Fiscal Expansion and Adjustments in OECD Countries
In several countries policymakers are striving to improve the budget balance. Trivially, this can be done by raising taxes and/or cutting expenditures. But the two strategies are not equivalent. In this paper, we investigate several issues referring to the relationship between the fiscal stance, i.e. loose or tight fiscal balance, and the composition of the budget, based on the experience of 20 OECD counties after 1960. We find that large fiscal expansions typically are biased toward increases in expenditure, while large fiscal adjustments on average rely more on tax increases. However, we find a large and fundamental difference between fiscal adjustments that lead to permanent improvements in the fiscal balance and those that are reversed in a short time. The former are implemented mainly via cuts in two types of expenditure: transfer programs and compensation of government employees. The latter are carried out almost exclusively via tax increases. We also find that coalition governments, although they often try to make substantial fiscal adjustments, are much less likely than other governments to carry out the two types of expenditure cuts that make an adjustment successful. Our findings convey a clear message: the composition of a fiscal adjustment is of fundamental importance in determining its success. A fiscal adjustment cannot have long-lasting effects unless it tackles two expenditures - government employment and social programs - often regarded as untouchable by policymakers and their advisors.
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