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 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

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.)

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

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

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 The starving the beast hypothesis is rejected

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