<blockquote>
<p>I was told that this was an economically illiterate piece of reasoning. I’m wondering why?</p>
</blockquote>
<p>It is not necessarily economically illiterate. Theoretically a subsidy could be revenue neutral under the right conditions. This is not to say that it is plausible that this particular policy was revenue neutral, but I can't see how one could dismiss the idea out of hand. Also, the report is quite long but using search bar I wasn't able to find any mention of the word 'revenue neutral'.</p>
<blockquote>
<p>My assumption is that it is because it does not consider:</p>
</blockquote>
<blockquote>
<p>a) what would have happened if the government had invested the money in something else and what investment that would have generated</p>
</blockquote>
<p>But this is a moot point. Revenue neutral just means that the net effect on government revenue that government collects is 0. That is a policy is revenue neutral if <span class="math-container">$\tau=g$</span>, where <span class="math-container">$\tau$</span> is tax revenue collected as a result of a policy and <span class="math-container">$g$</span> spending on the policy. Sure there might be better investments that might be more desirable for society, it could be also argued that total welfare would be lower under the policy than pursuing some other policy. Nonetheless, none of this mean that the policy can't be revenue neutral since we are only discussing government revenues.</p>
<blockquote>
<p>b) what else the private sector would have invested in had the government subsidy not been there (e.g. some smaller sum invested in energy efficiency and the rest likely somewhere else that would have also generated tax revenue.</p>
</blockquote>
<p>Again, it is well to point that maybe government revenues would be higher under non-intervention or some other policy. However, that does not mean the current policy is not revenue neutral. Moreover, there can be multiple revenue neutral policies in principle.</p>
<blockquote>
<p>c) it doesn’t consider discounting (e.g. the tax returns would have come in some years after the initial government investment)</p>
</blockquote>
<p>Again no. While discounting future benefits is important in cost benefit analysis or any welfare analysis, again by definition a policy will be revenue neutral as long as <span class="math-container">$\tau_t=g_t$</span>. The same policy could be revenue neutral in one year but not in another.</p>

CC BY-SA 4.0
2022-06-26T12:53:06.157Z
Thanks for the response. I follow you on a), but not on b) or c).
hmmmm
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2022-06-26T13:05:27.620Z
On b), surely the counterfactual matters. Let’s assume that the size of government spend is $g$, that the total private sector investment after the government spend is $p$, that the rate of VAT is $v$, so that $\tau=p.v$ and finally that the policy is ‘revenue neutral’ so that $g =p.v=\tau$
hmmmm
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2022-06-26T13:14:28.443Z
@hmmmm the counterfactual matters for policy decisions but not for definition of revenue neutrality. By definition you get revenue neutrality when $\tau = g$, $\tau -\tau^*< g$ does not mean policy is not revenue neutral.
1muflon1
CC BY-SA 4.0
2022-06-26T13:15:30.310Z
However, if lets also assume that the private sector investment without the government spend is $p*$. There is presumably a discussion on the level of $p*$, and what sectors the investment would be in (assuming some of it wouldn’t go to energy efficiency). Let’s also make the simplifying assumption that VAT on $p*$ remains $v$. 
The tax collected without government spend is $\tau*=p*.v$. The additional revenue from the government spend is then given by $\tau - \tau* < g$, provided $p* > p$.
hmmmm
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2022-06-26T13:18:46.003Z
@hmmmm again, the fact that government would collect more without the policy has no bearing on whether policy itself is tax neutral. Let's make it more concrete because maybe you have problem with understanding the point with abstract variables. Suppose that government spends \$1000 on policy 1,  suppose that multiplier for this policy is such that every \$1 spend means that private individuals spend another \$9. Also suppose that there is alternative policy 2 where every \$1 spent results in individuals spending \$10. Also suppose VAT = 10%
1muflon1
CC BY-SA 4.0
2022-06-26T13:21:11.580Z
then under policy 1. We have gov spending = 1000, Total spending consumers + gov  =10000, 10% VAT means government revenue = 1000. So this policy by definition of revenue neutral policy is revenue neutral. It matters not that under second policy total spending would be 11000 and thus government could have collected 1100 and thus implemented policy where it would get 100 extra. That 100 extra would matter for welfare, or CBA since it can be viewed as an opportunity cost but it does not matter for revenue neutrality because definition of revenue neutrality ignores opportunity costs
1muflon1
CC BY-SA 4.0
2022-06-26T13:26:58.353Z
But you are looking at two different policy interventions. I’m looking at a policy intervention against a baseline of no policy. If we assume that $p*=p$, that is, the policy intervention generates no additional private sector investment, the government has spent $g$ for no additional revenue.
hmmmm
CC BY-SA 4.0
2022-06-26T13:29:25.697Z
@hmmmm ok then another example, suppose the policy 1 is the same and in absence of any policy government would just somehow get 10000 extra revenue not implementing the policy.  Still for definition of revenue neutrality it does not matter. The policy is still revenue neutral even though government could earn more by not implementing it.
1muflon1
CC BY-SA 4.0
2022-06-25T21:25:06.363Z
2022-06-25T21:25:06.363Z
1muflon1
<p>I read a recent <a href="https://9tj4025ol53byww26jdkao0x-wpengine.netdna-ssl.com/wp-content/uploads/Making-markets-through-the-UKIB-The-green-homes-infrastructure-opportunity-.pdf" rel="nofollow noreferrer">policy paper</a> (bottom of page 4, KfW being the German development bank) that asserted that the German government’s spend on subsiding energy efficiency schemes in homes was revenue neutral, as the subsidy stimulated enough private sector investment that the spend was offset by increase VAT returns.</p>
<p>I was told that this was an economically illiterate piece of reasoning. I’m wondering why?</p>
<p>My assumption is that it is because it does not consider:</p>
<p>a) what would have happened if the government had invested the money in something else and what investment that would have generated</p>
<p>b) what else the private sector would have invested in had the government subsidy not been there (e.g. some smaller sum invested in energy efficiency and the rest likely somewhere else that would have also generated tax revenue.</p>
<p>c) it doesn’t consider discounting (e.g. the tax returns would have come in some years after the initial government investment)</p>
<p>Is my understanding here right, or am I missing something?</p>
<p>Thanks for any help,</p>
<p>hmmm16</p>

<government-spending>
Recycling tax revenues
hmmmm
# Recycling tax revenues

(Asked by: username_0 on 2022-06-25)

I read a recent [policy paper](https://9tj4025ol53byww26jdkao0x-wpengine.netdna-ssl.com/wp-content/uploads/Making-markets-through-the-UKIB-The-green-homes-infrastructure-opportunity-.pdf) (bottom of page 4, KfW being the German development bank) that asserted that the German government’s spend on subsiding energy efficiency schemes in homes was revenue neutral, as the subsidy stimulated enough private sector investment that the spend was offset by increase VAT returns.

I was told that this was an economically illiterate piece of reasoning. I’m wondering why?

My assumption is that it is because it does not consider:

a) what would have happened if the government had invested the money in something else and what investment that would have generated

b) what else the private sector would have invested in had the government subsidy not been there (e.g. some smaller sum invested in energy efficiency and the rest likely somewhere else that would have also generated tax revenue.

c) it doesn’t consider discounting (e.g. the tax returns would have come in some years after the initial government investment)

Is my understanding here right, or am I missing something?

Thanks for any help,

hmmm16

**Tags:** government-spending


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## 1 answers

### Answer by username_1 on 2022-06-25. Score: 1

> I was told that this was an economically illiterate piece of reasoning. I’m wondering why?

It is not necessarily economically illiterate. Theoretically a subsidy could be revenue neutral under the right conditions. This is not to say that it is plausible that this particular policy was revenue neutral, but I can't see how one could dismiss the idea out of hand. Also, the report is quite long but using search bar I wasn't able to find any mention of the word 'revenue neutral'.

> My assumption is that it is because it does not consider:

> a) what would have happened if the government had invested the money in something else and what investment that would have generated

But this is a moot point. Revenue neutral just means that the net effect on government revenue that government collects is 0. That is a policy is revenue neutral if $\tau=g$, where $\tau$ is tax revenue collected as a result of a policy and $g$ spending on the policy. Sure there might be better investments that might be more desirable for society, it could be also argued that total welfare would be lower under the policy than pursuing some other policy. Nonetheless, none of this mean that the policy can't be revenue neutral since we are only discussing government revenues.

> b) what else the private sector would have invested in had the government subsidy not been there (e.g. some smaller sum invested in energy efficiency and the rest likely somewhere else that would have also generated tax revenue.

Again, it is well to point that maybe government revenues would be higher under non-intervention or some other policy. However, that does not mean the current policy is not revenue neutral. Moreover, there can be multiple revenue neutral policies in principle.

> c) it doesn’t consider discounting (e.g. the tax returns would have come in some years after the initial government investment)

Again no. While discounting future benefits is important in cost benefit analysis or any welfare analysis, again by definition a policy will be revenue neutral as long as $\tau\_t=g\_t$. The same policy could be revenue neutral in one year but not in another.

> **Comments:**
> **username_0**: Thanks for the response. I follow you on a), but not on b) or c).  
> **username_0**: On b), surely the counterfactual matters. Let’s assume that the size of government spend is $g$, that the total private sector investment after the government spend is $p$, that the rate of VAT is $v$, so that $\tau=p.v$ and finally that the policy is ‘revenue neutral’ so that $g =p.v=\tau$  
> **username_1**: @username_0 the counterfactual matters for policy decisions but not for definition of revenue neutrality. By definition you get revenue neutrality when $\tau = g$, $\tau -\tau^*< g$ does not mean policy is not revenue neutral.  
> **username_0**: However, if lets also assume that the private sector investment without the government spend is $p*$. There is presumably a discussion on the level of $p*$, and what sectors the investment would be in (assuming some of it wouldn’t go to energy efficiency). Let’s also make the simplifying assumption that VAT on $p*$ remains $v$.  The tax collected without government spend is $\tau*=p*.v$. The additional revenue from the government spend is then given by $\tau - \tau* < g$, provided $p* > p$.  
> **username_1**: @username_0 again, the fact that government would collect more without the policy has no bearing on whether policy itself is tax neutral. Let's make it more concrete because maybe you have problem with understanding the point with abstract variables. Suppose that government spends \$1000 on policy 1,  suppose that multiplier for this policy is such that every \$1 spend means that private individuals spend another \$9. Also suppose that there is alternative policy 2 where every \$1 spent results in individuals spending \$10. Also suppose VAT = 10%  
> **username_1**: then under policy 1. We have gov spending = 1000, Total spending consumers + gov  =10000, 10% VAT means government revenue = 1000. So this policy by definition of revenue neutral policy is revenue neutral. It matters not that under second policy total spending would be 11000 and thus government could have collected 1100 and thus implemented policy where it would get 100 extra. That 100 extra would matter for welfare, or CBA since it can be viewed as an opportunity cost but it does not matter for revenue neutrality because definition of revenue neutrality ignores opportunity costs  
> **username_0**: But you are looking at two different policy interventions. I’m looking at a policy intervention against a baseline of no policy. If we assume that $p*=p$, that is, the policy intervention generates no additional private sector investment, the government has spent $g$ for no additional revenue.  
> **username_1**: @username_0 ok then another example, suppose the policy 1 is the same and in absence of any policy government would just somehow get 10000 extra revenue not implementing the policy.  Still for definition of revenue neutrality it does not matter. The policy is still revenue neutral even though government could earn more by not implementing it.  

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