Causal Link between Central Government Revenue and Expenditure: Evidence for India

This paper attempts to analyze the causal relationship between central government revenue and expenditure for India using annual data over the period 1970-2008. The Johansen cointegration test suggests that there is a long-run relationship between central government revenue and expenditure. The result from Granger causality test based on Vector Error Correction Models (VECM) suggests bidirectional causality between central government revenues and expenditures in the long-run supporting Fiscal Synchronization hypothesis. Under this hypothesis, our finding indicates that the fiscal authority of India should try to raise revenue and cut expenditure simultaneously in order to control the respective fiscal deficit. The short-run Granger causality test based on WALD test restriction suggests unidirectional causality from expenditure to revenue supporting “Spend-and-Tax” hypothesis. This hypothesis suggests that the unsustainable fiscal imbalances can be mitigated by policies that adjusted government expenditure.