Growth and Variability in State Tax Revenue: An Anatomy of State Fiscal Crises.

• Author: Proctor, Allen J.

Holcombe, Randall and Sobel, Russell

Westport, CT: Greenwood Press, 1997. (224 pp)

Reviewed by Allen J. Proctor, Executive Director, Ohio Police and Firemen's Disability and Pension Fund.

This excellent book fills an important empirical gap in the literature of state fiscal crises, revenue elasticities, and rainy-day funds. The authors, both professors of economics, provide a strong theoretical and empirical justification for the use of rainy-day funds to reduce fiscal stress during economic recessions. Their analysis starts with the question of whether insufficient revenue is the real reason for recurrent budget problems by states or merely a straw man, then systematically eliminates various explanations to arrive at a strong endorsement of regular contributions to rainy-day funds as the only statistically significant method to reduce fiscal stress. This argument is not new; what makes this book important is the force of its statistical analysis, which is the most thorough this reviewer has encountered on the topic.

The authors make their argument clear, concise, and accessible, especially in the preface and conclusion to the book. They summarize their entire treatise on page 193: "State government fiscal crises are caused by cyclical variability in state government revenues. When recessions reduce the growth in state government revenues, states tend to have fiscal crises. There is no good way to meaningfully reduce the cyclical variability of state government revenues. Therefore, the best way to minimize state government fiscal crises is to establish a properly structured rainy-day fund. By setting aside some revenues during prosperous years for use during recessions, states can minimize their recession-induced fiscal stress and avoid fiscal crises."

The statistical study begins by establishing that all state revenues exhibit nonstationarity, a statistical quality that creates problems in traditional time series estimation. The most important problem is that the usual estimates will severely misstate the elasticity of revenues during a recession. The authors identify the type of stationarity and go on to develop the appropriate estimation methodology for short-run and long-run elasticities. They come to the surprising result that most state revenue bases are not elastic in a cyclical downturn. They present an excellent discussion of the miscues policy makers would receive from using the results of traditional estimation methodologies as...