IMUN P.A. COLLOQUIUM For the public good 1

REVENUE VOLATILITY AND BUDGET INSTABILITY Sunjoo Kwak Jan

Budget (in)stability “An ongoing (im)balance between the supply and demand for government services, or more technically, between revenues and spending” (NASBO, 1995, p. 1) NASBO. 95. Budget stability: A policy framework for states 3

Indicators of budget instability: Mid-year budget cuts Source: summary of the 2015 Fiscal Survey of the States (NASBO) 4

Indicators of budget instability: Short-term borrowing 5 Aggregate state short-term debt per capita (in 2007 constant dollars)

Research questions What factors affect budget stability? Does revenue volatility lead to budget instability? Does fiscal reserve play any moderating role in the relationship b/t revenue volatility and budget instability? 6

Understanding the business cycle 7

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The dynamics of state fiscal behavior over the business cycle Public choice theory and political economy models of public finance suggest: increase in overall revenue availability → increase in spending, despite the tax smoothing (or countercyclical fiscal policy) principle Empirical evidence: procyclical fiscal policy (i.e. spending increases and tax cuts during booms and spending cuts and tax increases during recessions) Theoretical reasoning 1: rapid and sustained revenue growth during booms → excessive spending increases and unaffordable tax cuts → structural budget deficits → fiscal crisis Theoretical reasoning 2: moderating effect of fiscal reserve 9

Alabama Florida KentuckyIowa New Mexico Connecticut

Empirical analysis Data: state finance data ( ) Model: budget instability = f(revenue volatility, fiscal reserve, RV*FR, controls) Measures of budget instability: Mid-year budget cuts as % of direct expenditure Short-term debt per capita Measure of fiscal reserve: fiscal reserve as % of direct expenditure (fiscal reserve=GFS(general fund surplus)+BSF(budget stabilization fund)) Controls Balanced budget requirement (no-deficit-carryover) Party control: Republican control of governorship, Senate, and House, and divided government Economic-demographic: population, unemployment rate, population over 65 and under 17, non-south 11

Measurement of revenue volatility Measured in two steps: first measuring the volatility of each tax base and then weighting each tax base’s volatility according to its respective share in the total tax revenue and adding them together to form a composite index Calculation of each tax base’s volatility: standard deviation of tax base gap 12

Tax bases used: general sales, personal income, corporate income, motor fuel, alcohol General sales: tax revenue/tax rate Personal income: tax revenue/average tax rate(TAXSIM) Corporate income: gross corporate surplus Motor fuel: net volume of motor fuel taxed Alcohol: total alcohol consumption 13

Results Mid-year budget cutsRobust Coef.Std. Err.tP>t crevvol crainy crevvol_crainy nodef repgovn repsen rephou divgov pop-6.20E E unempl over under nonsouth _cons

Short-term debtRobust Coef.Std. Err.tP>t crevvol crainy crevvol_crainy nodef repgovn repsen rephou divgov pop3.14E E unempl over under nonsouth _cons