The Stability of Tax Elasticities over the Business Cycle in European Countries

We estimate short- and long-run tax elasticities that capture the relationship between changes in national income and tax revenue. We show that the short-run tax elasticity changes according to the business cycle. We estimate a two-state Markov-switching regression on a novel data set of tax policy reforms in 15 European countries from 1980 to 2013, showing that the elasticities during booms and recessions are statistically (and often economically) different. The elasticities of personal income taxes, corporate income taxes, indirect taxes and social contributions tend to be larger during recessions. Estimates of long-run elasticities are in line with existing literature.