LONDON Chancellor of the exchequer George Osborne's case for cutting taxes if his Conservative Party wins a 2015 election was bolstered on Monday when a government study said lower taxes would stimulate economic activity and partially offset a loss of revenue.
A reduction in the real rate of fuel duties, enacted in 2011 by the coalition government, will increase Britain's economic output by 0.3 to 0.5 percent over the next 20 years, according to a government model which aims to better capture the full effects of changes in fiscal policy.
The finding offers some backing for Osborne and the Conservatives, who sit on the centre-right of British politics and advocate lower taxation as the way to generate economic growth and prosperity.
The Conservatives - who govern alongside their junior Liberal Democrat coalition partner - are pinning much of their re-election campaign on the view, supported by opinion polls, that their economic policies are the best way to help Britain recover from a prolonged recession and balance its books.
The study showed an increase in economic activity would offset around half of the revenue to the public purse lost as a result of the government's decision to abolish above-inflation increases in fuel duty.
"The modelling shows increased profits, wages and consumption all add to higher tax revenues," the finance ministry report said. "As a result, the cost of the policy falls by between 37 and 56 percent in the long term."
The analysis is the second time the government has used its "dynamic modelling" technique to illustrate the benefits of tax cuts. The technique looks at direct and indirect effects on investment, consumption and wages.
The first such report was published in December last year, showing that foregone revenue from a reduction in the rate of corporation tax would be partly offset by increased growth.
Static modelling, which takes a narrower view of the impact of policy changes, continues to be the benchmark used by official forecasters to assess government finances.
Prime Minister David Cameron told the party's conference last year that he believed in lower taxes. If the Conservatives win the 2015 election outright, Osborne has committed to reduce the deficit through spending cuts rather than tax increases.
When questioned earlier this year on the purpose of the first dynamic modelling report, Osborne said he hoped it would "begin a quiet revolution" in the way people thought about tax cuts.
"It reflects a debate that is had, I would not just say on the centre right of British politics, but primarily on the centre right, which is that lower taxes can, at least in part, pay for themselves," Osborne told lawmakers in March.
The finance ministry said on Monday it wanted to use the model more often to gauge the effects of policy changes.
Although dynamic models are also used by international organisations like the World Bank and the International Monetary Fund, independent economists have expressed concern about a heavy reliance on difficult-to-judge assumptions.
The study released on Monday said the forecasting was "subject to some uncertainty", highlighting that some factors such as a deterioration in economic confidence were not captured by the model.
(Editing by Janet Lawrence)