Economic freedom, the cost of public borrowing, and state bond ratings

The purpose of this paper is to show that state economic policies, in addition to state economic performance, impact state bond ratings.

Using a sample of 39 states over the period 1998‐2008, regression analysis is employed to determine whether various measures of economic freedom contribute to state bond ratings.

After controlling for common factors such as state per‐capita income, unemployment, the ratio of tax revenue to income, state debt as a percentage of government revenue, and public corruption, results suggest that greater economic freedom is associated with higher bond ratings. For example, a one standard deviation increase in Area 2 of the Economic Freedom of North America index (Takings and Taxation) would be associated with a 0.36 increase in Moody's bond rating for that state, which translates to approximately a $247 lower cost per million dollars of debt.

This study contributes to the empirical state bond rating literature by highlighting that states with greater economic freedom have higher bond ratings and, therefore, pay lower borrowing costs than their counterparts with lower economic freedom index scores.