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Explaining output volatility: The case of taxation

  • Olaf Posch

    ()

    (School of Economics and Management, University of Aarhus, Denmark and CREATES)

This paper studies the effects of taxation on output volatility in OECD countries to shed light on the sources of observed heterogeneity over time and across countries. To this end, we derive tax effects on macro aggregates in a stochastic neoclassical model. As a result, taxes are shown to affect the second moment of output growth rates without (long-run) effects on the first moment. Taking the model to the data, we exploit observed heterogeneity patterns to estimate effects of tax rates on macro volatility using panel estimation, explicitly modeling the unobserved variance process. We find a strong empirical link between effective tax rates and output volatility, with some evidence of a cointegrating relationship. In accordance with theory, taxes on labor income and corporate income empirically are found to be negatively related to volatility of macro aggregates whereas the capital tax ratio has positive effects.

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Paper provided by Department of Economics and Business Economics, Aarhus University in its series CREATES Research Papers with number 2008-04.

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Length: 73
Date of creation: 18 Jan 2008
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Handle: RePEc:aah:create:2008-04
Contact details of provider: Web page: http://www.econ.au.dk/afn/

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