Understanding the Aggregate Effects of Anticipated and Unanticipated Tax Policy Shocks

55 Pages Posted: 17 Nov 2009

See all articles by Karel Mertens

Karel Mertens

Federal Reserve Banks - Federal Reserve Bank of Dallas

Morten O. Ravn

European University Institute - Economics Department (ECO); London Business School - Department of Economics; University of Southampton; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Date Written: October 2009

Abstract

We evaluate the extent to which a dynamic stochastic general equilibrium model can account for the impact of "surprise" and "anticipated" tax shocks estimated from U.S. time-series data. In U.S. data, surprise tax cuts have expansionary and persistent effects on output, consumption, investment and hours worked. Anticipated tax liability tax cuts give rise to contractions in output, investment and hours worked before their implementation while thereafter giving rise to an economic expansion. A DSGE model with changes in tax rates that may be anticipated or not, is shown to be able to account for the empirically estimated impact of tax shocks. The important features of the model include adjustment costs, variable capacity utilization and consumption habits. We derive Hicksian decompositions of the consumption and labor supply responses and show that substitution effects are key for understanding the impact of tax shocks. When allowing for rule-of-thumb consumers, we find that the estimate of their share of the population is only around 10-11 percent.

Keywords: anticipation effects, fiscal policy, structural estimation, tax liabilities

JEL Classification: E20, E32, E62, H30

Suggested Citation

Mertens, Karel and Ravn, Morten O., Understanding the Aggregate Effects of Anticipated and Unanticipated Tax Policy Shocks (October 2009). CEPR Discussion Paper No. DP7505, Available at SSRN: https://ssrn.com/abstract=1507502

Karel Mertens (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of Dallas ( email )

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Morten O. Ravn

European University Institute - Economics Department (ECO) ( email )

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National Bureau of Economic Research (NBER)

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