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Loic Berger Lena Koerber UPF, May 4, 2009

Romer and Romer (2007): “The Macroeconomic Effects of Tax Changes: Estimates Based on a New Measure of Fiscal Shocks” and “Do Tax Cuts Starve the Beast? The Effect of Tax Changes on Government Spending”. Loic Berger Lena Koerber UPF, May 4, 2009. Motivation.

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Loic Berger Lena Koerber UPF, May 4, 2009

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  1. Romer and Romer (2007):“The Macroeconomic Effects of Tax Changes: Estimates Based on a New Measure of Fiscal Shocks” and “Do Tax Cuts Starve the Beast? The Effect of Tax Changes on Government Spending” Loic Berger Lena Koerber UPF, May 4, 2009

  2. Motivation • Measuring the impact of taxes on output, government spending and other macroeconomic variables is difficult: Tax changes and macroeconomic variables have often a common cause giving raise to a endogeneity problem • Romer and Romer propose new measure of fiscal shocks based on exogenous variation in taxation • Their work provides empirical evidence of the effects of fiscal policy using the dummy variable approach

  3. Data • Romer and Romer use narrative records (Economic Report of the President, Congressional records etc) to identify significant tax laws between 1947 and 2006 • Classification of tax laws into • Exogenous tax laws (not motivated by the state of the economy) intended to either • Promote long-run growth or • Reduce an inherited budget deficit • Endogenous tax laws (motivated by the state of the economy) related to either • Countercyclical policy or • Changes in government spending

  4. Data (cont.)

  5. Methodology Where Y is either output, its components, or government spending and T (measured in % of GDP) is • Any exogenous tax change in the first paper • An exogenous, long-run growth tax change in the second paper

  6. Findings(1) The Macroeconomic Effects of Tax Changes: Estimates Based on a New Measure of Fiscal shocks • Tax cuts are contractionary

  7. Findings (cont.)(1) The Macroeconomic Effects of Tax Changes: Estimates Based on a New Measure of Fiscal shocks

  8. Findings (cont.)(1) The Macroeconomic Effects of Tax Changes: Estimates Based on a New Measure of Fiscal shocks • Persistency • Mechanism: The negative effect of tax increases on output works primarily through investment

  9. Findings (cont.)(2) Do Tax Cuts Starve the Beast? The Effect of Tax Changes on Government Spending • The starving the beast hypothesis is rejected

  10. Findings (cont.)(2) Do Tax Cuts Starve the Beast? The Effect of Tax Changes on Government Spending • How does the government balance the budget? • Exogenous long-run tax cuts are counteracted by future tax increases

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