A note on the relation between government expenditure and receipts in Italy : a quarterly analisys

A precise knowledge of the relation between government expenditure and revenues may be useful to control budget deficits because, if there is interdependence raising taxes to reduce deficits may lead directly to more spending. An effective manipulation of central government spending and tax revenues requires information on the direction of causality between these economic variables. The purpose of this paper is to investigate the relationship between government expenditure and receipts based on quarterly data, using the structural cointegration approach of Pesaran and Pesaran 1997. This approach tries to link the new literature of cointegration and the traditional literature of dynamic structural econometric modelling and not only identifies cointegration vectors, but also suggests the use of model selection criteria, together with diagnostic tests, to specify short-run dynamics and deterministic components. In the results presented below, the structural cointegration approach provides evidence of a long and short-run equilibrium between government spending and receipts, supporting the assumption that the Italian Government’s expenditure is a sort of automatic stabiliser as opposed to Wagner’s Law. Tests were performed for the presence of short and long-run causality: all the estimates point out to bi-directional causality, with Granger expenditure causing revenues and Granger revenues causing expenditure for almost all lag structures.