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State and Local Government Fiscal Constraints: Public Sector and Private Sector Effects

The Tennessee Econometric Model is employed to simulate the effects of alternative fiscal limits on a state economy. Limits modelled on those currently in effect in California, Colorado, New Jersey, and Tennessee are applied using both an elastic and an inelastic revenue structure. Economic and fiscal effects depend on the elasticity of the revenue structure, the coverage of the limits, the degree of restraint imposed by the limit, whether business or individual taxes are reduced, and the timing of tax reductions. The limits have a greater constraining effect on elastic structures. A frequent effect of the limits is a reduction in the size of the public sector and a small increase in the private sector with the overall level of economic activity generally declining. Fiscal limits are found to have more stimulative economic effects if the tax relief is business-oriented, so that the net economic effect may be positive.