Non-Linear Distortion-Based Effects of Tax Changes on Output: A Worldwide Narrative Approach

We estimate the effect of worldwide tax changes on output following the narrative approach developed for the United States by Romer and Romer (2010). We use a novel dataset on value-added taxes for 51 countries (21 industrial... [ view full abstract ]

We estimate the effect of worldwide tax changes on output following the narrative approach developed for the United States by Romer and Romer (2010). We use a novel dataset on value-added taxes for 51 countries (21 industrial and 30 developing) for the period 1970-2014 to identify 96 tax changes.  We then use contemporaneous economic records to classify such changes as endogenous or exogenous to current (or prospective) economic conditions.  In line with existing theoretical distortion-based arguments - and based on the exogenous tax changes - we find that 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 much larger (in absolute terms) as the initial tax rate and the size of the change in the tax rate increases.  We also show that the bias introduced by misidentification of tax shocks critically depends on the procyclical or countercyclical nature of endogenous tax changes. We simultaneously evaluate the relevance of our arguments both for our global sample and for Romer and Romer's U.S. dataset.