Balanced Budget Requirements Research Articles

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

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.

Political budget cycle and unfunded pension liabilities in states in the USA

IMPACT Evidence shows that gubernatorial elections affect pension funding in US states. Contrary to expectations, this article shows that pension plans in election and post-election years tend to be better funded. Other political factors, such as partisanship and unionization, also play a role in funding state employees’ pension plans—the higher the level of unionization, the lower the pension funding. Institutional factors, including tax and expenditure limits (TELs), ‘rainy day funds’ (RDFs), and balanced budget requirements (BBRs), also affect pension funding. TELs positively affect pension funding, while the level of RDFs and the stringency of BBRs tend to reduce pension funding. These findings caution state fiscal administrators and state-level policy-makers as they indicate that political factors along with fiscal institutions are important to consider for their long-term impacts on the viability of pension plans. This article informs policy-makers in the USA and in other countries to exercise more caution during election years as electoral politics may affect pension funding. Political factors are critical in making fiscal decisions, and while this study focuses on the USA states, the lessons are equally important for pension administrators and policy-makers in other countries.

To manage or reserve accruals? Evidence from a balanced-budget requirement reform

IMPACT Discretion in the financial reporting process can help reveal private information to external parties; it can also be used to avoid disclosing information that makes agents vulnerable to criticism—especially under strong political incentives to avoid transparency. This must be taken into account by higher levels of governments when designing and implementing balanced-budget requirements tied to financial reporting figures produced on an accrual basis, as well as by other stakeholders using accrual-based information for monitoring purposes. ABSTRACT In 2013, an accounting reform permitted Swedish municipalities to voluntarily adopt a system with accrual reserves that was designed to increase flexibility in meeting budget requirements and decrease regulatory incentives to engage in earnings management. However, since a system with accrual reserves imposes potentially undesirable transparency from the perspective of politicians, it is unclear whether the (regulatory) benefits of adopting accrual reserves are perceived to exceed the (political) costs. The authors found that municipalities with higher levels of earnings management were less likely to adopt a system of accrual reserves, and they attribute this to political incentives to avoid transparency.

Balanced Budget Requirements and Local Austerity Multipliers

Balanced Budget Requirements and Local Austerity Multipliers

The Interplay Between Fiscal Institutions and the Great Recession: Evidence From U.S. School Districts

Recessions may disproportionally affect school districts, especially with established fiscal institutions and policies including balanced budget requirements, tax and expenditure limitations, and school finance reforms. Analyzing the Great Recession and school districts in the United States between 2003 and 2016, we estimated difference-in-differences models leveraging variation in state recession severity to evaluate revenue and expenditure impacts as well as to measure differential recession effects for districts exposed to and not exposed to fiscal institutions and policies. Although revenues and expenditures increased relative to pre-recession levels in all districts, increases were much larger in school districts with less severe than more severe recessions. Balanced budget requirements exacerbated recession effects for low-income districts, and local tax and expenditure limitations intensified recession effects for high-income districts. School finance reforms worsened recession effects for all districts. Our findings can aid districts in understanding potential recessionary impacts, given their prior established fiscal policies and institutions.

Summaries of Articles

Summaries of Articles

Balanced Budget Requirements Revisited

We test the effect of balanced budget requirements (BBRs) on budget outcomes using data published in audited financial statements. With a focus on the General Fund, we find states frequently reported deficits in their adopted budgets and relied on sizeable and favorable expenditure variances to close budget gaps before the end of the budget period. Empirical analysis shows that technical or strict BBRs procedures did not increase the likelihood that a state would report a balanced budget. We corroborate our findings using fund balance data. If technical or strict BBRs are effective, states would report higher fund balances, all else equal. Results show that states that adopted political BBRs reported lower fund balances. More importantly, the adoption of strict or technical BBRs did not lead to higher fund balances.

Analyzing state government spending: balanced budget rules or forward-looking decisions?

We analyze US state government spending behavior with a general intertemporal model allowing for asymmetry in balanced budget rules in a panel data setting. We find no strong evidence for forward-looking behavior in state spending; balanced budget rules are a significant constraint. States with budget rules imposing lighter restrictions are more likely to exhibit habit formation, while those with stricter rules demonstrate asymmetric responses to revenue changes. Evidence for a precautionary savings motive is limited. Balanced budget requirements trigger substantial pro-cyclical spending, possibly amplifying state economic volatility for states with tight fiscal rules, especially after revenue increases.

State and local government employment in the COVID-19 crisis

Local governments are facing large losses in revenues and increased expenditures because of the COVID-19 crisis. We document a causal relationship between fiscal pressures induced by COVID-19 and the layoffs of state and local government workers. States that depend more on sales tax as a source of revenue laid off significantly more workers than other states. The CARES Act’s provision of $150 billion in aid to state and local governments reduced the fiscal pressures they faced. Exploiting a kink in the formula for allocation of funding across states, we estimate that without this funding state and local governments would have laid off an additional 401,000 workers in April 2020, 40 percent more than realized. State rainy day fund balances limit the sensitivity of employment to these revenue shocks, revealing that balanced budget requirements for state and local governments increase the procyclicality of public service provision.

Local Government Finances and Balanced Budgets in the COVID-19 Crisis

Local governments are facing large losses in revenues and increased expenditures because of the COVID-19 crisis. We document a causal relationship between fiscal pressures induced by COVID-19 and the layoffs of state and local government workers. States that depend more on sales tax as a source of revenue laid off significantly more workers than other states. The CARES Act's provision of \$150 billion in aid to state and local governments reduced the fiscal pressures they faced. Exploiting a kink in the formula for allocation of funding across states, we estimate a state and local government employment multiplier for federal aid---each dollar of federal aid was used by states to support 31 cents of payrolls. State rainy day fund balances limit the sensitivity of employment to both revenue shocks, revealing that balanced budget requirements for state and local governments increase the procyclicality of public service provision.

Aggregate stability under a budget rule and labor mobility

Whether a balanced budget rule stabilizes or destabilizes an economy depends on various factors such as the production function or the instrument used to balance the budget. This paper argues that migration, which has widely been neglected in the literature, also affects equilibrium properties. We study the effect of pro-cyclical labor mobility in a neoclassical growth model with public debt and a balanced budget requirement. Labor mobility can destabilize the economy due to external effects. After a negative shock hits the economy, living abroad becomes relatively more attractive, resulting in out-migration. This increases per capita public debt as migrants leave behind their implicit liabilities. The government increases tax rates to satisfy the balanced budget requirement, which further depresses the economy and increases out-migration. The destabilizing effect of public debt kicks in at only slightly higher debt levels than the ones observed in the Euro area after the financial crisis.

Less fiscal oversight, more adjustment

In Norway, a reform in 2001 lifted budget and borrowing approval for local governments that comply with the balanced budget requirement (BBR). It was a concern that less fiscal oversight would lead to less fiscal discipline. A neglected effect however, was that the reform implicitly introduced sanctions for violating the BBR. In addition a register informing financial institutions about authorities in need of borrowing approval provides voters with reliable information about fiscal performance. We find evidence of stronger fiscal adjustment after the reform, in particular for local governments with past deficits that are at risk of being enrolled in the register. Moreover, an important finding is that this result also holds for local government with past deficits that do not end up in the register. Local governments with past surpluses are less affected by the reform, but there is some evidence in the direction of lower surpluses for this group.

Fiscal autonomy and stabilization: an empirical analysis of US state governments

PurposeEven though fiscal autonomy plays a role as one of the prerequisite conditions for fiscal decentralization, there has been little research into why fiscal autonomy is important or how it works for subnational governments. This study aims to examine the effectiveness of fiscal autonomy by using a panel dataset of US state governments from 2001 to 2013.Design/methodology/approachAccording to the results of general method of moments, the author find that fiscal autonomy leads to reducing volatility in total expenditures.FindingsIt indicates that fiscal autonomy is necessary for state governments performing one of the three Musgravian role of government (e.g. stabilization). However, when we look at the more detailed relationship between fiscal autonomy and volatility by applying expenditures from major categories such as capital outlay, general expenditure and public welfare, this study finds no statistically significant results. Interestingly, balanced budget requirement and tax and expenditure limitation indicate different effects on expenditure volatility, even though they belong to the same institutional factors.Originality/valueThis paper is meaningful because it can support the importance of fiscal autonomy on fiscal performance.

The effects of government spending shocks: Evidence from U.S. states

Using panel structural VAR analyses and a recently released dataset on quarterly gross domestic product by state, this paper finds that an increase in state spending raises output, employment, and the real wage. Our baseline estimates imply that the multiplier effect of a spending increase on output is 1.3 contemporaneously and 1.2 over three years. The effects, however, vary considerably depending on the economic environment and institutional context. Specifically, we find that (i) the spending multiplier is larger during recessions than expansions (ii) the spending multiplier is relatively larger during periods of low debt than in episodes of high debt; (iii) spending shocks have relatively larger effects on states with “medium” balanced-budget requirements than those with either weak or strong balanced-budget requirements; and (iv) the spending multiplier is relatively smaller for states with either lax or strict debt restriction provisions compared to those with moderate provisions. These differences in the magnitude of the spending multiplier across states with different balanced budget rules and debt restriction provisions are rather small and not always statistically significant.

The political economy of budget trade-offs

AbstractBecause the American states operate under balanced budget requirements, increases in spending in one area typically entail equal and opposite budget cuts in other programs. The literature analysing the correlates of government spending by policy area has mostly ignored these trade-offs inherent to policymaking, failing to address one of the most politically interesting and important dimensions of fiscal policy. Borrowing from the statistical literature on compositional data, we present more appropriate and efficient methods that explicitly incorporate the budget constraint into models of spending by budget category. We apply these methods to eight categories of spending from the American states over the years 1984–2009 to reveal winners and losers in the scramble for government spending. Our findings show that partisan governments finance their distinct priorities by raiding spending items that the opposition prefers, while different political institutions, economic conditions and state demographics impose different trade-offs across the budget.

Implications of Medicaid Financing Reform for State Government Budgets

We analyze potential reforms to Medicaid financing through the lens of fiscal federalism. Because substantial dollars are at stake, both the economic and political sides of intergovernmental transfers have high relevance in this setting. We show that changes in Medicaid financing formulas can shift amounts exceeding several hundred dollars per capita from “winning” states to “losing” states. In some cases, these amounts exceed 10% of states’ own-source revenues. States’ balanced budget requirements imply that such changes would, if not phased in gradually, require significant budgetary adjustment over short time horizons. We next show that alternative Medicaid financing structures have significant implications for states’ exposure to budgetary stress during recessions. During the Great Recession, an acyclical block-grant structure would have increased states’ shortfalls by 2–3.5% of own-source revenues relative to either an explicitly countercyclical block grant or the current matching system. Finally, we assess the implications of several financing structures for the extent to which they subsidize states’ decisions on both the “extensive” and “intensive” margins of coverage generosity over the short and long term.

Fiscal rules and the intergenerational welfare effects of public investment

A common argument against balanced-budget fiscal rules has it that the costs of durable public capital fall entirely on current generations while its benefits also accrue to future generations. This paper proposes an additional argument whereby balanced-budget rules imply uneven welfare effects of public investment across generations. Using an overlapping generations model of a small open economy, I show that, when subject to a balanced-budget constraint, public investment causes a negative financial wealth effect on current generations. Numerical simulations of the model show that, in terms of welfare, this negative financial wealth effect more than offsets the productivity gains of higher public investment spending, leaving current generations worse-off. A golden rule exempting net public investment from the balanced-budget requirement overturns this effect and allows for welfare gains to both current and future generations. Allowing for debt-financing may thus be necessary to ensure public support for efficient increases in public investment spending.

Fiscal institutions and the funding of US state and local pension plans

This paper investigates the relationship between the funded ratio of US public pension plans and several fiscal institutions adopted by state governments. The author analysed a large data set from 1997 to 2012, and found that states with stricter balanced budget requirements and debt limits had a lower pension funded ratio, whereas states with tax and spending limits in place had a higher funded ratio. The findings contribute to the current debate on public sector pension reforms in the US and internationally.

Wagner’s law, fiscal discipline, and intergovernmental transfer: empirical evidence at the US and German state levels

Does fiscal discipline restrain the government from increasing its budget size? To answer this question, this paper investigates whether Wagner’s law is satisfied for two types of states: US states, in which fiscal sovereignty is established, and German states, in which fiscal transfer dependence is high and budget constraints are softened. In US states, we demonstrate that Wagner’s law is validated, while some of the balanced budget requirements weaken the validity of the law. In German states, we find an “inverse” law, especially after the bailouts of Bremen and Saarland. The “inverse” law is a new channel of growth in government size and means that soft budget constraints cause significant negative correlation between government size and output. These results are robust regardless of whether intergovernmental fiscal transfers are taken into account, while they quantitatively change the validity of the law. Our findings imply that the characteristics of fiscal discipline are the prime determinants of the channel and degree of growth in government size.

How Washington Uses the Power of the Purse to Bribe and Control State and Local Governments

Through over 1,100 programs, the federal government provides one-fourth of all revenue spent by state and local governments. This creates a dependency upon the federal government, requires local and state governments to conform with federal policies and priorities, and perpetuates demands for continued deficit spending. Although state and local governments typically have balanced budget requirements, they expand their programs and spending by taking advantage of the lack of a federal balanced budget requirement.