Inflation and Taxable Capacity

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1983 Inflation and Taxable Capacity: Some Recent Evidence Barbara Allison Haney-Powell Eastern Illinois University This research is a product of the graduate program in Economics at Eastern Illinois University. Find out more about the program.

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Date Author INFLATION AND TAXABLE CAPACITY:

SOME RECENT EVIDENCE (TITLE)

BARBARA ALLl:SON ...HANEY..-POWELL -

THESIS

SUBMITTED IN PARTIAL FULFILLMENT OF THE REQUIREMENTS

FOR THE DEGREE OF

Master of Arts in Economics

IN THE GRADUATE SCHOOL, EASTERN ILLINOIS UNIVERSITY

CHARLESTON, ILLINOIS

19..83 YEAR

I HEREBY RECOMMEND THIS THESIS BE ACCEPTED AS FULFILLING

THIS PART OF THE GRADUATE DEGREE CITED ABOVE

July 28, 1983 DATE ADVISEF( ..

July 28, 1983 DATE COMMITTEE MEMBER

,July 28, 1983 DAT DEPARTMENT CHAIRPERSON TABLE OF CONTENTS

CHAPTER

I. INTRODUCTION. 1

II. COMMENTARIES ON CLARK 7

Pre-Clark Theories on a Taxable Limit 7 Clark's Determination of Inflation • 9 Data • 16

III. METHODOLOGY 22

Regression Analysis 22 The T Statistic 24 The Coefficient of Determination. 25 Analysis of Variance (F-statistice) 26 Durbin-Watson • 26 Defining the Problem • 27 Defining Inflation 29 Price Index • 31 The Consumer Price Index 34 The Ratio 35 Sample Population 37 Preliminary Model Test 39 Alternative Formulation • 40

IV. CONCLUSIONS. 42

Results. 42 Category 1 Countries 45 Category 2 Countries 48 Concluding Remarks 50

SUMMARY 53

APPENDIX I 57

APPENDIX II 60

BIBLIOGRAPHY. 69

ii INFLATION AND TAXABLE CAPACITY:

SOME RECENT EVIDENCE

BARBARA ALLISON HANEY-POWELL

B. A. in Economics, Eastern Illinois University, 1981

ABSTRACT OF A THESIS

Submitted in partial fulfillment of the requirements for the degree of Master of Arts in Economics at the Graduate School of Eastern Illinois University

CHARLESTON, ILLINOIS 1983

Colin Clark's theory of inflation has had a profound effect on present-day economic theory concerning taxation policy. While his belief that inflation occurred when all tax revenues exceeded 25 percent of national income was rejected by his contemporaries in the 1940's, supply side economists incorporate Clark's theory into their proposals for curing the unemployment and inflation of the 1970's and 1980's. These proposals gained popular support and resulted in the election of President

Ronald Reagan who implemented such proposals. The purpose of this study is to determine the veracity of Clark's theory.

Clark's theory was tested in this study with the use of regres sion analysis. The dependent variable, inflation, was measured as the percent change in the consumer price index. The consumer price index was chosen because it is a broad-based index that is representative of commodity and service prices and excludes labor costs. Measurement error was minimized by the use of annual CPI data. The independent variable is the ratio of total tax receipts as a percent of the officially reported national income. The preliminary run of the test was performed on the

United States from 1941-1981 using ordinary least squares contained in

the Econometric Software Package. Autocorrelation appeared in the

regression and attempts to correct this failed.

The modified test model used the rate of inflation acceleration

(percent change in the inflation rate) as the dependent variable. This

dependent variable exaggerates the magnitude of price changes, making the

relationship more likely. The independent variable represented the elasticity coefficient of total tax receipts to national income (percent

change in taxes divided by percent change in national income, expressed

as a percentage). This independent variable is far more descriptive of

the interaction between tax revenues and national income. The model was

used to test Clark's theory in Canada, Finland, France, Germany, Italy,

Switzerland, the United Kingdom, and the United States from 1963-1981.

The regression results show that there is no relationship between the

rate of inflation acceleration and the elasticity of total tax receipts

and national income.

On the basis of the regression analysis and the country by country statistical analysis, this study finds little evidence to support Clark's theory of inflation. For this reason, the study reconnnends a re-examina tion of all policies that have been implemented on the basis of Clark's theory or other similar theories of inflation. CHAPTER I

INTRODUCTION

The ineffectiveness of government policy in curing inflation and unemployment in the 1970's prompted a few economists to revise their theories regarding fiscal measures, especially taxation policy. These revisionists, who are known as supply-side economists, feel high rates of taxation on income reduce the work effort of employees, thereby causing distortions in both the input and output markets. Decreased work effort by labor makes the costs of production increase and is trans mitted as higher prices for final goods. In the input markets, employers attempt to substitute capital for labor; causing a decrease in the demand for labor (resulting in unemployment) and an increase in the demand for capital goods. The higher demand for capital goods increases the demand for loanable funds to purchase the capital goods; the increased demand for funds results in higher interest rates. This new level of interest rates increases the interest payments on the deficit of the federal government, necessitating further increases in tax revenues to meet those payments. Without an impetus for change, this sequence becomes self-perpetuating, resulting in increasing levels of unemployment and inflation. While traditional theory calls for tax increases to reduce aggregate demand and alleviate upward pressure on prices, supply-side economists advocate tax cuts in order to increase aggregate supply and

thus apply downward pressure on prices.

1 2

While many of the supply-side foundations can be traced back to 1 the writings of Adam Smith, much of the recent popularization of supply -

side analysis can be attributed to Colin Clark, a mid-twentieth century

Australian economist. Clark's theory, first presented in the Economic

5; Journal, December 194 ;, 2 describes how government budgetary deficits and taxation as a percent of income is the cause of inflation. In this article,

Clark does not indicate whether taxes or deficits are the real cause of

inflation. However, his later article, "The Danger Point in Taxes, " pub 3 lished in Harper's nagazine, December 1950, clearly presents the hypothesis which gained Clark considerable notoriety.

In the second article, Clark stated that if the levels of taxation are too high, people will lose their incentive to engage in activities that further increase their incomes. Consequently, the quantity of goods pro-

duced (supplied) does not grow as rapidly as demand, and price increases result. Clark's statistical analysis led him to conclude that inflation

will occur when tax revenues exceed 25 percent of national income during peace time in non-totalitarian countries. Clark describes the sequence of events as follows:

We have learned, from the experience of many countries what happens when taxes mount too high. Many people don't find it worth their

1 Adam Smith, An Inquiry Into the Nature and Causes of the Weal th of Nations, Max Learner, ed. (New York, NY: Random House, Inc., 1937), see Ch. 2 of Book 2 and Book 5 for a complete discussion of the relation ship between sovereign revenues and the prod uctiv ity of workers. 2 colin Clark, "Public Finance and Changes in the Value of Honey," Economic Journal, Vol. LV, No. 220 (New York, NY: Macmillan and Co., Ltd., 1945), pp. 371-389. 3 colin Clark, "The Danger Point in Taxes, " Harper 's Magazine, Vol. 201, No. 1207 (New York, NY: Harper and Brothers, Publishers, 1950). pp. 67-69. 3

while to work hard and efficiently. Produc tion doesn't expand as fast as it should. There is a shortage of goods followed by an 4 inflationary rise in prices.

The disagreement among economists about Clark's theory did not stem from his postulation that a taxable limit existed. To some economists, like Francis Bator, the idea of extremely high .levels of taxation having negative effects on an economy was not new. Bator speculated that if Clark had specified a much higher figure, there would have been little controversy over his thoery; many Western nations had exceeded Clark's

25 percent limit for most of the post-World War II decade without apparent damage to their economies. Bator's concern was that the 25 percent figure 5 would be used as a universal policy guide for governments. Other economists, such as Monteath Douglas, feared Clark's analysis would provide the basis for legal restrictions on the budgetary powers of government.

As Douglas observes:

When economists in England a generation ago were interesting themselves in the subject of taxable capacity the circumstances of time and the method of their inquiry caused them to give forth a subdued and uncertain sound to which the public paid no attention. But when in recent years Mr. Clark's warning hit the newspapers, many people who had not previously paid much attention to the views of economists about anything received it as a revelation and a dogma binding the conscience of the citizen and the conduct of his government. 6

4 Ibid. , pp. 67-69. 5 Francis Bator, "Inflation," The Question of Governrr1ent Spending --Public Needs and Private Wants (New York, NY: Harper and Brothers, 1960 ), p. so. 6 ' Monteath Douglas, "Taxable Capacity and the British and Canadian Experience, " The Limits of Taxable Capacity, presented at the National Tax Institute Symposium, Nov. 20-21, 195 2 (Princeton, NJ: Tax Institute, 1953), p. 30. 4

The fears of these economists were not unfounded. Twenty-nine states

sent petitions to the United States Congress requesting a constitutional

peace-time limit of 25 percent of national income for estate and income 7 tax revenues as a result of Clark's thesis.

The taxable limit put forth by Clark had a profound effect on the

development of economic theory. Clark's methodology and conclusions pro 8 9 vided the framework for the writings of Jude Wanniski, Arthur Laffer, lO . and Craig Roberts. These latter writings were the basis of the Kemp 11 Roth tax cut proposals and the popularization of the current supply 12 side theory. Supply-side theory gained the support of much of the

American public and resulted in the election of a U. S. President (J1r,

Ronald Rea�an) who promised to implement such proposals.

7 wall Street Journal, Aug. 13, 195 2. Only seventeen petitions were sent out of the House Judiciary Committee to the House floor for consideration. For more information see, Constitutional Limitation on Federal Income, Estate, and Gift Tax Rates, Joint Economic Connnittee, 86th Congress (Washington, D. C. : U. S. Government Printing Office), p. 26. 8 see Jude Wanniski, The Way the World Works (New York, NY: Basic Books, Inc., 1978).

9 Arthur Laffer, The Economics of the Tax Revolt (New York, NY: Harcourt, Brace, Jovanovich, 1979). lO Since Paul Craig Roberts is a guest writer for the Wall Street Journal, he has many published writings. Craig Roberts, "The Case for Kemp-Roth, " Wall Street Journal, Aug. 1, 1978, p. 26, clearly shows Clark's influence. 11 The Kemp-Roth tax proposal calls for a 10-10-10 reduction of personal income taxes. While the Kemp-Roth proposal was never enacted, the Economic Recovery Act of 1981 (ERA) included a very similar proposal, except the ERA cut taxes only 5 percent the first year. 12 otto Eckstein, Forecasting the Supply Side of the Econom�, Hearings before the Joint Economic Committee, 96th Congress, May 21, 1980 (Washington, D. C. : U. S. Government Printing Office), p. 26.

The influence of Clark's writings can be seen in the Reagan

Administration':s economic plan. Clark's taxable limit provided the foundations for the tax changes implemented by this administration.

As Budget Director David Stockman states:

tax receipts under current law would rise by 14 percent annually from 1981 to 1986, and by 1986 the share of GNP taken by taxes would rise to over 24 percent. Such large increases stemming from continued bracket creep and inadequate depre ciation would have a debilitating effect on growth, savings, entrepreneurial activity and work effort. This tax break effect generates continued economic stagnation, higher unemployment, and declining living standards. By contrast, the proposed tax rate reductions and the more rapid writeoffs of plant and equipment costs will contirbute new incentives for strong growth rates of investmen� production and real income. Under the President's plan, the share of worker incomes and industry profits taken by Government will fall to 20.4 percent of GNP in 1982, and to about 19. S percent in subsequent years.13

However, the anticipated effects of the Reagan economic plan have yet to occur. More than a year after the implementation of this policy, the U.S. economy has experienced record levels of unemployment and a prolonged recession. While current price increases have moderated due to the recession, forecasts by some of the most prestigious fore-

casting firms indicate inflation will be more severe in the future than

in the past. Dr. Robert Gough, Jr. , of Data Resoruce, Inc., concludes

from his analysis of the Reagan economic program:

13 navid Stockman, President Reagan's Economic Program. Hearings before the Senate Committee on the Budget, 97th Congres s, Feb. 19, 1981 (Washington, D. C.: U.S. Government Printing Office, 1981), p. 9. 6

On a net basis, one cannot escape this conclusion if one believes in the relationships that have governed the economy in the past, that the net

effect of the President's program, •••is to make the inflation rate worse.14

The reason the rate of inflation would become worse is because a tax cut would increase disposable income and provide consumers with greater purchasing power. This led Dr. Gough to conclude that the Reagan tax cut would add fuel to current inflationary pressures.

It is important to investigate the validity of Clark's analysis because of its impact on current policy. The purpose of this inquiry is to determine if inflation occurs when tax revenues exceed 25 pereent of

National Income. A review of Clark's method and dat a is necessary in order to develop a model for testing his hypothesis. From this analysis, it will be possible to evaluate the veracity of Clark's conclusions.

14 nr. Robert Gough, Jr., Economic Forecasts. Hearings before the Joint Economic Committee, 97th Congress, March 12 , 1981 (U.S. Government Printing Office, 1981), p. 42. CHAPTER II

COMMENTARIES ON CLARK

Pre-CLark Theories on a Taxable Limit

Although the concept of a taxable limit has been debated since the first comprehensive tax system, the first cognizant theory of a taxable limit was not formed until the late nineteenth century. During this period, the British Parliament was attempting to determine the maximum rental tax which could be imposed on Ireland without serious harm to

Irish agricultural productivity and political stability. A British economist of this period, Charles Francis Bastable, estimated that any form of taxation that exceeded 15 percent of Irish national agricultural income would have severe ramifications for Ireland's economic and political stability. However, this was based more on Bastable's impression 1 of the Irish temperament rather than solid scientific analysis.

Shortly after the First World War, discussion by the British Par- liament about war debt repayment prompted Sir Josiah Stamp to investigate the limits to which a nation could be taxed. Stamp postulated that factors such as the use of tax revenues, the "spirit and the national psychology" toward taxation, population growth, the distribution of income and wealth, the type of tax imposed, and the progressivity of the tax were the deciding factors of a nation's taxable limit. Within this framework, Stamp concluded

1 Francis Bator, The Question of Government Spending--Public Needs and Private Wants (New York, NY: Harper and Bros,, 1960), p. 50.

7 8 that taxation policy in Great Britain from 1860 to 1914 had thwarted new business investment, particularly when a preponderance of the revenue went to debt payment. Stamp observes:

A man may be unaffected in his efforts, so far as

they at present exist • • • but every new effort and every new responsibility will come under taxa tion of a drastic kind, and makes the reward far

less attractive •••Their new business enterprise or saving is taxed to pay tribute for the past absti nence of others. The prizes of successful enterprise and risk taking are seriously reduced, and the dead hand of debt stretches out over the zeal of future 2 generations..

Because of this reasoning, Stamp opposed A. C. Pigou's schedule 3 for British debt retirement, and favored instead a scheme of taxes called the Rigano Scheme of Death Duties. The Rigano Scheme taxed second and third generation inheritances, but allowed first generation inheritances to pass free from taxes. Thus, work incentives of the current generation of workers could be maintained and the necessary revenue for debt repayment would be obtained.

2 Sir Josiah Stamp, Wealth and Taxable Capacity (London, UK: P. S. King and Sons, Ltd. , 1922), pp. 171-172. 3 Ibid. , p. 180. Pigou assumed that (1) National Income would be 3 trillion pounds, (2) productivity and debt interest growth rates would remain equal, (3) no change in the price of inputs, (4) the size of the government budget would not change substantially. A capital levy could reduce the aggregate tax burden funded by general revenues as follows:

% of Levy on Needed General Revenue for National Income Capital Interest Payment on the Debt ---

No Levy...... 800 million pounds...... 27% Half of debt funded

by a capital levy. . . . .560 million pounds...... 25% All of debt funded

by a capital levy. . . . .320 million pounds...... 12% 9

Stamp found consensus in the New Fabian Research Bureau. A

Socialist Budget, a Fabian pamphlet, concluded that the Rigano Scheme could raise taxation from 23 .4 percent of National Income to 25 percent of National Income without substantial price increases. The pamphlet stated that price increases would not result from the Rigano Scheme because work and investment incentives would be maintained for the current generation of workers, thereby ensuring adequate business investment to provide for goods and services in the market. The principle author of this pam 4 phlet was an obscure Australian economist, Colin Clark.

Clark's Determination of Inflation

Clark's purpose was to find the causes of inflation in times of peace in non-totalitarian countries. In the initial presentation of Clark's theory, he delineates two predominant factors which were generally considered

by economists to cause inflation: external currency depreciation by foreign

bankers and/or governments, and wage increases. He believed that these were only mechanisms by which inflation was transmitted to the private sector;

government actions, particularly taxation, are the primary inflationary

sources. From statistical analysis, Clark believed the inflationary pres-

sures on the two mechanisms became significant when tax revenues exceeded

25 percent of National Income.

The consideration of external depreciation is dated for this ana-

lysis, but worthy of mention to understand Clark's data adjustments on

domestic prices. During Clark's writings, international exchange was

4 Ironically, many of the co-authors of the pamphlet speaking out against Pigou's proposal, like Joan Robinson and G. F. Shove, were Pigou's students. "Public Finance and Changes in the Value of Money," Economic Journal, Dec. 1945 (New York, NY: Macmillan and Co. , Ltd.), pp. 380-381. 10 regulated under the terms of the Bretton Woods Agreement. This system assigned currencies fixed par values and these values were maintained by official intervention in the currency markets. Hence governments were able to minimize the effect of international markets on the domestic supply of money, making domestic monetary policy more accurate. However, to maintain the balance of trade (goods to goods relationship) the level of prices had to rise or fall, depending on whether a surplus or deficit 5 occurred in the countries' current accounts. Even in countries where the foreign trade sector composed a small segment of Gross National Product, these price adjustments occurred to maintain the balance of trade. Thus the foreign sector determined a larger role in domestic price fluctuations.

In fact, it was this feature of the Bretton Woods System that contributed 6 to its demise in the early 1970 's.

5 clark also fails to consider the role of the central bank in the transmission process. In a fiat reserve system such as the United States, the Federal Reserve is not obligated to respond to international current account deficits or surpluses. Historically, there has been little rela tionship between the international markets and U. S. domestic price levels. See William Gale, Inflation, Causes and Consequences and Control (Cambridge: MA: Oeleshlager, Gunn, and Hain, Publishers, Inc. , 1981), pp. 115 -131. 6 nue to a $9. 8 billion overseas current account deficit of the U. S., President Nixon suspended American participation in the Bretton Woods System and instituted a domestic wage and price freeze. Other nations who had their currency tied to the American dollar or who were close trading partners of the U. S. then left the system, allowing their currencies to float freely. Temporary dollar parities were established under the Smithsonian Agreement, but these countries abandoned the temporary parities by 1973. The demise of the Bretton Woods System in the early 1970's removed currency exchange rates from the international currency markets. Under the new float system, domestic prices can remain stable, while international currency values fluctuate to accommodate activity in that market. Therefore, this variable is omitted from the model developed later in this paper. Wilfred Ethier, Modern International Economics (New York, NY: W. W. Norton & Co. , Inc ., 1983), pp. 459-461. Also see C. A. r.oorobs, The Arena of International Finance (New York, NY: John Wiley Co. , 1976). 11

ism to which Clark refers , wage The second transmission mechan ge resist either through the corporate wa increases, occurs in two ways : wage leisure substitution effect. The ance effect or through the work- ess profits corporations are subject to exc resistance effect occurs when 's view , corporate income taxes. In Clark taxes and/or very progressive that are grant wage concessions to employees corporations are inclined to te costs. productivity in order to infla greater than their increases in taxab le the firm is able to reduce its By inflating production costs , costs are s tax liab ility. These inflated income and therefore reduce it prices . creasing the level o f output passed on to the consumer , in it implicit assumptions. First, However, this argument has two costs. The reases in labor costs over other assumes corporations favor inc ially if to favor wage increases, espec corporation may not be inclined (e.g ., control over future wage increases they tend to reduce corporate to labor inten if the corporation is limi ted union contracts). Secondly , greater. Thus , number of employees will be sive production techniques, the successive ility may prove less costly than the firm' s increased tax liab ugh wage incentive to inflate costs thro wage increases, leaving little

increases. le m could use to reduce its taxab There are other methods the fir ing the and advertising costs, increas income: increasing maintenance e accounts , etc. , i ncreasing executive expens payout ratio to stockholders corporate ls of tax r evenues leaving the However , if there are high leve retained earnings r remaining out of corporate treasury , each and every dolla to spend money the corporation is not likely is especia lly important, and . If thes e eld a subs tantial rate of return on these items unless they yi 12 monies are spent wa stefully, inefficient business practices may result, contributing to further declines in the diminished profit margins of the firm. Th erefore, it is not likely that corporations will be encouraged 7 to inflate costs, unless taxation becomes extreme . Even if the argument was valid, Clark does not provide reasons why this effect becomes significant wh en tax revenues exceed 2 5 percent of National Income .

The work-leisure substitution argument presented by Clark is more interesting. As presented in the first chapter, Clark feels that individuals are less inclined to increase their productivity and work effort under high rates of taxation, therefore , people tend to favor more leisure rather than time spent increasing their level of income . Clark postulated that this effect is predominant among members of a society when tax revenues exceed 2 5 percent of National Income .

\. The work-leisure effect has been debated for many years . Some economists believe that taxes may cause individuals to work harder to com- 8 pensate for their loss of income , especially at the lower end of the scale.

Other economists feel non-economic motives , such as power , prest ige and wo rker pride, play a more important role in the actions of individuals than do taxes . Thomas Saunders ' series of interviews with businessmen concluded that tax rates have little or no effect on the work effort of bus inessmen; 9 other motives , such as power within the organization, are more important .

7 Joseph Pechman and Thomas Mayor, "Mr . Clark on the Limits of Taxa tion ," Review of Economics and Statistics (Cambridge, MA: Ha rvard University Press , 1952) , p. 240 . 8 Francis Bator, op. cit ., pp. 52-54 . 9 Thomas Saunders, Effects of Taxation on Incentives of Executives (Cambridge, MA: Harvard Unive rsity Press, 1951) , especially the last chapter.

Recent statistical research contradicts Saunders ' work . Chris- topher Frenze, staff economist for the Joint Economic Committee, found 10 that the Revenue Acts of 1921, 1924, 1926 and 1964 removed worker disincentives and expanded output. Frenze concluded that the results of the

1921 Revenue Act caused unemployment to decline and productivity to increase. The 1924 Revenue Ac t caused unemployment rates to drop 27.3 percent and industrial produc tivity to expand by 12 percent. The 1926

Revenue Act caused a 50 percent reduction in the unemp loyment rate and an expansion in output per man hour over the two years following the tax 11 cut . Lawrence Klein found the unemployment rate declined 0.5 percent 12 in 1964 as a result of the tax cut in the first six months of the tax cut .

However, the reader should note that the unemployment rate represents

10 The Revenue Acts of the 1920's are commonly referred to as the Mellon tax cuts, named after Secretary of the Treasury , Andrew Mellon. The 1921 Act consolidated brackets and cut the effective marginal rates by 1 percent . The 1924 Act lowered the bottom marginal rate l� percenf and the highest rate by 10 percent . The 1926 Ac t increased exemp tions and cut the rates 1 percent across the board. The Revenue Act of 1964 is commonly referred to as the Kennedy cut. This two-year tax cut reduced taxes on taxab le income as follows : 0-2 ,000 were cut 30 percent , 2,000-100,000 rates were cut 16 to 20 percent, and over 100, 000 rates were cut 23 to 26 percent. See Christopher Frenze , The Mellon and Kennedy Tax Cuts : A Review and Analysis , Subcommittee on Monetary and Fiscal Policy of the Joint Economic Committee , 97th Cong. , 2nd sess . (Washington, D. C.: U.S . Government Printing Office, 1982) . 11 rb id., pp. 8, 10-12, and 23-26 . 12 Lawrence Klein, "Econometric Analysis of the Tax Cut of 1964, " in James Duesenberry , ed . , The Brookings Mo del : Some Further Results (Chicago, IL : Rand McNally & Co ., 1969) , pp. 459-4 72. Using the Wharton Model, Klein found the unemployment rate to drop 0.8 percent in 1964 due to the tax cut . 14 people who are actively seeking work (ergo , willing to work) but canno t find emp loyment; it does not measure their work effort . Also, the use of output per man hour should not be considered as an accurate guage of work effort, since increases in this index can be attributed to other nongovernment variables, such as changes in technology , worker morale, level of labor force education, reorganization of inputs, other non- monetary incentives such as worker pride, and managerial abilities within an industry.

In a series of stratified income studies , Michael Evans , president of Evans Economics, Inc ., found a significant relationship between the level of taxation and work effort . In his regression analysis, Evans held reported adj usted gross income levels (AG!) constant to measure the effect of changes in the AG! after the 1964 Revenue Act. As Evans reports:

We found the following results for a 1% reduction in tax rates . For lower income workers , such a reduction would raise work effort by about 0.1%. For middle and upper-income workers , the reduction was about 0.25% . For upper-income workers--those with taxab le incomes of $120, 000 or mor e--we found that the elasticities were in excess of 2.0.13

Evan ' s research also found that for every one percent reduction in the rate of personal income tax, the rate of labor force participation increased 14 by 0.2 percent and wage rate increases were reduced by 0.4 percent . While

Clark does not provide an explanation as to why worker disincentives become

1 3 Forecast ing the Supply Side of the Economy , Hearings before the JEC , 96th Congress , May 21, 1980 (Washington, D. C. : USGPO) , 1980, p. 47. It should be noted that Evans believes that the 2.0 elasticity is over stated because individuals in this income range are more likely to shift their form of income from capital gains to earned and back , depending upon which rate of taxation is lower. Even so , Evans was able to verify his statistics with cross-sectional analysis . 14 Ibid. , p. 48. 15

significant as tax revenues approach 25 percent of National Income,

Evans' research contains interesting implications for Clark's analysis.

The degree in which work-leisure substitution takes place in any

given economy is most likely dependent upon how much income and wealth

is in the possession of those with the highest substitution elasticities.

Therefore, the more wealth that is concentrated at the higher end of the

income spectrum, the more the work-leisure substitution effect will pre-

dominate in a given society, consequently, the lower the taxable limit.

In other words, the more wealth is concentrated, the more_!_f!: f_!_

In fact, Clark does make some allowances for the distribution of

income. In countries with a relatively equal income distribution, infla-

tion will occur when tax revenues exceed 18 percent of National Income,

rather than at 25 percent. Clark bases this conclusion on the apparent

statistical relationship. As Clark explains, "This means on the whole, 15 to be borne out by the figures." If Evans' research is correct, then

higher taxable limits, not lower ones, would be expected when incomes are

equa 11y d1str1. .b ute d • 16 It should also be noted that for a society to

achieve income equality, there would have to be a political consensus that

income equality is desirable. Thus, a higher social and economic tolerance

15 colin Clark, "Public Finance and the Changes in the Value of Money," The Economic Journal (New York, NY: Macmillan & Co., Ltd., 1945), p. 383. 16 This is because per capita income would be lower and thus, the work-leisure substitution effect less predominate. If this effect does not predominate among the members of the society, then the inflationary effects would not occur until tax revenues as a percent of income became very high. 16 of high tax rates would be expect ed; any negative effects would have to be considered, on balance, with the desirability of income equality.

Therefore, even if inflation is incurred in the achievement of this social goal, it may be considered the lesser of two evils by that society .

When incomes are more equally distributed, then more of the population is in the area with lower leisure substitution elasticities . Therefore, a high level of taxation is neces sary for the substitution effect to become significant .

Clark believed these factors became significant enough to induce inflat ion when tax revenues exceeded 25 percent of National Income because there was a statistical correlation. Therefore, to assess the validity of

Clark 's analysis , an examination of his data is in order.

Data

Prior to World War II, there was no consistency in the formulation of National Income statistics . While the United States and the United 17 Kingdom have been the pioneers in formulat ing consistent and reliable data, none of this data was formulat ed in any consistent methodology before the

1900 ' s. It wasn ' t until 1944 that the use of certain concepts of national 18 income account became internationally defined . The establishment of the

Organization for European Economi c Cooperation in 1960 increased the numb er of countries that used internationally recognized concepts, me thods and

17 osker Morgenstein , On the Accuracy of Economic Observations (Princeton, NJ : Princeton University Press, 1950) , p. 242. 1 8 This occi.wred when Canadian , British and American officials met to agree upon what should be included in different income statistics . See Paul Studenski , The Income of Nations (New York , NY: New York University Press, 1961) , Vol. 1, p. 154. forms of national income accounts. Prior to this time (19 46- 1955)

eighty countries had nationa l income statistics ; however , only four

countries had official accounts. 19

Even where these statistics were official, their accuracy is

questionable before 1950 . For example, OECD found French National Income 20 in 1949 to be 80 percent accurate. In the United States (where an offi.,...

cial statistical methodology was not established until 1947) Simon Kuznets 21 found national statistics to have a margin of error of about 10 percent .

In the United Kingdom, the Central Statistical Office did not have a 22 method of determining the margin of error until 1956. This error was

found to range from 3 percent for some statistics to 15 percent for 23 others . Therefore , one must beware of any analysis based on national

income prior to the 1960's.

In Clark' s analysis , many of the movements in national income may be from errors in measurement , changes in statistical methodo logy , or from 24 real economic factors , or all of these factors . Since Clark gathered his

own data, there is no way to determine the statistical accuracy of the

19 Ibid. , p. 155. 20 Ibid. , Vol. 2, p. 102. 2 1 osker Morgenstein , op. cit. , p. 273. For examp le, if GNP was 550 billion dollars , this would be accurate within 60 billion dollars. 22 Ibid. , p. 268. 2 3 For more information see National Income Statistics : Sources and Methods (London , UK : H. M. Stationary Office , 1956) . 2 4 It should be noted that these statistical problems were not un ique to Clark. In the next part of this chapter, some degree of statistical accuracy in Clark's data will be granted. Even if his data was accurate, there are many problems with Clark ' s statistical conclus ions . 18

data presented in his analysis. Thus, it is difficult to assess the

accuracy of Clark ' s conclusion.

On the surface, Clark's French statistics look convincing, as

shown in Appendix I, Tab le 1. In this table Clark shows his longest

data series. As Clark describes:

France found herself , when the world level of prices became stabilized in 1922, with taxation absorbing 25% of her national income , and with an uncovered deficit representing a further 8% o f national income . This burden was intolerab le, and a devaluation of the franc was clearly indicated. By 1924 equilibrium was in sight . In 1925 and 1926 it appeared that the mark

had been oversho t • • • The devaluation was therefore sharply checked in 1926. But it will be noted that the value of money finally adopted was such as to make the ratio of taxation to national income almost exactly

25% for the next four years •

• The French deflation of 1931-35 commenced with taxation already at 26% of the national income , and was foredoomed to failure from the start . Taxation could not in fact be raised to any substantially higher proportion, and a mounting deficit accumu lated.

By 1934 France found herself again in a similar position to that of 1922 • • • The situation of the years 1936-38 cannot be analyzed as precisely as the previous devalua tion , because of rapidly rising military expenditure, but the tendency to settle down with taxation in the neighborhoo of 25% of the national income can again 25 be noticed .

In the time periods listed, Clark indicated that price increases are due to heavy taxation plus government deficits. However, a close examination of a few of the years contradict Clark's exp lanation. For instance, the largest price increase is from 40.0. in 192 5 to 505 in 1926. Yet taxes plus deficits in this time period only changed 0.3 percent of national income and were well below the 25 percent limit (21 percent and 2 1 .2 percent ,

25 colin Clark , "Public Finance and Changes in the Value of Money ,"

££. • cit. , pp. 376-377. 19 respectively) . If Clark's suggested two-year lag is used, this example is feasible, but not for other examples. In 1933, the price index is given as 520, taxation as 26.5 percent and the deficit as 5.8 percent .

Yet two years later in 1935 , the largest price drop in the series occurs with an index of 482 . Clark's later inference of a three-year lag does not work either . Using the same example, taxes plus deficit in 1934 are still over Clark's limit, although by not as much as in 1935. With or without lags , from 1923 to 1927, there were price increases when taxes plus deficits were below the critical limit.

Pechman and Mayor averaged Clark's statistics of France to find out if any relationship existed (Appendix I, Table 2). Taxes alone exceeded Clark's limit in only one period, 1928 to 1935 , averaging 26.3 percent of national income ; only when deficits are included does Clark's limit work . This would lead one to conclude deficits, not taxes , are the cause of inflation. Clark also considered Great Britain, Belgium, Italy,

Japan , and Norway , primarily from 1925 to 1930 (Appendix II, Tab le 1) .

The inclusion of Italy is surprising since (a) Benito Mussolini began his fascist dictatorship in 1922, and (b) it does not support Clark's thesis.

When taxation as a percent of income increases from 15.3 percent in 1926 to 22.0 percent in 1929, the price index falls from 517 to 446. One would expect the opposite since taxation is nearing the critical limit . Japan, another military dictatorship , is of little value to Clark's proof, since prices vary between 218 and 182 without any significant change in taxation; the same is true for Norway . Britain has only slight price fluctuations and very little change in taxation, leaving one to wonder why it was included in the analysis . 20

Perhaps the Belgium example is the most interesting because it is one of Clark � s exceptions to the 25 percent limit. Clark indicates that the "Low countries ," Scandinavia and a few of the British Dominions have a lower limit due to their size and personal wealth distribution.

Belgium's limit of 18 percent is reached in 1928 and the price index moves from 798 to 869 in 1930 , one of the few consistent observations Clark 26 has. 2 7 Data in Clark' s later writings includes a f ew additions , but it is difficult to analyze the data since he creates his own price indices 28 to include the affect of the foreign sector. Recall from the previous section that when exchange rates are fixed, fluctuations in overseas exchange rates are forced on domestic prices , and this is what Clark attempts to control with this index . However, Clark's omission of agricultural products seriously biases his indices in the foreign sector 29 adjustment and the domestic base of the index.

26 rt is not clear why Norway is not included With the Scandinavian countries. He singles out Norway as having the highest social expenditure as a percent of national income . Perhaps an examination of Norway in this manner would have been more useful to Clark. 27 clark's testimony in Emplo)'}!!ent , Growth and Price Levels, Joint Economic ·Committee, 86th Congress , ·Resolution'.' 13, October 1, 1959 (Wash ington, D. C. : USGPO), especially pp . 2459-2477, will be used as repre sentative of Clark ' s later writings , since it is the most comprehensive . 2 8 c1ark uses "Excess wage increases over productivity increases at normal levels of production imports and exports per year." Clark does not indicate how he weights world trade dependence into this factor as well as wo rld trade activity into this sector, so we cannot check his calculation . For the United States, it does not represent a concernable difference during the time period studied. 29 For example, if agriculture products were included in the average price index for the United States series from 1933-58 (Appendix III, Figure 1) , the average would have gone from 3.0 to 2.5. If we continue to lower the indices (or raise them as the case may be) the relationship is less striking . Emp loyment , Growth , and Price Levels, .£.£.• cit. , p. 2464. 21

This is why Clark's later results have never been confirmed .

Francis Bator made several attempts to confirm Clark's limit by using several different lags and price indices. As Bator notes :

The little evidence we have appears to be against Clark . Whether one uses the consumer price index or that for who lesale prices, wh ether concurrent data or a two-or three-year lag (as specified by Clark) , whether 2S percent or 27 percent (or even 30 percent) , the only two periods since the war during wh ich prices did not rise (1948-49 and , depending on the index , 19Sl-S3 or 19S4-SS) should have been , by Clark' s conjecture, years of marked inflation. Evidently a ratio of tax revenue to national income in excess of 2S percent (or 27 30 percent , or 30 percent) does not imp ly inflation.

Due to the impact of Clark ' s theory , it is important to confirm or rej ect the 2S percent taxable limit . At this point , it is necessary to develop

the model to test Clark' s hypothesis . From this ffiodel, the significance

of the relationship between tax revenues and inflation can be assessed .

30 sator notes here that "If he means 25 percent (and is willing to accept either the consumer or the wholesale index) , part of the evidence is still relevant--and inconsistent wi th the hypothesis. (The implicit deflator for GNP fell only between 1948 and 1949) . Francis Bator , .£e..· cit. , p. SS. CHAPTER III

METHODOLOGY *

othesis . thod of test ing Clark's hyp This chapter discusses the me tical calculat ion , metric pro cedure of statis Regression analys is , an econo analysis can a test model. Regres sion is the method us ed to develop de with a change in one variab le will coinci determine how ofte n a change n affect the the methods of measuring data ca in another variable. Since regression ana- is , a brief introduction to results of regression analys ter. The second first section of this chap lys is is presented in the ms associated b les are defined and proble section dis cusses how the varia on is followed by a se variab les. This secti with the measurement of the y test of the model. discussion of the preliminar

Regression Analysis such on defines a linear relationship A simple regres sion equati

as : (1) Y = a+ BX + u

e dependent on X wh ere: Y = a variabl intercept (constant) a = the vertical cient of X B = the coeffi that is suspected , a priori X = a variable to exert in fluence on Y

u = the error term

The observed values of X and Y can be sampled in one of two different

methods to fit this relationship. In cross sectional dat a, the samples

c course in Algeb ra * the reader has had a basi This chapter assumes st of Chapter t h ave this background , mo cs. If the reader does no and S tatisti . a loss in comp rehension III can be skipped without 22 23 are observed at a given point in time. In time series data, the samples are observed over many time periods. { Although Clark used both kinds of data, this analysis uses time series data to test the relationship. With / time series data the relationship between the variables can be tested over the past se�enteen years. /

Ordinary least squares are generally employed in regression analysis since it estimates coefficients that are the best unbiased, efficient,

1 and consistent with the sample's population. The estimated coefficient will possess these properties if the following assumptions are not violated:

1. The equation describes a linear relationship between X and Y.

2. The X's are non-random and fixed (non-stochastic).

3. The error term (u) has an expected value of zero. This will occur if the error term is normally distributed around zero. A violation of this assumption is referred to as heterosche dasticity.

4. The error term in time t is unrelated to the error term in the previous time period, t-1. A violation of this assumption is referred to as first order autocorrelation.

5. The error term is unrelated to the variables; they are independent. A violation of thi� assumption is referred to as second order autocorrelation.

Once a coefficient is determined, several statistics are used to determine if the assumptions are violated and if the relationship is significant. It is important to determine if the assumptions hold before

1 A more complete explanation of regression analysis can be found in: Henry Theil, Principles of Econometrics (New York, NY: John Wiley, 1971). 2 navid Katz, Econometric Theory and Applications (Englewood Cliffs, NJ: DS Prentice Hall, Inc., 1982), p. 67.

a significance test is performed since the significance test may lead to false conclusions. Consequently, a biased coefficient would be used to represent the relationship tested. The statistics used to test the 2 assumptions are the Durbin-Watson, the coefficient of determination (R ), and the correlation matrix. 3 The significance test uses the T statistic, the F statistic, and R2• The simpler significance statistics will be explained first, followed by the more complicated statistics.

The T Statistic

Before the T statistic can be defined, the term "standard error" must be explained. Standard error is defined as the standard deviation of a sampling distribution from the sample's mean value. However, this tech- nical definition is vague to the layman. The mean refers to the average of all observed values of a given variable, mathematically expressed as:

N L: xi N = 1 (2) x N

where: N the number of observations i = the

The standard deviation (S) describes how far observations vary from the sample's mean value. Mathematically, it is expressed as:

N E ( - =;: X (3) l i 2 1 N X) s = ( )"2 N- 1

3 An explanation of the correlation matrix is omitted here. The interested reader may consult any introductory econometrics book to gain an insight of this analytical tool. 5 2

4 The standard error (SE} can then be expressed as:

s (4) SE = N�

The standard error is then used to calculate the T statistic. The

T statistic measures how much influence a given X has on a given Y. Usually, a critical value is established and if the T value exceeds (or is less than the negative value) the critical value, the variable can be considered a significant influence on Y. The coefficient of X shows the magnitude of

5 this influence. The mathematical expression of the T statistic is:

T (X - W) (5) (SE)

where: W = the assumed population mean

The Coefficient of Determination

The R2 statistic measures how much of the variation in the dependent variable (Y) is explained by the model. The value of R2 is always between

0 and l; the closer to 1, the more the model explains the variation of Y.

Mathematically, R2 is:

1: (xy) 2 (6) R2 = 1:x2 1:y 2

where: x = (X. - X) and y = (Y 1 l.. - Y)

When the regression model has many variables, the R2 value may increase without an increase in the amount of variation in Y explained by the model. 6

4 Katz, op. cit., pp. 8- 9. 2 2 5 Ibid., p. 32. 6 For example, an equation may have several insignificant variables, but have an R2 value close to 1. Ibid., p. 116. 26

increase in the number of xy terms sunnnated . Thus, most

computer programs report an adj usted R2 value, calculated as:

- 2 2 (N - 1) R = - ( - R ) ) 1 1 N - K (7

where: K = the number of regressors 2 When the adj usted R is close to 1 and the variables have failed the T-test,

then the assumptions of the analysis have been violated . This may be due to non-linearity of the relationship, a relationship between the independent variables, or heteroscedasticity. In order to determine which of these is the problem, a closer examination of the other statistics is necessary.

Analysis of Variance (F-st�tistic)

The F test determines the significance of the model . The F test is one method of verifying the results of the T test. Mathematically, F

7 can be expressed as:

(N K} (8) F = R2 - (J.<-1, N-K) ( 1 -R2 )(K - 1)

Like the T test, the F test relies on a predetermined critical value to surmise if the model is significant. The F test is a good test to check the significance of the model since it accounts for the number of regressors as well as the number of observations.

J)urbin-Watson

The Durbin-Watson (DW) statistic measures the level of first order autocorrelation. When an autocorrelation is present, the assumptions of regression analysis have been violated and model adj ustments roust be made.

7 Ibid ., p. 117 27

ideal value of DW is 2 ; values that lie in between the upper and lower

lead to indeterminate conclusions about the existence of

A DW that is less than the lowest critical value or

highest critical value reveals definite negative or positive first order autocorrelation . The DW statistic is calculated as:

N (u -u )2 E t t-1

t = 2 (9) DW = N u 2 E t t = 1

utocorrelation is often associated with measurement error within the data .

his problem is especially acute when time series data is employed because

he error term is allowed to accumulate and bias coefficient estimates .

erefore, it is imperative that the variables be defined and the observa-

ions me asured as accurately as possible .

efining the Problem

The problem is to determine at which point the level of taxation

ecomes a detriment to the productive capacity of an economy. This concept,

eferred to as taxable capacity, is generally considered within a po litical

ontext, not an economic one . Even among economists, political upheavals

8The critical region varies with the number of regressors and bservations . See James Durbin and G. S. Watson , "Testing for Serial orrelation in Least Sqaures Regression, " Biometrica (New Haven, CT: ale University Press) , January 1951, pp . 159- 178. The critical regions re delineated in Chapter 4 of this paper . 28 are generally used to determine when an economy's taxable limit has been reached.9 This ad hoc approach has provided modern theory with little insight into the nature of this problem .

A logical sequence indicates the economic limit is reached before the political expression of the limit occurs. As William Crotty observes:

• • • what constitutes an opinion of political relevance are determined by the situational factors present at the point in time that is in question.10

Thus, the taxable limit must be evident to the populace before the political opposition to this limit occurs. In other words, there should be a

"leading indicator" of sorts that signals the economy is nearing its taxable limit .

Clark considered the declining value of money to be the economic signal that a system had reached its taxable limit. He measured the changes in the value of money as changes in "retail prices" and referred to these changes as inflation. It is unclear which price index Clark used. It is also unclear at which level increases in the price index must be classified as inflationary . Therefore, to understand and measure taxable limit, it is necessary to determine what constitutes inflation.

9 For example, Jude Wanniski uses revolution of the masses as an indicator of a taxable limit. See Jude Wanniski, The Way the World Works (New York, NY: Basic Books, Inc ., 1972), Chs . 2 and 3. 10 william Crotty, Public Opinion and Politics (New York, NY: Rine hart & Winston, Inc., 1970), p. 2. It shou ld be noted that this applies to any economic problem, whether it is tax policy, growth, unemp loyment, etc. 2 9

Defining Inflation

Webster's Dictionary defines "inflation" as :

An increase in the volume of money and credit relative to available goods resulting in a substantial and continuing rise in the general price leve1. l l

Economists do not generally agree upon this definition of inflation. First, the phrase "substantial and continuing" is vague ; how substantial and how continuing must price increases be to consider them as inflationary? Second, the definition indicates that price increases are a symptom of inflation and not considered inflation in and of itself. Third, inflation is defined as a causal relationship, and even the strictest of monetarists would concede that not all inflation stems from an increase in the volume of money and credit. As G. L. Bach observes :

Under it, inflation may or may not be associated with rising price levels, and rising prices may

or may not be associated with inflation. • • • it is not operationally clear (what is an overissue of money? ) l 2

As an alternative, Bach defines inflation as a rise in the general

13 price level. Bernard Herber defines inflation as " •••an increase in

14 the level of index of various prices. " Howard Sherman defines inflation

11 webster 's New Collegiate Dictionary, lSOth Anniversary ed. (Spring field, MA: G & C Merriam-Webster, 19 81), p. 586. 12 G. L . Bach, The New Inflation, 2 ed . (Providence, RI : Brown Uni versity Press, 1972), p. 6. Words in parentheses are my own. 13 Ibid., p. S.

14 Bernard Herber, Modern Public Finance, 4th ed. (New York, NY: Richard Irwin, Inc. , 1979), p. 392. 30

15 as ". • • a rise in the average price level of all goods." Other econ- 16 17 omists, such as William Thorp and Richard Quandt, \Villiam Albrecht, Jr., 18 and Milton Spencer also define inflation in this manner. Since this is a more generally accepted definition of inflation, it will be the one used in this analysis. Mathematically, inflation can be expressed as:

PI - PI t t-1 (100). INF (10) PI t t-1

v1here: PI the price index t the current time period in years t-1 the previous time period INF inflation expressed as a percentage rate of inflation

Yet this definition still does not give a real meaning to the term inflation. Under this definition, any increase in the general price level, no matter how small, would be considered inflation. However, increases in the general price level may be due to increases in the quality of many products, a one-time shift in consumer preference toward consumption rather than savings, or any other factors that could cause a one-time price

increase. Also, the fact that the price level rises does not necessarily

indicate a problem exists. Steady price increases are necessary to maintain

production incentives for producers. As Koilpillai J. Charles observes:

15 Howard Sherman, Stagflation, 2nd ed. (New York, NY: Harper and Row, Publishers, 1983), p. 15. 16 william Thorp and Richard Quandt, The New Inflation (New York, NY: McGraw-Hill, Inc., 1959), pp. 1-2. 17 william Albrecht, Jr., Economics, 3rd ed. (Englewood Cliffs, NJ: Prentice-Hall, Inc., 1983), p. 161. 18 . Milton Spencer, Contemporary Economics, 5th ed. (New York, NY: Worth Publishers, 1983), p. D-20. In fact, this definition (rather than the \lebster definition) is used in most principles of economics textbooks. 31

Some writers apply the term to all price

increases. • • Rising prices are one of the facts of contemporary international

economic life. • ••Some increases in prices seem to characterize all economies of the modern world , and who can say that all economies are unhealthy. We have to accept that a certain measure of price increase is normal to healthy economies in the contemporary world.19

inf lation of change in inflation , not the Charles suggests that the rate l l, prices If the rate of increase is sma rate , should be used for research. should be rate of increase is large , then it are considered stable; if the "small" should be considered "large" or considered as significant. What of the economy in question. This should be based on the past performance \ Robinson's inf lation can be traced to Joan �ind of analytical treatment of 20 \ ation theory. ear lier contributions to inf l in the inflation rate will be In this study, the rate of change

lation acceleration (RIA): referred to as the rate of inf

INF - INF t t-l ( 1 00) = RIA (11) INF t t-l

Price Index .) the ana- is the next step necessary to The choice of a price index an appropriate llowing criteria for choosing lysis. Bach presents the fo 2 1 late rates of inflation. p�jce index on which to calcu

a, of Inflation , 2nd ed. (Manitob 19Koilpillai, J. Charles , The Myth 19 8) , p. 10. Canada: Highnell Printing Ltd., 6 0 Papers (Oxford, UK: Basil 2 Joan Robinson, Collected Economic , p. 89. Blackwell, Ltd. , 1 9 60) 1 costs should be exc luded since 2 sach , p. 5. Labor 2£.• .£!!_., ustment for inflation costs contain cost of living adj increases in labor double Thus, exc luding labor costs avoids in the previous time period. counting of inflation.

index. 1. It must be a broadly based

of conunodity 2. It must be representative and service prices.

costs. 3. It should exclude labor , as computed by the const.llller price index (CPI) Bach suggests the use of the Product (BLS) , and the Gross National 'U .S. Bureau of Labor Statistics Department of , as calculated by the U.S. Implicit Price Deflator (GNPD) in the two indices notes, the maj or difference Commerce. As William Gale while the the effect of government expenditures is that the GNPD measures 22 Since the in the level of retail prices. CPI measur�s only the changes a ratio involving national is between inflation and relationship to be tested is an inappro- a built-in relationship and income, use of the GNPD provides

priate choice. is for this analysis. This index The CPI also p resents problems it relies more which it is calculated. First, biased due to the manner in causing this index urban areas than rural areas, heavily on price changes in on goods commonly . Secondly, the index focuses to be slightly overstated from the so that many goods are omitted bought by lower income families the index, or its . 23 of influence a good has on index. Third, the degree by the BLS, and thu�, periodic consumer syrveys weight , is determined by fixed weight the next survey period. This the weight remains fixed until resulting in over- changes in consumer preferences, does not allow for rapid

or under estimated index values.

Control 22 Causes, Consequents , and william Gale, Inf lation : ishers, Inc., 1981), lager, Gunn, and Hain, Publ (Cambridge , MA: Oelsch P• 4. 23 �- · p. 5. 33

Notwithstanding, the CPI does have advantages. First, more is known about the error in the CPI than the GNPD, making error adj ustments easier.

Second, there is more international methodological standardization with the

CPI than with many other deflators , since similar survey techniques are employed to determine which goods will be used to measure the price changes.

Third, other deflators measure price changes based on a particular accounting statistic (e.g., GNP, Net National Product, National Income, etc.). Since these statistics include labor income, Bach's third criteria is violated and double counting of inflation may result.

However, William Gale has found that there is not a significant difference in which measure is used to calculate the rate of inflation . In his correlation analysis, Gale found a very high correlation between the three most widely used price indices : CPI, GNPD, and the Producer Prices Final

24 Goods Index (PPFG). In a correlation matrix, the numbers in the matrix

reveal how often changes in the statistic listed in the columns coincide

with changes in the statistic listed in the rows . A value of 1. 00 indicates

perfect correlation ; a value close to zero indicates the two statistics are

unrelated. The table below shows the correlation Gale found between these

three indices from 1948- 1979:

4 2 The PPFG is issued by the BLS. This index measures changes in the price of final goods before these goods are sold at the retail level. It is determined by a survey of wholesalers of final goods . 34

CORRELATIONS BETWEEN INFLATION RATES 1948- 1979*

CPI GNPD PPFG

CP I 1.00 .96 .94

GNPD 1.00 • 95 PPFG 1.00

*Source: William Gale, Inflation: Causes, Consequents 2 and Control (Cambridge, MA: Oelschlager, Gunn, and Hain, Publishers, Inc., 1981) , p. 4.

The matrix numbers are all close to 1.00 and reveals that the indices are

highly correlated. Due to this relationship, Gale concludes that ".

the choice between these measures of inflation is more a matter of

5 aesthetics in conforming to a theory than of practical difference.11 2

The consumer price index is the closest to Clark's retail prices.

/ionsumer Price Index

The U.S. Bureau of Labor Statistics calculates the CPI measuring

the change in price of a "basket" of commonly purchased consumer goods.

6 Each good is assigned a weight2 on the basis of the fraction of household

budget spent on the good ; this fraction is determined by the BLS Survey of

Consumer Expenditures. Gale cites seven different types of error problems

in the calculation of the consumer price index. They are:

1. Omission of many goods 2. Omission of consumers 3. Periodic omission of goods 4. Not allowing for substitutes when there is a change in the relative prices of goods

25 Gale, op. cit ., p. 5. 26 There is a tremendous amount of controversy over the use of fixed weight, and this discussion will be omitted from this paper . The interested reader should see Paul Earl, ed., Analysis of Inflation (Lexington, MA: Lexington Books, Inc., 1977) , as we'll as various other BLS publications . 35

5. Not allowing for changes in the choice of consumer goods 6. Samp ling errors in surveys 27 7 . Incomplete adj ustments for quality changes

Gale found that these measurement errors can cause autocorrelated errors in regression analysis , leading to biased coefficient estimates . l�en monthly CPI statistics are used , the coefficient bias stems from all seven of the onnnissions listed above with omitted consumers being the most significant source of autocorrelation . The total bias in estimated coefficients was found by Gale to be 2.9 when monthly data are used. For quarterly CPI data, the autocorrelated error is caused by the omission of consumers and inadequa te quality adj ustments. The effect of these omissions causes estima ted regression coefficients to be biased by approximately 1.67.

Th e same omissions cause autocorrelated error when annual statistics are used. However, the problem is less severe and bias the estimated coeffi 28 cients by only 1.07. Hence, annual data will be us ed to minimize the autocorrelated error.

The Ratio

Clark believed total government receipts (including both local and central governments) should be used to measure total tax revenues .

His reasoning was that often taxes are "disguised" in the form of licensing fees , surtaxes , tolls , etc. , and that these fees could discourage productive 29 activity much like direct income taxes (although not to the same degree) .

27 Gale , ££..• cit. , p. 52. 28 . Ibid. , pp . 52-53. 29 For examp le an individua l may work very hard and save for better housing. If this individual incurs licensing fees and periodic property taxes that exceed one-half of their monthly budget, the person may become discouraged , surrender their aspirations , and reduce work effort substan tially . 36

Total government receipts are also a very standardized calculation in international statis tics , therefore, this accounting identity will be used to measure tax revenues in this analysis.

National Income , however , is not so easily compared on an international basis . In the United States, National Income is calculated by subtracting Depreciation and Indirect Business Taxes and adding Subsidies to Gross National Product . In the United Kingdom , France, Germany , and other European countries , National Income is calculated by subtracting 30 Subsidies and Deprecia tion from Gross National Product. Therefore, it

is unclear which method of calculation Clark used . In this analysis, the officially reported National Income will be used . However, the reader should be aware of the methodological differences in this statistic among 31 nations . The ma thematical expression of the ratio is :

TR (100) x ( 12} NI

where : TR = total government receipts

NI = National Income

X = the ratio as a percentage

While Clark used this statistic to show how the interaction between

the tax revenues and national income cause inflation , it really is not

descriptive of his hypothetical interaction. When tax schedules are pro-

32 . gressi. ve , in fl ation. not on 1 y in. creases nom i na 1 nati. ona 1 inc . ome , it . a 1 so

30 In the U.S. this statis tic is closer to Net National Product than Nationa l Income . 31 Recall from Chapter 2, Francis Bator's research revealed that the me thod of calculation did not affect the significance of his regression results. 32 Recall from Chapter 2, Clark's theory was true only when tax schedules were progressive and proportional. 37

· 33 increases t ax receip' t s. If tax revenues an d na tion. a 1 . income in. crease proportionately with inflation, then the ratio would remain constant (or change little) when inflation increases . The only way the ratio could be positively related to inflation is if tax revenues rose more rapidly than inflation. The speed at which tax revenues rise is determined by the progressivity of the tax structure of a given country ' s economy . This can be easily measured by us ing an elasticity approach . Inst ead of calculating the relationship as Clark did , the ratio can be calculated as :

TR - TR t t-l TR t-1 z = 1100 ] ( ) t I 13 NI t - N t-l /_, I N t-l

If taxation does reduce work effort and productivity , and spur inflation , then there should be a significant relationship between this identity (12) and inflation, since the more progressive the tax structure, the greater the value of Z. If Clark ' s theory is correct, there should be a positive relationship between equations (12) a1'1d (10) . s�mo le Pop ulation

The countries selected for this analysis were bas ed on the following criteria:

1. The country should have a tax system collected by the central government;

2. The country was tested by Clark ;

3. The country mus t have a non-totalitarian form of government;

4. The country should be at peace throughout the entire time tested ;

3 3 rn present-day terminology , this is referred to as bracket creep . 38

5. The country has a proportional or progressive tax system.

6. There should be reliable, confirmable data from two sources for that country ; and

7. The country should have achieved a level of economic development that is comparable to the rest of the sample group .

The first criterion is obvious since it would be difficult to test the effects of taxation when a tax system does not exist. Criteria 2, 3, 4, and 5 were established by Clark. Using these criteria will facilitate the comparison of this study 's results with the conclusions of Clark.

The sixth criterion is necessary to ensure .a more accurate estima tion of the relationship . Often, nations will report preliminary data to an agency and revised data to another , depending on the point in time the data is requested. Therefore, two different agencies may report different values for the same country in a given year. Also, honest reporting mis takes can be made in the process of pub lishing the data.

International data collection is an enormous task, and it is unreasonab le to assume an agency with · limited resources will be able to find all the errors before publication. Thus , as two agencies report the same statistic, it is likely that value of the statistic is accurate. With the exception of the United States , all countries ' data will be verified with official publications , if availab le , or United Nat ions publications . How- ever, numb ers will be rounded to the nearest billion to avo id specious accuracy .

The last criterion was established to ensure some degree of compar- ability among the results. In less developed countries (LDC's) , government policy tends to be oriented toward stabilization, especially price stabilization . Therefore, the level of price increases acceptab le in LDC ' s may be greater than is acceptable in developed countries . 39

On the basis of these seven criteria, the countries selected are

Canada, Finland , France, Germany , Italy, Sweden, United Kingdom, and the

United States. The test period will be 1963-1981 (19 years) . All the countries conform to the criteria with the except ion of the United States , who was involved in the Viet Nam conflict during this time . However, heavy involvement only occurred for five years of the test period; also it was not an offi cially declared war and so will be included in the analysis .

Preliminary Model Tests

The preliminary test model utilized ordinary least squares con 34 tained in the Econometric Software Package. The variab le G, a zero/one 35 dummy variable, is included to test Clark ' s 25 percent theory . A second model included dUI1II11.y variable H, a test of the Reagan Administration's 19 percent theory discussed in Chapter 1. The country tested was the United 36 States from 1941 to 1981. The number of years tested was increased to

include the years Clark used to prove his theory in the United States .

The models and preliminary results are as follows :

34 For programming information about ESP contact Wesley Pickard , Synergy , Inc., 229 E. St. , Washington, D. C. 20002 . 35 Values less than 25 were assigned a zero value , and greater than or equal to 25 a value of 1. The same was performed for H, except 19 was used instead of 25. 36 See Appendix 2 for data list . The reader should note the United States was involved in military action during two other periods , 1941-45 and 1950-53. 37 The zero slope-intercep t form was used since prior model te sts revealed constants very close to zero . 40

(14 ) INF = B X + B G 1 2

= +2 .17G Coefficient O. l 79X SE (0. 029) (l.43) T (6.192) ( l . 5 1)

2 9} = 2.5 7 N = 41 = R = 0.062 F(l 3 DW 1.16 ,

( 15) INF = B X + B H 1 2

= -6.046H Coefficient 0.459X SE (O . 120) (2. 77) T (3. 812) (-2 .18)

= 2 = N 41 = , 39) 5.05 DW = 0.834 R 0. 114 F(l

= = 1.2 and both t for K 2 and N 40 is The lower limit of the DW tes For this reason , the autocorrelation. equations exhibit first order ntative of the cannot be co nsidered represe coefficients are biased and t iterative technique variables . The Cochrane-Orcut relationship between the , and these statistics to 1.3 and 1.2, respectively improved the DW statistic 38 = = 40 and K 2 ). minancy (1.2 and 1.4 for N are in the area of indeter test the relationship thod must be developed to Therefore, an alternative me

between the variables .

Alternative Formulation ed to test asticity approach can be us As discussed earlier, an el national income lation and the percentage of the relationship between inf ns (12) and (14) into t. By substituting equatio collected by the governmen

omes: equation (1) , the model bec ( 16)

= Z + u RIA a + B 0 revealed mild equation on the United States The initial test run of this ive method further . The Cochrane-Orcutt iterat first order autocorrelation

38 p. Katz, ££.• cit., 27 1. 4 1

improved the Durbin-Watson statistic :9 This statistic was further improved

by deleting 194 1-196 2 from the model. The improvement is probably due to

changes in the methods of measuring statistics in the early 1960's. 40

This deletion did not significantly affect the coefficients, but did

increase the value of the T statistic. (The final results are included

in Chapter 4 .)

Since the model defined in equation (2 1 ) conforms to the assumptions

of regression analysis better than the previous model, it is the model used

to test Clark 's hypothesis. While the 25 percent limit cannot be statis-

tically verified for any particular country, it can be evaluated by inter-

national comparisons of the results . The data is listed in Appendix 3 and

it can be seen that some of the countries tested are well above the 25

percent threshold throughout the test period . By comparing the results

among the different countries, conclusions about the 25 percent limit can

be formulated.

39 The use of various lag structures contained in the Econometric Software Package did not generate rational numbers but rather, a zero correlation matrix. Therefore, the analysis assumes that there is no lagged effect .

4 °ilecall from Chapter 2 tha t quality control standards on national income accounts were not implemented until the 19 60's. CHAPTER 4

CONCLUSIONS

Results

The results of the regression analysis show there is not a dis- cernible relationship between the rate o f inflation acceleration and the elasticity variable. In six of the countries tested, the Cochrane-Orcutt iterative technique was necessary to eliminate autocorrelation : Canada ,

Finland , France, Italy, Switzerland and the United States . In Germany and

the United Kingdom, this adj ustment was not necessary ; hence a rho statistic is not reported for these two countries . All the Durbin-Watson statistics 1 are greater than the upper limit of the lower boundary and very close to 2.

Therefore, the coefficients estimated by the regression can be cons idered to be the least biased obtainable.

The T-test utilized a two-tail test at the 0.05 significance level.

The two tail test is necessary since some T values are positive and some

are negative. The critical values are � 2.131 for 15 df. and � 2.120 for 2 16 df. If the T value of a coefficient lies in between the positive and

negative crit ical values , that coefficient is not significantly dif ferent

1 The Durbin-Watson boundaries are :

N D D L U

K = 1 16 .84 1.09 K = 1 17 .87 1.10 Katz , op. cit. p 271. 7 tbid. , p . 267.

4'?.. 43

from zero ; the variable is considered to be an insignificant influence on

the rate of inflation acceleration. If the T value lies outside the

critical region, then the variable is considered significant . 3 The F-test is used to confirm the T-tes t. The F-critical value

for (1, 14) df. is 4.6 and for (1, 15) df. is 4.54. If the F-values generated by the regression are greater than the F-critical values , the coefficients are cons idered to be a signifi cant influence upon the dependent variable.

The results below are presented in alphabetical order :

Canada

RIA = 67.82 - 0.432X SE (43.63) (0 . 353) T (1 .55) (-,1.122) 2 R = 0.096 DW = 1. 78 rho = 0.028 N = 16 F(l, 14) = 1.49

Finland

RIA = 10. 7 + 0.00156X SE (1 2.69) �(0�00314) T (0. 846) (0. 497) 2 R = 0.0249 DW = 1.748 rho = 0.089 N = 16 F (1, 14) = 0. 357

France

RIA = -16.19 + 0.248X SE (55.27) (0.492) T ( 0.50) ("".0.29) 2 R = 0.0181 DW = 2.38 rho = 0.010 N = 16 F(l, 14) = 0.257

3 2 F = T • F-critica l values are at the 0.05 significance le vel . Ibid. , p . 269. 44

Germany

RIA = 74 .02 - 0.506X SE (3 1.3) (0. 244) T (-2.06) (2.35) 2 R = 0.22 DW = 2.14 rho = N/R N = 17 F(l, -. 15)-�=�"4�27

Italy

RIA = 18.177 + . 0000290X SE ( 1 7.83) (.000142) T ( 1.019) (0�20 3) 2 R = 0.019 DW = 1.99 rho = 0.1 42 N = 16 F(l , 14) 0.280

Switzerland

RIA = 38.7 + .00425X SE (41.0) (0. 104) T ( 1. 109) (0. 203) 2 R = 0.05 DW = 1.93 rho = 0.23 N = 16 F(l, 14) = 0.759

United King_dom

RIA = 3.37 + 0.138X SE (26.6) (0 . 18) T ( 0 .12) co;-166) 2 R = 0.037 DW = 1.67 rho = N/R N = 17 F(l, 15) = 0.58

United States

RIA = 5.98 + 0.095X SE (15.7) (0 . 108) T ( 0.379) (0. 878) 2 R = 0.0484 DW = 1.93 rho = 0.00732 N = 17 F(l, 15) = 0.762

As these statistics indicate, there is not a signifi cant relationship between the degree of progressivity of government receip ts and percent changes in the rate of inflation. All of the T-tests reveal the variab les do not exert a significant influence over the dep endent variab le.

The T-values and the F-values fail the significance test at the 0.05 2 significance level. Even if the variables were significant, the R values 45 reveal only a small portion of RIA is exp lained by the model. Since these variables exaggerate changes in prices and tax revenues as a percent of national income, it is not likely that Clark's hypothesis is correct .

An examination of the data in Ap pendix 2 confirms Clark ' s theory is incorrect. The countries will be discussed in two categories . The first category consists of countries that have collected over 30 percent of national income in the form of tax receipts during the test period

(1963-1980) . This group consists of Canada , Finland , France, Germany ,

Italy and the United Kingdom . In the second group , the countries are those whose ratios have been less than 30 percent during most of the test period. The latter group consists of only two countries : the United States and Switzer land.

Category 1 Countries

In addition to the statistical similarities, the countries in this category all have parliamentary forms of government and have mixed economic systems . With the exception of France, all the countries had tax ratios in the low thirties in 1963; and the ratios then increased to the mid-forties by the end of the 1970 ' s. France had a considerably higher tax ratio

(41 .1 percent) in 1963. Despite this ratio, the growth of the government sector in France has been similar to the other countries in this category. 4 In Canada , from 1969 to 1979, the tax ratio remained between 40-4 1 percent . Yet during this time , inflation varied from 1.9 percent to 11.1 percent . In fact , when the ratio did increase during this period, such as

4 Recall that Clark believed the British Dominions had a lower tax ab le limit of 18 percent . If this ratio had been used, the comparison is more striking. 46

the 1970-1971 interval , the inflation rate fell from 4.5 percent to 2.9 percent (a decrease of 36 .2 percent) . Then in 1972, when the tax ratio

fell slightly , the inflation rate rose to 4.2 percent , representing a 45 percent increase in the rate of inflation. The two years with the largest increases in the inflation rate were 1966 and 1973; in 1966, the ratio 5 increased slightly and in 1973, inflation fell by 0.6 percentage points .

On the whole, the Canadian experience contradicts Clark's theoretical relationship . 6 Finland represents the country with the highes t degree of sociali- zation in the test group . The years with the largest percent declines in the inflation rates were 1965, 1966, 1969 and 1978; yet , the ratio increased in all these years with the exception of 1978. The highest tax ratio in the Finnish data set, 48.9 percent in 1976 , coincides with a 22.2 percent decline in the rate of inflation. For the years 1963 and 1964, the tax ratio reached its lowest point o f 35 percent ; yet, the inflation rate rose from 5.2 percent to 9.9 percent (a 90 percent increase in the inflation rate) . While 1971 and 1978 conform to Clark ' s theory , those years do not outweigh the other 15 years which are contrary to Clark' s hypothesis .

France is particularly important since Clark relied on this country to prove his theory when it was first published. France has collected well over 40 percent of its national income in the form of tax revenues in every year since 1963. Yet during this time , France has experienced levels of inflation as low as 2.5 percent and as high as 10.7 percent . In 1963 and

5 This small of a change is not likely to be within the realm of measurement accuracy. 6 Finland is another country Clark believed to have a lower taxab le limit. Again if 18 or 19 percent had been used instead of 25 percent , the analysis becomes more striking . 4 7

1964, the tax ratio grew slightly from 41.1 percent to 42. 1 percent ; however, the inflation rate declined by 29 .1 percent. When the rate of inflation declined 14 percent in 1975 and almost 18 percent in 1976 , the tax ratio was 45.7 percent and 48.3 percent, respectively . In 1978, the rate of inflation declined by 10 percent and the tax ratio remained at

47 percent . When the ratio rose to 51 percent in 1980, the inflation rate dropped by 1.8 percent . Although 1968 and 1969 do conform to Clark's theory , these two years do not outweigh the French evidence against the theory.

The data for Germany is the most interesting. First, if the regression results had been evaluated at the 0.2 significance level rather than the .002 level, Germany would have been the only country where the relationship is significant . The negative sign of the coefficient indi cates that as overall tax collections become more progressive , the rate of inflation acceleration declined. In fact , Germany has experienced the most moderate levels of inflation of the countries in this category.

Rej ecting Clark's theory on the basis of the regression ca n be confirmed with Germany 's data. The periods with the largest decline in inflation were 1966-1967 and 1975-1976. In the first period , the rate of in flation dropped from 3.3 percent to 1.4 percent (a 57.5 percent decline) , yet the tax ratio remained at 40 percent . In the second time period, the ratio increased from 47.4 percent to 48.9 percent , wh ile the inflation rate fell from 5.9 percent to 4.5 percent (a 23.7 percent decline) .

In fact , from 1975 to 1978, the ratio remained at 48 percent and the infla tion rate dropped from 5.9 percent to 2.6 percent .

The period in which the rate of inflation had the largest increase in Italy wa s 1968-1969. In 1969, the rate of inflation rose by 163.6 48 percent. However, the tax ratio fell from 33.7 percent in 1968 to 32.8 in 1969. The two years in which inflation was at its highest level of

19 percent were 1974 and 1977, and the ratio had increased in a manner consistent with Clark ' s theory . The years 1975 and 1978 experienced sub stantial declines in the rate of inflation and the tax ratio continued to increase. Therefore, the Italian experience does not appear to be con sistent with Clark ' s theory .

The United Kingdom's tax ratio was at its lowest level, 34 percent, during 1963 and 1964. At this time , the rate of inflation increased 123.5 percent . While the ratio continued to rise in 1966 and 1967, the inflation rate declined by 22 percent in 1966 and by 34 percent in 1967. From 1 968 to 1972, the inflation rate shifted correspondingly with the tax ratio .

In 1975, the ratio reached its highest point , 48,6, and the inflation rate reached 24.2 percent. However, from 1976 to 1979 , the tax ratio remained very near 44 percent and inflation fluctuated from 15.9 percent to 9 per

cent . While six of the seventeen years tested in the United Kingdom are

consistent with Clark's theory , the other eleven years do not weighfavor

ably with Clark .

Category 2 Countries

The two countries in this category, the United States and Switzer

land , have had relatively low levels of tax revenues as a percent of national

income . However, these countries share other connnon characteris tics . First,

both countries are populated by peoples with diverse cultural backgrounds .

Because the actions of governments must appeal to these diverse groups ,

government policy has tended toward the moderate range of the political

spectrum. Secondly, the financial sector composes a very large portion of

the Gross Nat ional Product of both countries . They are also able to draw 49 substantial amounts of foreign investment monies . As a r esult, there is a smaller need for government subsidies or ownership of productive resources to provide socially necessary goods and services . This free market orien tation has provided the political pressure to keep taxes low , resulting in a lower tax ratio .

Switzerland 's tax ratio remained close to 25 percent from 1963 to

1965 and inflation remained around 3.5 percent . The ratio increased from

26 percent in 1967 to 27.6 percent in 1968. Yet the rate of inflat ion declined by 13 percent in 1967 and by 42.5 percent in 1968. A similar situation occurs in the period of 1969-1974. When the ratio increased from 32 .1 percent in 1974 to 34.7 percent in 1975, the inflation rate dropped by 30.9 percent . In 1976, when the tax ratio increased to 36 .3 percent , the inflation rate dropped from 6.7 percent to 1.7 percent (a 74 percent decline) . While the ratio remained at 36 percent in 1977 and 1978, the inflation rate dropped by 88.3 percent in 1977 and by 400 percent in

1978. When the tax ratio fell to 35 percent in 1979 , the rat e of inflation rose by 260 percent of its 1978 level. Eleven of the seventeen years do not conform to Clark ' s theory.

The tax ratio in the United States did not reach the 25 percent mark until 1978 and has not substantially exceeded this ratio. Therefore, it is difficult to determine if inflation does result when the ratio exceeds

25 percent of national income . However, the ratio did reach 26.7 percent in 1981 and the rate of inflation dropped from 11.0 perc e nt in 1980 to 9.0 percent in 1981 (an 18 percent decline) . Clark uses the late 1940's to prove his theory in the United States , and in 1946 when the ratio reached

25 percent , inflation did not increase. Yet in 1947 when the ratio declined 50

7 to 22 percent , inflation rose from 2.2 percent to 8.5 percent . The little evidence which does exist seems to contradict his theory : Inflation has declined when the tax ratio has exceeded 25 percent and the rate of inf lation has risen when the ratio was under 25 percent .

As discussed in Chapter 1, recent supply-side economists believe that when tax revenues exceed 19 percent of national income (in the United

States) , inflation will result . Only once since 1944 has the tax ratio in the United States been significantly less than 19 percent , that being in

1950 when the ratio was 16.7 percent , and the inflation rate was 0.01 percent . When the ratio increased to 18.9 percent in 1951, the rate of inflation rose to 7.9 percent. However, wh en the ratio rose to 23 percent in

1952, the rate of inflation fell to 2 .1 percent . The ratio rema ined at

23 percent in 1953 and 1954, yet inflation did not even exist. From 1956 to 1966, the ratio remained near 21 percent , yet the highest rate of inflation was 2.7 percent , the lowest being 0.08 percent . While prices do rise 8 slightly when the ratio is over 19 percent , they also rise wh en the ratio is less than 19 percent.

Concluding Remarks

On the basis of the data, there is not a significant relationship between inflation and tax revenues as a percent of national income . There does not appear to be any magical ratio at which inflation will necessarily result . While inflation does occur when tax revenues exceed 25 percent of national income , it also occurs at less than 25 percent (or 19 percent) .

7 This also suggests the measu rement error in Clark 's data contains a larger degree of measurement error than expected by this economist . 8 After the experience in the ,1970's, it is difficult to cons ider inflation rates less than 1.0 perceqt a serious problem. 51

Not only is Clark's hypothes is rej ected , but also the premises on which the Reagan Administration has based its fiscal measures are also rej ected by this analysis. 9 Price stability does not seem to occur at any particular tax ratio. However, it does seem to occur more often when the ratio is stable.

It could be that changes in the tax system caus e price shocks ; these shocks could result as increases or decreases in prices , depending on the type of change, the level of income and its distribution, and the attitude toward the tax reform in question.

The rate of inflation appears to be greater in the mid-1970's than in any other time period for all the countries tested. These high levels of inflation do not appear to be related to any particular government action.

Rather, these rates seem to be more closely associated with changes in the pricing policies of the Organization of Petroleum Exporting Countries

(OPEC} . However, OPEC should not be used as a political scapegoat for the economic woes of other non-member nations . Perhaps the failure of governments to institute effective anti-inflation policies to counter OPEC price changes is a more appropriate place at which to point the finger of blame .

For the na tions considered , the rate of inflation and the rate of inflation acceleration do not appear to be an accurate indicator of when a nation has reached its economic taxable limit . This does not preclude the existence of an economic indicator of this limit. A nation's taxable capacity is most likely dependent upon many institutional factors , such as the kind of tax used , how the tax is collected , how revenues are spent ,

9 Price stability is a rather subj ective phrase. Here it refers when the rate of change in the price index is from -3.0 percent to +3.0 percent . 52 the distribution of after-tax income , and the general state of the economy .

Further research into the area of taxable capacity could greatly facilitate government budgetary planning and economic policy formulation. SUMMARY

Colin Clark ' s theory of inflation has had a profound effect on present-day economic theory concerning taxation policy . Whi le his belief that inflation occurred when all tax revenues exceeded 25 percent of national income was rej ected by his contemporaries in the 1940's, supply- side economists incorporate Clark ' s theory into their proposals for curing the unemp loyment and inflation of the 1970 's and 1980's. These proposals gained popular support and resulted in the election of President

Ronald Reagan who implemented such proposals. The purpose of this study is to determine the veracity of Clark 's theory .

On the basis of his statistical analysis Clark concluded that high levels of taxation transmitted inflation to the private sector through wages in peacetime , non-totalitarian nations . He argued that workers , if not compensated for income "lost" through taxation, would choose more leisure time or become less productive. As firms attemp t to reduce taxable income , they lose their "reistance" to worker 's demands for higher wages , since this higher wage increases production costs and thereby reduces taxable income . Thus , fewer goods are available at higher prices .

However, this analysis was rej ected in the 1950 's by economists such as Walter Heller, Joseph Pechman , Thomas Meyer, and Francis Bator

for several reasons . Initially , there was not an internationally (or nationally) accepted method of collecting national income data prior to

1960; the accuracy of Clark ' s data was unknown . Second ly , tax revenues

greater than 25 percent of national income coincided with deflations almost

53 54 as often as inflation , making Clark's conclusions appear unfounded .

Thirdly, Clark's theo ry was not consistent with bus iness and worker behavior at that time . Many studies , most notab ly Thomas Saunder's study of work effort, showed business executives worked harder or just as hard after tax increases since non-monetary considerations were as important to workers . Corporations , on the whole, did not appear to engage in more or less wasted practices when faced with tax increases.

Fourthly , Clark's theory presumed wage increases came before price increases when the opposite appeared to be mo re common. Fifthly , those who attemp ted to confirm Clark 's theory with regrssion analysis , were unable to find a significant relationship between inflation and tax revenues as a percent of national income .

Clark's theo ry was tested in this study with the use of regres sion analysis. The dependent variab le , inflation, was measured as the percent change in the consumer price index. The consmner price index was chosen because it is a broad-based index that is representative of commodity and service prices and excludes labor costs. Measurement error was minimized by the use of annual CPI data. The independent variable is the ratio of total tax receipts as a percent of the officially reported national income . The preliminary run of the test was performed on the

United States from 1941-1981 using ordinary least squares contained in

the Econometric Software Package . Autocorrelation appeared in the regression and attemp ts to correct this failed .

The modified test model used the rate of inflation acceleration

(percent change in the inflation rate) as the dependent variable. This dependent variable exaggerates the magnitude of price changes , making the

relationship mo re likely . The independent variable represented the 55 elasticity coefficient of total tax receipts to national income (percent change in taxes divided by percent change in national income , expressed as a percentage) . This independent variab le is far more descriptive of the interaction between tax revenues and national income . The model was used to test Clark's theory in Canada, Finland, France, Germany , Italy ,

Switzerland, the United Kingdom , and the United States from 1963-19 81.

The regression results show that there is no relationship between the rate of inflation acceleration and the elas ticity of total tax receipts and national income .

A country by country analysis confirms that inflation is not any more or less severe when tax revenues exceed 25 percent of national income .

Canada , Finland , France , Germany , Italy and the United K ingdom all have their lowest ratio at 30 percent during the test period and all experi enced similar growth rates in the public sector. Yet thes e countries exp erience volatile price fluctuations (and consequently inflation rates) that do not often coincide with increases in the tax ratio. In fact ,

Germany , with one of the highest tax ratios in this group , has had rela tively stab le prices during many of the years tes ted. The United Kingdom , with the slowest growth in tax revenues as a percent of national income , has experienced the highest rates of inflation.

The last two countries, Switzerland and the United States , conform

less frequently with Clark's theory . From 1963 to 1980 , Switzerland 's

tax revenues have grown from 25 percent of national income to 35 percent ; yet prices have been relatively stab le duri ng a good portion of the test

period . The United States reached the 25 percent tax ratio only recently

and has experienced inflation at ratios less than 25 percent quite often.

Neither country provides evidence to support Clark's theory. 56

On the basis of the regres sion analysis and the cou ntry by country statistical analysis , this study finds little evidence to support Clark's theory of inflation . For this r eason , the study reconnnends a re-examination of all policies that have been imp lemented on the basis of Clark's theory or other similar theories of inflation. I XIUNHddV 58

Table 1

Retail Prices Taxation as a Country Year 19 13 or 1914 Percent of =100 National Income

France 1922 296 25.4 1923 333 23.8 1924 369 21. 9 1925 400 20. 1 1926 505 21.2 1927 514 24.9 1928 519 25.2 1929 556 25.6 1930 581 25 .0 1931 569 26.1 1932 526 26. 3 1933 520 26 .5 1934 515 28.8 1935 482 26.9 1936 507 24.6 1937 619 19.6 1938 697 21.3 Belgium 1925 519 14.2 1926 621 16 .5 1927 771 17.3 1928 798 18.2 1929 847 17.3 1930 869 13.1 Great Britain 1925 176 22. 1 1926 172 23. l 1927 168 23.l 1928 166 23.0 1929 164 22.0 Italy 1926 517 15.3 1927 472 16.8 1928 438 23.6 1929 446 22.0 Japan 1925 218 14.7 1926 199 14.9 1927 189 14.8 1928 184 14.7 1929 182 14.7

Source : Colin Clark "Public Finance and Changes In the Value of Money ." Economic Journal, Vol LV , No. 220. (New York , NY: Macmillan and Co ., 1945) , p. 375 . Table 2

Taxation as Rate of Marginal Percent of Productivity Price Price National Country Period Growth Increase Increase Income

Australia 1924-31 2.0 -1.5 0.7 15.0 1954-57 2.0 1.2 0.8 26.0 Aus tria 1953-57 2.0 6 . 0 .6 29.7 Belgium 1949-57 2.1 2.5 1.2 21.1 Britain 1923-38 1.2 .5 .5 21.0 1949-58 0.9 3.6 .7 26.6 Canada 1922-35 1.9 -2 .4 .6 17.9 1953-57 1.9 2.1 .6 31.2 Denmark 1923-39 1.2 1.0 1.1 20.0 1949-57 1.2 5.2 1.0 28.6 Finland 1930-57 2.0 -1.2 1.1 26.0 France 1925-35 2 .3 3.9 .3 27.0 1950-57 2.3 5.5 .6 40.9 Germany 1927-38 1 .6 .4 .2 23.0 1952-58 1.4 5.4 1.0 43.6 Italy 1922-35 .7 -2 .7 --- 25.0

1950-57 3.8 1.8 • 1 30.0 Japan 1927-38 1.4 -.4 .4 15.6 Netherlands 1949-57 2.2 -.4 .4 35 .0 New Zealand 1927-38 2.2 -.7 . 8 18.0 1947-57 2.2 2.3 .7 31.6

Norway 1948-57 2.6 3.2 • 3 35 .3 Sweden 1923-29 1.4 0 --- 19.0 1930-39 3.0 .5 .3 19.0 1946-58 3.0 .5 .3 29.9 Switzerland 1931-57 2.1 .8 .3 20.0 United States 1902-32 2.3 -.9 .4 11.0 1933-58 2.1 3.0 .4 31.3

Source: Employment , Growth and Price Levels, Hearings before the 1, 1959 , Washington , D. C. : Joint Eqonomi c Connnittee , 86th Congress , October . United States Government Printing Office , p. 2 4 80 II XICIN.3ddV L'N ITED STATES 61

Hh zi YEAR CPI a INFb RIAC TRd Nre xf G9 -- - - bf 1 1 of nol•lOO - (Tn" i1Jns U.S. dollars) 4 0.0 1 941 44 .1 4.9 -- - 8.6 102 .6 8. o.o 1942 48.8 10.6 - -- 1 4 . 3 137.7 10.5 o.o o.o 1943 51 .8 6.1 23 .S 169 .1 13.9 o.o o.o --- 0 1 .0 1944 52 .7 1.7 - -- 44 .2 1 81 .9 24.3 1. 1945 53 .. 2.2 - - 45 2 180.6 25.0 1.0 1.0 - . 22.0 0.0 1.0 1946 58.5 8.5 - - - 39 .3 178.3 1947 66 .9 14.3 - - 38 .3 194 . 6 19.7 o.o 1.0 - 1.0 1948 72 .1 7.7 - 41 .7 219.0 1 9.0 o.o -- 1.0 1949 71 .4 -0.1 - -- 39 .4 212.i 18.5 o.o 1950 72 .1 0.1 - 3 9 5 236.2 16.7 o.o o.o -- . 0.0 1.0 1 951 77.8 7.9 --- 51 .6 272.3 18.9 1952 79 .5 2.1 - - - 66.2 285 .8 23.1 o.o 1.0 1953 80 .1 0.07 6 9 5 2 9 9 .7 23.2 o.o 1.0 --- . 1.0 1 95 4 80.5 0 .049 - 69. 7 299 . 1 23.2 o.o -- 1.0 1955 80 .2 -.03 --- 65.4 328.0 20.0 o.o 195 6 81 .4 1.4 - 7 4 . 5 346.9 21 .4 o.o 1.0 -- 1.0 1957 84 . 3 3.5 -- 79 .9 362 .3 22 .o o.o - 1.0 1958 86 .6 2.7 --- 79 .6 364 .0 21 .9 o.o 1959 87 .3 .08 - - - 79.2 397 .1 20.0 o.o 1.0 1960 88 . 7 1.6 -- 9 2.5 412.0 22 .4 o.o 1.0 - 1.0 1961 89 .6 1.0 - -- 94 .4 424.2 22 .5 o.o 1962 90 .6 1.1 --- 99 .7 457.4 21 .8 o.o 1.0 1.0 1 96 3 91 .7 1.1 - -- 106.6 482 .8 22 .1 o.o 1964 92 .9 1.3 18.2 112 .7 519.2 21 . 7 o.o 1.0 62 .7 1965 94 .5 1.6 23 .1 116.8 566 .0 20 .6 o.o 1.0 3 9.� 1966 97 .2 2.7 68 .S 130.9 622 .2 2 1.0 o.o 1.0 122 .I) 1 96 7 100 .0 2.8 3.7 1 49 .6 655.8 22 .8 0.0 1.0 275.5 1968 104.2 4.0 42 .9 153.7 714.4 24 .5 1.0 1.0 29.9 1969 109.8 5.0 25.0 187.8 7 6 7 . 9 24.5 1.0 1.0 299 . 4 1970 116.3 6.0 20.0 193.7 798 .4 24.3 1.0 1.0 79 .4 1971 121 . 3 4.1 -31 .7 188.4 858.1 22 .0 o.o 1.0 -34 .5 1972 125.3 3. 1 -24 .4 208.6 951 . 9 21 .9 o.o 1.0 98 .1 1973 133 .1 5.9 90 .3 232 .2 1 ,064 .5 21 .8 0.0 1.0 97 .1 1.0 1974 147.7 9.8 66 . 1 264.9 1,136.0 23.3 0.0 203 .8 1975 161 .2 8.4 -14.3 -281 .0 1 ,215 .o 2 3. 1 o.o 1.0 87 .2 1.0 60 .3 1976 1 70 .5 5.4 -3 5.7 300 .0 1 .359.2 22 .1 0.0 1977 181 .5 6.0 11.1 357.8 1 ,515.3 23 .6 0.0 1.0 165.5 1978 195 .3 7.0 16.7 432 .1 1 ,724.3 25. 1 l.O 1.0 152.3 1979 217.7 10.0 42 .9 497 .6 1,924 .8 25 . 9 1.0 1.0 129.7 1980 2 47 .0 11.0 10.0 540 .7 2 ,117.1 25 .5 1.0 1.0 86 . 3 1981 272 .3 9.0 -18.2 628 .2 2,352.5 26.7 1.0 1.0 146.8

a : Eco noni c Report of the ?res ident 1 9 82 (l:ashin�ton, D.C. nting O ice Pr> · 222-223. U.S. Gove-r nMe nt Pri ff ) , b Calculated as ( [CPI CPI J / CPI ) x lOC>. t - t- 1 t-1 CCalculated ( n;F / INF ) x 100. [ I:lF t - t-l 1 t-1

dEconomic Re p o r t of the President 1982 (Uashin�ton, D.C. : U.S. Government Printinr, Office) , �· 243 , Tab le B- 73.

e a Economic Report of the Pres ident 1982 (�: s h i n �to n , D. C. : U.S. Go v e r n Ment ?rint ing Office) , ,. 1%, Tab le B-2 1.

x f Ca lculated as (':.'P.. /:

hDumrny va r i ab l e for 19 pe rcent rat io . j Ca lcul ated as e q ua t i o n (13) Chap ter III of t!l is study . 62

CANADA

a b c d e f g Year CPI INF RIA TR Ni x z 1975= 100 (in billions of Canadian dollars)

1963 56.0 12.0 40.0 30.0 1964 57.0 1.8 o.o 14.0 43.0 32 .5 222.2 1965 58.0 1. 7 -1.8 16. 0 48.0 33.3 122.9 1966 60.0 3.4 96.6 18.0 53.0 33. 9 120.0 1967 63.0 5.0 45.0 21.0 58.0 36 .2 176.7 1968 65.0 3.2 -36.5 24.0 63.0 38.0 165.7 1969 67 .o 3. 1 -3. l 28.0 70 .0 40.0 150.0 1970 70 .0 4.5 45 .5 30.0 75.0 40.0 100.0 1971 72.0 2.9 -36.2 34.0 82.0 41.4 142.9 1972 75.0 4.2 45.8 38.0 93.0 40.8 87.7 1973 81.0 8.0 92.0 44.0 109.0 40.3 91.8 1974 90.0 11.1 38.9 56.0 131.0 42.7 135.1 1975 100.0 11. l o.o 61.0 146.0 41.7 78.0 1976 108.0 8.0 -28.0 70.0 169.0 41.4 93. 7 1977 116.0 7.4 -7.4 77.0 183.0 42.0 120.7 1978 126 .o 8.6 16.4 85.0 201.0 4 1.8 95.1 1979 138.0 9.5 10 .5 96.0 231.0 41.5 93.8 h 1980 8.7 -8.7 110.0 255.0 43. 1 140.4

a Source: Historical Statistics 1960-1979: Main Economic Indicators . Organization for Economic Cooperation and Development (Paris , France, 1980) , p. 34. b Calculated as ( [CPi - CPI J / CPI x 100. t t-1 t-1) c Calculated as ([INF - INF J /INF ) x 100 . t t-1 t- 1 d Organization for Economic Cooperation and Development National Accounts 1963- 1980 (Paris , France , 1982) , p. 147, Table 9, line 12. e lbid. , p. 146 , Table 6, line 7. f Calculated as (TR/NI) x 100. g Calculated as equation (13) Chapter 3 of this study . h From the Organizat ion for Economic Cooperat ion and Development , Finland, an Economic Survey 1982, pp . 15-16 , World Survey Table, line 10. 63

FINLAUD*

a b c d e f Year INF RIA TR Ni X z (in bil lions of markkaa)

1963 5.2 6.2 18.0 34 .4 1964 9.9 90.3 7.3 20.4 35.7 441.0 1965 5.2 -47.4 8.4 22.6 37.1 364.2 1966 3.9 -25.0 9.3 24.3 38. 2 421 . 5 1967 5.6 33. 3 10. 8 26 .7 40.0 235.8 1968 8.4 61.5 12.4 30.5 40.4 2,000.0 1969 2.4 -71.4 13.8 34 .5 40.0 -841.6 1970 2.7 12.5 15.6 38.3 40.7 879.1 1971 6.5 140.7 17.9 42.4 42.4 478.8 1972 7.1 9.2 20.8 49.6 41. 9 942.2 1973 12 .o 89 .0 25. 7 60. 2 4 2.6 1,496.4 1974 16.2 33. 3 32 .3 75.5 42.7 11,92 7.3 1975 17.9 12. 5 39.4 87.7 44.8 9,341.4 1976 14.4 -22.2 48.6 99.3 48.9 161.9 1977 12.7 -7. 14 52.8 109 .0 48.4 -897.5 1978 7.6 -41.5 55.3 119.4 46.3 -5.8 1979 7.3 5.2 61.5 137.7 44.6 .07 1980 10. 7 33.7 70.5 158.3 44.5 -6 ,579.9

a Organization for Economic Cooperation and Development Finland from the Economic Survey Series (Paris , France) , various issues , listed as "percentage in CPI . " b Calculated as (INF - INF ) / (INF ) x 100. t t-1 t-1 C Organization for Economic Cooperation and Development Nat ional Accounts 1963-1980 (Paris , France, 1980) , p . 147, Table 9, line 12 . d ibid. , p. 146, Table 6, line 7. e Calculated as (TR/NI) x 100. f Calculated as equation (13) Chapter 3 of this study . * CPI data was not available in a continuous form for Finland. the CPI Therefore , official rate of inflation was us ed in the analysis and is not listed . 64

FRANCE

a b c d e f g Year CPI INF RIA TR Ni x z 1975=100 (in billions of francs)

1963 50.0 4.8 15Q.O 364.9 41.4 1964 51.7 3 .4 -29.1 0 17.0 405.3 42. 1 118. 3 1965 53.0 2.5 -26.4 185.7 435. 8 42 .6 119 .1 1966 54.4 2.6 4.00 200.7 471.1 42.6 97.9 1967 55.9 2.7 3.8 2 16.1 508.2 42 .5 10 1.8 1968 58.4 4.4 62.9 238. 1 5 53.2 43.0 114.9 1969 62.2 6.5 47.7 2 78.7 631.8 44.11 119.1 1970 65.5 5.3 -18.4 305 .0 698.7 43.6 91. 4 1971 69.0 5.3 0.0 333.9 785.7 42.4 73.6 1972 73. 7 6.8 28.3 357 .1 882.9 42.4 102.0 1973 78.7 6.7 o.o 430.0 999.3 43.0 110.5 1974 89 .5 13. 7 101.4 503.8 1,135.6 44.3 124. 7 1975 100.0 11. 7 -14.5 587.1 1,284 .0 45.7 1 2 7.2 1976 109 .6 9.6 -17.9 713.3 1,474.4 48.3 145.0 1977 119.9 10.0 4.1 798.8 1,66 5.1 47.4 92.0 1978 130.8 9.0 -10.0 305 .2 1,892. 5 47.8 98.3 1979 144.8 10. 7 18.8 1,064.9 2,163.8 49 .2 122.6 h 1980 10.5 -1.8 1,251.2 2,450.3 51.0 132.4

a Source: Historical Statistics 1960-1979: Main Economic Indicators . Organization for Economic Cooperation and Development (Paris , France, 1980) , p. 296. b Calculated as ( [CPI - CPI 1 / CPI ) x 100. t t-1 t- 1 c Calculated as ( [INF - INF 1 / INF ) x 100 . t t- 1 t-1 d Organizat ion for Economic Cooperation and Development National Accounts 1963-1980 (Paris , France, 1982) , p. 101, Table 9, line 12. e ibid. , p. 101, Table 6, line 7. f Calculated as (TR/NI ) x 100 . g Calculated as equation (13) Chapter 3 of this study . h From �h e Organization for Economic Cooperation and Development Finland, an Economic Survey 1982, pp . 15-16, World Survey Table , line 10 . 65

GERMANY

a b c d e f g Year CPI INF RI C TR Ni x z 1975=100 (in billions of marks)

1963 61.7 3.0 139.4 347.1 40 .1 1964 63. 1 2.2 -26.6 151.4 380.6 39.7 90.7 1965 65.3 3.4 54.4 162.2 414.8 39. 1 81.4 1966 67.5 3.3 -2.9 175.1 439.6 40.5 132.8 1967 68.5 1.4 -57.5 179.5 443.1 40.2 250.8 1968 70.5 2.9 107 .1 194.0 481.8 42.3 97.6 1969 71.8 1.8 -37 .9 228.4 539.5 41.6 145.3 1970 74 .2 3.3 83. 3 254.2 610.6 4 2.6 86. 5 1971 78.2 5.3 60 .6 288.9 677.5 43. 2 121. 8 1972 82.5 5.4 1.8 320.1 740.8 45.9 ll9.4 1973 88.2 6.9 27.7 378.7 824.0 46 .7 159.6 1974 94.4 7.0 1.4 409.8 876.6 45.9 129. 9 1975 100 .0 5.9 -15. 7 421. 7 917.8 47.4 62.6 1976 104 .5 4.5 -23.7 474.7 999.5 48.9 140.7 1977 108 .4 3.7 -17.7 522.0 1,066.3 48.5 150.9 1978 lll. 3 2.6 -29.7 556.8 1,145.9 48.2 87.8 1979 ll5.9 4. l 57.6 597.8 1,239.8 48 .2 89 .8 h 1980 5.5 34.1 637.8 1,316.0 48.4 107.8

a Source: Historical Statistics 1960-1979 : Main Economic Indicators . Organization for Economic Cooperation and Development (Paris , France, 1980) , p. 341. b Calculated as ( [ CPI - CPI 1 / CPI x 100. t t-1 t-1) C Calcula ted as ( [ INF - INF 1 INF ) x 100. t t-1 I t-1 d Organization for Economic Cooperation and Development National Accounts 1963-1980 (Paris , France, 1982) , p. 111, Table 9, line 12. e ibid. , p. 110, Table 6, line 7. f Calculated as (TR/NI) x 100. g Calculated as equation (13) Chapter 3 of this study. h From the Organization for Economic Cooperation and Development Finland , an Edonomic Survey 1982, pp . 15- 16. Wo rld Survey Table, line 10. 66

ITALY

a b c d e f g Year CPI INF RIA TR Ni x z 1975=100 (in billions of lira)

1963 46.4 7.4 9.8 30.8 31.8 1964 49.2 6.0 -18.9 11.1 33.5 33. 1 122.4 1965 51.3 4.2 -30.0 11. 7 36.2 32 . 3 69.9 1966 52.3 1.9 -54.7 12. 7 39.3 32 . 3 102 .5 1967 53.4 2.1 10. 5 14.4 43.4 33.l 130.5 1968 54.0 1.1 -47.6 15.9 47. 1 33. 7 111.9 1969 55.6 2.9 163.6 17. 1 52.0 32.8 70.9 1970 58.4 5.0 72.4 19.1 58. 1 32 .8 101.3 1971 61.3 4.9 -2.0 21.2 63.4 33.4 127. 5 1972 64.7 5.5 12.2 23.1 69.5 33.2 94.1 1973 71.5 11.0 100.0 27.3 82.5 33.0 96.5 1974 85.4 19.4 76.3 33.8 100.0 33.6 108.4 1975 100.0 17.0 - 12.3 39.1 112.1 34.8 130.6 1976 116.5 16.5 -2 .9 51.5 140.4 36.6 126.8 1977 139.0 19.3 16.9 65. 1 170.3 38.2 123.9 1978 156.3 12.4 -35 . 7 80 .1 199.4 40.l 585.3 1979 180.9 15. l 21. 7 96 .3 244.0 39 .4 425.4 h 1980 16.6 9.9 126.6 305.8 41.3 125.8

a Source: Historical Statistics 1960-1979: Main Economic Indicators . Organization for Economic Cooperation and Development (Paris , France, 1980) , p. 45. b Calculated as ( [ CPI - CPI / CPI x 100. t t-1 ] t-1 ) C Calculated as ( [ INF - INF . INF x 100. t t-1J / t-1 ) d Organization for Economic Cooperation and Development Nat ional Accounts 1963-1980 (Paris , France, 1982) , p. 147, Table 9, line 12. e ibid., p. 146, Table 6, line 7. f Calculated as (TR/NI) x 100. g Calcuiated as equation ( 13) Chapter 3 of this study . h From the Organization for Economic Cooperation and Development Finland , an Economic Survey 1982, pp . 15- 16 , World Survey Table, line 10. 67

SWITZERLAND

a b c d e f Year CPI INF RIA TR Ni x zg 1975=100 (in billions of francs)

1963 54.7 3.5 11.8 47.0 25.1 1964 56.3 2.9 -17.1 13.4 51.9 25.8 170.9 1965 58. 3 3.5 20.6 14. 1 55.6 25.3 100.0 1966 61.0 4.6 31.4 15.7 59. 7 26.2 266.6 1967 63.5 4.0 -13.0 17.0 64.3 26 .4 73. 7 1968 65.0 2.3 -42.5 19.0 68.8 27.6 188.2 1969 66.7 2.6 13.0 21.4 74.6 28.6 199.2 1970 69.1 3.5 34.6 24.0 83. 1 28.8 117 .4 1971 73.6 6.5 85.7 27.0 94.2 28.6 94.3 1972 78.5 6.6 1.5 30.8 106.4 28.9 87.0 1973 85.4 8.7 31.8 37.5 119.2 31.4 190. 2 1974 93. 7 9.7 11.9 41.8 130.2 32 .1 116.9 1975 100.0 6.7 -30.9 44 .9 129.3 34.7 -951.2 1976 101. 7 1.7 -74.4 48 . 1 132.2 36 .3 390.9 1977 103.0 1.2 -88.3 49 .1 135.9 36.1 91.6 1978 104.0 1.0 -400.0 51.2 141.0 36 .3 91.8 1 979 107.9 3.6 260.0 52.4 148.4 35 .3 39.4 h 1980 2.3 -16.6 55.9 158.9 35. l 113.8

a Source: Historical Statistics 1960-1979 : Ma in Economic Indicators . Organization for Economic Cooperation and Development (Paris, France, 1980) , p. 557. b Calculated as ( [CP I - CPI ] CPI ) x 100. t t-1 / t-1 c Calculated as ( [ INF - INF ] INF ) x 100 . t t-1 / t-1 d Organization for Economic Cooperation and Development National . - Accounts 1963-1980 (Paris , France, 1982) , p. 217, Table 9, line 12. e ibid., p. 216, Table 6 , line 7.

f-c alculated as (TR/NI ) x 100. g Calculated as equation (13) Chapter 3 of this study . h From the Organization for Economic Cooperation and Development Finland , an Economic Survey 1982, pp. 15-16, World Survey Table, line 10. 6 8

UNITED KINGDOM

a b c d e f g Year CPI INF RIA TR Ni x z 1975=100 (in billions of pounds)

1963 40.4 1.7 9.6 28.0 34.2 1964 42.0 3.9 123.5 10. 4 30.5 34.1 155.5 1965 44.0 4.7 18.4 11.8 32 .8 35.9 100.0 1966 45.6 3.6 -22.2 13. l 34 .8 37.6 300 .0 1967 46.7 2.4 - 34.2 14.6 36 .7 39 . 7 134.6 1968 48.9 4.7 95.6 16. 4 39 .7 41.3 176.l 1969 51.5 5.3 11. l 18.4 42.5 43.2 250.0 1970 54.8 6.4 20 .0 20. 7 46 .6 44 .4 93.3 1971 60.0 9.4 43.3 22.0 52.l 42.2 94.0 1972 64.1 6.8 -25.5 23.3 57.4 40.6 47.2 1973 69.5 8.4 20.3 26 .4 66.0 40.0 82.6 1974 80. 5 15.8 76.6 33.2 74.6 44.5 197.4 1975 100.0 24.2 43.3 42.5 93.0 48.6 113.6 1976 115.8 15.8 - 30.2 49.5 110.1 44.9 91.l 1977 134.3 15.9 1.4 56 .4 126.3 44.6 98.2 1978 146 . 4 9.0 -42.7 6 2.7 144.0 43.5 75.0 1979 165.9 13.3 48.l 74.9 168.8 44.3 116. l h 1980 14.4 23.l 91.3 196.9 46.3 133.0

a Source: Historical Statistics 1960-1979: Main Economic Indicators . Organiz�tion for Economic Cooperation and Development (P aris , France, 1980) , p . 606. b Calculated as ( [ CPI - CPI ] / CPI ) x 100. t t-1 t- 1 c Calculated as ( [INF - INF ] / INF ) x 100 . t t-1 t- 1 d Organization for Economic Cooperation and Development National Accounts 1963-1980 (Paris, France, 1982) , p. 235, Table 9, line 12. e ibid., p. 235, Table 7, line 7. f Calculated as (TR/NI) x 100 . g Calculated as equa tion (13) Chapter 3 of this study . h From the Organization for Economic Cooperation and Development Finland, an Economic Survey 1982, pp . 15-16, World Survey Table, line 10. BIBLIOGRAPHY

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