Tax_elasticity on Gov Spending

8/8/2019 Tax_elasticity on Gov Spending

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T h e e f f e c t o f t a x e l a s t i c i ty o n g o v e r n m e n t s p e n d in g

E L E A N O R D . C R A I G a n d A . J A M E S H E I N SU n i v e r s i ty o f D e l a w a r e U n i v e r s i ty o f I ll i n o is

T h e p u r p o s e o f t h is p a p e r i s t o e x p l o r e t h e e f f e c t o f t h e e l a st ic i ty o f th e t a xs t r u c tu r e o n t h e a m o u n t o f s p e nd i ng b y s t at e g o v e r n m e n t . W h ile t h e e m -p i ri ca l an a ly s is cen t e r s o n s t a t e g o v e rn m en t s p en d in g , t h e u n d er l y i n g t h eo rym a y b e g e n e ra li z ed to a n y g o v e r n m e n t u n i t .

1 . E l a s t ic i t y a n d s p e n d i n gEl as t i c it y m eas u res t h e ex t en t t o wh i ch a t ax s t ru c t u re g en e ra t e s r ev en u e i nr e s po n s e t o i n cr e as e s i n t a x p a y e r i n c o m e w i t h o u t a c h a ng e i n s t a t u t o r y ta xra tes . Whi le e las t i c i ty depends in par t on propens i t i es to engage in t axab leac t i v i t y , i t s m a i n d ep en d en cy ac ro s s p o l i t i ca l u n i t s i n t h e Un i t ed S t a t e s i so n t h e p ro g res s iv i t y o f t h e i n co m e t ax . S t a t e s w i t h h i g h l y p ro g res si v e i n -co m e t ax es t en d t o h av e e l a s ti c t ax s t ru c t u res .I t h as b een p ro p o s ed t h a t g rea t e r e l a s t ic i t y i n t h e t ax s t ru c t u re g en e ra te sa g rea t e r v o l u m e o f p u b l i c s p en d in g [3 , 5 , 1 2 ] . Th i s p ro p o s a l g en e ra l lyres t s o n the co nc ep t o f ' f isca l i l lus ion ' , the i l lus ion being tha t i f the l egi s-l a t u re d o es n o t en ac t a s t a t u t e r a is in g t ax r a t e s , t ax es h av e n o t i n c reased . I tfo l l o ws t h a t s t a te s w i t h e l a st ic t ax s t ru c t u res ex p e r i en ce g rea t e r i n c reas esi n t a x r e v e n u e s w i t h o u t h a v i n g t o g o t h r o u g h t h e t h r o e s o f a t a x i n c re a s e ,an d t h o s e s t a te s w i ll s p en d m o re .

We ad m i t t o b e i n g s u p p o r t iv e o f t h e i d ea t h a t e l a s t ic i t y d r iv es s p en d i n g .We a ls o ad m i t t o t h e u s u a l d i s co m fo r t th a t eco n o m i s t s f ee l wh en t h ey l eano n n o t i o n s c o n f l ic t in g w i t h t h e a s s u m p ti o n s o f ' r a t i o n a l it y ' t h a t u n d e r g ir dt h e co n v en t i o n a l u t i l i t a r i an an a l y s i s . B u t , we p ro ceed w i t h t h e h o p e t h a tt h e re w i ll b e a r eco n c i l i a t io n o f t h i s co n f l i c t .

O n e c o u l d b u i l d a c o m p e t i n g t h e o r y b a s e d o n p u b l i c c h o i c e n o t i o n s t oex p l a i n t h e h y p o t h es i s t h a t e l a s t i c i t y b reed s s p en d i n g . As s u m i n g t h a t t h em e d i an v o t e r p rev a i ls , i t i s o b v i o u s t h a t w e co u l d s p ec i fy in d i v i d u a l d em an dfu n c t i o n s fo r p u b l i c g o o d s s u ch t h a t i f co s t a l l o ca t i o n were m ad e p ro -gress ive to income, spending increases would resu l t . But , there i s d i f f i cu l tyi n p r o p p i n g u p s u c h a n o t i o n i n t h e f a c e o f T i e b o u t m o b i l i t y [ 1 1 ] .S i m i l a r l y , i f we a s s u m ed t h a t t ax s h a r i n g a r r an g em en t s were p res c r i b edPubl ic Cho i ce 35 , 267- 27 5 ( 1980) 0048 - 5829 / 80 / 0353- 0267 $1 . 35 Ma rtinus NijhoffPublishers, Th e Hag ue, Printed in Th e Netherlands.


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2 68 E.D. Craig and A.J. Heinscons t i t u t i ona l l y , and were no t sub j ec t t o change by a s imp le ma jo r i t y , wecou ld exp l a in a pos it ive r e l a ti onsh ip be twe en e l a s t ic i t y and spend ing wi th -ou t r e so r t ing t o i ll u s ion . B u t , t he i n s t i tu t i ons o f t axa t i on , a t l eas t fo r t hem o s t p a r t , w o u l d s e e m t o b e s u b j e c t t o s t a t u t o r y a n d n o t c o n s t i t u t i o n a lchange . Thus , we f a ll back on t he con cep t o f f is ca l i ll u s ion . I t ma t t e r s no t ,how ever , s ince t he empi r i ca l m ode l t ha t fo l lows s ea rches on ly fo r there l a t i onsh ip be tween e l a s t i c i t y and spend ing , and no t fo r any t heo re t i ca lunderp inn ings .

2. Earlier em pirical wo rkThe e l as t i c i t y - spend ing hypo thes i s has no t gone unexp lo red [8 ] . Oa t eshas r e l a t ed t he g ro wth i n spend ing by s t a te and c i t y governmen t s f rom 1960to 1970 t o va r ious measu res o f t ax e l a s t ic i t y . While Oa t es i s obv ious ly un -happy wi th t he f i s ca l i l l u s ion no t i on t ha t underp ins t he e l a s t i c i t y - spend ingt h es is , h is n u m b e r s f o r c e h i m t o c o n c l u d e t h a t t h e r e m a y b e s o m e t h i n g t othe not ion . The e las t i c i ty var iab les a lways have the r igh t s ign and t - ra t iosare no t un impress ive . But , i t i s equal ly obvious that he v iews the resu l t ssuff ic ien t ly un impress ive to raise the spect re of speci f ica t ion and the t imeper iod b ias .

B u t , i t is p rec i s e ly t he t ime pe r i od p ro b l em th a t l eads u s t o conc lud e t ha tOates has underassessed the im pac t of e las t i c i ty on spending , no t overassess-ed as he con j ec tu res . The fundam en ta l p ro pos i t i on a t is sue is : ' Does an e la s-t i c t ax s t ruc tu re p rovoke g rea t e r pub l i c spend ing? ' The app rop r i a t e de -pen den t va r iab l e t o exp lo re t h i s p ropo s i t i on is t he l eve l o f spend ing , no tg row th i n spend ing over any pa r t i cu l a r pe r i od .

T h e p r o b l e m a ris es f r o m t h e m a n n e r i n w h i c h w e t e n d t o t h i n k a b o u t t h ee l as ti c it y - spend ing ques t i on . ' Normal r even ue g row th , ' t he i nc rease i n r e -venue r esu l t i ng f rom inc reased economic ac t i v i t y , s t a t u to ry t ax r a t e s con -s t an t , i s g rea t e r ove r t ime b y t he e x t en t t o wh ich the t a x s t ruc tu re is e l a st ic .F i scal i l lus ion sugges t s tha t po l i t i c ians f ind i t eas ier to fund publ ic serv icesf r o m n o r m a l r e v e n u e g r o w t h t h a n f r o m r e v e n u e g e n e r a te d b y e x p l i c it i n-c reases i n t ax r a t e s . Hence , t he e l a s t i c i t y - spend ing hypo thes i s no rmal lyreads : ceteris paribus, t he more e l a s t i c t he t ax s t ruc tu re t he g rea t e r t he i n -c rease i n pub l i c spend ing . The Oa t es work t e s t s t ha t p ropo s i t i on .The p rob l em w i th t h is t e s t is t ha t i t w i ll on ly p rove ou t genera l l y i fspend ing i nc reases a re no t bou nde d . S uppose t he re a re lim i t s t o wh ich no r -mal revenue increases wi l l be spent , i r respect ive of e las t i c i ty . In th i s casethe e f f ec t o f e l a s t ic i t y on spend ing m ay be mi sasses sed i f t he i nc rease inspending is used as the de pe nd en t var iab le .Th i s po in t can be ma de by r e fe renc e t o F igu re 1 . S uppo se G1 rep re -s en ts a pa th o f g overnm en t ex pen d i t u re w i th a g iven e l a s t ic i t y va lue , andG2 rep resen t s t he pa th exp ec t ed w i th an i nc rease i n e l a s t ic i t y . B e tw een


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Yo and Y l , t he e f f ec t o f t he g re a t e r e l a s t ic i t y imp l i c it i n G 2 wil l show upb o t h i n e x p e n d i t u r e i n cr ea s es a n d e x p e n d i t u r e l ev e ls . H o w e v e r , b e y o n dY 1 , the ef fe c t o f grea ter e la s t i c i ty W'_fll show up on ly in th e l evel o f spend-i ng , a n d n o t i n t h e i n c re a s e. A n y n u m b e r o f f u n c t io n a l f o r m s c o u l d g e n e r a tethese r e su l ts . T he p rac t i ca l imp l i ca t ion o f t hese a s sumpt ions i s t ha t f i sca li ll u s ion m ay a l low e l as t ic i t y t o c rea t e ex pen d i t u re d i f f e ren t i a ls , bu t no tcon t i nuou s ly i nc reas ing d i f f e ren t ia l s .

Thu s we use pe r ca p i t a spend ing as t he d epe nde n t va r i ab le i n ou r ana ly -s is . Ou r hyp o thes i s i s s imp ly t ha t : ceteris paribus, t he g rea t e r t he e l a s t ic i t yo f a s ta te ' s t ax s t ructu re the m ore i t wi l l spen d for publ ic services.

3 . T he r eg res sion m ode lW e o f f e r t o t e s t o u r h y p o t h e s i s w i t h a c o n v e n t i o n a l d e t e r m i n a n t s m o d e l o fspend ing by s t a t e governmen t s . The r e l a t i onsh ips a re a l l a s sumed t o bel i nea r and es t ima t ed b y o rd ina ry l east squares. T he va r i ab l es a re:

G = pe r cap i ta st a t e spend ing , t he de pen den t va r iab l eY t = p e r c ap i ta p e rs o n a l i n c o m e b y s t a te


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2 7 0 E.D. Craig and A.J. HeinsF t = p e r c a p i t a f e d e r a l a idD t = p o p u l a t i o n d e n s i t yCt = p e r c e n t o f p o p u l a t i o n u r b a nA t = p e r c e n t o f p o p u l a t i o n o v e r 1 8St = p e r c e n t o f s t a t e a n d lo c a l r e v e n u e s o r ig in a t in g a t th e s t a t e l e v elE = e l a s t i c it y o f t h e s t a t e t a x s t r u c tu r e

I n a l l c a se s t h e s u b c r ip t r e f e r s t o t h e y e a r u n d e r o b s e r v a t i o n . Sa v e e l as -t i c i t y , a ll d a t a c o m e f r o m t h e U . S . B u r ea u o f t h e C e n s u s a n d c a n b e f o u n din the Statistical Abstract of the United States f o r t h e v a r io u s y e a r s . O u re l a s t i c i t y m e a s u r e c o m e s f r o m t h e A d v i s o r y C o m m i s s i o n o n I n t e r g o v e r n -m e n ta l Re l a t i o n s [ 1 : 5 0 ] . 1

F o r t h e m o s t p a r t t h e t h e o r y u n d e r l y i n g t h e m o d e l i s o b v i o u s a n d w e l le x p l i c a t e d i n t h e d e t e r m in a n t s l i t e r a tu r e [ 2 , 6 , 7 , 9 ] . I t is a l so s imi l a r t o t h eO a t e s m o d e l .T o t e s t f o r la g s i n t h e s y s t e m , b o th 1 9 7 5 a n d 1 9 7 0 s p e n d in g w e r e r e -g re s se d o n t h e 1 9 7 0 A C I R m e a s u r e o f e l a s ti c it y . I t w o u l d s e e m r e a s o n a b let h a t , a s s um i n g t a x s t r u c tu r e s t o b e c o n s t a n t , t h e p a ss a g e o f t i m e w o u l df a rm u p t h e e l a s t i c i ty - s p e n d in g r e l a t io n s h ip i f o u r h y p o th e s i s w e r e c o r r e c t .

T a b le 1 s h o w s f o u r v a r i a n t s o f t h e b a s i c r e g r e s sio n . I n e a c h c a s e t h e c o -e f f i c i e n t o f t h e e l a s t ic i t y v a r ia b l e is p o s i t iv e a n d s ig n if i c a n t. I t w a s p o in t e do u t t o u s t h a t A la s k a h a s a p a r t i c u l a r ly h ig h v a lu e f o r b o th e l a s t i c i t y a n ds p e n d in g , a n d t h a t o u r r e s u l ts m i g h t d e p e n d o n t h e i n c l u s io n o f t h e A l a s k ao b s e r v a t i o n . A c c o r d in g ly , w e r a n t h e s a m e r e g r e ss io n s , o m i t t i n g A la s k a , a n dn o te t h a t i n t h r e e o f t h e f o u r v a r i a n t s t h e t - r a t i o s f o r t h e e l a s t i c i t y v a r i a b lew e r e g r e a t e r w h e n A l a s k a w a s o m i t t e d . A s e x p e c t e d , th e c o e f fi c i e n ts o f th ein c o me a n d f e d e r a l a id v a r i a b l e s a r e p o s i t i v e a n d h ig h ly s ig n i f i c a n t . T h es t a ti s ti c s f o r t h e d e m o g r a p h ic v a ri a b l e s a r e mix e d a s u s u a l. We n o t e f o r l a t e rr e f e r e n c e t h a t t h e c o e f f i c i e n t o f t h e e l a s t i c i t y v a r i a b le is g r e a t e r in t h e 1 9 7 5v a r i a n t s , a l t h o u g h i t i s n o mo r e s ig n i f i c a n t . T h e s t a t e s h a r e v a r i a b l e , St , w a sin s ig n i f ic a n t a n d c o n t r i b u t e d l i tt l e t o t h e e x p l a n a t i o n . 2T a b l e 2 s h o w s a n a l t e rn a t iv e s p e c i f ic a t io n o f t h e O L S m o d e l in w h i c h t h ed e p e n d e n t v a r ia b l e a n d f e d e ra l a i d a re e x p r e s s e d a s a p e r c e n t o f i n c o m e . O u rp u r p o s e f o r th i s s p e c i f i c a t i o n o f t h e m o d e l is t o d e f l a t e t h e s p e n d in g v a r i a b leb y i n c o m e i n o r d e r t o f a c il it a te t h e c o n s i d e r a ti o n s o f i n fl a t io n w e m a k e inth e n e x t s e c t i o n . Be f o r e p a s sin g o n , h o w e v e r , w e n o t e t h a t t h e s e r e g re s s io n ss h o w t h a t s p e n di n g b y s t a te s w a s in c o m e e l as ti c i n b o t h y e a r s - a s sh o w nb y th e p o s i t iv e s i gn a n d s ig n if ic a n c e o f v a r i a b l e Yt - b u t l e s s s o i n 1 9 7 5 .

4 . T h e e f f e c t o f i n f l a t io nE v e n a s w e s h o w th a t e l a s t i c i t y i s r e l a t e d t o s p e n d in g w e h a v e n o t p r o v e nt h a t e l a s ti c i ty o f t h e t a x s t r u c tu r e i s t h e p r i m e c a u s e . I t c o u l d b e a r g u e d t h a t


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2 7 2 E.D. Craig and A .J. Heinsthe e lec tora te an t ic ipa ted i t s des i res fo r h igher cos t s o f publ ic serv ices andb u i l t e l a s ti c i ty i n t o t h e t ax s t ru c t u re i n o rd e r t o r ed u ce t ran s ac t i o n co st so f s t a t u t o r y t a x c h a n ge [ 1 2 ] .Th e i m p ac t o f t h e i n f l a t i o n a f t e r 1 9 7 4 o n l ev e ls o f p u b l i c s e rv i ce p ro -v i s ion wi ll p rov ide gro und for t es t ing tha t ra t ionale . E las t i c i ty increases t axrev en u es w i t h n o m i n a l a s we l l a s rea l eco n o m i c g ro wt h [1 0 ] . B u t t h e th eo -r ie s o f p u b l i c s e rv ice p ro v i s i o n b as ed o n a r a t i o n a l e l ec t o ra t e wo u l d p red i c tch an g es i n r ea l g o v e rn m en t s p en d i n g o n l y i n t h e f ace o f r eal g ro wt h .Wh ile ex p e r i en c e w i t h i n f l a t i o n is li m i t ed a s o f t h is wr i t in g , o u r r e s u l tsm ay s h ed s o m e l ig h t o n t h i s q u es t i o n . Lo o k i n g a t Tab l e 2 , v a r i an t s o n e an dt h ree , t h e co e f f i c i en t s o f t h e e l a s t i c it y v a r iab l e were 2 .2 4 an d 3 .6 4 fo r 1 9 7 0an d 1 9 7 5 s p en d in g , re s p ec t i v e ly . In 1 9 7 0 an e l a s t ic i t y v a l u e o f 1 .2 wo u l d ,ceteris paribus, h a v e g e n e r a te d s p e n di n g o u t o f i n c o m e o f 0 . 4 5 p r e c e n ta g ep o i n t s h i g h e r t h an t h a t w i t h an e l a s t ic i t y v a l u e 1 .0 . In 1 9 7 5 . t h e s p en d in gd i f f e ren t ia l a s s o c ia t ed w i t h t h e s am e e l a s t ic i t y d i f f e ren t i a l wo u l d h av e b een0 .7 7 . In o t h e r wo rd s , a g iv en e l a s t ic i t y s p read g en e ra t ed a l a rge r s p read int h e p e rcen t o f i n co m e s p en t o n p u b l ic s e rv ices i n 1 9 7 5 t h a t i t d i d i n 1 9 7 0 .Ap p are n t l y , e l a s t ic i t y d i v e r t ed r ea l r e s o u rces i n t o t h e p u b l i c s ec t o r d u r in gt h e p e r i o d 1 9 7 0 t o 1 9 7 5 , ev en th o u g h t h e r ea l an n u a l g ro wt h i n p e r cap i t ai n c o m e w a s o n l y 1 .6 p e r c e n t c o m p a r e d w i t h a n i n f l a ti o n r a te o f 6 .3 p e r c e n t .

We n o t e t h a t t h i s co m p ar i s o n i s s ug gestiv e o n l y . Ev en th e m o s t d o g m at i cu t i l i ta r i an the or i s t s w ou ld ad m i t to some s luggishness in th e po l i t i ca l p roce ss ,a n d e x p e r ie n c e w i t h o n l y t w o o r t h r e e y e a r s i n f la t i o n w o u l d h a r d l y g e n e r a teco n c l us i ve r e su l ts ab o u t t h e r a t i o n a l i t y o f t h e p o l i ti ca l p ro ces s.

5 . S o m e c u r r e n t developmentsWere t h i s p ap e r wr i t t en o n e y ea r ea r l i er , it m i g h t h av e en d ed h e re w i t h as ec t i o n en t i t l ed . ' Su m m a ry an d co n l u s i o n s . ' B u t o f l a t e , C a l ifo rn ia h as pass -ed "Propos i t ion 13 ' ;3 an d C o l o rad o h as i n d ex ed i t s p e r s o n a l i n co m e t ax .Ten n es s ee an d New J e r s ey h av e r e s t r i c t ed an y p u b l i c s p en d i n g i n c reas est o a s p ec i fi ed p ro p o r t i o n o f t h e i n c rease in s t a t e p e r so n a l i n co m e , an d o t h e rs t a t e s h av e fo l l o wed s u i t . B ey o n d t h a t , p u b l i c i n t e re s t g ro u p s a re cu r ren t l yw o r k i n g i n v i r t u a l l y e v e r y s t a t e t o a d o p t s o m e f o r m o f t a x r e d u c t i o n o rl i m i t a t i o n p ro g ram . Th e t e rm wi d e l y u s ed i n t h e p o p u l a r l i t e r a t u re t o d es -t r ib e t h e c u r r e n t m o o d o f th e c o u n t r y is: ' ta x p a y e r s ' r e v o lt . 'An as ses sm en t o f t h e fu l l i m p l i ca t io n s o f a l l t h i s m u s t awa i t t h e s e t tl in go f t h e d u s t an d t h e co l l ec t i o n o f d a t a . B u t , it i s c l ea r t h a t e l a s t i c i t y o f st a t erev en u e s t ru c tu res l ay n ea r t h e co re o f ev en t s .

M o s t o f t h e cu r ren t t ax l i m i t a t i o n p ro p o s a l s ti e t h e r a t e o f an y s p en d in gi n c reas e t o t h e r a t e o f in c reas e i n p e r so n a l i n co m e . Th e r e s tr i c t io n s ad o p t edb y New J e r s ey in 1 9 7 6 ( s t a t u t o ry ) , Ten n es see an d M i ch ig an i n 1 9 7 8 ( co n s t i -t u t i o n a l ) a r e o f t h i s t y p e . I f t h e t ax s t ru c t u re h as u n i t a ry e l a s t i c i ty , t h e r a t e


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Tax e las t ic i ty and spending 2 7 3o f r e v e n u e i n c r e as e i s e q u a l t o t h e r a t e o f i n c o m e i n c r e a se . I n t h i s c a se ,s p e n d in g l i m i t a t i o n s t ie d t o i n c o m e h av e t h e e f f e c t o f m a k i n g c u r r e n t t a xr a t e s t h e m a x i m u m t a x r a t e . B u t , i f t h e t a x s t r u c t u r e is e l as t ic , t h e n t h ee f f e c t o f t y i n g s p e n d i n g i n c r e a s e s t o t h e r a t e o f i n c r e a se i n i n c o m e w i l l b et o m a n d a t e r e d u c t i o n s i n t h e s t a t u t o r y r a t e s o f so m e t a x e s.

T h e n a t u r e o f t h e r e l a t i o n s h i p b e t w e e n t a x l i m i t a t i o n s a n d t h e e la s t i c it yo f t h e t a x s t r u c t u r e c a n b e e x p l i c a te d w i t h a s im p l e m o d e l . L e t :( 1 ) T = t ( Y J Y = t a x r e v e n u e s , w h e r e

Y = i n c o m e , a n dt ( Y ) = th e e f f ec t iv e ra t e o f t a x , a f u n c t i o n o f Y .

A s s u m e a c o n s t a n t e l a st ic i ty m o d e l :( 2 ) t ( Y ) = t Y7-b , b > O ; a n d s u b s t i t u t i n g ( 2 ) i n t o ( 1 ) :( 3 ) T = t Y b , w h e re

b = e l a s ti c i ty o f t h e t a x s t r u c t u r e , a n dt = a c o m p o s i t e o f s t a t u t o r y r a te s .

N o w a s s u m e t h e a d o p t i o n o f a t a x l im i t s u c h th a t t o t a l ta x r e v e n u e s a r el im i t e d t o s o m e p e r c e n t o f i n c o m e . I n th i s c a se :

T / Y < . k , a c o n s t a n t ,( 4 ) t


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2 7 4 E.D. Craig and A.J. Heinsp l a i n e d b y t h e m i n i m i z a t i o n o f t r a n s a c t i o n s c o s t s a s s o c i a te d w i t h s e e k in gh i g h e r s t a t u t o r y r a t e s . T h i s n o t i o n f i ts w e l l w i t h t h e e x p e r i e n c e o f t h e l a s t2 5 y e a r s w h e n t a x e s w e r e i n c re a s in g f a s te r t h a n i n c o m e , a n d i t m a y b e u s e da s a r a t i o n a l e f o r t h e v e r y r e s u l ts w e o f f e r e d e a r l ie r . T a x l i m i t s w o u l d t u r nt h i s a r o u n d , h o w e v e r , a n d f o r c e s t a t e s w i t h h i g h l y e l a s ti c t a x s t r u c t u r e s t os e e k f r e q u e n t r e d u c t i o n s i v s t a t u t o r y r a te s . T h e t ra n s a c t i o n c o s t t h e o r yw o u l d p r o j e c t t h a t s t a te s w i t h t a x li m i ts w o u l d m a k e c h a n g e s d e si g n e d t or e d u c e e l a s t ic i t y . P e r h a p s t h e m o v e t o i n d e x a t i o n o f t a x e s c a n b e t h o u g h to f i n t h a t l i g h t .

6 . R e c a p i t u l a t i o nI n t h is p a p e r w e h a v e s h o w n t h a t l e v el s o f s p e n d i n g b y s t a te g o v e r n m e n t si n 1 9 7 0 a n d 1 9 7 5 w e r e p o s i t i v e l y r e l a t e d t o e s t i m a t e s o f th e e l a s t i c i t y o f t h et a x s t r u c t u r e s o f t h o s e s t a t e s. O u r s t a t i s ti c a l r e s u l t s w e r e s i g n i fi c a n t u n d e rO L S p r o c e d u r e s a n d T S L S p r o c e d u r e s u s in g p o o l e d d a t a f o r b o t h 1 9 7 0 a n d1 9 7 5 .

W e h a v e a l s o s h o w n t h a t a g iv e n e l a s t i c it y d i f f e r e n t i a l w a s a s s o c i a t e d w i t ha g r e a t e r d i f f e r e n t i a l i n th e p e r c e n t o f i n c o m e c l a i m e d b y s t a t e t a x e s i n1 9 7 5 . S i n c e i n f l a ti o n a c c o u n t e d f o r m o s t o f t h e i n c re a s e i n in c o m e o v e rt h a t p e r i o d , t h i s d i f f e r e n t i a l s u g g e s ts t h a t e l a s t i c i t y h a s d r i v e n s p e n d i n g t oa d e g r e e t h a t c a n n o t b e e x p l a i n e d b y a r a t io n a l , p e r c e p t i v e e l e c t o r a t e . U n -f o r t u n a t e l y , t h e d i f fe r e n c e i n c o e f fi c ie n t s b e t w e e n 1 9 7 0 a n d 1 9 75 is n o ts t a t i s t i c a l l y s i g n i f i c a n t .

F i n a l l y , w e n o t e d s o m e o f t h e i m p l i c a t i o n s o f e l a s t i c it y i n s t a te s i n w h i c ht a x r e v e n ue s h av e b e e n l i m i t e d t o s o m e p e r c e n t o f i n c o m e . A s ta t e w i t h i tsr e v e n u e s t i e d t o i n c o m e a n d a n e l a s t i c s t r u c t u r e w i l l h a v e to r e d u c e s t a t u -t o r y t a x r a te s a s i n c o m e i n c re a s es o v e r t i m e . I n t h a t v e i n , a n y m o v e t oi n d e x a t i o n o f s t a t e t a x e s m a y b e i n t e r p r e t e d a s r e d u c i n g t r a n s a c t i o n c o s tsa s s o c i a t e d w i t h c h a n g e s i n s t a t u t o r y r a t e s .

NOTES

1. In addi t ion to th e A CIR measure of e las t ic i ty , Oates cons t ruct s h i s own measuresbased on the re la t ive impor tance of income taxes in the var ious s ta te t ax s t ruc-tures . We disagree wi th h i s co ntent ion tha t h i s measures are super ior to those ofthe AC IR; bu t s ince the AC IR e las t ic i ty measure proved to be genera l ly theweak es t in h is analys is , fur ther deba te on th i s poin t would seem to be m ute .2. Because F t and S t are c lear ly endogenous to the sys tem, we ran two -s tage leas tsquares on 100 o bservat ions of poo led 1970 and 1975 data . As Oates found us ingsimilar procedures, F t clear ly conta ins exogenous e lemen ts , as expected , whi le S tappears to be co m ple te ly de term ined by the o ther e lemen ts in the sys tem . Most


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3.

Tax elasticity and spending 2 7 5i m p o r t a n t l y , w e c a n r e p o r t t h a t t h e c o e f f i c i e n t o f - t h e e l a s t i c i t y v a r i a b l e d i d n o tc h a n g e m a t e r i a l ly , a n d i n t h r e e o f f o u r v a r i a n t s it s s i g n if ic a n c e in c r e a s e d .P r o p o s i t i o n 1 3 w a s a 1 9 7 8 C a l i f o r n ia i n i ti a t i v e t h a t ro l l e d b a c k p r o p e r t y t a x e s too n e p e r c e n t o f 1 9 7 6 a s s es s e d v al u e s ( a b o u t a 6 0 p e r c e n t ro l l b a c k ) , l i m i t e d s u b -s e q u e n t i n c re a s e s i n t h e p r o p e r t y t a x , a n d r e q u i r e d a s p e c ia l m a j o r i t y i n th eC a l i f o rn i a S t a t e L e g i s l a t u re f o r i n c re a s e s in t h e r a t e o f a n y s t a t e t a x .

R E F E R E N C E S[ 1 ] A d v i s o r y C o m m i s s i o n o n I n t e r g o v e r n m e n t a l R e l at io n s . Significant Features ofFiscal Federalism, 1 9 7 6 - 7 7 E d i t i o n . V o l . 2 .[ 2 ] B a h l , J r . R o y W . , S a u n d e r s , R o b e r t J .( 1 9 6 5 ) . ' D e t e r m i n a n t s o f C h a n g e s i n S t a t ea n d L o c a l G o v e r n m e n t E x p e n d i t u r e s . ' National Tax Journal, 1 8 ( M a r c h ) : 5 0 - 5 7 .[ 3 ] B u c h a n a n , J a m e s . (1 9 6 7 ) . Public, Finance in Democratic Process. U n i v e r s i t y o f

N o r t h C a r o l i n a P re s s.[ 4 ] B u c h a n a n , J a m e s . ( 1 9 7 1 ) . ' P r in c i p le s o f U r b a n F is c a l S t r a t e g y . ' Public Choice,

(Fa i l ) : 1 -6 .[ 5 ] B u c h a n a n , J a m e s , a n d D e a n , J . ( 1 9 7 4 ). ' I n f la t i o n a n d R e a l R a t e s o f I n c o m e T a x . 'Proceedings of the National Tax Association. 3 4 3 - 5 0 .[ 6 ] F a b r i c a n t , S o l o m o n . ( 1 9 5 2 ) . T h e Trend of Government Activity in the UnitedStates Since 1900. N B E R .[ 7 ] F i s h e r , G l e n n W . ( 1 9 6 4 ) . ' I n t e r s t a t e V a r i a t i o n in S t a t e a n d L o c a l G o v e r n m e n tExpenditure.' National Tax Journal, 1 7 ( M a r c h ) : 5 5 - 7 4 .[ 8 ] O a t e s , W a l l a ce E . ( 1 9 7 5 ) . ' A u t o m a t i c I n c r e a s e s i n T a x R e v e n u e s - T h e E f f e c t o n

t h e S i z e o f P u b l i c B u d g e t . ' I n : W . E . O a t e s ( E d . ), Financing the New Federalism.J o h n s H o p k i n s P r e ss . 1 3 9 - 6 0 .

[ 9 ] S a c k s , S e y m o u r , a n d H a r r is , R o b e r t . ( 1 9 6 4 ) . q ' h e D e t e r m i n a n t s o f S t a t e a n dL o c a l G o v e r n m e n t E x p e n d i tu r e s a n d I n t e r -G o v e r n m e n t a l F l o w o f F u n d s . ' Na-tional Tax Journal, M a r c h : 7 5 - 8 5 .

[ 1 0 ] S u y d e r h o u d , J a c k P . , a n d V e s e t h , M i ch a e l. ( 1 9 7 6 ) . T h e E f f e c t o f I n f l a ti o n o n t h eI n c o m e E l a s t ic i ty o f T a x e s . ' Public Finance Quarterly, 4 ( J u l y ) : 3 2 3 - 3 7 .

[ 1 1 ] T i e b o u t , C h a r le s . ( 1 9 5 6 ) . ' A P u r e T h e o r y o f P u b l ic E x p e n d i t u r e . ' Journal ofPolitical Economy, 6 4 ( O c 0 : 4 1 6 - 2 4 .[ 1 2 ] W a g n e r , R i c h a r d E . (1 9 7 1 ) . T h e Fiscal Organization of American Federalism.M a r k h a m .

[ 1 3 ] W a g n e r, R i c h a r d E . ( 1 9 7 6 ) . ' R e v e n u e S t r u c t u r e , F i s c a l Il l u s io n , a n d B u d g e t a r yChoice.' Public Choice, 2 5 ( S p r i n g ): 4 5 - 6 1 .

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