We apply non-linear error-correction models to the empirical testing of the sustainability of the government's intertemporal budget constraint, in order to verify
(i) whether current and past budgetary law and fiscal policies allow the time-path of fiscal revenues and expenditures to be consistent with a long-run sustainable equilibrium, i.e. an equilibrium where the discounted present values of government outlays and revenues are equal.
(ii) whether the sustainable budgetary equilibrium is achieved via changes in the average tax rate or via changes in the government spending share on GDP or some policy mixes
(iii) whether the adjustments towards equilibrium are linear, or they change when they are above/below and/or close/far from the equilibrium
(iv) the behaviour of fiscal policy in different phases of the economic cycle
Our empirical analysis, based on Italy, shows that the Italian government is meeting its intertemporal budget constraint, in spite of the high levels of public debt. Nevertheless, the burden of correcting budgetary disequilibria is entirely carried out by changes in the average tax rate, with a weakly exogenous government spending, possibly determined by the political process. We document some rigidities of the tax instrument, in terms of downward inflexibility of the average tax rate, not only with respect to its long-run level, but also during periods of decreasing economic growth, pointing to a regressive performance of the tax instrument- in contrast with article 53 of the Italian Constitution.
Further, we provide some evidence in favour of a non-linear adjustment towards a sustainable long-run equilibrium, as the average tax rate adjusts faster the farther away it is from the equilibrium.