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Fiscal Rules and State Borrowing Costs: Evidence from California and Other States

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Abstract:

Because most of California’s new infrastructure spending will be financed with long-term debt, the state’s borrowing costs are a key fiscal issue. In this study, James Poterba and Kim Rueben analyze bond market data over the last two decades to calculate the effects of three variables on state borrowing costs. Noting that a rise in unemployment increases a state’s borrowing costs, the authors maintain that fiscal rules play an equally important role. States with expenditure limits typically borrow at lower rates than others, but those with tax restrictions, or that require supermajorities to increase taxes, face higher borrowing costs than other states. Unexpected budget deficits are also associated with higher bond yields especially in states with large outstanding debts.