Empirical Investigation of Government Expenditure and Revenue Nexus; Implication for Fiscal Sustainability in Nigeria

Abstract

The study attempted to find out if a long-run relationship exists between government expenditure and revenue. It also explored the direction of causality between the government expenditure and revenue growth. These were with a view to examining the nexus between government expenditure and revenue growth in Nigeria between 1961-2010.

The study employed econometric techniques such as unit root tests, cointegration test, error correction mechanism and Granger causality tests. Times series data covering the period (1961-2010) on such variables as government expenditure, government revenue and real GDP were sourced from CBN Statistical Bulletin (2010) Edition, augmented with CBN Annual Report and Statement of Accounts (Various Years) and World Development Indicators (WDI) of the World Bank’s CD-ROM.

The results from ADF and PP unit root tests show that both government expenditure and revenue are I(1) process. The two variables became I(0) after taking their first differences. Also, the results obtained from Engle-Granger and Johansen methods of cointegration tests indicate that there was no long-run relationship between government expenditure and revenue in Nigeria during the period under investigation. The result of the error correction model of government spending confirmed the non-existence of long-run relation between expenditure and revenue. The ECM coefficient is significant and positively signed showing that instead of convergence relationship, there was evidence of a divergence relationship (ECM coefficient=0.368; t=3.636; p<0.01). Similarly, the result of the error correction model of government revenue provided no evidence in support of long-run relationship between revenue and expenditure. The ECM coefficient is significant and positively signed showing that instead of a convergence relationship, there was evidence of a divergence relationship between government revenue and government expenditure (ECM coefficient=0.297; t=2.620; p<0.01). The study further conducted Granger causality tests, for the three lags used by this study, there was no causality, one-way or two-way between government expenditure and revenue invalidating spend-revenue as well as revenue-spend hypotheses. It rather provides evidence in support of institutional separation hypothesis. This implies that government decision to spend as well as government decision to raise revenue is independent of each other. The decisions on these two fiscal variables are made with no consideration for each other.

The finding of this study has a serious implication on fiscal sustainability in Nigeria. Government spending should be based on revenue yields to reduce large fiscal deficits that are unsustainable to economic growth in Nigeria. The study concluded that institutional separation hypothesis holds in Nigeria during the period under investigation.

Keywords: Fiscal sustainability, Cointegration, Convergence, Divergence, Long-run relation