The Empirical Test of Fiscal Illusion Hypothesis

The Fiscal Illusion Hypothesis is one of the theories explaining the increase of government size under the Public Choice Theory. Based on the empiric al equation of Fiscal Illusion Hypothesis, the “Fiscal Illusion” was separated into “Deficit Illusion” and “Expectation Illusion”. Using the annual data o f China from 1978 to 2004, the relationship between the “Fiscal Illusion” and the increase of government size was demonstrated with the Chow Turning Point tes t, integration analysis and vector error correction model. It was found that the “Fiscal Illusion” was one reason of the increase of China's government size. The existence of the “Deficit Illusion” was not confirmed remarkably, but the “Expectation Illusion” has a positive effect on the increase of government siz e.