Abstract:

Most studies on cyclical fiscal policy ignore statutory taxes due to a lack of data. In this paper I build on singular data on statutory tax rates in Israel, in order to study how they are changed by the government in expansions and recessions. After differentiating between ideological (exogenous) tax changes, and those that react to the cycle (endogenous) using the Romer and Romer (2010) technique, I check whether endogenous statutory tax rates are acyclical or countercyclical, as recommended by theoretical models. I find that while direct taxes are a-cyclical, indirect taxes (and in particular VAT) are changed procyclically. A pseudo-panel analysis based on the different types of taxation and a panel analysis based on indirect taxation show that the main reason for statutory tax changes is the existence of economic crises. This explanation is stronger than economic considerations like population or expenditure growth, legal considerations like the rigidity for changing statutory taxes, and income distribution considerations like the incidence on the bottom income decile.