Fiscal Illusion and the Output Expansion Hypothesis

Abstract

In the traditional certainty model of voter fiscal illusion, voters misperceive non-stochastic tax prices as being lower than they actually are and therefore allow public sector officials to expand output beyond the perfect information output. This article shows how modeling fiscal illusion as imperfect voter information or uncertainty introduces an additional risk term that offsets the certainty model illusion-output expansion effect. The fiscal illusion-output expansion hypothesis is evaluated by empirically examining the impact of fiscal structure complexity, both with respect to sources and uses of revenues, on public expenditure demand. In keeping with the uncertainty model of fiscal illusion, the data reveal little support for the illusion-output expansion hypothesis.