Christoph Priesmeier Boeken

The empirical and theoretical literature on long-term relationships in public finance is dominated by two approaches: Fiscal sustainability and Wagner's law of an increasing state activity. In this paper, we argue that these two relationships should be analyzed simultaneously and not separately. We show how Wagner's law might influence fiscal sustainability and how the interaction of the two can be modelled using vector error correction models that include public expenditures, revenues and GDP. For Germany, we find strong evidence for Wagner's law throughout the whole period analyzed (1960-2007), while our results indicate sustainability of public finances only until 1973. We show that, for the period after 1973, it is the interaction of permanent expenditure increases and revenue reductions resulting from fiscal policy reactions to the oil crisis and Wagner's law that ruins the sustainability of public finances in Germany. Our findings underline the importance of the German debt brake for re-establishing sustainable public finances even under Wagner's law.

How do German public finances respond to economic developments? And what is the impact of large economic shocks on fiscal sustainability? Vice versa, what is the effect of sustainability restrictions on fiscal stimulus measures? In the context of the ongoing sovereign debt crisis, these questions constitute the core of public finance debates. Based on advanced macro-econometric methods, this study offers new insights to this field. The author shows how expenditure dynamics have been decisive for ruining the sustainability of public finances in Germany and how a debt brake could bring them back on a sustainable path. He demonstrates how static estimation methods fail to detect dynamic relationships between tax bases and tax revenues – especially with respect to profit taxes. Finally, he shows that economic stimuli programmes in Germany have become gradually more pro-cyclical over the last four decades and sustainability restrictions have strong effects on the size of fiscal multipliers.