The Effects of Tax Shocks on Output: Not So Large, But Not Small Either

Roberto Perotti ()

No 16786, NBER Working Papers from National Bureau of Economic Research, Inc

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.

JEL-codes: E62 H20 H60 (search for similar items in EconPapers)
Date: 2011-02
Note: EFG PE
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Citations: View citations in EconPapers (24)

Published as The Effects of Tax Shocks on Output: Not So Large, but Not Small Either , Roberto Perotti. in Fiscal Policy (Trans-Atlantic Public Economics Seminar, TAPES) , Gordon and Perotti. 2012
Published as Roberto Perotti, 2012. "The Effects of Tax Shocks on Output: Not So Large, But Not Small Either," American Economic Journal: Economic Policy, vol 4(2), pages 214-237.

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Chapter: The Effects of Tax Shocks on Output: Not So Large, but Not Small Either (2010)
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