Treasury releases December working papers
The Treasury today released nine new working papers in the December instalment of its Working Papers series.
This quarter’s set of papers includes: Income Tax Revenue Elasticities with Endogenous Labour Supply (Paper 02/22),
Investing in Well-being:
An Analytical Framework (Paper 02/23),
Publicly Financed Education in an Endogenous Growth Model (Paper 02/24),
Consumption Externalities and the Role of Government:
The Case of Alcohol (Paper 02/25),
A Structural VAR model of the New Zealand business cycle (Paper 02/26)
An Analysis of a Cash Flow Tax for Small Business (Paper 02/27)
Population Ageing and Social Expenditure in New Zealand:
Stochastic Projections (Paper 02/28)
Low Wage Jobs and Pathways to Better Outcomes (Paper 02/29)
Indicators of Fiscal Impulse for New Zealand (Paper 02/30)
A full list of the abstracts from all nine papers follows.
The papers can all be found at http://www.treasury.govt.nz/workingpapers.
The Treasury Working Papers series contains work in progress on a variety of economic and financial issues. The series
aims to help to increase understanding of Treasury and its work, and to make this work available to a larger audience.
The working papers build internal capability, as well as generating more informed debate on key issues. The series has
been running since 1998.
The views expressed in the Working Papers are those of the authors and do not necessarily reflect the views of the New
Zealand Treasury. The papers are presented not as policy, but with a view to inform and stimulate wider debate.
02/22 Income Tax Revenue Elasticities with Endogenous Labour Supply
John Creedy (Treasury) and Norman Gemmell (University of Nottingham)
Abstract: It is important for the design of tax policy to be able to measure reliably the income elasticity of tax
revenue. This gives the extent to which tax revenues change as a result of a change in earnings. Analytical expressions
for income tax revenue elasticities treat earnings as exogenous, so that they do not accommodate the endogenous response
of labour supply to the income tax system. This paper shows how these expression can be adapted to allow for endogenous
labour supply. It identifies how far, and in what circumstances, labour supply effects are quantitatively important for
revenue responsiveness estimates, both for individual taxpayers and in aggregate. It is shown that even a relatively
simple tax-benefit structure can produce labour supply responses which considerably alter tax revenue elasticity
calculations. It is shown that , even with modest leisure preferences, tax-wage elasticities are significantly higher
that tax-income elasticities.
02/23 Investing in Well-being: An Analytical Framework Veronica Jacobsen, Barbara Annesley, Paul
Christoffel, Sid Durbin, Grant Johnston, Nick Mays (Treasury) and Ron Crawford (Ministry of Economic Development)
Abstract: The NZ Treasury is currently engaged in a project to identify cost-effective interventions to improve outcomes
for children and young adults in order to maximise the value of government expenditures across the social sector. The
central aim of this paper is to provide an empirically-robust framework to compare intervention across a range of social
sectors. There are two key components to the framework. The first is a life-course view of child development that
emphasises that experiences and influences in childhood can affect well-being throughout life. The second component
involves viewing social expenditures as investments addressed at achieving particular outcomes, typically directed at
enhancing well-being. The paper presents evidence from a review of the literature on how the process and experiences of
childhood have a later impact on well-being; how child development and outcomes are influenced by individual, family and
communal factors and how risk and resilience can be used to indicate that an individual is at increased or decreased
risk of negative outcomes. Case studies of youth suicide, teenage pregnancy, educational underachievement and youth
inactivity provide evidence about what interventions work using key empirical findings from the literature.
02/24 Publicly Financed Education in an Endogenous Growth Model John Creedy (Treasury) and
Normal Gemmell (University of Nottingham)
Abstract: This paper constructs an endogenous growth model, applicable largely to developing countries, based on human
capital accumulation in which education is publicly provided and financed, and schooling is compulsory. Public
investment in human and physical capital are financed from taxes on wage and capital income, and consumption. The
equilibrium growth properties of the model are examined and the steady-state effects of education and fiscal policy are
derived. The specification of the human capital production function and the strength of labour supply effects are shown
to be important for the magnitude of steady-state outcomes. Simulations illustrate the model's properties.
02/25 Consumption Externalities and the Role of Government: The Case of Alcohol Felicity Barker
(Treasury)
Abstract: This paper considers the role of government in the case of externalities and, in particular, in the case of
alcohol externalities. The purpose of the paper is to assess whether the current level of the alcohol excise can be
justified on externality grounds.
The paper assesses various mechanisms to address externalities. These mechanisms are institutional solutions, trade in
rights to generate externalities, regulatory measures and Pigouvian taxes. The paper assesses these tools in the case of
alcohol and concludes that institutional, trade and regulatory solutions are limited in their ability to address the
externalities of alcohol. A specific tax can be justified in the case of alcohol. The externalities are large and there
is sufficient information on which to base a tax. Given the information constraints the specific tax must be applied
uniformly across a rage of units of consumption, rather than to particular individuals. Where an optimal uniform tax is
imposed it is reasonable to assume that the amount of revenue collected by the government would be at least as large as
the total externality.
In 1999/00 the amount of revenue collected from the tax on alcohol was $580 million. This is near the mid-point of the
estimated bound of the external tangible costs of alcohol. Thus the current rate of excise tax can be justified on
externality grounds.
02/26 A Structural VAR Model of the New Zealand Business Cycle Bob Buckle, Nathan McLellan, Heather
Kirkham, Jared Sharma (Treasury) and Kunhong Kim (Victoria University of Wellington)
Abstract: This paper develops a new open economy structural VAR model of the New Zealand economy. The model adopts
techniques introduced by Cushman and Zha (1997) and Dungey and Pagan (2000) to identify international and domestic
shocks and dynamic responses to these shocks in a small open economy. The international variables are block exogenous
and the model includes restrictions on contemporaneous and lagged variables. Novel features include the introduction of
an expanded set of domestic financial variables not captured in previous New Zealand VAR models, the use of a forward
looking Taylor Rule to identify monetary policy, and the introduction of a climate variable to capture the impact of
climatic conditions on the business cycle. Key results to emerge are the significant influence of international
variables on the New Zealand business cycle, the importance of separately identifying import price and export price
shocks, and the significant influence of climate.
02/27 An Analysis of Cash Flow Tax for Small Business Peter Wilson (Treasury)
Abstract: This paper analyses whether it might be possible to design a cash flow tax (CFT) for small businesses in New
Zealand to replace the existing income tax.
Certainly, it is feasible to design the core rules of a CFT that applies to new small businesses. As with all examples
of a CFT, these rules are very simple and easy to understand and apply. Integration with existing Goods and Services Tax
and Pay-As-You-Earn systems provides significant simplification potential.
Designing a set of rules to define what is a “small business” is possible, although there is a risk that these rules
would involve some arbitrary features.
The main barrier to a CFT relates to the transition from an income tax. Research in New Zealand and overseas has been
unable to develop a workable set of rules that involve acceptable fiscal, economic and compliance costs.
Designing a set of transition rules from a CFT to an income tax for businesses that cease to be small also appears to be
an insurmountable task.
Even if the considerable difficulties with a transition could be overcome, integrating a CFT into a world where most of
the economy is subject to an income tax would also pose difficulties. There is a risk that the rules needed to maintain
CFT treatment on distributions to owners and financers, while at the same time protecting the income tax base, might
negate significant portions of the simplification gains from a CFT.
Given these difficulties, an income tax will remain necessary, if the Government wants some progressivity in the tax
system and to apply “ability to pay“ to determine tax liabilities.
02/28 Population Ageing and Social Expenditure in New Zealand: Stochastic Projections John Creedy and Grant
Scobie (Treasury)
Abstract: It is widely recognised that as the population ages there will be potentially significant implications for a
wide range of economic variables, including in particular the fiscal costs of social expenditures. Long term fiscal
planning requires estimates of the possible future path of public spending. This paper presents projections for 14
categories of social spending. These projections are based on detailed demographic estimates covering fertility,
migration and mortality disaggregated by single year of age and gender. Distributional parameters are incorporated for
all of the major variables, and are used to build up probabilistic projections for social expenditure as a share of GDP
using simulation. Attention is focussed on health expenditures which are disaggregated into seven broad classes. In
addition we explore the impacts of alternative hypothesis about future health costs. While it can be predicted with some
confidence that overall social expenditures will rise, the results suggest that long term planning would be enriched by
recognising the distributions about point estimates of projected social costs. 02/29 Low Wage Jobs and Pathways
to Better Outcomes Sue Richardson and Lauren Miller-Lewis (Flinders University, Australia)
Abstract: Many people find their first employment in a low wage job. Others accept low wage jobs after a period out of
the workforce or unemployed. An issue of vital social interest is the speed with which low wage workers move on to
better jobs. This review of the international literature finds that the extent of mobility depends on the definition of
low wage, and that the least upwardly mobile are older, less educated workers, including middle aged women, sole mothers
and men who have been retrenched. Young, educated, urban workers quickly move to better paid jobs. Everywhere, women are
more likely to be low paid than men, and have lower mobility. Higher education reduces the risk of low pay, but not to
zero. The paper goes on to examine the extent and sources of wage mobility, and looks carefully at the question of
whether a low wage job can be assumed to be preferable to no job (and finds that it cannot). It finds that countries
with high levels of wage inequality have lower levels of wage mobility. It concludes with a discussion of possible
policy steps that could reduce the risk of people being stuck in low wage jobs for long periods. These should be
targeted at both the demand side (the structure of jobs) and the supply side (the capacity of workers).
02/30 Indicators of Fiscal Impulse for New Zealand John Janssen (Treasury) and Renee Philip
(Reserve Bank of New Zealand)
Abstract: This paper defines fiscal impulse as a measure of whether government fiscal policy decisions are adding to, or
subtracting from, aggregate demand pressures in the economy. When assessing the effects of fiscal policy on the economy
it can be useful to have an approximate estimate of fiscal impulse. Estimates of fiscal impulse range from simple
indicators based on fiscal aggregates, to more complicated approaches requiring greater use of judgement and economic
theory. This paper develops reasonably simple indicators based on adjusted fiscal aggregates. It also sets out some
sensitivity analysis. The indicators reflect intuitive assessments about changes in New Zealand fiscal policy over the
last decade and looking forward into the forecast period. Although estimates are relatively insensitive to alternative
assumptions, this is likely to be the result of the relative stability of the time period under consideration. Simple
indicators of fiscal impulse have limitations. At best they can only provide an indication of the first round impact of
changes in discretionary fiscal policy. A more complete assessment of the effects of fiscal policy on the economy
requires a full-scale macroeconomic model, perhaps complemented with time series analysis.