The name is absent

bound to be incomplete descriptions. Tax receipts may change even when both the tax
base and the tax rate do not move. A change in tax paying behaviour after the
introduction of self assessment in the UK in the 1990s could not have been picked up by
any model. A shift in the pattern of consumption away from taxed to untaxed goods may
not be picked up in equations for indirect tax receipts unless we have very detailed
models. Both of these events will look like random (but explicable) elements in our
analysis of taxes.

Modelling the Economy

We use the National Institute Global Model, NiGEM, to scale the relationship between
output gaps and the budget deficit. It is an estimated world model, which uses a ‘New-
Keynesian’ framework in that agents are presumed to be forward-looking but nominal
rigidities slow the process of adjustment to external events¹²⁹. Economies are linked
through the effects of trade and competitiveness and are fully simultaneous. There are
also links between countries in their financial markets as we model the structure and
composition of wealth, emphasising the role and origin of foreign assets and liabilities.
We have forward-looking wages, forward looking consumption, forward-looking
exchange rates and long-term interest rates are the forward convolution of short-term
interest rates.

Each country has a description of its domestic economy that can be broken up into
sectors: the government, the labour market, consumption behaviour, the supply side of the
economy and financial markets. We need to ensure that interest rates, rt, are set to
stabilise the economy. We use a policy of nominal aggregate targeting and inflation rate
targeting, or the two pillar strategy advocated by the European Central Bank

rt =γ1(PtYt-(PtYt)*) +γ2(ΔPt-ΔPt*)                          (7.3)

All variables are in logs, PY is (the log of) nominal GDP, P is (the log of) the Consumer
Price Index (CPI) inflation rate, and a * denotes a target.

We have models of direct and indirect taxes, and of government spending. We consider
the financing of the government deficit (BUD), and we allow either money (M) or bond
finance (DEBT).

BUD = ΔM + ΔDEBT                                         (7.4)

Current fiscal revenues can be disaggregated. Personal taxes (TAX, which includes both
personal income tax and social security contributions) depend on personal incomes.
Corporate taxes (CTAX) depend on longer term profitability. Indirect taxes (MTAX)
depend on consumer expenditure. Transfers to individuals (TRAN) depend upon prices
and on unemployment, and hence these vary with the economic cycle. Government
consumption and investment (GC and GI) which are assumed to be on plan except for
random fluctuations, and they are not influenced by the cycle. As GC and GI are in
constant prices, we convert them to nominal terms using the private consumption CED
deflator. Government interest payments (GIP) are modelled as the income on a perpetual

The structure and the simulation properties of NiGEM are described in, Barrell et al. (2003).

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