The macroeconomic effects of legislated tax changes in Germany

Abstract

This paper studies the short-term macroeconomic effects of legislated tax changes in Germany using a five-variable vector autoregression (VAR) framework. Identification of the tax shock follows a recently proposed narrative approach. Based on a historical account of German tax legislation, the timing, size, and motivation of legislated tax changes are assessed and a time series of exogenous tax shocks is constructed. The VAR results indicate a substantial and statistically significant reaction of output following implementation of a tax change. In response to a one percentage point increase in the tax-to-GDP ratio, we observe a maximum output reduction of 2.4%. These results suggest that previous estimates of the effects of tax changes on output in Germany are downward biased.