Changing State Fiscal Capacity and Tax Effort in an Era of Devolving Government, 1981–2003

Abstract

The American system of fiscal federalism requires that state and local governments finance the bulk of their budgets from own-source revenues, not transfers. This article analyzes state total taxable resources from 1981 to 2003 to evaluate how state fiscal capacity has changed in that time and how it has been affected by national recessions, to examine the extent to which fiscal capacity differs among states and whether capacity has converged, and to consider whether states have responded to service demands by changing tax effort and whether tax effort has converged in the face of interstate competition and other harmonizing forces. Because the capacity measure employed here can be compared across years, something impossible with major alternative indices, the analysis provides insights important to the analysis of fiscal federalism and of the implications of revenue devolution not previously possible.