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State and Local Spending: Do Tax and Expenditure Limits Work?

May 8, 2013
By Benjamin Zycher

Since 1978, 30 states have enacted formal limitations on taxes, budgets, or outlays as tools with which to strengthen fiscal discipline.

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Since 1978, 30 states have enacted formal limitations on taxes, budgets, or outlays as tools with which to strengthen fiscal discipline. These tax and expenditure limits (TELs) vary substantially in terms of their details, definitions, and underlying structures, but the empirical finding reported here is simple and powerful: TELs are not effective.

It is no secret that the fiscal pressures facing states and localities are likely to intensify sharply in the near future. These pressures are reflected in the rising share of federal finance (or revenue transfers) observed in state and local spending over time, driven heavily by health care programs, Medicaid in particular. Future pension liabilities also are a prominent source of the growing fiscal crisis that states and localities are beginning to confront. These pressures will inevitably strengthen demands that the federal government increase its transfers to lower levels of government.

The empirical analysis reported here applies data from 49 states (excluding Alaska) over the period 1970-2010 to the empirical question of the effectiveness of TELs, which across the states display a wide variety of features. The ineffectiveness of TELs is unambiguous in terms of summary statistics, case-study examination of the records of several individual states, and estimation of an econometric model. This model was estimated for both state and local spending combined and state outlays considered alone. The econometric model estimated here differs from those in the earlier literature, most importantly in that the existence of a TEL in a given state is treated here as a decision variable. The finding of ineffectiveness is broadly consistent with the findings reported in the earlier peer-reviewed literature.

The almost-universal weakness of TELs is striking, but the empirical evidence by itself does not explain these findings. In part, it is likely that the limits themselves are the products of the same political pressures and election dynamics that yield fiscal outcomes. Moreover, the competition among political interests that results in budget outcomes also is likely to weaken or circumvent limits that otherwise would be effective. This raises a larger overall question: what are the sources of government growth? Five hypotheses are discussed in this study, the upshot of which is that TELs by themselves are unlikely to affect the demand for or the cost of government spending.

The findings reported here should interest state (and local) officials seeking ways to reduce or to neutralize powerful pressures for spending and revenue growth. They should also interest federal policymakers subjected to state and local demands for revenue transfers and others kinds of aid; a quid pro quo in the form of a tax or expenditure limitation is very unlikely to reduce future pressures for additional federal aid. Moreover, they should interest the broader policy community as state and local (and federal) fiscal problems intensify, and with them the public discussion of alternative policy responses, and the public, ultimately the source of all resources consumed or allocated by government.

It is likely to be the case that such mechanical tools as TELs cannot substitute for the hard work of long-term public education and persuasion about the central benefits of limited government. In the long run under democratic institutions, popular will is likely to impose sharp constraints on the behavior of government; this means that attitudes must be changed through a process of debate and enlightenment.