How Do Balanced Budget Rules Impact Fiscal Performance Based On Revenue Structure?: Evidence From U.S. States

• Author: Sungchan Kim,Soyoung Park
• Published date: 01 June 2022
• Date: 01 June 2022
• DOI: http://doi.org/10.1177/0160323X221094805
• Subject Matter: Original Research General Interest Articles

How Do Balanced Budget Rules

Impact Fiscal Performance

Based On Revenue Structure?:

Evidence From U.S. States

Sungchan Kim

1

and Soyoung Park

2

Abstract

Revenue condition needs to be considered in the design of balanced budget rules (BBRs), because

revenue stream, which varies across state governments, is an important factor in balancing the bud-

get. Also, revenue factors may inf‌luence state responses to economic crises through the employ-

ment of BBRs.Thus, this study examines the inf‌luence of BBRs on states’f‌iscal performance

depending on revenue structure using a panel data set from 1997 to 2016. The results demonstrate

that the strongest BBRs are effective in reducing def‌icit shocks, although this amplif‌ies f‌iscal volatil-

ity. However, the weakest BBRs play a role in stabilizing volatility. Considering revenue structure, if a

state government is concerned about def‌icit shocks, it would do well to adopt the strongest BBRs,

with lower levels of own-source revenue. Conversely, if a state government wishes to pursue f‌iscal

stabilization, it should adopt the weakest BBRs, with lower levels of own-source revenue and less

diversif‌ied source.

Keywords

balanced budget rules (BBRs), stringency of BBRs, f‌iscal performance, revenue context, f‌iscal

discretion

Introduction

Concerns about f‌iscal discipline at the state

level are signif‌icant, particularly during eco-

nomic downturns. Fiscal rules are considered

a form of f‌iscal discipline, helping to maintain

f‌iscal soundness. In the U.S., balanced budget

rules (BBRs) as a form of f‌iscal discipline

tend to compel state governments to engage in

procyclical policies involving budget cuts or

tax increases in response to a f‌iscal crisis.

State governments in the U.S. cut services and

reduced assistance payments during the most

recent recession, which began in 2007. This is

because BBRs prevent states from spending

when they have def‌icits, and indeed states

should spend based upon anticipated revenue.

Under BBRs, policy makers are constrained in

making budgetary decisions. Essentially,

1

Department of Public administration, Catholic University

of Korea, Bucheon, South Korea

2

Department of Public administration, Incheon National

University Incheon, Incheon, South Korea

Corresponding Author:

Soyoung Park, Department of Public administration,

Incheon National University Incheon, songdo yeonsu gu,

Incheon 22012, South Korea.

Email: soyoungp@inu.ac.kr

Original Research General Interest Articles

State and Local Government Review

2022, Vol. 54(2) 146-164

© The Author(s) 2022

Article reuse guidelines:

sagepub.com/journals-permissions

DOI: 10.1177/0160323X221094805

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policy makers must decide whether to cut ser-

vices and/or increase taxes.

However, whether these institutional con-

straints lead to eff‌icient responses to f‌iscal

shocks or economic crises, ensuring f‌iscal

soundness through the adjustment of f‌iscal

policy, remains an open question. Several

scholars have argued that f‌iscal discipline may

cause a decline in average budget def‌icits

(Alesina and Perotti 1996), while other scholars

have argued that governments with such con-

straints are less likely to respond quickly to eco-

nomic shocks (Poterba 1994). For example,

Poterba (1994) found that more stringent

BBRs, such as “no-def‌icit carryover”rules,

prevent states from adjusting their f‌iscal policy

in a f‌inancial crisis. In terms of budgetary con-

straints related to f‌iscal discipline, it is neces-

sary to explore whether these constraints lead

to effective budgetary responses in practice

across both states and time periods.

The impact of BBRs on f‌iscal policies has

been more extensively examined relative to

their strictness (Alt and Lowry 1994;

Endersby and Towle 1997; Hoover and

Pecorino 2005). However, few studies have

examined how the impacts differ depending

on revenue condition. Revenue condition must

be considered in the design of BBRs, because

revenue stream, which varies across state gov-

ernments, is an important factor in balancing

the budget. Revenue factors may inf‌luence

state responses to economic crises through the

employment of BBRs. The ability of states to

respond to f‌iscal crises will likely be affected

if they have f‌iscal restrictions relative to their

revenue condition. Thus, the purpose of this

study is to examine how BBRs impact f‌iscal

performance depending on the revenue condi-

tion of state governments. Specif‌ically, this

research will measure revenue condition using

revenue diversity, revenue elasticity, and level

of own-source revenue. Using a panel data set

from 1997 to 2016, this paper will investigate

the inf‌luence of BBRs on def‌icit shocks and

expenditure volatility depending on the

revenue condition of state governments.

The article is structured as follows. The next

section provides a brief review of the literature

on BBRs and tax structure, focusing on

revenue elasticity and revenue diversif‌ication.

We then explain variables and methods and

provide our empirical f‌indings. Finally, the

study offers concluding remarks.

Literature Review

BBRs and their Impact

All state governments except Vermont employ

BBRs. There are four types of BBRs, which

are as follows: (1) a governor must submit a

balanced budget to the legislature; (2) the legis-

lature must pass a balanced budget; (3) the gov-

ernor must sign a balanced budget; and (4) a

def‌icit cannot be carried over into the next

f‌iscal year (NASBO 2008; Poterba 1996).

Fatás and Mihov (2006) argued that the

degree and form of BBRs are related to the

phase of the budget process and associated

strictness. The f‌irst two forms are considered

weaker; neither imposes f‌iscal discipline at the

end of the f‌iscal year (Bohn and Inman 1996).

The remaining two forms proceed to the

ex-ante budget. Among the four categories, pro-

hibiting states from carrying over a def‌icit is

considered the most stringent form (Alesina

and Bayoumi 1996; Bohn and Inman 1996).

According to Bohn and Inman (1996), “tight”

end-of-year, higher-level, legal-based balanced

budget requirements play a signif‌icant role as

a constraint, while “soft”limitations applying

only to the beginning-of-the-year balance are

not considered effective constraints. State gov-

ernments adopt different conditions for BBRs.

Regarding the impacts of BBRs, Hou and

Smith (2006) explained that BBRs serve as an

effective tool for curbing state expenditures

and maintaining a balanced budget. Kudrin

and Sokolov (2017) also found that BBRs

reduce debt levels and may also increase

reserves. Schakel, Wu, and Jeurissen (2018)

revealed that BBRs lead to lower expenditures

and may control public spending through

f‌iscal rules. However, Costello, Petacchi, and

Weber (2017) demonstrated the probability of

BBRs’negative long-term effects on f‌iscal

soundness. In that study, governments sold

public assets to their own budget as well as

Kim and Park 147