Explaining Output Volatility: The Case of Taxation

Abstract

This paper presents strong empirical evidence that the observed heterogeneity of output volatility across countries and over time is partly endogenous. In particular, based on a closed-form solution we obtain a (long-run) equilibrium relationship between taxes and output volatility in the stochastic neoclassical model by showing that asymptotically the variance of output growth rates is affected by the level of taxes, without affecting the mean. We estimate the tax semi-elasticities on output volatility and provide convincing empirical evidence that taxes are important to understand differences in output volatility among OECD countries.

Keywords: Macroeconomic volatliity, Tax effects, Continuous-time DSGE models

JEL Classification: E32, E62, H31