Monday, March 25, 2019

Project I: Why do States Spend Money?

I have a file drawer full of research projects that I at some point started and then abandoned. Since I am unlikely to ever get back to them I thought it would be worth describing some here in the hope that someone else, earlier in his career, would be interested in reviving them, perhaps for a PhD thesis or a book. This is the first such post.

At a crude level, there are two theories of government expenditure. One is that it is determined by the need for government services. The other is that it is determined by the ability of the government to get money. It would be interesting to know the relative importance of the two in the real world.

One obvious test is the behavior of government finance before, during, and after a war. The war sharply increases the need for government spending. Its end eliminates most of the need but leaves standing the higher taxes used to pay part of the cost of the war. On a pure need theory, one would expect government expenditure to fall back to something close to its pre-war level. On a pure revenue theory, one would expect expenditure to remain high—not as high as during the war, when it was financed in part by borrowing and/or inflation, but at least as high as the taxes enacted during war time would support.

That is one approach to the question, but I thought of another. Different U.S. states have different sources of revenue, different tax structures. Different taxes respond differently to exogenous changes such as inflation. If a state is financed by a progressive income tax, inflation pushes taxpayers into higher brackets and so raises real revenue; if prices and incomes double, tax revenue should more than double. If, at the other extreme, a state is financed by regressive income taxes or by property taxes in a system where reassessment of property values is infrequent, inflation should reduce real revenue; if prices and incomes double, tax revenue should less than double. Keeping tax laws is easier than expanding them, so, if expenditure is driven by the availability of revenue, we would expect the first sort of states to have real expenditure increased, the second sort to have it decreased, by inflation. One could do a similar analysis for other changes in the economic environment that could be expected to change, in one direction or another, real revenues, and then see how the expenditure of states was affected by those changes.

To test the alternative, need, hypothesis, you need changes that affect needs for revenue. The largest expenditure of state and local governments is schooling. The cost of schooling largely depends on the number of school age children, which changes over time. On a need theory, when the fraction of the state’s population that is school age goes up, as it did for (I think) all states as the baby boom reached school age, state expenditures should go up. When it goes down, as it did in the years when the baby boom was coming out of the schools and onto the labor market, it should go down. While this effect would apply to all states, its strength should depend on how large a fraction of state expenditure goes to schooling. And other changes that affect the need for state expenditure may vary more across states.

For both hypotheses, the best evidence would be differences in what happened in different states, since that eliminates causes you are missing that affect all states equally, such as changes in technology that  make schooling or tax collection more or less costly. But you would also want to look at changes that affected all states similarly, such as demographic changes that affected the fraction of the population of school age.

That’s the project. Calculate, for each state, how real revenue would be expected to respond to changes in its environment. Calculate, for each state, how the demand for government services would be expected to respond to changes in its environment. See which plays how large a role in predicting what actually happened.

I have described the project from a U.S. point of view but it could also be done for Canadian provinces, Indian or Australian or Brazilian states, or as an international comparison—perhaps with the price of oil as an important exogenous variable.


drethelin said...

Seems important to include a third basic hypothesis: it goes into the pockets of the members of the government or their close friends and allies.

Tim Fowler said...

I would be really interested in some one performing a study along these lines. Esp. if it actually become prominent for me (not an economist or socialist, or political scientist, or researcher or academic of any kind) to be aware of it.

Fortnit said...

One huge variable not mentioned and just assumed, is that ANY taxes or government programs will go away as profits decrease. A tyrannical government will always have the direct say in what they can take from you. Just because they have only been stealing small amounts of money from you monthly doesn't mean it was ever acceptable, so if they steal lots of money from you in the latest shakedown, and goes back to lower taxing afterwards, it doesn't mean they were ever right to tax you x-amount to begin with. Such organizations who has forceful ability to take from you without your say is inherently bad.
Anyone who attended a US public schools should know half the teachers there were very bad teachers, yet they kept their jobs and were paid by tax dollars. So what do they want? They want move money of course. When tax paid employees will never take a reduction in pay even if they give a reduction of work. No matter the inflation rate, government will find a way to pay for it, even if they have to put your children in debt.
Just like with proven scientific methods, when removing all apex predators from a closed environment will raise the population of its prey. There is a natural order of things ,in economics it is called the invisible hand of the free-market.
When the government does overtax, much as more than it can steal, when there is nothing left, the people have to take the streets and topple government that is killing them. But what if the government only steals enough that it doesn't kill you, while stock piling it's military arms and removing any rights for civilians to own guns?
One of the biggest flaws of any economic theory is that it does not include the fact that (bad) individuals have the huge sway that gives static to hampering the natural states of equilibrium. They don't explain how dictators are able to live full long happy lives while those who followed him only died in freezing in poverty. While millions starved in the gulag, Stalin died peacefully of natural causes in his comfortable bed. What if a few bankers want to make big profit in a year while costing the country billions? Bernie Madoff and Elizabeth Holmes are only the examples of those who DID get caught. Trump is friends with CEOs who call for tariffs against competition- he could say no but it is his absolute hand that has the say in making few handful of men very rich at the cost of many nations, These are little anomalies and unlikely exceptions, but they had large economic and social effects that last for decades!
Even if a theory does identify and predicts perfect correlation of growth and spending, it totally ignores big social factors and the fact that evil politicians of big government do harm and will commit more harm against its tax payers. Big brother government could send a gunman to your door to take 95% of your money, he would be successful and you would be outraged, angry enough to join with others to form a mob, but by only stealing 25% of your money, there isn't enough to put your life on the line to take back what is yours. I don't even get kings and queens, they have "royal" blood, but they are just like you and me but they got to send hundreds and thousands of men to fight and die. Politicians are todays new kings and queens, they are the new Churches, they feel that because they gave themselves 6 figure tax salaries, that they have the right to run peoples lives from cradle to the grave.