Long-Run Impact of Tax Rate Changes On Government Receipts

Abstract

Taxes are believed to have adverse effects on economic activity, work effort, consumption , savings, and capital formation. Although higher marginal tax rates are expected to yield an increase in government revenues in the short run, their long-run effects are not as certain. In the long run, the taxpayers alter their behavior to avoid paying more taxes. Using the unit root methodology, the authors examine whether tax rate changes during the past half century had a permanent or temporary impact on various revenues collected by the federal and state and local governments as a percentage of gross domestic product (GDP) (revenue/GDP ratios). Our results show that past shocks to tax rates did not alter the long-run levels of most federal revenue/GDP ratios. In the case of state and local governments, although permanent changes in the levels of the ratios are indicated, the authors explain that this occurs only under some special circumstances.