Financing the Budget Deficit of Pakistan: A study of the Revenue and Expenditure Nexus

Abstract

This paper examines the Revenue-Expenditure nexus for Pakistan over a period of 39 years, from 1976 – 2014. It studies whether there exists causality between total revenue and total expenditure, as well as their components: non tax revenue, tax revenue, development expenditure and current expenditure. It employs a five-step procedure which includes the stationarity testing using both ADF and PP tests, there determination of optimal lags using AIC criteria, and the long run and short run relationships using the Ordinary Least Square (OLS) method and Vector Auto Regressive (VAR) framework respectively. At the end, the Granger causality is used to determine the existence of the causality. The paper comes to find that for Pakistan, there is no causality between total revenue and total expenditure, total expenditure and tax revenue, development expenditure and tax revenue, current expenditure and tax revenue, and, total revenue and development expenditure thereby showing that the institutional separation hypothesis holds true in this context. However, there does exist a positive uni-directional causality running from Total Revenue to Current Expenditure, Non-Tax Revenue to Total Expenditure, Development Expenditure and Current Expenditure, which suggests that the government should target revenues before spending, i.e. Spend-and-tax hypothesis.