Abstract
We analyze US state government spending behavior with a general intertemporal model allowing for asymmetry in balanced budget rules in a panel data setting. We find no strong evidence for forward-looking behavior in state spending; balanced budget rules are a significant constraint. States with budget rules imposing lighter restrictions are more likely to exhibit habit formation, while those with stricter rules demonstrate asymmetric responses to revenue changes. Evidence for a precautionary savings motive is limited. Balanced budget requirements trigger substantial pro-cyclical spending, possibly amplifying state economic volatility for states with tight fiscal rules, especially after revenue increases.
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Notes
In this paper, for convenience we refer to any sub-federal governments such as states, localities, or municipalities as “state governments.”
Craig et al. (2016) present a buffer stock model for state unemployment insurance. Implicit in their model is the presence of the precautionary saving motive by state governments.
For a concrete example, Biolsi et al. (2020) demonstrate that “habits” are an important part of the dynamics of state spending on education. A second might be the fact that state governments still largely rely on defined benefit pension plans, even while most of the private sector has moved toward defined contribution plans. We thank Steven G. Craig for helpful discussion of these issues.
Sørensen and Yosha (2001) examine asymmetric budget responses to fluctuations in state output, but they do not analyze the asymmetry in balanced budget rules in the context of a general intertemporal model of state spending.
One might imagine our approach as estimating an “as if” preference function, along the lines of Inman (1978).
This is an approximation (see Dynan 2000).
This is an adaptation of the asymmetric nature of liquidity constraints in consumption (see Shea 1995).
Construction of the interest rate variable is discussed in Sect. 4.
Luengo-Prado and Sørensen (2008) take state-disposable labor income growth (in deviation from aggregate income) as an AR(1) process without controlling for state-level variables. Then, they use the estimated standard error of the innovation to aggregate income as a measure of state-level uncertainty.
We also estimate the model with the main spending variable expressed as the sum of current operations expenditure and capital outlay. The results are not radically different, except that the coefficients on general revenue growth are larger in magnitude and generally more statistically significant. Our coefficients on the lagged spending term are smaller and less significant. These results are available from the authors on request.
Growth in nonfarm payrolls provides better coverage for our sample than, say, the unemployment rate, which is available at the state level only from 1976.
Fiscal Discipline in the Federal System: National Reform and the Experience of the States, 1987. Washington, DC.
For information on the other criteria governing the relative tightness or looseness of rules, see Bohn and Inman (1996).
Although the sample including only states with an ACIR index of 10 does not produce a first-stage F-statistic of at least 10 for the conditional variance term (it is just a little above 8), we study this split anyway, in order to maintain comparability with the symmetric model results.
Sørensen, Wu, and Yosha (2001) find that the budget surpluses of states with more stringent budget rules exhibit less procyclicality, implying that the spending of states with more stringent budget rules exhibits more procyclicality, consistent with Fatás and Mihov (2006). Poterba (1994) finds that states with weak antideficit or balanced budget rules adjust spending less in response to positive deficit shocks than their counterparts with strict antideficit rules. Clemens and Miran (2012) find that states with relatively tight fiscal rules experience more rapid fiscal adjustments when revenues fall short of expectations or spending exceeds projections. These results are also consistent with Fatás and Mihov (2006).
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Acknowledgements
The authors acknowledge support from the Aim High Research Grant program of the Gordon Ford College of Business at Western Kentucky University. We also thank conference participants at the 2018 Eastern Economic Association Annual Meetings in Boston and the 2018 Western Economic Association International Annual Meetings in Vancouver for helpful comments.
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Appendix
Appendix
See Tables 10, 11, 12, 13, 14, 15, 16, and 17.
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Biolsi, C., Kim, H.Y. Analyzing state government spending: balanced budget rules or forward-looking decisions?. Int Tax Public Finance 28, 1035–1079 (2021). https://doi.org/10.1007/s10797-020-09634-1
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DOI: https://doi.org/10.1007/s10797-020-09634-1