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
Taken together the theories of incrementalism, punctuated equilibrium and cutback management provide a theoretical framework, albeit at times contradictory, for
understanding how states can and might respond to fiscal stress and the factors that influence their decisions. Despite differences in the root causes of behavior, several
common relationships and activities emerge from these theories. The empirical research
41 provides a framework for understanding how and why institutional and political factors
will affect state responses to fiscal stress and the level of fiscal stress they experience. Empirical research also provides guidance on the effectiveness of state responses, in both
the short- and long-term, in mitigating fiscal stress. A major theme that emerges around the question—how will states respond to
fiscal stress—is that states are unlikely to react immediately or urgently to fiscal stress. Punctuated equilibrium theory suggests that it takes a while for tension to build up in the
system for change to occur; in addition, it is difficult to get the multiple decision-making layers to see the need for change. Cutback management theory suggests decision-makers
will try to delay their acknowledgement of a problem. Even in cases where this does not occur, decision-makers will hope that the fiscal stress is temporary or transient and that a
quick fix, such as using rainy day funds, will meet the balanced budget requirement and obviate the need for further action Hackbart and Ramsey 2004; Levine et al 1981a.
Based on this research my first hypothesis is: H
1
: States are strategic in their response to fiscal stress. Flowing from these implications is that state actions will differ by the level of
fiscal stress. They may not differ in a clean, sequential pattern as initially predicted by Levine et al 1981a, but it stands to reason that certain actions are more likely at lower
levels and others at higher levels of fiscal stress. When answering the question —will state actions differ depending on the level of fiscal stress—these theories provide
guidance. As described above cutback management theory predicts fiscal stress responses proceed based on the severity of fiscal stress.
As such, we should expect to see smaller, less disruptive measures at first and then as fiscal stress continues or worsens, more drastic changes. Low fiscal stress is
accompanied by denial and delay tactics such as using cash balances e.g., rainy day funds and deferring maintenance. Moderate fiscal stress then calls for hiring freezes,
productivity improvements and across-the-board cuts. These are the activities generally
42 associated with incremental budget theory as they are non-confrontational and tend to
affect all interest groups equally. These tactics would also likely be observed in the punctuated equilibrium lens before or after a punctuation. Severe fiscal stress is more
likely to necessitate targeted cuts, privatization of public services, program terminations, layoffs and an increase in user fees or taxes. Many of these actions are more typically
associated with a punctuation in budget policy, especially targeted cuts. Based on this research, the second hypothesis and its sub-hypotheses are:
H
2
: Responses will differ based on the severity of fiscal stress. H
2.1
: Rainy day funds will be used in periods of lower fiscal stress. H
2.2
: Incremental budget strategies e.g. across-the-board cuts and hiring freezes will be used in periods of moderate fiscal stress.
H
2.3
: Punctuated equilibrium strategies e.g. targeted cuts, privatization, and layoffs will be used in periods of high fiscal stress.
Based on the empirical literature we can form several hypotheses linking state characteristics with their responses and experience of fiscal stress. In addition, based on
these theories we should expect state responses to differ depending on the flexibility granted decision-makers as well as their ability to reach decisions. As punctuated
equilibrium theory suggests, factors that increase decision, transaction, andor information costs will lead to more punctuations and less gradual change.
H
3
: Institutional factors will affect state responses to fiscal stress. H
3.1
: States with balanced budget rules will take more actions to address fiscal stress.
H
3.2
: States with TELs will use more expenditure cuts and other non-tax measures to address fiscal stress.
H
3.3
: States with divided governments will take fewer actions to address fiscal stress.
H
4
: Institutional factors will affect states’ levels of fiscal stress.
43 H
4.1
: States with balanced budget rules will experience lower fiscal stress. H
4.2
: TELs will affect state levels of fiscal stress. H
4.3
: States with divided governments will experience higher fiscal stress. The difference between states experiencing fiscal stress due to cyclical fluctuations
and structural imbalance is mentioned throughout this chapter. This distinction is important because the cause of fiscal stress is likely to impact both the experience and
response to it. Hackbart and Ramsey 2004 suggest that states may take measures to meet the yearly balanced budget requirement, while ignoring a structural imbalance –
setting the stage for drastic action farther down the road. Based on this, it seems that states with structural imbalances are more likely to follow the punctuated equilibrium
pattern or jump to the last stage of the response pattern detailed by Levine et al 1981a. In addition, the extent to which a structural imbalance demonstrates states deferring
decisions on prioritizing spending andor adjusting revenue levels, we expect states with structural imbalances to have higher levels of fiscal stress.
H
5
: States with structural deficits will engage different responses and experience higher fiscal stress.
H
5.1
: States with structural deficits will be more likely to engage punctuated equilibrium responses in periods of high fiscal stress.
H
5.2
: States with structural deficits will experience higher fiscal stress. Based on both the theoretical guidance and empirical research it is harder to
hypothesize the effectiveness of different responses to fiscal stress. Certain educated guesses can, however, be made. Although response effectiveness is not addressed
directly, the unintended consequences and paradoxes of cutback management highlighted in the cutback management theory suggest that all responses are not equal. Some may
have negative unintended consequences that result in recurring or extended fiscal stress; while other responses may reduce future fiscal stress levels. In the short-term, multiple
exogenous factors influence a state’s level of fiscal stress, including the growth of the
44 state economy and federal stimulus activities, are more likely to have an impact on the
immediate fiscal stress levels. In addition, the timing of fiscal stress responses may not be soon enough to counteract current levels of fiscal stress. The hypotheses below
differentiate between the short-term and long-term effects of state responses to fiscal stress.
H
6
: The short-term effect of state responses e.g. tax increases, expenditure cuts, rainy day fund use on fiscal stress will be minimal.
H
7
: The long-term effects of state responses e.g. tax increases, expenditure cuts, and rainy day fund use on fiscal stress will differ.
H
7.1
: Tax increases andor expenditure reductions will, in the long-term, reduce fiscal stress.
H
7.2
: Rainy day fund use will increase fiscal stress in the long-term.
2.7 Conclusion
