Policy Implications of Non-Linear Effects of Tax Changes on Output

20 Pages Posted: 5 Apr 2021 Last revised: 10 Apr 2025

See all articles by Samara Gunter

Samara Gunter

Colby College - Department of Economics

Daniel Riera-Crichton

Bates College

Carlos A. Vegh

University of Maryland - Department of Economics; Johns Hopkins University - Paul H. Nitze School of Advanced International Studies (SAIS); 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: April 2021

Abstract

In an earlier paper, titled "Non-linear effects of tax changes on output: The role of the initial level of taxation," we estimated tax multipliers using (i) a novel dataset on value-added taxes for 51 countries (21 industrial and 30 developing) for the period 1970-2014, and (ii) the so-called narrative approach developed by Romer and Romer (2010) to properly identify exogenous tax changes. The main finding is that, in line with existing theoretical distortionary and disincentive-based arguments, the effect of tax changes on output is highly non-linear. The tax multiplier is essentially zero under relatively low/moderate initial tax rate levels and more negative as the initial tax rate and the size of the change in the tax rate increase. This companion paper first shows that these findings have important policy implications, given that the initial level of taxes varies greatly across countries and thus so will the potential output effect of changing tax rates. The paper then turns to some specific policy applications. It focuses on the relevance of the arguments for revenue mobilization in countries with low levels of provision of public goods and social and infrastructure gaps, as well as in commodity-dependent countries. The paper then considers some practical implications for the standard debt sustainability analysis. Lastly, it evaluates the implications of the findings for the Laffer curve.

Suggested Citation

Gunter, Samara and Riera-Crichton, Daniel and Vegh, Carlos A. and Vegh, Carlos A. and Vuletin, Guillermo Javier, Policy Implications of Non-Linear Effects of Tax Changes on Output (April 2021). NBER Working Paper No. w28646, Available at SSRN: https://ssrn.com/abstract=3819549

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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Guillermo Javier Vuletin

World Bank ( email )

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Washington, DC 20433
United States

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