Tax-Spend or Spend-Tax Hypotheses: A Case Study of Pakistan using Threshold Cointegration with Asymmetric Adjustment

Abstract

Revenue-spending nexus has significant inferences for the political economy to understand the fiscal policies particularly in context of Pakistan economy. In the current study, the traditional tax-spend versus spend-tax view of fiscal policy is investigated based on asymmetrical TAR and M-TAR tests of cointegration. For this, we have used annual data on taxes and government spending for Pakistan over the period 1976 to 2019. The results show some evidence in favor of the traditional tax-spend view. It implies that catering revenue from tax side results in more spending and increases the fiscal deficit. Hence, the devastating effect on fiscal balance is evident, if it is targeted through taxes. Therefore, it is required that fiscal adjustment should be from spending side rather than tax. Furthermore, the results indicate that both taxes and government spending are cointegrated (have long-run equilibrium relationship) with asymmetric adjustment process towards long-run equilibrium. Moreover, budgetary deviations below long-run equilibrium are corrected faster than deviations above it.