David K.H. Begg, Gianluigi Vernasca-Economics-McGraw Hill Higher Education (2011)

CHAPTER 17 Fiscal policy and foreign trade
Table 17. l UK public finances, 2009/l 0
Revenue
£bn
Expenditure
£bn
Direct tax
Goods and services
Income tax 140
-
Corporation tax 34
Health 119
Education 88
-
Social security 95
Defence 38
Law and order 36
Indirect tax
VAT 67
Business rates 24
Housing, environment 30
Tra nsport 23
Industry and agriculture 21
Excise duties 44
Council tax 25
Personal social services
Transfer payments
29
Other receipts 69
Social security 190
Debt interest
30
Other spending 72
Total revenue 498
Total spending 676
Deficit 178
Source: www. hm-treasury.gov.uk.
Net taxes are taxes minus
transfers.
national income and output. If YD is disposable income, Y national income and
t the net tax rate (which for simplicity we assume to be a constant proportion
of income), then disposable income YD = (1 - t)Y.
Suppose taxes net of transfer benefits are about 20 per cent of national income. We can think of the (net)
tax rate t as 0.2. If national income Y rises by £1, net tax revenue will rise by 20 pence, so household
disposable income will increase only by 80 pence.
We still assume that households' desired consumption is proportional to their disposable income. For
simplicity, suppose autonomous consumption is zero but that, as before, the marginal propensity to
consume out of disposable income is 0.9. Households plan to spend 90p of each extra pound of disposable
income. The consumption function is now C = 0.9 YD.
With a net tax rate t, disposable income YD is only ( 1 - t) times national income Y. Thus, to relate
consumption demand to national income, C = 0.9YD = 0.9(1 - t)Y.
If national income rises by £1, consumption demand rises by only 0.9(1 - t), which is less than £0.90. If the
net tax rate t is 0.2, consumption demand rises by only £(0.9 x 0.8) = £0.72. Each extra pound of national
income increases disposable income by only 80 pence, out of which households plan to consume 90 per cent
and save 10 per cent.
Clearly, spending £0.72 of each extra pound of national income implies a flatter consumption function,
when plotted against national income, than spending £0.90 of each extra pound of national income. The
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