DIAGRAMAS DE SECUENCIA

Using VURMTAX, we performed two simulations:

(1) We accommodate a marginal increase in the personal income tax rate, which yields an additional A$100m in personal income tax collections. The results are used to evaluate the MEB of Australia’s personal income tax at the national-level; and

(2) The personal income tax is removed to determine the AEB of this tax at the national- level.

Our simulation results for excess burdens are reported in Table 12-1. From Table 12-1, we see that the MEB of a flat-rate personal income tax system in Australia is 39 cents per dollar of net revenue, which as expected lies slightly above the average excess burden of 34 per cent.

12.3 Macroeconomic impacts

The long-run (2040, fifteen years post tax policy shock) macroeconomic impacts of a (i) small rise in the personal income tax rate that yields an A$100m increase in tax-specific collections; and (ii) removal of the personal income tax, are summarised in column [1] and column [2] of Table 12-2. State results are given in Table 12-2(a), while national results are provided in Table

153 | P a g e

12-2(b) and (c). We study the impact of removing the tax, i.e., the outputs in column [2]. While the direction and magnitude of the simulation results for any given variable differ, the relative impacts on the variables are similar between the two simulations. Hence, an explanation of results for one column serves as an explanation of results for the other column.

Focusing on the national results in Table 12-2 (b), from row 24 in column [2] of Table 12-2(b), we see a strong rise in the post-tax consumer wage (+20 per cent) in response to removal of the personal income tax. This drives a significant long-run expansion in employment (+3.34 per cent in row 22 of column [2] in Table 12-2(b)), because the participation rate increases in response to the rise in the post-tax real wage.

Why does the capital stock rise so sharply (+6.67 per cent in row 21 of column [2] in Table 12-2(b)) in the long-run? In VURMTAX, as discussed in section 12.1, corporate equity income that accrues to local investors is taxed at the personal income tax rate. Removing the personal income tax increases the post-tax rate of return for local equity investors, relative to foreign equity investors. 60 This drives the capital stock above baseline. With the capital stock and employment above baseline in the long-run, real GDP is also elevated relative to baseline (+3.1 per cent in row 14 of column [2] in Table 12-2(b)), with the capital/output ratio rising (because capital growth exceeds the growth in real GDP), and the investment/GDP ratio also rises.

While also increasing the share of the domestic equity stock owned by locals, which pushes net inflows of foreign capital income to Australia towards surplus. All else equal, this pushes the income account towards surplus. With the income account tending towards surplus, real national income rises relative to real GDP (rows 14 and 20 in column [2] of Table 12-2(b)). Because national income increases relative to real GDP, real private and public consumption also rise relative to real GDP (rows 14, 15 and 16 in column [2] of Table 12-2(b)). With real private and public consumption, and real investment, all rising relative to real GDP, real GNE rises relative to real GDP and the real balance of trade moves towards deficit (see rows 18 and 19 in column [2] of Table 12-2(b)).

How is this growth in the national capital stock financed, in light of deterioration in the trade balance? As a single country model of a small, open economy, at the margin new investment

60 _{Foreign investors benefit indirectly from removal of personal income taxes because employment increases,}

154 | P a g e

in the capital stock VURMTAX is foreign-financed. This foreign financing requirement can be met in two ways: either via an increase in foreign equity capital inflows, or via an increase in net foreign debt. With foreign equity shares tied down by changes in relative post-tax rates of return on equity between local and foreign investors, the trade deficit that arises when we cut the personal income tax rate is financed by foreign debt. In VURMTAX, Australia is assumed to pay a fixed real interest rate on its stock of foreign debt. Importantly, the rate of interest on net foreign debt is lower than the rate of return on Australian equity. This ensures the income account surplus caused by the increase in local ownership of the domestic equity stock, is preserved despite the increase in net foreign debt payments.61 Our findings are therefore sensitive to changes in the

For this reason, while personal income tax cuts increase local ownership shares of the domestic stock of equity capital, they also drive up the stock of net foreign debt. At the margin, new capital investment in Australia is therefore financed by an increase in foreign debt, rather than foreign equity. This change in the national capital structure drives the income account balance towards surplus, which buoys real GNI relative to real GDP.

12.4 Industry impacts

Table 12-3 shows results for output in the ANZSIC-level 1 industries in NSW. The table is structured in a similar way to Table 12-2; column [1] and column [2] summarise the impacts of a A$100m rise in personal income tax collections and removal of the personal income tax respectively. As in section 12.3, we focus exclusively on the impact on NSW industry of personal income tax removal. As highlighted in column [2] of Table 12-3, all NSW industries benefit from removal of the personal income tax. Consistent with the expansion in labour supply at the macro level, the biggest beneficiaries are labour-intensive industries such as Accommodation and food services (+7.04 per cent) and financial and insurance services (+6.24 per cent), while the output of construction (+6.68 per cent) rises in line with the rise in real investment. Expansion of export-oriented sectors such as Agriculture, forestry and fishing is constrained by the supply of fixed factors (land in this case). Other sectors, such as Transport, the Public sector, Business services and Manufacturing all expand in line with the growth in NSW GSP, which from row 5 of column [2] in Table 12-2(a) rises by 5.29 per cent, which exceeds the rise in real GDP (+4.36 per cent).

155 | P a g e

12.5 Conclusions

In this section, we have described how a flat-rate personal income tax system has been modelled in VURMTAX. This system takes explicit account of the role franking credits play in Australia’s personal income tax system. Interestingly, we find that personal income tax cuts. In our macroeconomic discussion, we highlight why removal of such a tax drives an expansion of Australia’s capital/output and capital/labour ratios. The key to understanding this result lies in understanding the compositional shift a reduction in the personal income tax rate causes on the stock of Australian net foreign liabilities: at the margin, Australian investment is financed less by foreign equity investment, and more via foreign debt. We also summarise the key long-run industry impacts at the ANZSIC-1 aggregate level.

12.6 Tables

Table 12-1: Marginal and average excess burdens (in cents-per-dollar-of-tax-revenue generated) caused by changes in the personal income tax rate in Australia.

MEBs AEBs

Personal income tax rate

156 | P a g e Table 12-2: State and national level macroeconomic impacts in 2040, due to a A$100m rise in personal income tax collections or removal of personal income tax in Australia

Column [1] PIT rate Macroeconomic impacts % deviation from baseline (unless otherwise indicated),

2040

Column [2] Remove personal income tax

Macroeconomic impacts % deviation from baseline (unless otherwise indicated),

2040

(a) NSW state-level results

1 Price deflator, GSP 0.000 0.642

2 Capital stock (rental weights) -0.004 8.116

3 Real investment -0.004 7.303

4 Employment -0.002 4.190

5 Real GSP -0.003 5.287

6 Real private consumption -0.004 7.131

7 Real public (state) consumption -0.004 7.131

8 Imports, volume -0.003 6.232

9 Exports, volume 0.002 -3.164

10 Real post-tax consumer wage -0.002 3.413

11 Real producer wage -0.001 2.283

12 Tax base ($m) -20.613 41099.200

13 Aggregate tax revenue ($m) -3.070 6135.910

(b) National results

14 Real GDP -0.002 4.361

15 Real private consumption -0.003 5.392

16 Real public (state and federal) consumption -0.003 5.325

17 Real investment -0.003 6.381

18 Real exports 0.002 -1.313

19 Real imports -0.003 5.338

20 Real GNI -0.003 5.559

21 Capital stock (rental weights) -0.003 6.673

22 Employment -0.002 3.335

23 Capital rentals (investment-price deflated) 0.002 -5.271

24 Real post-tax consumer wage -0.009 22.134

25 Real producer wage -0.001 2.587

26 Terms of trade 0.000 0.413

27 Price deflator, consumption (CPI) 0 0

28 Price deflator, GDP 0.000 0.082

29 Tax base (all states and federal, $m) -54.613 103952.100

30 Aggregate tax revenue (all states and _{federal, $m)} 156.609 -324997.430

(c) Change expressed as percent of GDP

157 | P a g e Table 12-3: NSW industry impacts in 2040 due to a small rise in the personal income tax

rate, or removal of personal income tax in Australia Column [1] PIT rate Effects on real industry output % deviation from baseline, 2040 Column [2] Remove personal income tax Effects on real industry output % deviation from baseline, 2040

1 Agriculture, forestry and fishing 0.00 -0.91

2 Mining 0.00 -0.47

3 Manufacturing 0.00 2.06

4 Electricity, gas, water and waste _services 0.00 4.09

5 Construction 0.00 6.68

6 Wholesale trade 0.00 4.75

7 Retail trade 0.00 5.68

8 Accommodation and food services 0.00 7.04

9 Transport, postal and warehousing 0.00 2.26

10 Information media and communications 0.00 5.25

11 Financial and insurance services 0.00 6.24

12 Dwelling ownership 0.00 4.87

13 Business services 0.00 5.11

14 Public administration and safety 0.00 5.87

15 Education and training 0.00 4.94

16 Health care and social assistance 0.00 6.15

158 | P a g e

13

Corporate income tax