The Persistent Effects of Transitory Tax Changes

We study the persistent effects of transitory changes to U.S. personal and corporate income taxes using a narrative identification of their associated federal tax liability changes. In the short-run, only personal income taxes have a large impact on productivity and output whereas in the long-run, only corporate income taxes lead to a significant response of productivity and output. We develop and estimate a structural model with endogenous growth, variable factor utilization and distortionary taxation, and show that labour effort is crucial to explain the short-run impact of personal income taxes. In contrast, business innovation is key to account for the long-run effects of corporate income taxes. The reason is that variable factor utilization and R&D spending make productivity pro-cyclical in the short-run and in the long-run respectively and, through that, shape the dynamic effects of personal and corporate tax changes on the economy.