Fiscal Vulnerability Sources: Empirical Evidence for the European Union

Abstract

The aim of this paper is to study the sources of fiscal vulnerability in the European Union countries. For this purpose, we employ an ordered logistic regression with random effects for a balanced panel comprising of 20 countries using a dataset ranged from 2000 to 2012. The results show that higher overall taxation and especially non-distortionary taxes decrease the probability of fiscal policy to be vulnerable. Total government expenditures, as well as productive an unproductive expenditures contribute to an increase in fiscal vulnerability. Discretionary tight fiscal policy reduces it. Fiscal rule are more efficient in lowering vulnerability when unproductive expenditures are included in the model. Fostering economic growth mitigates the risk of one country to become vulnerable, while large financial sector contributes to the increase in fiscal vulnerability. Government effectiveness lowers vulnerability of fiscal policy. Additionally, we found that Central and Eastern European countries are more exposed to fiscal vulnerability than their advanced counterparts.