Discretionary measures and tax revenues in the run-up to the financial crisis

This paper examines the influence of governments' discretionary measures on tax revenues and tax elasticity in the European Union during the run-up to the 2008/2009 global financial crisis which was characterised by large swings in tax revenues.

Using data collected in the context of the Output Gap Working Group of the Economic Policy Committee we show that while discretionary measures have had a limited impact on tax yields, they have in some cases significantly affected tax elasticities and thereby altered the relationship between tax revenues and the business cycle which plays a key role in the EU fiscal surveillance framework. Furthermore we provide evidence on the pro-cyclical nature of discretionary measures affecting tax revenues whereby governments tend to implement tax cuts during expansionary phases while resorting to tax increases during slowdowns. More generally our results suggest that the availability of detailed projections on the impact of discretionary measures by broad tax category would be instrumental to a better monitoring of tax revenues developments in the EU in order to better identify the role played by non-policy factors (such as asset prices) in driving tax revenues. Given that the time span covered by this database is in most cases still relatively short (covering on average 7 to 8 years) future updates of the data would allow to further dig into the issue of the influence of discretionary measures on tax elasticities as well as to provide elements for a backward assessment of fiscal plans vs. outcome.