BPEA | Fall 2010

State Fiscal Policies and Transitory Income Fluctuations [with Comments and Discussion]

discussants: Brian Knight and
Brian Knight headshot
Brian Knight Director of Innovation and Governance and a Senior Research Fellow - Mercatus Center at George Mason University
William G. Gale
William G. Gale The Arjay and Frances Fearing Miller Chair in Federal Economic Policy, Senior Fellow - Economic Studies, Co-Director - Urban-Brookings Tax Policy Center

Fall 2010

State and local expenditure and tax revenue respond less to the
business cycle than do federal spending and revenue, thereby reducing the
countercyclicality of total government expenditure and revenue. This paper
considers forces responsible for the cyclical pattern of state expenditure and
revenue. Annual fluctuations in state personal income are associated with
small changes in state spending and significant changes in tax receipts; receipt
of federal grants is associated with greater state spending. Tax collections, and
to a lesser degree expenditure, of larger states are more closely associated
with annual income fluctuations than are the tax collections and expenditure of
smaller states. These state size differences may proxy for other state characteristics,
such as the extent to which a state faces interstate competition for
mobile businesses and individuals, and the quality of state government. The
spending and tax revenue of states with less mobile populations closely track
income fluctuations, as does spending in states where convictions of public
officials for federal corruption crimes are more common. In small states, and
in states with more mobile populations and better corruption records, government
expenditure and revenue appear to rise and fall less with income, and in
that respect more closely resemble the federal government.