It's Spending that Matters: From Robust Control Theory to Practical Heuristics

Abstract

The problems caused by state and local revenue volatility are inherently challenging. The State of Oregon has an especially volatile revenue structure, which can cause all sorts of problems as the state moves through the business cycle. Nevertheless, we have concluded that these problems are caused less by revenue volatility per se than by adjusting spending up and down to match current revenue flows, from growing spending at unsustainable rates during booms and cutting back precipitously during busts. The mild recession of 2001-2 had a particularly severe aftermath in Oregon. This event shocked the state’s policy makers into addressing the revenue volatility issue, making sense of it, and taking steps that greatly mitigated the adverse effects of the ‘Great Recession.’ This essay describes three things: the public-policy processes that produced this moderately happy outcome, my own voyage of discovery as I observed/participated in these processes, and a set of practical mechanisms states can use to stabilize spending.

Keywords: State taxes, State and local spending, Process, Mechanism, Martingale methods, Optimal stopping models

JEL Classification: H71, H72