title: Tax and expenditure limitations as a tool of counter cyclical fiscal policy: post-2001 recession fiscal strategies in three states
title: Post-2001 recession fiscal strategies in three states
titleType: AlternativeTitle
Creators: name: Juppe, David B.
Publisher: name: Maryland Shared Open Access Repository
Year: 2010
Subjects: tax and expenditure limitations

description: The central research question for this study is to determine whether state tax and expenditure limitations play a role in fiscal management by constraining growth in state government general fund spending during boom times to mitigate the effects of revenue loss following an economic downturn.  There has been much study of tax and expenditure limitations and a separate theme on cyclical instability and how states prepare and react to downturns through reserves, temporizing actions, higher revenues, and spending cuts.  While these themes have evolved separately, they are beginning to approach each other.  Given the wide ranging characteristics of tax and expenditure limitations, which vary based on how binding they are and whether they restrict revenue, expenditures, or both, the research design in this study adopted an analytical strategy that compared three states before and after the recession of 2001:  Delaware, which has a constitutional limit on spending as a percent of revenues; Maryland, which has a non-binding informal limit on spending; and Virginia, which has no tax and expenditure limitations in place.

Three case studies employed qualitative interviews with elected officials and budget personnel to gauge their perceptions of the effectiveness of their respective budget practices relative to quantitative data on revenue and spending trends, as well as general fund and rainy day fund policies and balances prior to and following the 2001 recession.  The study concluded that both binding and non-binding tax and expenditure limitations were successful in limiting ongoing general fund operating budget spending during the boom economic times of the late 1990s.  Reserve fund balances, which were expected to be larger in states with tax and expenditure limitations, were affected by caps on maximum balances, the ability to use balances for purposes unrelated to fiscal crises, or the age of the fund.  Fiscal stress following the 2001 recession was influenced by other factors including revenue and reserve fund policies.

In most instances, interview participants felt that the system under which their state operated (i.e., formal tax and expenditure limit, non-binding limit, or no limit) was the best system.  Those in states with limits also opined that their presence did help constrain growth in state government spending in periods of economic growth.  Interestingly, the interviewees in Maryland and Delaware also expressed a reluctance to use reserve fund balances below the 5% level over concern for potential credit rating downgrades.

The researcher believes that states may benefit from policies to limit spending growth relative to some measure of economic activity and to maintain an established percent of revenues in general fund balance.  With respect to rainy day funds states should determine the optimal balance recognizing that reserves cannot carry a state through a recession.  Other considerations include eliminating maximum balance caps, using automatic deposit requirements, and limiting use of balances only for budgetary shortfalls.  States need to pay attention to revenue policies during good times, as cumulative tax actions impact financial management.  States ought to determine methodologies for allocating surplus funds at closeout to unmet spending needs, PAYGO and other one-time purposes, transfers to reserves, or application to unfunded liabilities.

Further study could assess the effectiveness of tax and expenditure limitations in other states at constraining spending growth, the fiscal management policies of states to ascertain use of funds for one-time purposes, general fund balance requirements, the optimal size of reserve balances, and the effect of bond ratings in decisions to use balances during recessions.