A Regional Computable General Equilibrium Model of Wales for Tax Policy Analysis By Long Zhou A Thesis Submitted in Fulfilment of the Requirements for the Degree of Doctor of Philosophy of Cardiff University Economics Section of Cardiff Business School, Cardiff University May 2019 ABSTRACT Under the background of ongoing regional tax devolution in Wales, the development of new regional economic models has been needed to understand tax policy variations. This thesis develops a Computable General Equilibrium model of Wales for tax policy analysis. This model is a static, multi-sector and single-regional model. A Social Accounting Matrix is also developed as the benchmark database for the model. It features 21 sectors, 1 representative household, 2 external agents, 7 types of taxes and 3 production factors, and is balanced with various methods. Unknown model parameters are calibrated by the data information contained in the SAM. The model can be solved to replicate the benchmark SAM and the simulation is conducted regarding three taxes: Stamp Duty Land Tax, Corporation Tax and Income Tax; and three time frames: short, medium and long run. The time frames are defined according to different degrees of factor mobility. The whole simulation is also run with sensitivity analysis that three elasticity values regarding substitution between production factors are examined: 0.5, 1 and 1.5. For all the taxes, the simulation results generally give negative effects in the short run, and only in the medium to long run there appears expected reasonable results. The results of SDLT variation effects generally suggest that narrowing the gap between residential and non-residential SDLT rates has slightly more impact than simply cut of both rates. In this case, the mutual drag between residential and non-residential property prices can be observed. Generally, a relatively lower elasticity of substitution tends to deliver more significant economy-wide effects than a high elasticity. This implies that it is important to avoid over- substitution effect between production factors so as to produce better results in response of a tax variation shock. I ACKNOWLEDGEMENT This thesis would not have been possible without the continuing support of my supervisor Prof. Max Munday and his truthful dedication to the academic and supervisory work. Notably, his actual accomplishment is not only to provide advice when required, but to establish a relaxing environment where the productivity can flourish. My sincerest gratitude belongs to him. In addition, I would like to thank Prof. Kent Matthews for his always warm and encouraging smile and unconditional trust in me. His valuable experience and suggestions on the modelling work has given me massive confidence. This certainly constitutes a critical juncture in my life. Great thanks also go to Prof. Patrick Minford. As an influential economist, he led me into the world of macroeconomics whose advice is always gratefully appreciated. Without his help and encouragement I cannot finish this thesis with peace of mind. I would also like to express my gratitude to Dr. Andrew Crawley. He provides so generous technical help on my modelling practice. I owe gratitude to Dr. Annette Roberts and Neil Roche, for your continuous support and encouragement. This thesis is funded by the Welsh Government and I truly appreciate for the generous financial support. The final words belong to my family. I am particularly grateful to my mother. The meaning and influence of her in my life extends far beyond my ostensible academic achievements. I am so grateful for my beloved wife’s support and patience during these years, especially for her understanding for all the days and nights I am absent. At last, this dissertation is dedicated to my son, Baichen, as you are my power and strength. I keep looking forward to our joint future. II DECLARATION This work has not been submitted in substance for any other degree or award at this or any other university or place of learning, nor is being submitted concurrently in candidature for any degree or other award. Signed …………Long Zhou ………………………………… (candidate) Date ……………29/05/2019…….…………….……… STATEMENT 1 This thesis is being submitted in partial fulfillment of the requirements for the degree of …PhD……(insert MCh, MD, MPhil, PhD etc, as appropriate) Signed …………Long Zhou……… ……………………….…………… (candidate) Date ……………29/05/2019……………….…………… STATEMENT 2 This thesis is the result of my own independent work/investigation, except where otherwise stated, and the thesis has not been edited by a third party beyond what is permitted by Cardiff University’s Policy on the Use of Third Party Editors by Research Degree Students. Other sources are acknowledged by explicit references. The views expressed are my own. Signed …………… Long Zhou………………………….……….…… (candidate) Date ……………29/05/2019……….………………… STATEMENT 3 I hereby give consent for my thesis, if accepted, to be available online in the University’s Open Access repository and for inter-library loan, and for the title and summary to be made available to outside organisations. Signed …………… Long Zhou…………………………..…..….. (candidate) Date ……………29/05/2019…………………………… STATEMENT 4: PREVIOUSLY APPROVED BAR ON ACCESS I hereby give consent for my thesis, if accepted, to be available online in the University’s Open Access repository and for inter-library loans after expiry of a bar on access previously approved by the Academic Standards & Quality Committee. Signed ……………Long Zhou………………………..……… (candidate) Date ……………29/05/2019……………………………. III TABLE OF CONTENTS CHAPTER 1 INTRODUCTION ............................................................................................... 9 1.1 Background ...................................................................................................................... 9 1.2 Economic models of Wales ............................................................................................. 9 1.3 Modelling the Welsh effects of regionally-set tax changes ........................................... 10 1.4 Structure of the thesis..................................................................................................... 10 CHAPTER 2 ECONOMIC AND FISCAL BACKGROUND OF DEVOLVED TAX VARIATION IN WALES ....................................................................................................... 15 2.1 Introduction .................................................................................................................... 15 2.2 Basics of the Welsh economy ........................................................................................ 16 2.3 Devolution in Wales ...................................................................................................... 20 2.4 Current fiscal status of Wales ........................................................................................ 25 2.5 Devolved taxes of Wales ............................................................................................... 30 2.5.1 Council Tax ............................................................................................................. 30 2.5.2 Non-Domestic Rates ............................................................................................... 33 2.5.3 Land Transaction Tax ............................................................................................. 35 2.5.4 Landfill Disposals Tax ............................................................................................ 42 2.5.5 Welsh Rates of Income Tax .................................................................................... 42 2.5.6 Other taxes considered for devolution .................................................................... 45 2.6 Conclusion ..................................................................................................................... 46 CHAPTER 3 LITERATURE REVIEW OF CGE MODELLING AND ITS FISCAL POLICY APPLICATIONS ..................................................................................................................... 48 3.1 Introduction .................................................................................................................... 48 3.2 Economic modelling developed for Wales and applications ......................................... 48 3.3 Regional CGE models.................................................................................................... 52 3.4 CGE applications and the general effects of tax changes .............................................. 56 3.5 CGE model time perspectives ........................................................................................ 59 1 3.6 CGE and regional fiscal institutions .............................................................................. 60 3.7 CGE: parameterization and sensitivity analysis ............................................................ 62 3.8 CGE and regional tax effects in the UK ........................................................................ 63 3.9 CGE: different labour market closures .......................................................................... 66 3.10 Conclusion ................................................................................................................... 69 CHAPTER 4 THEORY AND SPECIFICATION OF ECONOMIC BEHAVIOURS IN CGE MODELLING .......................................................................................................................... 70 4.1 Introduction ...................................................................................................................