Friday, 30 November 2012

What was the effect of increasing the top rate of income tax?

From John Cochrane's site, I only just came across this, The Exchequer effect of the 50 per cent additional rate of income tax

From the executive summary:

  1. The 50 per cent additional rate of income tax was introduced on 6 April 2010. It was the first increase in the highest rate of tax in the UK for over 30 years, and was expected to yield around £2.5 billion.
  2. This report provides the first comprehensive ex-post assessment of the additional rate yield using a range of evidence including the 2010-11 Self Assessment returns.
  3.  This analysis shows that there was a considerable behavioural response to the rate change, including a substantial amount of forestalling: between £16 billion and £18 billion of income is estimated to have been brought forward to 2009-10 to avoid the additional rate of tax. This behavioural response is entirely legitimate, and difficult to prevent using anti-avoidance legislation.
  4. The modelling suggests the underlying behavioural response was greater than estimated previously in Budget 2009 and in March Budget 2010, decreasing the pre-behavioural yield by at least 83 per cent. This result is also consistent with that contained in the Mirrlees review, and suggests the additional rate is a highly distortionary form of taxation. Although there is uncertainty around these estimates, sensitivity testing demonstrates that is difficult to construct a plausible outcome consistent with a yield estimate as high as those original forecasts. The conclusion that can be drawn from the Self Assessment data is therefore that the underlying yield from the additional rate is much lower than originally forecast (yielding around £1 billion or less), and that it is quite possible that it could be negative. 
Eek.  Dani Rodrik's Has Globalisation Gone Too Far book predicted years ago that we cannot tax corporations or highly skilled individuals.  It looks like he is right.

Wednesday, 21 November 2012

Is there a relation between growth and R&D? And why it doesn’t matter


A lot of interesting tweets last night from the Royal Society Innovation Debate. (Twitter mark: #innovationdebate). I couldn't go, so I am relying on the tweets I received that raised some interesting points on R&D and innovation. (There were some annoying and, IMHO opinion wrong, comments about economists which I shall return to at the end of this post).



One point raised was by @JackStilgoe "Annoyingly, national R&D spending does not correlate with economic growth. See Edgerton, To which I replied "well yes, but growth is determined by other things than R&D. Taking those into account there is a correlation IMHO". And @GordonBrianR chimed in with "R&D also needed for absorptive capacity - to stay on the knowledge frontier. There is a Red Queen effect here too.".


So what do economists know about all this?


The assertion of the non-relation between growth and R&D refers to the article by David Edgerton. Now, I consider myself a friend of David and his books and expertise in this area are unmatched. On this issue however, I beg slightly to differ. Actually, I think he's mostly talking about the correlation between growth and public R&D. So let's break it down.


There is of course no simple bivariate correlation between growth and R&D since, as mentioned above, one has to control for other things, R&D takes time to come through etc. etc. One very thorough study on this at the company level is Foray, Hall and Mairesse, Cemi-Working paper-2007-003. They criticize the assertion of no relationship made by Booz Allen Hamilton, Winter 2006, issue 45, "Strategy and Business" and show there is just such a relation at firm level as long as one is careful with data construction, accounts for the correct lags etc. An study at the country level is Griffith, Redding and van Reenen.


But let me put out another thought. Who cares if there is no relation?


To be fair, many economists are interested in the correlation between R&D in country/industry/firm A and growth in country/industry/firm A. But most are interested in an even more interesting correlation: the relation between R&D in country/industry/firm A and growth in firm B. That is to say, one might not find any correlation at all between one entity's R&D and its growth, for it might all be relying on using R&D from another place. Indeed, part of the Royal Society's honourable tradition is to foster that very information flow, by encouraging open science and communication. And if there is such a relation then we are off to the races, for the free market might under-provide research, there might be role for subsidies and public provision, mobility of scientists and absorbtive capacity might affect such transfer etc. etc. So the lack of a relation actually makes the policy issues more urgent and not less.


So, I shouldn't really say that the lack of relation does not matter, but that its not right to cite that lack of relation as an indication that policy is impotent.


If interested, here are some additional comments from an earlier post, "Innovation: A guide for the Perplexed".
Additional comment
There were some rather negative tweets about economics which may or may not have accurately recorded what the participants said. I can only say economists never sit around at Economics conferences and complain that scientists just spend their time watching apples fall from trees. Let's base criticism of other disciplines on what they actually do, not what people seem to think they do.


Saturday, 17 November 2012

Fiscal policy, multipliers and austerity in the UK again

Gavyn Davies suggests that fiscal policy has not contributed that much to why the US has recovered fater than the UK (the US has had looser fiscal policy).  Here's the puzzle:


and here's comparative fisscal stance, the US is looser:


As he says, these estimates depend heavily on the multiplier. Higher multipliers give more weight on fiscal tightening. But there's a catch to higher multipliers if you want to assume them that I think is interesting: 

The assumption of higher multipliers also creates another problem. If fiscal and export multipliers are higher than we have assumed, then the implication is that the output gap in the UK economy is also very high. This can only have occurred if the growth in potential GDP was also very high. For example, a fiscal multiplier of 1.3 would imply that UK potential GDP growth has averaged 3.2% per annum in the years of austerity, significantly above its 1950- 2007 average of 2.4%, and also significantly above the recorded growth of productivity over the period.

BTW, he says the problem is that we are not exporting relative to the US

our exports being concentrated to the Eurozone that is so weak.