The deficit-reduction debate in the USA: an investigation of cointegration and causality Online publication date: Tue, 03-Mar-2015
by Fatih Mangır; Bansi Sawhney
International Journal of Revenue Management (IJRM), Vol. 7, No. 3/4, 2013
Abstract: The most recent financial crisis and the great recession have led to renewed questioning of the US fiscal deficit problem. This study revisits the relationship between government expenditures and revenues in the USA using the most recent datasets. It examines the long run relationship between spending and revenue by testing for integration using Engle-Granger and Johansen-Juselius methods of cointegration. Results from cointegration tests suggest that a long run relationship between expenditures and revenues exists in the USA. The Granger causality tests indicate that there is a bidirectional causal relationship between the two variables. Not only do the expenditures cause revenues but revenues in turn cause spending in the USA. The finding strongly supports the fiscal synchronisation hypothesis proposed by Meltzer and Richard (1981). This study has important policy implications that call for simultaneous changes in both taxes and spending to control deficits in the USA.
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