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 dataset 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 (i) indirect taxes, (ii) social contributions,
and (iii) corporate income taxes, tend to be larger during recessions. Tax elasticities for
personal income tend to be more stable across the regimes. Estimates of long-run
elasticities are in line with existing literature.