Tax Base Variability and Procyclical Fiscal Policy

37 Pages Posted: 30 Jun 2000 Last revised: 14 Oct 2010

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: January 2000

Abstract

Based on a sample of 56 countries, we find that 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 is much more volatile in developing countries than in the G-7 countries.

Suggested Citation

Talvi, Ernesto and Vegh, Carlos A., Tax Base Variability and Procyclical Fiscal Policy (January 2000). NBER Working Paper No. w7499. Available at SSRN: https://ssrn.com/abstract=227599

Ernesto Talvi (Contact Author)

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

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Carlos A. Vegh

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

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University of Maryland - Department of Economics ( email )

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University of California at Los Angeles ( email )

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310-825-9528 (Fax)

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

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