The Causes and Consequences of Increasing State Tax Revenue Volatility
57 Pages Posted: 5 Jun 2016 Last revised: 2 Apr 2017
Date Written: June 3, 2016
This paper documents a striking empirical regularity that average state tax revenues increased from 2.9 percent of revenues in 1970-1999 to 10.8 percent in 2000-2014. Because many states cannot deficit spend, government expenditure volatility increased by a similar amount, subjecting some states to a financial crisis. Using a novel data set and decomposition methods, I estimate how much differences in economic uncertainty (e.g., the dot-com and housing bubbles) and tax policy (e.g., relying more on income taxes) contributed to the increase in tax revenue volatility. I find that differences in tax policy explain 59 percent of the increase in revenue volatility. In light of this finding, I derive a simple rule that determines whether a state's tax policy is over-exposed to a given source, meaning that by shifting away from that source deadweight loss and volatility can be decreased without a change in expected revenues. Using this rule I find that the number of states that exposed themselves to excessive risk increased from 26 in 1975 to 36 in 2005.
Keywords: State Taxes, Tax Revenue Volatility
JEL Classification: H21, H7, R51
Suggested Citation: Suggested Citation