State Fiscal Crises : States Abilities to Withstand Recessions

During the most recent recession, many state governments faced substantial budget shortfalls.State politicians often blame the fiscal crises created by those shortfalls on factors largely outside their control, such as the declining economy or reductions in federal aid. Others have suggested that what state politicians themselves do, especially during expansionary years?whether they enact rapid spending increases, implement large tax cuts, increase the size of their rainy day funds, or take some combination of these actions?may be an important factor contributing to budget shortfalls during recessions. We examine these competing hypotheses and tend to find a positive relationship between spending growth (both current and lagged) and fiscal stress during recessions and a negative relationship between the size of rainy day funds and fiscal stress. We tend not to find a significant relationship between fiscal stress and either the unemployment rate or federal aid. That lack of a significant relationship supports the idea that politicians have greater control over the fate of the state's finances than they often claim. It also illustrates the importance of spending restraint and rainy day funds as strategies for minimizing fiscal stress