DP6673 The Aggregate Effects of Anticipated and Unanticipated U.S. Tax Policy Shocks: Theory and Empirical Evidence

Author(s): Karel Mertens , Morten O. Ravn

Publication Date: February 2008

Keyword(s): anticipation effects , fiscal policy , structural estimation , tax liabilities

JEL(s): E20 , E32 , E62 , H30

Programme Areas: International Macroeconomics

Link to this Page: www.cepr.org/pubs/dps/DP6673.asp

We provide empirical evidence on the effects of tax liability changes in the United States. We make a distinction between "surprise" and "anticipated" tax shocks. Surprise tax cuts give rise to a large boom in the economy. Anticipated tax liability tax cuts are instead associated with a contraction in output, investment and hours worked prior to their implementation. After their implementation, anticipated tax liability cuts lead to an economic expansion. We build a DSGE model with changes in tax rates that may be anticipated or not, estimate key parameters using a simulation estimator and show that it can account for the main features of the data. We argue that tax shocks are empirically important for U.S. business cycles and that the Reagan tax cut, which was largely anticipated, was a main factor behind the early 1980’s recession.