The Dynamics of State Fiscal Behavior Over the Business Cycle

Abstract

The purpose of this study is to examine how cyclical fluctuations in tax revenue affect state fiscal policies, using a state panel data set. In particular, the study develops a measure of revenue gapthe cyclical component of tax revenue-by calculating the orthogonal deviations of tax bases from the trend, and then analyzes its effects on the level of spending and taxation-as measured by expenditure gap and overall tax rate-using a dynamic panel-data model. The analyses reveal that revenue gap is positively related to expenditure gap and negatively to overall tax rate. These results clearly show the procyclical patterns of state fiscal policies and further suggest the association between revenue volatility and fiscal instability. Based on the results, the study discusses the spending stabilization rules as a policy solution to the recurring state fiscal crises. Keywordsstate fiscal policy, business cycle, revenue gap, political economy of fiscal policy, fiscal sustainability "Expenditures rise to meet income."

The effects of tax and expenditure limits on state fiscal reserves

“…Navin and Navin argue that BSFs in the other states (Ohio, Wisconsin, Iowa, Minnesota and Missouri) are typically underfunded and drawn down for purposes other than counter-acting down swings in the economy. In a more recent study of state fiscal behavior, Kwak (2014) finds that the existence of BSFs had no measurable effect on state expenditure gaps, measured as deviations in per capita real expenditures from the trend. The differences in findings across studies may be the result of different time frames, different research questions, and differences in measurement; Kwak measures BSFs as a dichotomous variable, whereas Hou and others measure the BSF funding levels.…”

“…Both academic and professional-focused public finance literatures appear to accept a priori that state governments need to take an active role in crafting policies that help mitigate the effects of economic downturns and instability on service provision (Hou and Moynihan, 2008; Kwak, 2014). This is, historically, the principal justification for the retention of tax dollars in funds without a designated purpose.…”

When Would a Democratic Governor Increase Social Welfare Funding? The Joint Moderation of a State's Economy and a Governor's Budgetary Authority

“…Such pressures can push a Democratic governor to increase social welfare spending to score electoral points and as a signal to party leaders of her commitment to core party ideals. In other words, the procyclical nature of budget policy (Kwak, 2014) makes it more likely for a Democratic governor to increase the resources available to social assistance programs compared to a non‐Democratic governor who is less likely to prioritize social assistance programs. Kelly and Witko (2014) provide evidence to support the claim that the fiscal policy of left‐leaning governments during a period of economic growth is associated with a reduction in the unemployment rate.…”

Cyclical Asymmetry in State Fiscal Policy: Is It Biased Toward Big or Small Government?

“…In addition, McNichol (2003a) and Ruffing and Van de Water (2012) report that in response to the fiscal crises of the early and late 2000s, states raised taxes and/or cut expenditures. Kwak (2014) provides empirical evidence suggesting the procyclical effects of business cycles on state fiscal policies. Using state panel data, he finds that cyclical fluctuations in tax revenues are positively correlated with changes in per capita expenditure and negatively to changes in the overall level of taxation.…”