The Macroeconomic Effects of Tax Changes: Estimates Based on a New Measure of Fiscal Shocks

71 Pages Posted: 13 Jul 2007 Last revised: 30 Sep 2022

See all articles by Christina D. Romer

Christina D. Romer

University of California, Berkeley - Department of Economics; National Bureau of Economic Research (NBER)

David H. Romer

University of California, Berkeley - Department of Economics; National Bureau of Economic Research (NBER)

Date Written: July 2007

Abstract

This paper investigates the impact of changes in the level of taxation on economic activity. We use the narrative record -- presidential speeches, executive-branch documents, and Congressional reports -- to identify the size, timing, and principal motivation for all major postwar tax policy actions. This narrative analysis allows us to separate revenue changes resulting from legislation from changes occurring for other reasons. It also allows us to further separate legislated changes into those taken for reasons related to prospective economic conditions, such as countercyclical actions and tax changes tied to changes in government spending, and those taken for more exogenous reasons, such as to reduce an inherited budget deficit or to promote long-run growth. We then examine the behavior of output following these more exogenous legislated changes. The resulting estimates indicate that tax increases are highly contractionary. The effects are strongly significant, highly robust, and much larger than those obtained using broader measures of tax changes. The large effect stems in considerable part from a powerful negative effect of tax increases on investment. We also find that legislated tax increases designed to reduce a persistent budget deficit appear to have much smaller output costs than other tax increases.

Suggested Citation

Romer, Christina D. and Romer, David H., The Macroeconomic Effects of Tax Changes: Estimates Based on a New Measure of Fiscal Shocks (July 2007). NBER Working Paper No. w13264, Available at SSRN: https://ssrn.com/abstract=1000366

Christina D. Romer (Contact Author)

University of California, Berkeley - Department of Economics ( email )

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David H. Romer

University of California, Berkeley - Department of Economics ( email )

549 Evans Hall #3880
Berkeley, CA 94720-3880
United States
510-642-0822 (Phone)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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