The Relationship between Government Revenue and Expenditure in Sri Lanka

Abstract

The causal relationship between government revenue and government expenditure represents a widely studied topic in public finance literature. Although it is very well known that there is a strong correlation between government revenue and government expenditure, the issue of ?causality? still remains to be answered. Understanding the relationship between government expenditure and government revenue is important from a policy point of view, especially for Asian countries, which is suffering from persistent budget deficits. Budget deficit has been one of the economic problems in Sri Lanka over the six decades. For establishing prospective and effective policies it is essential to know causation between the government revenue and government expenditure. The purpose of this paper is to examine the relationship between government revenue and expenditure in Sri Lanka. It investigates causal relationship between government revenue and expenditure using co integration and error correction modeling framework for the period 1977 to 2009. The empirical results show that bidirectional causality exists between government revenue and expenditure and there is long run equilibrium between these two variables in Sri Lanka. JEL Classification: H2, H5, H6