Fiscal Decision and Fiscal Performance: the Case of Kelantan and Penang

AbstractThis paper attempts to shed some lights on the relationship between the fiscal balance of state governments in Malaysia and their decision concerning their revenue and expenditure. In particular, the paper seeks to examine whether the fiscal situation of the Malaysian state governments can be explained by the way decision process regarding expenditure and revenue collection is made. For the purpose of this study, we choose to focus on two states governments namely Penang and Kelantan. The choice of these two states was made based on the significant difference in term of their fiscal situation. This study employs ARDL or bound test procedure proposed by Pesaran and Shin (1996), Pesaran and Pesaran (1997) and Pesaran et al (2001) to test for the cointegration relationships. Our results show that in the short- run, the causality seems to run from state government expenditure to state government revenue of Kelantan. This finding is consistent with the spend-and-tax hypothesis. In other words, the state government of Kelantan decides on its expenditure first before it decides on its revenue. As for Penang, the finding seems to point to an institutional separation as no causality is found between its revenue and its expenditure in the short run. In the case of long- run causality, Kelantan is found to have a negative sign of error correction model (ECM) in the revenue equation