State Fiscal Adjustment During Times of Stress : Possible Causes of the Severity and Composition of Budget Cuts

Efforts to maintain balanced budgets, driven in part by formal requirements, lead to substantial pro-cyclicality in states' capital investments, transfers to local governments, and spending in areas like education and transportation. Extensive reliance on relatively volatile revenue sources (e.g., the personal income tax) predicts relatively severe volatility in these expenditures. The length of state budgetary and legislative cycles predicts the volatility of capital expenditures. States with strict balanced budget requirements must restore fiscal balance faster than those without, leading to rescissions during years in which they face unexpected shocks. I study the composition of these rescissions, finding that they occur disproportionately in areas with significant year-to-year variation (e.g., the capital portion of the budget and spending on utilities), which may indicate the presence of deferable projects. Evidence points to the relative strength of public sector union groups as a driver of variation in the composition of mid-year rescissions across states