The Impact of Budget Stabilization on Economic Growth

March 7, 2014

Spending restraints and tax cuts lead to significant economic gains, say John Merrifield, a senior fellow at the National Center for Policy Analysis and professor of economics at the University of Texas-San Antonio, and Barry Poulson, a professor of economics emeritus at the University of Colorado-Boulder.

Merrifield and Poulson developed a dynamic scoring model to determine the impact of tax reductions and spending constraints on economic growth and fiscal health. The authors applied the model to California, Montana and Utah (choosing one blue state with a poor business climate, one middle-of-the-road state and one conservative state with a strong business climate).

The study simulated a combination of rules to limit taxes and expenditures, capping general fund spending growth at population plus inflation.

  • With budget stabilization rules that limited spending in place, all simulations indicated that the states would have seen significant gains in economic growth had they utilized these fiscal measures from 1994 to 2012.
  • With spending constraints, California and Montana could have reduced their income tax rates greatly, raising the personal income growth rate. Between 1994 and 2012, the two states could have seen a respective 3 percent and 2 percent gain in personal income.
  • California would have reduced spending by 28 percent over the same time period, while the reduction in spending in Montana and Utah would have been 11 percent and 10 percent, respectively.

The model indicates that the revenue generated from income tax cuts would have offset much of the revenue loss from the cut and would have significantly increased economic growth. The authors determined that California would have received a 4 percent tax revenue dividend, while Montana and Utah would have seen respective 2 percent and 1 percent dividends.

Stable spending growth curbs pressures to raise taxes and cut back on spending caps, pressures that would otherwise result from fiscal stress. These state simulations demonstrate how a set of tax and expenditure limits can produce a stabilized budget.

Source: John Merrifield and Barry W. Poulson, "State Fiscal Policies for Budget Stabilization and Economic Growth: A Dynamic Scoring Analysis," Cato Institute, Winter 2014.

 

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