Impacts of Revenue Diversification and Revenue Elasticity on State Fiscal Health

Abstract

Revenue diversification and elasticity of the revenue portfolio are important characteristics of a revenue structure. Using state financial data from 2007–2012, this study identifies the different impacts of revenue diversification and revenue portfolio elasticity on the fiscal health of US states. Fiscal health is measured by a comprehensive set of indicators including measures of revenue, expenditure, operating position, and debt. We find that during an economic downturn fiscal health is improved by revenue diversification but reduced by a more elastic revenue structure. Furthermore, the overall positive impact of revenue diversification outweighs the negative effect of revenue elasticity. Findings provide important guidance in designing a sound tax portfolio that generates adequate revenue while being able to withstand significant stress from business cycles.