Terror and its Fiscal Consequences

This chapter examines how terrorism can affect the public finances. The literature identifies three main ways in which terrorism can affect fiscal outcomes. First, by influencing real economic activity and, thereby, government revenues, fiscal deficits and public debt. Second, by negatively affecting both the tax base and the efficiency of the tax administration. Third, by changing the composition of government spending in favor of military outlays. We confirm the importance of these three channels through new research on the impact of major terrorism shocks on macroeconomic and fiscal variables´ dynamics using an unbalanced panel of 191 heterogeneous countries from 1970 to 2018. We find that a terrorist shock lowers a country’s real GDP as well as government tax revenues and raises the debt-to-GDP ratio. The composition of government spending shifts in favor of military spending. Low-income countries are affected more than both emerging market and advanced economies.