Adaptation to taxation: Corporate income tax changes generate persistent effects on R&D expenditure, productivity and output whereas personal income tax changes trigger large but short-lived responses on the same

Short-Term Tax Cuts, Long-Term Stimulus. James Cloyne, Joseba Martinez, Haroon Mumtaz & Paolo Surico. NBER Working Paper 30246. July 2022. DOI 10.3386/w30246

Abstract: We study the persistent effects of temporary changes in U.S. federal corporate and personal income tax rates using a narrative identification approach. A corporate income tax cut leads to a sustained increase in GDP and productivity, with peak effects between five and eight years. R&D spending and capital investment display hump-shaped responses while hours worked and employment are much less affected. In contrast, personal income tax cuts trigger a short-lived boost to GDP, productivity and hours worked but have no long-term effects. We develop and estimate an endogenous growth model with variable factor utilization and show that these features generate a pro-cyclical response of productivity which is key to account for our empirical findings.

8 Conclusions

Do transitory changes in corporate and personal income taxes have persistent effects on output? And what are the channels? We answer the first question using local projections and narrative-identified tax shocks on post-WWII U.S. data. We answer the second question by running counterfactual simulations from an estimated structural model with endogenous growth, variable factor utilization and distortionary taxes.

Our main findings are that corporate income tax changes generate persistent effects on R&D expenditure, productivity and output whereas personal income tax changes trigger large but short-lived responses of capital expenditure, productivity and output. We show that matching the pro-cyclical response of productivity in the short-run and in the long-run is crucial for the ability of the estimated model to account for the dynamic effects of the two tax shocks on economic activity. Variable labor utilization appears important for replicating the short-term response of productivity and output to a personal income tax change, while R&D expenditure and technological adoption are key to account for the long-term effects of corporate income tax changes.