We divide fiscal policy equally into spending and taxation subcategories.7 These subcategories are highly interdependent; we include them both as redundant measures of the size of government. Redundancy in variables reduces error in measuring the underlying concept.
We rate lowest the narrow, technical variable, local government budget constraints (local ownsource revenues as a percentage of local spending). Local government budget constraints, a measure of how much local governments depend on their own resources rather than on grants from state and federal governments, are a prudent fiscal measure aimed at ensuring that local governments spend within their means.8
Fiscal decentralization (local own-source revenues as a percentage of total state and local spending, adjusted for state population— higher is better) is considered to be four times as important, and state and local government employment as a percentage of total employment (lower is better) is considered to be three times as important. The remainder of the spending subcategory (onehalf of the total) is devoted to aggregate measures of state and local spending. Taxation is a simple subcategory. We include debt burden here because it represents future taxation. State and local tax revenues as a percentage of personal income (lower is better) account for threefourths of the total taxation weight—fully 9.4 percent of the total freedom score—while state and local outstanding debt as a percentage of personal income (lower is better) accounts for one-fourth of the total taxation weight.
Table 1 gives the ranking and scores of the states on fiscal policy in 2009.
7. Fiscal variables are measured for fiscal year 2008. Thus, they omit the effects of the federal stimulus, but in this edition we derive some rough estimates of the stimulus’s projected long-term effect on state taxes and spending
8. Jonathan Rodden, “Reviving Leviathan: Fiscal Federalism and the Growth of Government,” International Organization 57 (2003): 695–729.