The Causality between Taxes and Public Expenditure in Mauritius,1970-1999: A VECM Approach

While this paper tries to fill a particular niche in the literature on the tax and spend nexus of the public sector, it provides new insights on the causality between public expenditure and public revenue from a small island developing economy perspective. We apply the Johansen technique to uncover the dynamics characterising the public sector’s decision–making process with respect to taxing and spending. In particular, data covering the period 1970-1999 are used to test this causal link by applying a Vector Error Correction Mechanism (VECM). It is found that unidirectional causality runs from public revenue to public expenditure. This result, which is consistent both in the short run and the long run, implies that the government taxes first and then spends. Further, an important implication of our result is that the lack of evidence in favour of fiscal synchronization (bi-directional causality between tax and spend) would make it easier for the fiscal authority to dictate either its revenue or spending plans, hence making fiscal policy a stable and an effective tool for demand management in Mauritius.