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

This paper tests a version of Barro's tax-smoothing model, which assumes intertemporal optimization by a government seeking to minimize the distortionary costs of taxation, using Pakistan and Sri Lankan data for the periods 1956-95 and 1964-97, respectively. The empirical results indicate that Pakistan's fiscal behavior is consistent with tax smoothing, but Sri Lanka's is not. Moreover, fiscal behavior in both countries was dominated by a stagnation of revenues, large tax-tilting-induced deficits, and the consequent accumulation of excessive public liabilities. Analysis of the time-series characteristics of tax-tilting behaviour indicates that for both countries the stock of public liabilities is unsustainable under unchanged fiscal policies.