erc/metu
INTERNATIONAL CONFERENCE IN ECONOMICS  IV
September 13-16, 2000, Ankara

Empirical Analysis of the Causal Relationship between General Government Spending and Revenue

Costas Milas (University of Sheffield, UK)
Gabriella Legrenzi (University of Milan, Italy)

Abstract

This paper tests the causal relationship between general government expenditure and revenue for Italy, based on annual data for the period 1956-1999. Economic theory suggests 3 different links between revenue and spending: (i) taxation causes spending, (ii) spending causes taxation, (iii) spending and taxation are simultaneously determined. This is tested on Italian data.

The econometric model is based on the Johansen cointegration analysis for the long-run and a full information maximum likelihood analysis for the short-run model. In the long-run we fail to find a cointegrating relationship between general government expenditure and revenue. This suggests that the Italian public sector is not facing strict budgetary constraints. In fact, (i) the possibility of creating debt was favoured by the low independence level of the Italian central bank (over most of the period considered) and (ii) the expansion of government expenditure for political purposes weakened this link. This result is consistent with the high dimensions of the Italian public debt, that reached 130% of GDP, an outlier inside the EMU countries.

Interesting insights can be obtained by analysing the short-run: once again the link between spending and taxation appears very weak, nevertheless the empirical results support the short-run simultaneity of spending and revenue.

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