A Model-Based Evaluation of the Debate on the Size of the Tax Multiplier

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American Economic Journal: Economic Policy 2012, 4(2): 28–45
http://dx.doi.org/10.1257/pol.4.2.28
The recent empirical literature has delivered two main approaches to estimating
tax multipliers. The first, pioneered by the work of Blanchard and Perotti (2002),
is based on a structural vector autoregression (SVAR) analysis. The second strand
of the empirical literature, initiated by the work of Romer and Romer (2010), estimates
tax shocks using a narrative approach and then regresses a measure of aggregate
activity, such as gross domestic product (GDP), on current and lagged values of
the identified tax shock.
The motivation of this paper is that the SVAR and narrative approaches deliver
significantly different estimates of the size of the tax multiplier. The former approach
yields relatively small values of less than 1, whereas the latter delivers large values
of about 3. That is, a cut in taxes equivalent to 1 percent of output generates a maximal
increase in output of less than 1 percent according to the SVAR approach and of
about 3 percent according to the narrative approach.
The starting point of our analysis is the observation that the two approaches differ
along two dimensions. One dimension is the assumed reduced-form transmission
mechanism. The transmission mechanism invoked by the SVAR approach consists
of a multi-equation, multivariate autoregressive system in which taxes evolve jointly
* Chahrour: Department of Economics, Columbia University, 420 West 118th Street, New York, NY 10027
(e-mail: rc2374@columbia.edu); Schmitt-Grohé: Columbia University, NBER, and CEPR, 420 West 118th Street,
New York, NY 10027 (e-mail: ss3501@columbia.edu); Uribe: Department of Economics, Columbia University and
NBER, 420 West 118th Street, New York, NY 10027 (e-mail: martin.uribe@columbia.edu). This paper grew out of
Martin Uribe’s discussion of Favero and Giavazzi (2010) at the NBER’s TAPES conference held in Varenna, Italy
in June of 2010. The authors would like to thank for comments seminar participants at that conference, especially
Carlo Favero, Roberto Perotti, Morten Ravn, and Marty Eichenbaum.
† To comment on this article in the online discussion forum, or to view additional materials, visit the article page
at http://dx.doi.org/10.1257/pol.4.2.28.
A Model-Based Evaluation of the Debate
on the Size of the Tax Multiplier†
By Ryan Chahrour, Stephanie Schmitt-GrohÉ, and MartÍn Uribe*
The SVAR and narrative approaches to estimating tax multipliers
deliver significantly different results. The former yields multipliers
of about 1 and the latter of about 3. The two approaches differ
along two important dimensions: the identification scheme and the
reduced-form transmission mechanism. This paper uses a DSGEmodel
to evaluate the hypothesis that the difference in multiplier

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