Recent concern over Federal budget deficits has led to many public policy proposals. Proposals range from short-term combinations of tax-expenditure changes to long-term changes like a balanced budget amendment and line-item veto provisions for the President. Since much of the debate focuses on alleged symptoms of unacceptably large deficits (high interest rates, high values of the dollar and unfavorable trade balances), these proposals may offer solutions that are temporary and, at best, offer only obscure routes to eliminating the underlying sources of deficit growth. At worst, such proposals may contribute to larger future deficits if they foster the underlying factors causing deficit growth.
Following work on the Federal sector in Manage and Marlow (1986), we examine the causal relation between expenditures and tax revenues at the state and local levels of government. Manage and Marlow (1986) provides some evidence that Federal spending is determined by tax revenue. This paper addresses the issue of whether or not the many different fiscal constraints that exist at the state and local level affect the causal relations between tax receipts and expenditures of those governments. Motivation for our study stems from the frequently-made observation that, unlike their Federal counterpart, the finances of state and local governments are relatively well-behaved. Examination of causality may suggest how constitutional and legislative constraints have affected the finances of state and local governments. In terms of policy implications, this examination may yield information on the appropriatability of extending currently-existing constraints at the state and local levels to the Federal level of government.