Preventing state budget crises: Managing the fiscal volatility problem

California Law Review

Volumn 98, Issue 3, 2010, Pages 749-812

  Gamage, David ^a  

^a UNIVERSITY OF CALIFORNIA   (United States)

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EID: 78649596615     PISSN: 00081221     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Article

References (314)

1. Jaime Calleja Alderete, Tracy Gordon & Jon Sonstelie, Much Ado About Nothing?: Tax and Expenditure Limits and Government Responsiveness (2007) (unpublished manuscript, on file with author).
2. Id. at 1.
3. See DONALD J. BOYD & LUCY DADAYAN, THE NELSON A. ROCKEFELLER INST, OF GOV'T, ST. REVENUE REP. NO. 76, STATE TAX DECLINE IN EARLY 2009 WAS THE SHARPEST ON RECORD 1 (2009), http://www.rockinst.org/pdf/government-finance/ state-revenue-report/200907-17-SRR-76.pdf.
4. This Article uses the term "balanced-budget constraints" to refer to informal forces that lead states to balance their budgets in addition to the formal legal rules that require states to do so. For further discussion on the nature of state balanced-budget constraints, see infra Part I.B.
5. Fiscal volatility dilemmas have troubled U.S. cities and states, as well as many foreign nations. There is even reason to think the U.S. federal government might face fiscal volatility problems at some point in the future (see infra Part I.D.). Although this Article will briefly consider how fiscal volatility plays out at other levels of government, and although most of the Article's prescriptions apply to other government levels, the Article's primary concern is how U.S. state governments should respond to the fiscal volatility created by their balanced-budget constraints.
6. The distinction between ordinary politics and institutional-design policy is drawn from the writings of public choice scholars like James Buchanan and Gordon Tullock. See generally Gordon Tullock, Public Choice, in THE NEW PALGRAVE DICTIONARY OF ECONOMICS ONLINE, http://www.dictionaryofeconomics.com/article? id=pde2008-P000240. Public choice scholars typically use the term "constitutional politics" in place of "institutional-design policy," but I avoid this phrase as legal audiences sometimes associate "constitutional" rules as necessarily being part of an actual written constitution.
7. The distinction between ordinary politics and institutional-design policy captures two different modes in which academics might be called on to give policy advice. "Ordinary politics" refers to when policymakers ask academics how they should respond to a given problem at a specific point in time. During an economic downturn, the ordinary politics question usually involves policymakers asking academics for advice on how to raise additional revenues or cut spending while causing the least economic harm. In contrast, "institutional-design policy" refers to when policymakers ask academics how to reform budgetary institutions and procedures so as to improve the decisions made by future policymakers.
8. In the context of this Article, measures for reducing the harmful consequences of fiscal volatility are considered "second-best" as compared to "first-best" measures for eliminating fiscal volatility. If fiscal volatility could be completely eliminated, there would be no need for secondbest coping measures such as those this Article proposes.
9. See infra Part I.C for a definition and discussion of rainy-day funds.
10. ADAM SMITH, THE WEALTH OF NATIONS 351 (University of Chicago Press 1976) (1776).
11. See, eg., TAXING SIMPLY: TAXING FAIRLY, FULL REPORT OF THE DISTRICT OF COLUMBIA TAX COMMISSION 132, available at http://www.ntanet.org/dctax/dcstudy. htm ("One of the longstanding principles of taxation is that taxes should be certain and made clearly known to the taxpayers");
12. ARTHUR P. HALL, TAX FOUND. SPECIAL REP. NO. 41, THE COST OF UNSTABLE TAX LAWS 1 (1994).
13. A notable exception is: Jesse Edgerton, Andrew Haughwout & Rae Rosen, Institutions, Tax Structure and State-local Fiscal Distress, 57 NAT'L TAX J. 147 (2004). However, Edgerton and his co-authors only discuss the macroeconomic stimulatory consequences of fluctuating spending as compared to fluctuating tax rates; they do not discuss the microeconomic riskallocation consequences that are the focus of this Article.
14. The term "broad-based taxes" refers to tax instruments that reach the majority of state economic activity. In contrast, "narrow-based taxes" reach a much smaller portion of state economic activity. For instance, cigarette taxes are much narrower in base than retail sales taxes, as cigarette taxes cover only tobacco-related sales while retail sales taxes also cover non-tobaccorelated sales. Income taxes, sales taxes, and property taxes are probably the broadest-based of the commonly used state tax instruments. However, the bases of these tax instruments are broader in some states than in others, depending on the level of built-in exemptions, credits, and other preferences.
15. In reference to tax and spending policies, the term "steady states" refers to the average settings of these policies taken across both boom and bust years.
16. E.g., Stephanie Condon, Club for Growth Opposes Utah GOP Sen. Bob Bennett's ReElection, CBS NEWS POLITICAL HOTSHEET, Jan. 8, 2010, http://www.cbsnews.com/blogs/2010/01/08/politics/politicalhotsheet/entry6073174. shtml (reporting on examples of "the anti-tax group Club for Growth['s] . . . trend of backing conservative candidates over more traditional Republican politicians").
17. See, e.g., Larry Rohter, Will the Real Tax-and-Spender Please 'Fess Up?, N.Y. TIMES, June 13, 2008, at A25 (reporting on John McCain calling Obama a "tax-and-spend liberal"), available at http://www.nytimes.com/2008/06/ 13/us/politics/13check.html.
18. I describe the literature on these phenomena in Part III.A.2.
19. Timothy Egan, States, Facing Budget Shortfalls, Cut the Major and the Mundane, N.Y. TIMES, Apr. 21, 2003, at Al.
20. ADVISORY COMM'N ON INTERGOVERNMENTAL REL., FISCAL DISCIPLINE IN THE FEDERAL SYSTEM: NATIONAL REFORM AND THE EXPERIENCE OF THE STATES 37-38 (1987) (categorizing the various types of balanced-budget constraints);
21. James M. Poterba, Balanced Budget Rules and Fiscal Policy: Evidence from the States, 48 NAT'L TAX J. 329, 330 (1995).
22. There is actually some controversy as to whether Vermont has a balanced budget requirement. See, e.g., Yilin Hou, Budgeting for Fiscal Stability over the Business Cycle: A Countercyclical Fiscal Policy and the Multiyear Perspective on Budgeting, PUB. ADMINISTRATION REV. 730, 739 n.8 (2007) (claiming that Vermont has a "legal obligation ... to balance the budget" despite some studies "exclud[ing] Vermont from this category"). Regardless, using the broader definition for "balanced-budget constraints" discussed in Part LB, infra, Vermont appears to operate under balanced-budget constraints.
23. See, e.g., RICHARD BRIFFAULT, BALANCING ACTS: The REALITY OF STATE BALANCED BUDGET REQUIREMENTS 3 (1996).
24. Jon David Vasché & Brad Williams, Revenue Volatility in California, 36 ST. TAX NOTES 35, 37 (2005).
25. Id. at 35.
26. NAT'L ASS'N OF ST. BUDGET OFFICERS, BUDGETING AMID FISCAL UNCERTAINTY: ENSURING BUDGET STABILITY BY FOCUSING ON THE LONG TERM 7-8 (2004) [hereinafter NASB]. Equivalent data is not yet available for the current downturn that began in 2008.
27. Elaine Maag & David Merriman, Tax Policy Responses to Revenue Shortfalls, 29 ST. TAX NOTES 363, 363-64 (2003) (emphasis omitted).
28. NASB, supra note 23, at 7.
29. Id.
30. Vasché & Williams, supra note 21, at 40;
31. NASB, supra note 23, at 7-8.
32. See infra notes 91-94 and accompanying text.
33. See infra note 63-66 and accompanying text.
34. J. Fred Giertz & Seth H. Giertz, The 2002 Downturn in State Revenues: A Comparative Review and Analysis, 57 NAT'L TAX J. 111, 114 (2004).
35. Id.
36. Id. Note that state governments only stopped growing as a percentage of state GDPs; in both real and nominal dollar values, state governments continued growing along with the privatesector portions of states' economies.
37. Richard F. Dye & David F. Merriman, Understanding State Government Budget Problems: Insights from the Midwest Region, 34 ST. TAX NOTES 233, 240 (2004) ("[E]ach recession since at least 1970 has been accompanied by significant state and local government fiscal distress.").
38. See ROBERT W. SMITH & THOMAS D. LYNCH, PUBLIC BUDGETING IN AMERICA (5th ed. 2004);
39. Fred Block, Read Their Lips: Taxation and the Right-Wing Agenda, in THE NEW FISCAL SOCIOLOGY 68 (Isaac William Martin, Ajay K. Mehrortra & Monica Prasad eds., 2009). The rise of the antitax movement was undoubtedly at least a partial cause of the stabilization of state tax revenues.
40. William G. Gale & Brennan Kelly, The "No New Taxes " Pledge, 104 TAX NOTES 197, 198 (2004).
41. See id. The pledge, in its entirety, states; "I,-, pledge to the taxpayers of the -district of the state of-, and to the American people that I will: ONE, oppose any and all efforts to increase the marginal income tax rates for individuals and/or businesses; and TWO, oppose any net reduction or elimination of deductions and credits, unless matched dollar for dollar by further reducing tax rates."
42. Id.
43. ROBERT ZAHRADNIK, IRIS J. LAV & ELIZABETH MCNICHOL, CTR. ON BUDGET & POL'Y PRIORITIES, FRAMING THE CHOICES 1 (2005), http://www.cbpp.org/files/ 5-9-05sfb1.pdf [hereinafter FRAMING THE CHOICES]. Note that these figures define tax hikes as increases in the statutory tax rates and spending cuts as reductions from projected spending. Nominal spending totals (as opposed to real totals or spending as a percent of GDP) were not cut.
44. Id. ("[S]tates were three times more likely to rely on spending cuts to close deficits than on revenue increases."); see also Irene Rubin, The State of State Budget Research, PUB. BUDGETING & FIN., Dec. 2005 Silver Anniversary Ed., at 46, 49 (2005) ("One conclusion from this research is that states that used to use both revenue increases and spending decreases to close gaps have in recent years ruled out tax increases, leading nearly exclusively to spending reductions."). At the time of this writing, it is still too soon to know how states will respond to the current downturn that began in 2008. But early reports suggest that spending cuts continue to dominate tax hikes as the preferred coping strategy.
45. CTR. ON BUDGET & POL'Y PRIORITIES, NEW FISCAL YEAR BRINGS PAINFUL SPENDING CUTS, CONTINUED BUDGET GAPS IN ALMOST EVERY STATE (2009), available at http://www.cbpp.org/cms/index.cfrn?fa=view&id=2853.
46. Maag & Merriman, supra note 24, at 371-72.
47. Id. at 372;
48. Iris J. Lav, Elizabeth C. McNichol & Robert Zahradnik, Faulty Foundations: State Structural Budget Problems and How to Fix Them, 37 ST. TAX NOTES 43, 75-77 (2001).
49. See generally Nicholas W. Jenny & James Orsi, Budget Balancing Tactics, 3 THE ROCKEFELLER INST. ST. FISCAL NEWS NO. 7 (2003) (describing the politically feasible mechanisms for states to raise revenue in a downturn).
50. Consider the 2006 budget crisis in New Jersey, at a time when Democrats controlled the governor's mansion and both legislative chambers. The governor's proposed solution to the state's budget crises was to be funded: 50% by spending cuts, 25% by license and user fees, and only 25% by raising the state's sales tax rate from 6% to 7%. Yet where the first two components of the budget proposal were relatively non-controversial, the legislature refused to enact the salestax hike, which led to the government being shut down in an act of brinkmanship. See Richard G. Jones, Corzine Shuts Down New Jersey's Government, N.Y. TIMES, July 1, 2006, available at http://query.nytimes.com/gst/fullpage. html?res=9B04E2D81530F932A35754C0A9609C8B63.
51. NASB, supra note 23, at 6.
52. NAT'L ASS'N OF ST. BUDGET OFFICERS, 2003 STATE EXPENDITURE REPORT 5 (2004) [hereinafter 2003 STATE EXPENDITURE REPORT].
53. For examples of the impact of these cuts, see generally Dale Russakoff & Linda Perlstein, States Cutting School Funding; Officials Predict Toll on Students and Bush's Goals, WASH. POST, Mar. 15, 2003, at A1.
54. See 2003 STATE EXPENDITURE REPORT, supra note 44, at 5. Note that Medicaid spending is sometimes only cut relative to previously authorized expenditures. The general trend of rapid growth in Medicaid spending over time may overpower cuts in previously authorized expenditures during downturns. See infra notes 53-54 and accompanying text.
55. ELIZABETH C. MCNICHOL & IRIS J. LAV, CTR. ON BUDGET & POL'Y PRIORITIES, STATE REVENUES AND SERVICES REMAIN BELOW PRE-RECESSION LEVELS 4 (2005), http://www.cbpp.org/files/12-6-05sfp2.pdf.
56. FRAMING THE CHOICES, supra note 37, at 5.
57. Federal government policies have also contributed to increased fiscal volatility at the state level. David A. Super, Rethinking Fiscal Federalism, 118 HARV. L. REV. 2544, 2562-613 (2005).
58. John Matthews, Tax Revenue Volatility and a Statewide Education Sales Tax, 38 ST. TAX NOTES 305, 305-07 (2005);
59. see also Roger E. Brinner, Joyce Brinner, Matt Eckhouse & Megan Leahey, Fiscal Realities for the State and Local Governments: What You Don't Know Will Hurt You; What You Can Learn Will Help You, 43 Bus. ECON. 55, 60-62 (2008).
60. Giertz & Giertz, supra note 30, at 114.
61. Vasché & Williams, supra note 21, at 42 ("[O]ther factors that have contributed to volatility in the past-namely, increased reliance on the personal income tax and increasing concentrations of income at the high end of the income distribution-are more permanent and thus likely to continue to contribute to volatility in the future.").
62. Giertz & Giertz, supra note 30, at 115. One reason for the dramatic revenue shortfalls following the 2001 downturn was the collapse of realized capital gains, a pattern which might not be repeated in future economic cycles. But the other causes of increased fiscal volatility are likely to continue.
63. Super, supra note 48, at 2630-32.
64. STAFF OF H. COMM. ON WAYS & MEANS, 108TH CONG., 2004 GREEN BOOK: BACKGROUND MATERIAL AND DATA ON THE PROGRAMS WITHIN THE JURISDICTION OF THE COMMITTEE ON WAYS AND MEANS app. C at 5-6 (Comm. Print 2004). Note that these figures refer to total state spending, as opposed to just general account spending (the portion of spending relevant to balanced-budget constraints). Medicaid spending is slightly smaller as a percentage of general account spending than of total spending, as some Medicaid spending is financed by dedicated revenue sources.
65. DANIEL SHA VIRO, DO DEFICITS MATTER? 205-11 (1997);
66. Torben M. Andersen, Is There a Role for an Active Fiscal Stabilization Policy?, 51 CESIFO ECON. STUD. 511 (2005); see also infra notes 140-145 and accompanying text.
67. See Neil H. Buchanan, Social Security, Generational Justice, and Long-Term Deficits, 58 TAX L. REV. 275, 294 (2005) ("The practical consequences of failing to adjust for the business cycle are especially severe for state and local governments, most of which operate under (modified) balanced budget requirements.").
68. Arik Levinson, Balanced Budgets and Business Cycles: Evidence from the States, 51 NAT. TAX. J. 715 (1998).
69. See Alberto Alesina, The Political Economy of the Budget Surplus in the United States, 14 J. ECON. PERSP. 3, 3-4 (2000) [hereinafter Alesina, Budget Surplus] (noting the "predictions of a traditional Keynesian model of fiscal policy").
70. DAVID HUME, ESSAY ON PUBLIC CREDIT (1752).
71. See Alberto Alesina, Guido Tabellini & Filipe R. Campante, Why is Fiscal Policy Often Procyclical?, 6 J. EUR. ECON. ASS'N 1006 (2008).
72. See infra Part I.C for a discussion of why administratively mandated limits on debt financing are unlikely to solve the fiscal volatility problem.
73. The incentives for this sort of behavior may be even stronger due to term limits on state officials.
74. A. JAMES HEINS, CONSTITUTIONAL RESTRICTIONS AGAINST STATE DEBT 7 (1963);
75. BENJAMIN U. RATCHFORD, AMERICAN STATE DEBTS 79 (1941);
76. Stewart Sterk & Elizabeth Goldman, Controlling Legislative Shortsightedness: The Effectiveness Of Constitutional Debt Limitations, 1991 Wis. L. REV. 1301;
77. John Joseph Wallis & Barry R. Weingast, Dysfunctional or Optimal Institutions?: State Debt Limitations, the Structure of State and Local Governments, and the Finance of American Infrastructure, in FISCAL CHALLENGES: AN INTERDISCIPLINARY APPROACH TO BUDGET POLICY 331, 342-49 (Elizabeth Garrett, Elizabeth Graddy & Howell E. Jackson eds., 2008) [hereinafter FISCAL CHALLENGES].
78. Heins, supra note 63, at 7;
79. Ratchford, supra note 63, at 79;
80. Sterk & Goldman, supra note 63;
81. Wallis & Weingast, supra note 63, at 342-49.
82. Heins, supra note 63, at 7;
83. Ratchford, supra note 63, at 79;
84. Sterk & Goldman, supra note 63;
85. Wallis & Weingast, supra note 63, at 342-49.
86. Heins, supra note 63, at 7;
87. Ratchford, supra note 63, at 79;
88. Sterk & Goldman, supra note 63;
89. Wallis & Weingast, supra note 63, at 342-49.
90. See Alberto Alesina & Allan Drazen, Why are Stabilizations Delayed? 81 AM. ECON. REV. 1170 (1991).
91. Alesina, Budget Surplus, supra note 58, at 14-15.
92. Jonathan Baron & Edward J. McCaffery, Starving the Beast: The Political Psychology of Budget Deficits, in FISCAL CHALLENGES, supra note 63, at 221. The advantages of campaigning for tax cuts without specifying which spending programs will be cut can be explained both by the political psychology literature, as in the Baron and McCaffery article cited above, and by more traditional public-choice models. When spending reductions are specified, the beneficiaries of the spending have strong incentives to campaign against tax cuts. When spending cuts are left unspecified, the beneficiaries of each spending program have only a probabilistic chance of seeing their benefits cut, and thus have reduced incentives to campaign against the tax cuts as compared to the known beneficiaries of the tax cuts.
93. This may be currently happening at the federal level. See infra Part I.D.
94. Even if members of either the liberal or conservative coalitions would prefer to limit spending hikes or tax cuts (respectively) in order to restore slack to the budget, they may refrain from doing so out of fear that the opposing coalition will simply take advantage of the slack to advance that coalition's preferred use of revenues.
95. See, e.g., John E. Petersen, Changing Red to Black: Deficit Closing Alchemy, 56 NAT'L TAX. J. 567 (2003);
96. State Government Experience with Balanced Budget Requirements: Relevance to Federal Proposals: Hearing Before the H. Comm. on the Budget, 102d Cong. (1992) (statement of Steven D. Gold, Director of the Center for Study of the States, Nelson A. Rockefeller Institute of Government, State University of New York).
97. Petersen, supra note 72.
98. See Levinson, supra note 57, at 717 ("[M]ost state midyear budget gaps appear to be met by spending decreases or revenue increases, rather than interfund or intertemporal transfers that would be symptomatic of gimmickry.").
99. Poterba, supra note 19, at 332.
100. FRAMING THE CHOICES, supra note 37, at 1. The remaining 76% was split between spending cuts (42%), tax and fee increases (14%), use of rainy-day funds (10%), and federal fiscal relief (10%). The use of budget gimmicks was much higher than the historical average partly because states generated significant revenues from one-time securitizations of their future income from the tobacco litigation settlements. See Maag & Merriman, supra note 24, at 372.
101. See, e.g., FRAMING THE CHOICES, supra note 37, at 5-6 (providing examples of painful coping measures).
102. Briffault, supra note 20, at 5.
103. Id. at 60
104. (quoting NAT'L ASS'N OF ST. BUDGET OFFICERS, STATE BALANCED BUDGET REQUIREMENTS: PROVISIONS AND PRACTICE 3 (1992));
105. see also Yilin Hou & Daniel L. Smith, A Framework for Understanding State Balanced Budget Requirement Systems: Reexamining Distinctive Features and an Operational Definition, 26 PUB. BUDGETING & FIN. 22, 27 (Sept. 2006) ("[W]e can conclude that both qualitative and empirical studies of state BBRs are grounded in data that at least partially reflect personal perception, judicial interpretation, and other nonstatutory and nonconstitutional considerations."). See also infra notes 105-113 and accompanying text for a discussion of how antideficit norms governed the behavior of the U.S. federal government for most of the nation's history.
106. The existence of antideficit norms corresponds with much of the theory behind the new social-norms scholarship, particularly as developed in ROBERT C. ELLICKSON, ORDER WITHOUT LAW: How NEIGHBORS SETTLE DISPUTES (1991).
107. See also Robert C. Ellickson, Law and Economics Discovers Social Norms, 27 J. LEGAL STUD. 537 (1998). For the reasons discussed in Part I.B.I, these norms are functional and are likely enforced through extralegal means-such as through voter retaliation against politicians seen as violating the norms.
108. Briffault, supra note 20, at 3.
109. In other words, this Article uses the term "balanced-budget constraints" to refer to informal forces that lead states to balance their budgets in addition to the formal legal rules that require states to do so.
110. In addition to the first-best solutions discussed in the text of this Article, states could adjust their tax bases by replacing volatile income taxes with less volatile alternatives like property taxes. However, adjusting tax bases in this fashion would have numerous policy implications that many state legislators (and voters) would consider undesirable. As such, I do not view adjusting state tax bases as a viable first-best solution. For further discussion of the limitations to this alternative approach in the context of California, see David Gamage, Managing California's Fiscal Roller Coaster, 49 ST. TAX NOTES 659, 661 (2008).
111. NAT'L CONF. OF ST. LEGISLATURES, RAINY DAY FUNDS: app. A., State Budget Stabilization Funds (2004), http://www.ncsl.org/programs/fiscal/rdfaxa.htm;
112. Brian Knight & Arik Levinson, Rainy Day Funds and State Government Savings, 52 NAT'L TAX J. 459 (1999).
113. NASB, supra note 23, at 10-11.
114. ROBERT ZAHRADNIK, CTR. ON BUDGET & POL'Y PRIORITIES, RAINY DAY FUNDS: OPPORTUNITIES FOR REFORM 1 (2005), http://www.cbpp.org/files/4-16-07sfb.pdf [hereinafter RAINY DAY FUNDS] (indicating that states had $30 billion in reserves to cover a need of approximately $250 billion).
115. Super, supra note 48, at 2643.
116. Seesupra Part I.B.1.
117. See, e.g., RAINY DAY FUNDS, supra note 86;
118. Gamage, supra note 82, at 664;
119. Yilin Hou & William Duncombe, State Saving Behavior: Effects of Two Fiscal and Budgetary Institutions, 28 PUB. BUDGETING & FIN. 48 (Fall 2008);
120. Super, supra note 48. An extended discussion of these measures and their limitations is beyond the scope of this paper. For an introduction to the topic, see Dye & Merriman, supra note 33, at 245-46.
121. See, e.g., NASB, supra note 23, at 11;
122. Giertz & Giertz, supra note 30, at 130.
123. NASB, supra note 23, at 11.
124. Id.
125. Dye & Merriman, supra note 33, at 246.
126. Id. at 245. Dye & Merriman highlight some of the difficulties inherent in relying on saving during boom years to resolve fiscal volatility problems: U.S. business cycles have not been symmetric-expansions have lasted about five times as long as recessions. Observed revenue cycles are also asymmetric, with revenue above trend for about four out of every six years.... A government that wants to keep spending equal to the average or trend level of revenue will be obligated to accumulate surpluses long after actual revenues have begun to fall. Because the expansion lasts so much longer than the contraction, the accumulated surplus must reach a very high peak (more than $1,000 per capita or 50 percent of average annual revenues in our example). And, also because of the asymmetry, the surplus would disappear in extremely short order once revenues dip below trend. We doubt that many political actors could resist the pressure to increase spending or cut taxes with surpluses of this magnitude and could defend reserving so much revenue as insurance against future declines. Even if sufficiently large rainy-day fund contributions could be mandated in light of forecasting problems, politicians could easily raid these funds, either directly or indirectly through the use of budgetary gimmicks. The impulses that lead the ordinary political process to channel all available revenues into tax cuts and spending hikes can only be overcome through powerful countervailing pressures - such as from capital markets or from antideficit norms. Historically, these pressures have not operated to force saving during upturns.
127. Super, supra note 48, at 2649.
128. See id. at 2575.
129. See, e.g., Edgerton et al., supra note 12, at 147 (noting that "significant distress" pervades the local government sector);
130. Steven G. Craig, How a City Can Survive a Boom and Bust Cycle Without Bankruptcy: The Case of Houston, in 1997 PROC. 89TH ANN. CONF. NAT'L TAX ASS'N 90, 90 (noting the near-constant use of the term "urban fiscal crisis" in connection with cities over the past thirty years).
131. See Edgerton et al., supra note 12, at 147 (explaining that New York City's budget problems in 2003 were at "the extreme of the distribution" of state and local budget crises).
132. See Alesina, Tabellini & Campante, supra note 60;
133. Luis Catão & Bennett Sutton, Sovereign Defaults: The Role of Volatility (Int'l Monetary Fund, Working Paper No. 02/149, 2002);
134. Michael Gavin & Roberto Perotti, Fiscal Policy in Latin America, in NBER MACROECONOMICS ANNUAL 1997 11 (Ben S. Bernanke & Julio Rotemberg eds., 1997);
135. Graciela L. Kaminski, Carmen M. Reinhart & Carlos A. Végh, When It Rains, It Pours: Procyclical Capital Flows and Macroeconomic Policies, in NBER MACROECONOMICS ANNUAL 2004 11 (Mark Gertler & Kenneth Rogoff eds., 2005);
136. Ernesto Talvi & Carlos Végh, Tax Base Variability and Procyclical Fiscal Policy in Developing Countries, 78 J. DEV. ECON. 156 (2005).
137. See Alesina, Tabellini & Campante, supra note 60, at 2-4;
138. Roberto Perotti, Fiscal Policy in Developing Countries: A Framework and Some Questions (World Bank Pol'y Res. Working Paper No. 4365, 2007). Latin American nations have experienced particularly severe problems with fiscal volatility.
139. Roberto Perotti, Estimating the Effects of Fiscal Policy in OECD Countries 2 (Innocenzo Gasparini Inst, for Econ. Res., Working Paper No. 276, 2004).
140. Alesina, Tabellini & Campante, supra note 60, at 1007 n.2.
141. There are additional complications influencing how national governments should respond to fiscal volatility that are not considered in this Article, due to its focus on the U.S. state level. The Article's prescriptions should be viewed as a relevant contribution to the literature on comparative- and national-level fiscal volatility, but not as an authoritative guide for coping with fiscal volatility on these levels.
142. Nancy C. Staudt, Constitutional Politics and Balanced Budgets, 1998 U. III. L. REV. 1105, 1152-75 (1998).
143. Alesina, supra note 58, at 5-6.
144. Staudt, supra note 105, at 1171
145. (quoting James M. Buchanan, Clarifying Confusion About the Balanced Budget Amendment, 49 NAT'L TAX J. 347, 347-48 (1995)).
146. GEOFFREY BRENNAN & JAMES M. BUCHANAN, THE POWER TO TAX: ANALYTICAL FOUNDATIONS OF A FISCAL CONSTITUTION 755 (1999).
147. See, e.g., Yilin Hou, The Rise and Fall of the Norm of Budget Balance: Seeking a Budgetary Logic Behind the Federal Budget Deficits (2007) (presented at Ann. Conf. of Ass'n for Budgeting and Fin. Mgmt., October 2007), available at http://papere.ssiB.com/sol3/papers.cfm? abstract-id= 1027640;
148. Alesina, supra note 58, at 5-11; Shaviro, supra note 55, at 28-27.
149. Alesina, supra note 58, at 6.
150. See, e.g., Rudolph G. Penner & C. Eugene Steuerte, Budget Rules, 57 NAT'L TAX. J. 547, 548-66 (2004);
151. Kate Stith, Rewriting the Fiscal Constitution: The Case of Gramm-RudmanHollings, 76 CALIF. L. REV. 593 (1988). The Gramm-Rudman-Hollings Balanced Budget Act can be considered a partial balanced budget constraint in that it attempted to make it more difficult for Congress to increase deficits, even as a means of coping with downturns.
152. See Shaviro, supra note 55, at 247.
153. Theodore Seto, Drafting a Federal Balanced Budget Amendment that Does What It Is Supposed to Do (And No More), 106 YALE L.J. 1449, 1451 (1997). Critics cited the amendment's lack of enforcement mechanisms as evidence that it would not have actually prevented deficit spending. Supporters responded that the amendment's symbolic value would have been enough to reestablish the antideficit norm that governed U.S. political culture for most of its history. Compare Staudt, supra note 105, with Buchanan, supra note 107.
154. Alesina, Budget Surplus, supra note 58, at 3.
155. ALAN J. AUERBACH, WILLIAM G. GALE & PETER ORSZAG, URBAN INST., NEW ESTIMATES OF THE BUDGET OUTLOOK: PLUS C'EST LA CHANGE, PLUS C'EST LA MÈME CHOSE (2006), http://www.urban.org/publications/1000873.html.
156. Id.
157. See ALAN J. AUERBACH & WILLIAM G. GALE, BROOKINGS INST., THE ECONOMIC CRISIS AND THE FISCAL CRISIS: 2009 AND BEYOND (2009), http://www.brookings.edu/ papers/2009/0219-fiscal-future-gale.aspx.
158. Id.
159. See supra notes 60-66 and accompanying text.
160. Shaviro, supra note 55, at 308.
161. Arguably, the currently dominant deficit measurements are inadequate for this purpose and will need to be replaced by alternatives that better account for future liabilities. See id.
162. By using a balanced-budget constraint as a precommitment device, Congress could potentially overcome the collective action problems that hinder efforts to address directly the sources of fiscal unsustainability. This was the idea motivating the Gramm-Rudman-Hollings Act. See Stith, supra note 111, at 621-69. Balanced budget constraints might also serve to reassure government bond holders or taxpayers (or anyone concerned about inflation), once painful adjustments are made, that the dynamics leading to unsustainability will not be repeated. This was the main reason states adopted balanced-budget constraints after the debt crises of the 1900s. See supra notes 60-66 and accompanying text.
163. This is essentially what has happened in many developing countries and in developed nations that have accrued unsustainable levels of debt. See supra notes 102-104 and accompanying text.
164. Notably, the magnitude of fiscal volatility has increased dramatically at the federal level in recent years, and this volatility may be interfering with the reestablishment of antideficit norms. See Edmund L. Andrews, Those Wild Budget Swings, N.Y. TIMES, July 16, 2006 at 4. During upturns, politicians can claim credit for deficit reductions that are merely cyclical. This has caused some commentators-and possibly a significant number of voters-to conclude that deficits do not matter or that taxes can be cut without revenue loss.
165. See DANIEL SHAVIRO, TAXES, SPENDING, AND THE U.S. GOVERNMENT'S MARCH TOWARDS BANKRUPTCY 53 (2007) (quoting former Vice President Cheney as claiming "[djeficts don't matter" and proceeding to discuss the politics of budget deficits).
166. KENNETH ARROW, ESSAYS IN THE THEORY OF RISK-BEARING 90 (1971).
167. Louis Kaplow, Horizontal Equity: Measures in Search of a Principle, 42 NAT'L TAX J. 139, 145 (1989).
168. David S. Bizer & Kenneth L. Judd, Taxation and Uncertainty, 79 AM. ECON. REV. 331, 335(1989).
169. See supra Part I.A.
170. These are related concepts. From the perspective of actors affected by tax or spending programs, fiscal volatility can be thought of as a form of either risk or uncertainty. Although the terms "risk" and "uncertainty" have distinct meanings, the differences between them are unimportant for our purposes. I will thus use the terms "volatility," "risk," and "uncertainty" interchangeably. For more on this topic, see, e.g., FRANK H. KNIGHT, RISK, UNCERTAINTY AND PROFIT (1921);
171. Arrow, supra note 124;
172. History of Economic Thought Website, Choice Under Risk and Uncertainty, http://cepa.newschool.edu/het/essays/uncert/choicecont.htm (last visited Mar. 23, 2010). When distinctions are made between the terms "risk" and "uncertainty," "risk" refers to when future outcomes are unknown, but when the probability distribution of those outcomes is known. In contrast, "uncertainty" refers to when neither future outcomes nor the probabilities of those outcomes occurring are known. KNIGHT at 233-34.
173. See, e.g., Guido Calabresi, Some Thoughts on Risk Distribution and the Law of Torts, 70 YALE L.J. 499 (1961).
174. There is an existing literature analyzing the effects of uncertainty on public investment decisions. However this literature focuses on idiosyncratic risks affecting only a single government program. The literature does not discuss how systematic risks-like fiscal volatility-should be allocated between taxation and spending. See, e.g., Kenneth J. Arrow & Robert C. Lind, Uncertainty and the Evaluation of Public Investment Decisions, 60 AM. ECON. REV. 364 (1970);
175. S.M. Kanbur, Risk Taking and Taxation: An Alternative Perspective, 15 J. PUB. ECON. 163 (1981).
176. See infra notes 163-168 and accompanying text.
177. See infra notes 175-182 and accompanying text.
178. See infra notes 183-190 and accompanying text.
179. See, e.g., Vidar Christiansen, Two Approaches to Determine Public Good Provision under Distortionary Taxation, 60 NAT'L TAX. J. 25 (2007);
180. Louis Kaplow, Public Goods and The Distribution of Income, 50 EUR. ECON. REV. 1627 (2006);
181. Joel Slemrod & Shlomo Yitzhaki, Integrating Expenditure and Tax Decisions: The Marginal Cost of Funds and the Marginal Benefit of Projects, 54 NAT'L TAX. J. 189 (2001).
182. Without quantifying the amount of harm that could be mitigated by improving the risk allocation of fiscal volatility, it is hard to know how serious the risk-spreading problem is as compared to the size-of-government problem (if there even is a size-of-government problem). Yet there already exists an enormous literature examining the size-of-government problem, whereas this is the first paper to evaluate the risk-spreading implications of state-level fiscal volatility. In order to analyze effectively the risk-spreading decision, it is useful to cabin the size-ofgovernment decision.
183. For a discussion of the concept of luxury goods, see PAUL KRUGMAN, ROBIN WELLS & MARTHA L. OLNEY, ESSENTIALS OF ECONOMICS 122 (2007).
184. 2003 STATE EXPENDITURE REPORT, supra note 44, at 13.
185. See Super, supra note 48, at 2611-40.
186. See also infra notes 185-187 and accompanying text.
187. A "zeroth-order approximation" is roughly equivalent to an educated first guess.
188. See DOUGLAS W. ELMENDORF & JASON FURMAN, BROOKINGS INST., IF, WHEN, HOW: A PRIMER ON FISCAL STIMULUS 7-9 (2008);
189. Shaviro, supra note 55, at 205-11.
190. See Super, supra note 48, at 2607-11.
191. See, e.g., Edgerton et al., supra note 12;
192. ALISSA ANDERSON, CALIF. BUDGET PROJECT, BUDGET CUTS OR TAX INCREASES: WHICH ARE PREFERABLE DURING AN ECONOMIC DOWNTURN? (2008), http://www.cbp.org/ pdfs/2008/0807-pp-cutsortaxes.pdf.
193. Glenn Follette, Andrea Kusko & Byron Lutz, State and Local Finances and the Macroeconomy: The High-Employment Budget and Fiscal Impetus, 61 NAT'L TAX. J. 531, 544 (2008) (concluding that the macroeconomic effects of state government policy options are "relatively modest").
194. See, e.g., Martin Feldstein, Rethinking the Role of Fiscal Policy, 99 AM. ECON. REV. 556 (2009);
195. John B. Taylor, The Lack of an Empirical Rationale for a Revival of Discretionary Fiscal Policy, 99 AM. ECON. REV. 550 (2009).
196. In any case, exploring these issues more fully is beyond the scope of this Article.
197. Arrow & Lind, supra note 130, at 364.
198. Harry Markowitz, Portfolio Selection, 7 J. FIN. 77, 91 ( 1952).
199. See STEPHEN A. ROSS, NEOCLASSICAL FINANCE 1 (2005).
200. See, e.g., Kelly D. Edmiston, Tax Uncertainty and Investment: A Cross-Country Empirical Investigation, 42 ECON. INQUIRY 425 (2004). However, some research has found that volatility in capital income taxation can be welfare enhancing.
201. See, e.g., Bizer & Judd, supra note 126;
202. Michael Dotsey, The Economic Effects of Production Taxes in a Stochastic Growth Model, 80 AM. ECON. REV. 1168 (1990).
203. See also James Aim, Uncertain Tax Policies, Individual Behavior, and Welfare, 78 AM. ECON. REV. 237 (1988) (concluding that uncertainty in the tax base may positively affect welfare, while uncertainty in tax rates generally negatively affects welfare, as tax base uncertainty-but not tax rate uncertainty-deters undesirable tax planning).
204. But see Julie H. Collins & Daniel P. Murphy, Experimental Evidence Of The Effect Of Tax Rate Uncertainity On Security Prices, Investers Clienteles, And Tax Payments, 17, J. AM TAX ASS'N, 1, 24 (1995)
205. Kaplow, supra note 125, at 152 n.21;
206. Matthew Rabin & Richard H. Thaler, Anomalies: Risk Aversion, 15 J. ECON. PERSP. 219, 219 (2001).
207. Rabin and Thaler, supra note 150, at 219-30, argue that the standard view (that risk aversion arises from the diminishing marginal utility of money) cannot explain the fact that individuals are averse to small risks as well as to large risks. Instead, Rabin and Thaler suggest that risk aversion results from the biases of loss aversion and mental accounting. There are also other nonstandard theories for why individuals are averse to risk and uncertainty. See, e.g., Yoram Halevy & Vincent Feltkamp, A Bayesian Approach to Uncertainty Aversion, 72 REV. ECON. STUD. 449 (2005). Yet, like the standard model, the nonstandard explanations for risk aversion also conclude that individuals exhibit increasing marginal risk aversion. Hence, the nonstandard views are equally consistent with the arguments of this Article as is the standard model. (Although I rely on the standard view of risk aversion in the text of this Article because it is far more widely accepted than the alternatives, I'll note as a tangent that I am partially persuaded by Rabin and Thaler's critique).
208. See ROBERT S. PINDYCK & DANIEL L. RUBINFELD, MICROECONOMICS 68-91 (2001).
209. Id.
210. Even billionaires may be frustrated by crime (lack of police funding), traffic (lack of transportation spending), and the like. Purchasing a private jet or one's own security force does not provide a perfect substitute.
211. This transfer would be efficient and welfare-enhancing following the Kaldor-Hicks methodology.
212. As Kenneth Arrow explains, supra note 124, at 137-38, "at any moment society is faced with a set of possible new projects which are on the average profitable though one cannot know for sure which particular projects will succeed and which will fail. If risks cannot be shifted, then very possibly none of the projects will be undertaken." Volatility can deter entrepreneurs and investors from taking on risks that would be expected to improve societal welfare. Moreover, firms as well as individuals can be risk-averse. Arrow and Lind, supra note 130, at 376. Both the managers of firms and stockholders owning large blocks of shares can cause firms to act in a riskaverse fashion. Consequently, by adding risk to the economy, fiscal volatility can deter both firms and individuals from socially-desirable entrepreneurial activities. Although the additional risk caused by fiscal volatility is not directly connected to entrepreneurial activities, it may combine with the risk already inherent in these activities to deter risk-taking behavior that would not have been deterred based on the inherent risk alone.
213. Just as planning costs can force administrators to fire staff or abandon projects during downturns, during upturns the administrators may find they have not previously hired enough staff or started construction projects early enough, and that surplus funds can thus not be used efficiently. See Matthews, supra note 49, at 306.
214. See supra note 156.
215. For instance, students must apply for teacher training programs at least a year or two in advance of seeking teaching jobs. Since volatile spending makes the availability of teaching jobs fluctuate significantly over time, this volatility probably deters some students from becoming teachers who would otherwise be inclined to enter the profession.
216. By "unprofitable" I mean unprofitable in the economic sense; a project becomes unprofitable if the resources that must still be invested in order to complete the project could yield greater returns if diverted to an alternative use (the opportunity costs of continuing the project exceed the expected gains).
217. See, e.g., Joseph L.C. Cheng & Idalene F. Kesner, Organizational Slack and Response to Environmental Shifts: The Impact of Resource Allocation Patterns, 23 J. MGMT. 1 (1997)
218. (discussing how slack operates in an environmental policy context);
219. Jitendra V. Singh, Performance, Slack, and Risk Taking in Organizational Decision Making, 29 ACAD. MGMT. J. 562 (1986).
220. While not every citizen receives direct payments from a state, every citizen benefits to at least some extent from spending programs such as transportation infrastructure, education, and the criminal justice system.
221. See Robert J. Landry, III, The Regressivity of Individual State Taxes from 1980 to 2000: A Nationwide Comparison, 41 ST. TAX NOTES 899 (2006), available at http://papers.ssrn.com/sol3/papers.cfm?abstract-id=927150##.
222. 2003 STATE EXPENDITURE REPORT, supra note 44, at 4. Again, this Article only discusses state general-account spending as this is the spending subject to balanced-budget constraints. Spending funded by the states' capital budgets is not usually cut during downturns.
223. There is no straightforward way to calculate the extent to which different income groups benefit from education spending. But, at least to me, it seems implausible to think that the benefits of education spending are distributed as unequally in dollar values as are incomes
224. See, e.g., LIAM MURPHY & THOMAS NAGEL, THE MYTH OF OWNERSHIP: TAXES AND JUSTICE (2002);
225. cf. Joseph M. Dodge, Theories of Tax Justice: Ruminations on the Benefit Partnership, and Ability-to-Pay Principles, 58 TAX L. REV. 399, 406 (2005) (acknowledging and disputing this argument).
226. See supra note 137 and accompanying text.
227. For an exception that demonstrates the general rule, this result might not apply if the taxes raised to fund the additional spending were head taxes-taxes that take the same dollar amount from each taxpayer. Or, somewhat more plausibly, if only user fees and licenses were raised to pay for additional spending, these revenue sources might be sufficiently regressive so as to make the net effect nonredistributive. But raising tax rates on the margin for the major-broad based state taxes (e.g., sales, income, and property) to fund additional state spending in the major categories will almost certainly be redistributive.
228. Stated more formally, the utility loss that the first taxpayer would experience is higher than the utility loss that the second taxpayer would experience, as the utility-to-dollar values are higher for the first taxpayer than for the second taxpayer.
229. The move here is similar to the logic typically used to justify making interpersonal utility comparisons based on the diminishing marginal utility of money. There may well be some wealthy taxpayer who derives more utility from a marginal dollar than does some poor taxpayer, but when abstracting across an entire population, it seems reasonable to conclude that wealthy taxpayers as a class will derive less utility from a marginal dollar than will poor taxpayers as a class. Similarly, wealthy taxpayers as a class should have more slack.
230. Indeed, the direct planning cost effects and the indirect risk-spreading effects are perhaps inextricably intertwined, as borrowing, saving, and the use of third-party insurance are both mechanisms for indirect risk spreading and also forms of slack.
231. Richard Blundell, Luigi Pistaferri & Ian Preston, Partial Insurance. Information and Consumption Dynamics (Inst, for Fiscal Stud, Working Paper No. W02/16, 2002), available at http://www.ifs.org.uk/publications/2002.
232. Michael S. Barr, Banking the Poor, 21 YALE J. REG. 121 (2004);
233. Ronald J Mann & Jim Hawkins, Just Until Payday, 54 UCLA L. REV. 855, 886-95 (2007).
234. The number of individuals insuring through these methods is probably small, but there is no doubt that these techniques are more available to the wealthy than to the poor.
235. Brinner et al., supra note 49, at 60-63.
236. Id.
237. In contrast, a gross receipts tax or a value added tax (VAT) would be due regardless of profitability.
238. See Kirk J. Stark, The Uneasy Case for Extending the Sales Tax to Services, 30 FLA. ST. U. L. REV. 435, 440-41 (2003).
239. See id. at 447-48.
240. For a more in depth discussion of the factors inherent in state level tax systems that contribute to revenue volatility exceeding of economic volatility, see Russell S. Sobel & Gary A. Wagner, Cyclical Variability in State Government Revenue: Can Tax Reform Reduce It?, 29 ST. TAX NOTES 569 (2003).
241. Brinner et al, supra note 49, at 60-63.
242. See Vasché & Williams, supra note 21, at 39 (estimating that California's short-term revenue elasticity was 3.51 between fiscal years 1992 and 2004).
243. Richard Briffault, Foreword: The Disfavored Constitution: State Fiscal Limits and State Constitutional Law, 34 RUTGERS L.J. 907, 915-18 (2003);
244. Super, supra note 48, at 2605-07.
245. See Briffault, supra note 183, at 915-18.
246. See, e.g., David N. Figlio & Arthur O'Sullivan, The Local Response to Tax Limitation Measures: Do Local Governments Manipulate Voters to Increase Revenues?, 44 J.L. & ECON. 233 (2001).
247. Id.
248. Id.
249. See Robert Whaples, Do Economists Agree on Anything? Yes!, THE ECONOMISTS VOICE, NOV. 2006, http://www.bepress.com/ev/vol3/iss9/artl (surveying economists' opinions on a variety of issues related to markets and government regulation).
250. The analysis here partially draws on the writings of David Super, supra note 48, at 2630. Note that although the market could theoretically fund some of these programs, moral hazard problems may make governments more efficient providers of these programs.
251. See Super, supra note 48, at 2611-14.
252. See John H. Bowman, Daphne A. Kenyon, Adam Langley & Bethany P. Paquin, Property Tax Circuit Breakers: Fair and Cost-Effective Relief, 53 ST. TAX NOTES 235 (2009).
253. Some further discussion of this issue can be found in Part III.B.
254. Another possible approach for coping with fiscal volatility is to broaden tax bases during downturns while narrowing them during upturns. This approach is similar to adjusting tax rates in that it results in tax burdens fluctuating across the economic cycle, but it accomplishes this through a different mechanism. However, broadening and narrowing a tax base will generally be suboptimal from a risk-spreading perspective. Changing the elements of a tax base typically affects a much narrower group of taxpayers than does adjusting the rates of the tax instrument, thus causing the effects of volatility to be more concentrated. Additionally, adjusting the elements of a tax base is likely to engender more undesirable game playing on the part of taxpayers than would adjusting tax rates.
255. Tax laws function like entitlement spending in that they remain in effect until explicitly altered. Discretionary general account spending must be rebudgeted annually.
256. This can be inferred from how rarely the political debate focuses on fiscal volatility issues as compared to questions related to the steady-state levels for taxes and spending.
257. The exceptions to this maxim only serve to support the general rule. For instance, Democrats and Republicans dispute whether allowing the Bush tax cuts to expire should be viewed as "raising taxes." The frame here is contestable because the parties can argue about whether the relevant baseline includes extension of the temporary tax cuts. But were the Democrats to propose raising tax rates further-beyond the pre-Bush levels-there would be no doubt that this would be considered a "tax hike." Whether overall revenues are increasing or declining due to economic circumstances is not currently viewed as a relevant consideration in whether a policy change is called a "tax cut" or a "tax hike." See infra notes 203-205 and accompanying text.
258. One might argue that general account spending does not have baselines in the same sense as does tax legislation, as general account spending must be reauthorized each year. But this argument is not fully persuasive as most general account spending is reauthorized without full review and changes from the previous year's levels of spending are usually viewed as "spending cuts" or "spending hikes." Zero-base budgeting is seldom implemented in practice.
259. The difference between state general account spending and federal discretionary spending is that the federal government can incur deficits. Hence, at the federal level, revenue volatility (the default response to economic cycles under a tax-rates baseline) causes the deficit to automatically grow and shrink unless the legislature proactively adjusts tax or spending policies. In contrast, at the state level, there is no actual default fiscal policy. The tax-rates baseline means that any legislated change to tax rates is coded as a "tax cut" or "tax hike," but any legislated change to spending will similarly be coded as a "spending cut" or a "spending hike." See supra note 194. Revenue volatility forces states to adjust either their tax or spending policies as their economies cycle, but the states must actively decide which specific policies to adjust. This Article focuses on the definition of "tax cuts" and "tax hikes" because these terms are more salient within the current political environment-as reflected by the increasing rarity of "tax hikes." The motivating idea is that, as voters appear to increasingly be making decisions based on whether politicians are seen as voting for "tax cuts" or "tax hikes," we should strive to make the content of these terms reflect what voters actually care about. Or, alternatively, we should strive to eliminate any negative consequences of the increased salience of these terms that does not result from the reasons voters care about the terms. Voters presumably care about these terms based on their preferences for steady-state policy, not based on preferences for how fiscal volatility should be allocated. Therefore, we should define these terms so that the terms convey the information voters seek about legislated changes to steady-state fiscal policy (the size-of-government decision), without negatively affecting how states respond to cyclical economic fluctuations (the fiscal volatility decision).
260. InvestorDictionary.com, Define meaning of the word Tax cut, http://www.investordictionary.com/definition/tax+cut.aspx (last visited Mar. 24, 2010).
261. For instance, the California State Department of Finance and the State's Legislative Analysts Office analyze the effects of a number of economic variables on the amount of tax revenue collected by the State, including trends in consumer and business spending, housing, employment, profits, and income distributions. See Vasché and Williams, supra note 21, at 40.
262. At this point, it may be helpful to clarify the difference between adopting a new tax baseline and adopting a tax expenditure limit. Numerous states have adopted tax expenditure limits in order to prevent legislatures from raising taxes or to limit the circumstances under which legislatures can raise taxes. An example of a tax expenditure limit is a rule requiring that a supermajority of a legislature vote to approve a tax hike. Whereas tax expenditure limits are designed to bias the evolution of steady-state policies (usually, against raising taxes and spending), the choice of baselines is only meant to influence which aspects of steady-state policies fluctuate in response to fiscal volatility. Adopting a new baseline should not prevent legislatures from adjusting steady-state policies as they desire. Instead, adopting a new baseline only alters the mechanism through which legislatures change steady-state policies.
263. Matthew Rabin, A Perspective on Psychology and Economies, 46 EUR. ECON. REV. 657, 662 (2002).
264. Gale & Kelly, supra note 35, at 198.
265. See Karen C. Burke & Grayson M.P. McCouch, Turning Slogans Into Tax Policy, 27 VA. TAX REV. 747, 759-61 (2008).
266. See LEONARD E. BURMAN & JEFFREY ROHALY, TAX POLICY CENTER, SENATOR KERRY'S TAX PROPOSALS (2004), http://www.taxpolicycenter.org/UploadedPDF/ 1000634-Kerry Plan.pdf (describing Kerry's tax proposals);
267. Adam Nagourney, Political Memo; Some Candidates Quick to Urge Tax-Cut Repeal, N.Y. TIMES, May. 30, 2003, at A24 (describing statements about whether the Bush Tax Cuts should be repealed by both Democrats and Republicans).
268. SHAVIRO, supra note 123, at 71.
269. Michael J. Graetz, Tax Policy at the Beginning of the Clinton Administration, 10 YALE J. ON REG. 561, 563 (1993).
270. Id.
271. Before indexing, inflation caused taxpayers' income to be taxed at increasingly higher rates over time as greater portions of their income moved into higher tax brackets. This effect was so pronounced in the late 1970s that the "change from 1976 to 1981 represented an increase of 23% in the real level of the income-tax burden." Edward J. McCaffery, Cognitive Theory and Tax, 41 UCLA L. REV. 1861, 1896-97 (1994). By any holistic measure, the level of taxation increased during this period. Yet these changes were not generally viewed as government-sponsored tax hikes. "Indeed, the two major Carter era tax bills, the 1977 Tax Reduction and Simplification Act and the 1978 Revenue Act, were each billed, projected, and expected to be tax reductions." Id. at 1897 (emphasis in original). With nominal tax rates functioning as the tax baseline, the Carter administration was credited with passing tax cuts even though the real level of taxation was increasing. The absence of indexing allowed the government's revenue intake to rise without Congress or the Carter administration taking significant political heat for passing tax hikes.
272. AARON B. WILDAVSKY, THE NEW POLITICS OF THE BUDGETARY PROCESS 240-97 (2d ed, 1992).
273. The advocates of inflation indexing were only partially successful; many important elements of the federal income tax remain unindexed-most notably, the alternative minimum tax. For further discussion, see Richard J. Kovach, Technical and Policy Standards for Inflation Adjustments Under the Internal Revenue Code, 33 OKLA. CITY U. L. REV. 603 (2008);
274. James C. Young, Inflation Adjustments Affecting Individual Taxpayers in 2003: Analysis and Commentary, 96 TAX NOTES 1895 (2002).
275. See SHAVIRO, supra note 123, at 159.
276. Id. at 11.
277. For other innovative proposals involving tax and spending baselines, see Leonard Burman, Robert Shiller, Gregory Leiserson & Jeffery Rohaly, The Rising Tide Tax System, Indexing the Tax System for Changes in Inequality (Mar. 22, 2007) (unpublished manuscript, on file with author); JASON FURMAN, BROOKINGS INST, COPING WITH DEMOGRAPHIC UNCERTAINTY (2007), http://wagner.nyu.edu/ performance/socialsecurity/demographicuncertainty.pdf. 215. See, e.g., Alesina, supra note 58, at 12 ("The academic literature has pointed out that the fragmentation of a political system is an obstacle to the implementation of the appropriate fiscal decisions, particularly when various shocks require a swift fiscal response. In the most general sense, political fragmentation is a situation in which many political groups have a voice in fiscal decisions, and many have veto power. The point is not that fragmentation necessarily creates budget deficits, but that fragmentation creates obstacles to policy changes, because it becomes more difficult to reach agreements about corrective fiscal measures.").
278. See Ellen Moule & Nicholas Weller, The Spread of Tax Revolt, the Diffusion of State Tax and Expenditure Limits (unpublished manuscript, on file with author);
279. James M. Poterba, State Responses to Fiscal Crises: The Effects of Budgetary Institutions and Politics, 102 J. POL. ECON. 799 (1994).
280. See BEHAVIORAL PUBLIC FINANCE (Edward J. McCaffery & Joel Slemrod eds, 2006).
281. See, e.g,. Russell Korobkin, The Endowment Effect and Legal Analysis, 97 Nw. U. L. REV. 1227 (2003);
282. John K. Horowitz & Kenneth E. McConnell, A Review of WTA / WTP Studies, 44 J. ENVTL. ECON. & MGMT. 426 (2002).
283. See SHAVIRO, supra note 123, at 26.
284. Edward J. McCaffery & Jonathan Baron, The Political Psychology of Redistribution, 52 UCLA L. REV. 1745 (2005).
285. See ALAN S. BLINDER, CENTRAL BANKING IN THEORY AND PRACTICE 55 (1999) (claiming that Congress's need to pass a law to overturn the Federal Reserve's interest rate decisions makes these "decisions, for all practical purposes, immune from reversal").
286. James R. Hiñes, Jr. & Richard H. Thaler, Anomalies: The Flypaper Effect, 9 J. ECON. PERSP. 217 (1995) (summarizing the literature on the flypaper effect).
287. Helen F. Ladd, State Responses to the TRA86 Revenue Windfalls: A New Test of the Flypaper Effect, 12 J. POL'Y ANALYSIS & MGMT. 82 (1993).
288. Id. at 82.
289. Id. at 83.
290. Id. at 101.
291. More generally, a sizeable empirical literature has concluded that fiscal institutions "matter." See, e.g., James M. Poterba, Do Budget Rules Work? 0 (Nat'l Bureau of Econ. Research, Working Paper No. 5550, April 1996) ("Several distinct strands of empirical evidence, from the U.S. federal experience with anti-deficit rules, from U.S. state experience with balanced budget rules, and from international comparisons of budget outcomes in nations with different fiscal institutions, suggest that fiscal institutions do matter.").
292. Robert L. Bland & Phanit Laosirirat, Tax Limitations to Reduce Municipal Property Taxes: Truth in Taxation in Texas, 19 J. URB. AFF. 45, 45-49 (1997).
293. See id.
294. See id.
295. See id.
296. Id. at 45-46.
297. TEX. CONST, art. VIII, §21(a).
298. See also OFFICE OF THE TEX. COMPTROLLER OF PUB. ACCOUNTS, TRUTH-IN-TAXATION: A GUIDE FOR SETTING TAX RATES (2005), http://www.window. state.tx.us/taxinfo/proptax/tnt05/96-312.pdf.
299. See U.S. ADVISORY COMM'N ON INTERGOVERNMENTAL REL. , SIGNIFICANT FEATURES OF FISCAL FEDERALISM 151-67 (1995, 1977).
300. Id.
301. Gary C. Cornia & Lawrence C. Walters, Full Disclosure: Unanticipated Improvements in Property Tax Uniformity, 25 PUB. BUDGETING & FIN. 106, 110 (June 2005).
302. The advocates of the truth-in-taxation property tax measures viewed themselves as promoting a softer version of a tax-expenditure limit with the purpose of reigning in the growth of local governments. See Bland & Laosirirat, supra note 228. This Article argues for revenue-target baselines for statewide sales and income taxes in order to transfer some of the effects of fiscal volatility from the public to the private sector, not to limit the growth of government. Consequently, the political actors supporting revenue-target baselines for local property taxes would not necessarily support these baselines for statewide sales and income taxes.
303. At the time of this writing, the truth-in-taxation property tax systems remain intact, and to this author's knowledge there have not yet been any significant political moves to abolish them.
304. Note that if a progressive-rate income tax (as opposed to a flat-rate income tax) is to be adjusted, the authorizing statute must specify which rates are to be adjusted as the economy cycles. As with indexing and other design variables, any answer to this question must be somewhat arbitrary. There is no theoretically "correct" method for adjusting the rates of a progressive income tax. One possible approach would be to attempt to adjust the rates so as to make the tax adjustments distributionally neutral. But this is not the only possibility, and a normative argument can be made in favor of adjusting the rates so that high-income taxpayers bear more of the tax burden during downturns and less during upturns. See supra notes 168-73 and accompanying text.
305. We currently label this forecasting as the revenue estimating process because we use tax rates as our baseline. With revenue targets as the baseline, the process would be labeled as taxrate estimating. Under either system, calculations made by administrative officials significantly impact fiscal policy outcomes.
306. See supra notes 91 -94 and accompanying text.
307. Additionally, the main obstacle to full financing of rainy-day funds remains the ability of the dominant political coalition to raid these funds either explicitly or through the use of gimmicks.
308. ELIZABETH MCNICHOL & IRIS J. LAV, CTR. ON BUDGET & POL'Y PRIORITIES, NEW FISCAL YEAR BRINGS NO RELIEF FROM UNPRECEDENTED STATE BUDGET PROBLEMS (2009), http://www.cbpp.org/cms/?fa=view&id=711.
309. Id. at 4.
310. FRAMING THE CHOICES, supra note 37, at 5-6.
311. See MCNICHOL & LAV, supra note 243, at 3.
312. See supra notes 48-54 and accompanying text.
313. For a discussion of alternative solutions for the state of California, see David Gamage, Coping Through California's Budget Crises in Light of Proposition 13 and California's Fiscal Constitution, in AFTER THE TAX REVOLT: PROPOSITION 13 TURNS 30 59-65 (Jack Citrin & Isaac William Martin eds, 2009).
314. Freakonomics Blog, http://freakonomics.blogs.nytimes.com/2009/08/13/ (Aug. 13, 2009, 12:27 EST) ("no crisis should go to waste").