Answer to Question #135653 in Finance for Ahmed Fawaz

Question

Suppose that five states reduce income taxes in a given year. You are interested in estimating whether the tax cut has increased saving, and you find that the saving rate for residents of these five states increased by 2 percent in the year after it was introduced. Can you reasonably conclude that the tax cut caused the increase in saving? How would you conduct a difference-in-difference analysis to estimate the impact on saving? What assumption must hold for the difference-in-difference analysis to be valid?

Answer 1

Yes, since tax cut encourages people to work, save, and invest this will in turn boost the productivity of the economy.

I would do a difference in average outcome in saving before and after increase in saving rate minus the difference in average outcome in the tax cut before and after tax cut.

The outcome in the treatment group must be larger than the outcome in the control group.