Eui and the Cepr

We provide empirical evidence on the effects of tax liability changes in the United States. We distinguish between “surprise” and “anticipated” tax shocks. We find that surprise tax cuts have expansionary and persistent effects on output, consumption, investment and hours worked. Prior to their implementation, anticipated tax liability tax cuts give rise to contractions in output, investment and hours worked. 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 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.