Sunjoo Kwak
Published: 2011
Total Pages: 82
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In response to the growing concerns over the recurring state fiscal crises, this dissertation aims to shed light on the determinants and consequences of revenue volatility. To this end, the dissertation specifically addresses two questions. First, it examines how the composition of tax bases varies across states and what effects tax base composition has on the cyclical volatility of tax revenues. With particular focus on two major revenue sources relied upon by state governments, general sales tax and individual income tax, this study develops a measure of revenue volatility and investigates the questions using pooled OLS on state panel data over the sample period from 1992 to 2007. Overall, the empirical analysis finds that there exists a wide variation in both sales and individual income tax across states. Regression results indicate that tax base composition significantly affects revenue volatility, with economic structure and demographic-economic characteristics being controlled for. Specifically, tax exemptions for household necessities (food and clothing) and producer goods are found to have statistically significant effects on sales tax volatility. On the other hand, exemptions for Social Security benefits, public pensions, and long-term capital gains, along with deduction for local tax property tax paid, are significantly related to income tax volatility. Second, this dissertation examines how cyclical changes in tax revenues affect state fiscal behavior in terms of the level of spending and taxation, using a panel data set for state governments over the period of 1992 to 2007. Specifically, the study tests fixed effects models that explain own-source expenditure and overall tax rate as a function of revenue gap, the cyclical component of state tax revenue. Regression results reveal that cyclical changes in tax revenues are positively related to changes in own-source expenditures, whereas they are negatively related to changes in tax rates, suggesting the relationship between revenue volatility and fiscal instability. Based on these findings, the dissertation concludes by discussing the dynamics of state fiscal behavior over the business cycle and suggesting spending-smoothing rules as a policy solution to structural budget deficits and fiscal crises.