Tax Base Variability and Procyclical Fiscal Policy

33 Pages Posted: 26 Jan 1999

See all articles by Ernesto Talvi

Ernesto Talvi

Centro de Estudios de la Realidad Economica y Social (CERES)

Carlos A. Vegh

Johns Hopkins University - Paul H. Nitze School of Advanced International Studies (SAIS); University of Maryland - Department of Economics; University of California at Los Angeles; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: November 1998

Abstract

While fiscal policy in the G-7 countries appears to be broadly consistent with Barro's tax smoothing proposition, in developing countries government spending and taxes are highly procyclical (i.e., government spending rises and taxes fall during expansions, while the reverse is true in recessions). To explain this puzzle, we develop an optimal fiscal policy model in which running budget surpluses is costly because they create pressures to increase public spending. Given this distortion, a government that faces large (and perfectly anticipated) fluctuations in the tax base will find it optimal to run a procyclical fiscal policy. We argue that the differences in fiscal policy between the G-7 countries and developing countries can be traced back to the fact that the tax base in developing countries is much more volatile than in the G-7 countries.

JEL Classification: F4, H3

Suggested Citation

Talvi, Ernesto and Vegh, Carlos A., Tax Base Variability and Procyclical Fiscal Policy (November 1998). Available at SSRN: https://ssrn.com/abstract=147211 or http://dx.doi.org/10.2139/ssrn.147211

Ernesto Talvi

Centro de Estudios de la Realidad Economica y Social (CERES) ( email )

Antonio Costa 3476
11300 Montevideo
Uruguay
(5982)628-7703 / 628 76 44 (Phone)
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Carlos A. Vegh (Contact Author)

Johns Hopkins University - Paul H. Nitze School of Advanced International Studies (SAIS) ( email )

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Washington, DC 20036-1984
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University of Maryland - Department of Economics ( email )

College Park, MD 20742
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University of California at Los Angeles ( email )

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United States
310-825-7371 (Phone)
310-825-9528 (Fax)

HOME PAGE: http://vegh.sscnet.ucla.edu

National Bureau of Economic Research (NBER)

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