State Fiscal Policies and Transitory Income Fluctuations

State and local expenditure and tax revenue respond less to the business cycle than do federal spending and revenue, thereby reducing the countercyclicality of total government expenditure and revenue. This paper considers forces responsible for the cyclical pattern of state expenditure and revenue. Annual fluctuations in state personal income are associated with small changes in state spending and significant changes in tax receipts; receipt of federal grants is associated with greater state spending. Tax collections, and to a lesser degree expenditure, of larger states are more closely associated with annual income fluctuations than are the tax collections and expenditure of smaller states. These state size differences may proxy for other state characteristics, such as the extent to which a state faces interstate competition for mobile businesses and individuals, and the quality of state government. The spending and tax revenue of states with less mobile populations closely track income fluctuations, as does spending in states where convictions of public officials for federal corruption crimes are more common. In small states, and in states with more mobile populations and better corruption records, government expenditure and revenue appear to rise and fall less with income, and in that respect more closely resemble the federal government.