Fiscal Response to Revenue Shocks

Abstract: We study the impact of fiscal revenue shocks on local fiscal behavior. We focus on a very volatile revenue source (immovable property gains tax) in the canton of Zurich, Switzerland, and analyze fiscal behavior following large and rare positive and negative revenue shocks. We apply causal machine learning strategies and implement the post-double-selection LASSO estimator to identify the causal effect of revenue shocks on public finances. We show that local policymakers are, on average, fiscally conservative: they smooth positive shocks and mitigate negative ones by spending cuts. Fiscal behavior is partly driven by the organization of the municipal legislative organ and the electoral cycle. The fiscal responses in towns with local assemblies as well as in pre-election years are best described as fiscally conservative. In contrast, the responses in towns with local parliaments and in post-election years are sensitive to revenue fluctuations, i.e., they spend positive and mitigate negative shocks.