THE IMPACT OF REVENUE DIVERSIFICATION AND ECONOMIC BASE ON REVENUE STABILITY: AN EMPIRICAL ANALYSIS OF COUNTY AND STATE GOVERNMENTS

In recent decades, revenue diversification has become a prevalent practice in state and local government finance. The trend of revenue diversification, according to the portfolio theory, has far-reaching implication for public financial management as it may change revenue stability, which has been an important policy objective for state and local government administrators. This study explores how revenue diversification affects revenue stability from both empirical and theoretical perspectives. Drawing on portfolio theory and regional science literature, this study develops a theoretical framework to explain how the effect of revenue diversification on revenue volatility of sub-national governments varies in terms of its economic base instability. To empirically test the theoretical framework, an econometric model that explores a series of factors that could affect revenue stability is estimated using socioeconomic and fiscal data of 156 Georgia county governments and 47 state governments during the years 1986-2004. The findings indicate that revenue diversification affects revenue stability conditional on the instability of a jurisdiction’s economic base. The county level analysis suggests revenue diversification significantly increases the revenue instability of a county that has a stable economic base and the revenue stabilizing effect of diversification is enhanced as an economic base becomes more unstable. However, the state level analysis shows that revenue diversification significantly reduces revenue volatility for a state that has a stable economic base and the revenue stabilizing effect of diversification decreases when an economic base gets more unstable. An important policy implication of the dissertation is that the degree of revenue diversification should be gauged by the condition of its corresponding economic base in order to achieve the goal of revenue stability