Balancing budget through tax increases or expenditure cuts: is it neutral?

Fiscal adjustment currently ranks at the top in the economic policy agenda of many OECD countries, and not only those European countries aiming to mee t the Maastricht convergence criteria. Recently, Alesina and Perotti argued that successful cases of fiscal adjustment resulted from cutting expenditu res, while those focusing oh tax increases were unsuccessful. The paper, us ing a bivariate VECM representation for the joint government revenue-govern ment expenditure dynamics for five of the main OECD countries, provides two contributions to this issue. First, it proposes and performs a neutrality test of the alternative adjustment strategies (through revenue or expenditu res), second it characterizes the departure fi om neutrality in the three c ountries where the neutrality hypothesis is rejected. The conclusion, preva iling for these three countries, is that adjustment through taxes not only is inefficient, but even results in a perverse effect with induced extra ex penditures which more than offset the increase in government revenue. (C) 1 999 Elsevier Science B.V. All rights reserved. JEL classifications: J32; H3 0.