Revenue volatility exacerbates state fiscal crises

There is a growing consensus among commentators and policymakers regarding the adverse effects of revenue volatility on state and local budgeting. In the years preceding the two most recent recessions, state and local tax revenues surged, permitting an expansion of government services and tax cuts. 26Link to the text of the note These boom-year fiscal policies generated political expectations regarding the level of services and taxes going forward. With the onset of each recession, however, state and local governments faced yawning gaps between expenditure levels and tax receipts - prompting demands for federal assistance. In other words, volatility played two separate and equally [*417] important roles in creating the conditions for fiscal crisis - surging tax receipts during the boom years stimulated demand for new programs and tax cuts, while plunging tax receipts during the bust years made continued satisfaction of those demands impossible. The implicit counterfactual here is that more stable revenue levels across time would have translated into more consistent and realistic public service demands, thereby minimizing the likelihood of (or at least reducing the severity of) budget imbalance in the down cycle.