Why Aggregate Indicators Fail in Fiscal Sustainability Evaluation: Tax Base Heterogeneity, Reweighting, and the Limits of GDP Elasticity

Etsusaku Shimada ()
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Etsusaku Shimada: Faculty of Policy Studies, Iwate Prefectural University

No 1123, KIER Working Papers from Kyoto University, Institute of Economic Research

Abstract: Fiscal sustainability is commonly evaluated using aggregate indicators such as GDP growth and tax revenue elasticity, yet this paper shows that such indicators can be fundamentally insufficient once fiscal capacity depends on the evolving structure of underlying tax bases. When tax revenue is generated by heterogeneous tax bases whose growth rates and revenue weights evolve over time, aggregation induces an intrinsic informational loss that cannot be resolved by refining elasticity estimates. To establish this result, tax revenue is modeled as the aggregation of industry-specific tax bases subject to heterogeneous growth dynamics and institutional features of corporate taxation. Within this framework, we show that tax revenue growth cannot, in general, be characterized by a single, time-invariant elasticity with respect to aggregate output. The analysis clarifies the structural conditions under which conventional benchmarks, including the Domar condition, remain valid. When tax bases evolve proportionally with aggregate output and industrial composition is stable, the Domar condition emerges as a special case of a more general stability condition. Once these restrictive assumptions are relaxed, changes in tax base composition and sectoral profit dynamics can generate systematic divergences between output growth and tax revenue growth. The paper derives a structural fiscal stability condition in which debt sustainability depends on the weighted growth dynamics of underlying tax bases rather than on aggregate output alone. Stylized facts from Japan and the United States illustrate how differences in industrial structure and tax institutions shape revenue dynamics in practice. More fundamentally, the analysis highlights the structural limitations of aggregate-indicator–based fiscal evaluation: fiscal sustainability is a property of how fiscal capacity is generated through the composition and dynamics of underlying tax bases.

Keywords: Fiscal sustainability; Tax revenue elasticity; Aggregation-induced informational loss; Reweighting; Domar condition; Tax base heterogeneity (search for similar items in EconPapers)
JEL-codes: E62 H20 H63 O40 (search for similar items in EconPapers)
Pages: 16pages
Date: 2026-01
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