Tax Cuts Starve the Beast! Evidence from Germany

Clemens Fuest, Florian Neumeier () and Daniel Stöhlker

No 8009, CESifo Working Paper Series from CESifo

Abstract: The ‘starving the beast’ hypothesis claims that tax cuts lead to lower public spending, rather than higher debt levels and higher taxes in the future. This paper uses the institutional setting of German fiscal federalism to its advantage in order to explore how fiscal policy reacts to exogenous tax revenue shocks. We use panel data from the German states covering the period from 1992 to 2011, and assess to what extent exogenous changes in tax revenues affect aggregate public expenditure as well as specific sub-categories of government spending. Applying the narrative approach pioneered by Romer and Romer (2009), we construct a measure of exogenous tax shocks. This allows us to identify the causal effect of tax changes on fiscal policy. Our results suggest that an exogenous decrease in tax revenues triggers a reduction in public spending of roughly the same amount, with a delay of two to three years. We find that a revenue decline of one Euro reduces public spending on administration and, with a larger delay, social security, by 30 to 45 cents in each case. Spending on infrastructure declines by ten cents. We find no significant effects on spending on education, legal protection and public safety, or culture.

Keywords: taxation; fiscal policy; tax-spend; public expenditure; narrative approach (search for similar items in EconPapers)
JEL-codes: E62 H11 H20 H62 H72 (search for similar items in EconPapers)
Date: 2019
New Economics Papers: this item is included in nep-eec, nep-mac, nep-pbe and nep-pub
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (5)

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Working Paper: Tax Cuts Starve the Beast! Evidence from Germany (2018)
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Persistent link: https://EconPapers.repec.org/RePEc:ces:ceswps:_8009

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