The growth impact of discretionary fiscal policy measures

• To measure fiscal policy correctly, this research does not use changes in fiscal deficits or other indirect methods, but relies on direct costings of tax and other revenue changes.
• In addition to total fiscal adjustment, this research distinguishes between various types of revenue and spending measures, finding that they tend to have very different impacts.
• Fiscal policy measures appear to affect economic growth, with fiscal consolidation generally being more harmful for growth when based on revenue adjustments, when applied in recessions, and when implemented in a front-loaded fashion.
• Most results are in line with other literature, but unusually this research finds that consumption tax increases are associated with lower growth, when applied in a recession.

This paper looks at the impact of discretionary fiscal policy on economic growth for a sample of 18 EU countries over the period 1998–2011. The main novelty of this paper is the use, on the revenue side, of a dataset of fiscal measures based on the yield of actual legislative and budgetary measures, rather than approximations, such as changes in cyclically-adjusted variables. Using static and dynamic panel data techniques, we find that fiscal consolidation generally has a negative impact on growth in the short run, although some specific budget categories are not found to be statistically significant. In general, expenditure-based measures are found to have a slightly lower detrimental effect on growth compared to revenue measures, although the difference is not statistically significant. Among expenditure cuts, reductions in government investment and consumption are found to be growth reducing. Among revenues, indirect tax increases are found to have a particularly strong negative impact. Dynamic specifications suggest that consolidation reduces growth mainly in the year of fiscal adjustment, while future growth rates are affected only through the usual time persistence. Non-linear specifications indicate that spreading out consolidation may reduce the negative impact on growth slightly, and there is weak evidence that this is especially the case for revenue-based adjustment.