The Effects of Tax Shocks on Output: Not So Large, But Not Small Either
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.
|Date of creation:||Feb 2011|
|Date of revision:|
|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|
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- Mertens, Karel & Ravn, Morten O, 2009.
"Empirical Evidence on the Aggregate Effects of Anticipated and Unanticipated U.S. Tax Policy Shocks,"
CEPR Discussion Papers
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- 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.
- Carlo A. Favero & Francesco Giavazzi, 2010.
"Reconciling VAR-based and Narrative Measures of the Tax-Multiplier,"
361, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
- 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.
- Ryan Chahrour & Stephanie Schmitt-Grohé & Martín Uribe, 2010.
"A Model-Based Evaluation of the Debate on the Size of the Tax Multiplier,"
NBER Working Papers
16169, National Bureau of Economic Research, Inc.
- Ryan Chahrour & Stephanie Schmitt-Groh� & Mart�n 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.
- 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.
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