Tax Revenue Volatility

Abstract

Revenue volatility affects the welfare of U.S. states, which typically do not smooth their expenditures over the cycle but instead spend revenues as received. Between 2000 and 2014 U.S. state tax revenue volatility increased to 10.8% of revenues, up from 2.9% in the previous three decades. This increase was due to a combination of a rise in the volatility of state GDP, changes in tax policy that increased the exposure of tax revenues to state GDP, and other factors in the tax base. An Oaxaca-Blinder decomposition indicates that tax policy changes explain 59% of the increase in tax revenue volatility, and that increased state GDP volatility and all other changes account for 22% and 19%, respectively. This evidence implies that tax policy is responsible for much of the recent increase in state government revenue instability, and the welfare consequences that follow from it.

Keywords: State Taxes, Tax Revenue Volatility

JEL Classification: H21, H7, R51