The Impact of Subnational Fiscal Policies on Economic Growth: A Dynamic Analysis Approach

Much previous research has analyzed the effect of state and local taxes and expenditures on economic growth, but usually in a static manner. In this paper, we use panel vector autoregression (PVAR) to examine the effects of taxes and expenditures on state income growth. This methodology allows us to treat all variables in the model as endogenously determined. Our approach allows us to address the endogeneity problem inherent in fiscal policy research as well as to obtain results for both the short term and intermediate term (up to six years). Consistent with prevailing wisdom, taxes are shown to have a negative effect on economic growth, but the effect only is present in the short run. Public capital spending has a positive effect on growth in both the short and intermediate terms. Operational expenditures exhibit positive effects on growth over the entire analysis period.