Abstract
Macroeconomic management of a small open economy in a currency board arrangement faces two serious problems: first, under a fixed exchange rate, fiscal policy is the only effective macroeconomic instrument for smoothing out the business cycle; second, the twin deficits phenomenon, if it exists, may jeopardize the stability of the currency board arrangement. This paper uses quarterly seasonally adjusted Eurostat data for the period of 1999–2019, the Hodrick–Prescott filter and a vector autoregression (VAR) to answer the three questions that are of utmost importance to Bulgarian policy-makers: first, is the discretionary fiscal policy of the Bulgarian government procyclical or countercyclical? Second, do the automatic stabilizers in the Bulgarian state budget function properly? Finally, is the twin deficits hypothesis valid for Bulgaria? Our findings imply that the fiscal discretion of the Bulgarian government is procyclical, while the automatic fiscal stabilizers do not work effectively. The first part of the twin deficits hypothesis (the causal link between the fiscal balance and the current account balance) is confirmed but the second part of the twin deficits hypothesis (the positive relationship between the fiscal balance and the current account balance) is rejected for Bulgaria. It may be inferred that both sides of the Bulgarian state budget (revenue and expenditure) need to be improved in order to increase the effectiveness of Bulgaria’s fiscal policy. Low budget deficits (not higher than 3% of GDP) are recommended for improving the current account balance and encouraging economic growth.
Highlights
Tax holidays were very popular with the countries reviewed, with over 75% of the sample offering some form of tax holiday, generally between 5-15 years (Table 2)
Loss relief was very popular among the sample of countries reviewed, with over three-quarters of the twenty-one countries reviewed offering some form of loss carryforward (Kenya, Singapore and Uganda offered unlimited loss carry-forward)
This review has found that developing countries have tended to rely on tax holidays, which are a popular and common tax incentive
Summary
Policy-makers’ choice of fiscal instruments from Table 3 depends on the structure of the economy, government objectives and on the activities, companies and investors that the government wish to promote According to how they operate, different tax incentives can have different impacts on:. Advocates of lower tax rates claim that they increase entrepreneurial incentives, encourage greater economic activity and reduce incentives for tax evasion, bringing more of the informal economy into the formal, registered sphere. Critics argue that they merely result in a so-called race-to-the-bottom, with developing countries making precious tax concessions that they can ill afford to give, in order to attract investment.
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