The Macroeconomic Effects of Income and Consumption Tax Changes

This paper estimates the effects of exogenous changes in income and consumption taxes. The tax shocks are proxied with a narrative account of tax liability changes in the United Kingdom. Income tax cuts have large effects on GDP, private consumption and investment. The effects of consumption tax cuts are modest and not statistically significant on GDP and its components. Shifting the burden of taxation from income to consumption is expansionary. Consistent with conventional public finance theories, these results indicate that it is crucial to distinguish between direct and indirect taxation when studying the transmission mechanism of fiscal policy.