A growing literature has sought to demonstrate when and how government capacity links to performance. This article examines those questions in the area of financial management. A basic challenge for state governments is to maintain budgetary stability and program predictability in face of economic downturns. State governments can best meet this challenge by developing what we call countercyclical fiscal capacity (CCFC).

The authors present the concept of CCFC as the creation and use of financial tools that help state governments maintain countercyclical spending and program stability during revenue shocks. They operationalize the concept in terms of fiscal reserves that are used to mitigate emergency-spending cuts and tax increases and analyze the operation of such reserves over a period that includes recessions in 1991 and 2001. They find evidence of the efficacy of CCFC and argue for greater investments in this aspect of government capacity.