Pay-as-You-Go Financing and Capital Outlay Volatility: Evidence from the States Over Two Recent Economic Cycles
18 Pages Posted: 11 May 2010 Last revised: 4 Sep 2010
Date Written: 2009
Pay-as-you-go (pay-go or cash) and pay-as-you-use (pay-use or debt) are two mechanisms to finance capital projects. While pay-go faces multiple constraints, pay-use smoothes outlays, stabilizes tax rates, and improves inter-generational equity. Thus, pay-use has dominated infrastructure financing for decades. In recent years, there has been revived academic interest in pay-go as an alternate financing mechanism; however, there is a large gap in the literature and inadequate evidence on the effects of pay-go, especially its effects on capital outlay volatility. This paper fills in the niche. Examining state experience over the two recent economic cycles, this paper finds evidence that suggests that pay-go is associated with lower volatility in capital spending in the long run, but may increase short-run variability. We recommend that states couple pay-go in boom years with pay-use in lean years. In unison, the two mechanisms can reduce aggregate volatility and increase long-run stability of capital expenditures.
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