Research Paper No. 700

Spend Now, Pay Later? Tax Smoothing & Fiscal Sustainability in South Asia*

by

Paul Cashin, Nadeem Haque & Nilss Olekalns

June 1999

Department of Economics. University of Melbourne. Parkville Victoria 3052 Australia

ABSTRACT

This paper tests a version of Barro's tax-smoothing model, which assumes intertemporal optimization by a government seeking to minimize the distortionary costs of taxation, using Pakistan and Sri Lankan data for the periods 1956-95 and 1964-97, respectively. The empirical results indicate that Pakistan's fiscal behavior is consistent with tax smoothing, but Sri Lanka's is not. Moreover, fiscal behavior in both countries was dominated by a stagnation of revenues, large tax-tilting-induced deficits, and the consequent accumulation of excessive public liabilities. Analysis of the time-series characteristics of tax-tilting behaviour indicates that for both countries the stock of public liabilities is unsustainable under unchanged fiscal policies.
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