OT equals other direct taxes (as distinct from T), fees, fines and other
payments to government while IP equals interest payments on consumer debt.
OT and IP are treated as exogenous variables. The treatment of the largest
component of the identity, TPY, requires some consideration. As defined
in the Quarterly Estimates of National Income and Expenditure published
by the Australian Bureau of Statistics, TPY is equal to the sum of wages,
salaries and supplements, income of farm unincorporated enterprises,
income of other unincorporated enterprises and from dwellings and interest
dividends, transfers from overseas and cash benefits from general
government. TPY would usually be incorporated into a model defined as
above and treated as an identity with a wage/price sector explaining the
evolution of wages, salaries and supplements. While the theoretical
treatment of wage/price sectors has reached a level of considerable
sophistication, for example, Turnovsky and Pitchford (forthcoming),
the empirical formulation of such functions has not progressed to the
same level, especially in Australia where researchers have in the past
found it extremely difficult to adequately model wage/price sectors
due to the nature of minimum wage fixation, the high level of unionism and
the arbitration system. For example, Higgins and Fitzgerald (1973)
exogenous. This would include the majority of wages and salaries
included in the definition of TPY. Due to the difficulties of
constructing an adequate wage/price sector for Australia (since the
introduction of wage indexation the modelling of the wage structure would
become considerably easier) and as wages and prices were extremely stable
of the estimation period, it was decided to exclude a sophisticated wage/
price sector in the model in favour of a more simplified treatment.
Indeed, any attempt to estimate a detailed wage/price sector would
constitute a major study in itself. A simple function relating TPY to
national income has been included in the model which is sufficient to
capture the essential movement in total personal income in a period of
wage and price stability.
To complete the identity for personal disposable income and
the income sector as a whole, we require a relationship for personal
income tax payments, T. The main influences on the level of personal
income taxes are obviously the level of total personal income which is
subject to taxation and of course the statutory tax rates which apply to
such income. Other important closely related factors include the
distribution of total personal income which is taxable and in the case
of Australia, the degree of progressiveness of the tax structure. The
notion of a progressive tax structure suggests that a non-linear relation
ship would be the most appropriate but this possibility is of course
eliminated due to the linearity requirements of the model and it is of
course very difficult to capture all the above factors without
incorporating a large disaggregated tax subsector in the model similar to
that constructed by Mackrell (1970) for RBA1. In fact, the use of a
linear structure prevents the explicit inclusion of tax rates in the
a significant drawback of the linear approach but is counter-balanced by
the earlier observation that as tax rates are not usually constantly
manipulated, the inclusion of them in a fixed or flexible target
stabilisation framework could lead to infeasible policies being specified.
Empirical evidence of this type of behaviour can be found in Wells (1977).
The only alternative to treating total tax payments as an instrument which
is clearly incorrect, would be to incorporate a tax surcharge instrument
in a similar way to that employed by Pindyck (1973) . This can be achieved
by fitting a simple linear relationship between tax payments and total
personal income but forcing the function through the origin and hence
excluding an estimated constant term. The surcharge can then be added to
the function as a constant term which can be directly manipulated bv the
government. Considerable experimentation was carried out with this type
of function but was excluded from the final structural form due to the
fact that most solutions required unrealistic shifts in the surcharge and
to avoid this problem the surcharge had to be weighted heavily in the
linear/quadratic framework and fixed a priori in the fixed target
framework and treated as an exogenous variable. The final form of the
tax function was a simple linear function relating tax payments to total
personal income
T = t + t1TPYt (3.14)
with t^ representing an average tax rate for the entire economy which of
course remains fixed. This is not an unreasonable approach in light of
past experience in Australia where governments have displayed considerable
reluctance to change tax rates and use tax rates as an instrument of short
run stabilisation. (3.14) adequately approximates the progressive tax
relevant to recent Australian history did not occur until after the
estimation period (pre 1972). It should be recognised that in a time of
rapidly increasing incomes, (3.14) would most likely be considerably less
than adequate.
In the past it has been customary to treat the supply of money as
a control variable subject to direct manipulation by the monetary
authorities. If this assumption is dropped we are left with a more
realistic and interesting proposition that the supply of money is a
variable which is endogenously determined within the system. The
implications of this for economic policy are very important. Specifically,
if the authorities require a particular target rate of growth of the
money supply then it cannot be guaranteed that this target will be
automatically achieved. The money supply function incorporated in the
model presented here is based on the work of Teigen (1964), although some
slight modifications to Teigen's work have been included. The significant
departure from Teigen concerns the introduction of a foreign component
of the money base which allows for the important interaction between the
money supply and the open sector. The total monetary base is given by
MB = DM + FR (3.15)
where DM constitutes the domestic component of the base and FR is the
foreign component with FR defined as the level of foreign reserves. The
government can inject or withdraw money into or out of the banking system
by manipulating DM through open market operations. By building up the
relationship between the required reserve ratio and deposits, the excess
reserves of the banking system and the foreign component of the base a