Party alternation, divided government, and fiscal performance within US States

Economics of Governance (2007) 8:111–128DOI 10.1007/s10101-006-0030-z

O R I G I NA L PA P E R

Party alternation, divided government, and fiscalperformance within US States

Peter T. Calcagno · Monica Escaleras

Received: 21 June 2005 / Accepted: 30 October 2006 /Published online: 21 December 2006© Springer-Verlag 2006

Abstract The literature on US state government fiscal performance has exam-ined the role of institutional factors such as budget rules and divided gov-ernment, but has largely ignored the impact of party alternation. This paperprimarily focuses on whether party alternation in the governor’s office affectsfiscal performance. Our hypothesis is that frequent party changes create a polit-ical environment that impacts fiscal performance. To further assess the impactof party alternation on fiscal performance, we consider our primary hypothesisin conjunction with the degree of division that exists between the governor’soffice and the legislature. Using panel data from 37 states between 1971 and2000 we test the hypothesis that frequent party alternation can be expected toaffect fiscal performance and find strong support for the hypothesis.

Keywords Fiscal performance · State government · Party alternation

JEL Classification D72 · H72

An earlier version of this paper was presented at the 2005 Public Choice Society Meetings. Theauthors would like to thank the conference participants, William Shughart, Charles Register,Jocelyn Evans, John D. Jackson, Amihai Glazer, and two anonymous referees for their comments.We would also like to thank Craig R. Stiller for his help in the collection of data. Any remainingerrors remain the responsibility of the authors.

P. T. Calcagno (B)Department of Economics and Finance, College of Charleston,5 Liberty St, Charleston, SC 29424, USAe-mail: [email protected]

M. EscalerasDepartment of Economics, Florida Atlantic University, 777 Glades Road,Boca Raton, FL 33431, USAe-mail: [email protected]

112 P. T. Calcagno, M. Escaleras

1 Introduction

Governmental fiscal performance has long been and continues to interest econ-omists as well as political scientists. In the United States alone, the issue offiscal structure and performance has been a matter of economic and pub-lic policy debate prior to the formation of the union. Scholars have investi-gated issues including which branch of government should ‘control the pursestrings,’ whether deficit spending can improve short term economic perfor-mance, whether deficits and debt are detrimental to the economy, whether tolimit, and if so to what degree taxes and expenditures, and the costs and ben-efits of the federal government adopting a balanced budget amendment (fora general discussion of the issue of fiscal performance see Buchanan et al.(1986)).

In an attempt to address the possible consequences of a constitutional amend-ment requiring an annually balanced federal budget, numerous studies haveanalyzed individual states that have such requirements. Similarly, many stategovernments have restrictions on taxes and expenditures, again providing a nat-ural laboratory to assess the affect of these policies at the federal level. Thus,there exists a large literature addressing a number of potential determinants offiscal performance both at the federal and state levels in the US.1 In a recentstudy, Reed (2005) examines whether it matters if Democrats or Republicansare in power in determining state tax burdens.

In addition to the US-based studies conducted to date, there are severalrelevant studies at the international level that address similar issues of fiscalperformance. Alesina et al. (1995) address the issue of balanced budgets forOCED countries using coalitions and ideology as determinants of fiscal policychoices. Similarly, Roubini and Sachs (1989) and Roubini et al. (1989) examinebudget deficits across countries by focusing on the degree of political cohesionwithin the national governments. Grilli et al. (1991) create an index of politicalinstability to determine its impact on debt and deficit spending in industrialcounties.

As this brief review shows, both economic and political determinants of fis-cal performance have been addressed. Most of these studies, however, focusmore heavily on political coalitions and divided government than on politi-cal party alternation. In this paper we extend the work of Grilli et al. (1991)and Reed (2005) by considering, at the US state level, the related issues ofhow fiscal performance is affected by the frequency that the political partyof the governor changes and the degree to which the government is unifiedacross the branches. Our primary contribution to this literature is that, con-trolling for political coalitions and ideology, we find political party alternationto be significantly and typically negatively related to state fiscal performance.

1 For a representative review addressing the various issues involved in this literature (see Rowleyet al. 2002; Von Hagen 1991; Poterba 1994, 1995a,b; Besley and Case 1995, 2003; Alt and Lowry1994, 2000; Lowry et al. 1998; Clingermayer and Wood 1995).

Party alternation, divided government, and fiscal performance within US States 113

Our findings suggest that frequent alternation in the party of the governorleads to political instability, which translates into poor fiscal performance. Theresults for divisions between the gubernatorial and legislative control are lessclear.

The next section of the paper reviews the existing literature and discussesvarious indices used to measure party alternation. Section 3 presents empiricalmodels to test the impact of party alternation and divided government on fis-cal performance in the US states. Sections 4 and 5 examine the results of themodels, and Sect. 6 offers concluding remarks.

2 State fiscal performance and political indices

In a wide ranging literature review, Besley and Case (2003) illustrate that polit-ical institutions are a significant determinant in policy choices. Their analysisincludes the role of budgetary constraints, party ideology, term limits, and vot-ing methods. What follows is a brief literature review of the findings for thesedifferent institutional arrangements with respect to policy choices.

2.1 Budget restrictions and party control

Balanced budget restrictions have long been a focus of state-level analysis.Poterba (1995a) provides a literature review of the types of budget restrictionsin place in various states. He finds that balanced budget rules appear to reducedeficits, reduce or at least restructure state indebtedness, and tend to lowermunicipal bond interest rates. Poterba (1994) finds that balanced budget rulesare effective, but only if they are accompanied by strong enforcement mech-anisms. He also notes that tax increases are preferred to spending cuts whendeficit reductions become necessary. Alesina et al. (1995) argue that successfuladjustments to fiscal policy must come from the expenditure side, which areless likely within coalition governments. On the issue of debt, Clingermayerand Wood (1995) find that state budget rules do not significantly deter bor-rowing. Politicians find creative ways to circumvent balanced budget rules.They find no effect of divided government on debt and note that prior litera-ture primarily examines budget shocks and adjustments as opposed to deficitor debt.

Party ideology and control are important institutional variables with respectto fiscal performance and electoral accountability. In terms of agility, Alt andLowry (1994) and Poterba (1994) find that a unified government reacts to bud-get shocks faster than does divided government. Lowry et al. (1998) concludethat both Democrats and Republicans are punished for having deficits and,somewhat surprisingly, surpluses as well. Roubini et al. (1989) and Roubiniand Sachs (1989) find that multi-party coalitions present a challenge to con-sensus-forming and deficit reduction. Roubini and Sachs (1989) construct a


political cohesion index, which classifies national governments based on whichparties hold a majority in the executive and legislative branches. This approachis similar to the Alt and Lowry (1994) definition of divided government atthe state level. Alt and Lowry (1994) identify Democrats as high demandspenders relative to Republicans. Reed (2005) also finds evidence that a state’stax burden is higher when Democrats are in control. Acknowledging ideo-logical variation within parties, while examining the effects of majority partyrule, Alesina et al. (1995) incorporate the role of ideology into their analysisby including indicators of being ‘left of center’, ‘center’, or ‘right of center’.Their findings are consistent with Roubini and Sachs (1989) and Grilli et al.(1991) that coalition governments have less fiscal constraint than single-partygovernments.

2.2 Time inconsistency and party alternation

The literature on time inconsistency in fiscal policy addresses strategic choicesin policy decision making, which includes issues of reputation, institutional con-straints such as term limits, and expectations of party alternation. Kydland andPrescott (1977), Perrson and Svenson (1989), Alesina and Tabellini (1990), andCrain and Tollison (1993) provide both a theoretical and empirical literature ontime inconsistency and fiscal policy. Specifically, they argue that the probabilitythat a regime change will occur in the future changes current fiscal decisions.Suppose “[t]he current regime is conservative, but expects to be replaced in thenext election by a liberal regime. The current regime will put in place a fiscalpolicy that features lower taxes and higher deficits than it would otherwise pre-fer in order to control the ability of the future liberal government to embark ona higher spending program.” (Crain and Tollison 1993, p. 154).

Grilli et al. (1991) focus on two aspects of government change: durability andstability. These measures are translated into frequency of change and significantchange, respectively. Their index of political stability is calculated as the aver-age number of years between significant government changes. Frequency hasa negative affect on government debt while significant political changes do nothave a statistically significant effect unless the frequency measure is omitted.Grilli et al. (1991) suggest that “high government turnover plays a crucial rolein explaining public borrowing” (p. 359).

Besley and Case (1995) examine reputation issues and how term limits affectreputation and fiscal performance. They find that term limits have a positiveand significant effect on both state taxes and spending per capita. Johnson andCrain (2004) report similar findings for democratic nations. Term limits in theUS may be a way to examine the Grilli et al. (1991) concept of durability ingovernment. That is a government that has a low durability, i.e., one that isshort-lived, would be weak and likely face frequent crises.

Rumi (2003) examines the effects of party alternation on the fiscal perfor-mance in Argentina’s provinces. Rumi’s contribution is the development of an


index of political alternation (IPA) that creates a continuous measure for thechange in political parties in the governor’s office. The findings are that greateralternation of political parties creates instability, which results in greater deficitsin the Argentinean provinces.

Our paper adapts the IPA to determine its affect on the fiscal performance ofindividual US states. One of the main differences between the US and Argen-tina is the status of the economy. Argentina is considered a developing countrywhile the US is a developed economy (United Nations 2004). From a politicalperspective Argentina has over a dozen official political parties, while the UShas two dominant parties and only a handful of “third parties.” The questionremains, does changing political parties in a developed economy that has a dom-inant two-party system influence fiscal performance? The use of IPA allows foran investigation of gubernatorial regime change on state fiscal performance totest whether the effects found for Argentina will hold for the US. The expansionof the role of political institutions and vote choices on state fiscal performanceconstitutes a novel contribution to this expansive literature.

3 Data and empirical methods

Following the specification of Alt and Lowry (1994) we present a structuralsystem of state expenditure and revenue in which causation, if any, runs fromrevenues to expenditures. Since most states have a balanced budget requirementwe argue that revenues influence expenditures, but expenditures do not affectrevenues. Thus, the system is recursive. The structural equations for revenueand expenditure are:

Revenueit = β0 + β1IPAit + β2Eit + β3Pit + ai + uit (1)

Expenditureit = φ0 + φ1IPAit + φ2Eit + φ3Pit + φ4Revenueit + bi + vit (2)

where Revenueit is the real general revenue relative to real income for state i inyear t. Eit is a matrix of economic variables and Pit is a matrix of political mea-sures, common in the literature. Expenditureit is the real general expendituresrelative to real income. Most importantly, we include our measure of party alter-nation, IPA. The ai and bi represent individual state-level fixed effects, allowingus to capture any unobserved state heterogeneity that is relatively fixed overtime, such as religious backgrounds, cultural norms, views toward governmentand so forth. Finally, uit and vit are the normally distributed residual terms.Substituting Eq. (1) into Eq. (2) allows us to express Eq. (2) in terms of onlythe exogenous variables.

After the substitution if we take the difference between Eq. (1) and (2) wehave (Revenueit−Expenditureit), which is our definition of fiscal performance.The substitution, subtraction, and gathering of terms provide us with Eq. (3),a reduced form equation that we estimate using a fixed-effects approach at the


state level.2,3

Performanceit = α0 + α1IPAit + α2Eit + α3Pit + ci + εit (3)

We chose to estimate a reduced form over a system of equations becausereduced form equations from a recursive system yield efficient estimates with-out loss of information (Pindyck and Rubinfeld 1998). Furthermore, accordingto Ford and Jackson (1998), structural coefficients are good for testing theoret-ical hypotheses, but bad for making quantitative policy forecasts.4 That is, thestructural coefficients of the policy variable in the various equations providean estimate of the direct effect of that variable on the dependent variable, butit ignores the indirect effect on the dependent variable. Thus, the structuralcoefficient on the policy variable in any given equation will misstate the mag-nitude of the policy’s full effect on the dependent variable in that equation;it may even misstate the direction of the effect. The authors offer a mutatismutandis approach to deducing the “full effect” (direct and indirect) of a policychange on the dependent variable of a model by estimating the reduced formof structural systems. Therefore, the advantage of the reduce form coefficientsis that they include both direct and indirect effects.

Performanceit is the current year difference between real general revenueand real general expenditures relative to real income for state i in year t.5

IPAit, Eit, and Pit maintain the same definitions as in Eqs. (1) and (2), ci is theindividual state fixed effects, and εit is the normally distributed residual term.Furthermore, since our interest is on the partial effects of time-varying cova-riates, fixed-effects estimation is attractive because it allows any unobservedheterogeneity to be freely correlated with the time-varying covariates. Table 1provides a detailed description of these variables and Table 2 presents descrip-tive statistics.

Following Rumi’s (2003) approach and notation, the IPA measures the prob-ability that two governors of a state selected randomly from different times

2 The choice of the fixed effects estimator was based on the result of a Hausman (1978) test. Grilliet al. (1991) examines stability and frequency of party changes using a cross sectional analysis forOCED countries and never finds significant results for his party stability index. Using panel datawe think allows us to compare both across time and states giving us a more thorough analysis thatdoes not rely on aggregating the data. Since IPA is a cumulative measure using a cross sectionalanalysis would force us to ignore important information over time.3 The detailed derivation of the reduced form Eq. (3) is available from the authors upon request.4 “Since structural coefficients relate to ceteris paribus changes, which implicitly hold all othervariables in the equation and in the system constant, they cannot allow for the measurement ofsecondary changes, precipitated by the initial perturbation, which feed back through the system tofurther affect the dependent variable in the relevant equation” (Ford and Jackson 1998, p. 996).5 Razzolini and Shughart (1997), Alt and Lowry (1994), and Poterba (1995a) all note that in spiteof balanced budget rules many state have historically run deficits. This pattern changes howeverbeginning in the 1980s, and our data suggests that many states are running a surplus according totheir balance sheets.


Table 1 Variable name and description

Variable Description Source

Dependent variablePerformance Annual difference between Statistical abstract of the US

Real revenue and realexpenditures over income

Independent variablesEconomic variables

Unemp State unemployment rate Statistical abstract of the USIncome State income per capita Statistical abstract of the US

Political variablesParty Party of Governor Book of the states,

1 = democrat; 0 otherwise gubernatorial elections 1787–1997CS State has a constitutional Book of the states, budget process

and statutory requirement that in the states, significant features ofthe governor submit a balanced Fiscal Federalismbudget 1 = yes; 0 otherwise

Const State has a constitutional Book of the states, budget process inrequirement that the Governor the states, significant features ofsubmit a balanced Fiscal federalismbudget 1 = yes; 0 otherwise

Tel State has tax and expenditure Book of the states, budget process inlimitation 1 = yes; 0 otherwise the states, significant features of Fiscal

federalism, national conference ofState legislatures

Term Term limit exists for the Book of the states, vital statistics onGovernor 1 = yes; 0 otherwise American politics

Political indicesIPA Index of political alternation Book of the states, gubernatorial

elections 1787–1997Alt Alternation of party in the Book of the states, gubernatorial

governor’s office 1 = yes; elections 1787–19970 Otherwise

PDEM Index of alternation based on Book of the states, gubernatorialpercent of terms held by democrats elections 1787–1997

DGI Divided government index statistical abstract of the US,Book of the States

IID Ideological index for democrats– Statistical abstract of the US,democrats hold 66% or greater Book of the statesof the share of seats in the legislature

IIR Ideological index for republicans– Statistical abstract of the US,republicans hold 66% or greater Book of the statesof the share of seats in the legislature

would belong to different political parties. This index is calculated as 1 minusthe percentage of political concentration and is defined as

IPAit = 1 − ∑

jγ 2

it,j i = 1, . . . , N

t = 1, . . . , T

j = 1, . . . , J

(4)


Table 2 Descriptive statistics Variable Mean Min Max

Performance 0.013116 −0.1442715 0.0885657Unemp 6.155936 2.3 14.2Income 21,497.04 11881.7 38169.38IPA 0.3972496 0 0.68Alt 0.4076164 0 1PDEM 2.146685 0 4Tel 0.4217207 0 1Term 0.5994358 0 1Const 0.157969 0 1Cs 0.022567 0 1Party 0.5825106 0 1DGI 0.7700987 0 2IID 0.3159379 0 1IIR 0.0832158 0 1

where i denotes the state, t denotes the governmental period, and γj indicatesthe percentage of periods that the governor in office belongs to party j.6 IPAequals zero for those states in which the party in power does not change. Highervalues of the IPA are indicative of greater party alternation.

To be an effective measure of political alternation, Rumi’s IPA requiresthe base year chosen for the analysis be one that follows an extended periodof political stability, that is, of one party rule. Rumi has a natural base yearestablished by the fall of the authoritarian government, which held power inArgentina for a number of decades. To establish a benchmark in our analysis wedefine stability as the most recent period in which one party held the governor’soffice for at least three consecutive terms. Since most states have a 4 year termof office this constitutes more than a decade of control by a single party. Giventhis definition and the fact that states have overlapping election periods resultin each state having a different base period in the empirical analysis, which canbe found in Table 3.7

To assess the relation between party alternation and fiscal performance, weanalyze a pooled cross-state, time series sample of 709 state-year observationsfor the period 1971–2000. The sample includes 37 states. Nebraska is removedfrom the sample because it has an unicameral legislation, which limits analysisof party control and divided government. The starting point for each state isdetermined by our definition of stability, but limited by the availability of data.

6 Since γ 2 is a cumulative evaluation it looks only to the periods that have occurred and not theones to come. Rumi uses a discontinuity measure δ = 0.2 to discount the effect that parties haveafter they lose power. Rumi’s analysis was for terms of office so she was discounting the effect of aprevious term; thus, since our data is annual we think the discount rate should not apply thus we donot include a discontinuity measure in our version of the IPA. Also, since our data is yearly ratherthan by four year terms IPA is constant for a given term, but varies from term to term.7 In order calculate the IPA for period 1 we use the benchmark term of stability as defined in thetext. Rumi’s (2003) has a clear benchmark as to the beginning of democracy in Argentina, 1983. Inorder to start with such a benchmark would require us to use data dating back to the founding ofthe US. The results reported in section five suggest our benchmark approach is not problematic.


Table 3 Benchmark years for stability

State Period of Number of State Period of Number ofstudya periodsc studya periodsc

Alabama 1983–1998 4 Montana 1981–2000 5Alaskab 1959–1998 10 Nevadab 1959–1998 10Arizona 1983–1998 4 New Hampshire 1983–1998 4Arkansas 1981–2000 7 New Jersey 1982–1997 4Californiab 1959–1998 10 New Mexico 1983–1998 4Colorado 1975–1998 6 New York 1975–1998 6Connecticut 1971–1998 7 North Carolina 1981–2000 5Delawareb 1961–1996 9 North Dakota 1981–2000 5Florida 1983–1998 4 Ohiob 1957–1998 11Georgia 1983–1998 4 Oklahoma 1983–1998 4Hawaii 1983–1998 4 Oregon 1975–1998 6Idaho 1983–1998 4 Pennsylvaniab 1955–1998 11Illinoisb 1969–2000 8 Rhode Island 1985–2000 6Indiana 1981–2000 5 South Carolina 1975–1998 6Iowa 1983–1998 4 South Dakotab 1971–1998 8Kansas 1975–1998 6 Tennessee 1971–1998 7Kentucky 1983–1998 4 Texas 1979–1998 5Louisiana 1980–1999 5 Utah 1981–2000 5Maineb 1955–1998 13 Vermont 1991–2000 5Maryland 1983–1998 4 Virginia 1982–1997 4Massachusettsb 1939–1998 22 Washington 1977–2000 6Michigan 1983–1998 4 West Virginiab 1957–2000 11Minnesotab 1961–1998 10 Wisconsin 1971–1998 7Mississippi 1980–1999 5 Wyoming 1983–1998 4Missouri 1981–2000 5

aPeriods denote when a governor takes office not election yearbExcluded from final samplecTerms of office have been 2 and 4 years

State level unemployment data is unavailable prior to 1970; therefore elevenstates (Alaska, California, Delaware, Illinois, Maine, Massachusetts, Minnesota,Nevada, Ohio, Pennsylvania, and West Virginia) which all have the three termperiods of one party rule, necessary to implement the IPA, prior to 1970 areomitted. Similarly, we exclude South Dakota from the sample since its unem-ployment data is only available starting in 1976 while its base period of stabilityis 1971.

The IPA has a mean value of 0.39 and ranges from 0 to 0.68. It is impor-tant to note that 26.8% of the observations have an IPA equal to zero this isdue to the fact that in six states (Georgia, Hawaii, Iowa, Kentucky, Maryland,and Vermont) one party held power during the entire sample period. In nineother states, (Colorado, Florida, Idaho, New Jersey, New York, Utah, Virginia,Washington and Wyoming) the governor’s party changed only once.

Using a hypothetical case we can illustrate how IPA changes. First, assumethat the governor’s office is under the control of Democrats for the requiredthree terms prior to period 1, providing the period of political stability needed


to effectively implement IPA, as discussed above. Suppose that Democrats arein power in periods 1, 3, and 4 while Republicans are in control in period 2.IPA is equal to zero in period 1 since we have the same party in power relativeto the base period. Democrats turn power over to Republicans in period 2, soIPA is cumulatively equal to 0.44 with the increase in IPA from zero showingthe increased alternation that has taken place as Republicans gain control. Inperiod 3 Republicans return power to Democrats, and IPA decreases to 0.38since in the history of the previous periods analyzed, Democrats have been inpower more times than Republicans which is indicative of less political alter-nation. Finally, in period 4 Democrats retain power and, accordingly, IPA forthe four periods falls to a value of 0.32. Thus, starting from our benchmark yearof one party control, rising values of IPA, point to greater political alternationwhile the opposite suggests lesser degree of alternation. Based on the timeinconsistency literature we expect that party alternation will have a negativeeffect on fiscal performance.8

We favor IPA relative to a simple dummy variable approach since it is acontinuous variable, allowing for the degree of party alternation to reflect thehistory over the entire time frame. That is, IPA accounts for the institutionalarrangements by examining election periods. In addition, this index allows forcomparisons within and across states. At the same time, as discussed in Sect. 5,this index is not without its shortcomings and, as such, we employ other indicesto assess the robustness of our results.

The matrix Eit is composed of two economic variables: the state unemploy-ment rate (Unemp) and real state income per capita (Income). The unem-ployment rate is an indicator of the state economy’s relative health. Higherunemployment rates could lead to a greater level of expenditures as state gov-ernments attempt to stimulate economic growth, and pay increased unemploy-ment compensation claims. On the revenue side, fewer people being employedwould likely lower tax revenues. In both instances unemployment should havea negative impact on a state’s overall fiscal performance. State income is asource of revenue and the higher the income level the more revenue that canbe generated. State income is often considered a measure of economic growth;therefore, higher income should signal a well-functioning economy and lead toa positive fiscal performance.

The matrix of political factors, Pit, illustrates the role of political institutionson fiscal performance. This matrix contains eight variables: the governor’s polit-ical party (Party), an index of divided government (DGI), an ideological indexfor left of center (IID), and right of center (IIR),9 whether the governor inpower faces a term limit (Term), whether the state has both a constitutional

8 See Kydland and Prescott (1977), Perrson and Svenson (1989), Alesina and Tabellini (1990), andCrain and Tollison (1993).9 A stability index as created in Grilli et al. (1991) was also attempted: however, similar to thefindings in Grilli et al. it was never significant and therefore not reported. Further, the Grilli et al.study was a cross sectional analysis and found the stability index to be highly correlated with itsfrequency index. As noted above, we argue IPA is both similar and superior to these indices byaddressing both frequency and significant changes.


and statutory budget restrictions (Cs), whether the state has a constitutionalbudget restriction (Const), and tax and expenditure limits (Tel). The variableParty captures political ideology of the governors and the role of ideology inthe handling of fiscal matters. Alt and Lowry (1994) and Reed (2005) hypoth-esize and find evidence that Democrats have a high demand for state spendingrelative to Republicans, forming our expectation for this variable. Specifically,Party is a dummy variable coded one for a Democrat and zero otherwise, whichmeans if Democrats spend more and have a weaker fiscal performance the signwill be negative.10

Along the same lines, party control of the state government is an importantinstitutional factor. Following the definition of Alt and Lowry (1994, 2000),and Poterba (1994), a state can have a unified party, a split branch, or a splitlegislature government. If one party controls the governor’s office and bothhouses of the legislature then it is a unified party government. A split branchgovernment consists of one party holding the executive branch and the otherparty the legislative. A split legislature is when the executive and one houseof the legislature are from the same party and the remaining house is held byanother party.

Roubini et al. (1989), and Roubini and Sachs (1989) develop an index formeasuring divided government or political cohesion (DGI). They code the databetween 0 and 3 based on coalitions within the government.11 Similarly, we codeour data based on cohesion of political party, but since we are using state datawe follow the divided government definitions of Alt and Lowry (1994, 2000).The index is constructed as follows:

Value0 Unified Government1 Split Legislature Government2 Split Branch Government

Consistent with Roubini et al. (1989), and Roubini and Sachs (1989) we expectthat multiple coalitions will have a negative impact on fiscal performance.

Alesina et al. (1995) argue that ideology has an impact on fiscal performance.Therefore, we create an ideological index that represents Democrats (left ofcenter) and Republicans (right of center). The ideological index for Democrats(IID) has a value of one when Democrats hold a 66% or greater share of theseats in the state legislature. The ideological index for Republicans (IIR) is

10 The democrat and republican parties are the dominant parties, but independent and third partycandidates who are successful at the state level exist. There are only a few instances of this situationand there is no expectation as to their demand for spending so their spending patterns are evaluatedrelative to democrats.11 Roubini and Sachs (1989) and Roubini et al. (1989) code their index as follows: 0 = one partymajority parliamentary government; or presidential government, with the same party in the majorityin the executive and legislative branch; 1 = coalition parliamentary government with two coalitionpartners; or presidential government, with different parties in control of the executive and legislativebranch; 2 = coalition parliamentary government with 3 or more coalition partners; 3 = minority par-liamentary government.


coded the same way.12 Term is a dummy variable with one indicating that thestate limits the number of terms a governor can serve and zero indicating noterm limit exists.13

The remaining political variables reflect the budgetary rules of the state. Allthree variables are dummy variables with a one indicating how the budget con-straint is enforced. According to Poterba (1994, 1995a) balanced budget rulescan be enforced through constitutional, statutory provisions, or both. Hou andSmith’s (2005) explain that balanced budget restrictions vary a great deal andsuggest that across all fifty states nine different balanced budget rules exist.For simplicity, we use the most common and weakest rule: the governor mustsubmit a balanced budget. How the rule is legally carried out: constitutionally,as a statutory provision, or both implies degree of strength to the rule. Thevariable Cs reflects states having this rule as both constitutional and statutoryrequirement, while Const denotes states having only a constitutional rule. Thethird case, statutory requirement, is left out to avoid multicollinearity issues,which means Cs and Const measure a shift from this case.14 The last variableTel is an indicator of tax and expenditure limitations. Many Tels were passed inthe 1970s as voters thought spending was not consistent with their preferences(Besley and Case 2003). Poterba (1994, 1995a) finds evidence that budget rulesof this sort effectively constrain fiscal policy. Von Hagen (1991) suggests thatfiscal restraints do more to change the composition of debt and debt instru-ments than to improve fiscal performance. Besley and Case (2003) note that theevidence concerning budgetary institutions as a whole is mixed at best as thereare ways for government officials to get around the constraints.15 The historyof fiscal performance bears this out as deficits and surpluses have been cyclical.States in the 1970s witnessed deficits while they experienced surpluses in the1980s with deficits returning in some states in the early 1990s.16

Before discussing the fixed-effects estimates of our model, an implicit assump-tion of this model deserves attention. Specifically, we have thus far assumedthat our key independent variable, IPA, is exogenous. While we have foundnothing in the literature to call this assumption into question, it does seem

12 Alesina et al. (1995) have a left, center, and right configuration of their index since they havemore than two parties to classify. However, it is often the case that neither Democrats nor Repub-licans hold a majority of the seats in the legislature effectively representing the center position.13 We attempted to use dummies for length of governor term limits. However, the variation in oneof the dummies is slight since only six states have a single term limit. Further it is common practicein the literature to use a single indicator for term limit as we do in our paper (See Besley and Case1995, 2003; Crain and Tollison 1977; Johnson and Crain 2004).14 Poterba (1995a) argues that statutes are the weakest restriction, but Hou and Smith’s (2005)suggest that in many instances more restrictions and details are provided in the statute than in theconstitution.15 It should be noted that there is a distinction between deficits and debt, Von Hagen (1991),Clingermayer and Wood (1995) and Poterba (1995b) address the issue of fiscal constraints on debtand debt finance as opposed to deficits. They all note that budget rules are either not effective, ornot applicable to debt.16 For a detailed explanation of changes in state deficits over time (see Poterba 1994; Alt andLowry 1994; Razzolini and Shughart 1997; Besley and Case 2003).


at least plausible that the IPA is itself influenced to some extent by a state’sfiscal performance. That is, IPA may be endogenous. To test the assumption ofexogeneity for IPA we use an instrumental variables approach applying bothHausman (1978) and Durbin-Wu-Hausman tests (Davidson and MacKinnon1993). More specifically, we estimate a preliminary auxiliary regression withIPA as the dependent variable using fixed-effects. From this regression, pre-dicted values are calculated for IPA and then used in lieu of the actual IPAin the Performance regression allowing for the exogeneity tests noted above.To properly identify the preliminary regression, we added (1) the percent ofthe state voting for the democratic presidential candidate, (2) whether a statehad a lame duck governor, (3) the percentage of the population between theages of 20–24, and (4) the percentage of the population that is female to theother exogenous variables in the models. The added variables should serve wellhere as each has a relatively strong correlation with IPA but comparativelyweak correlation with the dependent variable. With each test, the assumptionof exogeneity of IPA is not rejected leading us to treat IPA as exogenous.

4 Results for party alternation and divided government

Table 4 presents the results of the estimation of Eq. (3).17 Before discussing indi-vidual outcomes, it should be noted that the model provides a likelihood ratiotest that is highly significant, beyond the 0.001 level, indicating that the indepen-dent variables taken as a group are quite significant in explaining the variationin fiscal performance. The most important individual outcome, of course, is thenegative and significant coefficient on the party alternation variable, IPA. Thisresult indicates that states which tend to have high levels of party turnover inthe governor’s office (a higher IPA value) tend to have relatively poor overallfiscal performance.18 These findings provide additional empirical support to thetime inconsistency and fiscal policy literature.

Both of the economic variables, Unemp and Income are statistically signifi-cant and have the anticipated signs. Thus, not unexpectedly, it is clear thateconomic factors are a major determinant in fiscal performance at the statelevel. Of the eight political variables most have the expected sign, but onlythree are statistically significant. DGI while statistically insignificant is of thecorrect sign. IID, the measure of left wing control of government, has a negativeand statistically significant impact on performance, with the opposite found forright wing control, IIR. These results are similar to the findings in the literaturefrom which they are adapted. The budget rule Cs is negative and significant.While not of the expected sign, this variable measures the strongest enforcement

17 It should be noted that the estimation uses standard errors that are fully robust with respectto arbitrary heteroskedasticity (Wooldridge 2002). Also, the estimates of the state-specific fixedeffects are not reported in this table but are available upon request.18 To establish the effects of IPA on fiscal performance we also estimated equation (3) withoutIPA. The consistency of our results across the two models leads us to conclude that our findings arenot sensitive to the inclusion of IPA as an independent variable.


Table 4 Estimates ofPerformance Equation

Notes Standard errorscorrected forheteroskedasticity usingHuber/White correction inparentheses*, **, *** Denotes significanceat 10, 5, and 1% level,respectively

Variable Coefficient

Unemp −0.00147*** (0.0003057)Income 5.97e-07** (2.67e-07)DGI −0.00030 (0.0006949)IID −0.00232* (0.0013374)IIR 0.00326* (0.0019796)IPA −0.00532** (0.0024476)Tel −0.00037 (0.0017341)Term 0.00136 (0.0018444)Const −0.00552 (0.0035646)Cs −0.00742* (0.0044522)Party 0.00060 (0.0008671)N 709Log Likelihood 2237.465L-R test 357.726***

of the weakest budget rule. This suggests that the simple rule of the governorsubmitting a balanced budget is not an effective tool for restraining deficitspending, even with the stricter enforcement.19

While the analysis presented above gives insight into the impact of dividedgovernment on state fiscal performance, to more precisely address the issue ofIPA in conjunction with divided government, we re-estimate equation (3) forthree sub-samples: (1) where all three parts of the government are controlled bythe same party (Unified Government), 310 observations, (2) Split Branch Gov-ernment where the governor is from one party and the legislature is controlledby the opposing party, 296 observations, and (3) states where the governor andone house of the legislature are from one party (Split Legislature Government),121 observations.20 These results are presented in Table 5.21

Examining divided government reveals interesting and generally consistentresults with regards to the key variable IPA, relative to the combined sample.In the overall sample, party alternation was found to reduce fiscal performance,a result that is confirmed, significantly in the case of Unified Government andinsignificantly in the case of Split Branch Government. Interestingly, however,in the case of Split Legislature Government the opposite was found. That is,when the governor and one house of the legislature are a single party, opposedin the other house of the legislature by another party, frequent party alternationtends to be associated with improved overall fiscal performance, but the result isnot statistically significant. This outcome suggests that the extremes of Unified

19 This result also gives credibility to Hou and Smith’s (2005) view that statutory provisions maybe the stronger enforcement mechanism (see note 11).20 Obviously, DGI must be dropped from the sample, but due to the smaller sample IID, IIR, andCs are also excluded. There is little or no variation in these variables in the sub samples so theycould not be included.21 It should be noted that each of these regressions followed tests confirming the exogenous natureof IPA and each yields solid goodness of fit measures.


Table 5 Estimates of performance with divided government

Performance Unified Splitb Splitgvariable coefficient coefficient coefficient

Unemp −0.00166*** (0.0004378) −0.00091** (0.0004613) −0.00099 (0.0014412)Income 1.85e-07 (2.90e-07) 1.03e-06*** (2.68e-07) 2.92e-07 (1.20e-06)IPA −0.00798* (0.0045207) −0.00128 (0.0043183) 0.00612 (0 .0110708)Tel 0.00483** (0.0023465) −0.00051 (0.0025428) 0.00456 (0.0073972)Term 0.00779** (0.0037295) −0.00296 (0.0030812) −0.00973 (0.0060751)Const −0.00018 (0.0081761) −0.00248 (0.0035627) −0.00770 (0.0118266)Party 0.00050 (0.003209) 0.00669*** (0.0016901) −0.00841 (0.0064967)N 319 269 121Log Likelihood 1085.053 940.761 326.680L-R test 280.008*** 234.909*** 26.879***

Notes Standard errors corrected for heteroskedasticity using Huber/White correction in parentheses*, **, *** Denotes significance at 10, 5, and 1% level, respectively

Government and Split Branch Government tend to push a state in the directionof deficits as party alternation rises, while the opposite being true when there isSplit Legislature Government in place. Reed (2005) finds that once you controlfor the party of the governor, the party of the legislature determines the taxburden in the state. One can speculate that a unified government can pass itsexpenditure and revenue legislation with little opposition. In the split branchcase the party in control of the legislature may face opposition from the gover-nor. The split legislature suggests that opposition exists but that the coalition ofthe governor and one house of the legislature must work with the other to enactpolicies. Party alternation in the extreme cases changes the types of coalitions,but does not under the split legislature government. So, while the party of thegovernor itself may be of little consequence the alternation from one party tothe other appears to have an impact. Again, we think our results support theconclusions found in the time inconsistency literature.

Overall, our results provide relatively consistent support for the proposi-tion that not only standard economic determinants and political institutions areimportant, but party alternation and divided government are also relevant inexplaining the variability of fiscal performance between states and over time.

5 Robustness of results

To test the robustness of our results, alternative estimations were undertakenemploying different measures of party alternation. Specifically, since IPA is anew development in the literature, and this is its first application to the US,we have constructed two alternative measures to proxy party alternation. Thefirst measure is a simple dummy variable that records a one if party alternatesand a zero otherwise (Alt). As discussed in Sect. 3, this dichotomous approachhas limitations that are improved upon by IPA. The second variable is closer toIPA since it reflects the degree of alternation from low to high. It is an index


devised from the cumulative fraction of gubernatorial terms held by Democrats(PDEM).

PDEM =J∑

j

(t̃jt

), j = 1, . . . , J

t = 1, . . . , T(5)

where t̃ is the number of periods governed by party j and t is the period. Thiscalculation alone does not measure party alternation so the results are thencoded between zero and four to indicate the degree of alternation. If Dem-ocrats hold power during all gubernatorial periods then the value of PDEMwould equal one. This value becomes smaller as Democrats hold power duringfewer periods i.e. gubernatorial periods in which Republicans are in power.Values of 0.5 suggest the highest degree of party alternation and values smallerthan 0.5 suggest less alternation and greater control by the Republicans.22

The PDEM index is coded as follows:

Value0 Percentage of periods held by Democratic governors equals 1 and 01 Percentage of periods held by Democratic governors equals 0.99 − 0.85 and

0.15 − 0.012 Percentage of periods held by Democratic governors equals 0.84 − 0.70 and

0.30 − 0.163 Percentage of periods held by Democratic governors equals 0.69 − 0.51 and

0.49 − 0.314 Percentage of periods held by Democratic governors equals 0.5

Like IPA, higher values suggest greater party alternation; therefore, weexpect the sign of this variable to be negative.

We estimate equation (3) again using Alt and PDEM as proxies of partyalternation. Table 6 reports the results from these estimations. Specifically, bothAlt and PDEM are negative in sign, which is consistent with the results found inthe model using IPA, but only PDEM is statistically significant. The remainingindependent variables also have consistent signs and significance levels with theestimates of Eq. (3) using IPA. Thus, state fiscal performance will worsen if thegovernor’s office is turned over to another party frequently.

6 Conclusion

Fiscal performance at the state level continues to be a good laboratory for anal-ysis of policy choices. Our paper expands on the existing literature by adding tothe traditional economic and political factors thought to influence fiscal perfor-mance. Building on the work of Rumi’s (2003) IPA we show that frequent party

22 Values of zero also reflect no party alternation indicating Republican control. However, of theseven states with no party alternation only one, Iowa, is held consistently by Republicans.


Table 6 Estimates of performance with Alt and PDEM

Variable Coefficient Coefficient

Unemp −0.00135*** (0.0003062) −0.00150*** (0.000318)Income 6.02e-07** (2.60e-07) 5.90e-07** (2.72e-07)DGI −0.00029 (0.0006975) −.00028 (0.0006954)IID −0.00240* (0.0013431) −.00239* (0.0013243)IIR .00337* (0.002) 0.00309 (0.0019914)Alt −.00151 (0.0020509) –PDEM – −0.00096*** (0.0003819)Tel −0.00044 (0.001731) −0.00032 (0.0017423)Term 0.00114 (0.001874) 0.00120 (0.001841)Const −0.00661** (0.0034658) −0.00539 (0.0036004)Cs −0.00591 (0.0044644) −0.00723* (0.00441)Party 0.00095 (0.0008715) 0.00044 (0.0009013)N 709 709Log likelihood 2236.004 2237.838L-R test 354.805*** 358.474***

Notes Standard errors corrected for heteroskedasticity using Huber/White correction in parentheses*, **, *** Denotes significance at 10, 5, and 1% level, respectively

alternation creates an environment that has a negative impact on fiscal perfor-mance at the state-level in the US. Using other measures of party alternationwe test the robustness of our results, and find reasonably consistent results. Weexamined 37 states, over the years 1971–2000, with 709 observations, and wereable to show that IPA is an effective measure for analyzing party alternationwithin a developed country with a two party system. IPA proves to add realexplanatory power when we control for economic factors and political instabil-ity which is consistent with the existing literature on fiscal performance. Ourresults indicate that when voters change parties frequently, fiscal performancein the state suffers. Further, our findings suggest that IPA should be used infuture research to examine policy choices.

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Party alternation, divided government, and fiscal performance within US States