Intertemporal Tax-Smoothing and the Government Budget Surplus: Canada and the United States

This paper shows that, if the government smooths taxes, then the budget surplus should equal the present discounted value of expected changes in government expenditure. This implication of the tax-smoothing hypothesis imposes more stringent restrictions on the data than the more usual method of testing whether changes in tax rates follow a random walk. The tax-smoothing model is applied to the federal government budgets of Canada and the United States and, in each case, receives considerable empirical support.