The Fiscal Spillovers of Firm Risk: Tax Structure and State Finances
Abstract
How does risk among local firms affect state government finances, and how does tax structure shape states’ exposure and responses? I study these questions by linking stock return volatility to municipal bond spreads and state fiscal outcomes from 2001 to 2021. I find that higher return volatility among locally headquartered firms consistently predicts higher state borrowing costs on general obligation (GO) debt and lower tax revenue collections. Importantly, the estimated revenue decline is larger for general sales tax (GST) than for personal income tax (PIT). Although higher firm risk predicts comparable declines in statewide income and consumption, states raise PIT rates on high-income households while leaving broad-based GST rates largely unchanged. This asymmetric response appears to partly offset PIT revenue losses while leaving GST revenues exposed to tax-base declines. Consequently, states that derive a larger share of general fund revenue from GST face larger increases in borrowing costs and larger declines in tax revenue collections. To deal with these fiscal pressures, these states enact smaller budgets, cut public service spending more deeply, and are more likely to make large rainy day fund drawdowns. Overall, my findings suggest that tax structure and tax rate policy are important determinants of the fiscal consequences of firm risk. Reliance on sales taxes need not provide fiscal stability when local firm risk rises.
Presentations
Boca Finance and Real Estate Conference 2026 (scheduled), University of Maryland