Balanced-budget rules and public deficits: Evidence from the US states

Most states (Vermont is the exception) have constitutional or statutory limitations restricting their ability to run deficits in the state's general fund. Balanced budget Limitations may be either prospective (beginning-of-the-year) requirements or retrospective (end-of-the-year) requirements. Importantly, the state limits apply only to the general fund, leaving other funds (capital, pensions, social insurance) as potential sources for deficit financing. Do these general fund balanced-budget requirements Limit deficit financing? If so, which balanced-budget rules are most effective in constraining state deficit financing? Finally, how are state spending and taxation decisions affected by balanced-budget rules? Using budget data from a panel of 47 U.S. states for the period 1970-1991, the analysis finds that state end-of-the-year (not prospective) balance requirements do have significant positive effects on a state's general fund surplus. The surplus is accumulated through cuts in spending, not through tax increases. It is saved in a state ''rainy-day'' fund in anticipation of possible future general fund deficits. We find little evidence here that the constraints ''force'' deficits into other fiscal accounts.