Tuesday, 19 February 2019

Taxes are not part of GDP

Our Prime Minister doesn't know the difference between GDP and the government accounts. That much is clear from her slip-up last September. However, she can almost be forgiven for that. After all, she did a communication studies degree, which almost certainly didn't include any economics. And she isn't finance minister. However, I would expect business reporters to know better. From Aimee Shaw in yesterday's New Zealand Herald:
The beer industry contributed $646 million to GDP in the year to March 2018, made up of $331m in GST and $315m in excise tax.
That sentence is exactly wrong. GST and excise tax do not contribute to GDP. To see why, let's start with the definition of GDP: The market value of all final goods and services produced within a country in a given period of time.

There are three approaches we can use to measure GDP: (1) the expenditure approach, which adds up all of the spending in the economy; (2) the income approach, which adds up all of the income in the economy; and (3) the production approach, which adds up the value of everything produced in the country. All three of these should (in theory) add up to the same value. This is easiest to see for the expenditure and income approaches, since every dollar of spending by Person A must become income to Person B.

To see why GST and excise tax are not part of GDP, let's start with the production approach. The idea is to add up the value of everything produced in the country in the last year (or quarter). So, you add up every good and every service produced in that time, and multiply each of them by their market price. The market price is the price excluding GST or excise taxes. The reason they are excluded is simple - they don't affect the underlying value of the good or service. If you included GST or excise taxes in the measure of the value of goods and services, then the government could artificially inflate GDP every year by increasing GST. So, GST and excise taxes are not included in GDP.

The expenditure approach adds up all of the spending in the economy, including spending by households (consumption), spending by businesses (investment), and spending by government, with an adjustment for net exports (the difference between the amount that overseas countries spend on goods produced in New Zealand (exports), and the amount that New Zealand spends on goods produced overseas (imports)). Again, there is no room for GST or excise tax in there.

The income approach adds up all of the income in the economy, including income from labour (wages), income from capital (rents), income from savings (interest), and income from entrepreneurship (profits). Notice there is no role for GST or excise tax in there either.

Taxes are part of the government accounts, and the difference between taxes and government spending is the budget surplus (if taxes are larger than spending) or deficit (if taxes are less than spending). Our Prime Minister might not know the difference, but we should expect better of the business media.

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