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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

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

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


Loic berger lena koerber upf may 4 2009

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


Data cont

Data (cont.)


Methodology

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


Loic berger lena koerber upf may 4 2009

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

  • Tax cuts are contractionary


Loic berger lena koerber upf may 4 2009

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


Loic berger lena koerber upf may 4 2009

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


Findings cont 2 do tax cuts starve the beast the effect of tax changes on government spending

Findings (cont.)(2) Do Tax Cuts Starve the Beast? The Effect of Tax Changes on Government Spending

  • The starving the beast hypothesis is rejected


Findings cont 2 do tax cuts starve the beast the effect of tax changes on government spending1

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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