Christina Romer Studies the Impact of Tax Hikes on Growth

April 25, 2012



U.C. Berkley Professor and President Obama’s former Chair of his Council of Economic Advisers (CEA), Christina Romer, published a paper in 2010, concluding that a tax increase of 1 percent of GDP, about $160 billion today, reduces output over the next three years by nearly 3 percent, or $480 billion at current GDP figures.

"Tax increases appear to have a very large, sustained, and highly significant negative impact” on the economy. Romer left the Obama Administration soon after publishing the paper.

Romer and Romer computed a “fiscal shock” indicator focusing on tax hikes taken to deal with an inherited budget deficit or to achieve a long-run goal, given these are changes motivated by past decisions, philosophy, and beliefs about fairness. This is opposed to tax hikes offset by cuts.

Equally alarming, the tax increases have a large negative effect on investment, and a much lesser impact on consumption and imports. People and businesses continue to consume, they just cut back on investments in growth. Not only is the effect large, tax hikes hurt the most important type of spending – investment in the future.

Output responds more closely to the implementation of a tax change rather than to the news of the change.

The tax hikes are not about solving the budget problem, it’s about transfer payments, along with some hubris in their ability to spend money more effectively than entrepreneurs.

The consequence of shrinking the overall pie while the paternal force divides it has the same result as not having enough pie a family dinner. When there isn’t enough pie, the family fights over the scraps.

Source: Forbes, The Macroeconomic Effect of Tax Changes

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