Public Finance Review recent issues

Does Decentralization Reduce Government Size? A Quantitative Study of the Decentralization Hypothesis

Prohl, S., Schneider, F. — Wed, 21 Oct 2009 09:59:30 PDT

The ‘‘decentralization hypothesis’’ in the theory of fiscal federalism suggests that fiscal decentralization may have a dampening effect on government size, implying that government intrusion into the economy can be restricted if government responsibilities for taxes and expenditures are decentralized. We study the effect of decentralization on public sector growth for a panel of twenty-nine countries over the 1978—2003 period. The major purposes of this study are twofold. First, we examine the decentralization hypothesis using two different proxy variables of fiscal decentralization: a measure of expenditure and revenue decentralization based on government financial statistics and an index of fiscal federalism that incorporates the fiscal and administrative autonomy that constitutional and statutory law grants to subnational governments. Second, and relatedly, we also explore the hypothesis that direct democracy at the local level has a dampening effect on government growth.

The Effect of Tax and Expenditure Limitations on Public Education Resources: A Meta-Regression Analysis

Ballal, S., Rubenstein, R. — Wed, 21 Oct 2009 09:59:30 PDT

While tax and expenditure limitations (TELs) are intended to restrain government taxing and spending, empirical research has arrived at different, sometimes contradictory, conclusions on their impact. In this article, we use meta-regression analysis (MRA) to sort out these differences and to draw conclusions regarding the effect of TELs on one of the largest areas of state and local spending, education. We find evidence that TELs are associated with increases in state funding for education, relative to local or combined state and local funding. The results also suggest that some methodological factors may affect study results and that study publication is associated with findings of negative TEL effects on education resources.

The Output Effects of Labor Income Taxes in OECD Countries

Sonedda, D. — Wed, 21 Oct 2009 09:59:30 PDT

This article considers the relationship between labor income taxes and output. An illustrative model indicates that the sign of the output effect of labor taxation policies is ambiguous and depends not only on the technology parameters but also on the taxation level. The empirical evidence for fifteen Organisation for Economic Co-operation and Development (OECD) countries over the period 1974—97 shows that the effect is heterogeneous across countries both in the short run and in the long run when considering the average tax rate. We also find a common positive and significant long-run relationship for the marginal tax rate.

The Efficiency Loss of Capital Income Taxation under Imperfect Loss Offset Provisions

Ahsan, S. M., Tsigaris, P. — Wed, 21 Oct 2009 09:59:30 PDT

The importance of capital loss offset provisions in a world of risk is well documented in the tax literature. However, the potential deadweight losses owing to imperfect offset has not been fully explored. This article develops a framework, whereby that investigation can be carried out, and uses numerical simulations to investigate the size of potential losses. The results obtained show that welfare losses owing to the absence of offset provisions could be substantial. Under plausible assumptions about attitudes toward risk and time preference, and with a capital income tax rate of 35 percent, over forty-five cents per dollar of tax revenue raised may be dissipated. In contrast, full loss offset may reduce that loss to approximately twelve cents.

Investment Under Tax Policy Uncertainty: A Neoclassical Approach

El-Shazly, A. — Wed, 21 Oct 2009 09:59:30 PDT

This article studies the impact of investment irreversibility, delivery lags, and adjustment costs on the firm’s optimal investment policy in a world of uncertainty. The source of uncertainty is a future change in the corporate profits tax where both the timing of this event and the size of associated adjustment in the tax benefit of investing are random. Such a tax uncertainty is particularly evident in reform economies whose authorities consider significant reductions in the corporate tax rate to stimulate business life. It is shown that greater transparency on tax policy promotes the firm’s expected net worth and the capital accumulation process.

General Fund Financing, Earmarking, Economic Stabilization, and Welfare

Chen, B.-L., Lee, S.-F. — Mon, 31 Aug 2009 11:15:55 PDT

Discussion has been made concerning the pros and cons of financing public projects via either earmarking or a general fund. The article studies the desirability of earmarked and general fund financing based on economic stabilization in a two-sector growth model. Regardless of the nature of public goods, earmarked taxes contribute to aggregate stabilization, while general fund financing may be destabilizing and cause fluctuations. The underlying mechanism in favor of earmarked taxes against general fund financing is that general fund financing creates intersectoral externalities and strategic complementarities that are sufficiently large to exert endogenously persistent and recurring fluctuations in aggregate activities in the absence of shocks to fundamentals. Earmarked taxing generates only sector-specific externalities that are too small to exert local indeterminacy. In a calibrated version, we compute the level of long-run welfare, and the results reflect favorably on the use of earmarked taxing.

Fiscal Decentralization and Public Sector Employment: A Cross-Country Analysis

Martinez-Vazquez, J., Yao, M.-H. — Mon, 31 Aug 2009 11:15:55 PDT

This paper investigates the relationship between public sector employment and fiscal decentralization. We develop a theoretical framework modeling the interactions between the central and subnational executives regarding the level of public employment at the central and subnational government levels. In our empirical work, based on a large cross-country dataset, we find that, ceteris paribus, the level of total public sector employees in a country increases with its level of fiscal decentralization. Even though central government employment decreases with decentralization, this is more than fully offset by the increase in employment at the subnational level accompanying decentralization. Our empirical results also indicate that the relationship between GDP per capita and public sector employment is not monotonic but quadratic, that total public sector employment is higher in unitary countries vis-à-vis federal countries, and that public employment increases with the country’s international economic openness.

Does the Gubernatorial Term Limit Type Affect State Government Expenditures?

Escaleras, M. P., Calcagno, P. T. — Mon, 31 Aug 2009 11:15:55 PDT

Political institutions within a society often serve to create the rules governing economic actions, to establish norms of economic behavior, and ultimately to help explain the relative economic performance of society. Institutions like budgetary constraints, party ideology, term limits, and voting methods have been analyzed with emphasis on the interplay of politics and economics. Within this field, we believe that the study of term limits is of particular importance. Hence, this article empirically investigates the link between the different types of gubernatorial term limits and state expenditures, after controlling for political institutions. Using panel data from thirty-seven U.S. states between 1971 and 2005, we find that all three types of term limits (weak, moderate, and strong) have a positive impact on gubernatorial spending. However, only weak and moderate term limits are statistically significant, suggesting that the more lenient is the constraint on the governor the greater is the impetus to spend.

Should the Federal Government Reallocate Funds within Federal Transfers?

Neves Sequeira, T., Ferreira-Lopes, A. — Mon, 31 Aug 2009 11:15:55 PDT

It is recognized that one of the goals of federal transfers is to provide the states with some financial leverage during recessions. Federal transfers in the United States comprise such components as retirement and disability payments for individuals, other direct payments for individuals or organizations, grants, procurement contracts, and salaries and wages. Is the composition of the federal transfers’ budget having an optimal effect on the business cycle or should the federal government reallocate some expenditure? In this article, we argue that the federal government may improve its role in stabilizing the business cycle if some reallocation is made from procurement contracts and payments for other than individuals to direct payments for individuals, grants, and disability and retirement payments.

Longitudinal Effects of Impact Fees and Special Assessments on the Level of Capital Spending, Taxes, and Long-Term Debt in American Cities

Jung, C., Roh, C.-Y., Kang, Y. — Mon, 31 Aug 2009 11:15:55 PDT

This article examines whether the use of impact fees and special assessments affect the level of capital spending and two major own source revenues of local capital spending (taxes and long-term debt) by analyzing a panel of 695 American cities with populations over 20,000 during the time period of 1980—2000. Since impact fees and special assessments are heavily used in a growing community and because it covers less than half the costs of new development, the findings demonstrate that the private financing of public infrastructure (impact fees and special assessments) increases the level of local capital spending. It also leads to an increase in the level of long-term debt use. Although it provides partial tax relief, it is not a strong substitute for taxes. Thus, impact fees and special assessments are not a substitute for local capital spending. It is rather a supplemental revenue source to fund local capital infrastructure.

Do Tax Incentives Affect Investment?: An Analysis of the New Markets Tax Credit

Gurley-Calvez, T., Gilbert, T. J., Harper, K., Marples, D. J., Daly, K. — Fri, 05 Jun 2009 09:46:41 PDT

The authors construct panels of individual and corporate income tax data from 1997 to 2004 to investigate whether the new markets tax credit (NMTC) program leads to increased investment. The authors' approach is unique in the examination of development incentives as their focus is on investor behavior instead of community-level outcomes. They use both instrumental variables and propensity score approaches to address nonrandom selection into the program. The authors' results suggest at least a portion of NMTC investment by individual investors is ``new'' investment financed through a decrease in consumption. This ``new'' investment represents an increase in investment funds available to low-income communities. On the corporate side, the authors find no change in corporate investment levels in response to the NMTC. Using survey data from the Government Accountability Office, the authors infer that corporations have most likely shifted investment funds from higher income communities to NMTC-eligible communities.

Tax Collection in History

Cosgel, M. M., Miceli, T. J. — Fri, 05 Jun 2009 09:46:41 PDT

This article examines the rich variety of tax collection methods that have been employed throughout history. Three general categories have been observed: share contracts, rent contracts, and wage contracts, which differ depending on whether the government needs to measure the actual tax collected, the tax base, or the collector's effort, respectively. We develop a principal—agent model that seeks to explain the choice among these forms based on collector incentives, the value of state-specific collection effort, and measurement costs. We then review the actual use of the various forms in light of the model, both across countries and over time.

Education and Civic Outcomes in Italy

Di Pietro, G., Delprato, M. — Fri, 05 Jun 2009 09:46:41 PDT

This article attempts to identify the causal effects of education on multiple measures of civic engagement in Italy. The identification strategy is based on changes in education legislation that have exogenously affected the schooling decision. Our empirical analysis delivers two main results. First, the ordinary least squares (OLS) estimates of the effects of education on some civic measures are likely to be biased. Second, the instrumental variables (IV) estimates suggest that the direction of this bias varies across measures of civic outcomes.

Income and Lottery Sales: Transfers Trump Income from Work and Wealth

Coughlin, C. C., Garrett, T. A. — Fri, 05 Jun 2009 09:46:41 PDT

The effect of income on lottery expenditures has generally been studied using an aggregate measure of income, usually personal income. Reasons exist for thinking that lottery expenditures do not respond equally to all sources of income. This article examines lottery consumption and income from three sources, namely income from earnings, wealth, and transfer payments. Using county-level data for seven states and controlling for demographic and other characteristics, we find that each source of income has a different effect on lottery ticket expenditures. A noteworthy finding is that purchases are most strongly influenced by transfer payments. Several policy implications follow from our results.

Hunting the Unobservables for Optimal Social Security: A General Equilibrium Approach

Caliendo, F. N., Gahramanov, E. — Fri, 05 Jun 2009 09:46:41 PDT

We study the optimal size of a pay-as-you-go social security program for an economy composed of both permanent-income and hand-to-mouth consumers. While previous work on this topic is framed within a two-period partial equilibrium setup, we study this issue in a life-cycle general equilibrium model. Because this type of welfare analysis depends critically on unobservable preference parameters, we methodically consider all parameterizations of the unobservables that are both feasible and reasonable—all parameterizations that can mimic key features of macro data (feasible) while still being consistent with micro evidence and convention (reasonable). The baseline model predicts that the optimal tax rate is between 6 percent and 15 percent of wage income.

Do Local Residents Value Federal Transfers?: Evidence from Interprovincial Migration in Canada

Bakhshi, S., Shakeri, M., Olfert, M. R., Partridge, M. D., Weseen, S. — Fri, 10 Apr 2009 13:44:19 PDT

A fundamental governance challenge for federal nations is benefiting from decentralization, while addressing potential negative side effects, including vertical and horizontal imbalances. Inefficient migration due to differential net fiscal benefits in subnational units is one potential negative side effect. To avoid this type of migration, federal payments to disadvantaged subnational units, a place-based policy, are often advocated. In this article, we assess federal equalization transfer payments in Canada as an example of such a policy. Equalization is appraised in terms of its marginal influence on interprovincial migration, after accounting for the persistent relative attractiveness (unattractiveness) of provinces as migration destinations/origins. We then compare equalization to an alternative policy that directly subsidizes workers. Compared to a ``people-based'' policy of wage subsidies, our findings suggest that at the margin, these federal transfers have virtually no impact on net migration.

Intrastate Competition for Debt Resources

Denison, D. V., Hackbart, M. M., Moody, M. J. — Fri, 10 Apr 2009 13:44:19 PDT

Limited economic resources create constraints that force trade-offs among desired objectives. Likewise, state-balanced budget requirements force policy makers to make budgetary trade-offs among competing state programs. Constrained state resources have also encouraged states to issue bonds to finance infrastructure and capital assets rather than using pay-as-you-go financing for such investments. However, the expanded use of debt financing often faces another constraint known as debt capacity. As a result, states may be required to make trade-offs among the competing demands for debt financing similar to the trade-offs they must make for operating program expenditures. The authors' empirical findings indicate that tradeoffs occur between highway project—related debt and other state debt in those states with formal restrictions on total general obligation and revenue-backed debt (umbrella debt limits). In states without umbrella debt limits, there is no evidence of a trade-off between the highway debt and all other state debt.

Horizontal and Vertical Tax Competition in Florida Local Governments

Wu, Y., Hendrick, R. — Fri, 10 Apr 2009 13:44:19 PDT

This is an empirical exploration of tax competition among Florida local governments. We estimate a spatial lag reaction function for property tax rate of Florida municipal governments in 2000 and 2004. The level of ``neighborliness'' is measured as spatial distance between geographical centers of municipalities. The weight matrix excludes the municipalities locating within the same county to eliminate their common responses to higher-tier government property tax policy. By including the property tax rate levied by other local governments (counties, school districts), we find that tax competition exists for property tax among neighboring municipalities (horizontal) as well as between municipalities and other local governments (vertical). The response of municipal governments is negative to county's property tax rate but positive to school district's property tax rate.

Intergovernmental Revenue Estimation: Evidence from New York State School Districts

Vanyolos, I. — Fri, 10 Apr 2009 13:44:19 PDT

This study develops a model of school budget decision making and examines the nature of state aid estimation. Revenue estimation can be divided into three distinct components: strategy-driven difference, uncertainty-triggered difference, and true error term. Underestimation of state aid revenues is the dominant budgetary behavior, but a significant number of districts end up with undesired overestimation. Overestimation is more prevalent among high aid dependent, rural, and urban districts. Institutional constraints, such as local budget vote, tend to reduce the size of state aid estimation difference. The uncertainty-triggered difference tends to increase as a response to compounded negative signals (low levels of Governor's proposal on state aid and late state budgets). Although there is evidence that state aid estimation differences ultimately end up in the fund balance, this study could not confirm that lower levels of prior year fund balances would trigger districts into a more aggressive underestimation of state aid.

Taxing Under the Influence?: Corruption and U.S. State Beer Taxes

Fredriksson, P. G., Gohmann, S., Mamun, K. — Fri, 10 Apr 2009 13:44:19 PDT

This article examines the effect of state level corruption on state beer taxes in the United States. Our lobby group model predicts that corruption reduces the beer tax, but this effect is conditional on the level of alcohol-related vehicle deaths. Using a panel of state level data from 1982 to 2001, we find that increased corruption is associated with lower state beer tax rates. The magnitude of the effect, however, declines with increases in alcohol-related traffic deaths. Our findings suggest that future empirical work estimating the effect of alcohol taxes on alcohol-related traffic fatalities should treat alcohol taxes as endogenous.