Fiscal Illusion and Cyclical Government Expenditure: State Government Expenditure in the United States
| Author | Andrew Abbott,Philip Jones |
| Date | 01 May 2016 |
| DOI | http://doi.org/10.1111/sjpe.12095 |
| Published date | 01 May 2016 |
FISCAL ILLUSION AND CYCLICAL
GOVERNMENT EXPENDITURE:
STATE GOVERNMENT EXPENDITURE
IN THE UNITED STATES
Andrew Abbott* and Philip Jones**
ABSTRACT
A well-established literature argues that fiscal illusion increases the level of gov-
ernment expenditure. This article focuses on the proposition that fiscal illusion
also influences the cyclicality of government expenditure. Predictions are formed
with reference to government reliance on high income elasticities of indirect tax
revenues and on intergovernmental transfers. Predictions are tested with refer-
ence to the expenditures of 36 states in the United States from 1980 to 2000.
Government expenditures are more likely to be procyclical when citizens system-
atically underestimate the cost of taxation.
II
NTRODUCTION
Procyclical public expenditure increases as national income increases and falls
as national income decreases. Economists usually anticipate counter-cyclical
expenditure (Alesina et al., 2008), but empirical studies increasingly report
procyclical expenditure (Gavin et al., 1996; Talvi and V
egh, 2005; Alesina
et al., 2008; Woo, 2009; Abbott and Jones, 2013). Studies that explain pro-
cyclical expenditure highlight the relevance of political pressures for public
expenditure. The likelihood of procyclical expenditure increases if there are
‘voracity effects’, i.e. if political pressures to raise public expenditure increase
as national income increases and fall as national income falls (Lane and Tor-
nell, 1996; Tornell and Lane, 1999). Empirical studies indicate that political
pressure to increase public expenditure is a significant determinant of procycli-
cal expenditure (Lane, 2003; Abbott and Jones, 2013).
This article focuses on the way that the intensity of pressures to increase
government expenditure changes over the economic cycle. The intensity of
political pressure is gauged with reference to politicians’ willingness to increase
expenditure to win votes (Downs, 1957). Pressure is intense when politicians
believe they are able to increase expenditure without alarming voters that tax-
ation will increase.
*University of Hull
**University of Bath
Scottish Journal of Political Economy, DOI: 10.1111/sjpe.12095, Vol. 63, No. 2, May 2016
©2015 Scottish Economic Society.
177
Correction added on 23 December 2017, after initial online publication. A duplicate of this
article was published under the DOI 10.1111/sjpe.12093.This duplicate has now been deleted
and its DOI redirected to this version of the article.
A well-established literature focuses on the circumstances in which voters
are likely to underestimate taxation systematically.
1
This literature has focused
on the level of government expenditure. In this article, the objective is to
introduce and explore the proposition that fiscal illusion is also likely to
increase the cyclicality of government expenditure.
When focusing on the cyclicality of government expenditure, some of the
sources of fiscal illusion are likely to be more relevant than others. In the next
section of the article, the intention is to review the many sources of fiscal illu-
sion. Studies that have tested the reasons why voters underestimate taxation
have focused on variables that capture the extent to which individuals are
likely to underestimate taxation. For example, one of these variables is the
complexity of the tax system. Studies test the significance of these sources of
fiscal illusion separately. In the case of tax complexity, they test the proposi-
tion that adding a single variable (to measure tax complexity) to the socio-
economic variables that are likely to influence the level of government spend-
ing, will reveal that tax complexity is a significant determinant of the level of
taxation. In this article, a first attempt (to our knowledge) will be made to
assess the relative importance of all of these different sources of fiscal illusion
on the level of government expenditure. The intention is to add this full com-
plement of variables (variables that are said to be relevant when considering
different sources of fiscal illusion) to the socio-economic variables that are
likely to influence the level of government spending, to compare the impact
that they exert on the level of government spending.
2
In section III of the article, attention focuses on two sources of fiscal illu-
sion that are likely to be particularly relevant when considering the level and
the cyclicality of government expenditure. These sources of fiscal illusion are
more important when national income is increasing. If politicians are myopic
in economic upturns (Downs, 1957), they are likely to indulge pressures to
increase government expenditure with little regard for the difficulties they will
face when the economy moves into recession. If fiscal illusion increases as
national income increases, fiscal illusion increases the likelihood that there will
be ‘voracity effects’. How relevant are these sources of fiscal illusion when
national income is increasing? How relevant are these sources of fiscal illusion
when anticipating that governments will spend procyclically?
If politicians indulge lobby-group pressures to increase public expenditure
in an economic upturn, the pressures they face to sustain expenditure in a
recession will depend on the extent to which governments are able to borrow.
1
Oates (1988), Dollery and Worthington (1996) and Dell’Anno and Mour
ao (2012) have
surveyed this literature.
2
Dell’Anno and Dollery (2014) employed a Multiple Indicators Multiple Causes model
(that relies on the main indicators of fiscal illusion) to consider the relative importance of
determinants of fiscal illusion. They discovered “...the chief determinants for the deployment
of fiscal illusion strategies are the share of self–employment on total employment, the educa-
tional level of citizens, and the size of tax burden” (p. 937). In this article, the approach is
quite different. Here, the approach is to assess the relative impact of alternative sources of fis-
cal illusion on the level of government spending. It is a new approach to the extent that it
includes the full complement of the sources described in this article.
178 ANDREW ABBOTT AND PHILIP JONES
Scottish Journal of Political Economy
©2015 Scottish Economic Society
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