• Fiscal crises and divided government

    For methodological reasons I recently read “State Responses to Fiscal Crises: The Effects of Budgetary Institutions and Politics” by James Poterba (Journal of Political Economy, 1994). Yes, I’m aware that it’s a 17-year-old paper. No, I don’t know if that itself invalidates the findings. Nevertheless, they include,

    States vary in the speed with which such deficits must be eradicated. Nine states allow actual deficits to be carried forward to the next fiscal year, whereas only six do not require the deficit to be eliminated in the following fiscal year.

    States also vary in the policies that are available to eliminate a deficit and satisfy balanced-budget rules. In most states with no-deficit rules, some types of borrowing can be used to close a current budget gap. Some states require such borrowing to be repaid in the next fiscal year and prevent the use of long-term debt to cover deficits. Other states have constitutional limits requiring a referendum on new issues of long-term debt. These limits make it relatively more costly to use debt to cover unexpected deficits. States can also draw down their general fund balances to cover budget deficits.

    In the short run, states may also employ cosmetic accounting changes to satisfy balanced-budget rules.

    I have heard it said that states can’t run deficits (or some states can’t), but I didn’t know that even some of those that “can’t” actually can borrow their way out of trouble, at least for short durations (circa 1994).

    Whether political factors are important determinants of economic policy is a long-standing subject of debate in political economy. One issue in this debate, analyzed for example in Alesina and Rosenthal (1994), is whether divided governments function differently, and select different policies, than governments with a single party in power. Roubini and Sachs (1989) find that nations with a divided government have higher budget deficits, and McCubbins (1991) tries to explain the pattern of U.S. budget deficits by appealing to the role of divided government. The wide array of state variation in political control provides a natural opportunity to obtain further evidence on the importance of party differences. Alt and Lowry (1994) find that states with governors from a party different from that of the legislature are more likely than single-party states to run budget deficits. […]

    The results in this paper suggest that fiscal institutions and political factors matter for short-run deficit dynamics. States with relatively tight constitutional or statutory rules that make it more difficult to run deficits experience more rapid fiscal adjustment when revenues fall short of expectations or spending exceeds projections. Political factors also matter: states in which one party controls both the governorship and the lower house in the legislature are more likely to respond quickly to unexpected deficits than their divided-government counterparts are.

    The proverbial “gridlock” effect. I don’t think my intuition is that unified government more likely leads to lower deficits, at least not on the national level. But my intuition wasn’t very well formed in this area, and it certainly wasn’t based on anything like a systematic analysis of data, such as that presented by Poterba and the authors he cites. No doubt there is plenty of more recent work in this area. I’ve not looked for or read it (yet).

    References

    Alesina, Alberto, and Rosenthal, Howard. Partisan Politics, Divided Government, and the Economy. Cambridge: Cambridge Univ. Press, 1994.

    Alt, James E., and Lowry, Robert C. “Divided Government and Budget Deficits: Evidence from the States.” American Polit. Sci. Rev. 88 (December 1994).

    McCubbins, Matthew D. “Party Governance and U.S. Budget Deficits: Divided Government and Fiscal Stalemate.” In Politics and Economics in the Eighties, edited by Alberto Alesina and Geoffrey Carliner. Chicago: Univ. Chicago Press (for NBER), 1991.

    Roubini, Nouriel, and Sachs, Jeffrey D. “Political and Economic Determinants of Budget Deficits in the Industrial Democracies.” European Econ. Rev. 33 (May 1989): 903-33.

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