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

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  • Perotti, Roberto

Abstract

In 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.

Suggested Citation

  • Perotti, Roberto, 2011. "The Effects of Tax Shocks on Output: Not So Large, But Not Small Either," CEPR Discussion Papers 8252, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:8252
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    References listed on IDEAS

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    1. Karel Mertens & Morten O. Ravn, 2012. "Empirical Evidence on the Aggregate Effects of Anticipated and Unanticipated US Tax Policy Shocks," American Economic Journal: Economic Policy, American Economic Association, vol. 4(2), pages 145-181, May.
    2. Ryan Chahrour & Stephanie Schmitt-Grohé & Martín Uribe, 2012. "A Model-Based Evaluation of the Debate on the Size of the Tax Multiplier," American Economic Journal: Economic Policy, American Economic Association, vol. 4(2), pages 28-45, May.
    3. Carlo A. Favero & Francesco Giavazzi, 2010. "Reconciling VAR-based and Narrative Measures of the Tax-Multiplier," Working Papers 361, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
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    Citations

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    Cited by:

    1. repec:ifs:fistud:v:38:y:2017:i::p:219-267 is not listed on IDEAS
    2. Daniel Riera-Crichton & Carlos A. Vegh & Guillermo Vuletin, 2017. "Tax policy and the macroeconomy: Measurement, identification, and non-linearities," Revista Ensayos sobre Política Económica, Banco de la Republica de Colombia, vol. 35(82), pages 10-17, April.
    3. Karel Mertens & Morten O. Ravn, 2013. "The Dynamic Effects of Personal and Corporate Income Tax Changes in the United States," American Economic Review, American Economic Association, vol. 103(4), pages 1212-1247, June.
    4. Hernando Vargas & Andrés González & Ignacio Lozano, 2015. "Macroeconomic Gains from Structural Fiscal Policy Adjustments: The Case of Colombia," ECONOMIA JOURNAL, THE LATIN AMERICAN AND CARIBBEAN ECONOMIC ASSOCIATION - LACEA, vol. 0(Spring 20), pages 39-81, February.
    5. Mertens, Karel & Ravn, Morten O., 2014. "A reconciliation of SVAR and narrative estimates of tax multipliers," Journal of Monetary Economics, Elsevier, vol. 68(S), pages 1-19.
    6. Francesco Caprioli & Sandro Momigliano, 2011. "The effects of fiscal shocks with debt-stabilizing budgetary policies in Italy," Temi di discussione (Economic working papers) 839, Bank of Italy, Economic Research and International Relations Area.
    7. Karl Aiginger, 2011. "Why Growth Performance Differed across Countries in the Recent Crisis: the Impact of Pre-crisis Conditions," Review of Economics & Finance, Better Advances Press, Canada, vol. 1, pages 35-52, August.
    8. Florian Wöhlbier & Caterina Astarita & Gilles Mourre, 2014. "Consolidation on the revenue side and growth-friendly tax structures: an indicator based approach," European Economy - Economic Papers 2008 - 2015 513, Directorate General Economic and Financial Affairs (DG ECFIN), European Commission.
    9. Daniel Riera-Crichton & Carlos A. Vegh & Guillermo Vuletin, 2017. "Tax policy and the macroeconomy: Measurement, identification, and non-linearities," ENSAYOS SOBRE POLÍTICA ECONÓMICA, BANCO DE LA REPÚBLICA - ESPE, vol. 35(82), pages 10-17, April.
    10. Bernd Hayo & Matthias Uhl, 2015. "Regional effects of federal tax shocks," Southern Economic Journal, Southern Economic Association, vol. 82(2), pages 343-360, October.
    11. Antoine Goujard, 2017. "Cross‐Country Spillovers from Fiscal Consolidations," Fiscal Studies, Institute for Fiscal Studies, vol. 38, pages 219-267, June.
    12. 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.
    13. Luigi, Bernardi, 2011. "Economic crisis and taxation in Europe," MPRA Paper 31007, University Library of Munich, Germany.

    More about this item

    Keywords

    fiscal policy; tax multiplier; tax shocks; taxation;

    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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