The (Subjective) Well-Being Cost of Fiscal Policy Shocks

IMF Working Papers, January 17, 2020

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Do discretionary spending cuts and tax increases hurt social well-being? The study combines subjective well-being data covering "over half a million" of individuals across "13 European countries" with macroeconomic data on fiscal consolidations.
Fiscal consolidations reduce individual well-being in the short run, especially when they are based on spending cuts.
Accompanying monetary and exchange rate policies mitigate the well-being cost of fiscal consolidations:
- Disinflation has a dampening effect on the well-being cost.
- Depreciations mitigate the well-being cost.
- The liberalization of capital flows mitigates the well-being cost.
Even expansionary fiscal consolidations can have well-being costs; the paper investigates two well-known expansionary fiscal consolidation episodes in the "80s" (in Denmark and Ireland) and finds well-being costs in those episodes.
The results may help explain why some governments may choose to consolidate through taxes even at the cost of economic growth: if spending cuts generate a large well-being loss, they can trigger opposition and protest and make consolidation politically costly.

Spending cuts versus tax increases:
- Spending cuts are associated with larger short-run reductions in subjective well-being than tax increases.
Interaction with macro policies:
- Monetary policy (disinflation) and exchange rate adjustments (depreciations), as well as capital flow liberalization, can attenuate the negative well-being effects of fiscal consolidations.
Political economy implication:
- Large well-being losses from spending cuts can generate opposition and protest, increasing the political cost of consolidation and potentially influencing governments to favor tax-based consolidation despite slower economic growth.

Subjective well-being data: over half a million individuals.
Geographic coverage: 13 European countries.
Historical episode analysis: two expansionary fiscal consolidations in the 80s (Denmark and Ireland).
Study focus keywords/subjects (as listed): Active labor market policies, Consumption taxes, Fiscal consolidation, Fiscal policy, Income inequality, Labor, National accounts, Taxes, dampening effect, effect of fiscal consolidations, Europe, Fiscal consolidation, Fiscal Consolidations, fiscal policy shock, Income inequality, inflation rate, public goods, recessionary effect, spending cut size, Spending cuts, Subjective Well-Being, substitution effect, Tax hikes, well-being cost, WP.