Non-Linear Effects of Tax Changes on Output: The Role of the Initial Level of Taxation

56 Pages Posted: 24 Dec 2019

See all articles by Samara Gunter

Samara Gunter

Colby College - Department of Economics

Daniel Riera-Crichton

Bates College

Carlos A. Vegh

Johns Hopkins University - Paul H. Nitze School of Advanced International Studies (SAIS); University of Maryland - Department of Economics; University of California at Los Angeles; National Bureau of Economic Research (NBER)

Guillermo Javier Vuletin

World Bank

Multiple version iconThere are 2 versions of this paper

Date Written: December 2019

Abstract

We estimate the effect of worldwide tax changes on output following the narrative approach developed for the United States by Romer and Romer (2010). We use a novel dataset on value-added taxes for 51 countries (21 industrial and 30 developing) for the period 1970-2014 to identify 96 tax changes. We then use contemporaneous economic records to classify such changes as endogenous or exogenous to current (or prospective) economic conditions. In line with theoretical distortionary and disincentive-based arguments — and using exogenous tax changes — we find that the effect of tax changes on output is highly non-linear. The tax multiplier is essentially zero under relatively low initial tax rate levels and more negative as the initial tax rate increases. Based on a global sample, these novel non-linear findings suggest that the recent consensus pointing to large negative tax multipliers in industrial countries, particularly in industrial Europe (e.g., Alesina, Favero, and Giavazzi, 2015), (i) is not a robust empirical regularity, and (ii) is based on results mainly driven by high initial tax rates in these countries. We also show that the bias introduced by misidentification of tax shocks critically depends on the procyclical or countercyclical nature of endogenous tax changes.

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Suggested Citation

Gunter, Samara and Riera-Crichton, Daniel and Vegh, Carlos A. and Vuletin, Guillermo Javier, Non-Linear Effects of Tax Changes on Output: The Role of the Initial Level of Taxation (December 2019). NBER Working Paper No. w26570, Available at SSRN: https://ssrn.com/abstract=3508549

Samara Gunter (Contact Author)

Colby College - Department of Economics ( email )

Waterville, ME 04901
United States

Daniel Riera-Crichton

Bates College ( email )

Lewiston, ME 04240
United States

Carlos A. Vegh

Johns Hopkins University - Paul H. Nitze School of Advanced International Studies (SAIS) ( email )

1740 Massachusetts Avenue, NW
Washington, DC 20036-1984
United States

University of Maryland - Department of Economics ( email )

College Park, MD 20742
United States

University of California at Los Angeles ( email )

Box 951477
Los Angeles, CA 90095-1477
United States
310-825-7371 (Phone)
310-825-9528 (Fax)

HOME PAGE: http://vegh.sscnet.ucla.edu

National Bureau of Economic Research (NBER)

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Cambridge, MA 02138
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Guillermo Javier Vuletin

World Bank ( email )

1818 H Street, NW
Washington, DC 20433
United States

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