Budget Slack, Institutions, and Transparency

• Published date: 01 March 2012
• Date: 01 March 2012
• DOI: http://doi.org/10.1111/j.1540-6210.2011.02491.x

Shanna Rose is assistant professor

of public f‌i nance in the Robert F. Wagner

Graduate School of Public Service at New

York University.

E-mail: shanna.rose@nyu.edu

Budget Slack, Institutions, and Transparency 187

Daniel L. Smith is assistant professor of

public budgeting and f‌i nancial management

in the Robert F. Wagner Graduate School of

Public Service at New York University.

E-mail: daniel.smith@nyu.edu

Public Administration Review,

Vol. 72, Iss. 2, pp. 187–195. © 2011 by

The American Society for Public Administration.

DOI: 10.111/j.1540-6210.2011.02491.x.

Shanna Rose

Daniel L. Smith

New York University

Economic theory suggests that it is optimal for governments

to use precautionary saving as a countercyclical tool.

However, the availability of surplus funds often triggers

political pressure for tax cuts and spending increases.

Mechanisms for alleviating that pressure include limiting

the transparency of slack resources and limiting politicians’

discretion to use slack resources for purposes other than

stabilization.  is article investigates the extent to which

these two mechanisms are substitutes. In particular, the

authors examine whether the widespread adoption of

budget stabilization funds (BSFs) in the U.S. states over the

past several decades has been accompanied by a decline in

conservative revenue forecast bias. Using panel data from

47 states over a 22-year period, they f‌i nd that the adoption

of a BSF reduces revenue underestimation by approximately

two-thirds; however, the size of the ef‌f ect depends in part on

how much a state saves in the BSF and the rules governing

BSF deposits and withdrawals.  e results suggest that BSFs

have the unintended ef‌f ect of increasing f‌i scal transparency.

Economic theory suggests that it is optimal for

governments to accumulate surpluses during

expansionary periods for use during contraction-

ary periods so as to “smooth” taxes and spending over

the business cycle (Barro 1979; Lucas and Stokey 1983).

Slack resources can help governments cope with eco-

nomic uncertainty, absorb temporary shocks, cover cash

f‌l ow problems, meet contingency needs, and even take

advantage of investment opportunities (Finkler 2010;

Hendrick 2006; Tyer 1993). Precautionary saving has the

additional benef‌i t of reassuring f‌i nancial markets about

the government’s creditworthiness, thereby improving

credit ratings and reducing inter-

est costs (Wagner 2004).

Budget slack is particularly im-

portant for governments that are

legally required to balance the

budget at the end of each year,

as many U.S. state and local gov-

ernments are required to do. In

the absence of precautionary sav-

ing, such governments have little

choice but to respond to budget shortfalls by making

structural adjustments such as tax increases and service

cuts (Poterba 1994).  ese adjustments often come at

a high political cost, not to mention the administrative

cost of changing spending and tax policies during the

year and the economic cost of doing so in the context

of an already struggling economy.

Precautionary saving is often dif‌f‌i cult to undertake

in practice, however, as budget slack tends to trigger

political pressure from a variety of external and internal

stakeholders: taxpayer groups seek tax relief, special

interest groups pressure the government to spend the

funds on their preferred programs, agency heads push

for increased allocations, and unions are more aggressive

in collective bargaining (Tyer 1993).  ese pressures

may lead lawmakers to save too little, use precautionary

savings for purposes other than stabilization, or both.

Governments can accumulate slack resources in at least

three ways, some of which may be more vulnerable

to political pressure than others. First, lawmakers can

budget a general fund surplus by setting expenditures

lower than anticipated revenues; second, they can

balance the budget but deliberately underestimate rev-

enues or overestimate expenditures; and third, they can

set aside money in a separate budget stabilization fund

(BSF), sometimes known as a “rainy day fund.”  e

f‌i rst form of slack is both highly visible to stakeholders

and highly accessible to lawmakers, and thus arguably

the most likely to attract unwanted attention.  e

second and third forms of slack are less transparent to

interest groups and less discre-

tionary to lawmakers, respec-

tively, and therefore may be less

vulnerable to political pressure.

 is article conjectures that

limiting transparency and limit-

ing discretion are substitutable

mechanisms for alleviating po-

litical pressure triggered by unal-

located surpluses. To test this

Budget Slack, Institutions, and Transparency

 is article conjectures

that limiting transparency

and limiting discretion are

substitutable mechanisms for

alleviating political pressure

triggered by unallocated

surpluses.