Post-Keynesian Public Budgeting & Finance: Assessing Contributions From Modern Monetary Theory

While Modern Monetary Theory (MMT) offers contributions that are worthy of serious consideration, some additional theory-building and synthesis with existing theory may be in order to tie MMT into the established budgeting literature. MMT focuses primarily on monetarily sovereign governments. These are governments that face extremely “soft” budget constraints insofar as they: issue and regulate the value of their own currencies, possess central banks that function as the fiscal agents of their government treasuries, are able to issue sovereign debt denominated in their domestic currency, and operate in a system of freely-floating currency exchange rates, with a minimum of currency and capital controls. National governments that are sovereign according to these criteria are able to make all debt service payments as they come due, virtually without regard to their level of outstanding debt; they cannot be forced to default against their will. They are also macroeconomically-autonomous. It is the collective position of the symposium papers that these conditions describe, in precise terms, the fiscal position of the U.S. federal government. As such, the existence of an ultra-soft U.S. government budget constraint is grounded in the extremely favorable conditions of money and credit that the federal government is subject to, and which in fact it has created and nurtured for itself since the Second World War. An important implication is that the federal level budgeting literature cannot ignore the macroeconomics and the administration of a sovereign currency regime, nor the monetary economics that ungirds it, without sustaining charges of unrealism.     

Why Is Central Regulation of Local Spending Decisions So Pervasive? Evidence From a Case Study

While the “classical” theory of fiscal federalism argues that local authorities should have substantial discretion to set the local budgetary mix, surveys show that central regulation of local spending decisions is pervasive. Norway provides an ideal setting for studying spending regulations. An attempt to decentralize fiscal choice to the local levels, the block grant reform, has been reversed in recent years. This article presents a case study of the interaction between a county and the national government from 1986, when the reform was implemented, to 1992. The study concludes that the government introduced new regulations to prevent local authorities from distorting spending decisions in order to elicit higher grants.     

Simulation of a Constitutional Spending Limit for a Conservative State: With Dynamic Adjustment and Sensitivity Analysis

Longstanding concern about the rate of state and local government spending growth, strengthened by “Great Recession” economic and fiscal conditions, sustains advocacy of constitutional amendments to cap the growth of state and local taxes or spending. For some states, interest recently changed to necessity, and current constitutional limits—most notably the California experience with the Gann Spending limit (1979–1990) and the Colorado experience with its Taxpayer Bill of Rights (1992‐present)—contain numerous valuable lessons for fiscal restraint proponents. We use those lessons, and others, to develop a constitutional spending limit (CSL) for Utah, and describe a CSL simulation for the state for 1990–2009. In contrast to what an “Institutional Irrelevance Perspective” suggests for a politically conservative state such as Utah, we find that Utah would have seen large and robust CSL impacts from setting the spending growth rate at school‐age population plus inflation for K‐12 education funding, and at population plus inflation for remaining nonexempt state spending.¹ Those impacts include a reduced tax burden, sizable reserves to cope with emergencies, elimination of fiscal crises, and expanded personal income. Extensive sensitivity analysis identifies the key underlying factors and demonstrates the robustness of those findings. We compare the Utah results to a 1990–2009 CSL simulation for California, and a 1995–2009 CSL simulation for Ohio.     

The Changing Property Tax in the West: State Centralization of Local Finances

Diminished local government autonomy and increased fiscal centralization in the hands of state government are the consequences of the restrictions on the local property tax imposed in the western states in the past twenty years. While the trend is a national one, it is more evident in the West than in other regions. Statewide voter initiatives account for some of the restrictions, particularly the more severe ones, but legislatures and governors also impose these limitations. In tracing the recent course of the centralization of local finance, this article details the property tax restrictions adopted in individual western states, examines the initiative and conventional legislative sources of these actions, and provides quantitative and qualitative evidence for the centralization thesis. In many western states the property tax has lost much of its local character, becoming in large part a fiscal and political tool for state policymakers.     

Tax and expenditure limitations and the fiscal relationships between state and local governments

This paper uses comprehensive data on state and local tax and spending limitations for forty-nine states between 1976 and 1990 to estimate the effects of these limits on the fiscal relationships between state and local government. Results indicate that tax and spending limits on local governments are only partially effective in reducing revenues because political agents bypass limitations by transferring revenue reliance to unconstrained revenue sources, or because unconstrained levels of government take on additional revenue responsibilities. In particular, the empirical analysis demonstrates that binding local government fiscal constraints are associated with reductions in local revenues and increases in state aid to local governments. In contrast, state government limitations are related to reductions in both state and local own source revenues.     

When the Interest Rate on the National Debt Is a Policy Variable (and “Printing Money” Does Not Apply)

Modern Monetary Theory (MMT) argues that the interest rate on the national debt for a monetary sovereign is a policy variable, not subject to whether bond markets “accept” or “reject” it. This paper defines measures of the components of the standard analysis of fiscal sustainability. It then methodically describes the Federal Reserve's operations relevant for understanding why interest rates on government debt in the United States have been and continue to be driven by monetary policy. A corollary that emerges—“printing money,” as economists usually understand it—is not applicable and has never been advocated by MMT.     

When Do Municipal Consolidations Reduce Government Expenditures? Evidence on the Role of Local Involvement

Higher levels of government motivate municipal consolidations as a tool to increase efficiency in the local government sector, yet research shows that consolidations typically fail to deliver the promised spending reductions. Since mergers often require significant changes to institutional structures, one explanation is that local decision makers can substantially influence the outcomes of the consolidation process. To explore this possibility, this article contrasts “encouraged but voluntary” mergers with those that were “forced” on local governments in the state of New South Wales, Australia. Results show that voluntary mergers resulted in a 10 percent decline in total per capita expenditures, but forced consolidations failed to reduce spending across the board. The policy conclusion is that decision makers considering structural reform should invest in obtaining the support and participation of local government decision makers.     

Local interests,central leadership,and the passage of TRA86

The U.S. federalist public economy is an ever-evolving system of financing and expenditure responsibilities between local, state, and federal governments. The past decades have seen a significant centralization of responsibility for the financing of state and local public services through grants-in-aid and federal tax subsidies. This article advances a model of local constituent influence in central government fiscal policies which seeks to explain this trend, and then examines how strong executive branch and congressional leadership might begin to control the local pressures for central government financing. TRA86 is offered as one example in which this leaedership proved effective. The general lesson is that good fiscal policy in federalist public economies requires not only capable local governments, but central government political institutions with the strength to meet national needs as well.     

The scissors crisis in public finance

The late 1970s saw the beginnings of a “scissors crisis” in public finance, i.e., a growing divergence between the expansion of government revenues and the increase in government expenditures. Unless strong measures are taken, the 1980s threaten to become the age of mega-deficits. The sluggish growth of public receipts and the buoyant development of public outlays are linked to a number of structural tendencies in the economies of the industrialized world. Efforts to close the gap have included both tax increases and expenditure cuts, but as more and more governments gain experience with the phenomenon of “fiscal cannibalism,” i.e., that taxes eat up each other, the main thrust of the counter-offensive has come to be directed against the growth of public spending. Current strategies to reinforce expenditures control include such elements as global norms, new indexing techniques, new methods of decentralizing hard choices, better methods of cash management, well-balanced policy packages, and incentives especially designed to stimulate cutbacks and policy termination.     

SUB‐NATIONAL GOVERNMENT CAPITAL SPENDING IN INDONESIA: LEVEL,STRUCTURE, AND FINANCING

Sub‐national government capital spending is important for both public service delivery and economic development. Currently, Indonesian sub‐national public capital spending appears barely sufficient to cover the annual depreciation of its fixed assets. A substantial proportion of local government investment spending goes to create relatively unproductive assets, such as administrative office buildings. Sub‐national governments finance their capital acquisitions out of gross operating budgets and have thus far not used, to any great extent, either borrowed funds or their significant cash reserves for such purposes. Indonesian sub‐nationals need to spend more on capital than they do now and also need to focus that spending on more useful types of infrastructure. The major constraints to increasing capital spending at the sub‐national level are not related to a dearth of finance, but regulatory rigidities in budget preparation and implementation and, most importantly, a lack of capacity to plan, design and implement investment projects. Copyright © 2010 John Wiley & Sons, Ltd.     

Does Foreign Aid Promote the Expansion of Government?

Building on the literature on public finance, I seek to advance our understanding of variations in government size by exploring the impact of official development assistance on fiscal policy. I hypothesize that foreign aid operates in accordance with the "flypaper effect," systematically generating incentives and opportunities for the expansion of government spending. Results from a time-series cross-sectional regression analysis of growth in government spending over the 1970–99 time period are consistent with the hypothesis. For middle- and lower-income nations, aid represents an important determinant of government expansion. Looking at the tax and revenue side of the equation, however, reveals a more perverse pattern of response: aid promotes not only increased spending but also reduced revenue generation. The results have important implications from both a theoretical and policy perspective. Inter alia they point to the potentially self-defeating nature of efforts to promote market-oriented programs of state retrenchment via development assistance as well as to the importance of incorporating international transfers into future research on government spending.     

Effects of the Form of Government and Property Tax Limits on Local Finance in the Context of Revenue and Expenditure Simultaneity

This paper examines the impact of the form of government and state‐imposed property tax limits on municipal finance. We suggest that municipal revenues and expenditures are determined concurrently and estimate revenue and expenditure functions as simultaneous equations. We use the instrumental variable approach and fixed effects to address revenue and expenditure endogeneity. By testing the model on a cross‐section of rich municipal data for fiscal year 2002, we find evidence that revenues and expenditures are simultaneously determined, that potentially binding state‐imposed property tax limits effectively restrict local revenues and that the form of government is a significant predictor of local expenditures.     

Reinvention and retrenchment: Lessons from the application of the New Zealand model to Alberta,Canada

Is New Zealand a model for “reinventing” government and cutting spending? The government of Alberta, Canada, consciously replicated significant elements of the New Zealand model to attain fiscal balance and public sector reorganization, including the core element of restructuring institutions to change individual behavior. Despite broad similarities in policy content and outcome, differences in the specific content of policy and the politics of policy implementation led to differences in the sustainability of reform and the location of budget cuts. Alberta's Progressive Conservative party emphasized expenditure cuts where both the New Zealand Labour and National parties emphasized government reorganization and the introduction of market mechanisms. Contrasting these efforts to balance budgets and reinvent government suggests that there is considerable variation in the “model,” and that left governments in general are probably more likely to pursue and succeed at the reinvention of government, while stinting fiscal balance. Right governments, on the other hand, are more likely to achieve short-run fiscal balance at the expense of successful reinvention. In turn this suggests that while the partisan orientation of the reforming party matters, neither has an ideal policy mix for long-term fiscal stability. Alternation of governments may provide the best policy mix.     

Off balance: The unintended consequences of fiscal federalism in China

This paper argues that neither the developmental state nor the marketpreserving federalism models are applicable to contemporary China. Despite superficial similarities with elements of each model, the political economy of reform in China violates key assumptions and expectations in both. In contrast to the expectations of the developmental state model, the center has not systematically allocated credit to the most productive sectors of the economy; instead the latter has had to rely on informal finance. And in contrast to the expectations of market-preserving federalism, fiscal decentralization has lead to a host of unintended consequences at the local level—namely, the hoarding of off-budget revenues for public goods provision, reliance on informal finance for private sector development, and local protectionism. These unintended and informal coping strategies depart substantially from the core components of both the developmental state and market-preserving federalism models. At present, China’s financial order is very chaotic. For example, a lot of funds have been lost through off-budgetary channels and systems. It is quite common for [local governments and agencies] to wantonly collect fees and fines, to levy various charges, and to set up “little money lockers” without authorization... Such chaotic situations have not only seriously affected the government in exercising macro-economic regulations and control over fiscal revenues, and disrupted the unity in our national administrative order, but also provided an environment and conditions for corrupt behavior. —President Jiang Zemin, January 2001¹ the author ofBack-Alley Banking: Private Entrepreneurs in China (Cornell University Press, 2002). The earliest version of this paper was presented at the 2000 Annual Meeting of the American Political Science Association in Washington D.C.     

Intergovernmental relations in Nigeria: Local government and the 1979 Nigerian Constitution

This paper examines the intergovernmental relations prescribed by the Nigerian Constitution of 1979. In particular it discusses the elevated constitutional status of local government, tracing the origins of this to the 1976 local government reform. The question of how to interpret the provisions of the Constitution on the restructuring of local government and whether this is solely a State responsibility or a joint State/Federal responsibility is analysed. The article argues that the States have political and administrative responsibility for local government whereas the Federal responsibility concerns the regulation of the amount of money to be distributed to local government from the Federal Account. The Lagos State High Court judgement which supports the view that States have political and administrative responsibility for local government, but nullified the State's legislation, is extensively reported and analysed. Also discussed is the Allocation of Revenue (Federation Account, etc.) Act 1981 which both reflects and supports the view that the federal relationship to local government is defined by finance. The paper also probes the intention of the Constituent Assembly by analysing its report. The paper complements that by Smith and Owojaiye in the previous number.     

Contribution limits and the effectiveness of campaign spending

Much work on the apparent ineffectiveness on incumbent spending in congressional elections has hypothesized that the productivity of incumbent spending is low because incumbents operate on the “flat part” of their election returns function. Differences in campaign spending associated with state campaign finance laws allows for a test of this hypothesis because restrictions on campaign contributions tend to reduce campaign spending. Exploiting cross-state variation in campaign finance laws, this study tests whether campaign expenditures by state House candidates are more productive when candidates are subject to contribution limits. The results show that campaign expenditures by incumbents and challengers are more productive when candidates run in states with campaign contribution limits, as opposed to in states without limits. In states with contribution limits, incumbent spending and challenger spending are equally productive, and spending by both candidates is quantitatively important in increasing their vote shares.     

Decentralization as a constraint to Leviathan: a panel cointegration analysis

This paper extends the empirical literature about the effects of fiscal decentralization on the growth of government along three dimensions. It distinguishes between the effects of the level of decentralization from the way local governments finance their expenditures (common pool versus own resources); it uses a panel cointegration approach to separate the long run effects of decentralization from the short run dynamics; and it extends and revises the datasets generally used in these empirical analyses. The results show that the amount of revenue raised by sub-national governments leads to a long-term fall in the size of government but grants have the opposite effect. In addition, a greater decentralization of expenditure leads to greater overall spending. When the short-term is considered these influences work slowly, as the speed of adjustment towards the desired government size is relatively sluggish. In addition, in the short run, there is also a clear effect from the role of local revenue raising powers that stimulates the growth of government. These results appear robust to changes in the composition of the variables, countries and periods included the sample.     

Budget Deficits, Hyperinflation, and Stabilization in Ukraine, 1991–96

Since gaining independence in 1991, the former Soviet republic of Ukraine has been plagued by persistent fiscal deficits and punctuated periods of rampant inflation. Having few options to cover the fiscal deficit, Ukraine in 1992–94 largely resorted to money creation. The result was that hyperinflation broke out in late 1993, its burden falling mainly on households, but also eroding the capital of state enterprises. Falling revenues and robust expenditures—even in the face of the continuing output collapse—were exacerbated by a policy of lavishing large amounts of cheap credits on state enterprises. This article reviews and analyzes the causes of Ukraine's inflationary impulse, the descent into hyperinflation in 1993–94, its effects, and the subsequent drive to stabilization by 1996. It concludes that a substantial erosion of the inflation tax base by late 1995 propelled the government to pursue stabilization through an IMF-sponsored program of fiscal restraint. A two-year drive to fiscal and monetary stabilization ensued. Stabilization was largely achieved by mid-1996, permitting a currency reform in September.     

Tax decentralization and local government size

This paper investigates the relationship between fiscal federalism and the sizes of local governments. While many empirical studies emphasized that grants encourage the growth of local public spending and local taxes constrain it, they are more silent regarding the effects of different types of tax autonomy. The paper addresses this issue by arguing that tax decentralization as organized on tax bases used only by local governments (tax-separation), rather than on tax-base sharing, would restrain local public expenditures. Using an unbalanced panel of OECD countries, the key finding is that only property taxes—mostly based on a “tax-separation” scheme—seem to favor smaller local governments. Thus, while tax decentralization is a necessary condition for limiting the growth of local governments, it does not appear sufficient, as tax-separation schemes among government levels would in fact be required.     

The economic effects of direct democracy—a first global assessment

This is the first study that assesses the economic effects of direct democratic institutions on a cross-country basis. We find that total spending as well as spending on welfare is lower in countries with mandatory referendums, consistent with the previous literature. But we also find that countries with national initiatives appear to spend more and be more corrupt. Finally, budget deficits, government effectiveness, productivity and “happiness” appear unrelated to direct democracy. Institutional detail thus matters a great deal. In general, the effects of direct-democratic institutions become stronger if the frequency of their actual use is taken into account. Effects are usually stronger in countries with weak democracies.