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Tax and Expenditure Limits for Long-Run Fiscal Stability

October 1, 2009
By Emily Washington and Frederic Sautet

In the private sector, the profit and loss mechanism signals firms to adjust their production and costs quickly to changes in demand and revenue. In the public sector, no tool adjusts spending to changing conditions.

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In the private sector, the profit and loss mechanism signals firms to adjust their production and costs quickly to changes in demand and revenue. In the public sector, no tool adjusts spending to changing conditions. Instead, policy makers have incentives to increase government spending year after year, regardless of tax collection: Vested interests can benefit greatly from marginal expenditure increases that build over time, and the political process rewards legislators who cater to their strongest supporters by funneling spending to their programs.

In the current recession, many states have decreased revenues. Because government services have grown unchecked, these states now must make painful and unpopular cuts. California, Arizona, and New Jersey, among other states, have made headlines in recent months with their drastic measures to close budget shortfalls.

This pattern raises a difficult question: How do states correct for the inflexibility inherent in state expenditure systems to respect taxpayers' desires for government services over time? Some states have experienced relative success in this area because of Tax and Expenditure Limits (TELs) that constrain their budgets. While not a perfect solution, binding TELs prevent policy makers from increasing state spending that does not reflect voters' willingness to pay for government services.

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