The effects of structural changes on the intertemporal relationship between government revenue and expenditure : a case study of Malta

Abstract

This study assesses the intertemporal relationship between government expenditure and revenue in Malta and also tests for the presence of structural breaks, if any, during the period 2004Q1-2021Q3. Quarterly data for expenditure and revenue was collected from the National Statistics Office (NSO) while one-off and temporary expenditure and revenue data were also collected from the AMECO database. In order to meet the objectives set out for this research a number of econometric tests were employed. In essence, the study is split in two sections to determine the effect of structural changes. The first section deals with the entire dataset and the second section of the study tests whether the identified structural breaks affect the direction of the relationship established by the historical dataset. To test the co-integration and direction of causality the two-step Engle-Granger method and Granger causality test are employed. The findings confirm the existence of a long-run equilibrium relationship with a causality relationship running from revenue to expenditure. In the second section of the study the Bai-Perron approach is used to detect any structural breaks in the dataset. One break in the data, 2019Q2, was identified as expected given that the Maltese economy underwent significant turmoil due to the recent COVID-19 pandemic which drove the economic activity to a sudden halt. Consequently, the dataset is split into two subperiods, 2014Q1-2019Q1 and 2019Q2-2021Q3 respectively. The co-integration and causality tests were re-run. Given the small number of observations in each sub-period the ARDL bounds test method was used. The results suggest that a long-run relationship is evident for both subperiods. The interpretation of the causality test suggests that for the first sub-period, 2014Q1- 2019Q1, the tax-spend policy (causality running from tax to expenditure) holds, in line with the results of the historical dataset. However, for the second sub-period 2019Q2-2021Q3, the institutional hypothesis (expenditure and revenue decisions are made separately) is valid. The conclusions reached shed light on the importance for fiscal authorities and policy makers to analyse the relationship between government expenditure and revenue thoroughly when designing polices. It is also important to consider the presence of structural breaks to ensure that appropriate measures are introduced to promote a sustainable fiscal policy, and avoid spurious results which may lead to inadequate policy formulation.