Fiscal illusion, fiscal consolidation and government expenditure composition in the OECD: a dynamic panel data approach

Following the present atmosphere of budgetary cuts in the OECD countries we analyze the effects of fiscal consolidation in the composition of government expenditures by functions. We modify a standard median voter demand model to incorporate a form of fiscal illusion based on the idea that voters-taxpayers may not be fully aware of the true composition of government expenditures because all types of expenditures are not equally visible. Then we exploit the panel structure of the dataset - 26 OECD countries over the period 1970-1997- by GMM estimation of a dynamic model taking into account unobserved country effects and possible endogeinity of the explanatory variables. Under the assumption that governments know the relative visibility of each type of expenditure, the pattern of the last three decades indicates that defense and the non-productive economic services are the less visible expenditures. On the other hand, education and housing seem to be the more visible expenditures.