Taxing choices in deficit reduction

This paper attempts to: (a) determine whether governments have continuously attempted to align revenues or spending to control the deficit; (b) test for causality between taxes and spending; and (c) quantify the causality effects by; (i) estimating an error correction model, and (ii) calculating variance decompositions and impulse responses. The tests were carried out for the countries of Argentina, Brazil, Chile, Mexico, and Pakistan. The results can be summarized as follows: The governments of Brazil, Mexico, and Pakistan seem to have successfully aligned revenues and spending as means of controlling the deficit over the time period examined, while a similar deduction for Argentina and Chile could not be made. For Brazil, Mexico, and Pakistan, strong instantaneous causality runs both directions. In Argentina and Chile, deficit was found to cause and be caused by expenditures. Impulse responses for Mexico and Brazil were found to have short-run effects only, while for Pakistan the effects were more persistent. In terms of variance decompositions it was found that variations in both revenues and spending are explained in most part by past spending. The above results suggest that to control the deficit, Brazil, Mexico, and Pakistan should attempt to raise revenues and curtail expenditures simultaneously, while Argentina and Chile should control public expenditures as a first priority.