Testing the Validity of the Debt Laffer Curve in Iran: Evidence from a Smooth Transition Regression (STR) Model

Considering the importance of discussing the effect of government debt size on economic growth, this study examines the validity of the debt laffer curve using a Smooth Transition Regression (STR) model in Iran during 1973-2016. The findings support a threshold behavior of two regimes between the government debt size and economic growth in the Iran's economy. The threshold level of government debt size is 41.70% of the GDP. In periods that the government debt size is less than 41.70 % or the first regime, government debt size has a negative effect on economic growth. Therefore, the evidence does not corroborate the existence of the Debt Laffer Curve in Iran's economy. The disapproval of this hypothesis and the negative impact of government debt on economic growth - at low levels of debt size - can be rooted in the fact that government spends the borrowed funds on the deficits that emerged from structural imperfection and institutional rigidity, while it should be used to develop infrastructures or foster productive investments.