37 it is also a reason to explore the theory further and see where its merits and weaknesses
lie.
2.5 Assessing Effectiveness
While theoretical and empirical literature tends to focus on predicting and discussing the types of responses states use to address fiscal stress Dougherty and Klase
2009; Grizzle and Trogen 1994; Gold 1995; Finegold et al 2003, largely missing is an examination of the effectiveness of different responses – for example, a comparison of
the effect of rainy day fund use, reductions in expenditures, andor increases in taxes and other revenues on fiscal stress levels. With the exception of research on the effectiveness
of using budget stabilizationrainy day funds to reduce gaps between expected and actual expenditures, the effects of state responses to fiscal stress are unexplored Sobel and
Holcombe 1996a; Douglas and Gaddie 2002; Hou 2003; Hou 2004. This leaves questions such as – will a certain response yield a quicker recovery or protection from
fiscal stress in a subsequent period? – unanswered. The relative effectiveness of the range of possible responses – expenditure reductions, revenue increases, drawing on cash
reserves – is not assessed, individually or as a group. In 1979, Levine called for more research on the effectiveness of responses to fiscal stress; more recently, a retrospective
article identified effectiveness as a gap in state fiscal stress research Scorsone and Plerhoples 2010. A review of the fiscal stress focused research provides some guidance
as to the independent effects of different responses.
2.5.1 Rainy Day Funds
Studies on rainy day funds hint at the relationship between the existence of a rainy day fund, the size as a percent of total expenditures of the rainy day fund balance, the
rules governing rainy day fund deposits and use, and fiscal stress levels Hou 2003; Hou 2004; Douglas and Gaddie 2002; Sobel and Holcombe 1996a. The rules governing the
38 funds were found to play a more important role in reducing fiscal stress levels than the
presence of a rainy day fund or its funding level Douglas and Gaddie 2002; Sobel and Holcombe 1996a. Indeed, Douglas and Gaddie 2002 found that having more than one
fund designated as a rainy day fund reduced states’ fiscal stress levels significantly. Using general fund expenditure gaps as the dependent variable, Hou 2003’s
findings are not directly applicable to fiscal stress levels. This research does suggest that higher rainy day fund balances reduce reliance on expenditure cuts by states during
economic downturns. Other studies of rainy day funds focus on the appropriate size of the rainy day fund balance, not on the use of rainy day funds to address fiscal stress and
budget shortfalls Navin and Navin 1997; Joyce 2001. Confounding this analysis is these studies use different measures of fiscal stress – an issue discussed in the next chapter.
The long-term effect of rainy day fund use on fiscal stress has not received significant empirical or theoretical attention. However, certain case study analyses suggest that the
use of rainy day funds allows states to defer making crucial adjustments to spending andor tax levels Hackbart and Ramsey 2004; Gold 1995; Conant 2003. The finding
that rainy day funds allow states to reduce expenditure cuts during economic downturns supports this analysis Hou 2003. Therefore, choosing to use rainy day funds instead of
cutting expenditures or increasing taxes and fees, may lead a state to perpetuate structural imbalance and make it more vulnerable to future fiscal stress.
2.5.2 Expenditure Cuts
Research on expenditure cuts during periods of fiscal stress focus on changes in patterns of spending and identifying which functional areas tend to receive the largest
cuts Finegold et al 2003; Dougherty and Klase 2009; Hackbart and Ramsey 2004. Case study research shows that not calibrating spending levels to revenue collections leads to
extreme vulnerability to economic downturns Gold 1995; Conant 2003; Finegold et al 2003. A general theme in this research is that fiscal stress arises in states that misjudged
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
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