Does tax reduction have an effect on gross domestic product? An empirical investigation

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Summary Tax reduction shocks in US economy: 1964, 1979–81 and 2002 increased gross domestic product, GDP, in the short run (≈3 years) so that 1% reduction increased the detrended GDP with 0.48–0.77%. Following tax reductions, tax series became a leading variable to GDP for 9–13 years completing 1–2 cycles. However, in the long run, ≈10 years, 1% tax reduction decreased the detrended GDP with about 0.25%. The tax reduction by the Trump administration (2017) is in an economic environment that is different from the economy when the three earlier large tax reductions were undertaken (the Johnson, the Reagan and the Bush administration tax reductions). In particular, tax receipts and Federal debt is presently (2018) large, inflation, unemployment and federal funds rate are small. The economy may be more volatile and our result suggest that a great challenge for future tax reductions is to develop a sustainable economy. I used a novel technique that identifies running leading relationships between time series, extracts common cycle lengths for the series and estimates lag times.