An Empirical Analysis of State Government Revenue- Expenditure Nexus: The Case of Kedah, Kelantan, Penang and Perlis

The nexus between state government revenue and expenditure is vital because it is relevant for state fiscal policy makers with respect to the budget deficit. The aim of this study is to examine the direction of causality relationship between state government revenue and expenditure in Kedah, Kelantan, Penang and Perlis. Thus, in order to investigate the cointegration between the state government revenue and expenditure, the study uses bound testing approach and Granger causality test with applying Vector Error Correction Model (VECM) and Vector autoregression (VAR) methods for the period 1980 to 2009. Besides, the study examines whether state government revenue causes state government expenditure (tax-spend hypothesis) or whether the causality runs from state government expenditure to state government revenue (spend-tax hypothesis), and if there is bi-directional causality (fiscal synchronization). Results of finding on the direction of causation are mixed: (i) For Perlis in the long-run and for Kelantan in both the short-and long-run, empirical result supports for the spend-and-tax hypothesis; (ii) Perlis in the short-run is in conformity with the institutional separation hypothesis; (iii) For Kedah and Penang, there is evidence of separated decision making of revenue-expenditure in both the short-and long-run. The policy implication of states which are consistently with spend-and-tax hypothesis suggests that budget deficit reduction can be achieved through the reduction in expenditures. While states which are in conformity with the institutional separation hypothesis, it is suggested for policy makers to find alternative so as there is a relationship between these two state fiscal variables.