Abstract
Federal grants represent one of the main sources of revenues for state governments and, hence, shape the way states conduct their fiscal policy. While literature on fiscal federalism and the flypaper effect had extensively studied how grants influence subnational spending, there is relatively few evidence on the responsiveness of state tax decisions to changes on intergovernmental revenues. This paper analyzes and characterizes long-term trends on personal income tax policy of US states and explores how it is influenced by state’s reliance on federal grants as source of fiscal revenues. First, the empirical analysis shows there is a persistent trend on reductions on the top PIT rate across states. Results from our regression analysis suggest federal grants decrease the likelihood of states changing their taxes in the short-term, and in the long-term it increase (decrease) the likelihood of implementing policies that reduce (increase) the tax rate. These results shed some light on the implications of federal grants as a source of fiscal space for state governments, and provide some insights on the factors behind the long-term trends observed in state income taxation.
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Federal grants represent one of the main sources of revenues for state governments and, hence, shape the way states conduct their fiscal policy. While literature on fiscal federalism and the flypaper effect had extensively studied how grants influence subnational spending, there is relatively few evidence on the responsiveness of state tax decisions to changes on intergovernmental revenues. This paper analyzes and characterizes long-term trends on personal income tax policy of US states and explores how it is influenced by state’s reliance on federal grants as source of fiscal revenues. First, the empirical analysis shows there is a persistent trend on reductions on the top PIT rate across states. Results from our regression analysis suggest federal grants decrease the likelihood of states changing their taxes in the short-term, and in the long-term it increase (decrease) the likelihood of implementing policies that reduce (increase) the tax rate. These results shed some light on the implications of federal grants as a source of fiscal space for state governments, and provide some insights on the factors behind the long-term trends observed in state income taxation.
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