Contradicting the twin deficits hypothesis: The role of tax revenues composition

Abstract

The general theory of twin deficits hypothesis does not consider specific characteristics of domestic tax systems, i.e. whether the revenue side of the budget is dominated by indirect or by direct taxes. The main hypothesis of the paper is that in countries with fiscal systems dominated by indirect taxes, the deterioration of the current account balance would imply higher fiscal revenues due to larger imports and consumption. The hypothesis is based on the characteristics of domestic tax systems of Bulgaria, Croatia, Poland and Romania in which indirect tax revenues account for the majority of total budget tax revenues. Results suggest that the co-movements of the current account and the fiscal balance cannot be explained by the twin deficit theory in countries with indirect tax-oriented systems. These results imply that only the structural economic transformation and export orientation of the economy may reverse the causality direction between two deficits.

Impact of government balance and exchange rate regime on current account during the economic cycle: evidence from CEE countries

“…While the impact of productivity shocks turned to be large, impact of fiscal balance, as they conclude, seems to be either non-existing or not sufficiently stable. Evidences on "wrong" causality direction of fiscal policy to current account are also found in empirical studies dealing with less developed economies, like in Van Bon (2014) for ten Asian developing (panel GMM and panel error-correction) or Obadić et al (2014) for four European emerging economies (structural VAR).…”

“…On the other side, some CEE country-specific analysis fail to find evidences in support of the twin divergence (Jošić andJošić, 2011, for Croatia, Obadić et al, 2014, for Bulgaria, Croatia, Poland and Romania). Obadić et al (2014) provide an interesting consideration that in indirect tax-oriented systems like CEE observed twin divergence mechanics is stemming from the tax revenue loses during the current balance consolidation and imports/consumption reduction.…”

Examining the Relationship between Financial Development and International Trade in Croatia

“…Bilas and Bošnjak (2015) established and confirmed longrun and short-run effects of banking loans to private individuals' growth rate on the personal consumption growth rate in Croatia. If it is the consumption of mainly imported goods as reported by Obadić et al (2014) for example, it might increase the trade in the short-run. Furthermore, the Granger causality test results in Table 6 indicate the relationship between financial development and economic growth.…”

“…The interrelationship between financial development and international trade may exist through the linkage between debt-finance consumption and imports. Strong growth in domestic demand financed by the inflow of foreign loans and real appreciation of domestic currencies stimulated the consumption of mainly imported goods and resulted in current account deficit in European transition countries (Aristovnik 2008;Zakharova 2008;Bakker and Gulde 2010;Obadić et al, 2014). Kiendrebeogo (2012) examined the linkage between financial development and international trade in developed and developing countries for the period of 1961-2010.…”

The impact of supranational fiscal rules on public finance: the case of EMU member states

“…The basic rule of the fiscal discipline stipulated in the Maastricht Treaty is that members shall avoid excessive budget deficits (Obadić et al, 2014). The latter was defined as one exceeding 3% of GDP, except in cases where the reference value is exceeded only exceptionally and temporarily and the ratio remains close to the reference value.…”