Tax, regulation and economic growth: A case study of the UK

Abstract

This paper investigates whether government policy had a causal impact on UK output and productivity growth between 1970 and 2009. An open economy DSGE model of the UK is set up, with productivity growth determined by the tax and regulatory environment in which firms start up and operate. The agent's optimality conditions imply a reduced form linear relationship between policy and short-run productivity growth. Identification is assured for the DSGE model by the rational expectations restrictions,therefore the direction of causality is unambiguously from policy to productivity. The model is estimated and tested by Indirect Inference, a simulation-based method with good power against general misspecification. The results of this study offer robust empirical evidence that temporary changes in policies underpinning the business environment can have long-lasting effects on UK economic growth.