The effect of tax changes on economic activity in Peru: An application of the narrative approach

This paper estimates the effect of tax changes on economic activity in Peru. A narrative approach is used to construct a time series of exogenous tax changes, which are identified from the review of the historical records related to legislated tax changes. We use quarterly data for the period 1991-2015. The results show that the elasticity of real GDP with respect to tax-to-GDP ratio is approximately -0.11 in the quarter the tax change occurs and -0.22 after six quarters. In addition, a tax increase of one percent of GDP reduces tax revenue by 0.28 percentage points of GDP in the quarter the tax increase occurs and the maximum effect is a fall of 0.49 percentage points after seven quarters. These results imply that a tax decrease may have a positive and transitory effect on economic activity; however, such positive effect is not enough to recover the initial tax revenue loss. It should be noted that these outcomes represent short-term effects and do not take into account either the potential response of government spending or the effect on the budget deficit and fiscal sustainability. (Audio: Department of Economic Publications)