Asymmetric effects of personal income tax changes on economic activity: Increases, cuts, and for whom

Abstract

This paper explores whether changes in personal income tax have asymmetric effects on US economic activity. Using narrative measures of exogenous variation in personal income tax liabilities, we estimate the effects of these changes based on their direction and targeted income groups. We find that the contractionary effect of tax increases is approximately twice as large as the expansionary effect of tax cuts and this larger contractionary effect is mainly driven by tax increases for low- and middle-income groups. To investigate the mechanisms behind this asymmetry, we develop a heterogeneous agent model featuring downward wage rigidities and income-specific unemployment risks. The model suggests that labor demand shortfalls after tax increases amplify output and employment losses, primarily by reducing employment among the bottom 90% of income groups.