MEASURING THE GROWTH AND VARIABILITY OF TAX BASES OVER THE BUSINESS CYCLE

Abstract

The income elasticity of taxes is frequently used as an indicator of both short-run variability and long-run growth. This paper shows that the standard method for estimating elasticities results in asymptotic bias and inconsistent standard errors. Additionally, the standard estimates only provide information about the long-run growth potential of the tax. Thus, it is possible for a tax with a small estimated elasticity to fluctuate highly over the business cycle. This paper uses time-series econometric techniques to provide unbiased estimates of the long-run growth potential (the long-run elasticity) and cyclical variability (the short-run elasticity) of all major state tax bases.