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The Aggregate Effects of Anticipated and Unanticipated U.S. Tax Policy Shocks: Theory and Empirical Evidence

  • Morten O. Ravn

    (European University Institute)

  • Karel Mertens

    (Cornell University)

We provide empirical evidence on the effects of tax liability changes in the United States. We make a distinction between "surprise" and "anticipated" tax shocks. Surprise tax cuts give rise to a large boom in the economy. Anticipated tax liability tax cuts are instead associated with a contraction in output, investment and hours worked prior to their implementation. After their implementation, anticipated tax liability cuts lead to an economic expansion. We build a DSGE model with changes in tax rates that may be anticipated or not, estimate key parameters using a simulation estimator and show that it can account for the main features of the data. We argue that tax shocks are empirically important for U.S. business cycles and that the Reagan tax cut, which was largely anticipated, was a main factor behind the early 1980's recession.

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Paper provided by Society for Economic Dynamics in its series 2008 Meeting Papers with number 575.

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Date of creation: 2008
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Handle: RePEc:red:sed008:575
Contact details of provider: Postal: Society for Economic Dynamics Christian Zimmermann Economic Research Federal Reserve Bank of St. Louis PO Box 442 St. Louis MO 63166-0442 USA
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Web page: http://www.EconomicDynamics.org/society.htm
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  14. Nicholas S. Souleles, 1999. "The Response of Household Consumption to Income Tax Refunds," American Economic Review, American Economic Association, vol. 89(4), pages 947-958, September.
  15. Francis, Neville & Ramey, Valerie A., 2005. "Is the technology-driven real business cycle hypothesis dead? Shocks and aggregate fluctuations revisited," Journal of Monetary Economics, Elsevier, vol. 52(8), pages 1379-1399, November.
  16. Valerie A. Ramey & Matthew D. Shapiro, 1999. "Costly Capital Reallocation and the Effects of Government Spending," NBER Working Papers 6283, National Bureau of Economic Research, Inc.
  17. Cogley, Timothy & Nason, James M, 1995. "Output Dynamics in Real-Business-Cycle Models," American Economic Review, American Economic Association, vol. 85(3), pages 492-511, June.
  18. Susan Yang, Shu-Chun, 2005. "Quantifying tax effects under policy foresight," Journal of Monetary Economics, Elsevier, vol. 52(8), pages 1557-1568, November.
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