Tax and Spend, or Spend and Tax? An Inquiry into the Turkish Budgetary Process

Abstract

For resolving the budget deficit problem, some economists have advocated spending cuts, while others support either tax increases or tax cuts. This paper investigates the interrelationship between the two fiscal variables for Turkey using bivariate and multivariate cointegrating models. The Engle-Granger and Johansen tests consistently support the existence of one nonzero cointegrating vector representing a stable long-run relationship between government spending and revenues in Turkey. Furthermore, the multivariate error-correction model suggests that taxes unidirectionally Granger-cause negative changes in spending in accordance with the BuchananWagner hypothesis. Thus, from the perspective of policy making and the deficit solution debate, raising taxes in Turkey is perhaps the optimal solution to the current budget deficit predicament. Contemporary economies, perhaps without exception, have been plagued with huge and escalating government budget deficits. These deficits are expected to have adverse economic consequences including high real interest rates, slow capital formation, and high unemployment rates. Moreover, to the extent that the deficit is financed through the issuance of government bonds, the recurrent large deficits have further worsened the public debt problem, which threatens the well-being of numerous countries, both developed and developing. Therefore, researchers and policymakers have expended enormous efforts attempting to analyze the deficit problem and to suggest ways to resolve it. Some, for example, advocate cuts in government spending rather than tax increases as the optimal solution to the deficit dilemma. They reason that governments often spend all that they receive in taxes and perhaps much more. Under this line of reasoning, raising taxes would simply induce more spending, leaving the deficit unchanged (or even higher). Others, however, deny this implied tax-and-spend nexus, and argue that it is taxes that adjust gradually to spending. Under this latter scenario, tax increases will not lead to higher spending, and thus, could be used as an effective deficit-cutting measure along with spending cuts. Still, other researchers posit that changes in spending and taxes could occur simultaneously. Therefore, focusing on one component of the government budget while ignoring the interdependence with the other component would have an ambiguous overall effect on the deficit.