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Why Aggregate Indicators Fail in Fiscal Sustainability Evaluation: Tax Base Heterogeneity, Reweighting, and the Limits of GDP Elasticity

Author

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  • Etsusaku Shimada

    (Faculty of Policy Studies, Iwate Prefectural University)

Abstract

Fiscal sustainability is commonly evaluated using aggregate indicators such as GDP growth and tax revenue elasticity, yet this paper shows that such indicators can be fundamentally insufficient once fiscal capacity depends on the evolving structure of underlying tax bases. When tax revenue is generated by heterogeneous tax bases whose growth rates and revenue weights evolve over time, aggregation induces an intrinsic informational loss that cannot be resolved by refining elasticity estimates. To establish this result, tax revenue is modeled as the aggregation of industry-specific tax bases subject to heterogeneous growth dynamics and institutional features of corporate taxation. Within this framework, we show that tax revenue growth cannot, in general, be characterized by a single, time-invariant elasticity with respect to aggregate output. The analysis clarifies the structural conditions under which conventional benchmarks, including the Domar condition, remain valid. When tax bases evolve proportionally with aggregate output and industrial composition is stable, the Domar condition emerges as a special case of a more general stability condition. Once these restrictive assumptions are relaxed, changes in tax base composition and sectoral profit dynamics can generate systematic divergences between output growth and tax revenue growth. The paper derives a structural fiscal stability condition in which debt sustainability depends on the weighted growth dynamics of underlying tax bases rather than on aggregate output alone. Stylized facts from Japan and the United States illustrate how differences in industrial structure and tax institutions shape revenue dynamics in practice. More fundamentally, the analysis highlights the structural limitations of aggregate-indicator–based fiscal evaluation: fiscal sustainability is a property of how fiscal capacity is generated through the composition and dynamics of underlying tax bases.

Suggested Citation

  • Etsusaku Shimada, 2026. "Why Aggregate Indicators Fail in Fiscal Sustainability Evaluation: Tax Base Heterogeneity, Reweighting, and the Limits of GDP Elasticity," KIER Working Papers 1123, Kyoto University, Institute of Economic Research.
    • Handle: RePEc:kyo:wpaper:1123
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    References listed on IDEAS

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    1. Bohn, Henning, 2007. "Are stationarity and cointegration restrictions really necessary for the intertemporal budget constraint?," Journal of Monetary Economics, Elsevier, vol. 54(7), pages 1837-1847, October.
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    Keywords

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    JEL classification:

    • H20 - Public Economics - - Taxation, Subsidies, and Revenue - - - General
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • O40 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - General

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