Fiscal Illusion Theory Research Articles

Fiscal Discipline and Budget Processes: Evidence from Zimbabwe

Zimbabwe is one of the least fiscally performing countries in Sub-Saharan Africa, with some fiscal outcomes for years 2009 to 2019 being unsatisfactory. The IMF 2020 Article IV consultation report on Zimbabwe suggested that fiscal and monetary slippages experienced in 2018 and 2019 resulted in macroeconomic imbalances in 2019 and greater part of 2020. The study adopted a qualitative approach to investigate the relationship between fiscal discipline and the budget processes in Zimbabwe. Informed by the fiscal illusion theory as well as the formative fiscal federalism theory, the study established that the growth in fiscal indiscipline in Zimbabwe leads to widening fiscal deficits, increased direct budget financing requirements on the domestic market and unsustainable debt profile. Fiscal indiscipline is driven by weak budget institutional frameworks, party institutionalisation and economic sanctions.To enhance fiscal discipline, strengthening and implementation of existing fiscal institutional frameworks and engagement of the international community on sanctions are necessary. Publication of agreed fiscal targets for credibility purposes may help. Promoting increased savings during booms for consumption smoothening in periods during periods of droughts, cyclones and pandemics is encouraged.

Determinants of Financial E-Transparency in Honduran Municipalities

This paper contributes to the scarce literature on e-government transparency in Central America by analyzing the impact of political, financial and socio-economic factors on municipal financial e-transparency in Honduras. The sample covers 86 Honduran municipalities in 2016-17. The data show a weak impact of ideology and mayor's gender on e-transparency, with progressive governments and men achieving more e-transparency. Municipalities receiving more transfers are more transparent. Taking all financial variables together, the data are in line with the Theory of Fiscal Illusion and the Theory of Agency, since municipalities are not reporting greater levels of taxes, deficit, and debt to their taxpayers. Honduran municipalities are only concerned about meeting central government legal requirements about transfers received. The fact that municipalities do not increase e-transparency to be held accountable by their citizens is against the assumptions of the Theory of Legitimacy. Finally, larger municipalities and with greater income are more fiscally transparent.

Fiscal illusion as an incentive for local government public expenditure efficiency: The influence of community sensitization

Although the effect of public expenditure efficiency on local government fiscal performance is widely-documented, what precisely explains expenditure efficiency remains largely unclear. Nevertheless, past research holds fiscal illusion as the most likely predictor and community sensitization very critical for fiscal illusion-expenditure efficiency formation. We employed fiscal illusion theory to investigate possible fiscal illusion-community sensitization-expenditure efficiency mediation in 16 districts, 6 municipalities, and 160 sub-counties of Uganda’s northern region. Over the years, Uganda; an East African country, is applauded for its fiscal federalism proficiency. But presently, its northern region is grappling a 20-year post-conflict trauma likely to compromise entity spending efficiency. Structural equation modeling results suggest that all the four fiscal illusion constructs: fiscal imbalances, political divide, tax payment bias, and fiscal sabotage, predict changes in expenditure efficiency. However, community sensitization does not mediate the fiscal illusion-expenditure efficiency linkages. Implications for these findings and possible direction for future research are discussed.

Tax Reforms, Fiscal Illusion and Moral Hazard: Some Econometric Evidence from Indian Economy

Theory of Fiscal illusion as a theory of government expenditure was first conceived by an Italian economist Puviani suggesting that the benefits from tax revenue through government expenditure are not fully understood by the taxpayers if the government revenues are unobserved. This is due to information asymmetry. Since some or all taxpayers benefit from government expenditures from these unobserved or hidden revenues the public's demand for government expenditures increases, thus providing politicians incentive to expand the size of government. Fiscal Illusion is invoked as an explanation of the flypaper effect when a higher level of government provides a grant to a lower level of government because the local taxpayers are under the mistaken perception that the grant is to local government and not, in fact, to them. One of the sources of fiscal illusion is the complexity of the tax system. According to the fiscal illusion hypothesis, governments spending can be influenced by the size of the public sector and complexity in the tax system. An attempt is made in the present study to examine the fiscal illusion and explore its relationship with the fiscal dimension including revenue receipts and spending of the government. Considering the Indian federal system, the paper examines revenue diversification that has occurred during 1970 and 2016, and it estimates a model that examines the degree of moral hazard which arises mainly due to fiscal illusion within the framework of the principal agent.

Causes of Fiscal Illusion: Lack of Information or Lack of Attention?

According to fiscal illusion theory, voters misperceive fiscal parameters because of incomplete information. The costs of public services are underestimated, implying that if voters had full information, their support for public services would drop. The literature has focused on testing the implications of fiscal illusions, whereas the question why fiscal illusions occur at all has received less attention. According to the standard argument, individuals base their opinion of policy proposals on a valuation of benefits and costs. We formalize the standard argument and show that it is a special case of the attention model of fiscal illusion. In this model, opinion depends on the saliency of attributes of the proposal. We show that the attention model can better explain fiscal illusion by deriving competing hypotheses, which are tested in a survey experiment. We conclude that the mechanism behind fiscal illusion is attention and framing, not incomplete information.

Taxation, Inequality, and the Illusion of the Social Contract in Brazil

Brazil combines high inequality and high tax yield as percentage of the GDP. This situation contradicts the predictions of two central theories of taxation and democratic politics. The first theory predicts that, within a democratic context, high levels of income inequality should lead governments to carry out significant redistribution. The second theory sees the government’s ability to raise tax revenue as dependent on a social contract between the state and its citizens, and predicts a negative relationship between taxation and social polarization. In this paper, we propose that the theory of fiscal illusion (Puviani 1 903; Buchanan 1967) can account for this double puzzle Brazil presents us. We argue that, by heavily relying on the exploitation of fiscal illusion, the Brazilian state has been able to mobilize a huge amount of tax resources without the need of a broad social contract that could lead to more redistribution, effective public services, and growth-enhancing policies. The paper provides some evidence that supports our argument. First, using recent household surveys and a tax-benefit microssimulation model, we show that redistribution by the state is small, and that even the poorest 20% of the households are, on average, net contributors to the fiscal system.Second, we describe some main features of the Brazilian tax system that tend to induce voters-taxpayers to underestimate the cost of government’ activities. For instance, in the past, the inflation tax and debt financing were major instruments and, nowadays, complex and cascading indirect taxation plays a major role as a source of illusion. We then emphasize that the relationship between inequality and redistribution cannot be predicted without an understanding of the way inequality influences state financing: the institutions of taxation matters.

Determinants of Social Expenditure in Sri Lanka

The study examines the determinants of social expenditure in Sri Lanka for the period 1970–2010. The data are from a new data set assembled by the authors. The social spending data are collected from the Central Bank of Sri Lanka on education, health, and also on welfare spending. The study explains the determinants of social spending considering the demand-side and the supply-side driving forces and finds that inequality issues have been a major concern of social policy in Sri Lanka. Similarly, this study implies the influence of political behavior to satisfy voters as explained by the fiscal illusion theory. The globalization is not significant for social expenditure as commonly assumed in developed countries. Even the consequences of the self-interested behavior of bureaucrats are not evident in the Sri Lankan welfare sector.

The Relevance of the Theory of Fiscal Illusion. The Case of the Italian Tax System

This work analyses the phenomenon of fiscal illusion (Puviani, 1903) in the context of the Italian tax system. Financial (or fiscal) illusion refers to mechanisms which cause a cognitive alteration on the part of the taxpayer regarding the evaluation of the costs and benefits of public policies. Puviani (1903) was the first to classify the different types of financial illusions. He highlighted the main strategies used to hide the real costs of financing public goods and services through taxes (illusions on revenue) or to overestimate their usefulness (illusions on expenditure). The main conclusions of the work are that: (i) from a methodological point of view, there is a connection between Puviani’s theory of fiscal illusion and some of the assumptions of the behavioral approach and (ii) from an operational point of view, it is a useful tool to understand the motives that could have inspired several recent taxes and legislative measures within the Italian tax system. These results support the relevance of Puviani’s theory to the contemporary theory and practice of public finance.

The Behavioral Political Economy of Budget Deficits: How Starve the Beast Policies Feed the Machine

The notion of “starving the beast” has been an important justification for fiscal programs emphasizing revenue reductions since the mid-1970s. While the idea of restraining government spending by limiting government revenues has an intuitive appeal, there is convincing evidence the reducing federal tax rates without coordinated reductions in federal spending actually produces long-term growth in spending. This perverse result is explained by a theory of “fiscal illusion.” By deferring the costs of government services and benefits through deficit financing, starve the beast policies have the effect of lowering the perceived price of government in the minds of many citizens. We assess the principal behavioral prediction of the fiscal illusion theory.Incorporating estimates of the effects of federal deficits into a standard substantive model of Stimson's mood index, we find strong support for a subjective price-driven theory of demand for government. In particular, we find that the size of the federal budget deficit is significantly associated with greater demand for government services and benefits. This may have important implications for contemporary debates about fiscal discipline.

Budget Deficits and Demand for Government: How Starve the Beast Policies Feed the Machine

The notion of starving the beast' has been an important justification for programs emphasizing revenue reductions since the mid-1970s. While the idea of restraining government spending by limiting government revenues has an intuitive appeal, there is convincing evidence the reducing federal tax rates without coordinated reductions in federal spending actually produces long-term growth in spending. This perverse result is explained by a theory of fiscal illusion.'' By deferring the costs of government services and benefits through deficit financing, starve the beast policies have the effect of lowering the perceived price of government in the minds of many citizens. We assess the principal behavioral prediction of the illusion strategy. Incorporating estimates of the effects of federal deficits into a standard substantive model of Stimson's mood index, we find strong support for a subjective price-driven theory of demand for government. In particular, we find that the size of the federal budget deficit is significantly associated with greater demand for government services and benefits.

CENTRAL GOVERNMENT BUDGET PRACTICES AND TRANSPARENCY: AN INTERNATIONAL COMPARISON

From an international perspective, a relationship between public sector transparency and better economic and social outcomes is something that is increasingly acknowledged. In terms of lack of transparency in budget reports both bureaucratic model and fiscal illusion theory have been argued as explanations. To assess transparency in budget practices we analyse to what extent a sample of 41 countries are meeting OECD requirements according to its Best Practices for Budget Transparency document (OBP). We find an average OBP fulfilment of 56.4 per cent. Transparency is negatively correlated with corruption and positively correlated with economic development. Countries receiving external financial and technical support meet fewer OBP recommendations than countries not receiving it. Considering the political framework, both progressive and conservative governments reach similar transparency levels. OECD members do not significantly fulfil more OBP suggestions than non‐members. In respect of 4 variables: transparency, corruption, democracy and development, four clusters of countries arise: top‐performing, low transparency‐developed, low transparency‐developing and worst‐performing.

The Theory of Fiscal Illusion in a Constitutional Perspective

This article examines the theory of fiscal illusion, showing that after the international attention received, thanks to James M. Buchanan, it deserves some further reflections. In particular, this article emphasizes the general nature of the fiscal illusion processes, which can be found not only in totalitarian but also in democratic systems. At the end, the suggestion is made to remove (or at least minimize) the effects of the illusion processes and to make stable the fiscal system according to the Buchanan’s fiscal constitutional proposal.

Why people want something for nothing: The role of asymmetrical illusions

Abstract. This article examines if and why mechanisms exist at the individual citizen level that may contribute to public sector growth — and whether such mechanisms can be altered through provision of information about the costs of public services.We test and find empirical support for the theory of fiscal illusion according to which citizens underestimate the costs of public services and therefore demand more public spending than if they had been fully informed. We also develop and find empirical support for a theory of asymmetrical illusions. This theory claims that producers and users of public services are more spending–minded than ordinary taxpayers — and that limited rationality contributes to this difference. However, the provision of information about the unit costs of public services can weaken these mechanisms of fiscal illusion and asymmetrical illusions. The test is based on tabular, logit, and experimental analysis of survey data from Odense, a Danish city with 175,000 inhabitants.

FISCAL ILLUSION FROM GRANTS AND THE LEVEL OF STATE AND FEDERAL EXPENDITURES

The theory of fiscal illusion maintains that local grant receipts will increase the demand for local public goods. This paper extends the fiscal illusion thesis to the federal and state levels. Fed...

Citizens Strike a Balance: Discontent With Taxes, Content With Spending

ABSTRACTThis article presents the findings of a public opinion survey of the level of taxation in Sweden. The study demonstrates that opinions depend to a large extent on the framing of the problem. On general questions regarding taxes, the answers are usually negative. But when asked about both taxes and benefits, people normally express a positive attitude to both. The opinions about different kinds of taxes vary greatly, but the variation does not correspond to the predictions of the fiscal illusion theory. Opinions about taxes can be assigned to three underlying attitude dimensions. A comparison with an earlier Swedish survey shows that discontent with the level of taxation has not increased since the 1960s, with but one exception, marginal taxes.

Beliefs and errors in voting choices: A restatement of the theory of fiscal illusion

This paper reformulates the theory of fiscal illusion to make it more compatible with the median-voter model of collective choice. It emphasizes the requirement that misperceptions about marginal tax-costs and benefits must be permanent to have any significant effect on the level of public expenditures. The Lancaster-Becker model of consumer demand is then used to demonstrate the peculiar effects of permanent misperceptions on consumer demand. It can be shown, for example, that other things being the same, a Republican who underestimates continuously the marginal benefits of public activities may demand more public goods than a Democrat who overestimates those same benefits in a permanent fashion.