The tax-spending nexus: Evidence from a panel of US state-local governments

We re-examine the tax-spending nexus using a panel of 50 US state-local government units between 1963 and 1997. We find that, unlike tax revenues, expenditures adjust to revert back to a long-term equilibrium relationship. The evidence on the short-term dynamics is also consistent with the tax-and-spend hypothesis. One implication of this finding is that the size of the government at the state-local level is not determined by expenditure demand, but rather by resource supply. This is consistent with the fact that many US state and local governments operate under constitutional or legislative limitations that seek to constrain deficits.

Research Highlights►Our empirical evidence is based on a panel of 50 US state-local governments and covers over 35 years. ►Our model controls for several factors that are likely to affect the tax--expenditure relationship. ►The model is also very general and accounts not only for the non-stationarity, but also for the panel structure of our data. ►We use panel tests that account for both the time series and cross-sectional dependencies. ►We employ alternative variable definitions to check the robustness of our results.