The Case for Countercyclical Fiscal Capacity

Abstract

A growing literature has sought to demonstrate when and how government capacity links to performance. This article examines those questions in the area of financial management. A basic challenge for state governments is to maintain budgetary stability and program predictability in face of economic downturns. State governments can best meet this challenge by developing what we call counter-cyclical fiscal capacity. We present the concept of countercyclical fiscal capacity as the creation and use of financial tools that help state governments maintain counter-cyclical spending and program stability during revenue shocks. We operationalize the concept in terms of fiscal reserves that are used to mitigate emergency spending cuts and tax increases, and analyze the operation of such reserves over a period that includes recessions in 1991 and 2001. We find evidence of the efficacy of counter-cyclical fiscal capacity, and argue for greater investments in this aspect of government capacity.2

Do Local Governments Save and Spend Across Budget Cycles? Evidence from North Carolina

“…Counter-cyclical fiscal policy has, however, been assumed to be the sole responsibility of the central government in the standard (or conventional) Musgrave theory (Musgrave 1959;Oates 1972). Edward Gramlich (1987) expanded the idea of practicing counter-cyclical fiscal policies to subnational governments (Hou and Moynihan 2008). Gramlich observed that the conventional wisdom that only central governments should conduct fiscal stabilization policy might have been seriously misguided because empirical studies have shown that the migration of production factors are slow and limited in the short run; therefore, states should practice fiscal policies to stabilize their budgets.…”

“…States vary a lot in whether they allow local governments to create their budget stabilization funds. Some states allow their local governments to formally create budget stabilization funds, but others do not (Hou 2008). The informal vehicle refers to resources accumulated in the general fund, other governmental funds, and enterprise funds that can be used for expenditure stabilization across business cycles (Marlowe 2005).…”

“…The informal vehicle refers to resources accumulated in the general fund, other governmental funds, and enterprise funds that can be used for expenditure stabilization across business cycles (Marlowe 2005). At the local level, formal saving devices are not as widely used as by the states (Hou 2008).Local governments rarely establish a separate budget stabilization fund, relying more on the informal form of fiscal reserves, such as unreserved general fund balances (Marlowe 2005 The Government Finance Officers Association (GFOA) recommends that state and local governments establish a formal policy on the level of unreserved fund balance that should be maintained in the general fund. The unreserved fund balance is expected to safeguard against the effects of unanticipated natural disasters and economic downturns and to help stabilize tax and fee rates and public service levels (Shelton and Tyer 2000;Coe 2007).…”

Capacity for public administration: analysis of meaning and measurement

“…Ingraham et al (2003, p. 15) conceive of this connection as a link between organisational resources, management characteristics and policy results. Based on the increasingly widespread arguments that 'management matters', we see renewed attempts to understand the nature of performance and capacity as linked concepts (Meier and O'Toole, 2001;Eisinger, 2002;Brown and Potoski, 2003;Hou et al, 2003;O'Toole and Meier, 2003;Sowa et al, 2004;Boyne et al, 2005;Riccucci, 2005;Berman, 2006;Radin, 2006;Hou and Moynihan, 2008).…”

“…This latter set of conditions is generally described as organisational capacity and is the primary focus of our inquiry. In the literature, we see efforts (for example Hill and Lynn, 2005 generally;Agranoff and McGuire, 2001 in networked settings; Thomson and Perry, public administration and development 2006 in collaborative settings, Hou and Moynihan, 2008 in public finance settings) to open the 'black box' of management and define its contents, along with attempts to define explicit frameworks for understanding how management matters. Despite these efforts, capacity's meanings are multiple and few comprehensive frameworks have been developed.…”