The Effect of Fiscal Illusion on Public Sector Financial Management

Abstract

An important concern to the efficiency of public finance systems is that voters may suffer from various “fiscal illusions” that can be exploited by politicians to grow the public sector. This article contributes evidence on the specific public financial management mechanisms by associating the impact property reassessments have on the “visibility” of budget size signaled by property tax rates. Using data from Virginia cities and counties from 2001 to 2011, the results indicate mass reappraisals, which reduce property tax visibility cause contemporaneous property tax levy increases, as do reappraisals that increase future tax visibility. These revenue shocks are then smoothed into expenditures through the management of assets, indicating policy makers prefer the spending to be drawn from future cash reserves than immediate projects that might draw attention to the source of fiscal illusion.