Paul L. Caron

Thursday, July 22, 2010

Romer & Romer: Tax Increases Significantly Contract the Economy

Christina D. Romer (Chair, Council of Economic Advisers) & David H. Romer (UC-Berkeley, Department of Economics) have published The Macroeconomic Effects of Tax Changes: Estimates Based on a New Measure of Fiscal Shocks, 100 Am. Econ. Rev. 763 (2010). Here is the abstract:

This paper investigates the impact of tax changes on economic activity. We use the narrative record, such as presidential speeches and Congressional reports, to identify the size, timing, and principal motivation for all major postwar tax policy actions. This analysis allows us to separate legislated changes into those taken for reasons related to prospective economic conditions and those taken for more exogenous reasons. The behavior of output following these more exogenous changes indicates that tax increases are highly contractionary. The effects are strongly significant, highly robust, and much larger than those obtained using broader measures of tax changes.

Scholarship, Tax | Permalink

TrackBack URL for this entry:

Listed below are links to weblogs that reference Romer & Romer: Tax Increases Significantly Contract the Economy:

» Will the tax cuts expire? from Common Sense Political Thought
Battle Looms in Washington Over Expiring Bush Tax Cuts By David M Herszenhorn WASHINGTON — An epic fight is brewing over what Congress and President Obama should do about the expiring Bush tax cuts, with such substantial economic and political cons... [Read More]

Tracked on Jul 25, 2010 8:54:32 AM


While your headline is overall true, it ignores some detail Ms. Romer goes into later in the study. According to her estimates, the overall effect on GDP of deficit driven tax increases are positive on GDP, rather than negative. (page 787 of the PDF). Her error bands are twice as wide on that, given there is less data to analyze, but that is something that needs to be taken into account during the current tax discussion.

Posted by: John J | Aug 6, 2010 8:47:06 AM

It may be obvious to us but it is not obvious to Sec'y (candidate?) Clinton. She is on record a number of times to the effect that taxes just make folks work harder to keep up their standard of living.

Posted by: Sou'western SongDog | Jul 23, 2010 12:19:01 PM

The disturbing thing about this is that the idea that high taxes reduce economic output comes straight from the intellectual grandaddy of the stimulus himself: John Maynard Keynes.

I'm not a fan of Keynesian economics but at least it is a cohesive and coherent theory that makes explicit policy recommendations for different circumstances. When times are bad, the government borrows saved/hoarded money and cuts taxes to raise economic activity. When times are really good, the government raises taxes to reduce economic activity.

In other words, the theory upon which last year's "stimulus" was based states explicitly that the one thing you never do in an economic downturn is raise taxes. Yet, the Democrats are praising the stimulus even while they are salivating over the coming tax increase with the expiration of Bush's tax cuts next year.

If they really believed in the economic theory behind the "stimulus" they would be working to extend Bush's tax cuts. Instead, they clearly care for only one thing: more money passing through their hands and the power that gives them. They pick and choose whatever theory provides the rational. Times good? They point out that Keynes says raise taxes. Time bad? They point out that Keynes says borrow money. Then they mumble something and raise taxes.

Posted by: Shannon Love | Jul 23, 2010 10:57:08 AM

In other news, after three years of exhaustive research, the chairman of the Federal Marine Mammal Commission just published a paper indicating that water makes things wet.

Seriously, how hard is it to grasp that the steeper the hill you're trying to climb (ie tax rates), the harder it is to pick up speed (have economic growth)?

I guess if you're a member of the political class addicted to spending other people's money, its pretty hard.

On another note, does this mean (to coin a phrase) that "the science is settled" when it comes to the deleterious economic effects of tax increases?

Posted by: Looking closely | Jul 23, 2010 6:55:44 AM

Thank you, oh thank you Captain Friggin Obvious. Anybody with a lick of common sense or eyes to view history can see that Keynes was a bloviating blowhard who was full of sheep dip.

Posted by: The Grey Man | Jul 23, 2010 6:34:11 AM

It wasn't all that long ago that Ms. Romer was the queen of the multiplier, was she not? Interesting......

Posted by: Dazed | Jul 23, 2010 5:28:37 AM