The role of taxes in explaining the budget deficit fluctuations

Fiscal policies have an effective and dynamic role in the process of economicdevelopment. They are an almost inseparable part of countries’ economicprocesses. The efficiency of fiscal policies is a function of proper arrangement andcombination of fiscal policy instruments namely, the government revenues andexpenditures as well as their flexibility and their being effective on economicgoals. In Iran, however, fiscal policies are not sufficiently efficient due to thesignificant role of oil revenues in the government budget and insufficient taxrevenues alongside with inflexibility of government expenditures. The inefficiencyof fiscal policies has, in its turn, back grounded the role of tax revenues indecreasing the government budget deficits. This study aims at examining therelationship between budget deficit fluctuations and tax revenues using a structuralVAR approach. By imposing long-run restrictions on a VAR model, four structuralshocks have been identified: oil income shock, real product shock, tax shock andgovernment expenditure shock. The results show that an impulse in the tax revenuedecreases the economic growth (a result which is in line with economic theory) butthis negative effect converges to zero in the long-term. Positive impulses both inthe oil income and the real product increase the tax revenue levels. Moreover, thegovernment expenditure shock leads to an increase in tax revenues after threeperiods of time. The results of accumulative impulse response functions show thatpositive shocks both in oil income and tax revenue decrease the budget deficitlevels but the decreasing effect of an oil income shock on the budget deficit islarger than the tax revenue