Fiscal Rules in Recessions: Evidence from the American States

This study explores the impact of balanced-budget rules on states’ fiscal policy outcomes and tests whether this impact depends on the political and economic environments in light of the American states’ experience from 2004 to 2010. The findings suggest that (1) budget rules are more binding in recessions as compared with “normal” times; (2) the impact of the rule depends on the political environment, especially on the party identity of the governor; (3) a divided government influences the rule’s impact, particularly when one party controls the governorship and another controls the legislature; and (4) states’ responses, as measured by total budget cuts, to unexpected revenue shocks (such as unexpected decreases in tax revenue) tend to be larger than states’ responses to unexpected expenditure shocks.