Should governments provision against fiscal mismatch? : new evidence for fiscal sustainability

Abstract

Governments spend a signi cant share of non-traded goods, which become disproportionally more expensive as economies grow (e.g. Balassa- Samuelson e ect). In fact, government in ation increased twice above average in ation in countries like Finland and US. This paper shows a novel and simple model of how economic growth impacts scal sustainability. Also, we empirically explore the potential magnitudes behind this phenomenon. The main result is that governments should save for the future mismatch. As in standard models of hedging, the size of this provision depends on the product of the di erential price (in ation) times the net exposure, measured as the di erence of elasticities of scal revenue and expenditures respect to price. Besides, while tax systems focused on tradable goods make more e orts to maintain scal sustainability through of high tax rate, non-tradable good sector tend to display higher saving for this \government price risk" when the objective is to maximize welfare. From an empirical perspective, with a panel of 28 high-middle income countries, we show a mismatch at least for the last 20 years with an increasing trend over time. In general, an increase in 1% in GDP growth implies a 0.21% - 0.36% in mismatch on average. Besides, consumption taxes would be more mismatched. Instead, corporate taxes would not have problems to nance spending giving importance of how this e ect should be incorporated in the practical analysis, either in the discussion of tax or scal policy.