A key priority is to enhance investment to improve productivity, in which central steps are a cut in corporate tax and a raise in the personal allowance1.
To study the impact of such policies, consider a simplified closed economy (with 0% natural growth rate of output). Suppose that the economy was initially in a long-run equilibrium and that no other policy has been introduced nor other shocks have occurred during the considered time interval. Adopting a simplified picture describing the policies as a cut in corporate tax and a cut in personal income tax introduced in 2017, use the AD-AS model (including its foundations in the IS-LM model and considering an upward sloping SRAS curve) to interpret the behaviour of the main macroeconomic variables, in the short-run and the long-run, depicted in the figures below (with predictions extrapolated until 2030). Explain and illustrate your answer graphically.
Hint: The cut in corporate tax is to be taken as incentivising investment.
1 The personal allowance is the amount of income individuals can earn before starting paying income tax. In effect, a raise in the allowance reduces the overall personal income tax, so we treat it as a personal income tax cut.
You can also consult the data in the table below (numbers rounded).
| Year | Real interest rate | Real GDP | Real GDP growth rate | Unemployment rate | Price level |
| 2016 | 2.00 | 100.00 | 0 | 4 | 100.00 |
| 2017 | 2.38 | 100.62 | 0.615 | 3.69 | 101.36 |
| 2018 | 2.43 | 100.57 | -0.047 | 3.72 | 101.52 |
| 2019 | 2.48 | 100.52 | -0.043 | 3.74 | 101.66 |
| 2020 | 2.52 | 100.48 | -0.040 | 3.76 | 101.79 |
| 2021 | 2.55 | 100.45 | -0.037 | 3.78 | 101.90 |
| 2022 | 2.59 | 100.41 | -0.034 | 3.79 | 102.01 |
| 2023 | 2.62 | 100.38 | -0.032 | 3.81 | 102.10 |
| 2024 | 2.65 | 100.35 | -0.029 | 3.82 | 102.19 |
| 2025 | 2.68 | 100.32 | -0.027 | 3.83 | 102.26 |
| 2026 | 2.70 | 100.30 | -0.025 | 3.85 | 102.33 |
| 2027 | 2.72 | 100.28 | -0.023 | 3.86 | 102.40 |
| 2028 | 2.75 | 100.26 | -0.021 | 3.87 | 102.46 |
| 2029 | 2.77 | 100.24 | -0.020 | 3.88 | 102.51 |
| 2030 | 2.78 | 100.22 | -0.018 | 3.89 | 102.55 |
