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 di¤erent e¤ects on output than the automatic response of tax revenues to macroeconomic variables. Existing approaches, that do not allow for this di¤erence, exhibit impulse responses that are biased towards 0. I then show that allowing for this di¤erence leads to tax multipliers that are about half-way between the large e¤ects estimated by Romer and Romer and the much smaller e¤ects 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.
The effects of tax shocks on output: not so large, but not small either
PEROTTI, ROBERTO
2012
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 di¤erent e¤ects on output than the automatic response of tax revenues to macroeconomic variables. Existing approaches, that do not allow for this di¤erence, exhibit impulse responses that are biased towards 0. I then show that allowing for this di¤erence leads to tax multipliers that are about half-way between the large e¤ects estimated by Romer and Romer and the much smaller e¤ects 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.
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