Strategies and consequences of local fiscal consolidation: Evidence from Germany

Abstract

We investigate the consequences of a large-scale fiscal consolidation program for German municipalities. Identification relies on a difference-in-differences approach exploiting political discretion in the program’s assignment rule. We find that targeted jurisdictions improved their fiscal balance by EUR 190 per capita and year net of the program-induced grants. Local consolidation strategies differed significantly by population size, which we rationalize with agglomeration economies. Spending cuts and tax increases had little effect on the local economy. However, we detect declines in population levels and house prices as well as electoral backlash in smaller municipalities that disproportionally increased the property tax and cut spending on local public services.