More on saving, investment and income

The following builds on the preceding blog about chapter 6 of Keynes’s General Theory. It seeks to clarify the Keynesian framework for measuring national income and to give further clarity to the meaning of income, saving, and investment. Keynes’s closed-economy analysis, as set out in chapter 6 of his General Theory, will be extended to include the foreign and government sectors. A distinction between the creation of value added and its distribution will also be drawn. This is because commentators, politicians, and lobbyists often (deliberately or otherwise) conflate value creation with value distribution. Incorporating the government and foreign sectors, it will be shown, preserves the equality of saving and investment. Aggregate saving can be determined either from the expenditure approach to national income determination or from the income approach; both approaches yield the same figure for saving and this further confirms the power of Keynes’s framework.

Incorporating the government and foreign sectors

In the following table, the productive sector of an economy has been split into the B2B sector whose businesses buy and sell between themselves, the B2C sector whose businesses sell to households, the B2G sector whose businesses sell goods and services to the government, and to the B2F sector whose businesses sells goods and services to foreigners. Sales and purchases between businesses in the B2B sector have been cancelled against each other so that only transactions between the B2B and the other sectors remain. These remaining transactions cancel on consolidation. The residual purchases figure of 500 that remains after consolidation represents imports since all other purchases, totalling 1,000, were made from the B2B sector. In a closed economy without a government sector, as assumed in chapter 6 of Keynes’s General Theory, consolidated A1 would be zero.

CodeDescription B2B B2C B2G B2F AdjustmentConsolid
U = A1 – IUser cost100(3,000)3,900(6,200)(1,000)(6,200)
Y = A – UValue added90043,0006,10011,20061,200

User Cost

The items in red relate to User Cost, denoted as U, and is obtained from A1 – I. Subtracting user cost (U) from Revenue (A) yields business income (Y) known as Value Added. Value Added is a measure of the additional market value added by the factors of production to purchased materials, goods, and services (denoted by A1). The factors of production, namely land, labour, capital, and government, will subsequently receive a share of the value added as a reward for their respective contributions. This is covered later.

In cases where no capital expenditure has taken place, the user cost will consist of just revenue costs (purchases of materials or finished goods plus an inventory adjustment) and a charge for depreciation. When capital equipment has been purchased, A1 will include the cost of new capital equipment. In these cases, user cost U must be decreased by the cost of the purchased capital equipment so that only revenue expenditure is set against revenue (A). This is achieved via a capital adjustment. Examples of capital adjustments are supplied in the above illustration. If capital expenditure has taken place then the capital adjustment will be positive. If the capital adjustment is negative then this will be because of depreciation of capital equipment. If a positive capital adjustment is higher than A1 then capital equipment is being made “in-house” rather than being purchased in a finsished state from an outside supplier. In the above example, the B2C and B2F sectors are making their own capital equipment.

Factor Costs

In addition to user cost, Keynes also identifies a second set of costs which he calls factor costs. Whereas user costs are concerned with payments to other entrepreneurs, factor costs are those payments a business makes in exchange for services other than those provided by entrepreneurs. These services facilitate, or are necessary for, production and exclude raw materials, finished goods, and capital equipment. The classical factors of production are land, labour, and capital, but in modern advanced societies government should be included. Hence factor costs include wages, rental payments, interest charges, business rates and corporation tax, and dividend payments. Factor costs are a distribution of value added and represent factor income in the hands of the factors of production.

The table shown below lists the aggregate factor costs of an economy. The total is 61,200, which is equal to the aggregate value added calculated above.

Factor costConsolidatedHouseholdsGovernmentRentiers
Wages (W )50,000
Interest (i)1,000
Taxation (T)4,000
Dividends (d)5,000
Profit (Pi)1,200
Value added61,200

In the following table each factor cost in the above list has been assigned to the sector for which the factor cost is income. So wages paid to labour is household income, interest and dividends paid to financiers are rentier incomes, and taxation is income received by government. The aggregate retained profits (Pi) of 1,200 is assigned to the rentier sector since retained profits form part of shareholders’ equity. Rental payments made by businesses would be assigned to rentiers.

Factor costConsolidatedHouseholdsGovernmentRentiers
Wages (W )50,00050,000
Interest (i)1,0001,000
Taxation (T)4,0004,000
Dividends (d)5,0005,000
Profit (Pi)1,2001,200
Value added61,20050,0004,0007,200


Saving is given by aggregate A1 minus aggregate U. Referring to the value added statement above we get 500 – (- 6,200) = 6,700 which, reassuringly, is equal to business investment shown in the same statement.

The saving figure of 6,700 is further confimed by aggregating the saving of each sector, assuming that the expenditure by the government and by foreigners is consumption expenditure. The following table sets this out:

Saving by sectorHouseholdsGovernmentForeignersRentiersTotal
Income (W ) 50,000(T) 4,000(M) 5007,20061,700
Expenditure(C) 40,000 (G) 10,000(X) 5,00055,000
Saving (S)10,000(6,000)(4,500)7,2006,700

The government deficit of 6,000 falls short of total saving of 6,700, and falls short of household saving of 10,000, and of private sector saving of 17,200. This seems to refute the claim made by the MMT school that government deficits are necessary, otherwise the private sector can not save.

Consumption expenditure versus revenue expenditure

A source of confusion sometimes arises between these two terms. Consumption expenditure is spending by households on goods and services provided by business. Whether a householder perceives the items purchased as capital or revenue in nature is irrelevant – sales by firms to households are consumption expenditure. From a business point of view, items sold to households are stock-in-trade, which are revenue in nature. Capital expenditure is undertaken by businesses, not by households.

Summary and conclusions

Keynes’s framework set out in chapter 6 of his General Theory defines income, saving, and investment in a closed economy without a government sector. An attempt has been made here to extend his methodology and ideas, using his notation, to an open economy with a government sector.

Keynes’s concept of business income is value added. This has enabled his ideas to be illustrated by a value added statement.

It is business that creates value added. Other sectors of the economy, although they may facilitate the creation of value added, and/or be necessary for creation of value added, do not create value added. Instead, they absorb it. These value absorbing sectors correspond to the factors of production, namely land, labour, capital, and government.

For the purpose of national income accounting, household purchases of goods and services from firms are consumption expenditure, whether or not householders perceive the purchases as capital expenditure or as revenue expenditure. For national income accounting purposes, the distinction between capital and revenue expenditure is relevant only to the spending activities of firms.

MMT’s claim that government deficits are necessary for private saving to take place is not plausible (leaving aside the desirability of saving).

Understanding Keynes on Income, Saving, and Investment.

Keynes covers these topics in chapter 6 of his General Theory. The chapter is very wordy and contains few examples – Keynes was not a good communicator of his ideas. This piece seeks to present his key ideas from chapter 6 in a more user friendly way so as to make them more accessible to a wider audience. A brief case study will be used.

Keynes’s model excludes the foreign sector and thus assumes UK firms operate within a closed economy. Apart from the business and possibly the household sector, Keynes’s model makes no explicit reference to other sectors of the UK economy, eg the government or financial sector.

However, Keynes is correct to make this apparent omission because the trading section of a firm’s traditional income statement is alone relevant to the determination of how much wealth has been created in a period. The remaining sections of a traditional income statement report the revenues associated with the other sectors of the economy, and merely show how the created wealth has been distributed among the factors of production. Keynes calls these remaining costs “factor costs”. These factor costs, eg wages, rent, taxes, interest, and dividends can be associated with suitably chosen sectors, eg households, government, financiers, and/or rentiers. Keynes concentrates on wealth creation, not on how the wealth is distributed between the other sectors. For this reason, this exposition starts with a traditional, widely used and understood trading account before developing it into a value added statement.

Consider the following consolidated trading accounts of the B2B and B2C sectors of the domestic economy. The trading accounts are prepared in traditional format which any accountant would instantly recognise.

Trading Accounts (£k)Consolidated
Purchases 01,000
Closing inventories+100+200
Cost of goods sold– 1001,200
Gross profit + 900+ 800

The purchases figures in trading accounts consist entirely of revenue expenditure, eg raw materials, goods for resale, etc. The purchases figure for the consolidated B2B sector is zero because the aggregate purchases of B2B firms will cancel against B2B sales revenue on consolidation. In other words, B2B firms will be selling and buying from each other and, in aggregate, the sector’s purchases and sales will cancel out to zero (unless they import). For this reason, only sales made to B2C firms will be recorded in the B2B sector’s consolidated account. This is why the sales revenue of the consolidated B2B sector is identical to the purchases of the B2C sector. These like items will cancel when the B2B sector is consolidated with the B2C sector. The following table shows the consolidation of the two sectors and the cancellation of the like items:

Trading Accounts (£k)Consolidated
AdjustmentB2B consolidated
with B2C
Revenue+ 1,000+ 2,000 – 1,000+ 2,000
200400– 600
Purchases 01,000+ 1,000 0
Closing inventories+ 100+ 200+ 300
Cost of goods sold1001,200+ 1,000– 300
Gross profit + 900+ 800+ 1,700

The above trading accounts can be rearranged so that value added is yielded by the bottom line in place of gross profit. Value Added is what Keynes deemed, in the context of national income accounting, to be income (Y). He rejects using the bottom line (the net profit or net income) of traditional income statements as a relevant measure of income in the context of national income accounting. This is because net profit is calculated after deducting factor costs from gross profit. The factor costs are the revenue of the other sectors of the economy and so will cancel out on consolidation.

The value added statements of the two business sectors are shown below.

Code DescriptionConsolidated
B2B (£k)
B2C (£k)
ARevenue+ 1,000+ 2,000
A1Purchases 0– 1,000
IInventory adjustment100 200
Y Value Added+ 900+ 800

The letters appearing under the code heading are those used by Keynes in his General Theory to denote either a) the category into which an item falls or b) as a specific identifier. For example, closing and opening inventories both fall into the “Investment” category and hence have an I against them. A and A1 are specific identifiers and denote Revenue and Purchases respectively. The inventory adjustment ensures that it is materials used, or goods sold, that is set against revenue, not the purchases figure. So for the B2C sector, raw materials used, or goods sold, £1,200k has been set against revenue.

Value Added Statements can be consolidated using the same rules as with the trading account, i.e., cancel linked items and then aggregate the remaining items, as shown below.

Code DescriptionConsolidated
B2B (£k)
B2C (£k)
Adjustment (£k)Consolidated Value
Added Statement (£k)
ARevenue+ 1,000+ 2,000– 1,000+ 2,000
A1Purchases 0– 1,000+ 1,0000
IInventory adjustment100 200 300
YValue Added+ 900+ 800+ 1,700

Purchases (A1)

In a traditional trading account, the purchases figure (A1) will consist entirely of revenue items. An inventory adjustment is usually required to ensure that unused materials, or unsold goods, from the previous period are set against the current period’s revenue. The inventory adjustment also ensures that unused materials or unsold goods in the current period are carried over to the immediately following period.

Keynes, however, in his General Theory, includes both capital and revenue items within A1. So for Keynes, if a firm makes a one-off purchase of capital equipment from another firm then Keynes would designate the transaction as (A) by the seller and as (A1) by the purchaser. When capital items are included in A1, the purchasing firm’s value added will be understated because A1 will be overstated. An adjustment is necessary to correct for this and this is done via a capital adjustment which will show the part of A1 which is capital expenditure as investment (I).

Capital Adjustments

In his General Theory, Keynes brings up the need to recognise the deterioration of the entrepreneur’s capital equipment in the calculation of value added. He proposes what, in practice, might be an over elaborate calculation for capital consumption. However, his formula is elegant because it also yields how much capital formation has taken place. This calculation is hopefully explained correctly below.

Keynes’s calculation seeks to compare the theoretical value of capital equipment which has been hypothetically mothballed, to the actual value of the same equipment after it has been used in production. His premise is that capital equipment used in production loses value due to use and should have a lower value than identical, well maintained capital equipment that has hypothetically lain idle in the period. His method for determining the capital adjustment, using his notation, is to apply the following formula:

(G – B) – G

where G represents the theoretical end value of capital equipment that has been idle for the period after B has been spent improving it or keeping it in good working condition, and

where G is the actual end value of capital equipment after it has been used in production in the period.

G – B enables the opening valuation of the capital equipment to be determined.

Three possible cases may arise and Keynes’s formula is used below to illustrate.

Case 1: Capital consumption occurs

This occurs when (G – B) > G.

Put simply, this means the closing valuation of the capital equipment is less then the opening valuation. This indicates depreciation through use has occurred.


The theoretical end value (G) of idle equipment was £300,000 after spending £100,000 on idle equipment maintenance (B) during the period. The actual value (G) at the period end was £175,000.

The first step is to insert the relevant figures on the left hand section of the table. The theoretical opening balance can thereby be obtained and transferred to the right side section. The actual closing valuation (given) is then inserted. The capital adjustment (shown in red) is the difference between the actual closing valuation and the theoretical opening valuation.

Equipment idle£kEquipment used£k
Opening valuation (G – B)200Opening valuation200
Maintenance expenditure (B)100Capital consumption(25)
closing valuation (G)
closing valuation (G)

So in case 1 capital consumption is £25,000 and this amount should be charged to the entrepreneur’s value added statement. It represents disinvestment and should be coded with an I. The accountant’s production unit basis for depreciation may suffice as a reasonable proxy measure consistent with Keynes’s conception of capital consumption.

Case 2: No capital consumption or formation occurs

This occurs when (G – B) = G

The theoretical end value (G) of idle equipment was £300,000 after spending £100,000 on idle equipment maintenance (B) during the period. The actual value at the period end was £200,000.

Equipment idle£kEquipment used£k
Opening valuation (G – B)200Opening valuation200
Maintenance expenditure (B)100Capital consumption0
closing valuation (G)
closing valuation (G)

In this case, no capital consumption occurred so no charge to the value added statement is required in respect of capital consumption.

Case 3: Capital formation occurs.

This occurs when (G’ – B) < G.

Put simply, this means the closing valuation is higher than the opening valuation. This indicates that capital equipment has been acquired during the period


The theoretical end value (G) of idle equipment was £300,000 after spending £100,000 on idle equipment maintenance (B) during the period. The actual value at the period end was £450,000.

Equipment idle£kEquipment used£k
Opening valuation (G – B)200Opening valuation200
Maintenance expenditure (B)100Capital formation250
closing valuation (G)
closing valuation (G)

In this case, the firm may have been increasing its capital equipment by its own labour or by purchasing it from another firm. When capital equipment is produced in-house, the wages and salaries of that part of the labour force assigned to the production of the capital equipment will have been capitalised (i.e., included in the actual valuation). Capital equipment produced by an individual firm for its own use should be recognised in the individual’s firm’s value added statement as investment expenditure and should be coded as I.

In the value added statements that follow the capital adjustment from case 1 above has been incorporated into B2B’s results. The capital adjustment from case 3 has been incorporated in B2C’s results.

IInventory adjustment(100)(200)(300)
ICapital adjustment(25)250225
Value Added8751,0501,925

Apart from items on the edges, eg Suplementary Costs, income determination under Keynes’s scheme is concluded.

Consumption Expenditure (C)

The revenue figure of £2,000 in the consolidated column represents the total sales made by B2C firms to consumers. This is because all B2B sales figures have been eliminated by the consolidation process. The revenue figure in the consolidated value added statement thus represents consumption expenditure (C). Using Keynes’s notation consumption expenditure can be otained from the total of A minus the total of A1. The consolidated revenue, as shown above, is the result of the sum of A minus the sum of A1 .

Saving (S)

Saving is by (strict) definiton equal to income minus consumption. The consolidated value added figure of £1,925 represents aggregate income. Subtracting the aggregate consumption expenditure figure of £2,000, a negative figure for aggregate saving (S) of – £75 is obtained. It is no accident that the aggregate saving figure is equal to the aggregate investment figure shown in the consolidated value added statement.

User cost (U)

Keynes appears to set much store by this figure. The user cost repesents the costs that have been consumed (as distinct from being incurred). It is the sum of materials used/goods sold (A1 – inventory adjustments) and capital adjustments (capital consumption – capital formation). The user cost (U) can (theoretically) be negative in which case it is added to revenue. The user cost (U) can be calculated from A1 – I. It is most meaningful at individual firm level since A1 becomes zero on consolidation. The user cost for the B2C sector can be seen to be equal to £950 (£1,000 + £200 – £250). Value Added, which is now the accepted definition of income for national income determination, can be obtained from subtracting an individual firm’s user cost from the firm’s revenue (A) (eg, £2,000 – £950 = £1,050).

Investment Expenditure (I)

This is equal to the inventory adjustment plus the capital adjustment. If the closing inventories are higher than the opening inventories then investment will have occured. If the closing inventories are lower then disinvestment will have occurred.

Capital consumption decreases the period’s investment. Capital formation will increase investment.

Positive investment increases value added.


The above exposition is a condensed summary of chapter 6 of Keynes’s General Theory. The exposition is intended to make accessible the important material in that difficult-to-read chapter to a wider, less specialised readership, eg accountancy and business studies students. The more marginal topics in that chapter have not been given much weight in this exposition.

Chapter 6 shows that income for national income accounting is most closely aligned to the gross profit figure which is found in traditional commercial income statements. Gross profit figures are augmented with capital adjustments to arrive at value added. Keynes’s proposed formula for capital adjustments has been unpacked so as to make it more understandable. The resulting income is known as value added.

Keynes’s analysis has its focus on the creation of wealth. The distribution of wealth to the other sectors of the economy does not figure in his analysis. However, the government does prepare analyses to show “who got what” via the income approach to GDP determination.

Keynes shows how investment is equal to saving by adhering strictly to the defintion of saving as being equal to Income minus Consumption. In the consolidated value added statement value added (income) has been determined as £1,925k and consumption expenditure as £2,000k. Hence saving is – £75k.

Keynes’s analysis assumes a closed economy. The introduction of a foreign sector would appear to render some of his analysis inadequate.

Transmitting economic ideas

The table below demonstrates how a nation’s GDP is determined. The table contains specimen transactions. Not all of a nation’s transactions relevant to GDP determination are included, just a sample. The table reveals the logic behind GDP determination and the role of the actors. It’s worth noting immediately that the government is a producer of goods and services and that government produced goods and services are included in GDP at cost. Household income is derived from wages and self-employment. Rentier income is derived solely from ownership of financial capital or property; rentiers do not produce anything.

The advantages of setting out GDP determination in tabular format are several.

Firstly , for those wishing to learn the basics it demonstrates the logic underpinning GDP determination. Included in this group could be first year undergraduates in economics, accountancy, business studies, and cognate subjects. As a former teacher myself, demonstration is vastly superior to presenting equations or relying on words to convey knowledge. In my experience, students will thank you for providing demonstrations to accompany words and to explain equations.

Secondly, it provides a format whereby students’ understanding can be tested. It should be fairly straigtforward to provide pre-printed tables with appropriately headed columns for students to use to enter a list of transactions under examination conditions.

Thirdly, the quantum of saving for each of the actors drops out of a completed table as shown in the savings table below. It demonstrates how Keynes’s “saving equals investment” postulate is arrived at. The saving figures also permit an introduction to sectoral balance analyses, as well as capital flows in a balance of payments context.

Fourthly, from the same table, the three approaches to GDP determination can be obtained. This is shown below.

Finally, the approach is not limited to demonstrating national income determination. It can be applied to other topics in economics, eg the banking system. Try it!

Is the UK’s tax burden too high?


On December 2 2018, Jacob Rees-Mogg tweeted “The tax burden is too high”. His assertion derived from an analysis of historical data undertaken by the Taxpayers’ Alliance (TPA) which had been commissioned by the Sunday Telegraph. The TPA reported that the tax to GDP ratio had reached a new high of 34.6%, breaking the previous high of 34.3% seen in the early 1960s.

What does “too high” mean?

It seems reasonable to assume that “too high” in this context means that the tax level is impeding GDP growth; it’s not easy to think of a second reason for tax to be too high. This made me wonder whether there is an objective basis for asserting that tax is too high and prompted me to investigate whether a link between a nation’s GDP and its tax level exists.


I chose the year 2016 (for which complete data exists), and because it is recent, to examine whether a link exists. I used all 35 countries comprising the OECD (Lithuania was not then a member) to get a sampling frame of sufficient size and because these countries are considered to be developed. The UK is a member of the OECD.

To measure the tax level of a country I used “tax as a percentage of GDP” published by the World Bank for the year 2016. I then classified each country as “high tax” if the country’s measure was higher than the OECD average (published by the World Bank) and “low tax” if the measure was below.

To measure the affluence of a country, I used “GNI per capita” (at PPP) for 2016, also published by the World Bank. I classified each country’s affluence as “rich” if its GNI/capita was above the published OECD average and “poor” if the GNI/capita was below. The terms “rich” and “poor” to denote a county’s affluence have been assigned for convenience and are not intended to be literal.

I then set up a 2 x 2 contingency table and applied a Chi-squared test with one degree of freedom to test whether a significant link between tax level and affluence existed. I used Yates’ continuity correction  in calculating the test statistic as recommended by the literature. The contingency table is show below.

Chi Squared table


The Chi-squared test statistic, adjusted for Yates’ continuity correction, came to 0.00288.   This is well below the 5% significance level of 3.84 for a Chi-squared variable with one degree of freedom. A test statistic value of above 3.84 would be strong evidence that a nation’s tax level and national income are linked (one influences the other). Because the test statistic returned such a low value there is insufficient evidence to support a hypothesis that national income and a nation’s tax level are linked, at least for OECD members. In plain English, there is no discernible link between a nation’s level of taxation and its national income.


The claim made by Jacob Rees-Mogg and the Taxpayers’ Alliance that UK tax is too high does not stand up  when a cross sectional analysis is undertaken. A simple time series analysis on the UK’s “tax as a percentage of GDP”, as conducted by the TPA, is insufficient to conclude whether tax is either too high or too low. This is because the time series analysis says nothing about the consequences of tax levels on national income (or some other variable of interest).

Jacob Rees-Mogg is remunerated (rather well) by taxpayers. Many voters would say they deserve better than his shoddy, scantily-evidenced assertion.  It is also disappointing to discover that the study by the Taxpayers’ Alliance lacks sufficient rigour to support a meaningful conclusion. The TPA’s audiences should be wary – this example shows it does not seem to engage in research of sufficient depth to support its conclusions!  Is the TPA subordinating sound methodology to ideology  here? It seems so. Readers beware!

Appendix: World Bank source data

World bank data



Self-built assets and value added

Dealing with capitalised costs

Instead of purchasing non-current assets from third party suppliers, a firm may choose to itself construct or erect an asset for use in its own business. In these cases, costs and expenses which would otherwise be revenue in nature should be capitalised. Capitalised costs will not appear in a firm’s statement of profit or loss and hence materials and labour costs will be understated in this account, notwithstanding disclosure by way of a note.


ca[italised costs profit or loss

During the period, a new warehouse was constructed by the firm’s workforce for the firm’s own use at a cost of £4m. The materials cost of the construction was £1m and the labour cost assigned to the construction came to £3m. These costs were capitalised and hence do not appear in the above statement of profit or loss. A value added statement brings these costs in to view because the construction is part of the value created by the firm during the period.

Capitalisation of costs value added statement

Workings and notes

Bought in materials, goods, and services

Purchases of all materials, goods, and services whether or not capital or revenue but excluding depreciation.

To pay employees

All wages and employment on-costs including labour costs assigned to the construction of the new warehouse.

Investment adjustment

The capitalised cost of materials (£1m) and labour (£3m)

Inventory adjustment

Closing inventory minus opening inventory. This represents additional investment in inventory if positive or disinvestment in inventory if negative.

Depreciation adjustment

The total of the depreciation charges shown in the profit or loss statement. This is a measure of capital consumption during the period. In the national accounts, the government may substitute its own figure for a firm’s measure of capital consumption.

Link to the national income accounts

The total of the adjustments will be shown as an investment activity in the national income accounts where it will be denoted as I


I is for investment

How is the investment component, denoted by I, of national income determined? An explanation is proffered here by converting the following simple statement of profit or loss into a value added statement.

Investment and VAS

Additional information

During the period, the firm replaced some plant and machinery at a cost of £10m.

Points to note

A statement of profit or loss does not record purchases of a capital nature. Hence the purchase of plant and machinery for £10m is not reported in the statement of profit or loss.

A value added statement does report purchases of a capital nature.


Investment and VAS 2


Working for investment and VAS

National Income Accounts

If every firm prepared a value added statement the total of the net investment adjustments would represent the nation’s periodic investment activity shown in the national accounts prepared by the government. This figure for the periodic investment activity is shown as I in the national accounts.  

NB. The government may substitute its own standard calculation of the depreciation adjustment so as to achieve consistency.


Value Added Statements for Dummies

This is a short presentation to demonstrate how value added statements are prepared and to explain how they differ from the accountant’s traditional profit or loss account. A single example will be used which will capture the essential differences.


Below is shown a firm’s statement of profit or loss and value added statement. The two statements are shown side-by-side for ease of comparison.

During the period, the firm purchased plant and machinery for use within the business at a cost of £30m. Because this is capital expenditure, there is no entry in the statement of profit or loss to record this purchase. In the value added statement, the £30m cost appears against “bought-in materials, goods, and services” to obtain the “net value of output” figure. The firm’s investment activity is then shown by the investment adjustment to arrive at “net value added.”

VAS for dummies

Derivation of value produced figures

Bought-in materials, goods and services is equal to the purchases figure taken from the profit or loss statement (£80m) plus the capital expenditure (£30m).

The inventory adjustment is equal to the closing inventory minus the opening inventory. If this figure is positive then it represents additional investment in inventory. If negative then it represents disinvestment in inventory.

The depreciation adjustment is the total depreciation charged to the profit or loss account. This will usually be shown as a negative figure in the value added statement and represents consumption of capital in the period.

The investment adjustment is equal to the capital expenditure during the period. If this adjustment is positive then investment in new productive capacity has occurred. If negative, then disinvestment in productive capacity has occurred. The new productive capacity may consist of either tangible or intangible assets or some mixture.

Derivation of value distributed figures

To pay employees is the wages figure taken from the profit or loss account. The figure should include employer’s on costs, including employer’s National Insurance Contributions, and other employment taxes where they exist

To pay government is the sum of business rates and corporation tax charged to the profit or loss account. The figure represents the contribution the firm makes to the upkeep of the nation’s infrastructure and public services that enable firms to flourish.

To pay rentiers is the sum of property rents, licence fees, patent and copyright charges and the like. Payments to parties who derive income from ownership rather than from provision of a service or goods are recorded under this heading.

To pay financiers is the sum of interest charges in the profit and loss account plus dividends paid in the year. Payments of interest and dividends paid should be offset by interest and dividends received. Interest and dividends received are distributions of  value added produced by other firms. 

Undistributed value is equal to the retained profits shown in the profit or loss statement.

Negative Income Tax For Dummies

Personal Allowances

The UK income tax system ostensibly gives all income tax payers an identical allowance which exempts the first slice of an individual’s market income from income tax. This exemption is known as the personal allowance and is set by parliament each year. For the current year it stands at £11,500.

Basic Rate (20%) Tax Payers

The personal allowance typically reduces the amount of income tax a basic rate tax payer must pay on their market income by £2,300 pa. However, if a basic rate tax payer’s market income is below £11,500 p.a. they do not receive the full benefit of the annual personal allowance. This is arguably a weakness with the UK’s current income tax arrangements.


Susan earns £10,000 p.a. Her tax-free personal allowance is £11,500 p.a. This means she currently pays no income tax and her disposable income (ignoring her National Insurance Contribution) is £10,000.


If Susan had no personal allowance she would have paid income tax of £2,000 (£10,000 x 20%).  The personal allowance has saved Susan £2,000. Had Susan earned £11,500 in the year she would have saved £2,300 in income tax. Because she had only £10,000 of income to offset against her personal allowance of £11,500 Susan has £1,500 of unused personal allowance remaining. In the UK personal allowances can not be carried forward to be utilised in following years. Nor can personal allowances normally be transferred  to someone else or be traded –  it’s a case of use or lose.   

Is there a better way of administering income tax whereby surplus personal allowances would not be wasted if they remain unused at the end of a tax year? An answer to this question is “Yes, negative income tax”.

Negative Income Tax

Giving a taxpayer an annual personal allowance of £11,500  costs the government up to £2,300 in lost tax revenue. In Susan’s case, because her market income is below £11,500, the cost to the government of Susan’s personal allowance is £2,000 in lost tax.

Negative income tax departs from the current income tax system by paying out the value of the personal allowance (the tax shield) in cash to each and every qualifying citizen. To  help fund this apparent largesse, income tax would be collected and calculated without reference to personal allowances.

In Susan’s case, income tax of £2,000 would be deducted by her employer and remitted to HMRC. Susan’s net pay from her employer would therefore be £8,000.  Susan, along with all qualifying citizens, would receive from HMRC an annual amount equal to the value of her tax shield (£11,500 x 20%)  The following table summarises:


At the year end Susan’s income is £300 higher than her gross market income. This £300  is the value of her surplus personal allowance (£1,500 x 20%). So effectively Susan has been allowed to claim back the value of her unused personal allowance as a “refund” from HMRC. 


In Susan’s case, HMRC has paid out to Susan £300 more than she has paid to HMRC. So HMRC has a deficit while Susan has a surplus. So how will HMRC fund its deficit? 

Firstly, because Susan is on a low income there is a probability that she is on a means tested benefit, such as the dreaded Universal Credit, to augment her low market income. The benefits agency (DWP) may reassess Susan’s financial circumstances and adjust her award to take account of Susan;s additional source of non-market income. So the government may claw back all or part of Susan’s increased income to eliminate its deficit at HMRC.

Secondly, although Susan has a surplus with HMRC, many taxpayers will have a deficit. It is only qualifying citizens with market incomes below £11,500 who will be receiving more from HMRC than they pay in income tax.  Many taxpayers will be paying income tax far in excess of the £2,300 they will be receiving each year from HMRC. Deficits and surpluses would offset  each other

Purposes of Negative Income Tax

Firstly, to make the income tax system fairer. Currently, those with a market income of above £100,000 do not receive a personal allowance. Introducing a non-means tested negative income tax would enable policy makers to restore the tax shield to high income recipients. 

Secondly, to provide an enhancement to low incomes,  albeit a modest one.

Thirdly, to give every qualifying citizen a guaranteed, obligation-free income, although a small one. It should help individuals to better absorb and weather the shocks that humans are heir to, including those shocks administered by DWP.

Unlike Universal Basic Income (UBI), the purpose of NIT is not to replace contingent benefits, although some means’tested benefits may be reduced as a consequence of NIT’s introduction.

Qualifying Criteria

Every natural person of working age AND registered to vote in UK elections should qualify, irrespective of income. Qualifying individuals would include job seekers, students, disability benefit claimants, employees, self-employed persons, stay-at-home parents, rough sleepers, and prisoners (subject to voting rights). People of state pension age would be excluded.

Summary and Conclusions

The aims of the particular NIT scheme discussed are modest. The scheme is specific to the UK’s income tax system. The scheme provides an opportunity to equalise treatment of different income groups in respect of the operation of personal allowances, otherwise referred to as a tax shield. The parameters of the proposed scheme, that is the NIT rate and the size of the personal allowance, are under the control of the UK parliament and can be altered to suit. The scheme shares features of Basic Income, eg, it is obligation-free, it is not means tested, its coverage is universal (subject to fraud safeguards), and it supports active enfranchisement of disengaged voters. It also provides a small cushion against  loss of income and failure of the social security system. Although modest, the benefits would be real and in excess of its costs. 


The impact of Negative Income Tax on higher and additional rate taxpayers

Higher Rate (40%) Taxpayers



Stephen has an annual market income of £80,000

Stephen 1

Stephen 2

Stephen would pay £2,300 more under this particular NIT scheme than he does under the current income tax system. This is because HMRC is paying out at 20% x £11,500 while the lost personal allowance brings in 40% x £11,500 to HMRC.  HMRC is in surplus.


Additional Rate (45%) Tax Payers

For annual incomes above £150,000 the income tax rate rises to 45% and no personal allowance is available. 


Frances has an annual market income of £170,000

Frances 1

 Frances 2

Frances would pay £2,300 less under this particular NIT scheme. This is because in the current income tax regime taxpayers with market incomes above £100,000 have had their personal allowances completely withdrawn. The receipt of NIT of £2,300 from HMRC consequently would reduce tax payable in cases such as this. 

How to do a heli drop

Purpose of this piece

This piece proposes and illustrates a scheme whereby helicopter money can be delivered within existing legal and accounting constraints. It shows that it is legally and technically feasible to deliver.

Legal constraints

The chief legal constraint is on the UK government which is forbidden to borrow from its banker, the Bank of England. This means the UK government is restricted to raising funds either from taxation or by borrowing from private investors. Neither method is currently popular with the government or its voters.

Accounting constraints

All organisations must follow the rules of double entry. Accounting concepts and standards must also be adopted and complied with. Even the Bank of England must comply with these accounting constraints. The Bank of England’s accounts are audited and where departures are detected they will be reported upon. Serious consequences could potentially arise from an adverse auditor’s report.

Assumptions of the scheme

  1. The government would issue bonds to private investors to fund the helicopter drop.
  2. HMRC would deliver the helicopter drop via tax rebates.
  3. Bonds in issue held by the private sector would be purchased using QE.
  4. The government would not overdraw on its deposits held at the Bank of England.


  1. The government issues bonds to the private sector in the sum of the proposed helicopter drop.
  2. The government then uses the proceeds from the bond issue to give fixed sum tax rebates to household and firms.
  3. The central bank does QE for an amount equal to the bond issue.

The scheme in double entry form

The government issues bonds to private investors

Books of the Government £bn
Debit Deposit at Bank of England (asset increase) 30
Credit Bonds (liability increase) 30
Books of Commercial banks £bn
Debit Deposits by investors (liability decrease) 30
Credit Deposits at Bank of England (asset decrease) 30
Books of Investors £bn
Debit Bonds (asset increase)) 30
Credit Deposits at Commercial banks’ (asset decrease) 30
Books of the Bank of England £bn
Debit Deposits by Commercial banks (liability decrease) 30
Credit Deposits by government (liability increase) 30

The government gives a tax rebate of £30bn

Books of the Government £bn
Debit Income statement (expense) 30
Credit Deposit at Bank of England (asset decrease) 30
Books of Households and Firms £bn
Debit Deposits at Commercial banks (asset increase) 30
Credit Income statement (income) 30
Books of Commercial banks £bn
Debit Deposits at Bank of England (asset increase) 30
Credit Deposits by Households and Firms (liability increase) 30
Books of Bank of England £bn
Debit Deposits by Government (liability decrease) 30
Credit Deposits by Commercial banks (liability increase) 30
  1. Bank of England does QE for £30bn

Books of Bank of England £bn
Debit Bonds (asset increase) 30
Credit Deposits by Commercial banks (liability increase) 30
Books of Investors £bn
Debit Deposits at Commercial Banks (asset increase) 30
Credit Bonds (asset decrease) 30
Books of Commercial banks £bn
Debit Deposits at Bank of England (asset increase) 30
Credit Deposits by Investors (liability increase) 30


Here is a snapshot of the net changes to the respective balance sheets once all the transactions have been completed.  A table for Investors does not exist because the net changes amount to zero between their starting and end positions.

Heli money summary

Reversing QE

Because QE has effectively been used to fund the helicopter money (the tax rebates), at some point in the future the tax rebates must be reversed alongside the QE.  To defer this day far ino the future, long dated bonds could be used in both the bond issue and in the QE “buy back”. Long dating should eliminate the scuppering potential of Ricardian Equivalence.

Post Script

I have stuck to the technical aspects of making a helicopter drop. My intention has been to show that it is technically and legally possible within current constraints. Whether it would be successful in pulling the UK out of its current economic quagmire is moot and resolving that question is beyond my pay grade.