Fiscal Expansions and Adjustments in OECD Countries

Abstract

Fiscal adjustments Fiscal expansions and adjustments in OECD countries In several countries policy-makers are striving to improve the budget balance, which can be done either by raising taxes or by cutting expenditures. But the two strategies are not equivalent. Drawing on the experience of twenty OECD countries after 1960, this article shows that large fiscal expansions typically occur through increases in expenditure, while large fiscal adjustments rely on tax increases. It also appears that permanent improvements in the fiscal balance crucially differ from fiscal adjustments that lead to a temporary improvement and are reversed in a short time. Permanent improvements are implemented mainly via cuts in two types of expenditure: transfer programmes and compensation of government employees. Temporary improvements are carried out almost exclusively via tax increases. Finally, coalition governments may often try to make substantial fiscal adjustments, but they are much less likely than others to carry out the two types of expenditure cut that make an adjustment successful. These 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 programmes – often regarded as untouchable by policy-makers and their advisers. — Alberto Alesina and Roberto Perotti