Fiscal Dynamics after a Financial Crisis: Evidence from OECD Countries

Abstract

We analyze the dynamics of fiscal positions in the aftermath of financial crises based on a sample of 23 advanced OECD countries from 1970 to 2016. We apply a local projection approach and confirm that financial distress leads to a strong increase in debt-to-GDP ratios which also appears to be persistent. We provide robust evidence for a persistent shift to expenditures on social security. This shift most likely comes at the cost of public investment. In contrast, evidence in favor of significant changes in the composition of tax revenues is rather weak. Most likely, financial distress leads governments to shift tax burden to revenues from indirect taxes. Our findings also unveil that compositional shifts are especially pronounced in economies with relatively large financial sectors. We conclude that financial distress not only leads to high fiscal costs but also to a deterioration of the quality of public expenditures not only in the short- but also in the medium-run. And, according to our results, governments do not use episodes of financial distress as a window of opportunity to improve the quality of tax structures.