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THE ACADEMY OF ECONOMIC STUDIES, BUCHAREST DOCTORAL SCHOOL OF FINANCE AND BANKING

This dissertation paper analyzes the relationship between fiscal policy and economic growth in European Union countries. The empirical evidence and theoretical background are examined, and a panel data methodology is used for estimation. The results suggest that tax rates have a negative impact on economic growth, and government expenditures are situated above the point of maximum economic growth. The study concludes by discussing the limitations of the research and providing references for further reading.

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THE ACADEMY OF ECONOMIC STUDIES, BUCHAREST DOCTORAL SCHOOL OF FINANCE AND BANKING

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  1. THE ACADEMY OF ECONOMIC STUDIES, BUCHAREST DOCTORAL SCHOOL OF FINANCE AND BANKING DISSERTATION PAPER Fiscal Policy and Economic Growth in European Union Countries MSc Student: Zoescu Mihai Supervisor: Professor Moisă Altăr BUCHAREST, JULY 2003

  2. 1.Empirical Evidence 2.Theoretical Background 3.Methodology 4.Data 5.Estimation Results 6.Conclusions

  3. 1.Empirical Evidence • Ram (1986) • 115 countries - 1960-1980 (Summers-Heston database) • estimations for each country based on time-series • positive impact of government size in 100 cases • positive impact of marginal government size in 98 cases • Barro (1991) • cross-country evidence on 98 countries, 1960-1985 (Summers-Heston database) • growth inversely related to the share of government consumption in GDP • growth insignificantly related to the share of public investment

  4. Folster and Henrekson (2000) • panel study on OECD sample, 1970–95 period • government consumption is significantly negatively related to growth • robust negative relationship between government expenditure and growth Heitger (2001) • panel estimates for 21 OECD countries, 1960–2000 • negative and statistically highly significant relation government expenditures - economic growth • all subcategories of consumptive government expenditures: significantly negative impact

  5. 2.Theoretical Background Barro (1990) • endogenous growth • constant returns to a broad concept of capital Y=Ak • constant returns to scale in k and g together but diminishing returns in k separately

  6. Growth rate 0 20 40 60 80 100 Government (tax) share

  7. 3.Methodology Panel data Advantages: • double dimension a better representation of the dynamic behavior of the individuals takes into account individuals heterogeneity • data are numerous the biases and the variance of estimation go to zero are very precise Inconveniences: • the existence of aberrant observations • missing observations

  8. 4.The Data • annual data for the EU countries from 1977 till 1997 Source : World Bank, 2002, World Development Indicators

  9. 5.Estimation Results

  10. Fixed Effects vs. Random Effects • Hausman Test • test statistics are -0.025 respectively 0.021. • critical value at 5% level

  11. OLS vs. GMM • Ahn and Schmidt (1993) - GMM estimator • Balestra and Nerlove (1966) • Hausman Test • test statistics are 0.40 respectively 0.37 • critical value

  12. Model (1)

  13. Model (2)

  14. Fixed Effects with Cross Section Weights

  15. 6.Conclusions • tax rates have a negative impact on economic growth • the level of tax rates is beyond the optimum point • the relation: government expenditures - economic growth is negative and highly significant • government expenditures are situated above the point of maximum economic growth • government consumption has a much greater negative impact on output growth than total government expenditure

  16. Shortcomings: • economic growth has many determinants • data with measurement errors • tax revenues as proxy for tax rates • government total expenditure separated on types

  17. References Barro, Robert (1990), “Government spending in a simple model of endogenous growth”, Journal of Political Economy, 98(5), S103-117. Barro, Robert (1990), “Economic Growth in a Cross Section of Countries”, The Quaterly Journal of Economics, Volume 106, 407-443. Barro, R. and Sala-i-Martin, X. (1992), “Public finance in models of economic growth”, Review of Economic Studies, 59, 645-61. Barro, R. and Sala-i-Martin, X. (1995), “Economic Growth”, The MIT Press Cambridge, Massachusetts London, England, pp 153-161. Blanchard, O. and Perotti R. (1998), “An Empirical Characterization of the Dynamic Effects of Changes in Government Spending and Taxes on Output”, NBER, WP 7269 Corsetti, G. and Roubini, N. (1996), “Optimal Government Spending and Taxation in Endogenous Growth Models”, NBER, WP 5851 Devereux, M. and Love, D. (1995), “The Dynamic Effects of Government Spending Policies in a Two Sector Endogenous growth Model”, Journal of Money, Credit and Banking, Volume 27, 232-256. Fölster, Stefan, Henrekson, Magnus (2000), “Growth Effects of Government Expenditure and Taxation in Rich Countries”, The European Economic Review. Gale, W. and Easterly, W. (1995), “What Do Cross-Country Studies Teach about Government Involvement, Prosperity and Economic growth? Comments and Discussion”, Brookings Papers on Economic Activity, Volume 1995, 416-431.

  18. Gerson, Philip (1998), “The Impact of Fiscal Policy Variables on Output Growth”, IMF WP/98/1. Greene, William H. (2000), “Econometric Analysis”, Fourth Edition, Prentice Hall International, Inc., New Jersey. Gupta, S., Clements B., Baldacci E. and Mulas-Granados, C., “Expenditure Composition, Fiscal Adjustment, and Growth in Low-Income Countries”, IMF WP/02/77. Heitger, Bernhard (2001), “The Scope of Government and Its Impact on Economic Growth in OECD Countries”, Kiel WP No. 1034. Islam, Nazrul (1995), “Growth Empirics: A Panel Data Aproach”, The Quarterly Journal of Economics, Volume 110, 1127-1170. Jones, L., Manuelli, R. and Rossi P. (1993), “Optimal taxation in models of endogenous growth”, Journal of Political Economy, 101(3), 485-519. King, R., and Rebelo, S. (1990), “Public Policy and economic growth: Developing neoclassical implications”, Journal of Political Economy, 98(5), S126-51. Levine, Ross and Renelt, David (1992), “A Sensitivity Analysis of Cross-Country Growth Regressions”, The American Economic Review, Volume 82, 942-963. Perotti, Roberto (2002), “Estimating the Effects of Fiscal Policy in OECD Countries”, BCE WP no.168. Ram, R. (1986), “Government size and economic growth: A new framework and some evidence from cross-section and time series data”, The American Economic Review, 76(1), 191-203. Sala-i-Martin, Xavier (1997), “I just run four million regressions”, NBER, WP 6252 Sevestre, Patrick (2002), “Econometrie des donnees de panel”, Dunod, Paris. Stokey, N. and Rebelo, S. (1995), “Growth effects of flat-rate taxes”, Journal of Political Economy, 103(3), 510-50. ***The World Bank, World Development Indicators (2002)

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