Revisiting the Narrative Approach of Estimating Tax Multipliers

• Published date: 01 April 2018
• DOI: http://doi.org/10.1111/sjoe.12232
• Date: 01 April 2018

©The editors of The Scandinavian Journal of Economics 2017.

The International Monetary Fund retains copyright and all other rights in the manuscript of this article [Revisiting the

Narrative Approach of Estimating Tax Multipliers] as submitted for publication.

Scand. J. of Economics 120(2), 428–439, 2018

DOI: 10.1111/sjoe.12232

Revisiting the NarrativeApproach of

Estimating Tax Multipliers*

Shafik Hebous

International Monetary Fund, Washington, DC 20431, USA

shebous@imf.org

Tom Zimmermann

Federal Reserve Board, Washington, DC 20551, USA

tom.zimmermann@frb.gov

Abstract

We analyze whether popular measures of narrative tax shocks can be treated as relevant

instruments for observable endogenous tax series of interest. We find that narrative

tax measures are only weakly correlated with cyclically adjusted tax revenues for the

US and the UK. Using weak-instrument robust inference, narrative tax measures often

yield insignificant estimates of tax multipliers. We conclude that the literature currently

understates the uncertainty associated with estimating the tax multiplier using the narrative

approach.

Keywords: Fiscal stabilization; narrative approach; tax multiplier; weak instruments

JEL classification:C54; E62; E69; H30

I. Introduction

The effect of a discretionary change in taxes or government spending on

aggregate output is traditionally called “the multiplier”. Estimating the

multiplier is challenging because causality between changes in taxes and

changes in output can run both ways, and because tax changes are often

correlated with other economic developments.

Romer and Romer (2010, hereafter R&R) suggest an identification

approach that relies on extracting the exogenous component of tax changes

using published information in official policy documents (“narrative

records”). R&R identify all significant legislated tax changes after World

War II in the US, classify them as exogenous or endogenous, and estimate

*We thank an anonymous referee, Robert Chirinko, Alfons Weichenrieder, and seminar

participants at the ECB, Goethe University, and the IIPF for comments. The views expressed

here are those of the authors and do not necessarily represent the views of the IMF, its

Executive Board, IMF management, or the Federal Reserve Board.