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

45 Pages Posted: 21 Feb 2011

See all articles by Roberto Perotti

Roberto Perotti

Bocconi University - Department of Economics; European University Institute - Economics Department (ECO); Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 2 versions of this paper

Date Written: February 2011

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 Classification: E62, H20, H60

Suggested Citation

Perotti, Roberto, The Effects of Tax Shocks on Output: Not so Large, But Not Small Either (February 2011). CEPR Discussion Paper No. DP8252. Available at SSRN: https://ssrn.com/abstract=1763660

Roberto Perotti (Contact Author)

Bocconi University - Department of Economics ( email )

Via Gobbi 5
Milan, 20136
Italy

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

Villa San Paolo
Via della Piazzuola 43
50133 Florence
Italy

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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