Spatial dependence in models of state fiscal policy convergence

We apply spatial econometric techniques to models of state and local fiscal policy convergence. Total tax revenue and expenditures, as well as broad tax and expenditure categories, of state and local governments in each of the 48 contiguous U.S. states are examined. We extend work by Scully (1991) and Annala (2003) in much the same way that Rey and Montouri (1999) extended the literature dealing with income convergence among U.S. states. Our results indicate that most fiscal policies have been converging and exhibit spatial dependence. A more specific interpretation of our general spatial results is that the finding of spatial dependence indicates that the growth paths of state and local fiscal policies are not independent. In addition, we find that total expenditures have been converging faster than output, whereas total tax revenues have been converging slower that output. Our models further demonstrate that state expenditure growth is dependent upon expenditure growth in economically and demographically similar states, while output growth and revenue growth in a state are dependent on output growth and revenue growth, respectively, in contiguous states.