Causality Between Revenues and Expenditures and the Size of the Federal Budget

Abstract

Recent legislation has reduced federal tax rates and provided for indexation of the personal income tax against inflation. These changes are in part designed to reduce the relative size of government in the U.S. economy. Testing assump tions behind this proposition, this article examines the causal relation between revenue and expenditure changes in explainingfederal budget growth. Statistical causality tests reveal that revenue growth generally precedes expenditure growth, confirming that growth in revenue capacity stimulates budget expan sion rather than deficit reduction. A trivariate causal model including GNP, however, suggests that both demand and supply factors are responsible for the budget's growth.