Weekly Economic Update: October 2 – October 6, 2017

October 02, 2017

CHART OF THE WEEK

Taxes Reduce Economic Growth

The graph shows the inverse relationship between tax changes and economic output. An exogenous* tax increase equal to 1% of GDP lowers output to a maximum of just over 3% ten quarters later. The negative effect of the tax increase on economic growth is not only large but highly statistically significant. The graph is from a 2010 study by Christina Romer, former CEA Chair in the Obama Administration, and well-known economist, David Romer.¹

Many studies on the subject have difficulty isolating the effect of tax changes on output because other determinants of output (such as the business cycle, government spending, monetary policy) can simultaneously change tax revenue. The Romers analyzed the origin of each tax change they included to circumvent this problem. Subsequent variants of the Romer study by other economists² all confirm the negative effect of taxes on output, indicating that tax reductions indeed may accelerate economic growth.

On a related note, the JEC will hold a hearing on Tuesday to examine how pro-growth tax reform could help reverse the decline in job-creating business startups.

* A standalone change that is not affected by other determinants of output.

¹Romer, Christina D., and David H. Romer (2010). “The Macroeconomic Effects of Tax Changes: Estimates Based on a New Measure of Fiscal Shocks,” American Economic Review, 100 (3): 763-801

²Subsequent studies:

Barro, Robert J., and Charles J. Redlick (2011). “Macroeconomic Effects from Government Purchases and Taxes,” Quarterly Journal of Economics, 126 (1): 51-102.

Favero, Carlo, and Francesco Giavazzi (2012). “Measuring Tax Multipliers: The Narrative Method in Fiscal VARs,” American Economic Journal: Economic Policy, 4 (2): 69-94.

Perotti, Roberto (2012). “The Effects of Tax Shocks on Output: Not So Large, but Not Small Either,” American Economic Journal: Economic Policy, 4 (2): 214-237.

Merten, Karel, and Morten O. Ravn (2013). “The Dynamic Effects of Personal and Corporate Income Tax Changes in the United States,” American Economic Review, 103 (4): 1212-1247.

LAST WEEK

The CFNAI is an index generated as a weighted average from 85 different economic indicators measuring economic growth. Values above zero indicate above-trend economic growth.

Category	August	July	June	May
Most recent CFNAI (3-month moving average) estimates	-0.04	0.00	0.15	0.06
Previous CFNAI (3-month moving average) estimates	N/A	-0.05	0.09	0.00

Noteworthy: Between February 2015 and November 2016 the 3-month moving average of CFNAI was negative, indicating below-trend economic growth. In seven of the last nine months it has been positive or zero. The negative number for August is likely attributable to Hurricane Harvey.

Gross Domestic Product (Final Estimate) (Q2-2017, seasonally adjusted at annualized rates)

Category	3^rd estimate	2^nd estimate	1^st estimate
Second Quarter Real GDP growth	3.1%	3.0%	2.6%

Noteworthy: Second quarter real GDP growth was revised upward from 3.0% to 3.1% due to greater business inventory investment growth than was initially estimated.

Personal Consumption Expenditures (PCE) Deflator (August 2017; percentage changes from same month last year)

Category	August	July	June
Overall PCE Deflator	1.43%	1.41%	1.42%
Core PCE Deflator (excludes food and energy)	1.29%	1.42%	1.50%

Noteworthy: After falling for five consecutive months, the Fed’s main inflation ticked up slightly this month to 1.43%. However, the “core” measure, which excludes volatile food and energy prices decreased to 1.29%. This tepid inflation reading makes the Fed less likely to raise the fed funds rate this year.