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The Effects of Tax Shocks on Output: Not So Large, But Not Small Either

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  • Roberto Perotti

Abstract

In a seminal contribution, Romer and Romer (2010) (RR henceforth) estimate GDP tax multipliers of up to -3 after 3 years. These results have been criticized as implausibly large. For instance, Favero and Giavazzi (2010) (FG henceforth) argue RR's specification cannot be interpreted as a proper (truncated) moving average representation of the output process. They show that when the system is estimated in its VAR form, or its correct truncated MA representation, a unit realization of the RR shock has much smaller effects on GDP than in RR, typically about - .5 percentage points of GDP. I argue that on theoretical grounds the discretionary component of taxation should be allowed to have different effects than the automatic response of tax revenues to macroeconomic variables; existing approaches, including FG's, that do not allow for this difference, exhibit impulse responses that are biased towards 0. I show that the correct impulse responses to a RR tax shock are about half-way between the large effects estimated by RR and the much smaller effects estimated by FG: 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. I also create two new datasets of tax shocks, one based on receipts and the other on liabilities; in these datasets, I distinguish between different types of taxes (personal, corporate, indirect, and social security) and their subcomponents.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 16786.

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Date of creation: Feb 2011
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Publication status: published as The Effects of Tax Shocks on Output: Not So Large, But Not Small Either , Roberto Perotti. in Trans-Atlantic Public Economics Seminar (TAPES), Fiscal Policy , Gordon and Perotti. 2012
Handle: RePEc:nbr:nberwo:16786

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  1. Favero, Carlo A. & Giavazzi, Francesco, 2010. "Reconciling VAR-based and Narrative Measures of the Tax-Multiplier," CEPR Discussion Papers 7769, C.E.P.R. Discussion Papers.
  2. Chahrour, Ryan & Schmitt-Grohé, Stephanie & Uribe, Martín, 2010. "A Model-Based Evaluation of the Debate on the Size of the Tax Multiplier," CEPR Discussion Papers 7930, C.E.P.R. Discussion Papers.
  3. Karel Mertens & Morten Ravn, 2010. "Empirical Evidence on the Aggregate Effects of Anticipated and Unanticipated U.S. Tax Policy Shocks," NBER Working Papers 16289, National Bureau of Economic Research, Inc.
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Cited by:
  1. Olivier Cardi & Romain Restout, 2014. "Unanticipated vs. Anticipated Tax Reforms in a Two-Sector Open Economy," Open Economies Review, Springer, vol. 25(2), pages 373-406, April.
  2. Mertens, Karel & Ravn, Morten O, 2011. "The Dynamic Effects of Personal and Corporate Income Tax Changes in the United States," CEPR Discussion Papers 8554, C.E.P.R. Discussion Papers.
  3. Daniel Riera-Crichton & Carlos A. Vegh & Guillermo Vuletin, 2012. "Tax Multipliers: Pitfalls in Measurement and Identification," NBER Working Papers 18497, National Bureau of Economic Research, Inc.
  4. Luigi, Bernardi, 2011. "Economic crisis and taxation in Europe," MPRA Paper 31007, University Library of Munich, Germany.
  5. Tommaso Monacelli & Roberto Perotti & Antonella Trigari, 2011. "Taxes and the Labor Market," Working Papers Central Bank of Chile 623, Central Bank of Chile.
  6. Institute for Fiscal Studies, 2011. "A retrospective evaluation of elements of the EU VAT system," Taxation Studies 0039, Directorate General Taxation and Customs Union, European Commission.
  7. Anja Baum & Marcos Poplawski-Ribeiro & Anke Weber, 2012. "Fiscal Multipliers and the State of the Economy," IMF Working Papers 12/286, International Monetary Fund.
  8. Bernd Hayo & Matthias Uhl, 2012. "Regional Effects of Federal Tax Shocks," MAGKS Papers on Economics 201217, Philipps-Universität Marburg, Faculty of Business Administration and Economics, Department of Economics (Volkswirtschaftliche Abteilung).
  9. Marcello M. Estevão & Issouf Samaké, 2013. "The Economic Effects of Fiscal Consolidation with Debt Feedback," IMF Working Papers 13/136, International Monetary Fund.

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