Subnational government tax revenue capacity and effort convergence: New evidence from sequential unit root tests

Abstract

Convergence in revenue capacity and effort around rising trends help more subnational governments assume their devolved functions. We examine the extent of such convergence by estimating the proportion of all pairwise convergent gaps in a panel of 48 combined state-local governments (SLGs) over the period 1981–2013 using a novel methodology. We found no evidence of convergence in tax revenue capacity or tax effort. However, about half of the revenue effort gaps were convergent when revenue was more broadly defined. At a given revenue capacity level, SLGs significantly varied with respect to the revenue effort and incidence of its convergence. Our results caution against inferring convergence as a sample wide phenomenon based on conventional tests, reveal a potential challenge to devolution in the absence of redistribution of federal grants, and are consistent with desire for fiscal diversity.