Media Briefings


  • Published Date: March 2015

Budget cuts and tax increases are harming future business investment and growth in the Europe, while new government policies relaxing these austerity measures to encourage investment may have come too late. These are among the findings of new research by Silvia Albrizio and Stefan Lamp to be presented at the Royal Economic Society’s 2015 annual conference.

Their study analyses the relationship between changes in tax laws and investment by manufacturing firms in Germany between 1970 and 2010, and finds that:

• Firms change their future investment plans based on the current tax laws and any recent changes to them. A 1% tax increase on all manufacturing goods is countered by a 4% decrease in planned investment by a firm. This translates to an 8% actual decrease in business investment in the year the rate change was announced.

• Personal income taxes and sales taxes affect business investment more strongly than corporate income taxes. This is because firms anticipate reduced demand for their goods due to lower consumer buying power. What’s more, small businesses decrease their planned investment more disproportionately than large ones.

The authors comment:

‘While our study focuses on German manufacturing, the findings are likely to apply to any wealthy OECD nation with a strong industrial production base.

‘Policy-makers should be aware of the negative effect of tax adjustments on firms’ future and current investment. Tax laws should be designed in a way that is least harmful for future investment and long-term economic growth.’


After years of fiscal consolidation being the upmost priority for policy-makers in most OECD countries, the European Union recently changed its position on the issue, refocusing on growth-enhancing policies instead of budgetary cuts. The European Investment Plan is the central pillar of this endeavour with the objective of leveraging an ambitious amount of private investment and restarting the engine of growth and productivity.

Does this strategy come to late? What has been the impact of the fiscal tightening on business confidence and investment? Is it possible to design consolidation measures that at the same time safeguard firms’ future investment?

This research addresses some of these key questions by looking at the relationship between fiscal consolidation and firm investment in Germany, the largest economy in Europe.

The authors find that firms in the manufacturing sector change their future investment strategy depending on the tax laws currently under discussion and recently passed tax adjustments. In particular, they find that firms anticipate future tax changes by revising downwards their planned investment by about 4% subsequently to an tax increase equal to 1% of the value added in the total manufacturing industry. Realised investment growth drops by 8% in the year of the announcement of the tax change.

Moreover, these findings suggest that the design of the tax adjustment matters. The authors show that shifts in income and consumption taxes have a stronger impact on investment than changes in corporate taxation. In particular, consumption taxes affect households’ choices and firms adjust their demand expectations, decreasing future investment.

Finally, the authors find that the investment effect differs according to firm size, which is in line with the notion that smaller firms are likely to be financially constrained and have more difficulties in responding to aggregate shocks.

To provide robust estimates, the analysis is based on an innovative approach that combines a detailed narrative of German tax adjustments for the period 1970-2010 with a rich firm-level dataset. The results apply to German manufacturing industry, however given the large industrial production share in the overall economy, the effects are likely to be interpretable in a broader sense. Also, as previous literature has shown, these effects are not country-specific but are likely to apply to a large set of OECD countries, especially those with a strong industrial production base.

Previous literature has shown that spending-based adjustments are preferable over tax-based adjustments when it comes to fiscal consolidation, as the latter lead to deeper and more prolonged recessions. But using public spending in periods of economic downturn is likely to imply future tax increases.

On the basis of these results, policy-makers should be aware of the negative effect of tax adjustments on firms’ future and current investment and consequently tax laws should be designed in a way that is least harmful for future investment and long-term economic growth.


‘The Investment Effect of Fiscal Consolidation’ by Silvia Albrizio and Stefan Lamp, EUI Working Paper 2014/10

Contact details:
Silvia Albrizio,, cell. +33 781 66 1323 (PRESENTER)
Stefan Lamp,, cell + 1 (203) 901-2798