39 or willfully ignored the need to match spending levels with volatile tax collections in the
years prior to fiscal stress Gold 1995; Conant 2010. As such, to reduce fiscal stress in the future, balancing spending levels and tax levels is the recommended course of action
for states. Research on the long-term effects of fiscal stress induced changes in expenditures
tends to concentrate on permanent changes in programs and staffing levels Berne and Stiefel 1993. Drawing from the research focusing on short-term effects of expenditure
cuts Gold 1995; Finegold et al 2003 and research with a longer time frame Hackbart and Ramsey 2004, expenditure cuts may be effective at reducing future levels of fiscal
stress. To do so, the focus of cuts is important, as is the extent to which the expenditure cut balance overall spending and revenue levels.
2.5.3 Tax and Fee Increases
As with expenditure cuts, tax and fee increases affect fiscal stress levels by helping states achieve revenue and expenditure balance. The effectiveness of tax and fee
increases depends on several factors including the diversification of revenue sources and the type of taxes and fees increased by states. Certain taxes e.g. sales taxes, corporate
income taxes, capital gains tax may have dramatically reduced revenue collections during economic downturns Sjoquist and Wallace 2003; Sobel and Holcombe 1996b;
Suyerhoud 1994. While other taxes e.g. alcoholic beverage taxes, motor fuels taxes, and personal income taxes are less susceptible to cyclical variations Suyerhoud 1994; Sobel
and Holcombe 1996b. Other research explores differences in the cyclical variability of taxes depending on a state’s tax portfolio and finds that the same tax will have different
cyclical variations depending on the suite of taxes employed by a state Braun and Otsuka 1998. Based on research in this area, it appears that there is no single optimal portfolio
of revenue sources Braun and Otsuka 1998; however, there is evidence – although not entirely conclusive that having a mix of taxes able to adjust to cyclical changes may
40 improve state fiscal performance or at the very least provide a more stable revenue
baseline Hendrick 2002; Braun and Otsuka 1998; Brinner and Brinner 2002. As related to the effectiveness of tax and fee increases in reducing fiscal stress,
this research has both short-term and long-term implications. In the short-term, especially during an economic downturn, tax and fee increases may not raise as much revenue as
anticipated due to the cyclical variability of revenues. In the long-term, states that are willing to use tax increases may diversify their revenue base and enhance its flexibility in
the face of cyclical variation. In addition, if the tax changes broaden the tax base or adjust previously inefficient tax systems, this may contribute to a more flexible tax system that
then can protect the state against future periods of fiscal stress or reduce the severity of stress at a future period Gold 1995.
A theme throughout the literature on state responses to fiscal stress is that certain responses have long-term effects Levine et al 1981b; Druker and Robinson 1993;
Greenhalgh and McKersie 1980; Berne and Stiefel 1993. This suggests an important distinction between the types of responses: whether a response improves the efficiency in
either spending or taxation or rather is sufficient only in allowing the state to muddle through to the next crisis Gold 1995. This research does suggest that the use of certain
responses over others – rainy day funds instead of broadening tax bases or reassessing spending priorities – may not only ease states fiscal stress in the current year, but set
states up for more troubles in subsequent years.
2.6 Summary of Hypotheses
