Assessing the Impact of Tax and Expenditure Limitations on the U.S. State's Debt and Pension Solvency: A Dynamic Model

ABSTRACT This study examines how tax and expenditure limitations (TELs) reduce government impact on long‐term and pension solvencies. It tests whether the fiscal illusion assumption, which postulates government expansion using long‐term debt, holds when TELs are adopted at the state level. Our results provide evidence that TELs are not significant in the case of long‐term debt. The evidence regarding pension funding is mixed, with significant results in the case of improving the most visible category, the per capita unfunded pension. These findings support the fiscal illusion hypothesis, implying that fiscal instruments such as TELs are ineffective in expenditure categories that are less transparent to the taxpayers. This study contributes to the budget literature by providing empirical evidence in support of the fiscal illusion theory. It also warns practitioners to be fiscally prudent with long‐term debt.