WORKING PAPERS IN ECONOMICS No 378 The Tax-Spending Nexus: Evidence from a Panel of US State- Local Governments

We re-examine the tax-spending nexus using a panel of 50 US state-local government units between 1963 and 1997. We find that, unlike tax revenues, expenditures adjust to revert back to a long-term equilibrium relationship. The evidence on the short-term dynamics is also consistent with the tax-and-spend hypothesis. One implication of this finding is that the size of the government at the state-local level is not determined by expenditure demand, but rather by resource supply. This is consistent with the fact that many US state and local governments operate under constitutional or legislative limita-tions that seek to constrain deficits. JEL Classification: H71; H72; C33