Royal Economics – or, why British taxpayers should celebrate the birth of a new prince…

Whenever Buckingham Palace finds itself in the spotlight of global media attention, an ancient debate is revived, a debate that some experts estimate might be older than the monarchy itself: The debate of whether the royal family is still worth the taxpayers’ money in the 21^st century.

At first, this might seem like a dispute that ought to be confined exclusively to British pubs, starring the Royals’ loyal supporters on one side and the isolated republican troublemaker on the other. Greatly diverging estimates of the costs attached to maintaining the Royal family can be exchanged  there, and then compared to the torrential flows of tourists who would have stayed at home were it not for the chance to catch the occasional glimpse of Queen Elizabeth II behind the windows of Buckingham Palace.

In these debates, the monarchists seem to have the edge over their subversive counterparts; for who could possibly argue that an average of GBP 42 million of Civil List payments (the Royal family’s annual income from the Treasury) in real terms over the past decade outweighs an added GBP 500 million in tourist spending on Royal castles, Royal towers, Royal mugs, and Royal mugs with Royal castles and Royal towers on them?

This squares well with 69% of British subjects agreeing that they would be worse off without the monarchy, against only 22% of unappreciative respondents in a 2012 survey by the Guardian. It is important to stress here that this argument is not based on the common misconception that the taxpayers receive about GBP 300 million from Royal assets every year. This income is generated by the Crown Estate, a collection of assets worth GBP 7.3 billion that has been surrendered to the Treasury by King George III as early as 1760 in return for a steady income through the Civil List.

Nevertheless, there is a case to be made to move the discussion out of the pubs and introduce economic reflection. So far, we have compared apples and oranges—government expenditure that has to be raised through tax revenue, and tourist spending, which needs to be taxed. This is like saying that it is reasonable for a simple employee to buy a GBP 40 million mansion because he just secured a GBP 500 million contract for his company.

In order to answer the question, one has to make specific assumptions about how increased consumer spending will affect the economy. In traditional economic theory, an increase in demand for tourism represents an increased demand for exports. In a small open economy with flexible exchange rates and nearly perfect capital mobility, i.e. a country like the UK, an increase in export demand puts upward pressure on the interest rate, which draws in foreign capital. This increases demand for pound sterling on the foreign exchange market and therefore leads to an appreciation of the exchange rate until the pressure on the interest rate subsides. At this point, according to theory, the increased demand for tourism has been offset by a drop in exports (manufactured goods etc.) of the same magnitude. Overall, the output of the economy therefore remains unchanged.

Now what does this mean for tax revenue? Most tourist expenditures will be taxed at the VAT—so the tax revenue from increased spending on tourism is 20% of the increase in expenditure. At the same time, exports go down by an equal amount, but since exports are not usually taxed, tax revenue does not decline. While profits increase in the tourist sector, they decline in the export sector. Depending on gross profit margins in both sectors and the corporate tax rate, overall tax revenue therefore rises by slightly less than the VAT revenue due to increased tourist spending.

All of the following are assumptions within the framework laid out above and may be replaced by the reader in the attached Excel sheet.* The estimates have been chosen according to conservative estimates and available economic data. While most of the assumptions are self-explanatory, the fiscal multiplier can be used to assess the change in GDP due to an increase in domestic spending or an increase in export demand (both affect GDP and the exchange rate equivalently). In accordance with an econometric analysis by the IMF, it is here assumed to be zero—although an increase does not significantly change the results. Secondly, the VisitBritain estimate of the increase of consumer spending has been decreased by 30% because GBP 500 million in added tourist expenditure already include GBP 90 million in spending on admission to the Tower of London, Westminster Abbey, and the National Maritime Museum.

These figures include an estimated increase in consumer spending of GBP 413 million in 2011 due to the Royal Wedding, and an increase of GBP 243 million due to the Royal Baby. On the other hand, the wedding also increased security spending in 2011 by GBP 21.1 million. While this is a rough estimate, one also has to consider adverse incentives that reduce innovation and productivity increases in the export sector due to crowding out. Even without counting these long-term effects, it seems that the Royal Family is not worth the money.

Obviously, these numbers will hardly impress staunch monarchists who have been supporting the Windsors for centuries—just like it will be difficult to convince die-hard republicans that the necessary inequality is acceptable as long as the Royals attract enough tourists. However, everyone can benefit from moving the argument beyond the exercise of shouting out the highest numbers in pubs. There is still cause for celebration: When everyone gets together and celebrates Royal weddings and babies, the monarchy heals Britain’s wounds of the financial crisis.

*Unless indicated as 2013 prices, the figures given refer to the respective year.

By: Marvin Gouraud

Sources: Centre for Retail Research, IMF, World Bank, The Economist, Yahoo Business, The Guardian, Slate, Intelligent Life, Reuters, Consultant-News, VisitBritain, The Telegraph, royal.gov.uk, European Commission, Office of National Statistics (UK)