Brexit and tax policies in the EU and the UK

Tax policies in the United Kingdom (UK) and the European Union (EU) are likely to change in the Brexit process. How such reforms will impact the efficiency and growth of the economy, allocation of resources across major production sectors, and redistribution of welfare of households in these economies is an interesting issue. A dynamic computable general equilibrium (CGE) model of these two economies, based on the heterogeneity of households and firms as revealed in the latest input-output tables of these economies, is employed to measure these quantitative impacts. This study focuses on how far the existing taxes deviate from the optimal taxes in these economies. We try to find the optimal level of taxes with the synthesis of broad-based household level information. Input-output tables are obtained from the Organisation for Economic Co-operation and Development (OECD), and time series or panel data from the Eurostat and the Office for National Statistics (ONS).

We compare our findings to the popular macro models: the two country global economy under the Keynesian multiplier model, or the Ricardian trade model based on the comparative advantage between these two economies.

The dynamic general equilibrium model of Germany, France, the UK, and Spain takes the above realities under consideration and builds on the micro-consistent data set from the input-output tables of these countries. Computation of the dynamic general equilibrium model supports the basic results that Brexit effects can be negative or positive depending on how kill-biased technical progress in the UK compares to the rest of the EU. There is significant uncertainty about the processes and outcome of Brexit negotiations. While efficiency in allocation of resources can improve in the UK, the cost of production may decrease, and the UK may become more competitive in the global economy. When the UK may trade in better terms with the emerging markets and developing economies, these gains may be eroded if the EU retaliates to the UK. The future is hanging on the balance.