1972-5, the adjustment will return to its rising trend path. If we had assumed a continued faster increase in the ratio above the past trend rate starting at the high value estimated for 1971, the adjustment could be higher by nearly 1% of G.D.P. in 1972 and'very much higher by 1975. Given the trend decline of the share in consumers' expenditure of tobacco and alcohol, which in 1963 were the most highly-taxed items, we do not believe that it would be reasonable to project such high values for the future period. 13. Consumers' expenditure at factor cost is obtained by subtracting all other items, measured at factor cost, from G.D.P. The assumed ratio of factor cost adjustment to expenditure is then used to convert this estimBte to market prices and to obtain the total factor cost adjustment. The results of these calculations are given in Appendix table 9. The real burden of taxation; concepts and method 14. Fiscal policy impinges on the personal sector's real income not only through direct taxation but also through current transfers from the public sector, ind1rect taxes (including local authority rates) and even through VII - 8 subsidies to public corporations which affect the prices charged by the laite1 to consumers. The real income of the personal sector also varies, in relatic to G.D.P., because of changes in the undistributed income of the company sector, and in the ratio of import prices to home costs (which affects the cost of goods and services at market prices in relation to G.D.P. at factor cost). 15. The concept of neutral, or unchanged, fiscal policy can be defined 1n various ways. For our purpose what is relevant to policy decisions 1s the real burden of net taxation on the personal sector. We therefore define an unchanged fiscal policy as being one which does not alter the ratio of real personal disposable income to G.D.P. (apart from any indirect effects via the pressure of demand on the distribution of income qetween wages and salaries and other factor incomes). 16. In this exercise we assume initially a fiscal policy which imposes the same real burden of taxation as that expected, on current policies as regards tax rates, for 1972. An estimate of the ratio of consumers' expenditure to G.D.P. which can be expected on current policies is given in the November f orecast b y t h e Nat1.ona 1 I nst1tute (1) · The initial assumption 1s that net taxation bears this same constant ratio to personal income in each year and that import prices bear the same relation to home costs as expected for 1972. 17. We have made two adjustments to the consumption share forecast by the National Institute In order to obtain the ratio of consumers' expenditure to G.D.P. in the par economy on the initial assumption about fiscal policy and import prices. Firstly, the savings ratio of the personal sector In the par economy is assumed to be 8. 2% of disposable inconte, .-rhich j s an average of e~timated actual savings ratios over recent years. Secondly, we assume that at the par pressure of demand personal sector income would form (1) National Institute Economic Review, November 1971. VII. - 9 a slightly lower share of G.D.P. than 1s expected for 1972 (with G.D.P. st1ll below par), because of the higher profit incomes expected at the par pressure of demand. 18. The initial estimate of the level of consumers' expenditure which woulJ be generated in the par economy, given a constant real burden of taxation as defined above (paragraphs 15-16), can be modified in the ligilt of various announced or assumed policy measures. In the par economy we assume that the terms of traJe will be shifted down over the period 1971-5 in order to achieve the required target balance of trade. Apart from changes in import prices expected under our various projections of the terms of trade, the level of consumer prices is expected to rise relative to domestic incomes because of two long-term policies of the Government. These are the increase in rents for local authority housing, dnd the higher level of food prices which will result from the imposition of levies and adoption of the Common Agricultural Policy. 19. Apart from these two increases in effective taxation, there 1s a general presumption that a higher share of personal income will be absorbed in taxation as the level of real income rises, on account of the progressive elcnwnt in the tax :;~r:;L~·in. This 'real fiscal drag' does not necessa~ily raise the real burden of taxation ilS it appears to any individual taxpayer, and should certainly be distinguished from the effects of money inflation (which increase the ratio of net taxation to income without any increase in real income), and from increases in the tax rates themselves. We shall give some estimates of the 'real fiscal drag' on a rather arbitrary assumption about its quantitative magnitude as an indication of the increased tax burden which may, to some extent, represent the expectations of taxpayers. 20. The assumptions explained above provide us with a number of different estimates of the level of consumers' expenditure which would be generated in the pa.r economy; similar estimates can be obtained for the hypothetical projections t0 1975. Each of the estimates has a different interpretation in terms of fiscal policy but none of them are intended to represent the effect of maintaining unchanged tax rates (in money terms). The estimates are designed to show the effects on real personal income of the requirements of demand management and of the need to achieve a reasonable balance of trade. - VII-10 Con&umption in the par e:onomy, 1971-5 21, The first step in the analys1s of levels of ~on&umpt1on generated by thE flow of 1ncomes is to adJUSt the forecast ot the rat1o at ~onsumers' expenditure to GDP, at 1963 pr1ces, for 1972 calculated by the Nat1ona1 Inst1tute assuming no change 1n current fiscal pol1cy tdef1ned in terms of money rates). We assume that 1n the par economy the personal sav1ngs rat1o would be 8 2% (an average of recent past values) rather than the 7 9% forecast by the National lnst1tuteThis requ1res an adJUStment ot 0 26% to the ratio of private consumption to GDP. We also assume that Lhe ratio of consumpt1on to GDP would be lower by 0.2% for every l% 1n~rease 1n the pressure of demand as measured by the ratio of actual GDP to par GDP, because at the 1rnprovement 1n the share of company profit 1ncomes. Atter mak1ng these two adJuStments the rat1o ot consumers' expend1ture to GDP 1n 1972 would be 73.1% Hoid1ng th1s ratio constant we obtain initial estimates of consumption for each year 19/l-5 1n the par e~onomy, betore allowing tor the effe~ts of changes in the ratio of 1mport pr1ces to home costs or in the real burden of taxat1on The effect of the terms of trade 22, We also need to take into account the effect on real personal income of the terms of trade and 1mport pr1ces. We assume that in the absence of devaluation, import pr1ces will tend to decl1ne sl1ghtly relat1ve to home un1t costs, and that any changes in the terms of trade result from movements of 1mport prices rather than export pr1ces, relat1ve to home costs. Movements of 1mport pr1ces relative to home costs are assumed to reduce real pr1vate consumption by 1% for each 4% increase 1n the ratlo of import ptlces to home ~osts, 23. D1fierences between the assumed terms oi trade 1n the par economy and the actual or expe:ted actual terms ot trade are assumed LO resul[ fro~ ex~hange-rate change&. Recenc exper1ence suggesLs that devaluat1on causes a substant1al shift 1n expert prtces re1aL1Ve to home ~osts, as would be expected 1n the case of Vll-11 exporr.ers sell~ng in rather ol~gopulLbt1~ markets who would invite retaliation it <:hey cut the~r fore1gn prices tc tht:: iuli ext.-ant ot the devaluation. Because exports have d part~~ularly h1gh Lffipo.t cvntent, export pr~~es tend 1n any case tJ be pushed up relauve tJ hume c.:.::.t:, by the r1se in import pr~ces after devalua- t~on We theretore assume that a rorced sh1tt ~n the terms of trade would be a.:.hieved only w~th a substantlal ...:hange .n export. prices relative to home costs and therefore that the change ~n ~mp~tt pr1ces w1li substantially exceed the sh~ft 1n the terms of trade ltselt Our ~alculations are based on a 4% ~ncrease ~n ~mp,)rt pn.ces for every l% tor'-ed deter~..:>rat~on 1n the terms ot trade. 24. SLnce the terms cf trade are requlred to deter~orate between 1971 and 1975 1n the par econ~my 1n order to a.:h1eve a rtsing ·crade target under rather adverse cona1~1ons lsee Chapter IV) a substant~al increase ~n the de~latlunary effect of 1w~ort pr1ces, equal to iJJ6 m~llLJn at l96J pr~.:es, on consumers' expenditure 1s e::.tlmated for 1975 as compared wtth l91t The etteLtS ot htgher tood pr1ces and Lencs 25 It 15 well-known that est1mates 0i the ~ncrease 1n food prices which will follow trom the lntroductlon ot the C.::mmon Ag.n~ultural Policy are very uncertain be.:ausc they depend on assumptions about th£ relationsh~p between world pr1ces and EEC support pr~~es. The recent ex.hange-rate changes have made the situation even less clear, and we have had to make rough guesses at the probable magnitudes, E~tlmates o£ the 1ncreased rents to be charged by public author~t1es are taken from the White Paper. These two effects are d1st1ngu1shed separately from fiscal pol1cy ~n general because they are spe~1f1c measures which may have a substantial ~mpact on real personal 1ncome <:o whi~h the Government has a long-term commitment. F1scal drag 26. The ~nd1rect tax 6y6tem and current grants to the personal sector, net of ~nsuran.:e contr~butLms, are assumed not to exert any s1gn~f1.:ant drag on the growth of reaL ~n...:omes prov1ded that the normal e.xpec(at~on that benet1ts will rise in real terms ac the same pace as real 1ncomes as a whole 1s in fact realized. The real fisc.a.l drag ~nherent ~n the ~n:.::cme and :::.urtax system, defined as the effe~t 0t the differen~e between ~arginal and average tax rates on the growth at consumers' exrend~ture is est~mated to be 15% This ratio is applied to the ditferc:n.:e between con5umers' expt:.nell.tu.re proJecto::a J..n any gi·1en year and that· a:.s..:.med ior 1911 to ind~..:ate the 1os., ot ._:;.,n;.umption which might be expected on account cf the progressive nature ui this part of the tax system Tax gaps in the par e.:onomy, 1971-5 27 The levels ot consumers' expendlture which would be generated ~n the par e.::onomy under the v<~crl.ous assumpt~ons dLs.:ussed above are shown in det:.ail 1.n Append:x Table l3. The d1.fteren..:e between the estimates ot generated consumpt1.on and the level of consumpt~cn £equ1.r~d t~ balance total demand with GDP (estimated 1.n the f1rst parr. ot thu, Chapter) ind .. Lat\:0& the su.e of the impiled tax gap. We express the tax gap l.n terms ot the va1ue at the change ~n net taxatl.on of personal i.n:...ome requ1.red, measured aL 1971 pr.:...:e;:, Th1& 1s obta~ned by dl.v1d1ng the 'c.:mS·.lmptron gap' at. 1963 pr1ces by the rat 1.0 ot .::.onsumptl.On tc d1sposable incom.o, and then adjuStl.ng to 1911 p!l.Ct&. Tht tax gap 1mp1ied rn uur 1n1tiaL estimate ;:;f generated ..:onsumpt.~on, before ai..luwrng for the erte.:ts of the: terms of trade, ·t~:.cdi. drag, etc. l.S qu~te large o.nd negat.1.ve tor 1971 1.n the par economy, 1mp1y~ng that the par pressure of demand ~ould only have been ach~eved w1th a lower level cf net taxatl.on. By 1975 the 1nit1al tax gap be~owes pos1tive, but is much smaller than the derlattonary ettect expected from the r1se 1n import prices by that year Tax gaps under the hypothet~cal pruJeCttons, i97l-5 28. The analysis descr1.bed above for t.he par e..:or..omy can: als0 be applied t.o our tw.J hypothetical proJeCtl.ons wh1ch assume 4 5% per y<::ar g.cowth of GDP to 1975. AdJ ustmer.ts have to be made for ditferen..:es 1n the assumed p.cessure ot demand (see paragraph 21 above) and 1.n the assumed terms of trade (see paragraphs 22-23) The result& of these calculatl.ons, also d~:.played in Append~x Table 13, Vll-lJ show Lhat large reductions 1n real taxati0n would have to be made in order to susLa1n 4 5% per year growth of GDP to 1975 Wlthout devaluat1on. The devaluation at end-1973 assumed under the 6econd proJe~tlon doeb not require deflat1onary t1scal ctCt1on because under our db~urnpttonb Lhe requ1red reduction in customers' expenditure relative to GDP is ach1eved by the rise in import pr~ces.  Dublin Core The Dublin Core metadata element set is common to all Omeka records, including items, files, and collections. For more information see, http://dublincore.org/documents/dces/. Title A name given to the resource Chapter VII Private consumption Creator An entity primarily responsible for making the resource Cambridge Economic Policy Group Source A related resource from which the described resource is derived Problems in the management of the economy 1971 - 75 pages VII-1 to VII-13 Date A point or period of time associated with an event in the lifecycle of the resource 1972