Tax Revenues and State Expenditures in the US with Balanced-Budget Requirements Using Panel VAR

Abstract

We examine Granger causality between state expenditures and tax revenues in the US with Balanced-Budget Requirements (BBRs). BBRs are statutory or constitutional rules to prevent states from spending more than tax revenues. Policymakers may adjust taxes, change expenditures, or do both to achieve BBRs. Panel VAR is introduced to address endogenous interactions between state expenditures and tax revenues. Panel VAR provides a unifying empirical framework and identification strategy which might be lacking in the previous literature. The empirical result supports that tax revenues Granger cause state expenditures. As BBRs are about planning, tax revenues make states plan on how to spend them. Considering BBRs with the empirical results from this study, states expenditures should be adjusted close to (projected) tax revenues. Additionally, this study finds that the business cycle has counter-intuitive effects. Tax revenues did not change when the US experienced the recession during 2008-2009 with the increases in intergovernmental transfer from the federal. State expenditures also increased during the recession.