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

by Paul Cashin

One rationale for the existence of fiscal imbalances is to minimize the distortionary effects of levying nonlump-sum taxes (for a given present value of tax collections), by spreading the burden of these taxes over time. For a given amount of public expenditure, if taxes are lump sum and the other conditions for Ricardian equivalence are present, there are no real effects from shifts between taxes and the issuance of public debt as modes of financing fiscal imbalances. However, if taxes are distorting then the timing of taxes will matter, and it will be desirable to smooth tax rates over time, financing any temporary difference between public revenue and public expenditure by creating public debt.2 This concept of tax smoothing, first introduced by Barro (1979), is now well established in the literature on fiscal policy. Tax smoothing has the normative implication that budget imbalances can be optimal fiscal policy responses to anticipated future events. In particular, a government anticipating an increase in its own expenditure can minimize the distortionary effects of raising the finance for that expenditure if it brings forward some of the associated tax increase and runs a budget surplus (or a smaller deficit) in the current period. Similarly, a budget deficit (or a smaller surplus) is optimal if the government anticipates future falls in its expenditure.

35 pages, Kindle Edition

First published May 1, 1999