Testing Wagner’s Law Based on Government Functions: Is There Evidence of Quality of Public Finances Regarding Sustainability?

Abstract

The issue of the quality of public finances is gaining importance in light of long-term fiscal sustainability challenges. The Recovery and Resilience Facility (RRF) can play a role in improving the quality of public finances by reshaping the composition of general government expenditure by function and supporting the economy’s long-term growth potential. This paper analyses the validity of Wagner’s law for Euro area countries and examines the evidence on the quality of public finances based on productive government expenditure. The quantitative approach is based on panel data approaches. The results do not confirm the validity of Wagner’s law. However, they indicate that the RRF, as an instrument of exogeneous fiscal intervention, has contributed to a shift in the composition of government expenditure, thereby providing some evidence of an improvement in the quality of public finances. Given that the RRF is a temporary, performance-based programme, it represents—at best—a temporary form of exogeneous fiscal intervention on the quality of public finances, which, upon its completion and ceteris paribus, will remain within the domain of the Member States.