Testing the Tax Smoothing Hypothesis of Fiscal Policy: Some Evidence from Italy
This paper tests Barro's (1979) tax smoothing model of fiscal policy. The model implies that budget deficits and surpluses are used optimally to minimise the distortionary effects of taxation, given a certain path of spending. The theory has a number of implications both for the statistical time series properties of government budget data and for causality amongst these variables. These implications are derived and tested on a vector autoregression model using annual data for Italy covering the period for the full sample. However, when we consider the post World War II period all of the tests clearly reject the tax smoothing hypothesis.
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