Explaining output volatility: The case of taxation

This paper presents strong empirical evidence that the observed heterogeneity of output volatility across countries and over time is partly endogenous. In particular, based on a closed-form solution we obtain a (long-run) equilibrium relationship between taxes and output volatility in the stochastic neoclassical growth model by showing that asymptotically the variance of output growth rates is affected by the level of taxes, without affecting the mean. We estimate the tax semi-elasticities on output volatility and provide convincing empirical evidence that taxes are important to understand differences in output volatility among OECD countries.

► We present strong empirical evidence for a link between output volatility and taxes. ► We show that asymptotically the level of taxes affect output volatility. ► Moments of output growth rates and tax semi-elasticities are obtained analytically. ► We estimate tax semi-elasticities using regression- and likelihood-based methods. ► Our empirical model captures output volatility patterns for OECD countries.