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The assessment of twin divergence in Croatia: The impact of trade deficit on the budget deficit

This paper empirically assesses the twin divergence hypothesis in Croatia by estimating the impact of trade deficit on the budget deficit in Croatia from the first quarter of 2004 to the fourth quarter of 2019 using Johansen’s cointegration approach. The trace and maximum eigenvalue tests point to the existence of one cointegrating relation between two deficits. The increase in the trade deficit results in a reduction in the budget deficit, pointing to the important role of indirect tax revenues in the Croatian tax system. In line with the results of empirical research, restructuring of the Croatian tax system is recommended. Taking into consideration the twin divergence as well as the importance of the export competitiveness for the economic growth, lower dependency of revenues on consumption and imports is suggested.

twin deficit, indirect taxes, Johansen's cointegration approach, fiscal policy, twin divergence, trade balance

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