Flicking through the Queensland Budget papers I was reminded that Australian State Governments aren’t fettered like their cousins in the US, with many US states forced by state constitutions to run balanced budgets.  In recessions, when tax revenues fall, balanced budget rules require many US states to cut expenditures, which is precisely the wrong thing to do in a downturn.

While you can legitimately debate the effectiveness of stimulus measures (e.g., new spending or tax cuts) in a recession, it’s pretty uncontroversial that you shouldn’t be cutting expenditures.  Luckily Australian State Governments can let their Budgets temporarily slip into deficit as tax revenues decline, so spending can at least be maintained on its previous trajectory.

With US state governments having to balance their budgets, you can end up with perverse fiscal policy – the negative stimulus from the state governments can offset any positive stimulus from the US federal government.  Prof. Alvin Hansen (Keynes’s biggest promoter in the US) argued in the forties that this “fiscal perversity” was a contributor to the duration and severity of the Depression.

Unfortunately, fiscal perversity may still afflict the US: Stimulus? What stimulus?

We can be thankful for Australia’s flexible fiscal policies and institutions.