Working Paper: NBER ID: w16786
Authors: Roberto Perotti
Abstract: 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.
Keywords: Tax Shocks; GDP; Discretionary Tax Changes; Automatic Tax Changes
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 |
|---|---|
| 1 percentage point increase in taxation (H29) | GDP (E20) |
| Anticipated tax changes (H26) | GDP (E20) |
| Unanticipated tax changes (H26) | GDP (E20) |
| Discretionary tax changes (H29) | Automatic tax changes (H29) |
| Tax changes (H29) | GDP (E20) |
| Discretionary tax changes (H29) | GDP (E20) |
| Automatic tax changes (H29) | GDP (E20) |