Working Paper: CEPR ID: DP8252
Authors: Roberto Perotti
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.
Keywords: Fiscal Policy; Tax Multiplier; Tax Shocks; Taxation
JEL Codes: E62; H20; H60
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| exogenous increase in taxes (H29) | decline in GDP (E20) |
| discretionary tax changes (H29) | influence on output (C67) |
| discretionary tax changes (H29) | stronger influence on output than automatic tax responses (H31) |
| methodological choices (C90) | differences in estimated multipliers (C13) |
| discretionary and automatic components of taxation (H29) | tax multipliers (H29) |
| VAR approach (C29) | estimated effects are empirically robust (C51) |