Analysis of Fiscal Synchronization Hypothesis: Evidence From Pakistan

Abstract

Objective: This research intends to examine the relationship between tax revenue and government expenditure in Pakistan, with a focus on testing the fiscal synchronization hypothesis and assessing the indicators of future fiscal sustainability. Additionally, this study seeks to estimate the elasticity of TR with respect to PE.

Research Gap: The causal relationship between Government revenue and expenditure has remained an empirically debatable issue in the field of finance. Pakistan's fiscal policy has been characterized by persistent and large fiscal deficits, which have raised concerns about the country's economic stability and growth prospects. This study aims to fill this gap by examining the dynamics of government revenue and expenditure in Pakistan and assessing the implications for future fiscal sustainability.

Methodology: It employed TSD from 1989 to 2024. The study employed the Augmented Dickey-Fuller Test, Granger causality test Engel Granger Co-integration test, and elasticity regression for analysis of the data.

The Main Findings: The results of Granger causality in million PKR suggest that the fiscal synchronization hypothesis exists in Pakistan, indicating a bidirectional causality between tax revenue and public expenditure. In contrast, when TR and PE are measured as a tax-to-GDP ratio, the results support the revenue-spend hypothesis, implying that changes in tax revenue lead to changes in public expenditure. The findings of Regression No.1, which measures tax revenue and public expenditure in units, provide evidence that these two fiscal variables are strongly interconnected. Conversely, Regression No.2, which examines the impact of GDP growth on tax revenue and public expenditure as a ratio of GDP, reveals an insignificant relationship, implying that GDP growth may not be a significant factor influencing changes in tax revenue and public expenditure. Results of TR elasticity with respect PE show that there is weak future fiscal sustainability in Pakistan.

Practical implication of the Findings: The study findings highlight the importance of effective expenditure management. Policymakers should prioritize expenditure allocation, ensure efficient use of resources, and reduce wasteful spending. The study findings can inform Pakistan's fiscal policy by highlighting the importance of coordinating tax revenue and public expenditure plans. The revenue-spend hypothesis suggests that tax reforms can be an effective way to improve tax revenue mobilization and finance public expenditure. To address the fiscal deficit and debt burden, it is essential to implement a fiscal consolidation strategy that focuses on increasing tax revenue and reducing public expenditure. One key approach to increase tax revenue is to broaden the tax base by reducing exemptions and concessions, thereby increasing the number of taxpayers and revenue generated Therefore, policymakers should prioritize tax revenue mobilization through reforms and efficient tax administration, while simultaneously reducing non-essential public expenditure. This approach can help control the fiscal deficit, reduce the debt burden, and ensure fiscal sustainability. Strengthening tax administration through automation, digitization, and capacity building can also improve tax collection efficiency.