Spend Now, Pay Later? Tax Smoothing and Fiscal Sustainability in South Asia

Abstract:     
This paper tests a version of Barro`s tax-smoothing model, which assumes intertemporal optimization by a government seeking to minimize the distortionary costs of taxation, using Pakistan and Sri Lankan data for 1956-95 and 1964-97, respectively. The empirical results indicate that Pakistan`s fiscal behavior is consistent with tax smoothing, but not Sri Lanka`s. Moreover, fiscal behavior in both countries was dominated by a stagnation of revenues, large tax-tilting-induced deficits, and the consequent accumulation of excessive public liabilities. Analysis of the time-series characteristics of tax-tilting behavior indicates that for both countries the stock of public liabilities is unsustainable under unchanged fiscal policies.

Number of Pages in PDF File: 34

Keywords: Tax smoothing, tax tilting, fiscal sustainability, Pakistan, Sri Lanka

JEL Classification: E6, H21, H62, O23

working papers series