The Effects of Tax Shocks on Output: Not So Large, But Not Small Either
AbstractIn a seminal contribution, Romer and Romer (2010) introduce a new dataset of exogenous tax changes and estimate a tax multiplier at 3 years of about -3. These results have been criticized as implausibly large. In this paper, I argue that on theoretical grounds the discretionary component of taxation should be allowed to have different effects on output than the automatic response of tax revenues to macroeconomic variables. Existing approaches, that do not allow for this difference, exhibit impulse responses that are biased towards 0. I then show that allowing for this difference leads to tax multipliers that are about half-way between the large effects estimated by Romer and Romer and the much smaller effects estimated by Favero and Giavazzi (2010): typically, a one percentage point of GDP increase in taxes leads to a decline in GDP by about 1.5 percentage points after 3 years.
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Bibliographic InfoPaper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 8252.
Date of creation: Feb 2011
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Find related papers by JEL classification:
- E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
- H20 - Public Economics - - Taxation, Subsidies, and Revenue - - - General
- H60 - Public Economics - - National Budget, Deficit, and Debt - - - General
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