How Can States Limit Spending?

What can states do to arrest the rapid growth in state spending? What tools do state legislators have to limit the growth of their budgets?

One popular tool is a “tax and expenditure limitation” (TEL). This is a formal rule—written into a state’s statutes or its constitution—that limits the growth of its budget via a fixed formula. Twenty seven states currently operate under TELs, but their design varies considerably from state to state. In my latest working paper, I examine the various ways TELs might be structured to see which varieties work best and under what circumstances.

I examined data from 49 states over 30 years (sorry Alaska, most researchers ignore your budget data since it is so strange). The analysis also included a standard set of control variables to account for the impact that other factors might have on state budgets.

Perhaps the most-surprising thing I found was that TELs have a different impact in high and low-income states (others have found this too). As the Figure below shows, in low-income states, TELs seem to reduce spending as a share of total personal income by about 4/10 of one percentage point (or about 3 percent relative to the average state spending share). But in high-income states, TELs increase spending as a share of total person income by about 2/10 of one percentage point.

What accounts for this? It appears that the driving factor is the fact that TELs often include income in their formula (by limiting budget growth to some multiple of personal income growth or by limiting budget size to some share of total personal income). So in high-income states, these types of formulas fail to restrain and may actually act as an excuse for the state to spend up to the limit.  

Not all TELs have this strange characteristic. As indicated by the figure below, TELs that limit budget growth to the sum of inflation and population growth seem to limit spending as a share of total personal income in both high and low-income states.

What other characteristics make for more-effective TELs? I found that four others seem to stand out:

  • The TEL should automatically and immediately refunds revenue in excess of the limit to taxpayers. This means policy makers won’t have a chance to spend the surplus and it means that taxpayers will come to appreciate the merit of the limit first-hand.
  • The TEL should target spending rather than revenue. This makes it harder to get around the limit through borrowing.
  • The TEL should be codified in the state constitution rather than in statute. This makes it more-binding.
  • The TEL should require a supermajority or a public vote to be overridden. All TELs can be overridden in case of emergencies. But to have any teeth at all, the TEL should require a supermajority vote to do this. Without, it is more like a suggested limit on spending, rather than an actual limit.

There are a lot more details in the paper, which can be found here.