The 2019 budget in Ireland saw the VAT rate increase from 9 to 13.5%. VAT (value added tax) is a charge on goods and services. So this basically meant that goods and services were going to cost more. Obviously, this could lead to a reduction in consumption because it’s possible that consumers wouldn’t be willing or able to afford the goods and services at the new higher price. In order to try and overcome this issue, the Electric Picnic festival opted to put their tickets on sale in December before the new rate of VAT would apply. I thought this was interesting because it illustrates the idea behind Keynesian economics quite well.
Keynesian economics is a branch of economics started by British economist John Maynard Keynes. Before Keynes the general strategy for dealing with economic downturns was to just leave the market alone and hope that it would eventually return to equilibrium. So, when we hit a recession we’d just have to endure that period of hardship in the hopes that economic prosperity would soon return. Keynes however felt this just wasn’t good enough. He was of the view that with government intervention the peaks and troughs of the business cycle could be smoothed out and society wouldn’t have to endure the severe periods of depression it once had. This is how it works.
The growth of the economy is dependent on a number of factors. One of these is consumption (the activity of people buying goods and services). If consumption is low, one of the ways you can increase it is by cutting taxes to leave people with more money to spend. Alternatively if consumption is too high you can increase taxes to cool the economy down. This kind of idea is clearly what the organizers of Electric Picnic had in mind. They wanted people to buy their product, and when a tax increase was going to make their product more expensive, they sold the product before the tax increase occurred so as to encourage consumption.
The above figure is how an economist would try to illustrate this process. If we look at point C1 we can see that the rate of tax is relatively low and the corresponding level of consumption is high. However, if we move to point C2 the tax rate gets higher and as a result the corresponding level of consumption decreases. Obviously, Electric Picnic were trying to sell their tickets before the tax increase in the hopes that they would enjoy an unaffected level of consumption.
In a very broad sense, this is the basic idea behind Keynesian economics which attempts to influence people’s behavior through the use of incentives like tax changes. The principle is basic enough, make things expensive and they won’t be bought as much, make them cheaper and they will. Which may seem a very simplistic and unimportant idea, but a lot of economists argue that if this is done correctly on a macroeconomic scale we can manipulate the fluctuations of the economy into smoothing out.
By Daragh O’Leary