The Crucible of Debt and Welfare Spending: Evidence from State-level Welfare Expenditures in the United States

Abstract

This paper argues that financial pressures affect state public welfare expenditures, controlling for economic effects, financial constraints faced by state administrations and general economic conditions. It develops a series of panel models for 17 states with the largest muni markets (representing 71 per cent of all state-level public welfare spending in the US or $326 billion) from 1998 to 2010. As economic conditions worsen, government revenues decline. Coupled with marginal increases in social spending, state governments face higher debt and binding budget constraints. As investors realize the situation, muni bond prices drop, yields increase and higher finance costs compel state governments to decrease expenditures. These cuts are generally focused on public welfare expenditures. Between 1998 and 2010, one percentage point increases in short (1y), medium (5y) and longer (10y) bonds yields are associated with 0.01 per cent, 0.03 per cent and 0.04 per cent decreases in public welfare expenditures relative to gross state output.