Academic journal article Journal of Regional Analysis & Policy

Modeling the Louisiana Local Government Fiscal Module in a Disequilibrium Environment: A Modified COMPAS Model Approach

Academic journal article Journal of Regional Analysis & Policy

Modeling the Louisiana Local Government Fiscal Module in a Disequilibrium Environment: A Modified COMPAS Model Approach

Article excerpt

Abstract. The objective of this study is to assess and measure the relative forecasting performance of local government expenditures in Community Policy Analysis Models (COMPAS) during periods of supply/demand disequilibrium. We evaluate whether a fiscal module under the COMPAS framework (an equilibrium model) fits better under a disequilibrium economic environment. We find that both a simple naïve model with one year lagged expenditure and a lagged expenditure model with revenue capacity variables significantly increased forecasting performance relative to the traditional supply/demand equilibrium model of the public sector. We also found weak evidence suggesting that in cases where the equilibrium model is used in a cross-sectional setting, quantile regression may improve forecasting performance given the heterogeneity in the quantity and quality of preferences in public services.

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1. Introduction

Most of the public service expenditure models under the community policy analysis system (COMPAS) are structured under an equilibrium condition assumption, i.e., supply equals demand (Johnson, Otto, and Deller, 2006). Based on Inman (1978), the expenditure equations tend to describe the equilibrium of public expenditure demand and supply. First, the demand side is explained, deter- mining how revenue is raised to pay for goods and services and/or how the goods and services will be produced. Second, the supply (production) side is explained by the process of transforming inputs to outputs. These models have rarely been tested in an environment where the public sector may be argued to operate in a disequilibrium environment.

The primary objective of this study is to assess whether the forecasting performance of the public sector expenditure under a COMPAS fiscal module (an equilibrium model) fits reasonably well under a disequilibrium environment. Conceptually, the fis- cal module under a COMPAS framework represents an equilibrium concept, and this equilibrium is op- erationalized by demand shifters modeled empiri- cally. These shifters, however, may not work well in a disequilibrium environment, where exogenous shocks push the public sector into an intermediate period (or long-term period) where local govern- ment public sector supply in less sensitive to tradi- tional demand curve shifting conditions. In such cases, one should consider alternative models for forecasting local government revenues and expendi- tures during the period of supply-demand disequi- librium. This study is focused on evaluating the conceptual framework for modern day local gov- ernment revenue and expenditure forecasting along with the strengths and weaknesses of such modeling in terms of empirical specification. We compare the traditional COMPAS model with a modified COM- PAS model and analyze the forecasting performance of several indicators under disequilibrium condi- tions. The study evaluates forecasting performance during the time frame of proposed disequilibrium, where the data represents a period of time of major exogenous shocks (Hurricanes Katrina, Rita, and Gustav)1 to local government.

A traditional equilibrium public service model is tested against a naïve model (that incorporates dy- namics with inclusion of a lagged dependent varia- ble) where we evaluate public service expenditure forecasting in a disequilibrium environment. The naïve model (lagged dependent variable) then is tested against the "naïve plus" model (an inclusion of revenue capacity variables in the naïve model) and a "modified naïve" model (a hybrid model that includes the naïve plus model as well as demand shifter co-variates from the traditional COMPAS empirical specification). In addition, a comparative- ly newer approach (quantile regression) is also in- troduced to evaluate its performance among existing single year cross-sectional data-based COMPAS es- timators.

The remainder of the study begins with a section that presents a historical background of local fiscal modeling. …

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