Tax Base Variability and Procyclical Fiscal Policy

Ernesto Talvi and Carlos Vegh

No 7499, NBER Working Papers from National Bureau of Economic Research, Inc

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.

JEL-codes: F41 H30 (search for similar items in EconPapers)
Date: 2000-01
New Economics Papers: this item is included in nep-pbe
Note: IFM
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Citations: View citations in EconPapers (159)

Published as Talvi, Ernesto and Carlos A. Vegh. "Tax Base Variability And Procyclical Fiscal Policy In Developing Countries," Journal of Development Economics, 2005, v78(1,Oct), 156-190.

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