Chapter 1 Fisher

WHY STUDY STATE AND LOCAL
GOVERNMENT FINANCE?
STATE AND LOCAL PUBLIC FINANCE

RONALD C. FISHER
JOHNNY PATTA
KK PENGELOLAAN PEMBANGUNAN DAN PENGEMBANGAN KEBIJAKAN
SAPPK - ITB
9/2/2009 jpatta@pl.itb.ac.id 1
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FOUR PRIMARY REASONS
1. The state-local government sector is a substantial part of the U.S.
Economy, with its spending representing nearly 14 percent of
gross domestic product (GDP) and compromising more than half
of total government domestic expenditures
2. The major services provided by state-local governments-
education, transportation, social services, and public safety-are
those that most affect residents on a day-to-day basis
3. State-local government experiences, experiments, and policies
often form the basis for subsequent programs or policy changes
by the federal government or even by governments in other
countries
4. Because of the diversity of state-local governments and the ease
of mobility among them, the analysis of many economic issues is
substantially different in the state and local arenas than for the
federal government
FISCAL CHARACTERISTIC OF THE
SUBNATIONAL PUBLIC SECTOR
Size and Growth
In 1992, state-local governments $650 billion of resources
collected from their own sources (almost 11% of GDP)
When spending financed by federal grants is included, state
local expenditures represent nearly 14% of GDP
The current substantial relative size of the subnational
government sector arose from a roughly 25-year period of
sustained rapid growth between the early 1950s and mid-
1970s
Over those 25 years state-local spending had grown
substantially faster than did the overall size of the economy
SUBNATIONAL PUBLIC SECTOR (2)
Size and Growth
The relative growth of the state-local sector in this
period is usually attributed to three factors:
1. Income in United States increased rather substantially in
these years (caused by increase in demand for many
different types of goods and services)
2. Growth in population and change in the composition of
the population
3. Substantial increases in manufacturing-labor productivity
and thus manufacturing wages during this period created
pressures to increase wages of state and local employees
as well
Expenditure Categories
Nearly half of the money spent by state and local governments
in aggregate provides education or income maintenance services
Education is by far the largest category of spending for both
states and localities
States also spend a relatively large fraction of their expenditures
on welfare, transportation, and health and hospital services
The other major expenditure categories for local governments
are environment and housing, transportation, helath and
hospitals, and public safety
Revenue Sources
State-local governments receive revenues
from a wide variety of different sources,
including a number of different types of taxes
When all revenues to all state-local
governments are added together, the five
major sources are charges and miscellaneous
revenue, sales taxes, property taxes, federal
grants, and income taxes
DIVERSITY OF SUBNATIONAL
GOVERNMENTS
The two most common ways of standardizing are to
compare the data in per capita terms (per person) or as
a percentage of income
The rationale for per capita comparisons is that it may
require more expenditure and revenue to provide
equal services to a larger population than to a smaller
one
If the production of state-local services exhibits
constant return to scale-that is, if the average cost of
providing a unit of service to one consumer is constant-
then total cost will increase proportionately to
population
GOVERNMENTS (2)
In general, differences in state-local expenditures or revenues
among states may arise because of:
a. Different decisions about what services to provide through the
public sector as opposed to the private sector in different states
b. Differences in input prices (especially labor) among the states
c. Differences in environment such as area, population density, or
weather, which affect the cost of producing services
d. Differences in demand for services for services from either
population differences or income differences or differences in tastes
GOVERNMENTS (3)
A higher level of revenues and expenditures in one
state may mean there are more services in that state,
may reflect higher production costs in that state, or
simply may mean that residents of that state have
decided to provide some services through the
government rather than privately
GOVERNMENTS (4)
Expenditures
There are some important differences that stand
out although there is a general correspondence
between the ranking of states by per capita
spending and spending as a percentage of income
In California, per capita spending is 13% greater
than the national average, but spending relative
to income is only slightly above the average
On the other hand, West Virginia is among the
lowest states in per capita spending, but its
spending relative to income is above average
GOVERNMENTS (5)
Revenues
There is clearly more of a regional pattern in the reliance
on different revenue sources than for the level of taxes and
expenditures
In some cases, these regional patterns result from:
a. the relative fiscal importance of state as opposed to local
governments
b. the nature of the economies in these states and regions, or
c. historical factors coupled with inertia
The one economic argument that consistently is offered to
explain the choice of revenue structures is the opportunity
to export tax and other revenue burdens to nonresidents
FISCAL ROLE OF SUBNATIONAL
GOVERNMENTS
Richard Musgrave (1959) has identified three
traditional economic functions for
government:
1. Maintaining economic stabilization
2. Altering the distribution of resources
3. Obtaining an efficient allocation of societys
resources
GOVERNMENTS (2)
Stabilization Policy
Stabilization policy refers to the role of the
government in maintaining employment, price
stability, and economic growth through the use of
fiscal and monetary policy
The economic conditions in each spesific
subnational jurisdiction is a single state or
municipality has little control over prices,
employment, and the general level of economic
activity in that jurisdiction
GOVERNMENTS (3)
States should not have monetary authority
because separate state monetary decisions
would increase the costs of transactions over
boundaries and because each state would
have an incentive to pay for trade by
expandng its own money supply
The general openness of state-local
jurisdiction economies restricts the
opportunity for fiscal policy to be effective
GOVERNMENTS (4)
Stabilization Policy
Edward Gramlich (1987) argued that changes in the economy as
well as past misperceptions may make subnational fiscal policies
more potent than believed, and even necessary
He also argued that, increasingly, macroeconomic problems are
regional rather than national, resulting from economics affecting
spesific industries
There is totally different stabilization issue as well: whether the
aggregate fiscal position (taxes and spending) of the subnational
sector influences the overall national economy
Regarding stabilization policy, the conclusions seem to be that while
individual states and localities have been thought to be limited in
theri ability to influence aggregate demand in their own
jurisdictions, that case may be overstated
GOVERNMENTS (4)
Distribution Policy
Distribution policy refers to the role of the government
in obtaining and maintaining the socially preferred
distribution of resources or income, in most cases by
redistributing resources from rich to poor
Despite the conventional notion that redistribution is
best handled by the federal government, the actual
fiscal structure leaves a substantial amount of
redistribution to the subnational sector
Redistribution should be a subnational government
responsibility
GOVERNMENTS (5)
Allocation Policy
Government intervention in the market also may be necessary to
ensure that society achieves its desired allocation resources
The objective of government is to maintain market competition and
to provide those goods and services directly that the private market
fails to provide efficiently
The practical issues focus on which spesific responsibilities fall into
the category of privat-market failure, how large government should
be to meet those responsibilities, how the governments resources
should be generated, and on what mix of services those resources
should be spent
THANK YOU

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WHY STUDY STATE AND LOCAL

STATE AND LOCAL PUBLIC FINANCE

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