Government Policies Impact
As my semester project I decided to examine possible government’s impact on the economic performance of a country. It means whether a government is able to influence the economic performance by its policies.
I also wanted to prove the neoclassic economic theory saying that decreasing taxes is beneficial to the economic growth.
The project’s goal is simulating a simple environment which can be helpful for setting suitable government policies.
For my project I used the simulation method Monte Carlo. I combined this method with regressive analysis proving that the data selected by me are suitable for my experiment.
I decided to examine my theories on data from the Czech economy from 2008 to 2016 (data from 2017 are still not completely published). These data were released by Czech Statistical Office and Ministry of Finance of the Czech Republic.
As the indicator of economic performance I decided to use gross domestic product (GDP). Despite all criticism, I still recognize it as the most relevant economic state indicator of a selected economy. The commonly recognized theories are saying the GDP is created by consumption, investments, government spending and export. This should be reflected in possible government tools. As the government tools I decided to select those 4:
1. Individual Income Tax Rate. I believe this tax is important because in the Czech economics it taxes all wages of employees and self-employers. The tax rate can have influence on civil consumption and investments.
2. Corporate Income Tax Rate. I believe this tax is important because it taxes the profits of corporations in the Czech economy. The tax rate can have influence on civil consumption and investments.
3. Government Spending. By the most of mainstream economics theories a government can affects economy by government spending at least in short-run, so I decided to use it in my simulation.
4. Net Export. This factor is the most controversial and I considered really long time if should I use it in my model. Although a government cannot directly affect the net export (foreign trade is done by businesses, not government), it is commonly recognized a government can affect it indirectly by its pro-export or protectionists policies. This is a reason why I decided to use it in my model after proper consideration.
For my model I did a large simplification of reality. For example I did not used in my model value added tax (VAT) despite the fact is affects a consumption. The problem is VAT has 2 levels and some items are even not taxed by VAT, so reflecting this tax in my model would be extremely complicated. In reality a government uses more tools for reaching its economics goals.
I also realize a term from 2008 to 2016 can be too short in some cases. But I decided for this term based on fact in 2008 a lot of important tax changes came in legal power (for example flat individual income tax). By involving data from the previous years to my model, this can bring certain complication for result’s interpretation.
Even with these simplifications my model is not loosing its relevance. My goals were not involving all the government tools to my model but defining clear rules for setting the government policies.
Simulation and Modelling
For proving the relevance of selected economic tools I used regressive analysis. Then I did Monte Carlo Simulation.
Before using Monte Carlo I had to prove the influence of selected tools to the economic performance (GDP). For this purpose I used regressive analysis. The R rate was 0,877068461027525. This proves the tools selected by me have certain impact on the output (not the full one as I will explain later).
I also got coefficients for selected tools representing their contribution to the output. Since the individual income tax rate is still the same since 2008, its coefficient was 0 (based on this tool is not relevant for my future steps). For the other tools I got following coefficients: Corporate Income Tax Rate = 12994,6878898414 Government Spending = 2,95223111181548 Net Export = 2,79310070627737
Monte Carlo Simulation
When I had this done, I did Monte Carlo Simulation. With random numbers generator I generated random possible GDP values. Then I divided these values by the coefficients I got from regressive analysis. Based on this I set the values of all government tools necessary for reaching the selected GDP value.
The Monte Carlo simulation helped me to set the ideal values of the government tools for reaching certain level of GDP. This can be used for proposing the government policies enhancing an economic growth.
My simulation also did not prove the principles of neoclassic economics. The situations with the highest GDP were also situations with the highest income tax rates which is a right opposite of the neoclassic economic theory. In these situations the government spending was also the highest, so we can even say my simulation proves more the principles of Keynesian economics.
But this does not mean my simulation totally rejected the neoclassic economics theories. There are just more important factors directly influencing GDP than tax rates. Even the simulation is favouring the high taxes, we can still expect lowering the taxes have positive indirect impact on factors like consumption and investments which have direct impact on GDP but they are not under full control of a government, so they were not included in my simulation. This is also proved by a fact the fact R rate was only 0,877068461027525 (it means there are more factors having impact on GDP growth).
It is also good to realize the sources are not unlimited. With ignoring the other economic facts, my model can lead to an idea that for ensuring GDP growth, you just need to tax people more and spend more money. But the reality is much more difficult. Every government is supposed to behave fiscally responsible, so it has to keep the deficit and public debt under control. The Laffer Curve also proves you cannot raise the tax rate above certain level.