Public Choice (2006) 126: 177–199
DOI: 10.1007/s11127-006-7752-x
C
Springer 2006
State budget stabilization fund adoption: Preparing for the next
recession or circumventing fiscal constraints?
GARY A. WAGNER1,∗ & RUSSELL S. SOBEL2
1 School of Government, UNC Chapel Hill, Knapp-Sanders Building CB#3330, Chapel Hill, NC
27599-3330, U.S.A.; 2 Department of Economics, West Virginia University, Morgantown,
WV 26506, U.S.A.
(∗ Author for correspondence: e-mail: [email protected])
Accepted 16 December 2004
Abstract. The high rate of budget stabilization fund adoption during the 1980s is often attributed
to the 1980–1982 recession. In this view, states adopted funds to prevent a recurrence of the
fiscal crises experienced during that recession. An alternative hypothesis is that some funds
adopted during this period were intended to circumvent tax and expenditure limit laws. We find
that states with TELs in place were significantly more likely to adopt statutory funds, but were
significantly less likely to adopt funds with stringent deposit and withdrawal rules, suggesting
that some funds were adopted to circumvent existing fiscal constraints.
1. Introduction
State government fiscal institutions changed dramatically during the latter
half of the 20th century. During the 1950s and 1960s, growing state revenue
demands were satisfied with the adoption of many new taxes. Between 1951
and 1971, 16 states adopted retail sales taxes, 11 adopted personal income
taxes, and 11 adopted corporate income taxes. Moreover, a majority of states
who already had these taxes in place increased tax rates to generate additional
revenue.1 These significant changes in revenue structures fueled rapid growth
in state government spending throughout the 1950s, 1960s, and 1970s.
The 1980s and early 1990s were in sharp contrast to the improved fiscal
health states experienced during previous three decades. In particular, the
1980–1982 recession caused severe fiscal crises for states. Despite large
tax increases during the recession, most states were not able to maintain
expenditures. The result was cuts in state programs and increased turnover
in state legislatures as incumbent politicians were ousted for the poor fiscal
situations being experienced by states.2 The combination of sluggish revenue
growth, and the increasing popularity of expenditure and tax limit laws which
emerged during the late 1970s, limited the policy options available to state
decision-makers and help propagate the reliance on non-traditional sources
of revenue such as lotteries.
In the midst of these fiscal challenges during the 1980s, there was a rash
of states adopting budget stabilization, or “rainy day,” funds. Of the 44 states
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currently utilizing budget stabilization funds, only 10 states adopted their
stabilization fund prior to 1980. Although every year of the 1980s, with the
exception of 1980 and 1989, witnessed states adopting stabilization funds for
the first time, the bulk of stabilization fund adoption occurred between 1981
and 1986, when 20 states adopted funds. The conventional view regarding
the increase in stabilization fund adoption during this period, which has been
advocated by Gold (1983) and Douglas and Gaddie (2001), is that rainy day
funds were simply an outgrowth of the 1980–1982 recession as states attempted to ensure that sufficient reserve balances existed so that expenditure
growth could be maintained when future recessions arose.
What has traditionally been overlooked, however, is that the rash of stabilization fund adoptions during the 1980s also coincided with the “tax revolt” era of increased fiscal constraints such as tax and expenditure limit
laws (hereafter, “TELs”). While TELs are typically thought of as constraints
aimed at limiting the growth in expenditures and/or tax revenue, some TELs
have the potential to be tremendously influential as to the manner in which
states save. Several expenditure limit laws and some tax limit laws, such as
California’s expenditure limit law (Proposition 13) for instance, require some
or all of a general fund surplus to be returned to citizens. In cases such as
this, the adoption of a budget stabilization fund into which the general fund
surplus may be placed effectively circumvents the constraint imposed by the
TEL.
In this paper we explore the hypothesis that some budget stabilization
funds may have been adopted to circumvent existing expenditure and/or tax
limit laws by investigating the factors that influenced states’ decisions to adopt
budget stabilization funds. We not only explore which factors are correlated
with fund adoption, but we also explore how the same factors are correlated
with the stringency of the deposit and withdrawal requirements placed on the
fund, which we believe provides insight as to whether the fund was adopted as
a means to circumvent constraints imposed by TELs. We focus on estimating
the relative role of four major factors on fund adoption: (1) the severity of
the state’s revenue variability caused by business cycle swings; (2) the degree
of instability in the year-to-year revenue flow for the state; (3) the presence
and/or adoption of tax or expenditure limit laws; and (4) the state’s general
“need” of a fund as a tool to help the state save and/or improve its fiscal
health. As we proceed, we will discuss each of these potential influences on
fund adoption in more detail and proceed to develop empirical measures of
each.
2. The Adoption and Structure of State Budget Stabilization Funds
Figure 1 shows the cumulative number of states with budget stabilization
funds over the period 1970 to 1995. Referring to Figure 1, however, one
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Figure 1. Number of states with a budget stabilization fund 1970–1995.
would be hard pressed to suggest that the 1980–1982 recession was a critical
point in fund adoption. In fact, the trend of adoption after the recession is
almost identical to the trend prior to the 1980–1982 recession. In the figure it
appears that the 1980–1982 recession itself caused a dip, or a disruption, in
this trend of adoption that began sometime around 1975. If anything, the data
seem to suggest that it might have been the 1974–1975 recession, rather than
the 1980–1982 recession, that began the wave of adoptions.
The logic for adopting a budget stabilization fund is presumably to help
a state stabilize its budget from substantial business cycle variability or cope
with “rainy” fiscal days. While every state except Vermont is subject to a
balanced budget rule of one kind or another, nearly all rules are written in
stock rather than flow terms. Thus, most states are permitted to run surpluses
to build up savings and may then run annual deficits as long as there are
surplus funds to spend down. To smooth the budget, however, states could
simply save money and carry around a general fund surplus without ever
creating an explicit budget stabilization fund in which to place the money.
Following this commonly accepted line of reasoning, the only valid argument for adopting an explicit fund would be to place stricter rules on the
deposit and withdrawal of money than are present for a general fund surplus.3
With stronger constraints that require deposits and restrict withdrawals, states
could hope to save larger balances, and spend these balances more wisely.
This hypothesis, that states adopt these funds in an effort to increase their
stock of savings to better prepare themselves for future recessions, seems to
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imply that budget stabilization funds should in general be governed by strict
constraints.
Table 1 shows the year that funds were adopted, deposit and withdrawal
rules placed on the fund, and whether the fund was adopted statutorily (imposed by the legislature on itself) or constitutionally (an amendment generally
externally imposed on the legislature through citizen initiative or voter referendum). It is clear from the data in Table 1 that the rules governing stabilization
funds differ substantially across states. Nearly all stabilization funds (38 out
of 44) were adopted by statutory means, and the majority of such funds are not
governed by constraints that are more stringent than those placed on general
funds. We classify the rules governing budget stabilization funds into four
categories, with (1) denoting the weakest constraints and (4) denoting the
strictest constraints.4
For deposit rules, a value of (4) denotes that the state must deposit money
into the fund each fiscal year according to a strict mathematical formula.
These formulae are generally functions of the state unemployment rate or
growth rate of personal income. A value of (3) for the deposit rule indicates
that the state is required to deposit money into the fund every year, but that
the value is not strictly dependent on statistical measures of state economic
conditions. A value of (2) indicates that the state must deposit some share of
any budget surplus. The weakest value of (1) indicates that the state is never
required to deposit money, but rather the state legislature may deposit money
at their discretion through appropriation. Of the 44 states with funds, 6 have
statutory formulas governing deposits, 6 have required annual appropriations,
24 have general fund surplus deposit requirements, and 8 deposit funds at the
discretion of the legislature.
For withdrawal rules, a (4) indicates the state can only withdraw money
by a mathematical formula dependent upon state economic conditions, again
generally in practice using the state unemployment rate or the growth rate
of personal income. A value of (3) indicates that a supermajority vote of the
state legislature is required to withdraw money from the fund. A value of
(2) indicates that the state may access the money in the fund only to cover
a revenue shortfall (when actual revenues turn out less than was forecast).
Finally, a value of (1) indicates that the money in the fund may be spent
anytime by simple legislative appropriation. Of the 44 states currently utilizing
stabilization funds, 5 have statutory formulas governing withdrawals, 5 require
supermajority approval, 17 allow for withdrawals in the case of a revenue
shortfall only, and the remaining 17 allow for withdrawals to be made at the
discretion of the legislature.
Clearly, many states have stabilization funds that are very weakly structured (weak meaning those having category (1) or (2) deposit and/or withdrawal rules). If one accepts the conventional wisdom that these funds were
put in place to help states save more than they have been for future recessions,
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Table 1. Summary of state budget stabilization funds
State
Year of BSF adoption
Deposit rulea
Withdrawal ruleb
Fund typec
Alabama
–
–
–
–
Alaska
Arkansas
1986
–
1
–
1
–
S
–
Arizona
1990
4
4
S
California
Colorado
Connecticut
Delaware
Florida
Georgia
Hawaii
Idaho
Illinois
Indiana
Iowa
Kansas
Kentucky
Louisiana
Massachusetts
Maine
Maryland
Michigan
1985
1983
1979
1977
1959
1976
–
1984
–
1982
1992
1993
1983
1990
1986
1985
1986
1978
2
3
2
2
2
2
–
1
–
4
1
3
2
2
2
2
3
4
2
2
3
3
2
1
–
1
–
4
1
1
1
1
1
1
1
4
S
C
S
C
S
S
–
Minnesota
Mississippi
Missouri
Montana
Nebraska
Nevada
New Hampshire
New Jersey
1981
1982
1992
–
1983
1994
1987
1990
1
1
1
–
2
4
2
2
1
1
1
–
2
2
2
2
S
S
S
–
S
S
S
S
New Mexico
New York
North Carolina
North Dakota
Ohio
Oklahoma
Oregon
1978
1945
1991
1987
1981
1985
–
2
4
2
2
2
2
–
1
2
1
4
1
3
–
S
S
S
S
S
C
–
–
S
S
S
S
S
S
S
C
S
(Continued on next page)
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Table 1. (Continued)
Year of BSF adoption
Deposit rulea
Withdrawal ruleb
Fund typec
Pennsylvania
1985
2
3
S
Rhode Island
South Carolina
1985
1978
1
3
2
2
S
C
South Dakota
1991
2
2
S
Tennessee
Texas
Utah
Vermont
Virginia
Washington
West Virginia
Wisconsin
Wyoming
1972
1987
1986
1988
1992
1981
1994
1981
1982
3
2
2
2
4
2
2
3
1
2
2
2
2
4
3
2
2
1
S
S
S
S
C
S
S
S
S
State
Deposit rules: 1 = appropriation; 2 = General Fund surplus; 3 = required annual appropriation; 4 = statutory formula.
b
Withdrawal rules: 1 = appropriation; 2 = revenue shortfall; 3 = supermajority; 4 = statutory
formula.
c
Fund type: S = statutory; C = constitutional.
Source: Wagner (1999, 2001).
a
the fact that so many are weakly structured is indeed a puzzle. Our alternative
hypothesis, that legislatures created these funds to circumvent other fiscal
constraints such as TELs, however, offers a plausible explanation for this
phenomenon. By adopting and depositing surplus funds into a stabilization
fund, state decision-makers may effectively nullify the effect of a tax or expenditure limit law since money in stabilization funds are not subject to TEL
oversight.
In fact, even states with TELs that do not require surplus funds to be
returned to citizens may have an incentive to adopt weakly structured funds
because, as the National Association of State Budget Officers (1997) notes,
money spent from a stabilization fund is accounted for in state budgets as
“revenue”. As a result, state politicians may legally surpass spending limit
caps, but not revenue limit caps, by allocating money from the stabilization
fund rather than the general fund. And when one considers that more than
86% of stabilization funds were adopted statutorily, this suggests that state
decision-makers had more flexibility in structuring the rules governing the
fund than did a state whose stabilization fund was adopted by constitutional
means.
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Table 2 denotes the adoption dates of state expenditure and tax limit laws
and whether or not the state’s TEL either requires the return of some or
all of general fund surplus to citizens. As is evident, the rash of stabilization fund adoptions in the 1980s was preceded by the adoption of numerous
spending limit laws and a handful of tax limit laws. Only Hawaii, Montana,
and Oregon currently have a TEL in place and are without a stabilization
fund. Of the 23 states that have both a stabilization fund and an expenditure and/or tax limit law, 19 of these states had an expenditure and/or tax
limit law in place before adopting a stabilization fund (15 had expenditure limit laws, 3 had tax limit laws, and Missouri had both in place). In
addition, of the 15 states that possess TELs that require the return of all
or some of a general fund surplus to citizens, 11 of those states had such
restrictions in place prior to adopting a budget stabilization and only two
states with such TELs (Hawaii and Oregon) have yet to adopt a stabilization
fund.
Hence, if some state legislatures adopted stabilization funds in an effort to
circumvent the constraints imposed by TELs, we would expect those states
to adopt budget stabilization funds governed by very weak constraints so that
the funds would be easily accessible to politicians. While it may seem optimal
for states attempting to circumvent a TEL to adopt a budget stabilization fund
governed by a strict deposit rule to “keep a hold of the money,” it seems more
plausible that a utility maximizing politician would seek to maximize her discretion. In short, weakly structured budget stabilization fund deposit rules and
withdrawal rules provide legislators with a greater degree of decision-making
discretion than strict rules. For instance, legislators that wish to nullify an
expenditure limit constraint requiring the return of a general fund surplus
would prefer to have discretion over how surplus funds are allocated. Thus, it
would seem highly unlikely that such a state would adopt either strict deposit
or withdrawal rules on a budget stabilization fund since such rules would force
the legislature to save the funds and would limit how the funds could be spent.
Weak deposit and withdrawal rules, in contrast, would permit legislators with
the ability to save, and spend, any portion of an unallocated surplus since
transferring monies to a stabilization fund eliminates the monies from TEL
oversight.
On the other hand, if the legislature was genuinely interested in preparing
the state for future fiscal crises, it would seem more likely that a state would
adopt a budget stabilization fund governed by strict deposit and withdrawal
rules. In essence, strict deposit and withdrawal rules are more likely to reduce
the opportunity for “political raids,” both when the surplus is first realized and
while it is saved. Stabilization funds that are created through constitutional
amendments are generally externally imposed on the legislature by the citizens
of a state, and for these funds we might expect that they would be more likely
to be governed by strict rules.
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Table 2. State expenditure and tax limit laws
State
Expenditure
limit law
Tax limit
law
Restrictions on
general fund surplus
Alabama
Alaska
Arkansas
Arizona
California
Colorado
Connecticut
Delaware
Florida
Georgia
Hawaii
Idaho
Illinois
Indiana
Iowa
Kansas
Kentucky
Louisiana
Massachusetts
Maine
Maryland
Michigan
Minnesota
Mississippi
Missouri
Montana
Nebraska
Nevada
New Hampshire
New Jersey
New Mexico
New York
North Carolina
North Dakota
Ohio
Oklahoma
1982
No
1978
1979
1977
1991
No
Yes
Yes
Yes
1994
Yes
1978
1980
Yes
Yes
1992
No
1993
1980
1981
1979
1986
Yes
Yes
1978
Yes
1980
Yes
No
1979
No
1976–83, 90-
No
1991
Yes
1985
Yes
(Continued on next page)
185
Table 2. (Continued)
State
Expenditure
limit law
Oregon
1979
Pennsylvania
Rhode Island
South Carolina
South Dakota
Tennessee
Texas
Utah
Vermont
Virginia
Washington
West Virginia
Wisconsin
Wyoming
Tax limit
law
Restrictions on
general fund surplus
Yes
1977
No
1984
Yes
1978
1978
1979
No
No
No
1979
Yes
Note: States in bold had expenditure and/or tax limit laws in place before adopting a
budget stabilization fund.
Sources: Rueben (1995) and ACIR (1992).
In short, we believe that many states which adopted funds during the late
1970s and 1980s may not have intended their funds to be a vehicle for saving,
but rather as a means to lessen the sting of constraints imposed during the
“tax revolt” era. In addition, our hypothesis may provide an important insight
into the previous literature on budget stabilization funds. In particular, Sobel
and Holcombe (1996a), Knight and Levinson (1999), and Wagner (2001) find
that states with the most stringently structured budget stabilization funds also
experience the largest savings gains from adopting a fund.5 Moreover, Sobel
and Holcombe (1996a) find that states with weakly structured stabilization
funds did not weather the 1990–1991 recession any better than they weathered
the 1980–1982 recession.6 Thus, the actual poor ex post experience of states
with weakly structured stabilization funds during the 1990–1991 recession is
in stark contrast to the idea that these funds were adopted after a recession
as a vehicle to prepare for future recessions. Why do so many states adopt
weakly structured funds despite their ineffectiveness? These results are more
consistent with our hypothesis that legislatures created these weakly structured
funds to circumvent other fiscal constraints. Thus, the results of previous work
is not surprising especially if some states did not adopt stabilization funds with
the intent of being better prepared for future recessions.
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3. Factors Influencing Budget Stabilization Fund Adoption
This section suggests several factors that may potentially influence the timing
and/or decision of a state to adopt a budget stabilization fund that we wish
to incorporate into our empirical models. First would be a measure of recent
state economic performance. To measure this, we include a moving average of
the state’s real personal income growth rate over the previous five years. If experiencing poor economic conditions is a strong motivator for fund adoption,
which has been suggested in previous literature, the sign on this coefficient
should be negative, showing that slower growth increases the likelihood of
fund adoption.
The second variable suggested here is a measure of how harshly a state’s
budget swings up and down as the state economy fluctuates. Differences in
state tax structures, for example, can produce rather large differences in the
cyclical variability of revenues across states. For a given change in state income, two different states may have their budgets affected quite differently. To
measure this we adopt the technique of Sobel and Holcombe (1996b) to obtain
the short-run income elasticity of each state’s revenue with respect to state
personal income. The cyclical variability measure of Sobel and Holcombe
(1996b), which they denote the “short-run income elasticity of revenue,” is
estimated in a manner that allows it to differ for each state and through time.
For each state, a 20-year rolling regression of the form:
ln Ri = α + β ln PIi + ε
(1)
is performed, where Ri is the real general fund revenue of state iand PIi is
the total real personal income of state i. The estimate of β is the short-run
elasticity and it is a measure of the responsiveness of state revenue to changes
in personal income (i.e., the cyclical variability of revenue).7 An estimate of
2.5 for example would suggest that for every 1.0 percentage point reduction
in personal income growth, the state would experience a 2.5 percentage point
reduction in general fund revenue growth. We expect the sign on this variable
when included in the adoption equation to be positive, indicating that a state
with a more variable revenue stream is more likely to adopt a stabilization
fund, ceteris paribus.
Moreover, many stabilization funds contain a withdrawal provision in
which money can only be removed from the stabilization fund if actual revenues fall short of the state’s revenue forecast (withdrawal category (2) in
Table 1). The purpose of such a constraint is to enable the fund to be used
to avoid mid-year expenditure/program cuts due to inaccurate revenue forecasts. The presence of such withdrawal constraints suggests that some states
may have adopted funds as more of an attempt to smooth the year-to-year
random fluctuations in revenue rather than to weather recessions.8 Hence,
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we include an additional variable that measures the degree of year-to-year
random (non-business cycle) variance in the state’s revenue stream.9 To measure the non-cyclical, random year-to-year variability of revenue, we again
follow Sobel and Holcombe (1996b) and use the estimated standard error of
the short-run elasticity coefficient obtained from Equation (1) as our measure.
Essentially, the standard error of β is a measure of the non-business cycle,
random variability of a state’s revenue. We expect a positive sign on this variable because states whose revenue has more year-to-year random variance
should be more likely to adopt a budget stabilization fund, ceteris paribus.
In addition to economic factors, states face a complex set of fiscal constraints that may limit their ability to raise revenue in the short-run, and thus
may increase the likelihood that a state will adopt a budget stabilization fund.
Here we consider three; strict balanced budget requirements, tax limit laws,
and expenditure limit laws. While balanced budget laws are aimed at controlling public sector deficits, most states’ laws are imposed prior to the start
of the fiscal year and thus impose no significant constraint on fiscal behavior
(ACIR, 1987). Empirical evidence by Poterba (1994), Alt and Lowry (1994),
Bohn and Inman (1996), and Levinson (1998) suggests that strict balanced
budget rules, such as those which require fiscal-year-end adjustments, have
more influence on state fiscal behavior than less stringent laws. It is potentially
the case that states with stringent balanced budget rules may be more likely
to adopt budget stabilization funds because they are precluded from deficit financing. To account for the potential influence of state balanced budget rules,
a binary variable indicating that the state has a strict balanced budget rule
is included in the adoption equation.10 We expect stringent balanced budget
rules to be positively correlated with states’ adoption choice, ceteris paribus.
In general, tax and expenditure limit laws specify a maximum allowable
increase in the growth rate of the states’ expenditures and tax revenues over
the previous fiscal year. While their exact nature differs across states, most
are generally based on economic indicators such as inflation, personal income
growth, and/or population growth. Despite the mixed empirical evidence regarding the ability of expenditure and tax limit laws to limit the growth in
public sector spending, both types of constraints have the potential to be
tremendously influential as to the manner in which states save.11 Many expenditure limit laws and a few tax limit laws place restraints on general fund
surpluses. By creating a budget stabilization fund and transferring the surplus
into the account, states with these requirements can effectively circumvent
these laws and keep the surplus as savings in the fund for later use.
We include binary indicator variables in the adoption model to control for
the both existence of tax and expenditure limit laws that do not restrict general
fund surpluses and those that specifically require the return of some or all of a
surplus to citizens.12 For TELs that restrict the use of general fund surpluses,
we expect the signs on these variables to be positive, suggesting that the
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presence of these limits increases the likelihood the state will adopt a budget
stabilization fund, ceteris paribus. In addition, since state accounting practices
treat transfers out of budget stabilization funds as “revenue,” we would expect
expenditure limit laws that do not restrict general fund surpluses to also be
positively correlated with fund adoption, other factors constant, since monies
allocated from a stabilization fund, as opposed to the general fund, would not
be subject to TEL oversight. Finally, we expect the existence of a tax limit
law that does not restrict surplus usage to be negatively correlated, or not
correlated, with fund adoption since stabilization funds are not a means to
circumvent such constraints. Since the majority of the TEL constraints were
imposed on states between the late 1970s and late 1980s, the same period
during which most states adopted their funds, the presence of these limits
is the main competing hypothesis to the idea that the rash of adoptions was
brought on by the sluggish economic performance of the early 1980s.
Before moving on to the estimates, we discuss one final variable included
in our models, a measure of the current (pre-adoption) extent of state saving.
Decision-makers’ fiscal discipline and commitment to saving may influence
their decision to adopt a budget stabilization fund. For example, states that
are large savers and are committed to saving may adopt a budget stabilization
fund as a way to ensure that they continue saving. On the other hand, decisionmakers that have not been actively saving may see a budget stabilization fund
as a means to instill fiscal discipline and commit themselves to saving. We
include each state’s prior year savings (total balances in all state funds) as a
percent of the state budget in our regressions. A negative coefficient estimate
for this variable would indicate that states with low prior savings are more
likely to adopt funds, while a positive coefficient would indicate that states
with high prior savings (fiscal discipline) are more likely to adopt formal
budget stabilization funds.
4. Empirical Models and Estimation Results
This section presents our estimates of the determinants of stabilization fund
adoption and of the determinants of the stringency of stabilization fund rules.
The data is a pooled cross-section of 48 states over the time period 1945 to
1996.13 Explanatory variables for all models include: (1) the five-year moving
average of state real personal income growth, (2) the rolling estimate of the
short-run elasticity of state revenue, (3) the standard error of that elasticity,
(4) previous year savings as a share of the state budget, (5) an indicator variable for the presence of a strict balanced budget rule in the state in that year, (6)
an indicator variable for the presence of an expenditure limit law that requires
the return of some or all of a general fund surplus in the state in that year, (7)
an indicator variable for the presence of an expenditure limit law that does
not restrict the use of general fund surpluses, (8) an indicator variable for the
189
presence of a tax limit law that requires the return of some or all of a general
fund surplus in the state in that year, and (9) an indicator variable for the presence of a tax limit law that does not restrict the use of general fund surpluses.
4.1. The determinants of state budget stabilization fund adoption
To explore the determinants of stabilization fund adoption, our dependent
variable is a discrete variable taking the value of one if a state has a statutory
budget stabilization fund, two if the state has a constitutional stabilization
fund, and zero otherwise. We believe this is an important difference because
constitutionally adopted stabilization funds are generally imposed on the legislature through such processes as citizen initiative or a voter referendum,
while statutory funds are created and adopted by the legislature. Our hypothesis, that legislatures adopted these weakly structured stabilization funds in
an effort to circumvent tax and expenditure limit laws, would apply to those
funds that are statutorily adopted. Thus, we expect to see the TEL variables
being significant determinants of adoption of statutory funds, but probably
not significant in the adoption of constitutional funds.
As is typical in discrete choice panel models, we drop observations from
our sample once they adopt. In short, this approach is beneficial because
it allows the estimation of how each regressor influences the probability of
adopting either a constitutional or statutory budget stabilization fund conditional on never having adopted a fund to date. If the post-adoption data were
kept in the sample, the model would instead be exploring the factors influencing the joint probability of adopting and maintaining a fund, rather than just
the factors associated with the timing of the adoption decision.
Due to the fact that we have a discrete dependent variable with two alternatives (statutory or constitutional), and that our regressors reflect state rather
than choice attributes, we estimate our adoption model via multinomial logit.
The marginal effects from the resulting coefficients estimates, which are reported in Tables 3–5 reveal the marginal impact each regressor has on the
probability that a state adopts either a constitutional or statutory stabilization
fund conditional on never having adopted to date.
As the results in Table 3 show, for both statutory and constitutional stabilization funds, the five-year moving average of real personal income growth is
significant and negative as expected. This confirms the hypothesis that states
are indeed more likely to adopt these funds (both constitutional and statutory)
when their state economy has recently been experiencing bad economic times.
This result suggests that the slow economic growth experienced by states during the 1974–1975 and 1980–1982 recessions did contribute to an increased
probability of fund adoption in the years following the recessions.
In addition, the short-run elasticity of revenue, which is a measure of
the variability of the state’s revenue growth with respect to personal income
190
Table 3. Multinomial logit estimates of the determinants of BSF adoption
Constant
Five-year moving-average of real personal
income growth
Short-run elasticity of revenue
Standard error of short-run elasticity
Previous year savings as a share of the
budget
Strict balanced budget rule
Expenditure limit requiring the return of
some or all of a budget surplus
Expenditure limit not requiring the return
of some or all of a budget surplus
Tax limit requiring the return of some or all
of a budget surplus
Tax limit not requiring the return of some
or all of a budget surplus
Sample size
Chi-square test of model
Log-likelihood
Statutory BSF
Constitutional BSF
−5.543∗∗∗ (0.028)
−0.142∗∗∗ (0.001)
−6.557 (5.847)
−0.227∗∗∗ (0.003)
−0.201 (0.453)
2.239∗∗∗ (0.027)
0.065∗∗∗ (0.00004)
0.030 (0.277)
4.232∗∗∗ (1.779)
0.006 (0.060)
−0.076 (0.103)
2.104∗∗∗ (0.089)
−0.769 (1.949)
2.976∗∗∗ (0.071)
0.250 (2.231)
2.925∗∗∗ (0.385)
−1.036 (2.281)
−0.982∗∗ (0.412)
0.009 (0.086)
−0.605 (3.775)
1878
60.094∗∗∗
−186.040
Notes. Marginal effects are reported and standard errors for all estimates are in parentheses.
Significance levels are as follows: ∗∗∗ denotes significance at the 1% level, ∗∗ at the 5% level,
and ∗ at the 10% level. Sample includes all states except Alaska and Hawaii.
growth, did not significantly influence states’ decisions to adopt either a statutory or constitutional fund. However, the standard error of this short-run elasticity, which is a measure of the degree of year-to-year unpredictability of
the state’s revenue stream, is of the expected sign and is statistically significant in both models. Hence, the probability of adopting either a statutory
or constitutional stabilization fund is significantly higher in states with more
unpredictable revenue streams, other factors constant. Prior year savings as a
share of the budget is also positive, but only statistically significant in influencing the probability of adopting a statutory stabilization fund.
The most interesting results of the model arise when one examines the
impact of tax and expenditure limit laws. If one views statutory budget stabilization funds as a self-imposed institution by the legislature and constitutional
funds as a citizen-imposed institution, the effects of TELs on the probability
of adopting a particular type of stabilization fund is clearly suggestive that
some states responded to TELs with the adoption of statutory stabilization
funds. In fact, each of the four indicator variables reflecting the existence of
a TEL significantly influenced the probability of adopting a statutory fund,
−1.003 (0.656)
2.682 (1.9661)
3.331∗∗∗ (0.711)
−2.610∗∗ (1.075)
−150.512
1380
52.541∗∗∗
−2.251 (2.823)
1.869∗∗∗ (0.040)
0.064 (0.082)
−0.373 (1.160)
−1.997∗∗∗ (0.671)
−0.214 (0.613)
1.667∗∗∗ (0.707)
2.943∗∗∗ (0.040)
−0.087 (0.097)
0.061 (0.203)
3.961∗∗∗ (0.594)
0.255 (0.600)
−7.121∗∗∗ (0.513)
0.196 (0.229)
−6.008∗∗∗ (0.317)
−0.149∗∗∗ (0.007)
−0.926 (0.861)
−1.974 (1.831)
−2.397 (2.282)
−0.270 (0.852)
−0.093 (0.094)
−0.262 (0.448)
−4.290∗∗ (1.730)
−0.295 (0.760)
−6.760∗∗∗ (0.310)
0.171 (0.245)
Strict
−148.580
53.518∗∗∗
1380
2.176∗∗∗ (0.450)
3.157∗∗∗ (0.433)
2.191∗∗∗ (0.413)
2.512∗∗∗ (0.073)
−0.001 (0.012)
0.267 (0.242)
3.848∗∗∗ (0.315)
0.490 (0.611)
−5.966∗∗∗ (0.252)
−0.108∗∗∗ (0.004)
Weak
Withdraw rules
Notes. Marginal effects are reported with standard errors in parentheses. Significance levels are as follows: ∗∗∗ denotes significance at
the 1% level, ∗∗ at the 5% level, and ∗ at the 10% level. Sample includes only states that have a statutory budget stabilization fund.
Log-likelihood
Previous year savings as a share of the budget
Strict balanced budget rule
Expenditure limit requiring the return of some
or all of a budget surplus
Expenditure limit not requiring the return of
some or all of a budget surplus
Tax limit requiring the return of some or all of
a budget surplus
Tax limit not requiring the return of some or
all of a budget surplus
Sample size
Chi-square test of model
Standard error of short-run elasticity
Constant
Five-year moving-average of real personal
income growth
Short-run elasticity of revenue
Strict
Weak
Deposit rules
Table 4. Multinomial logit estimates of the determinants of statutory BSF rules
191
Weak
Strict
Withdraw rules
−1.852 (1.063)
−0.512 (0.599)
0.227 (2.470)
−0.193 (7.903)
∗∗∗
∗
∗∗∗
−0.214 (0.004) −0.254 (0.147) −0.178 (0.020) −0.243 (0.654)
−0.198 (0.336)
1.200 (2.088)
0.460 (0.455)
−0.193 (0.519)
1.215∗∗∗ (0.131)
3.856 (5.599)
2.863∗∗∗ (1.285) −1.122 (3.276)
0.103 (0.140)
0.052 (0.099)
0.110 (0.781)
0.117 (0.296)
0.209 (0.172)
0.360 (1.678)
0.188 (0.135)
0.217 (8.564)
−1.856 (4.789)
2.854 (3.402)
0.189 (0.116)
−1.987 (1.533)
–
–
–
–
–
–
–
–
–
–
–
–
238
238
50.153∗∗∗
52.143∗∗∗
−103.822
−100.351
Strict
Deposit rules
Note. Marginal effects are reported with standard errors in parentheses. Significance levels are as follows: ∗∗∗ denotes significance at the 1% level, ∗∗ at
the 5% level, and ∗ at the 10% level. Sample includes only states that have a constitutional budget stabilization fund. Of the TEL variables in the model,
there was only sufficient variation in the data to include “Expenditure limit requiring the return of some or all of a budget surplus.”
Constant
Five-year moving-average of real personal income growth
Short-run elasticity of revenue
Standard error of short-run elasticity
Previous year savings as a share of the budget
Strict balanced budget rule
Expenditure limit requiring the return of some or all of a budget surplus
Expenditure limit not requiring the return of some or all of a budget surplus
Tax limit requiring the return of some or all of a budget surplus
Tax limit not requiring the return of some or all of a budget surplus
Sample size
Chi-square test of model
Log-likelihood
Weak
Table 5. Multinomial logit estimates of the determinants of constitutional BSF rules
192
193
yet had no effect on the probability of adopting a constitutional fund. In particular, having either an expenditure limit law or tax limit that requires the
return of some or all of a general fund surplus increases the probability that a
state will adopt a statutory fund by nearly 3%, and they represent the largest
marginal effect on statutory adoption decisions. Hence, considering all factors in the model, the probability to adopt a statutory fund is most heavily
influenced by the existence of a TEL that restricts the usage of general fund
surpluses. In addition, an expenditure limit law that does not restrict surplus
usage positively impacts the probability of adopting a statutory fund, while a
non-restrictive tax limit law significantly reduces the likelihood of adopting
a statutory fund, which is consistent with our expectations since disbursements from stabilization funds are treated as “revenue” in state accounting
procedures.
The results in Table 3, taken as a whole, suggest that both statutory and
constitutional budget stabilization fund adoption is explained jointly by: (1)
weak economic conditions in the recent past; and (2) more year-to-year unpredictability in the revenue stream. However, the results also clearly indicate
that statutory fund adoption is most heavily influenced by the presence of a
TEL that restricts the usage of general fund surpluses. Thus, while our results
suggest that the “hard times” experienced by states during the recessions of
1974–1975 and 1980–1982 did contribute to the increase in the number of
states utilizing stabilization funds (both statutory and constitutional), some of
the “adoption rash,” especially among statutory funds, can be attributed to the
rising popularity of expenditure and tax limit laws.
4.2. The determinants of state budget stabilization fund rules
Earlier we hypothesized that if state legislatures created these funds primarily
to circumvent tax and expenditure limit laws, such states would have wanted
to create funds with very weak deposit and withdrawal rules so the funds
would be easily accessible. On the other hand, if states adopted the funds
primarily to help discipline themselves to save more for future recessions,
most of these states would have wanted to create funds with very strict deposit
and withdrawal rules. Using this logic we proposed the idea that perhaps the
presence of these tax and expenditure limit laws might help to explain why
some states have weakly structured funds, while others have strict funds.
After all, in a world with no tax and expenditure limit laws, having a weakly
structured rainy day fund is no different than simply carrying the balance
around as a general fund surplus.
To explore this idea further, we select two subsamples from our data – only
states with statutory budget stabilization funds and only states with constitutional budget stabilization funds – and perform two additional multinomial
logit regressions on each of the two subsamples. By dividing the full sample
194
into two subsamples we are able to explore the role any of the regressors
may play in influencing the probability of selecting weak/strict deposit and
withdrawal rules, conditional on already adopting either a statutory or constitutional fund. Thus, for both the statutory and constitutional fund samples
we estimate two multinomial logit regressions in which the dependent variables are defined as follows: (1) the dependent variable takes on the value
of one if the state’s budget stabilization fund is governed by a weak deposit
rule, two if the fund is governed by a strict deposit rule, and zero otherwise;
and (2) the dependent variable takes on the value of one if the state’s budget
stabilization fund is governed by a weak withdrawal rule, two if the fund is
governed by a strict withdrawal rule, and zero otherwise. Weakly structured
deposit/withdrawal rules are those rules taking on a value of either (1) or (2)
from Table 1, while strictly structured deposit/withdrawal rules are defined as
those taking on a value of (3) or (4) from Table 1.
Because we maintain the panel nature of the data and restrict our samples
to include only those states with either a statutory or constitutional fund, our
estimates are the marginal effect on the probability of adopting weak/strict
deposit or withdrawal rules conditional on adopting either a statutory or constitutional fund. The results of the two multinomial logit regressions using the
statutory subsample are shown in Table 4, while the constitutional subsample
results are in Table 5.
The results in Table 4 appear very similar to those in Table 3, as they
should. This is, after all, still a model of fund adoption so the same variables
should be significant and with the same signs. In particular, the presence of
any expenditure limit law is significant and positive in a state adopting both
weak deposit and withdrawal rules, while the presence of an expenditure
limit law that requires the return of some or all of a budget surplus is also
negative and significant in a state adopting either strict deposit or withdrawal
rules. States with tax limit laws that required the return of some or all of a
budget surplus were significantly more likely to adopt weakly structured funds
(again, both deposit and withdrawal rules), but the marginal probability they
adopted a strict fund is not significant. These results confirm our expectation
that the presence of tax and expenditure limit laws not only increased the
probability of adopting a fund, but also were instrumental in states adopting
weakly structured funds. This is consistent with our hypothesis that many
states adopting funds during the late 1970s and 1980s did so at least partially
in an attempt to circumvent TEL constraints rather than as a legitimate attempt
to improve savings through fiscal discipline.
Table 5 shows the results of a similar model estimated for the subsample of states with stabilization funds that were adopted through constitutional amendments. Because these are primarily cases where the fund was
exogenously imposed on the legislature through citizen initiative or voter
referendum (rather than being self imposed by the legislature on itself), our
195
hypothesis would suggest that the tax and expenditure limit laws should not
have the same significance. Unfortunately this is a small subsample of states,
so there wasn’t sufficient variation in the TEL variables to include them all.
However, as expected, for the variables that it is possible to include we find that
neither the presence of a balanced budget rule, nor the presence of an expenditure limit law that requires the return of some or all of a budget surplus, are
significant.
In summary, our empirical results show that the presence of tax and expenditure limit laws not only significantly increased the chances of a state
legislature statutorily creating a budget stabilization fund, but also that it significantly increased the chances that the fund would be governed by weak
deposit and withdrawal rules. This result is more significant for funds that
were self-imposed by the legislature on itself (statutorily adopted funds) than
for constitutionally imposed stabilization funds. For statutorily adopted funds,
the presence of all kinds of tax and expenditure limit laws are significant in explaining the adoption of stabilization funds with weak rules governing deposits
and withdrawals, but most significant is the presence of tax or expenditure
limit laws that require the state to return all or part of a budget surplus. This
result is exactly what we expected given our hypothesis that these funds were
adopted by state legislatures partially to circumvent the tax and expenditure
limit laws. Our hypothesis is further supported by our results that for the case
of constitutionally imposed stabilization funds, the only significant determinants of adoption were the variability in the state’s revenue stream and “hard”
economic times.
5. Conclusion
Budget stabilization funds are a popular vehicle of saving for state governments, and the rise in fund usage has been a relatively recent phenomenon.
Of the 44 states that currently utilize a budget stabilization fund, more than
two-thirds were adopted following the 1980–1982 recession. As a result, the
1980–1982 recession has long been thought of as the primary catalyst behind
the rapid increase in stabilization fund popularity (Gold, 1983; Douglas &
Gaddie, 2001).
Using an unparalleled data set, we not only examine the factors that have
contributed to stabilization fund adoption, but we also explore the factors
that are correlated with the deposit and withdrawal governing state rainy day
funds. Our results generate several new insights. First, looking at data on fund
adoption dates, it is clear that the trend in fund adoption across states was
not significantly different following the 1980–1982 recession. The trend of
adoption during the 1980s was simply a continuation of the trend of adoption
that began in the late 1970s. Thus, if any recession is to be blamed for starting
the wave of adoptions it should probably be the 1974–1975 recession.
196
Second, the existence of tax and expenditure limit laws, the majority of
which were adopted between 1979 and 1985, also significantly influenced
states’ adoption choices. We find substantial evidence that states adopted
budget stabilization funds during the 1980s as a means to lessen the constraints
created by tax and expenditure limit laws rather than strictly in response to
the recession. This result is not surprising given that stabilization funds can
provide politicians with a vehicle to partially or fully circumvent constraints
imposed by expenditure and tax limit laws.
Finally, we find that the presence of these tax and expenditure laws is a
significant determinant of whether the state placed strict or weak deposit and
withdrawal requirements on their fund. This finding is important because the
presence of weakly structured funds is somewhat of a puzzle. After all, the
only apparent benefit from having an explicit fund rather than simply carrying
around a general fund surplus is to place stricter controls on the inflow and
outflow of money. However, a weakly structured fund is exactly what we
would expect if the primary reason for adoption was to circumvent other
constraints rather than to prepare for future recessions. Our results here are
strengthened by subsample analysis of funds self-imposed by the legislature
on itself (statutorily created funds) versus funds constitutionally imposed on
the legislature. As expected, the significance of tax and expenditure limit laws
is only present for the statutorily created funds, and is particularly strong at
explaining why statutorily created funds were weakly structured.
Acknowledgments
The authors would like to thank Ronald J. Balvers, Stratford M. Douglas,
seminar participants at the 2000 Southern Economic Association meeting,
and an anonymous referee of this journal for comments and suggestions. Any
remaining errors are the sole responsibility of the authors.
Notes
1. See Holcombe and Sobel (1997), chapters 1–3 for a discussion of the fiscal trends in state
spending and taxation over this period.
2. Sobel (1998) finds that state tax increases and expenditure reductions during the 1990–1991
recession significantly influenced state legislative turnover in the next election.
3. Savings in the general fund may be sub-optimal because of the lack of stringent withdrawal
constraints may make reserve balances susceptible to special interest group demands,
especially around election time. In addition, state general funds suffer from the common
pool problem, which Wagner (2000) finds often results in states saving too little in their
general funds.
4. Information regarding funds was obtained individually from each state. We are grateful to
the following individuals for their assistance in obtaining these data: Carolyn Middleton,
Rick Zelznak, Robert Waisbord, Margaret Feigee, Alan Boifsvert, Bob Harris, David Blowman, Linda Keillor, Bill Smith, Rose Renn, Mark Brown, Calvin McKelvogue, Ron Carson,
197
5.
6.
7.
8.
9.
10.
11.
12.
13.
Steve Winham, Keith Todd, Neil Bergsman, Tim Sullivan, Nancy Rooney, Beth Colosimo,
Tom Kynerd, Mark Reading, Gerry Oligmueller, Tom Martin, Nancy Jones, Michael Benze,
John Traylor, Emily Sams, Jim Belonus, Frank Rainwater, Bill Anderson, Shawn Ashley,
Bill Petersen, Jason Dilges, Bryan Chriske, Lisa Minton, Patrick Ogden, Sheila Rogers,
Pam Davidson, John Montgomery, Lori Peal, and Jeff Urry.
Specifically, Sobel and Holcombe (1996a) find that states with stringent fund rules
experienced fewer reductions in expenditures below their long-run growth rate during
the 1990–1991 recession than did states with weak stabilization fund rules. Knight and
Levinson (1999) find that the mere presence of a fund does not significantly increase
reserve balances, but the existence of a stringent withdrawal rule does significantly increase
savings. Finally, Wagner (2001) finds that across all states total savings increases by less
than half of every dollar deposited into budget stabilization funds, implying that stabilization funds and general funds are largely substitutable. However, Wagner (2001) does find
that the degree of substitutability between stabilization funds and general funds depends
on the stringency of stabilization fund rules, with more stringent rules resulting in less
substitutability.
See also Gold (1995) and Gramlich (1991) for discussions of the severity of the 1990–1991
recession on states and the surrounding fiscal issues.
Since a consistent series for state personal income is not available prior to 1929, each state’s
estimate of β for 1945, 1946, 1947, 1948, and 1949 was obtained by estimating equation
(5) over the period from 1929 to each respective year. Beginning in 1950 and continuing
until 1996, the estimates were obtained from the sample period 1930–1950, updated by one
period each year. General fund revenue data for each state were obtained from the Statistical
Abstract of the United States, state personal income data were obtained from the Bureau
of Economic Analysis, and all nominal values were deflated using the CPI (1992 = 100).
It would be an interesting topic of future research to explore whether states with such
provisions have revenue forecasts that tend to be biased upward to that the state may gain
access to the funds. This is particularly interesting given that the current literature on the
accuracy of revenue forecasts was all done before the presence of these funds, and found
a tendency for states to do just the opposite, that is to have revenue forecasts which are
biased downward (too conservative). For examples of the previous literature in this area,
see Feenberg, Gentry, Gilroy, and Rosen (1989) and Gentry (1989).
More precisely, we use the equivalent of the short-run income elasticity of state revenue to
measure cyclical variability and we use the standard error of that estimate as the measure
of non-cycle random variance. See Sobel and Holcombe (1996b) for a more lengthy
derivation of this technique and some estimates for the states.
Each state’s balanced budget classification is from ACIR (1987). The Advisory Commission on Intergovernmental Relations has classified state balanced budget laws into five
categories. Of these five categories, only two prohibit deficits to be carried forward into the
future and thus impose end-of-the-year limits. We consider states with these two categories
as having strict rules for constructing our variable. We did, however, try several different
specifications of this variable, none produced results which were substantively different.
For evidence that tax and expenditure limit laws are not binding, see Abrams and Dugan
(1986), Cox and Lowery (1990), and Bails (1990). Evidence of their effectiveness can be
found in Dugan (1988), Elder (1992), Stansel (1994), and Rueben (1995).
The information tax and expenditure limit laws were obtained from Rueben (1995) and
Significant Features of Fiscal Federalism (1992), volume I.
Since personal income data for Alaska and Hawaii are not available prior to 1960, we
were unable to estimate their short-run elasticity of revenue and they were subsequently
excluded from the empirical model.
198
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