4. Budget Deficits & Taxation: Effect of Taxes/Debt on Output Flashcards
What is the idea of a tax multiplier?
The multiple by which GDP increases (decreases) in response to a decrease (increase) in taxes charged by governments
What have been the preferred models for estimate tax multipliers?
What problems are there with these models?
Vector Autoregression (VAR models
The results are not robust
What is the approach to estimating tax multipliers used by Romer & Romer (2010)
Narrative approach - use historical records to distinguish tax increases that were “exogenous” from those that that were related to expectations of economic conditions
What approach to estimating tax multipliers is used in Mertens & Ravn (2012)?
They use Romer & Romer’s narrative approach but also distinguish between anticipated and unanticipated tax shocks, and combine this with a VAR approach
What do Romer & Romer (2010) and Mertens & Ravn (2012) estimate the tax multiplier to be?
What does this mean?
2%
Cutting taxes by 1% would cause output to increase by 2%
What is the problem with an estimated tax multiplier of 2%?
Seems implausible as it would mean that tax cuts would pay for themselves
What does a 2% tax multiplier imply about stimulating the economy?
(2 points)
In the case of recession, cutting taxes is the best solution
Implies that taxes are better than government spending in terms of stimulating the economy
What are two possible policies that could be used to increase government expenditures?
Increase taxes
Increase government debt
What did Reinhard and Rogoff (2010) find?
(2 points)
What issues are there?
Found high correlation between high government deficits and low growth
Implicitly suggested that the relationship is causal
Errors in the paper, and it only showed correlation (not causation)
