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Article Excerpt
In many states, tax and expenditure limits constrain government spending. All but one state have adopted balanced-budget rules. Some governors have the power to veto individual budget items (the so-called line-item veto). This article reviews the evidence linking fiscal and political institutions to state taxation, spending, and debt.
It appears that properly designed fiscal and political institutions are effective in containing the growth of state government. Constitutional tax and expenditure limits have been more successful than spending constraints established legislatively. Balanced-budget rules that prohibit deficit carryover to the following fiscal year are superior to rifles that allow deficit carryover.
Researchers have identified two other relationships. First, there is evidence that fiscal rules reduce state borrowing costs. Second, the citizen initiative process has played a role in controlling spending: states with a citizen initiative process spend less.
State Spending and Fiscal Controls
In the United States, state government spending has grown rapidly, nearly doubling since 1995. Population and prices have grown as well, but at a much slower rate. The result has been a significant expansion in real per capita state government expenditures. Although the finances of state governments have improved considerably in the last few years, overspending in the 1990s was a major contributor to the fiscal problems that plagued state governments in 2001-03.
Conventional views of government do not offer a justification for fiscal controls. For example, Downs (1957) argues that elected officials provide public services consistent with the preferences of the median voter. From this perspective, politicians act to maximize the net benefits of the median voter and there is no need to limit government. Similarly, Tiebout (1956) contends that businesses and individuals affect the size of government by voting with their feet, leaving jurisdictions with levels of spending they consider too high. In this view, competition between states brings about the right level of spending.
Alternatively, the special-interest view of government (Stigler 1971, Peltzman 1976, Becker 1983) and the Leviathan view (Niskanen 1975, Brennan and Buchanan 1979) predict that the influence of lobbying groups and the behavior of self-interested bureaucrats result in levels of government spending that exceed what the average voter desires. In contrast to conventional views of government, special-interest and Leviathan views place far more emphasis on the role public institutions and rules play in facilitating (and limiting) the growth of government.
Certainly state governments have a role to play in the provision of public goods and services, such as police, courts, and infrastructure. They also play a role in transfer programs. However, there is increasing concern over the growth in state spending. Economists and others worry that excessive spending results in higher taxes that, in turn, stifle economic activity (Barro and Sala-i-Martin 1995 and Engin and Skinner 1996). In the political arena, this concern has been manifested in the various attempts to establish fiscal and political institutions citizens can use to control the growth of state government.
Fiscal Institutions
Tax and Expenditure Limitations
Tax and expenditure limitations (TELs) are rules that attempt to constrain the growth of a state's revenues or expenditures. Most TELs limit the increase in expenditures to the growth of state personal income or the growth in state population plus inflation. Poulson (2005) reports that 30 states have some form of a TEL limitation. The majority (18) are constitutional, while the remaining (12) are statutory. Statutory TELs tend to be weaker and easier for the legislature to modify or avoid.
The early studies by Abrams and Dougan (1986), Cox and Lowery (1990), and Bails (1990) found TELs to be ineffective in controlling the growth of state government expenditures. However, those studies examined a cross section of states at one point in time. With such limited data, it is difficult to control for all the factors that influence spending.
More recent studies look at states over time. With far more observations, they are able to control for observable and unobservable (using fixed-effects estimators) factors that influence spending. These studies do, in fact, find that TELs reduce state government spending. In examining the effect of TELs, it is important to isolate a political response to a change in voters' attitudes (which may lead to the imposition of a TEL) from the direct effect of a TEL itself. Using an instrumental variables approach, Reuben (1996) finds that the presence of a TEL reduces state spending by about 1.8 percent (partially offset by an increase in local spending). Bails and Tieslau (2000) confirm Reuben's results. Their estimates indicate real state and local expenditures per capita to be 841 less, on average, in states with TELs.
Poterba (1994) examines the influence of state TELs on the budget adjustment process following an economic downturn. Looking at the 1991-92 recession, Poterba finds that budgets in states with TELs tend to adjust faster. When revenues fall, TEL states are less likely to increase taxes to balance their books. For a 81.00 budget deficit increase, TEL states increase taxes by 80.47 while non-TEL states increase taxes by 81.03. Poterba finds no difference in spending reduction behavior between TEL and non-TEL states; TEL states are more likely to run a deficit than to increase taxes in response to a negative budget shock. Poterba's work suggests that the most effective TELs are constitutional, written by voters, and those that limit...
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