The short-term effects of tax changes: The role of state dependence

Ufuk Demirel

Journal of Monetary Economics, 2021, vol. 117, issue C, 918-934

Abstract: This study evaluates how the state of the economy, as measured by the rate of unemployment, influences the short-term effects of tax changes on output and employment. I examine the effects of narratively identified tax changes by adopting two alternative approaches to estimating state-dependent impulse response functions that have been widely used in the recent literature. Both approaches suggest that short-term effects of tax changes on output and employment are smaller during times of higher unemployment. I argue that increased labor market slack and tighter credit conditions in contractionary periods can reduce the responsiveness of labor supply to changes in labor income taxes, resulting in smaller effects on output from tax changes.

Keywords: Tax Policy; Fiscal Policy; State Dependence; Labor Market Frictions; Credit Constraints (search for similar items in EconPapers)
JEL-codes: E2 E6 H2 (search for similar items in EconPapers)
Date: 2021
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Citations: View citations in EconPapers (15)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:moneco:v:117:y:2021:i:c:p:918-934

DOI: 10.1016/j.jmoneco.2020.07.002

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