I think thresholds may make a difference.

Bloke on £25k, trying to decide whether to up his effort and do a more difficult job for £50k. For simplicity, suppose we start with income tax threshold of £25k. The government is planning to either put on a new VAT of 10%, or increase the income tax that kicks in at £25k from 0 to 20%.

Now, suppose they do the VAT raise. The real value of his £25k salary drops so he can only buy £22.5k of stuff. As does his prospective real value if he goes to £50 – now he can buy £45k of stuff. So the decision to work harder nets him £22.5k more stuff.

Now suppose it is an income tax raise. Now the choice is between £25k of stuff or £45k of stuff, so £20k more. So his incentives are slightly better if it is VAT

Also, if his marginal propensity to consume is 80%, it may change things. People may be incentivized by their total take home, even if they save 20% of it which therefore escapes VAT. Then, to raise the same amount, the VAT would have to be higher, I suppose.

My brain still tired. This is interesting stuff but I must dash or risk marital strife …. . nice weekend

So when I decide whether to get a job I think “How much would I keep of the money”

and on consuming I think

“what do I get for this”.

VAT reduces the value of all pounds: income tax reduces the value of the ones you are setting out to earn. My brain is too tired to work this through. Have a nice w/e

I don’t think that the incentive to work argument is strong tho’ – after all, we work to spend, so the amount of goods you can buy is pretty much unaltered.

A switch from income taxes to consumption taxes – yes, that sounds like something that might well work . . . good incentive effects for work, of course . . . distributional arguments for the bottom decile (Kate Green coming into sight) but nothing that could not be fixed with targetted interventions . . . worth thinking about

I actually had a chat with a man from the Gov about changing Bank remits. Like many in the US, I think it could be a real jolt. But I really worry what the gilt market would say. That is why I am keen on us offering more index linked debt so the markets know this is not about government default factored in.

So you are right that AS moves left, but AD moves right (people pay less income tax). Since the two amounts are the same, the best guess is that in the short term output remains unaltered, but the price level has increased.

Why is that useful? See my FT article: http://www.ft.com/cms/224ae9f2-fb95-11dd-bcad-000077b07658.html.

it is a convention, sure, but I reckon a relevant one

Microsoft Paint + 20 minutes to write this thing = bad graphs

This is a very good essay, and would have got an ‘A’.

However, your failure to provide axis labels on all but your first diagram mean that I am forced to give you only a ‘B+’

[Yes that's right, I only remember the irrelevant parts of A-level and first year undergraudate economics.]

[p.s. does it matter that you are holding LR AS to be completely inelastic? I understand the theory - namely, that an economy's productive output is limited and cannot expand indefinitely (well, within a given time frame...because obvioulsy technological improvements and increased productivity mean that in the long long run AS can be increased, surely?) - but is modelling inelastic LR AS definitely the correct way to conceptualise the problems of this recession? Totally genuine question, posed from profound ignorance.]