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Output Fluctuations and Fiscal Policy: 
U.S. State and Local Governments 1978-1994
Bent E. Sorensen 
Lisa Wu 
Oved Yosha 
September 1999
Last Revised: December 2000
RWP 99-05 
Research Division 
Federal Reserve Bank of Kansas City 
    Abstract
What are the cyclical properties of U.S. state and local government fiscal policy? The budget surplus of local and, in particular, state governments is procyclical, smoothing disposable income and consumption of state residents. This happens over both short- and medium-term horizons. Procyclical surpluses are the result of strongly procyclical revenues, and weakly procyclical expenditures. The budgets of trust funds and utilities are procyclical. Federal grants are procyclical, exacerbating the cyclical amplitude of state level income movements; although they smooth the idiosyncratic component of shocks to state output. State and local budget surpluses are affected by balanced budget rules at the short- but not at the medium-term horizon. Further, budgets are less procyclical in conservative states. 

JEL Classification: E6, H72 

Bent E. Sorensen is a senior economist at the Federal Reserve Bank of Kansas City. Lisa Wu is an economist at the Department of Finance Canada. Oved Yosha is a senior lecturer at Tel Aviv University. The authors thank the Armand Hammer Fund for Economic Cooperation in the Middle East, Tel Aviv University, for support, participants at presentations at Brown and Tel Aviv universities and, especially, Robert Inman for helpful comments, Robert Inman and Stephen Mark for access to their estimates of the liabilities of state pension funds, Donna Hirsch at the U.S. Bureau of the Census for help in understanding the data, Phil Barengolts, Shu-Yi Oei, and in particular, David Tom for outstanding research assistance. The views expressed in this paper are not necessarily those of the Federal Reserve Bank of Kansas City, the Federal Reserve System, or the Department of Finance Canada. 
Sorensen e-mail: Bent.E.Sorenson@kc.frb.org
Wu e-mail: Wu.Lisa@fin.gc.ca
Yosha e-mail: Yosha@post.tau.ac.il 
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