Economics 210c/236a Christina Romer Fall 2011 David Romer L ECTURE 5 The Effects of Fiscal Changes: Taxes and Fiscal Consolidations September 28, 2011
I. R OMER AND R OMER , “T HE M ACROECONOMIC E FFECTS OF T AX C HANGES : E STIMATES B ASED ON A N EW M EASURE OF F ISCAL S HOCKS ”
Background: Blanchard and Perotti • A VAR with Y, G, cyclically-adjusted T. • G and cyclically-adjusted T assumed not to respond to Y within the quarter. • More precisely: Shocks to G and cyclically-adjusted T assumed uncorrelated with present and future shocks to Y.
Framework (1) where Y is real GDP and Δ T is a measure of legislated tax changes. (2) (3) where the ω ’s are additional influences on tax policy.
Framework (cont.) These imply (4) We can rewrite this as: (5) where
Classifying Motivation • Endogenous – Countercyclical – Spending-driven • Exogenous – Deficit-driven – For long-run growth
Figure 1 New Measure of Fiscal Shocks b. Long-Run and Deficit-Driven Tax Changes 3 2 Deficit-Driven Tax Changes 1 Percent of GDP 0 -1 Long-Run Tax Changes -2 -3 -4 1945-I 1947-I 1949-I 1951-I 1953-I 1955-I 1957-I 1959-I 1961-I 1963-I 1965-I 1967-I 1969-I 1971-I 1973-I 1975-I 1977-I 1979-I 1981-I 1983-I 1985-I 1987-I 1989-I 1991-I 1993-I 1995-I 1997-I 1999-I 2001-I 2003-I 2005-I 2007-I From: Romer and Romer, “The Macroeconomic Effects of Tax Changes”
Figure 3 Comparing New Measure of Tax Changes and Cyclically Adjusted Revenues a. Exogenous Tax Changes and the Change in Cyclically Adjusted Revenues 3 2 Change in Cyclically Adjusted Revenues 1 Percent of GDP 0 -1 Exogenous Tax Changes -2 -3 -4 1947-II 1949-II 1951-II 1953-II 1955-II 1957-II 1959-II 1961-II 1963-II 1965-II 1967-II 1969-II 1971-II 1973-II 1975-II 1977-II 1979-II 1981-II 1983-II 1985-II 1987-II 1989-II 1991-II 1993-II 1995-II 1997-II 1999-II 2001-II 2003-II 2005-II 2007-II From: Romer and Romer, “The Macroeconomic Effects of Tax Changes”
Figure 3 Comparing New Measure of Tax Changes and Cyclically Adjusted Revenues b. All Legislated Tax Changes and the Change in Cyclically Adjusted Revenues 3 2 Change in Cyclically Adjusted Revenues 1 Percent of GDP 0 -1 All Legislated Tax Changes -2 -3 -4 1947-II 1949-II 1951-II 1953-II 1955-II 1957-II 1959-II 1961-II 1963-II 1965-II 1967-II 1969-II 1971-II 1973-II 1975-II 1977-II 1979-II 1981-II 1983-II 1985-II 1987-II 1989-II 1991-II 1993-II 1995-II 1997-II 1999-II 2001-II 2003-II 2005-II 2007-II From: Romer and Romer, “The Macroeconomic Effects of Tax Changes”
Specifications 1. 2. 3. A two-variable VAR with tax changes and GDP, 12 lags, tax variable ordered first.
Figure 4 Estimated Impact of an Exogenous Tax Increase of 1% of GDP on GDP (Single Equation, No Controls) 1.0 0.0 -1.0 Percent -2.0 -3.0 -4.0 -5.0 0 1 2 3 4 5 6 7 8 9 10 11 12 Quarter From: Romer and Romer, “The Macroeconomic Effects of Tax Changes”
Figure 5 Estimated Impact of a Tax Increase of 1% of GDP on GDP (Single Equation, Controlling for Lagged GDP Growth) 1.0 0.0 -1.0 With Control Percent -2.0 -3.0 -4.0 Without Control -5.0 0 1 2 3 4 5 6 7 8 9 10 11 12 Quarter From: Romer and Romer, “The Macroeconomic Effects of Tax Changes”
Figure 6 Results of a Two-Variable VAR for Exogenous Tax Changes and Real GDP b. Response of Tax to GDP 0.15 0.10 0.05 Percent 0.00 -0.05 -0.10 -0.15 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 Quarter From: Romer and Romer, “The Macroeconomic Effects of Tax Changes”
Figure 6 Results of a Two-Variable VAR for Exogenous Tax Changes and Real GDP c. Response of GDP to Tax 1.0 0.5 0.0 -0.5 -1.0 Percent -1.5 -2.0 -2.5 -3.0 -3.5 -4.0 -4.5 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 Quarter From: Romer and Romer, “The Macroeconomic Effects of Tax Changes”
Figure 7 Estimated Impact of a Tax Increase of 1% of GDP on GDP (Single Equation, No Controls) a. Using the Change in Cyclically Adjusted Revenues 1.0 Using the Change in Cyclically Adjusted Revenues 0.0 -1.0 Percent -2.0 Using Exogenous Tax Changes -3.0 -4.0 -5.0 0 1 2 3 4 5 6 7 8 9 10 11 12 Quarter From: Romer and Romer, “The Macroeconomic Effects of Tax Changes”
Figure 7 Estimated Impact of a Tax Increase of 1% of GDP on GDP (Single Equation, No Controls) b. Using All Legislated Tax Changes 1.0 Using All Legislated Tax Changes 0.0 -1.0 Percent -2.0 -3.0 Using Exogenous Tax Changes -4.0 -5.0 0 1 2 3 4 5 6 7 8 9 10 11 12 Quarter From: Romer and Romer, “The Macroeconomic Effects of Tax Changes”
Figure 10 Estimated Impact of a Tax Increase of 1% of GDP on GDP, Excluding Korea (Two-Variable VAR) 1.0 Using the Change in Cyclically Adjusted Revenues 0.0 -1.0 Percent -2.0 -3.0 -4.0 Using Exogenous Tax Changes -5.0 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 Quarter From: Romer and Romer, “The Macroeconomic Effects of Tax Changes”
From: Romer and Romer, “The Macroeconomic Effects of Tax Changes”
Figure 13 Changes in the Impact of an Exogenous Tax Increase of 1% of GDP over Time 1.0 0.0 Post-1980Q4 -1.0 -2.0 Percent -3.0 -4.0 -5.0 -6.0 Pre-1980Q4 -7.0 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 Quarter From: Romer and Romer, “The Macroeconomic Effects of Tax Changes”
Figure 12 Estimated Impact of a Tax Increase of 1% of GDP on GDP Including Tax Changes Dated Both at Time of Implementation and at Time of Passage (Single Equation, Controlling for Lagged GDP Growth) 3.0 Time of Passage 2.0 1.0 0.0 Percent -1.0 -2.0 -3.0 -4.0 Time of Implementation -5.0 -6.0 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 Quarter From: Romer and Romer, “The Macroeconomic Effects of Tax Changes”
Figure 14 Estimated Impact of Exogenous Tax Increase of 1% of GDP on Components of GDP a. GDP, Consumption, and Investment b. Consumption Expenditures on Durables, Nondurables, and Services 2 2 Services Consumption -2 -2 Percent Nondurables Percent GDP -6 -6 Durables Investment -10 -10 -14 -14 0 1 2 3 4 5 6 7 8 9 10 11 12 0 1 2 3 4 5 6 7 8 9 10 11 12 Quarter Quarter c. Investment, Nonresidential and d. Exports and Imports Residential Fixed Investment 2 2 Nonresidential Exports -2 -2 Percent Fixed I Percent Imports Residential -6 -6 Fixed I -10 -10 Investment -14 -14 0 1 2 3 4 5 6 7 8 9 10 11 12 0 1 2 3 4 5 6 7 8 9 10 11 12 Quarter Quarter From: Romer and Romer, “The Macroeconomic Effects of Tax Changes”
II. B ARRO AND R EDLICK , “M ACROECONOMIC E FFECTS FROM G OVERNMENT P URCHASES AND T AXES ”
Framework y is real GDP, g is real government purchases, g* measures expected future real government purchases, and τ is the average marginal income tax rate.
How Do Barro and Redlick Address the Possibility of Omitted Variable Bias?
From: Barro and Redlick, “Macroeconomic Effects from Government Purchases and Taxes”
From: Barro and Redlick, “Macroeconomic Effects from Government Purchases and Taxes”
From: Barro and Redlick, “Macroeconomic Effects from Government Purchases and Taxes”
From: Barro and Redlick, “Macroeconomic Effects from Government Purchases and Taxes”
III. O VERVIEW OF THE I MPACT OF F ISCAL C ONSOLIDATIONS
Fiscal consolidation • Deliberate measures to get the government budget deficit down. • Other terms: fiscal reform, austerity program, deficit reduction, fiscal contraction. • In a standard, Keynesian model, tax increases and government spending reductions lower GDP and raise unemployment.
How could fiscal contractions be expansionary? • Wealth effect: A decrease in G makes people expect more decreases and so lower future taxes, wealth rises and consumption could rise. • Confidence effect: If budget problems are severe, dealing with them may prevent having to take more extreme measures later on. Thus, consolidation can have positive confidence effects on C and I. • Interest rate effect: Fiscal consolidations may lower risk premium and so lower long rates. This may raise both I and C.
How could fiscal contractions be expansionary? • Omitted variable bias: Budget problems are a symptom of dysfunctional government. Fiscal consolidation is a sign that the government is functioning, and so may be correlated with other measures that are good for growth (i.e. relationship could be present but not causal).
From: Giavazzi and Pagano, “Can Severe Fiscal Contractions be Expansionary?”
From: Giavazzi and Pagano, “Can Severe Fiscal Contractions be Expansionary?”
From: Giavazzi and Pagano, “Can Severe Fiscal Contractions be Expansionary?”
Alesina and Ardagna’s Measure of Fiscal Consolidations • A year when the cyclically adjusted primary balance improves by at least 1.5% of GDP. • Primary balance is the budget position net of interest payments. • Cyclically-adjust the budget data using simple regression against the unemployment rate. (CBO and OECD uses more detailed methods.)
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