Cause and effect relationship between government expenditure and revenue collection

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1.1 Overview

The relationship between government revenue and expenditure is a very important topic and has been an essential issue for many economists and policy makers as it represents budget deficit, government expenditure Plans and taxation structure of a country. Since the main objective of every government is to improve economic growth with low debt levels, better education system, development of infrastructure and job opportunities better fiscal policy is needed to achieve these goals. From a short term perspective fiscal policy is said to be expansionary when government expenditures exceeds the total revenue and the resulting deficit is then financed by the government, However if these expenditures contributes in economic growth then there is a long term relationship exist between government expenditure and economic growth. In addition different studies indicate that the determination of Economic growth is depended on tax levels. Whereas many believe that the most significant factor that contributes in economic growth is tax level as the collection for development purposes of most developed and developing countries depend on tax revenue.

1.2 Research Problem

In Pakistan the level of budget deficits have consistently increasing from 2005 which is then financed by the government through external and domestic borrowing resulting in a higher debt levels due to high interest cost associated with it and leads to more future tax expectations. Thus the financing by the government for the compensation of deficit is an important variable, several studies have put light on the outcome of fiscal deficit but very few have tried to find the reasons and causes of these deficits which is why the nexus between government revenue and expenditure is still an unsolved issue. Therefore the main purpose of this research is to study the causal relationship between government revenue and expenditure.

1.3 Hypotheses

H1: Tax Revenue causes Government Expenditure. H2: Government Expenditure causes Tax Revenue. H3: Tax Revenue and Government Expenditure bidirectionally cause to each other.

1.4 Outline of the Study

The research studies the causal relationship between government expenditure and tax revenue to see the reasons for the consistent budget deficits in Pakistan from many years. In addition time series analyses have been done to forecast the trend of government expenditure and revenue based on the leading variable.



Nanthakumar and Taha (2007) have found a stable relationship between spending and revenue. Furthermore there is a long-term impact exist expenditures that enter as input into the production function and those that enter as inputs in investment technologies. Koch, Schoeman, and Tonder (2005) found that there is an association between burden of taxes and economic growth according to the findings based on the data of 1960-2002 if tax burden decreases economic growth increases significantly. Friedman (1982) explains expenditure of the government depends on total revenue because as taxes increases expenditure increases by which deficit remains at the same level,

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