Fiscal Federalism and Tax Effort in the U.S. States

Abstract

Anecdotal evidence suggests that U.S. state politicians manipulate rainy day funds for political purposes, but such claims remain untested in the literature. This article finds that lawmakers withdraw nearly three times more funds in response to a deficit shock of a given size if it occurs in an election year rather than in a non-election year; this occurs despite the fact that the magnitude of shocks does not vary over the electoral cycle. This effect is stronger when incumbents are eligible for re-election than when they are term-limited. When it comes to preventing political manipulation of funds, rainy day fund rules that increase the number of veto players who must approve of withdrawals seem to be more effective than rules that specify the economic conditions under which funds may be withdrawn.