Research Handbook on City and Municipal Finance (Elgar Handbooks in Public Administration and Management) 1800372957, 9781800372955

Table of contents :
Front Matter
Copyright
Contents
Contributors
Introduction to the Research Handbook on City and Municipal Finance
Part I Raising revenues and spending funds
1 Municipal revenues: data dilemmas, structures, and trends
2 Property taxes and municipal finance
3 Local option taxes
4 The growing role of nontax revenue sources in American cities
5 Municipalities in the intergovernmental revenue system: the federal government’s stabilization function?
6 The role of cities and public health expenditures in the COVID-19 era
7 Spending on physical infrastructure: is it enough?
8 Mitigating fiscal risk through municipal cybersecurity
Part II Fiscal organization structure, budgeting, and financial condition
9 The role of special districts and intergovernmental constraints
10 Municipal financial risks: special-purpose district financial health during COVID-19
11 Municipal budgets, balance sheets, and acute fiscal shock
12 Understanding financial success: an exploration of the determinants of fiscally healthy cities
13 State intervention in local government fiscal distress
14 The fiscal structure of county governments from 2002 to 2019: the impact of the Great Recession and the run-up to the COVID-19 pandemic
Part III Debt and pensions
15 The security, structure, and market of municipal debt: recent trends, research, and developments
16 The status of municipal financial intermediaries after the financial crisis and Dodd-Frank: underwriters, insurers, advisors, and credit rating agencies
17 The structure of county government debt from 2002 to 2020: the financial crisis, the Great Recession, and the COVID-19 pandemic
18 The impact of fiscal rules on local debt: credit ratings, borrowing costs, and debt levels
19 Do municipal pensions matter? A review of pensions’ impact on US local governments
Part IV City and municipal finance across the globe
20 Municipal finance in federalist systems
21 Municipal finances in unitary systems: the effects of crises on financial autonomy in four European countries
22 Government financial resilience – a European perspective
23 Measuring urban financial resilience: a resource flow perspective
24 Managing crises and public financial management in Singapore
Conclusion: themes and directions for future research
Index

Citation preview

RESEARCH HANDBOOK ON CITY AND MUNICIPAL FINANCE

ELGAR HANDBOOKS IN PUBLIC ADMINISTRATION AND MANAGEMENT This series provides a comprehensive overview of recent research in all matters relating to public administration and management, serving as a definitive guide to the field. Covering a wide range of research areas including national and international methods of public administration, theories of public administration and management, and technological developments in public administration and management, the series produces influential works of lasting significance. Each Handbook will consist of original contributions by preeminent authors, selected by an esteemed editor internationally recognized as a leading scholar within the field. Taking an international approach, these Handbooks serve as an essential reference point for all students of public administration and management, emphasizing both the expansion of current debates, and an indication of the likely research agendas for the future. For a full list of Edward Elgar published titles, including the titles in this series, visit our website at www.e-elgar.com.

Research Handbook on City and Municipal Finance

Edited by

Craig L. Johnson Associate Professor of Public Finance and Policy Analysis, Paul H. O’Neill School of Public and Environmental Affairs, Indiana University, Bloomington, USA

Temirlan T. Moldogaziev Associate Professor of Public Finance and Management, Paul H. O’Neill School of Public and Environmental Affairs, Indiana University, Bloomington, USA

Justin M. Ross Professor of Public Finance and Economics, Paul H. O’Neill School of Public and Environmental Affairs, Indiana University, Bloomington, USA

ELGAR HANDBOOKS IN PUBLIC ADMINISTRATION AND MANAGEMENT

Cheltenham, UK • Northampton, MA, USA

© Craig L. Johnson, Temirlan T. Moldogaziev and Justin M. Ross 2023 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical or photocopying, recording, or otherwise without the prior permission of the publisher. Published by Edward Elgar Publishing Limited The Lypiatts 15 Lansdown Road Cheltenham Glos GL50 2JA UK Edward Elgar Publishing, Inc. William Pratt House 9 Dewey Court Northampton Massachusetts 01060 USA A catalogue record for this book is available from the British Library Library of Congress Control Number: 2023941879 This book is available electronically in the Political Science and Public Policy subject collection http://dx.doi.org/10.4337/9781800372962

ISBN 978 1 80037 295 5 (cased) ISBN 978 1 80037 296 2 (eBook)

EE VS P

Typeset by Cheshire Typesetting Ltd, Cuddington, Cheshire

Contents viii

List of contributors Introduction to the Research Handbook on City and Municipal Finance Craig L. Johnson, Temirlan T. Moldogaziev, and Justin M. Ross

1

PART I  RAISING REVENUES AND SPENDING FUNDS   1 Municipal revenues: data dilemmas, structures, and trends Justin M. Ross and Lanjun Peng

8

  2 Property taxes and municipal finance Joan Youngman

24

  3 Local option taxes Whitney Afonso

42

  4 The growing role of nontax revenue sources in American cities Min Su

64

  5 Municipalities in the intergovernmental revenue system: the federal ­government’s stabilization function? Amanda Kass, Christiana McFarland, Farhad Omeyr, and Michael A. Pagano

88

  6 The role of cities and public health expenditures in the COVID-19 era Yusun Kim

105

  7 Spending on physical infrastructure: is it enough? Yonghong Wu

138

  8 Mitigating fiscal risk through municipal cybersecurity Douglas A. Carr

159

PART II FISCAL ORGANIZATION STRUCTURE, BUDGETING, AND FINANCIAL CONDITION   9 The role of special districts and intergovernmental constraints Christopher B. Goodman

173

10 Municipal financial risks: special-purpose district financial health during COVID-19187 Temirlan T. Moldogaziev, Marc Joffe, and Allan Wheeler 11 Municipal budgets, balance sheets, and acute fiscal shock Robert S. Kravchuk

v

204

vi  Research handbook on city and municipal finance

12 Understanding financial success: an exploration of the determinants of fiscally healthy cities Bruce D. McDonald III and Michaela E. Abbott 13 State intervention in local government fiscal distress Lang (Kate) Yang 14 The fiscal structure of county governments from 2002 to 2019: the impact of the Great Recession and the run-up to the COVID-19 pandemic Craig L. Johnson, Luis Navarro, and Andrey Yushkov

220 235

257

PART III  DEBT AND PENSIONS 15 The security, structure, and market of municipal debt: recent trends, research, and developments W. Bartley Hildreth and Justina Jose

271

16 The status of municipal financial intermediaries after the financial crisis and Dodd-Frank: underwriters, insurers, advisors, and credit rating agencies Martin J. Luby and Joshua E. Terkel

301

17 The structure of county government debt from 2002 to 2020: the financial crisis, the Great Recession, and the COVID-19 pandemic Craig L. Johnson, Andrey Yushkov, and Luis Navarro

319

18 The impact of fiscal rules on local debt: credit ratings, borrowing costs, and debt levels Sungho Park, Craig S. Maher, and Steven C. Deller

335

19 Do municipal pensions matter? A review of pensions’ impact on US local governments352 Gang Chen PART IV  CITY AND MUNICIPAL FINANCE ACROSS THE GLOBE 20 Municipal finance in federalist systems Chris Thayer, Alex Hathaway, and Jorge Martinez-Vazquez 21 Municipal finances in unitary systems: the effects of crises on financial autonomy in four European countries Ringa Raudla, Mark Callanan, Kurt Houlberg, and Filipe Teles

370

391

22 Government financial resilience – a European perspective Carmela Barbera, Bernard Kofi Dom, Céline du Boys, Sanja Korac, Iris Saliterer, and Ileana Steccolini

408

23 Measuring urban financial resilience: a resource flow perspective Christine R. Martell and Temirlan T. Moldogaziev

433

Contents  ­vii

24 Managing crises and public financial management in Singapore Chang Yee Kwan and Hui Lee

453

Conclusion: themes and directions for future research Craig L. Johnson, Temirlan T. Moldogaziev, and Justin M. Ross

469

Index

476

Contributors Michaela E. Abbott is a PhD candidate in public administration at North Carolina State University, USA. She is a doctoral fellow of the Municipal Research Lab and the editorial assistant for the Journal of Public Affairs Education. Whitney Afonso is an associate professor at the University of North Carolina, USA, at Chapel Hill’s School of Government. Whitney’s research focuses on state and local public finance with an emphasis on local sales taxes. Her work has appeared in journals including the National Tax Journal, Public Budgeting & Finance, Public Finance Review and Public Administration Review. In addition to her traditional research and teaching, her position engages her with elected officials and practitioners. Carmela Barbera is a researcher at the University of Bergamo, Italy. Her research focuses on public sector accounting and public administration and management, with special attention on the roles of accounting systems, governmental financial resilience, performance measurement, accountability, social reporting, and participatory mechanisms in public service production. Mark Callanan is a senior lecturer with the Whitaker School of Government and Management at the Institute of Public Administration in Dublin, Ireland. His research interests include local government territorial reforms and boundary change, participative structures in local government, and performance measurement, efficiencies, and economies of scale in local government. Douglas A. Carr is associate professor and Master of Public Administration program director at Oakland University, USA. His public finance research includes a focus on public sector information technology management, and he is a faculty member of the Oakland University Center for Cybersecurity. Gang Chen is an associate professor of public administration in the Rockefeller College of Public Affairs and Policy at the University at Albany, SUNY, USA. He is also the co-director of the State and Local Government Finance Project (SLGF) at the Center for Policy Research at Rockefeller College. His research focuses on state and local government budgeting, public financial management, and the governance of state and local pension plans. Steven C. Deller is a professor in the Department of Agricultural and Applied Economics at the University of Wisconsin–Madison, USA, and a Community Economic Development Specialist within the UW–Madison Division of Extension. Some of his work has explored the community economic impacts of women-owned businesses, manufacturing location decisions, local foods as a community development strategy, how public infrastructure influences local economies, and the role of taxes and public services in community economic growth and development. viii

Contributors  ­ix

Bernard Kofi Dom is a lecturer in accounting and finance at the Nottingham Business School, Nottingham Trent University, UK. He has also been a research officer at Essex Business School, University of Essex, UK. His research interests include private and public sector accountability and management, governmental financial resilience with perceived (financial) vulnerability, and organizational resilience in the public sector. Céline du Boys is an associate professor of public management and finance at the Institute of Public Management and Territorial Governance (IMPGT), Aix-Marseille University, France. Her research relates to public management and public financial management, with a special interest in local government financial management, budgeting, and resilience. Christopher B. Goodman is an associate professor of public administration at Northern Illinois University, USA. His research interests include local public finance, local governments, including fragmentation and special districts, and intergovernmental affairs, particularly state preemption of local laws. Alex Hathaway is a senior research associate in the Public Finance Research Cluster at Georgia State University, USA, specializing in state fiscal health. He is the principal investigator on the center’s multi-state evaluation of budgeting and financial management practices for the Volcker Alliance’s Truth and Integrity in Government Finance project. His other areas of interest include healthcare systems and finance, aging policy, and program evaluation. W. Bartley Hildreth is Professor Emeritus and a former dean in the Andrew Young School of Policy Studies at Georgia State University and Professor Emeritus of Public Finance at Wichita State University, USA. He was a municipal bond issuer official in two states and on the board of directors of the Municipal Securities Rulemaking Board. He received the Aaron B. Wildavsky Award for lifetime scholarship in public budgeting and finance and is the long-standing editor-in-chief of the Municipal Finance Journal. Kurt Houlberg is a professor of political science/public policy at VIVE, the Danish Center for Social Science Research. His research covers local government finance, policy and management, local government reform, public policy, public administration, and contracting out. His recent publications include articles published in American Political Science Review, European Journal of Political Research, Journal of Public Administration Research and Theory, Public Administration Review, Public Administration, Urban Affairs Review, and Local Government Studies. Marc Joffe is a federalism and state policy analyst at the Cato Institute, Washington, DC, USA and previously served as a senior policy analyst at the Reason Foundation. After a long career in the financial industry, including a senior director role at Moody’s Analytics, Joffe’s research focuses on municipal finances, alternative asset investments, transportation policy, and federal, state, and local fiscal policy.

x  Research handbook on city and municipal finance

Craig L. Johnson is an associate professor of public finance and policy analysis in the O’Neill School of Public and Environmental Affairs at Indiana University, Bloomington, USA. Johnson teaches courses on public finance and budgeting, state and local debt finance, financial markets, institutions, and instruments. He has won several teaching awards throughout his career. He has published extensively on state and local capital markets and public financial management. His latest scholarly articles appear in Eurasian Geography and Economics, Public Budgeting & Finance and Journal of Public Budgeting, Accounting & Financial Management. His latest co-authored book, State and Local Financial Instruments: Policy Changes and Management (Edward Elgar Publishing, 2021), covers the municipal securities market and fiscal federalism. His co-edited volume, Tax Increment Financing and Economic Development: Uses, Structures, and Impact (State University of New York Press, 2019), covers economic development financing and local general government and special district finances. Justina Jose is an assistant professor in the School of Public Affairs at San Diego State University, USA. Her research interests lie in public financial management with a special focus on public debt management. Justina is interested in examining inter-governmental relationships and their impact on local government fiscal outcomes. She recently received her PhD from the Andrew Young School of Policy Studies at Georgia State University with a specialization in public budgeting and finance. Amanda Kass is an assistant professor in the School of Public Service at DePaul University, USA. She is interested in the ways in which finance shapes and is shaped by geographies of economic and racial inequality, particularly at the local scale. Her research concerns public finance, public pensions, housing markets, and urban governance. Yusun Kim is an assistant professor in the School of Public Policy at the University of Connecticut, USA. She works in the areas of public finance and health policy. Her scholarship explores intergovernmental fiscal relations, property tax administration, as well as the fiscal and health impacts of natural disasters and viral outbreaks. Sanja Korac is a professor of public management at the German University of Administrative Sciences Speyer, and scientific director of the executive training program FKS Fuehrungskolleg Speyer. She is a board member of the International Research Society for Public Management (IRSPM) and active member of academic societies in the field of public management, public administration, and economics. In her research, she focuses on performance management, accounting and accountability in the public service provision, public personnel management, public service motivation, and public sector innovation. Robert S. Kravchuk is a professor emeritus in the Indiana University O’Neill School of Public and Environmental Affairs, USA. His research focuses on US public finance and budgeting, post-Keynesian economics, and monetary economics. He has authored numerous academic books and journal articles. He has taught at the University of Connecticut, the Ukrainian Academy of Public Administration, and the University of North Carolina at Charlotte. Kravchuk holds a PhD from the Maxwell School of Citizenship and Public Affairs at Syracuse University.

Contributors  ­xi

Chang Yee Kwan is a non-resident fellow at the Center for Southeast Asian Studies, National Chengchi University, Taiwan. He previously held appointments at Xiamen University Malaysia and the National University of Singapore. His research interests include macroeconomics, public economics, and policy design. Among others, his research has been published in the Australian Journal of Public Administration, Bulletin of Economic Research, Policy Studies, and the Singapore Economic Review. Hui Li is an assistant professor in the Department of Public Administration at California State University, Dominguez Hills, USA. Previously, she worked as an assistant professor at the National University of Singapore and Eastern Michigan University. Her research interests lie in fiscal decentralization and intergovernmental fiscal relations, local government finance and governance, and corruption and development in emerging economies. Her articles have appeared in Journal of Urban Affairs, Land Use Policy, Public Finance and Management, among other outlets. Martin J. Luby is an associate professor at the University of Texas at Austin’s LBJ School of Public Affairs, USA. His teaching and research broadly focus on public finance with an emphasis on public financial management. Much of this research has focused on the municipal securities market and the use of debt finance by state and local governments. He also has extensive banking, consultant, and financial advisory experience with many state and local governments as well as the federal government. Craig S. Maher is a professor and current director of the School of Public Administration at the University of Nebraska Omaha, USA. His primary research interest is public finance, with emphases on financial condition analysis, fiscal federalism, and revenue policy. His most recent work is Understanding Municipal Fiscal Health: A Model for Local Governments in the USA, co-authored with Sungho Park, Bruce McDonald, and Steven Deller (Routledge, 2023). Christine R. Martell is an associate dean and professor of public finance and public policy at the School of Public Affairs, University of Colorado Denver, USA. Dr Martell specializes in the nexus of public finance and international development issues, public financial management, financial resilience, local government fiscal capacity building, fiscal federalism, subnational capital markets, and fiscal institutions. Jorge Martinez-Vazquez is Regents Professor of Economics Emeritus at Georgia State University, USA and founding director of the International Center for Public Policy. He has published over 25 books and numerous articles in journals, such as Econometrica and the Journal of Political Economy. He has been involved in fiscal reform projects in over 90 countries, including China, Russia, Pakistan, Indonesia, and Mexico. He is the recipient of numerous prizes and awards and has directed or participated in over 100 doctoral dissertations. Bruce D. McDonald III is a professor of public budgeting and finance at North Carolina State University, USA. He is the editor-in-chief of Public Administration, co-editor-inchief of both the Journal of Public Affairs Education and Public Finance Journal. He is

xii  Research handbook on city and municipal finance

also a general editor for both the Routledge Public Affairs Education and the Routledge Public Budgeting and Finance book series. Christiana McFarland is director of the Center for Innovation Strategy and Policy at SRI International. She leads analysis, strategy, and policy development to improve the innovation potential, economic competitiveness, equity, and livability of states and regions. Prior to joining SRI, she was research director of the National League of Cities (NLC). Temirlan T. Moldogaziev  is an associate professor of public finance and management in the O’Neill School of Public and Environmental Affairs at Indiana University, Bloomington, USA. His primary research interests are in public sector management, regional and local governance, public sector infrastructure financing, and fiscal policy. He is co-author of  Information Resolution and Subnational Capital Markets (Oxford University Press, 2021)  and  State and Local Financial Instruments: Policy Changes and Management (Edward Elgar Publishing, 2021). His recent articles have been published by  Governance,  International Public Management Journal, Journal  of Public Administration Research and Theory, Public Administration Review, Public Administration and Development, Public Budgeting & Finance, and Urban Studies.  Luis Navarro is a PhD student in public affairs in the O’Neill School of Public and Environmental Affairs at Indiana University, Bloomington, USA. His research interests include public finance and public economics topics like local tax policy, municipal debt markets, and fiscal federalism. Farhad Omeyr is program director of Research and Data at the National League of Cities (NLC), USA. His research focuses on financial management and fiscal policy issues of state and local governments, particularly related to municipal capital and infrastructure budgeting and spending, municipal bond markets, and municipal tax authorities. He leads NLC’s projects City Fiscal Conditions (CFC), State of the City (SOTC), and the newly introduced Municipal Infrastructure Conditions (MIC). Michael A. Pagano is Professor Emeritus and Dean Emeritus of the University of Illinois Chicago’s (UIC) College of Urban Planning and Public Affairs, USA, founding director of UIC’s Government Finance Research Center, elected fellow of the National Academy of Public Administration, co-editor of Urban Affairs Review (2001–14), and former nonresident senior fellow of the Brookings Institution’s Metropolitan Policy Program. He has published 12 books, and over 100 articles on urban finance, capital budgeting, federalism, infrastructure, urban development, and fiscal policy. Sungho Park is an assistant professor of public policy and administration at the Department of Political Science, University of Alabama, USA. His research interests include state and local budgeting and finance with emphases in fiscal federalism, fiscal rules and institutions, and fiscal condition. He has recently published in the American Review of Public Administration, Public Budgeting & Finance, Public Performance & Management Review, Local Government Studies, and other journals.

Contributors  ­xiii

Lanjun Peng is a PhD candidate and associate instructor in the O’Neill School of Public and Environmental Affairs at Indiana University, Bloomington, USA. Her research interests include public budgeting and finance, state and local government administration, zoning, and tax policy evaluation. Ringa Raudla is a professor of fiscal governance at Ragnar Nurkse Department of Innovation and Governance, Tallinn University of Technology, Estonia. Her main research interests are fiscal policy, public budgeting, public administration reform, and institutional economics. Her recent publications include articles in Public Administration Review, Governance, Public Administration, Policy Studies Journal, the American Review of Public Administration, Journal of Public Policy, Public Money & Management, Public Budgeting & Finance, Journal of Comparative Policy Analysis, Urban Affairs Review, and Public Choice. Justin M. Ross is a public finance economist specializing in state and local tax policy. Ross teaches public revenue theory, public managerial economics, and benefit–cost analysis and is a two-time recipient of Indiana University’s Trustees Teaching award. His primary research interests include property tax-related issues such as assessment and zoning, and he explores local governments’ use and access to the property tax by examining how it affects politics, fiscal capacity, land use regulation, and community decisions. His published works appear in the top public finance, economics, and public administration journals. Iris Saliterer is a professor of public and non-profit management at the Faculty of Economics and Behavioral Sciences at the University of Freiburg, Germany. Her research focuses on performance management and the implementation of accounting reforms in public entities, and she frequently publishes on governmental resilience. Ileana Steccolini is a professor of accounting and the director of research at Essex Business School, University of Essex, UK, and a professor of accounting and public management at the University of Bologna, Italy. Her expertise develops at the interface among accounting and public administration and management. She has published on public sector accounting, budgeting, performance management and accountability, reform and change processes, governmental financial resilience, and participation in public services. Min Su is an associate professor in the Department of Public Administration at Louisiana State University, USA. She received a PhD in public policy from Georgia State University and Georgia Institute of Technology (joint program). Her research interests include public budgeting, public and nonprofit financial management, state and local revenues, and municipal finance. Filipe Teles is a pro-rector for regional development and urban policies at the University of Aveiro, Portugal. He is a member of the Research Unit on Governance, Competitiveness and Public Policy. He is currently president of the European Urban Research Association and member of the Steering Committee of the standing group on Local Government

xiv  Research handbook on city and municipal finance

and Politics of the European Consortium for Political Research. He serves as the editor of the recently published Handbook on Local and Regional Governance (Edward Elgar Publishing, 2023). Joshua E. Terkel is a graduate of the University of Texas at Austin’s LBJ School of Public Affairs, USA. He currently consults for state and local and federal government agencies at the intersection of innovation and human-centered design. Chris Thayer is a data scientist with the Georgia Policy Labs (GPL), Georgia State University, USA, specializing in data preparation, de-identification of sensitive data, and science & policy communications. Chris received master’s degrees in public policy and city & regional planning from the Georgia Institute of Technology and bachelor’s degrees in business administration and English from Otterbein University, USA. Prior to joining GPL full-time, they served as a research associate in the Andrew Young School’s Public Finance Research Cluster. Allan Wheeler is an institutional research data specialist at Los Angeles Pacific University, USA. Yonghong Wu is a professor and director of graduate studies (MPA/MPP) in the Department of Public Policy, Management, and Analytics at the University of Illinois Chicago, USA. His recent research has focused on topics of state and local public finance, fiscal policymaking of municipal governments, and government support of academic research in higher education institutions. Lang (Kate) Yang is an assistant professor at the Trachtenberg School of Public Policy and Public Administration at George Washington University, USA. Her research interest is in public finance, education finance, intergovernmental relations, and government transparency. Joan Youngman is a senior fellow at the Lincoln Institute of Land Policy in Cambridge, Massachusetts, USA. Her research interests include property taxation, land value taxation, and valuation for tax purposes. Andrey Yushkov is a PhD candidate and associate instructor in the O’Neill School of Public and Environmental Affairs at Indiana University, Bloomington, USA. His research explores various topics in subnational public finance, including fiscal federalism, the political economy of intergovernmental relations, and state and local borrowing.

Introduction to the Research Handbook on City and Municipal Finance

Craig L. Johnson, Temirlan T. Moldogaziev, and Justin M. Ross

Cities and municipalities can be viewed as society’s spinal cord, facilitating the delivery of essential services to citizens across the globe. Such services managed and delivered by elected officials and administrators must be paid for with revenues from households and businesses. This Handbook describes, explains, and theorizes about how city and municipal finances are and should be handled in the 21st century. We have brought together leading global scholars from the fields of public finance and budgeting, financial economics, law, public management and accounting, political science, and policy analysis, to author chapters covering city and municipal finance from an expert perspective, weaving together the foremost theoretical ideas, empirical findings, and practical applications. This Handbook, written during the COVID-19 pandemic, represents a first pass at understanding the impact of the pandemic on city and municipal government finances. The Handbook describes and analyzes the initial impact of the pandemic, as well as looks back at the effects of the financial crisis and Great Recession, showing how cities and municipalities have adapted their finances, institutions, structures, and relationships during and following crisis periods. The analysis and insights herein will help policymakers and administrators, teachers and students, scholars and others guide city and municipal finances in the future. It also highlights some of the most significant new areas for future research and practice. A running theme through the book is the strength and resilience of city and municipal finances. In addition to this Introduction and the concluding chapter, 24 chapters written by leading experts reveal the ability of cities and municipalities to meet longer-term liabilities or make quick, nimble, and effective short-term responses to crises after crises. This bodes well for their future, given the strength and resilience they have shown in the face of extreme adversity in the early 21st century. The governance context of the Handbook is primarily city and municipal finance as it occurs in a federalist system. But we also include cities and municipalities across the world that operate within other national systems, particularly unitary systems. An entire part of the Handbook is devoted to the global and comparative perspective. It covers city and municipal finances in different countries, exploring how different cities and municipalities operate across different governance contexts, political, administrative, and fiscal systems.

BOOK STRUCTURE We continue in this Introduction by providing an overview of the central themes and structure of the book. The Handbook is organized into four parts, as follows. 1

2  Research handbook on city and municipal finance

Part I: Raising Revenues and Spending Funds Part I begins with five chapters that describe and analyze city and municipal sources of revenue. Chapter 1, “Municipal revenues: data dilemmas, structures, and trends,” by Justin M. Ross and Lanjun Peng, provides an overview of the revenue structure of city governments in the United States from 1972 to 2017, with a focus on revenue changes since the Great Recession. Chapter 1 also shows the differing results and impressions that may be obtained from the alternative revenue data sources widely used by researchers. The next three chapters in Part I, Chapters 2, 3 and 4, cover several mainstay own-source revenues: property taxes, local option taxes, and nontax revenues. The ability to generate substantial revenues from their own sources gives cities and municipalities a level of fiscal independence and control over their own fiscal affairs. The final revenue chapter, Chapter 5 on intergovernmental revenues, highlights the inter-connectedness of cities and municipalities, states, regions, and national governments in the intergovernmental revenue system. In Chapter 2, “Property taxes and municipal finance,” Joan Youngman shows how the property tax provides a stable source of independent revenue, particularly well-suited to financing local governments, as well as the challenges involved in real estate valuation and effective administration. In addition, the administrative history of property taxation provides added insight into current asset and wealth taxation debates. As aptly concluded by Joan Youngman, “centuries of experience with the taxation of real property offer important lessons for asset and wealth taxes of all types.” In Chapter 3, “Local option taxes,” Whitney Afonso describes the variety of local option taxes (LOTs) used by local governments. LOTs have become a key component of local own-source revenues. The chapter describes the benefits and concerns of levying LOTs, and analyzes their impact on consumption and labor, cross-border shopping, fiscal disparities, and the impact of the COVID-19 pandemic and recession on such taxes. In Chapter 4, Min Su makes the case that the revenue structure in American cities has shifted to more reliance on nontax revenue sources, such as charges, fees, interest earnings, fines, forfeitures, and special assessments. In “The growing role of nontax revenue sources in American cities,” Min Su surveys the use of nontax revenues over the Great Recession and the COVID-19-induced recession. The chapter also examines the strategic use of fines and forfeits by government officials, the fastest growing source of nontax municipal revenue. In Chapter 5, “Municipalities in the intergovernmental revenue system: the federal government’s stabilization function?” Amanda Kass, Christiana McFarland, Farhad Omeyr, and Michael A. Pagano detail the fiscal relationship between US cities and the federal government. Their analysis starts with changes in federal transfers to cities during the 20th century and continues through shifts in federal support to cities during the COVID-19 pandemic, focusing on the Coronavirus Aid, Relief, and Economic Security (CARES) Act in 2020 and American Rescue Plan Act (ARPA) in 2021. The next chapters in Part I analyze three critical areas of city and municipal government spending. In Chapter 6, “The role of cities and public health expenditures in the COVID-19 era,” Yusun Kim explains the role of city governments and their health departments in spending funds to provide public health services. Kim examines the dynamic intergovernmental fiscal relations enabling the delivery of critical healthcare

Introduction  ­3

services by city governments in response to the COVID-19 pandemic, including descriptive analyses of New York City and San Francisco. Chapter 7, written by Yonghong Wu, addresses the basic capital improvements question in city and municipal finance. In “Spending on physical infrastructure: is it enough?” Wu examines the condition of the infrastructure of the 25 most populous cities in the United States, describing the barriers to appropriate levels of spending and providing insights into how governments can make up for infrastructure investment deficiencies. Douglas A. Carr analyzes the intersection of cybersecurity and municipal finance in Chapter 8, “Mitigating fiscal risk through municipal cybersecurity.” Carr provides specific guidance to government officials on how they can reduce their governments’ risk from significant and unexpected fiscal shocks to city and municipal budgets from cybersecurity attacks. Part II: Fiscal Organization Structure, Budgeting, and Financial Condition Part II begins with two chapters on special districts, in recognition of the fact that not all local governments are general-purpose governments. Though often overlooked, special districts are the most common single form of local government in the United States. In Chapter 9, “The role of special districts and intergovernmental constraints,” Christopher B. Goodman answers two basic questions: Why do special districts exist? And what are the effects of such governance arrangements on local fiscal outcomes? Goodman argues that the connection between special district proliferation and state fiscal restrictions on cities is an essential missing link in state–local government policymaking. In Chapter 10, “Municipal financial risks: special-purpose district financial health during COVID-19,” Temirlan T. Moldogaziev, Marc Joffe, and Allan Wheeler analyze the financial risk of two types of special-purpose districts in the state of California – community college districts (CCDs) and healthcare districts (HCDs). Both special-purpose districts are  organized around social policy-oriented service delivery tasks, and the analysis in the chapter covers the fiscal impact from the first wave of the COVID-19 pandemic on CCDs and HCDs in California. In contrast to the typical operating statement based financial analysis, Robert S. Kravchuk in Chapter 11 provides a balance sheet framework for understanding municipal liquidity. In “Municipal budgets, balance sheets, and acute fiscal shock,” Kravchuk presents municipal government liquidity as a multi-dimensional concept and provides an analytical approach and asset classification scheme to frame government balance sheets in a useful manner for financial administrators. In Chapter 12, “Understanding financial success: an exploration of the determinants of fiscally healthy cities,” Bruce D. McDonald III and Michaela E. Abbott provide an empirical model for understanding fiscally healthy cities. They use an event history analysis (EHA) methodology to analyze city fiscal health using a data set of the 150 largest cities in the United States from 1990 to 2017. While most studies on municipal fiscal condition focus on fiscal ill-health, this chapter provides a fresh look at the drivers of fiscally healthy municipalities. In Chapter 13, “State intervention in local government fiscal distress,” Lang (Kate) Yang presents a general framework, description, and empirical model for understanding state government responses to local government fiscal distress. Yang empirically examines the importance of intervention, bankruptcy authorization, and early warning system

4  Research handbook on city and municipal finance

strategies used by state governments in overseeing local government fiscal outcomes. This chapter highlights the importance of the intergovernmental dimension of city and municipal financial condition. In Chapter 14, “The fiscal structure of county governments from 2002 to 2019: the impact of the Great Recession and the run-up to the COVID-19 pandemic,” Craig L. Johnson, Luis Navarro, and Andrey Yushkov analyze the structure of county revenues and expenditures, and the financial condition of counties from 2002 to immediately prior to the COVID-19 pandemic. They evaluate county government finances and the potentially high opportunity costs associated with the financial crisis and the Great Recession. Part III: Debt and Pensions Part III comprises five chapters that focus on the longer-term municipal liabilities, debt, and pensions. Four chapters focus on the uniqueness of the municipal securities market in raising capital for municipal (and other subnational) governments in the United States. The American municipal securities market is where most municipal governments go to finance their public infrastructure projects. Chapter 15, “The security, structure, and market of municipal debt: recent trends, research, and developments,” by W. Bartley Hildreth and Justina Jose, covers recent market, institutional and regulatory developments, along with significant research findings. In Chapter 16, “The status of municipal financial intermediaries after the financial crisis and Dodd-Frank: underwriters, insurers, advisors, and credit rating agencies,” Martin J. Luby and Joshua E. Terkel analyze the importance of financial intermediation in the municipal securities market, which is a decentralized, over-the-counter market. The chapter describes the roles of several intermediaries in raising funds for municipalities: underwriters, bond insurers, municipal advisors, and credit rating agencies. The chapter also discusses changes in the regulatory scheme from the passage and implementation of the 2010 Dodd-Frank Act, and research advancements in the aftermath of the 2008 financial crisis. In Chapter 17, “The structure of county government debt from 2002 to 2020: the financial crisis, the Great Recession, and the COVID-19 pandemic,” Craig L. Johnson, Andrey Yushkov, and Luis Navarro analyze the US county debt market from 2002 to 2020 across sales, tax status, type of security, method of sale, insurance, maturity, and uses of proceeds. They note that the COVID-19 pandemic has highlighted the importance of the physical infrastructure, enabling the provision of essential county government public health services. Moreover, most municipal physical infrastructure used to support essential county services like healthcare, transportation, education, and general government facilities is financed by debt sold in the municipal securities market. They compare the level of resiliency in the county debt market from the pandemic shock of 2020 relative to the financial crisis and Great Recession. Chapter 18, “The impact of fiscal rules on local debt: credit ratings, borrowing costs, and debt levels,” by Sungho Park, Craig S. Maher, and Steven C. Deller, analyzes the impact of fiscal rules, often imposed by state governments, on local government debt. Using a data set focusing on municipal governments from 2008 to 2017, they empirically

Introduction  ­5

analyze the impact of tax and expenditure limitations (TELs), bond referendum and balanced budget requirements, on local credit ratings, borrowing costs, and debt levels. In Chapter 19, “Do municipal pensions matter? A review of pensions’ impact on US local governments,” Gang Chen describes the relationship between municipal pensions and municipal budgets in the United States. The chapter summarizes the impact of municipal pensions on local government fiscal risks, credit ratings, employees, equity issues and reform options, and discusses the impact of the Great Recession and early impact of the COVID-19 pandemic on municipal pensions. Part IV: City and Municipal Finance Across the Globe Part IV is devoted to providing a global and comparative perspective on city and municipal finances. It comprises five chapters exploring how cities and municipalities across the world operate within different governance contexts, political, administrative, and fiscal systems. Chapter 20, “Municipal finance in federalist systems,” is an analysis of federalism models in 26 countries by Chris Thayer, Alex Hathaway, and Jorge Martinez-Vazquez. They describe three context drivers behind countries selecting their federal model of governance: coming-together, holding-together, and putting-together. They also profile the federal countries and describe their federating units, capital cities, and municipal systems, and analyze their municipal finances, intergovernmental fiscal systems, and the level of municipal autonomy and finances in select federal countries. In Chapter 21, “Municipal finances in unitary systems: the effects of crises on financial autonomy in four European countries,” Ringa Raudla, Mark Callanan, Kurt Houlberg, and Filipe Teles describe municipal finances in unitary systems, analyzing the effects of fiscal crises on financial autonomy in four European countries: Denmark, Estonia, Portugal, and Ireland. Chapters 22 and 23 provide analytical models of financial resilience. In Chapter 22, “Government financial resilience – a European perspective,” Carmela Barbera, Bernard Kofi Dom, Céline du Boys, Sanja Korac, Iris Saliterer, and Ileana Steccolini present a framework for understanding and assessing financial resilience in response to shocks, vulnerabilities, and anticipatory and coping capacities. They use the financial resilience model to analyze the response to recent crisis in four large European countries: France, Germany, Italy, and the United Kingdom, and develop a governmental financial resilience self-assessment toolkit for further professional and scholarly use. Chapter 23, “Measuring urban financial resilience: a resource flow perspective,” by Christine R. Martell and Temirlan T. Moldogaziev, provides a resource flow perspective for measuring urban financial resilience. The authors define urban financial resilience as a city’s ability to meet its operating service demands, make debt service payments in full and on time, and continue to fund capital expenditures even when faced with a shock. They then present the urban financial resilience model using data from 46 cities around the world to develop baseline metrics for urban public policymakers, managers, and future scholars. In the last chapter of Part IV, “Managing crises and public financial management in Singapore,” Chang Yee Kwan and Hui Lee present the exceptional fiscal management case of the city-state of Singapore. Chapter 24 describes how public financial managers in Singapore have been able to generate fiscal resources in response to crisis without

6  Research handbook on city and municipal finance

incurring substantial fiscal deficits or potentially destabilizing public debts. The authors argue that the success of Singapore’s financial strength following a crisis is in the design of their fiscal rules and low revenue volatility from their use of broad-based taxes and nonconventional revenue sources. They argue that Singapore provides a model of success for cities and municipalities around the world. The Handbook concludes by summarizing the themes and selected findings of each chapter and discussing areas for future research.

PART I RAISING REVENUES AND SPENDING FUNDS

1. Municipal revenues: data dilemmas, structures, and trends Justin M. Ross and Lanjun Peng

INTRODUCTION The overarching purpose of this chapter will be to arrange stylized facts about revenue structure that will help serve a scholarly research agenda surrounding municipal revenues. The chapter will be organized around the United States, like much of the existing data and literature, though its lessons will hopefully be useful for overlapping concerns or contrasts for researchers considering applications in other countries. In the first section we provide a few stylized facts on sources of revenues, and in the second section on trends in revenue sources, with special attention to the Great Recession and its aftermath. In the third section we discuss common alternative data sources in municipal research: state-specific datasets, Annual Comprehensive Financial Reports, and Annual Surveys of State and Local Government Finances. These datasets may provide different advantages or disadvantages depending on the nature of the research question being asked, and this chapter will contrast them to help researcher selection.

SOURCES OF MUNICIPAL REVENUE Municipal revenues broadly come from taxes, charges, and transfers from other governments. Taxes consist of coercive payments extracted from the local economic bases. Charges consist of user fees, which are payments tied to direct exchanges of services and penalties generated from the criminal justice system and other activities. Transfers from other governments include receipts from federal and state governments, as well as other local governments. Figure 1.1 illustrates the sources of revenues generated by municipal governments for fiscal year (FY) 2017 according to the US Census Annual Survey of State and Local Government Finances. Taxes account for approximately 35 percent of total municipal revenues. Of the tax instruments, the property tax stands out in two ways. First, property taxes are the largest source of the three instruments, representing approximately 63 percent of total tax revenues. Compared to all local governments, municipalities are similarly reliant on taxes but less reliant on the property tax specifically. Second, most taxes are taxes on economic exchanges, while the property tax is not. That is, most taxes work by determining a tax rate, then a flow of exchanges (e.g., sales, labor income) occurs to which the rate is applied to determine revenue collections. The American property tax generally reverses this procedure, first determining the amount of revenue to be collected from the property tax base, which consists of a stock instead of a flow of exchanges. The property tax rate is then set as a residual of arithmetically dividing the desired revenue by total taxable 8

Municipal revenues: data dilemmas, structures, and trends  ­9

Source:  US Census Annual Survey of State and Local Government Finances.

Figure 1.1  Sources of municipal revenues, FY2017 property base. Legally, the tax is levied in rem, or against the immobile property rather than the person, so a “fleeing” taxpayer cannot escape the obligation, which would be inherited by the property’s new occupant. Consequently, property tax collection rates are extremely high, often 100 percent for most local governments (see Mikesell & Liu, 2013). The second largest source of tax revenue generated by municipalities is sales and use taxes, representing 12 percent of total revenue and one-third of tax revenues. Municipalities generate this from taxes on general sales that occur within their jurisdiction, as well as selective taxes. Sales taxes shift the cost of government to be assessed on the ability to pay as measured by consumption, but also in recognition that nonresidents are also beneficiaries of government services. Particularly in cities that are tourist destinations, selective sales taxes on food, beverages, and hotels are a common strategy. They are also often associated with the financing of economic development projects like sports stadiums and convention centers, where the expectation is that local expenditures on leisure and hospitality services expand. While the property tax base consists of an immobile base, sales transactions are generally highly mobile as consumers can make arrangements to incur some of their expenditures in lower tax jurisdictions. Indeed, cross-border shopping in response to differentials in sales tax rates is one of the most robust findings in the academic literature on taxation (e.g., see Baker et al., 2021). Like the sales tax, the income tax also attempts to assess the burden of government on the ability to pay, measured by the flow of incoming receipts. Elderly residents whose expenditures are from their life savings and are property rich are frequently taken as the stylized residents experiencing relief from a revenue base that includes the income tax. The basis for income taxes can be on place of employment, place of residence, or both, yet overall it remains a small contribution to municipal revenues at just 3 percent of total revenues.

10  Research handbook on city and municipal finance

Payments for services and criminal justice fees constitute about 43 percent of municipal revenues, substantially more than the national share of all local governments, where the figure is just 28 percent. This no doubt reflects the fact that municipal governments are typically incorporated to provide more services and are more population dense. This allows for parking revenues, fees generated from hospitals, building inspection fees, building permits, sewage services, and criminal justice fees to play a larger role in the functioning of government. Transfers from other governments represent most of the remaining source of revenue, accounting for 20 percent of revenues. Of this, the state is the overwhelming source, consisting of more than 70 percent of the transfers. The programs motivated by these transfers can differ considerably across states and over time. Interlocal transfers are often associated with mutual aid and sharing of resources. Transfers from state and federal sources, by contrast, are frequently justified in the academic literature by equity and efficiency considerations. Where equity is a concern, the case for lump sum grants provides some fiscal equalization. If there are interlocal externalities, then matching grants can provide an effective subsidy to lower the price of additional local consumption. Although notoriously difficult to discern in the data, local governments are often subjected to statemandated expenditure programs (Ross, 2018), for which some share of these obligations is backed with state grants. The statistics in Figure 1.1 represent aggregates of revenue sources in 2017 for municipal government, and in this way the numbers are weighted by the budget size of cities. If instead, for each municipality, we calculate the share of revenue for each source and take the mean across cities, we then arrive at an unweighted mean revenue source. This calculation is presented as Figure 1.2. Figure 1.2 qualitatively provides the same story of dominant sources as Figure 1.1, with just small differences in the specific values. However, whether weighted or unweighted, the means mask a considerable amount of heterogeneity among municipalities themselves. Figure 1.3 shows municipal revenue shares for municipalities in 2017 on a boxand-whisker plot that demarcates the minimum, 25th percentile, median, 75th percentile, and maximum. Utility fees, user charges, and property taxes in Figure 1.3 demonstrate a key point that is overlooked by the means of Figure 1.2, where they are 15–25 percent of the mean municipal government’s revenue share. Yet, this is not uncommon in municipalities, where these sources could be more than half of total revenues. By contrast, less than 50 percent of local governments collect revenues via sales taxes, income taxes, insurance payments, or receive transfers from nonstate governments.

TRENDS IN REVENUE SOURCES While the previous section examined contemporary levels of revenues, this section explores trends in the US Census Annual Survey of State and Local Government Finances data going back to 1972. More specifically, in each Census year ending in 2 and 7, the revenue sources are inflation adjusted to real 2020 US dollars and reported in per capita terms. Far from there being obvious evidence of economies of scale, per capita revenues tend to increase with municipal population, likely reflecting, at least

Municipal revenues: data dilemmas, structures, and trends  ­11

Total utility Total insurance Total charges

Category

State transfers State taxes Property taxes Local transfers Income taxes Federal transfers 0

5

10

15

20

Percentage

Source:  US Census Annual Survey of State and Local Government Finances.

Figure 1.2  Mean municipal revenue shares by source, FY2017

Source:  US Census Annual Survey of State and Local Government Finances.

Figure 1.3  Box-and-whisker plot of revenue source shares for municipalities, FY2017

25

12  Research handbook on city and municipal finance

partially, a greater scope of activities or complexities in service delivery associated with more dense populations. This can be observed consistently in total revenues in Figure 1.4, which distinguishes between municipalities according to their percentile in distribution of population sizes. In Figure 1.4, there is little per capita difference in almost any year for municipalities below the 90th percentile for population. In those municipalities in the top 10 percent by population size, and particularly in the top 1 percent, the per capita revenues are consistently higher and always have been since the data series began in 1972. Another way to consider this growth is that US real per capita gross domestic product in 2017 was 2.15  times its level in 1972. By contrast, American municipal governments below the 90th percentile in population have on averaged tripled their per capita level, while those above the 10th percentile have approximately doubled. While it is difficult to determine the geography of gross domestic product (GDP) at the level of municipality, there is at least some evidence that the large-population cities are the disproportionate contributors to US GDP (Ross et al., 2015), but if so this has not manifested itself in corresponding tax revenues.

Source:  US Census Annual Survey of State and Local Government Finances.

Figure 1.4  Trends in per capita property tax revenue (2020 USD) by municipal population size, 1972–2017

Municipal revenues: data dilemmas, structures, and trends  ­13

Another apparent observation from Figure 1.4 surrounds the Great Recession. From the 2007 to the 2012 Census years, the decline in per capita revenues increased with population. Indeed, total tax revenue collections actually increased for city governments that were below the median in population size. Indeed, the growth in real per capita tax collections for small governments continued to accelerate into the 2017 Census. The sources of tax revenue growth, however, have come from different principle instruments. For many cities, particularly smaller ones below the 50th percentile of population, the property tax has on average brought them to per capita parity with the largest 1 ­percent, as demonstrated in Figure 1.5. During this period, the largest cities have entered into periods of property tax declines deeper than municipalities below the 90th percentile in population. Compared to 1972, the top 1 percent of cities are about USD10 per capita higher in 2017 with regard to the property tax, while the 50th to 99th percentiles have increased to about double that rate. Those below the median in population have gone from being about one-fourth the per capita level of the top 1 percent to near parity. By this gauge, populations of small municipalities have been far more amenable to property tax reliance for their public sector investments over time than they have been in

Source:  US Census Annual Survey of State and Local Government Finances.

Figure 1.5  Trends in per capita property tax revenue (2020 USD) by municipal population size, 1972–2017

14  Research handbook on city and municipal finance

the largest cities. Some of this parity comes not only from the rapid increases in property tax reliance from the smaller local governments, but also from the fact that it seems that the largest local governments experienced a decline in property taxes with the housing crisis of the Great Recession, and in 2017 only managed to return to its 2007 level. If the largest city tax revenues have only been modestly outpaced by their smaller counterparts, where is their principle tax growth coming from if not property taxes? It would appear to be from general and selective taxes on sales, as demonstrated in Figure  1.6, as well as fees from user charges, as illustrated in Figure 1.7. Yet, these sources of rapid growth are less robust to the business cycle and the Great Recession in particular, which created a broad negative shock. Outside own-source revenues, there has been relatively little distinction between the levels or trends in those municipalities smaller than the top 1 percent by population. Figure 1.8 shows that the largest 1 percent of cities have had a per capita level of grant support from other governments in the 1.5–2.0 range since 1972, and that this gap has mostly been constant.

Source:  US Census Annual Survey of State and Local Government Finances.

Figure 1.6  Trends in per capita general and selective sales tax revenue (2020 USD) by municipal population size, 1972–2017

Municipal revenues: data dilemmas, structures, and trends  ­15

Source:  US Census Annual Survey of State and Local Government Finances.

Figure 1.7  Trends in per capita revenue from charges and fees (2020 USD) by municipal population size, 1972–2017

MAJOR DATA SOURCES FOR RESEARCH AND TRADE-OFFS FOR RESEARCH DESIGN The quest for data is an initial phase in the municipal finance researcher’s journey towards answering research questions. For this, there are three main sources: ●

state-specific datasets; Annual Comprehensive Financial Reports (ACFRs) produced under standards determined by the Governmental Accounting Standards Board (GASB); and ● Annual Survey of State and Local Government Finances produced by the US Census Bureau (“Census data”). ●

There are trade-offs to these data because their sources and purposes differ. As any data historian will agree, when looking at historical records one must take into consideration the purpose of the data’s author for assembling the information.

16  Research handbook on city and municipal finance

Source:  US Census Annual Survey of State and Local Government Finances.

Figure 1.8  Trends in per capita intergovernmental transfer revenue (2020 USD) by municipal population size, 1972–2017 State-specific Data Sources As one might expect, states often gather and report data on their own local governments’ finances. To generalize here is difficult because there is enormous variation in state data products. Of course, the formats of the data provided are widely varied and uneven; seldom is the intention to produce the data in a way that is easy to use by social scientists. More importantly, the purpose of this data is also very state specific, so combining state-specific data into a single dataset must be undertaken with great care to ensure appropriate comparisons. In many cases, local revenue and expenditure data is a product of efforts by their encompassing state to regulate finances under statutory budget requirements: ensuring compliance with limitations on property tax levies, property tax rates, revenue forecasts, expenditure growth, and so on. These limitations are ubiquitous but the details for their actual execution (especially to allow exceptions) are enormous. One common consequence is that states will distinguish and essentially report on “regulated” revenue while ignoring “unregulated” sources, though every state might use different terms to describe them. A common feature would be for a state to report on local revenue data derived from

Municipal revenues: data dilemmas, structures, and trends  ­17

taxation, but ignore certain user fees, penalties, or in-kind payments. Importantly, the data exists precisely where local governments face constraints, and this might incentivize local governments to directly seek further revenue opportunities from other sources. Not only would total revenues differ across states, but variation in sources would also appear because of differences in which revenue sources are subject to state oversight. Another common purpose for the data is monitoring of government agents. Particularly in small areas, there is a perception of a lack of government oversight that can allow for individual malfeasance. Yet, the accounting procedures that can be used to generate data on revenues and expenditures are not necessarily ideal for representing the data for comparing differences in spending choices across government. Tracking capital expenditures on vehicles to avoid local grift might result in a system that is good for vehicle purchases, but may not necessarily be informative for the intended use of the data. It is not that it is impossible to design accounting procedures to do both (or more) in all cases; it is just a reality that states do not readily collect and produce the data for all such cases that might be desired for research. Relatedly, the treatment of intergovernmental expenditures and revenues where governments operate as pass-through entities (when funds are housed with one government until they can be distributed to their proper “owner”) is a good illustration of how tracking true sources and targets of funds can be challenging with regard to all datasets of government finances: some sources attempt to instill cross-sectional consistency, but individual states have no obvious call to make their reporting decisions comparable with units of other states. For these reasons, it is likely best to use state-specific data on research questions that can be addressed within a single state with careful attention to the selection of the state and its data procedures. For cases where the research can span multiple states, care should be taken to ensure the data can be compared meaningfully across the states. In such cases, researchers must likely lean heavily on the use of models with panel unit fixed effects that would limit the influence of cross-state differences. Including panel unit fixed effects sweeps away explanatory power of state policy, relying instead on within-state variation in policy and practices of the local governments within states. Annual Comprehensive Financial Reports Annual Comprehensive Financial Reports (ACFRs) are audited financial statements used for government entities below the federal level. The standards employed are set by the Governmental Accounting Standards Board (GASB) and updated annually, which allows for some nationwide standardization that is advantageous for cross-state research into municipalities. Prior to 2021 they were titled “Comprehensive Annual Financial Reports” but as its acronym mimics a South African racial slur, GASB has since encouraged publications of the reports with the rearranged wording. ACFRs are intended to inform about the operations and financial position of the government, and municipal bond investors are eager audiences for their information. This makes their data particularly appealing in cases where government solvency related to saving and borrowing is of interest to the research question (e.g., see Ross et al., 2015). While varying in length, the reports all consist of three sections: Introduction, Financial, and Statistical. As a result, the Table of Contents across reports is extremely consistent

18  Research handbook on city and municipal finance

across governments in their Financial section. The Introduction contains basic information about the city’s government and provides a narrative summary of the government’s position and conditions. The Financial section includes an Independent Auditors’ Report, Management’s Discussion and Analysis, Basic Financial Statements, Required Supplementary Information, Notes to the Financial Statements, and Supplementary Information. For a large swath of municipal finance research, the main source of data is gathered from the fund accounting statements and government-wide financial statements found in the Financial section. The Statistical section also frequently includes information on tax bases, collections, and enforcement information. The importance of the property tax in particular makes it a commonly recurring feature of ACFRs for municipal governments. The use of fund accounting in the ACFRs means that data are reported on an accrual or modified accrual basis, and therefore will differ from other sources that use a cash or other basis. Of particular concern is the monetary values assigned to assets that are likely not very liquid for governments (land, buildings, etc.). ACFRs can also differ drastically within a given financial statement on the breakdown of different subcategories that are of interest. For instance, on the statement of revenue, expenditures, and changes in fund balances, there will be different subcategories across governments within an area like “Revenue.” For instance, “Taxes” might be listed as a single aggregate group, or it might specify various types of taxes (e.g., “Income” and “Property”). An interesting level of detail is the provision of fund distinctions (e.g., “General Fund” versus “Debt Service Fund”) and their associated finances. Furthermore, many governments sponsor various “dependent” governments in the form of Tax Increment Financing Districts, special districts, or business-type activities (e.g., golf courses) for whose liabilities they could become responsible. This is not as readily viewed or understandable from other data sources, and in some cases these dependent governments are sponsored for the explicit purpose of circumventing state regulations on financial actions (see Goodman & Leland, 2019) and therefore may be overlooked in state-collected data sources. In fact, at the state level, this contrast between the data sources has been a subject of study on government avoidance of transparency (see Zhao & Wang, 2017). The dependent agencies are defined in the ACFR primary government columns (Governmental Activities, Business-type Activities), and other agencies that receive government grants and provide public services such as public higher education, housing assistance, and economic development may be included in the Component Units column. Importantly for research, not all municipalities undertake the expense of commissioning the production of ACFRs, and consequently ACFRs are produced by a self-selected sample of governments that tend to be larger (by budget and population) and more complex than most municipalities. In particular, the emphasis of these reports on asset liquidity and fiscal solvency makes them of particular interest for municipal bond investors, and consequently these local governments are likely selected to some degree on that basis. Furthermore, it is generally difficult to find ACFRs earlier than the mid-2000s – that is, prior to GASB Statement No. 341 becoming effective for mid- and small-sized

1   GASB Statement No. 34 is a set of accounting and financial reporting standards for state and local governments in the United States. It was issued in 1999 and introduced a new framework for

Municipal revenues: data dilemmas, structures, and trends  ­19

governments. This is less than can be found for some municipalities in the Census data, but is not as limiting as one might suppose considering that many states do not produce much data about local governments going back to the 1990s or earlier. Finally, it is to be noted that while the auditing of ACFRs does provide a degree of confidence in the numbers, they are by no means regarded as completely trustworthy. In an analysis of local government ACFRs through 2012, Prachyl and Fischer (2020) found that the distribution of leading digits suggested significant nonconformity in their business-type activities, indicating that fraud could still be pervasive in local government reporting. Setting aside intended malfeasance, much of the concern is inherent to some of the assets held by governments. The confidence in estimated liquidity value of a family’s used car is one thing, but for a city’s police car could be another, and perhaps impossible for streets. This has led to skepticism over the quality of the information, but generally the literature has found that ACFRs provide at least some predictive information on the risk of default (see Plummer et al., 2007; Stone et al., 2015). Furthermore, creditors and rating agencies seem to react to information disclosures provided in these reports (see Davies et al., 2017; Johnson et al., 2012). Annual Survey of State and Local Government Finances Produced by the US Census Bureau, the Annual Survey of State and Local Government Finances (“the Census data”) provides data on individual local governments as far back as 1967. In years ending in 2 and 7, this survey aims to collect data for all 50 states, with intercensal surveys consisting of samples determined in years ending in 4 and 9. While participation is voluntary, the response rate has been reliably above 90 percent. Large-population governments are oversampled in the survey, which includes sampling weights that are used for producing aggregate estimates. The Census data is the primary source for research that relies on nationwide samples of local governments because of the standardization effort to draw comparisons across states. The survey asks about local government fiscal year revenues, expenditures, assets, and debt. The Census provides some distinctions between capital and current expenditures by economic function (e.g., transportation, housing, hospitals, parks, etc.) in an effort to collect these data on uniform definitions that allow for cross-sectional comparison. The data is used for executive agencies (e.g., determining grant allocation rules), the development of other data products (e.g., national income product accounts), and research. The Census provides information on quality of survey response, but survey respondents at local governments are informed that the survey may only take between two and six hours, so the quality of the data’s accuracy is likely well below audited financial statements. The Census attempts to distinguish between general-purpose local governments and other local governments on the basis of political independence (see Goodman & Leland, 2019) – that is, a unit with sufficient administrative and fiscal autonomy to qualify as a separate government. A local public hospital, for instance, may or may not have a board whose members are also elected members of the city council. A city may further use its

financial ­reporting that requires state and local governments to report their financial statements in a more comprehensive and user-friendly manner.

20  Research handbook on city and municipal finance

taxing powers that enable lower interest rates to issue debt on behalf of this hospital. How formal such arrangements are and their recognition under state law will determine whether such a hospital is a special district distinct from the encompassing local government. Trade-offs and Challenges Among Sources This section highlights trade-offs and challenges for researchers selecting among datasets. In addition to usual questions of coverage and detail important to researchers, the selected examples highlight the importance of knowing the purpose for which the data is being collected, as well as how differently data sources can represent seemingly identical revenue instruments. As a first example, we contrast data sources on local governments from the state of Indiana. Indiana provides data on finances2 for its local governments and most of its special districts going back to 2011. This is better cross-sectional coverage than the other datasets, as only a few Indiana municipalities produce ACFRs and the Census has only as many units in 2012 and 2017 for that time period. The state data is collected mostly due to regulations imposed by the state on budgets and property taxation, most of which are imposed at the fund level. However, “expenditures” and “revenues” are actually fund “distributions” and “receipts” on a cash basis, so any time cash is moved between funds, a distribution and receipt occurs without any conventional occurrence of expenditure and revenue. Consequently, some counties appear as if they have revenues and expenditures at levels equivalent to their residents’ total personal income, so annual budget levies are a much better approximation of actual expenditure levels, as are the Census data and ACFRs. However, the budgets shared through these portals are only for those funds subject to state approval and monitoring. For local governments with many off-budget sources of revenues and funds, such as those sponsoring Tax Increment Financing Districts, their published budgets understate the true amount of revenues and expenditures occurring in the local government. Another point of consideration is own-source revenue. In Indiana, local option income taxes are adopted and levied by the county. The state handles the collection of the local income taxes and distributes the funds to the county, which is to act as a pass-through organization for local taxing units, and municipalities receive a share of the county income tax proceeds based on a population formula. Consequently, residents of a municipality pay an income tax that becomes revenue for at least their own county and municipality (and other taxing units). In the Census data where effort has been made to standardize what counts as “own-source tax revenue,” there is no income tax revenue for the municipality because it is not the originating source of the tax, but instead a source of intergovernmental revenue because it is transferred from the originating county. However, the state data sources report “Income Tax Revenues” to these units, their budgets sometimes have funds for receiving the distribution, and ACFRs may itemize “Income Tax Revenues” as one of their tax revenues. It is important to understand that the consequences of these conflicting purposes of data can result in substantial differences, which we will illustrate with the case of Los   See the Indiana Gateway at https://gateway.ifionline.org/.

2

Municipal revenues: data dilemmas, structures, and trends  ­21

Table 1.1  Comparison of revenues in ACFR and Census’s Annual Survey of State and Local Government Finances for Los Angeles FY2017 (USD 000) Annual Comprehensive Financial Report Revenues

Governmental Business-type Activities Activities 1,991,694

Operating grants and contributions

774,953

Capital grants and contributions

145,509

7,344,966 – 186,635

General revenues Property taxes

Total

Revenues Total taxes

Program revenues Charges for services

Census Annual Survey

9,336,660 Property taxes 774,953 Total general sales tax 332,144 Total select sales tax

Total 4,708,713 1,947,556 701,216 1,110,684

Total license taxes

729,756

1,991,949 Total income taxes

219,501

1,991,949

–

Utility users’ taxes

629,952

–

629,952 Other taxes

Business taxes

433,985

–

433,985 Total intergovernmental revenue

1,131,027

Other taxes

727,376

–

727,376 Total current charges and miscellaneous General revenue

4,985,498

Unrestricted grants and contributions

555,409

–

555,409 Total utility revenue

4,550,794

Unrestricted investment earnings

1,291

32,997

Other revenues

63,831

386,934

Total revenues

7,315,949

7,951,532

34,288 Liquor store revenue 450,765 Total social insurance Trust revenue 15,267,481 Total revenues

–

–

5,845,735

21,221,767

Angeles. Table 1.1 provides a comparison of the city’s two reports, the ACFR and the Census data, for fiscal year 2017. The ACFR distinguishes whether revenues are for the purpose of governmental activities or business-type activities under GASB Statement No. 34, and is backed with an external audit. The Census attempts to report data according to the type of instrument that collected it. As can be seen, the datasets produce similar results for property tax revenues, but very different total revenues in that the Census revenues are nearly 140 percent higher than those reported in the ACFR. One source of the difference could be that survey respondents are less careful in responding to the Census than to audited financial statements, but most likely the difference is driven by distinctions in special districts in Los Angeles. Audited financial

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statements are of primary concern to bondholders who wish to know the ability of a unit’s ability to issue or repay debt in the city’s name, while the Census aims for a picture of units that lack political independence from the city of Los Angeles.

CONCLUSION This chapter began with a discussion of the three major data sources used in evaluating the structure of public revenues. The purposes of these data vary, and consequently the data can paint very different pictures. The city of Los Angeles reports nearly 50 percent more revenue to auditors of ACFRs, seeking to provide quality information to bondholders interested in debt repayment, than they do to the Census, where the interest is in political interrelationships. In tracking data for regulating levy growth and monitoring officials for fraud, Indiana both understates and overstates revenues in its state-provided local government data reports. This is done by reporting only those revenue sources that are state regulated, excluding many other sources, and tabulating aggregates generated from transaction log data that double count interfund transfers. Having made the case for caution in the stark differences of data across sources, we use the Census data to consider the status of the major revenue sources of city government, and the trend of revenue source changes. While the revenue calculation might differ by definition of categories, the property taxes, income and sales taxes, and payment for services account for the majority portion of local government revenue. Additionally, controlling for the population size of local government, there is little per capita difference in yearly trends of city revenue change below the 90th percentile for population. Growth in municipal revenues seems ­overwhelmingly attributable to governments with large populations.

REFERENCES Baker, S. R., Johnson, S., & Kueng, L. (2021). Shopping for lower sales tax rates. American Economic Journal: Macroeconomics, 13(3), 209–250. Davies, S. P., Johnson, L. E., & Lowensohn, S. (2017). Ambient influences on municipal net assets: Evidence from panel data. Contemporary Accounting Research, 34(2), 1156–1177. Goodman, C. B., & Leland, S. M. (2019). Do cities and counties attempt to circumvent changes in their autonomy by creating special districts? The American Review of Public Administration, 49(2), 203–217. Johnson, C. L., Kioko, S. N., & and Hildreth, W. B. (2012). Government-wide financial statements and credit risk. Public Budgeting and Finance, 32(1), 80–104. Mikesell, J. L., & Liu, C. (2013). Property tax stability: A tax system model of base and revenue dynamics through the Great Recession and beyond. Public Finance and Management, 13(4), 310–334. Plummer, E., Hutchinson, P. D., & Patton, T. K. (2007). GASB No. 34’s governmental financial  reporting model: Evidence on its information relevance. The Accounting Review, 82(1), 205–240. Prachyl, C. L., & Fischer, M. (2020). Evaluating conformity of municipality financial data to Benford’s Law: An exploratory study. Journal of Accounting and Finance, 20(4), 11–22. Ross, J. M. (2018). Unfunded mandates and fiscal structure: Empirical evidence from a synthetic control model. Public Administration Review, 78(1), 92–103.

Municipal revenues: data dilemmas, structures, and trends  ­23

Ross, J. M., Johnson, C. L., & Yan, W. (2015). The public financing of America’s largest cities: A study of city financial records in the wake of the Great Recession. Journal of Regional Science, 55(1), 113–138. Stone, S. B., Singla, A., Comeaux, J., & Kirschner, C. (2015). A comparison of financial indicators: The case of Detroit. Public Budgeting and Finance, 35(4), 90–111. Zhao, B., & Wang, W. (2017). Transparency in state debt disclosure (Federal Reserve Bank of Boston Working Paper No. 17–10).

2.  Property taxes and municipal finance Joan Youngman

INTRODUCTION: PROPERTY AND LAND-RELATED TAXES AS A SOURCE OF LOCAL REVENUE Real property taxes can provide important support for municipal finance, offering a potentially stable and efficient source of independent local revenue. Property taxes are used extensively in the United States, and this chapter will draw on the many property tax systems in this country to discuss the policy questions and design issues they raise. It will also introduce international examples as illustrative comparisons. This chapter will pay special attention to legal aspects of property valuation, a crucial element that can have a major impact on the operation of the tax. Compact units of government face serious challenges in taxing mobile revenue sources. Even state-level sales taxes in the United States can suffer from cross-border competition, and local wage taxes can lead to serious job losses. A fixed and immovable tax base is also a significant advantage for local administration. To the extent that a tax on immovable property is capitalized, and so reflected in its market value, future purchasers do not bear the tax burden, and the property cannot be moved or sold to avoid the tax (Fischel, 2001a). This is a great benefit in an era of global competition. Local government services such as police and fire protection often support property values, helping to achieve the goal of matching the region subject to the tax to the area benefiting from the corresponding expenditures (Bahl & Bird, 2018). Property tax revenue can be quite stable, an important consideration when sales and income taxes respond swiftly to economic downturns. The COVID-19 pandemic provided dramatic evidence of how rapidly payrolls and retail sales can be affected by global events. Long-term investments such as real property generally change value more slowly, and multi-year assessment cycles can further delay the full impact of market shifts. Most local governments have some ability to adjust property tax rates. As a result, property taxes can be the most stable state and local taxes (Anderson & Shimul, 2018). These benefits do not diminish the contentious political debate over property taxation. This is an inherent feature of a tax based on unrealized value, particularly when the asset is of great personal importance to the taxpayer, as in the case of a principal residence. The visibility of the property tax ensures that it will never be free of controversy, but this very feature can promote efficiency in local government by encouraging citizen engagement and signaling the cost of local services. At a time of increased attention to wealth taxation as a means of countering rising economic inequality, there is much to learn from centuries of experience in the taxation of real property.

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Property taxes and municipal finance  ­25

WHAT IS A PROPERTY TAX? The most familiar “property tax” is an annual charge related to the value of immovable property, but other taxes on property include capital gains taxes, transfer taxes and stamp duties, taxes on financial transactions, and estate, gift, and inheritance taxes. Property value can also be mobilized for public benefit through nontax instruments such as public ownership of land that is leased for private use, as in Hong Kong (Bourassa & Hong, 2003). The larger concept of recovering value increments due to public investment, often termed “value capture,” can encompass diverse policies. These range from requirements that new developments include affordable housing units to the actual sale of building rights at public auction, a long-established practice in São Paulo (Smolka, 2013). Value capture comes under discussion whenever land prices rise dramatically in the wake of government action such as the extension of a transit line (Ingram & Hong, 2012). Yet this can be a strong argument for a property tax. With accurate assessments, value increases automatically become part of the tax base even without new revenue instruments. Moreover, large-scale public projects often impose costs on some affected properties even as they increase the value of others. For this reason, early calls for value capture recommended using planning gains to offset losses, as in the seminal text Windfalls for Wipeouts (Hagman & Misczynski, 1978). A well-functioning property tax will recognize losses as well as gains and adjust tax liability accordingly. Each type of property levy will have its own economic effects and legal status. For example, in the United States, charitable and other tax-exempt organizations are generally still responsible for user charges, and for special assessments to fund improvements such as sidewalk construction and street lighting. As a result, localities often seek to characterize as charges or special assessments what exempt property owners consider hidden taxes, leading to extensive legal controversies as to whether, for example, a fire protection fee is a disguised property tax (McLoughlin, 2020). Recognizing this, Wisconsin lowers allowable property tax collections by any fees for services previously funded by the property tax (League of Wisconsin Municipalities, 2019). A 2016 decision by the Minnesota Supreme Court reclassifying special assessments as taxes resulted in a loss of US$30 million to the city of St. Paul (Galioto, 2021). Taxes on property transfers, such as deed-recording taxes and stamp taxes, have the benefit of generally matching the payment obligation with a cash exchange. Many countries with ineffective property tax systems obtain more revenue from transfer taxes than from the property tax. Even in the European Union, transfer tax collections exceeded property tax receipts in nine member states in 2015 (Brzeski et al., 2019). Market distortions are a major efficiency argument against overreliance on transfer taxes. High transfer taxes can also encourage under-reporting of sale prices, and the resulting degradation of property records can be an even more serious problem than revenue loss. Property Taxes and Wealth Taxes The 2014 publication of Thomas Piketty’s Capital in the Twenty-First Century catalyzed international debate on wealth and income inequality. Piketty’s call for a progressive global tax on capital sparked new consideration of tax-based policies to address inequality.

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A true net wealth tax would face the challenge of taxing intangible and personal property in addition to the formidable difficulties familiar to real property taxation. The international experience with net wealth taxes is sobering. In 1990, 12 countries in the Organisation for Economic Co-operation and Development (OECD) imposed net wealth taxes, but by 2017 only four remained (OECD, 2018), and after that, France replaced its wealth tax with a real property tax (Bunn, 2021). Wealth taxes are by no means politically secure even in nations with strong redistributive policies. In 2007, Sweden abolished its wealth tax in an effort to stem the flight of capital and increase business investment (Henrekson & Du Rietz, 2014). Germany’s wealth tax was overturned in 1997, the same year in which Denmark ended its wealth tax. Finland, Iceland, and Luxembourg all abolished wealth taxes in 2008 (Hansson, 2010). If proponents of wealth taxation seek a stable long-term revenue measure, they should begin with a study of successful property taxes. The property tax in the United States began in colonial times as a type of wealth tax, reaching movable, immovable, tangible, and intangible property. This became unworkable in the post-Civil War era, when the growing importance of financial instruments meant that a large portion of the tax base could easily escape detection or change taxable location on the assessment date. Limiting the tax primarily to real estate, with a new income tax reaching the earnings on intangible assets, became an important goal of tax reform. Columbia economist E. R. A. Seligman argued that the attempt to tax intangibles “puts a premium on dishonesty and debauches the public conscience; it reduces deception to a system, and makes a science of knavery… It is the cause of such crying injustice that its alteration or abolition must become the battle cry of every statesman and reformer” (Seligman, 1913, p. 62). The state of Florida, which has no general income tax, for many years imposed a tax on intangible property, including stocks, bonds, and mutual fund shares. However, over time, the proliferation of exemptions, including cash, bank accounts, retirement plans, and certificates of deposit, together with the ease of avoidance through trust arrangements, left the tax an insignificant source of revenue, and it was largely abolished in 2007. The Nobel economist Joseph Stiglitz observed: “Piketty’s recent book noted the enormous increases in the wealth–output ratio in most capitalist countries in the last third of a century. But these increases have been partly, and in some cases largely, related to increases in the value of land” (Stiglitz, 2015, pp. 442–443). In fact, one commentator observed that growing returns to capital could largely be explained by surging house prices, and suggested that Piketty’s work might better be titled Housing in the TwentyFirst Century (DeVore, 2015). A tax on housing, the most sensitive object of the property tax, is an important element in a tax-based approach to addressing inequality. The Mirrlees review of taxation in the United Kingdom took this position: “The house is a valuable asset, whose value rises and fluctuates like those of stocks and shares. So we might see homeownership as a form of saving that should be taxed consistently with other savings” (Mirrlees et al., 2011, p. 368). In his magisterial 2015 book, Inequality: What Can Be Done?, Professor Anthony Atkinson of the London School of Economics set out 15 specific proposals for public action. Proposal 11 states: “There should be a proportional, or progressive, property tax based on up-to-date property assessments” (Atkinson, 2015, p. 198).

Property taxes and municipal finance  ­27

Varieties of Local Taxation and Tax Administration The property tax is by far the most important local tax in the United States, supplying local governments with nearly half of their own-source revenue (US Census, 2017) and serving as the largest single funding source for public elementary and secondary education (McGuire et al., 2014). The tax systems of the 50 states have many individual features, and the tens of thousands of local taxing jurisdictions provide additional examples of alternate approaches to assessment, valuation, and collection. Around the world, property tax systems range from rudimentary charges with little revenue impact to extremely sophisticated estimates of value based on statistical models and geographic information systems (GIS). Hong Kong and Singapore are leaders in annual accurate revaluation, and South Korea values 30 million parcels of real estate annually, using 450,000 benchmark properties as guides. New technology can help compensate for incomplete property records. For example, with assistance from the World Bank, Kampala, Uganda used GIS to compile a database of all buildings in the city, raising the proportion of taxable properties from 47 percent to 64 percent (Farmer, 2021). In Montenegro, digital orthophotos allowed identification of previously untaxed construction, replacing an expensive and inefficient manual registry (Obradovic & Klikovac, 2021, p. 522). There is also a broad range of international practice with respect to tax administration. Local control over own-source revenue is a frequent goal of fiscal decentralization, permitting a measure of independent budgeting that reflects residents’ needs and preferences. In the United States, Maryland and Montana undertake centralized assessment as a state function, while Pennsylvania provides minimal state oversight. Massachusetts exemplifies the middle way, with local officials setting tax rates within statewide limits and the state Department of Revenue certifying the values assigned by local assessors.

DEFINING THE TAX BASE Real Property, Personal Property, Immovable Property, Intangible Property Although property taxes are generally imposed on real property, some tangible moveable or personal property is often included in the tax base, such as business equipment and inventory. Motor vehicles and other items requiring registration are commonly subject to tax. However, difficulties of location and identification, as well as tax competition for business, have reduced the role of personal property taxes, once again demonstrating the benefit of an immovable tax base, especially for small jurisdictions. Distinguishing tangible and intangible elements can present a significant valuation challenge. In 1948, the California Supreme Court ruled that intangible property that was not itself subject to tax could nonetheless increase the value of related real estate. In that case, the grant of a liquor license affected the value of real property, even though the license itself was not taxable (Roehm v. County of Orange, 1948). In 2013, the same court held that “emission reduction credits” that a power plant was required to purchase could affect the taxable value of the plant, although all parties agreed that the credits were intangible rights. The court found that the credits could “enhance the valuation of ­taxable

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property, not by including the value of intangible assets in the valuation…but simply by assuming the presence of intangible assets when valuing the taxable property” (Elk Hills Power, LLC v. Board of Equalization, 2013, at 304 P.3d 1064; original emphasis). A similar question might arise with regard to the effect of zoning regulations, an interesting example of publicly imposed use restrictions that in some cases may be revised at the owner’s request. Although government regulation is generally considered a binding limitation on a property’s highest and best use, taxpayers and assessors alike have sometimes taken a different approach. Florida courts have accepted an owner’s position that its successful request for a change to non-agricultural zoning did not negate “bona fide agricultural” use, permitting agricultural classification for tax purposes (Harbor Ventures, Inc. v. Hutches, 1979). California statutes recognize this ambiguity through a rebuttable presumption that the current zoning is permanent (California Revenue & Tax Code §§ 402.1, 402.5). This presumption can be overcome by, for example, evidence of similar zoning being changed upon request, or other “instability” in the regulatory system (Meyers v. County of Alameda, 1977, at 70 Cal. App. 3d 806). Property owned by a tax-exempt institution and leased to a private party for a nonexempt purpose will generally be taxable. The US Supreme Court has held that states and localities may tax federal property used by private contractors on its full market value, with no reduction to reflect the constitutionally exempt federal interest (United States v. City of Detroit, 1958). California has once again led the country in a broad interpretation of a taxable interest. It has allowed taxation of a defense contractor’s use of a government shipyard, ranger housing in a national forest, refreshment concessions in a public stadium, and even the right to rent television sets to patients in a county hospital. California literally pioneered this area of taxation with cases in the 1850s and 1860s taxing prospectors with mining claims on federal land and homesteaders who refused to take title to their property in the hope of avoiding taxation – demonstrating that both antitax sentiment and expansive interpretations of the tax have a long history in that state (Hellerstein et al., 2020, pp. 893–894). Land, Buildings, and Improved Real Property Although it is common for real estate sales to convey rights to land together with the structures on it, these two components have very different economic attributes, and their taxes will have different economic effects. Both equity and efficiency considerations can support land value taxation. Unimproved land has value not because of the actions of its owner, but because of demand produced by social growth and development. For this reason, a land-value tax has long been considered a particularly equitable source of public revenue. The efficiency argument stems from its fixed or inelastic supply. Most commodities can be produced and purchased in variable quantities, and supply and demand will generally be affected by the imposition of a tax. Any tax may leave the taxpayer poorer, but this transfer to the government can be put to productive use. However, the shift away from the preferred before-tax supply and demand can represent a “deadweight loss” or “excess burden” that is not compensated in this way. This economic point has had dramatic consequences for civic well-being, as in the case of a window tax levied in England from 1696 to 1851. Windows were considered an index of building value, and a tax on windows did not require intrusive interior inspections, as

Property taxes and municipal finance  ­29

had been the case with the earlier and much-resented hearth tax. Taxpayers responded with “such measures as the boarding up of windows and the construction of houses with very few windows. Sometimes whole floors of houses were windowless. In spite of the pernicious health and aesthetic effects and despite widespread protests, the tax persisted for over a century and a half ” (Oates & Schwab, 2015, p. 163). A tax on land value does not distort economic behavior, because the supply of land cannot be increased or decreased in response to the tax (Dye & England, 2009). The great 19th-century social reformer Henry George recommended a “single tax” on land value to replace all other forms of government revenue (George, 1879). However, even in a mixed revenue system the land tax portion of a real estate tax offers equity and efficiency benefits. Several jurisdictions in the United States have imposed separate land taxes, and a number of countries have “split-rate” systems under which land is generally taxed at a higher rate than improvements (Dye & England, 2009). Eastern European countries that formerly divided public ownership of land from rights to improvements often continue to tax these two elements separately (Radvan et al., 2021). The continuing relevance of George’s insight was illustrated by Joseph Stiglitz’s 2015 statement: “A tax on the return to land, and even more so, on the capital gains from land, would reduce inequality and, by encouraging more investment into real capital, actually enhance growth. This is, of course, an old idea, promoted most famously by Henry George (1879)” (Stiglitz, 2015, p. 443).

ISSUES IN VALUATION Capital Value, Rental Value, and Area The property tax in the United States is generally imposed on the market value of the property. The British system of taxing the occupant rather than the owner naturally led to annual or rental value as the basis of the tax. This is still the case in many countries with a British heritage, and in Britain itself with regard to business property. In theory, a tax on rental value could approximate a tax on capital value, with appropriate adjustments in the tax rate, if rents constitute a predictable percentage of market value. The great distinction between the two measures occurs when the current use of property is not its most profitable use. The “highest and best use” will determine market value if it is legally, economically, and physically feasible, even if the current rent is very low. The British focus on occupancy attempted to value the actual condition and use of the property, rebus sic stantibus, or “the thing as it stands.” This approach strove for clarity and certainty by rejecting consideration of hypothetical alternate uses, but it did not achieve its goal. Rental value was not equated with the actual rent, but rather with fair market rent. This simply shifted the question of hypothetical values to a different calculation. When Sir Frank Layfield chaired a Commission on Local Government Finance, he reported: “We received many complaints that the assessment of houses were difficult to understand and appeared to be entirely arbitrary…unrelated to any figure or value with which the occupier is familiar” (Layfield, 1976, p. 165). The situation only becomes more problematic if values are based on decades of rent control, as in India, or if luxury housing escapes tax when left unoccupied.

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Although an area base for the property tax could be an objective measure, properties of equal area can have vastly different market values. For this reason, an area base is rarely seen in its pure form but is usually adjusted by coefficients for different zones, building conditions, and other value indicators. For example, the area base for land taxation in Bulgaria includes coefficients for infrastructure, zoning, construction, and location (Radvan et al., 2021, p. 10). With sufficient modifications of this type, area-based taxes can approximate value-based measures. This was the case in the Netherlands, where an area-based option became so complex that it was replaced with the capital-value measure it had come to approximate. Area-based systems have no natural revenue growth, and adjustments to account for value differences can appear subjective and opaque. They also sacrifice the connection between efficient public spending and higher property values that can promote public support for the tax. Ironically, the state of California, which largely rejected market value assessment in its 1978 “Proposition 13” enactment, has seen local governments turn to parcel taxes as a source of revenue. These are typically a flat tax per parcel, with no adjustments for size, improvements, or condition (Sonstelie, 2015). A state rightly considered a center of advanced technology thus finds itself imposing the equivalent of a head tax for property. As Seligman wrote in 1913: “In primitive society, there is a certain rough equality in the personal status and the personal abilities of the individual… But as the social conscience develops, more stress is laid on other elements of ability to pay than on mere number… The poll tax becomes unjust and is gradually abolished” (Seligman, 1913, p. 10). In Russia, replacement of the poll tax with a land tax in 1875 constituted a major reform in which for the first time a tax was applied to the nobility as well as to other citizens (Paul, 2021, p. 802). Current Use and Highest and Best Use Although the British valuation at rebus sic stantibus did not provide the hoped-for clarity in assessments, the appeal of a value based on current use is evident. The most widespread alternative to market value in the United States is current-use valuation of agricultural land, justified as a means of farmland preservation. The adoption of such measures reflects the political influence of farmers, a common situation throughout the world, but does not necessarily protect farmland. Although some states recapture a portion of prior tax savings when land is developed, this is generally dwarfed by the gains to be made from its sale. True family farmers rightly consider their land value to be an important part of their compensation, and often their retirement savings. The decision to sell their property is governed by their family situation and finances, and the sale will generally be at market value for the highest economic use. Temporarily retaining farmland in the urban fringe is not necessarily a social benefit if it is not part of planned long-term preservation. It might simply encourage “leapfrog” development in more distant areas, increasing travel and commuting times. The preferential valuation of agricultural land is in some cases so extreme as to constitute a de facto exemption. San Francisco’s “urban agriculture” tax incentive offers enormous property tax reductions to owners who agree to use their land for agriculture for at least five years. Qualifying property can be as small as one-tenth of an acre. Typical news coverage featured the owner of a lot valued at US$2 million who planned to enroll

Property taxes and municipal finance  ­31

in the program and so reduce its assessed value to US$12,500 an acre (Duggan, 2014). In a region with extreme affordability issues, a tax subsidy for a five-year commitment to gardening achieves no long-term land preservation in exchange for the loss of tax revenue and additional housing. Specialty Valuation Estimating market value is particularly challenging when costly property built for a specific owner would not necessarily have the same utility to another purchaser. It is easy to reject value of such “specialty” property to the current owner as the basis for marketvalue assessment, but it is not equally easy to assign a negligible value to an expensive and well-maintained structure serving its intended function. As a result, such cases sometimes use a cost-based approach to valuation. The judicial rationale for such an outcome can take many forms. In the case of the architecturally acclaimed Seagram Building on Park Avenue in New York, designed by Mies van der Rohe, it was a failure of proof. The court wrote: “Nowhere in the record is it explained how just two years before the period under review an experienced owner employing a reliable contractor and having the services of outstanding architects put $36,000,000 into a structure that was only worth $17,800,000” (Joseph E. Seagram & Sons, Inc. v. Tax Commission, 1963, at 18 A.D.2d 116). When the New York Stock Exchange sought a negligible valuation, the court was dismissive of its argument that “this building can only be adequately used by the New York Stock Exchange and not by any one else, not even other exchanges.” The court found a “complete answer” in the provision of the tax law providing that “[a]ll real and personal property subject to taxation shall be assessed at the full value thereof ” (People ex rel. New York Stock Exchange Building Company v. Cantor, 1927, at 221 A.D.196). Property Subject to Divided Legal Interests Many courts have struggled to determine the appropriate valuation of property subject to divided legal interests. In most situations, the value of all interests in the property is taxed to the title holder, without dividing responsibility among joint owners, mortgagors and mortgagees, or life tenants and remainder holders. However, challenging situations continually arise, such as that of a landlord burdened by an unfavorable long-term lease. Most US courts consider the taxable property to include both the landlord’s and tenant’s interests, and therefore a below-market lease does not reduce the total assessment. Some courts take the opposite position, often in sympathy with a struggling landlord. The Pennsylvania Supreme Court held that failure to consider the lease would “ignore the economic realities of commercial real estate transactions” (In re Appeal of Marple Springfield Center, 1992, at 530 Pa. 127). The same court then faced a later case in which a tenant had constructed a multi-million-dollar shopping center with a movie theater, restaurant, parking lot, and access roads. The landlord’s interest would not include these improvements until the termination of the 50-year lease, and so it was argued that only their discounted present value should be taxed. The court realized that valuing only the landlord’s interest would mean that “a tenant under a long-term lease could build a Taj Mahal, or an Empire State Building, and such a structure would be wholly exempt from taxation merely because it was owned as a leasehold” (Tech One Associates v. Board of

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Property Assessment, Appeals, and Review, 2012, at 617 Pa. 462–463). It held that the tax concerned “the particular nature of the property involved, not the means by which the property is owned” (ibid.). This supports the position of UN-Habitat in its policy guide to land and property taxation: “[E]ven though the rights may be divided between different parties, the law should not attempt nor allow the tax authority to allocate the LPT [land and property tax] between interests. Any such allocation should be the responsibility of the private parties involved” (UN-Habitat, 2011, p. 39). An Illustrative Case: “Big-box” Retail Stores A current subject of extensive litigation that includes elements of highest and best use, specialty valuation, and divided legal interests involves “big-box” stores, a term usually associated with large, double-height, single-user retail establishments. Owners frequently argue that the appropriate comparable sales for estimating store value are “secondgeneration” transactions where the property is no longer used for its original purpose. This has been termed the “dark stores” approach – the comparison stores being “dark” because they have been vacated or abandoned. Tax officials object to using obsolete or abandoned stores in inferior locations as comparable sales for well-located operating stores, while taxpayers contend that business value to the owner should not affect a calculation of market value for tax purposes. These disputes have collectively involved hundreds of millions of dollars in tax revenue. As in the case of specialty property, cases may question whether a new store designed specifically for its current owner is worth less than its construction cost because those features might not be suitable for a different purchaser. A New York decision held that valuation of a drug store should use comparable drug store sales rather than “second-generation” comparables such as “a Dollar Tree store; a Staples office supply store; a Salvation Army thrift shop; a retail bicycle shop; and a Dollar General store” (Matter of Rite Aid Corp. v. Haywood, 2015, at 130 A.D.3d 1513). These stores are often subject to deed restrictions limiting any future competitive use, raising a question as to whether a voluntary use restriction should govern taxable value. They are also frequently built for a specific retailer, then sold to an investor and simultaneously leased back to the retailer. This transaction must then be analyzed to determine whether it reflects a sale and rental or serves instead as a financing vehicle. Disputes over divided legal interests have also considered the meaning of “fee simple” ownership, which in the legal context, but not in some appraisal definitions, can include ownership subject to a lease. All these elements contribute to the unsettled nature of the highly contentious current debate over the assessment of “big-box” properties.

ADMINISTRATIVE ISSUES Fractional Assessment Assessment of property at a fraction of its actual value is a widespread and highly problematic practice. As James Bonbright wrote in 1937: “There are several reasons for

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the persistence of partial valuation. Gullible taxpayers associate a larger valuation with a larger tax… The ability to maintain a stable rate and to increase revenue by tampering with the tax base – a change which calls for less publicity and less opposition – is naturally desired by the party in power” (Bonbright, 1937, p. 498). This is a widespread international practice. For example, the land tax in Hungary is imposed on 50 percent of sale value (Hulkó & Fehér, 2021, p. 161), and the Philippines assigns different assessment ratios to different classes of property (UN-Habitat, 2011, p. 70). Unauthorized fractional assessment can represent a failure to maintain updated values, but even authorized fractional assessment undermines transparency and accountability. Cook County, Illinois, the Chicago assessment district, explains the process of computing a tax bill in this way: “For residential property owners, the assessed value equals 10% of the fair market value of the home… The State Equalization Factor/Multiplier is applied to the assessed value, and this creates the Equalized Assessed Value (EAV) for the property. Any exemptions earned by the home are then subtracted from the EAV” (Cook County Assessor’s Office, 2022). In 2021, the State Equalization Factor was 3.0027. In New York City, the tax rate for Class 1 property, which includes one-, two-, and three-family units, was 21.045 percent in 2021, while for other residential property, including cooperative and condominium units, the rate was 12.267 percent. For utility property it was 12.826 percent, and for all other property it was 10.694 percent. These rates suggest that Class 1 property bears the heaviest tax burden. However, Class 1 property was assessed at 6 percent of market value, while all other classes were assessed at 45 percent of market value (New York City Department of Finance, 2021). Reassessment Policy and Practice Infrequent or delayed revaluations are a major cause of property tax revolts. Dramatic increases in assessments that have been unchanged for many years touch on the two most challenging aspects of asset taxation: changes in tax liability without corresponding changes in cash income, and changes in tax liability without any action on the part of the taxpayer. Frequent small adjustments reflecting current market developments are the only means of avoiding drastic and highly publicized tax shifts. Revaluation in a time of rising prices should be an opportunity to lower tax rates. Neglecting this undermines assessment equity when taxpayers resist revaluations, expecting them to increase taxes. Failure to revalue subsidizes affluent areas with rising market values at the expense of neighborhoods whose values are stagnant or declining. In New York State, Nassau County, protected by legislation from court-ordered full-value assessment, for decades used 1938 construction costs and 1964 land values as the basis for its property tax. The county was forced to undertake a revaluation in 2003 in the face of legal challenges based on civil rights law. Its failure to reassess placed a disproportionate tax burden on declining neighborhoods relative to prosperous areas experiencing rising home prices (O’Shea v. Board of Assessors of Nassau County, 2007).

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PROPERTY TAXES AND LAND POLICY Special Treatment of Specific Uses A tax on land and buildings will naturally have land policy implications, and special treatment, positive or negative, is often afforded to classes such as farmland, conservation land, vacant property, and vacation homes. “Current use” taxation may be compared to the traditional British approach of taxing the occupier, which can result in vacant property escaping taxation altogether. In 2018, two researchers at the International Growth Centre in the UK estimated that up to 10 percent of the land area of Kampala, Uganda was exempt from tax on these grounds, and recommended considering land use regulation and taxation together as a means of addressing this (Haas & Kopanyi, 2018, p. 6). On the other hand, Pretoria, South Africa, taxes vacant land at a rate six times higher than residential property as a means of supporting public services and infrastructure (Franzsen & McCluskey, 2017, p. 59). Punitive taxation of vacant properties is often politically popular but has uncertain land policy effects. It is not clear how recent changes in retail operations, particularly the rise of online sales, have affected commercial vacancies in major metropolitan areas. Without understanding the causes of this phenomenon, a simple policy response is problematic. In March 2021, San Francisco voters approved a tax on vacant property that could rise to US$1,000 per square foot annually. However, this measure was suspended only a few months later, in recognition of the uncertainty attendant on the COVID-19 pandemic. When first proposed, the measure sought to target “landlords who intentionally keep their properties vacant until they can extract higher rents from potential tenants” (Thadani, 2019, n.p.). In the midst of the pandemic, the newly passed measure seemed “like an anachronism from a bygone San Francisco era” (Andersen, 2021, n.p.). In 2017, Vancouver, British Columbia instituted a “vacant homes tax” in hopes that house prices would decline as “speculators and vacationers will sell properties to the local workforce” (Davidoff, 2016, n.p.). In 2018, rental vacancy rates had only declined from 0.9 percent to 0.8 percent (City of Vancouver, 2019). Yet in 2019, Vancouver’s basic tax rate was just 0.26 percent – by some counts, “the lowest in North America” (Hemingway, 2019, n.p.). This raises a question about the benefits of designing new taxes to discourage speculation rather than strengthening the existing broad-based property tax, particularly in a market with a “notoriously inelastic housing supply” (Davidoff, 2018, p. 575). Conservation land is often subject to favorable tax treatment to encourage environmental protection. In the United States, conservation easements are a relatively new property instrument, developed in the 1970s to permit perpetual development restrictions on privately held land. The ability to restrict development in perpetuity addresses a major problem in favorable farmland valuation, the lack of long-term protection for open space. It can be challenging to estimate the market value of property subject to a conservation restriction, particularly if specific development rights are retained and the property continues to function as part of a larger estate. It is important that a planned approach to land use balances open space conservation with adequate provision for affordable housing and economic development (Pidot, 2005). Affordable housing subject to long-term rent limitations has been the subject of many valuation cases. Some courts have felt that government-imposed rent restrictions must

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affect property tax valuation, while others have noted that private owners have voluntarily assumed these restrictions in exchange for substantial federal income tax subsidies. These disputes have generally been resolved in favor of the taxpayer, sometimes through special legislation (Jaconetty, 2003; Rizzetto & Zgobis, 2007). Primary Residence Allowances: Land Use and Tax Relief Favorable treatment of owner-occupied housing is extremely common, reflecting both the political power of property owners and the importance of a stable residential community. Professor William Fischel has gone so far as to suggest the category of “homevoter” in local public finance. “[H]omeowners, who are the most numerous and politically influential group within most localities, are guided by their concern for the value of their homes to make political decisions that are more efficient than those that would be made at a higher level of government” (Fischel, 2001b, p. 4). In upholding the acquisition-value approach of Proposition 13 against constitutional challenge, the US Supreme Court found that family and neighborhood preservation, continuity, and stability were legitimate state interests that could justify such preferential treatment (Nordlinger v. Hahn, 1992). Renters are generally less affluent than homeowners, and often are not aware of property taxes, even though they may bear all or some portion of them through higher rents. In 2018, the New York City Independent Budget Office estimated that rental properties with 11 or more units faced the city’s highest tax burden, with effective tax rates over five times that of owners of one-, two-, and three-family units (New York City Independent Budget Office, 2018, p. 3). Although some tax preferences are limited to owner-occupied housing, income-sensitive “circuit breakers” are offered by a majority of states, and most cover eligible renters as well (Bowman et al., 2009). They are termed “circuit breakers” because they are designed to avoid an overload, in this case property taxes that are excessive with respect to income. South Carolina demonstrated extreme favoritism toward homeowners when in 2006 it eliminated the school property tax on owner-occupied homes, with an exception for taxes to cover debt service. This shifted a large portion of the property tax burden from homeowners to businesses and renters (Kenyon, 2020). This is especially problematic because homeowners are far more likely than business taxpayers to benefit from local education spending. A generous principal residence exemption can help counter the regressivity introduced by inaccuracies in the assessment of low-value property. An exemption set in dollar terms rather than as a percentage of value will have a greater impact on low-price property, and so increase the progressivity of the tax system. In Massachusetts, municipalities have set this exemption at anywhere from 10 to 35 percent of the average assessed value for residential properties (Gilbert & Rassias, 2019). This does not come at the expense of other classes of property. The revenue to be raised from the residential class is first calculated without regard to the homestead exemption, and the tax rate is then set to raise that amount after application of the exemption. In this way, the exemption does not shift the tax burden to business, but rather produces a more progressive distribution across the residential class.

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PROPERTY TAX LIMITATION MEASURES Almost all property tax systems are subject to some restrictions, whether on tax rates, valuation procedures, or total collections (Paquin, 2015). These may be adopted in response to specific situations, such as political dissatisfaction in periods of rapidly rising house values. Unacceptable tax increases are not an inherent feature of the property tax. They are generally the result of long delays in revaluation and failure to reduce tax rates when values rise precipitously. The best protections against this are well-functioning assessment and rate-setting procedures. As farmland programs demonstrate, some of the most dramatic limitations operate through the valuation process. For example, New York requires that condominiums and cooperatives be valued “at a sum not exceeding the assessment which would be placed upon such parcel were the parcel not owned or leased by a cooperative corporation or on a condominium basis” (New York Real Property Tax Law § 581(1)(a)). This means that their assessments cannot reflect the very strong market demand for these types of units, which is one reason why renters in the city face much higher effective tax rates than owners. Extremely expensive luxury condominiums and cooperatives are sometimes valued by reference to hypothetical or rent-regulated rental apartments, often at a small fraction of their actual market value (Harris, 2012). Assessment limitations have become familiar since Proposition 13 made purchase price, not market value, the basic standard for assessment in California. An acquisitionvalue system generally rewards long-time property owners at the expense of those who have purchased more recently. Los Angeles resident Stephanie Nordlinger based her ultimately unsuccessful US Supreme Court challenge to Proposition 13 on the fact that the tax on her condominium was almost five times the amount paid by long-time owners  of identical property. As Justice Stevens wrote in his dissent, “This disparity is not unusual under Proposition 13. Indeed, some homeowners pay 17 times as much in taxes as their neighbors with comparable property. For vacant land, the disparities may be as great as 500 to 1” (Nordlinger v. Hahn, 1992, at 505 U.S. 29). An assessment limit, by design, undermines the distribution of the tax burden according to property value. Ironically, sometimes assessment limits lead to higher tax rates to compensate for the reduced tax base. Low-value properties experiencing appreciation only slightly above the assessment limit could pay more in taxes if high-value properties see appreciation dramatic enough to require a large increase in the tax rate. The Minnesota Department of Revenue studied the effect of that state’s assessment limits and found that more than one-third of the properties in the favored categories and more than 84 percent of all residential homesteads in the state faced higher tax bills as a result (Minnesota Department of Revenue, 2007). Assessment limitations can give rise to new problems when property owners face a lock-in effect, a disincentive to move if a change in ownership causes reassessment at the new sale value. Tax provisions that impede mobility can reduce the efficiency of housing markets and ill serve taxpayers who would benefit from different living arrangements. This led Florida to introduce “portability” to its “Save Our Homes” assessment limits, as fear of being taxed out of a home was replaced by fear of being locked into a home (Cheung & Cunningham, 2011). Florida homeowners can now carry a portion of these

Property taxes and municipal finance  ­37

tax savings to a new residence elsewhere. The assessment of the new home is neither its market value nor its acquisition price, but rather reflects tax savings accumulated on a prior residence, although the new owner comes with undiminished service needs and expectations. After approving Proposition 13 in 1978, California voters passed measures allowing children and grandchildren to inherit assessments limited under Proposition 13. There was no requirement that the heirs live in the property until a 2020 ballot measure added this provision, while at the same time it enhanced assessment “portability” for senior and disabled taxpayers. These expansions of assessment limitations magnify tax disparities even further, and undermine the clarity, transparency, and accountability that are key strengths of a value-based tax. They illustrate a phenomenon noted by researchers at the University of Illinois: “Special tax provisions have an addictive quality, in that they create distortions and inequities, which create a case for other special provisions, which begs for even more” (Dye et al., 2006, p. 715). Levy limits directly restrict revenue, and so can have severe consequences if they are not sufficient to support necessary services. A New York levy limit allows most local governments to increase annual revenue by no more than the lesser of 2 percent or the rate of inflation. Low inflation caused the limit to fall below 2 percent for 2014 through 2018, and under 1 percent in 2016 and 2017. Counties subject to this limit experienced double-digit declines in spending for health and community services (Lav & Leachman, 2018). States rarely impose only a single tax limit, and their complex interactions can have unintended consequences. Massachusetts imposes both a rate limit and a levy limit, each set at 2.5 percent. Struggling cities with little or no growth in their tax base may be unable to increase revenue by 2.5 percent a year even as they face steeply rising costs for items such as pensions and employee healthcare. From 2016 to 2020, Pittsfield, Massachusetts faced a situation in which increasing revenue by 2.5 percent would impermissibly exceed 2.5 percent of taxable value. In 2017, its property tax revenues were permitted to grow by only 0.51 percent. In the city of Springfield, allowable revenue actually fell in FY2012 and FY2013. An alternative to tax limitations, sometimes called “truth-in-taxation” or “full disclosure,” requires that tax increases due to rising property values follow the same procedures as tax increases that result from rising tax rates. These could involve public advertisements, hearings, and mailed individual notices, to avoid “silent” tax increases that allow officials to take credit for level tax rates while tax bills rise. These procedural steps can be a significant hurdle for local government, and there is evidence that they can reduce growth in property taxes without the distortions that accompany many limits (Cornia & Walters, 2006). Another important alternative allows eligible taxpayers, usually senior citizens, to defer tax payments until the property is transferred (Munnell et al., 2017). These programs address the fear that property taxes may force elderly taxpayers from their homes. Even the possibility of this occurrence can generate powerful antitax sentiment, and it is important that there is a policy instrument to avoid that. Senior citizens often have accumulated substantial equity in their homes that can secure the liability for unpaid taxes. Hungary allows “tax suspension” for a principal residence, recognizing that “wealth does not always go hand in hand with high income” (Hulkó & Fehér, 2021, p. 155).

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Very low participation rates are often identified as the greatest weakness of deferral programs. Although publicity and outreach should help eligible taxpayers receive this assistance, low participation rates do not necessarily mean that the programs are ineffective. The very existence of this option answers one of the most powerful and frequently raised arguments against taxing property at all: the possibility that impoverished or cash-poor elderly taxpayers could lose their homes or must choose between meeting their tax obligations and paying for necessities. Many homeowners choose not to defer taxes because they do not wish to encumber property they hope to leave to their heirs. This is a natural choice, but it provides evidence that taxes are not forcing these owners from their homes.

CONCLUSION The property tax offers many potential benefits, especially as an independent revenue source for local government. It also presents the challenge of assigning a market value to property that has not been the subject of a recent sale, and the need for a cash payment not necessarily matched to any income stream. These are significant hurdles, but the example of successful property tax systems shows that they can be met. In fact, some portion of a longstanding tax may be capitalized into the asset price, relieving future purchasers of that part of the tax burden. The experience of the property tax also demonstrates the policy importance of valuation and administration. Valuation decisions can essentially exempt property that nominally remains on the tax rolls, such as farmland, or tax elements that are excluded from the tax base, such as intangible rights. Effective administration is essential for successful asset taxation. Failure to maintain property registration systems undermines the tax base, and failure to keep values current shifts the tax burden to the least affluent areas and insures antitax efforts when long-delayed new values are put in place. Many promising subjects for future research could support major policy improvement in these areas. Even as advanced tax systems are considering the use of artificial intelligence and machine learning in valuation, other jurisdictions still rely primarily on cost data rather than more accurate and equitable statistical approaches. Research demonstrating the feasibility and benefits of continually updated computerized valuation methods could avoid the disruption and resistance that accompany infrequent and dramatic changes in assessments. New and less onerous payment options, from monthly billing to direct debit, can reduce the difficulties associated with large and infrequent lump-sum obligations not withheld from income. Similarly, research identifying difficulties that cause eligible taxpayers not to apply for relief programs, such as circuit breakers or deferral options, could help greatly increase participation rates. A careful review of exemptions, whether in the form of incentives for business location or non-market valuation of agricultural property, could yield insights for reducing the tax burden on residents, particularly lower-income homeowners. No tax will ever be without controversy, but the centuries of experience with the ­taxation of real property offer important lessons for asset and wealth taxes of all types.

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REFERENCES Andersen, T. (2021, June 11). San Francisco vacancy tax put off until 2022. San Francisco Business Times. https://www.bizjournals.com/sanfrancisco/news/2020/06/11/s-f-vacancy-tax-put-off-un​ til-2022.html. Anderson, J. E., & Shimul, S. N. (2018). State and local property, income, and sales tax elasticity: Estimates from dynamic heterogeneous panels. National Tax Journal, 71(3), 521–546. Atkinson, A. (2015). Inequality: What can be done? Harvard University Press. Bahl, R., & Bird, R. M. (2018). Fiscal decentralization and local finance in developing countries. Edward Elgar Publishing. Bonbright, J. C. (1937). The valuation of property (Vol. 1). McGraw-Hill. Bourassa, S. C., & Hong, Y.-H. (Eds.). (2003). Leasing public land: Policy debates and international experiences. Lincoln Institute of Land Policy. Bowman, J. H., Kenyon, D., Langley, A., & Paquin B. P. (2009). Property tax circuit breakers: Fair and cost-effective relief for taxpayers. Lincoln Institute of Land Policy. Brzeski, J., Románová, A., & Franzsen, R. (2019). The evolution of property taxes in post-Socialist countries in Central and Eastern Europe (ATI Working Paper WP/19/01). African Tax Institute, University of Pretoria. Bunn, D. (2021, February 5). What the U.S. can learn from the adoption (and repeal) of wealth taxes in the OECD. Tax Foundation. Cheung, R., & Cunningham, C. (2011). Who supports portable assessment caps: The role of lockin, tax share, and mobility. Regional Science and Urban Economics, 41(3), 173–186. City of Vancouver. (2019, February 8). Improving the effectiveness of the empty home tax. Standing Committee on Policy and Strategic Priorities. Cook County (Illinois) Assessor’s Office. (2022). Your assessment notice and tax bill. https://www. cookcountyassessor.com/your-assessment-notice-and-tax-bill. Cornia, G. C., & Walters, L. C. (2006). Full disclosure: Controlling property tax increases during periods of increasing housing values. National Tax Journal, 59(3), 735–749. Davidoff, T. (2016, November 17). Opinion: Empty homes tax a sensible property levy for Vancouver. Vancouver Sun. https://vancouversun.com/opinion/opinion-sensible-property-taxreform-for-vancouver. Davidoff, T. (2018). Policy forum: Vancouver’s property taxes in perspective. Canadian Tax Journal, 66(3), 573–584. DeVore, C. (2015, July 22). Piketty vs. Rognlie: Land use restrictions inflate housing values, drive wealth concentration. Forbes.com. https://www.forbes.com/sites/chuckdevore/2015/07/22/pikettyvs-rognlie-land-use-restrictions-inflate-housing-values-drive-wealth-concentration/?sh=6a0d76c​ 04698. Duggan, T. (2014, September 1). S.F. property owners to get tax break from creating urban farms. San Francisco Chronicle. https://www.sfgate.com/bayarea/article/S-F-property-owners-to-gettax-break-from-5725876.php. Dye, R. F., & England, R. W. (2009). Land value taxation: Theory, evidence, and practice. Lincoln Institute of Land Policy. Dye, R. F., McMillen, D. P., & Merriman, D. F. (2006). Illinois’ response to rising residential property values: An assessment growth cap in Cook County. National Tax Journal, 59(3), 706–716. Farmer, L. (2021). Making a good tax better. Land Lines, 33, 42–53. Fischel, W. A. (2001a). Capitalization is everywhere. In W. E. Oates (Ed.), Property taxation and local government finance (pp. 56–57). Lincoln Institute of Land Policy. Fischel, W. A. (2001b). The homevoter hypothesis: How home values influence local government taxation, school finance, and land-use policies. Harvard University Press. Franzsen, R., & McCluskey, W. (Eds). (2017). Property tax in Africa: Status, challenges, and prospects. Lincoln Institute of Land Policy. Galioto, K. (2021, June 28). St. Paul property owners continue legal fight against city’s street maintenance fees. Star Tribune. https://www.startribune.com/st-paul-property-owners-continue-legalfight-against-city-s-street-maintenance-fees/600072943.

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George, H. (1879). Progress and poverty. B. Appleton & Company. Gilbert, R., & Rassias, T. (2019, August 1). Living with the residential exemption. City & Town. Massachusetts Division of Local Services. Haas, A. R. N., & Kopanyi, M. (2018, June). Consideration for a tax on urban vacant land in Kampala (IGC Policy Brief No. 43407). International Growth Centre. Hagman, D. G., & Misczynski, D. J. (Eds.). (1978). Windfalls for wipeouts: Land value capture and compensation. American Society of Planning Officials. Hansson, Å. (2010, February). Is the wealth tax harmful to economic growth? World Tax Journal, 2(1), 19–34. Harris, E. A. (2012, October 15). As prices soar to buy a luxury address, the tax bills don’t. The New York Times. https://www.nytimes.com/2012/10/16/nyregion/many-high-end-new-york-apart​ ments-have-modest-tax-rates.html. Hellerstein, W., Stark, K. J., Swain, J. A., & Youngman J. M. (2020). State and local taxation: Cases and materials (11th ed.). West Publishing Co. Hemingway, A. (2019, December 3). Vancouver has Canada’s lowest property tax rate – and a housing crisis. Something has to give. Toronto Star. https://www.thestar.com/opinion/2019/12/03/vancou​ ver-has-canadas-lowest-property-tax-rate-and-a-housing-crisis-something-has-to-give.html. Henrekson, M., & Du Rietz, G. (2014). The rise and fall of Swedish wealth taxation. Nordic Tax Journal, 2014(1), 9–35. Hulkó, G., & Fehér, J. (2021). Hungary. In M. Radvan, R. Franzsen, W. J. McCluskey & F. Plimmer (Eds.), Real property taxes and property markets in CEE countries and Central Asia (pp. 143–176). Institute for Local Self-Government Maribor. Ingram, G. K., & Hong, Y.-H. (Eds.). (2012). Value capture and land policies. Lincoln Institute of Land Policy. Jaconetty, T. A. (2003). Valuation of subsidized housing. International Association of Assessing Officers. Kenyon, D. (Ed.). (2020, August). A deep dive on South Carolina’s property tax. Lincoln Institute of Land Policy. Lav, I. J., & Leachman, M. (2018, July 18). State limits on property taxes hamstring local services and should be relaxed or repealed. Center on Budget and Policy Priorities. Layfield, F. (1976). Local government finance: Report of the committee of enquiry. Her Majesty’s Stationery Office. League of Wisconsin Municipalities. (2019). Levy limits explanation and strategies. https://www. lwm-info.org/823/Levy-Limits-Explanation-and-Strategies. McGuire, T. J., Papke, L. E., & Reschovsky, A. (2014). Local funding of schools: The property tax and its alternatives. In H. F. Ladd & M. E. Goertz (Eds.), Handbook of research in education finance and policy (pp. 392–407). Routledge. McLoughlin, J. (2020, April 13). West Virginia justices find fire service fee not impermissible tax. Tax Notes. Minnesota Department of Revenue. (2007). Limited market value report: 2006 assessment year. https://www.revenue.state.mn.us/sites/default/files/2011-11/research_reports_content_2007_lmv_ report.pdf. Mirrlees, J., Adam, S., Besley. T., Blundell, R., Bond, S., Chote, R., Gammie, M., Johnson, P., Myles, G., & Poterba, J. (2011). Tax by design. Institute for Fiscal Studies. Munnell, A. H., Belbase, A., Hou, W., & Walters, A. N. (2017, November). Property tax deferral: A proposal to help Massachusetts seniors. Center for Retirement Research at Boston College. New York City Department of Finance. (2021). Calculating your property taxes. https://www.nyc. gov/site/finance/taxes/property-calculating-your-annual-tax-blll.page. New York City Independent Budget Office. (2018, April). Addressing the disparities: Winners & losers in two property tax reform scenarios [Fiscal brief]. Oates, W. E., & Schwab, R. M. (2015). The window tax: A case study in excess burden. Journal of Economic Perspectives, 29(1), 163–180. Obradovic, N., & Klikovac, D. (2021). Fiscal autonomy of local governments in Montenegro. In M. Radvan, R. Franzsen, W. J. McCluskey, & F. Plimmer (Eds.), Real property taxes and property

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markets in CEE countries and Central Asia (pp. 489–534). Institute for Local Self-Government Maribor. Organisation for Economic Co-operation and Development (OECD). (2018). The role and design of net wealth taxes in the OECD. OECD Publishing. Paquin, B. P. (2015). Chronicle of the 161-year history of state-imposed property tax limitations. (Working Paper No. WP15BP1). Lincoln Institute of Land Policy. Paul, A. (2021). Problems with cadastral value in the Russian Federation. In M. Radvan, R. Franzsen, W. J. McCluskey, & F. Plimmer (Eds.), Real property taxes and property markets in CEE countries and Central Asia (pp. 800–829). Institute for Local Self-Government Maribor. Pidot, J. (2005). Reinventing conservation easements: A critical examination and ideas for reform. Lincoln Institute of Land Policy. Piketty, T. (2014). Capital in the twenty-first century. Belknap Press of Harvard University Press. Radvan, M., Franzsen, R., McCluskey, W. J., & Plimmer, F. (Eds.). (2021). Real property taxes and property markets in CEE countries and Central Asia. Institute for Local Self-Government Maribor. Rizzetto, M., & Zgobis, J. (2007). Valuing affordable housing: A new challenge for assessors. Journal of Property Tax Assessment & Administration, 4(4), 51–86. Seligman, E. R. A. (1913). Essays in taxation (8th ed.). Macmillan & Co. Smolka, M. O. (2013). Implementing value capture in Latin America: Policies and tools for urban development. Lincoln Institute of Land Policy. Sonstelie, J. (2015). Parcel taxes as a local revenue source in California. Public Policy Institute of California. Stiglitz, J. E. (2015). The origins of inequality, and policies to contain it. National Tax Journal, 68(2), 425–448. Thadani, T. (2019, January 23). Vacancy glut in SF could spur tax on empty storefronts. The San Francisco Chronicle. UN-Habitat. (2011). Land and property tax: A policy guide. United Nations Human Settlements Programme. US Census (2017). 2017 Census of Governments: Finance tables [Dataset].

LEGAL SOURCES California Revenue & Tax Code §§ 402.1; 402.5. Elk Hills Power, LLC v. Board of Equalization (2013). 57 Cal.4th 593, 304 P.3d 1052, 160 Cal.Rptr.3d 387. Harbor Ventures, Inc. v. Hutches (Fla. 1979). 366 So.2d 1173. In re Appeal of Marple Springfield Center (1992). 530 Pa. 122, 607 A.2d 708. Joseph E. Seagram & Sons, Inc. v. Tax Commission (1963). 18 A.D.2d 109, 238 N.Y.S.2d 228, aff’d, 14 N.Y.2d 314, 200 N.E.2d 447 (1964). Matter of Rite Aid Corp. v. Haywood (2015). 130 A.D.3d 1510, 15 N.Y.S.3d 523. Meyers v. County of Alameda (1977). 70 Cal. App. 3d 799, at 806, 139 Cal. Rptr. 165. New York Real Property Tax Law § 581(1)(a). Nordlinger v. Hahn (1992). 505 U.S. 1, 112 S.Ct. 2326, 120 L.Ed.2d 1. O’Shea v. Board of Assessors of Nassau County (2007). 8 N.Y.3d 249, 864 N.E.2d 1261, 832 N.Y.S.2d 862. People ex rel. New York Stock Exchange Building Company v. Cantor (1927). 221 A.D. 193, 223 N.Y.S. 64, aff’d mem., 248 N.Y.533, 162 N.E. 514 (1928). Roehm v. County of Orange (1948). 32 Cal.2d 280, 196 P.2d 550. Tech One Associates v. Board of Property Assessment, Appeals, and Review (2012). 617 Pa. 439, 53 A.3d 685. United States v. City of Detroit (1958). 355 U.S. 466, 78 S.Ct. 474.

3.  Local option taxes Whitney Afonso

INTRODUCTION No government can exist without taxation. This money must necessarily be levied on the people; and the grand art consists of levying so as not to oppress. (Frederick the Great)

There are many types of local option taxes (LOTs) available to municipalities in the United States. The jurisdictional eligibility and discretionary authority of LOTs varies tremendously from state to state. Despite the diversity of LOTs, they can typically be characterized by three features. First, a LOT usually requires approval from residents via a referendum before the local government can levy it (Beale et al., 1996). Second, LOTs are not universally levied within the state. Local governments have the choice of whether to levy them. Third, the revenues are allocated at the local level (Goldman & Wachs, 2003). LOTs are increasingly important sources of revenue for municipal governments in the United States. The growing reliance on LOTs may be attributable to restrictions imposed by tax and expenditure limitations (TELs), the political palatability of LOTs versus other local taxes such as the property tax, greater revenue-raising capacity, and increased local autonomy. Other potential advantages include diversifying the revenue portfolio of local governments, exporting the tax burden to nonresidents, and ensuring that residents support the tax and associated expenditure by requiring a public referendum. There are, of course, potential disadvantages to reliance on LOTs, such as higher local tax burdens, vertical and horizontal competition with state and overlapping local governments, competition with neighboring jurisdictions, exacerbated fiscal disparities between jurisdictions, and greater inequity. Thus, the choice of tax portfolio entails local leaders choosing the right tax mix for their communities and considering potential consequences (Nechyba, 1997). This chapter proceeds with a discussion of the evaluation criteria for LOTs. That is followed by a discussion of local option sales, excise, and income taxes. Next it discusses the impact of the pandemic on LOTs. It concludes with a brief discussion of LOTs and possible areas for future work.

EVALUATION OF LOCAL OPTION TAXES Standard Criteria The most common criteria for evaluating taxes are efficiency, equity, adequacy, feasibility, and transparency. Evaluating LOTs entails additional considerations, including promotion of local autonomy, interjurisdictional competition, and vertical competition with 42

Local option taxes  ­43

the state (Bird, 2001; Brunori, 2020; Swianiewicz, 2003). This section briefly discusses tax criteria in the context of LOTs. Economic efficiency dictates that good taxes will minimize the distortions they create on firm or taxpayer behaviors. Taxes change the price of goods and services and the supply of labor and capital. The change in these prices can distort economic decision-making, which will, unless correcting for market failures, lead to inefficiencies. Government should strive to avoid creating inefficiencies. In fact, the US Joint Committee on Taxation (2017) notes that a “less efficient allocation of labor and capital resources leaves society with a lower level of output of goods and services than it would enjoy in the absence of the distortions caused by the tax system” (p. 4). In contrast, equity is a criterion that considers the fairness of a tax. Equity is typically addressed by the ability-to-pay principle and the benefit principle. The ability-to-pay principle, as the name suggests, considers the taxpayer’s ability to pay a tax. Equity in this context has a horizontal and a vertical dimension. A tax that is horizontally equitable places an equal burden on all those with the same ability to pay. Vertical equity introduces the idea that taxpayers with different abilities to pay should have different effective tax rates. A regressive tax is one whose effective rate grows as income decreases. A progressive tax is one whose effective rate grows as income increases. A proportional tax has the same effective rate for all payers. While many facets of assessing the fairness of a tax are challenging, deciding on what determines ability to pay is one of the most challenging. For example, ability to pay can be informed by considerations such as wages, wealth, size of the household, and the cost of living. The benefit principle is more straightforward. It dictates that the tax burden should be correlated with the benefits received from the service provided by the revenues. This principle is typically used for public services that resemble private goods, like utilities and public transportation, and are typically financed through user fees. The adequacy of a tax considers whether it produces enough revenue to finance government. This can be thought of in many ways, but two of the primary ones are revenue production and stability. Revenue production is simply how much revenue can be generated by a tax instrument at a reasonable rate. The fiscal disparities of revenue capacity between local governments are also an important factor when considering adequacy. Stability considers the predictability of the tax’s revenue. This is especially critical for municipal taxation since municipalities must balance their budgets and, unlike the federal government, do not have the option to deficit spend, even during economic downturns. Taxes must also be administratively and politically feasible. It is preferable for taxes to be easy and inexpensive to administer and collect. They also must be politically ­acceptable to municipal leaders and residents. There are some factors that can lead to increased political feasibility, such as the ability to shift a tax’s burden to nonresidents, the earmarking of revenues for popular programs, or a lack of transparency that prevents the full burden of a tax to be visible to the taxpayer. Transparency, as a criterion, suggests that good tax policy prioritizes transparency in the adoption and administration of taxes (including compliance requirements). Ideally, this transparency extends to keeping taxpayers well-informed about the true extent of their tax burdens (Mikesell, 2016).

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Additional Criteria Local government tax autonomy “focuses on the degree of discretion a local government has over the base, tax rates, and other attributes of the taxes it has at its disposal” (Reschovsky, 2019, p. 1). It is frequently noted how critical the property tax is to maintaining local autonomy in the US federalist system (Brunori, 2020; Farvacque-Vitković et al., 2014; Mikesell, 2016). However, the availability of other local taxes and fees – along with local governments’ discretion in levying them, setting the rates, and choosing the tax bases – is critical in the wake of the proliferation of TELs. Therefore, the more discretion the municipality has in choosing which taxes to levy and how to levy them, the greater the degree of local autonomy. Interjurisdictional competition combines many elements of the above criteria. At the local level, the effects of differences in tax portfolios, bases, and rates between neighboring and peer jurisdictions can lead to inefficiencies and market distortions. For example, it is considered a best practice for local governments to focus their taxes on immobile capital, so that once the tax is levied, it cannot be avoided by moving elsewhere (Bird, 2001). Vertical competition is also a common concern with local taxes. Typically, local governments rely on the same tax instruments as their overlapping governments (i.e., municipalities, counties, and special districts), but they often rely on the same instruments as the state, too. There is evidence that when two levels of government levy similar taxes on the same tax base, the combined rate is inefficiently large (Sobel, 1997). Similarly, this can lead to fiscal illusion and decreased transparency (Afonso, 2014).

COMMON LOCAL OPTION TAXES This section presents an overview of some of the most common LOTs available to local governments in the United States. A selection of LOTs is briefly discussed with examples from across the country, including the relevant literature and the application of the tax criteria. Local Option Sales Taxes Table 3.1 presents the states that permit local governments to adopt sales taxes. Thirty-seven states grant levying power to local governments, but only 32 states permit municipalities to levy them. Additionally, there is a wide range of jurisdictional eligibility and discretionary authority among the states (Afonso, 2017a). For example, in Alabama, all municipalities can levy a local sales tax and there are no restrictions on the rate. In contrast, only tourism-dependent jurisdictions in Montana can levy a sales tax, and there is a rate cap of 3 percent. However, as of 2021, Montana is considering expanding jurisdictional eligibility for the local option sales tax, which would allow local governments to levy a sales tax of up to 4 percent on nonessential luxury products and services. The proposed sales tax would exempt groceries, medicine, and gasoline, but it would tax clothing, rental vehicles, and purchases made in restaurants and bars (Mitchell, 2021). The reason for exemptions is that sales taxes are regressive and impose a larger effective tax rate on lower-income taxpayers. As a result, many state and local governments

Local option taxes  ­45

Table 3.1  Select LOTs available by statea State

Sales Tax

Alabama Alaska Arizona Arkansas California Colorado Connecticut Delaware Florida Georgia Hawaii Idaho Illinois Indiana Iowa Kansas Kentucky Louisiana Maine Maryland Massachusetts Michigan Minnesota Mississippi Missouri Montana Nebraska Nevada New Hampshire New Jersey New Mexico New York North Carolina North Dakota Ohio Oklahoma Oregon Pennsylvania Rhode Island South Carolina South Dakota Tennessee Texas Utah Vermont Virginia

M, C M, C M, C, O M, C M, C, O M, C, O C, O M, C, O C M M, C, O C M, C M, C, O

M, C M, C, O M, C, O M, C M, C C, O M M, C M, C, O C, O M, C, O C, O M, C, O M, C M, C, O M M, C M, C, O M, C M M, C, O

Meals Tax

M, C

M, C

O M, C M O C M, C M, C

C M, C

M U M, C

C M M, C

Occupancy Tax M, C M, C M M M, C M, C

“Soda” Marijuana Taxb Taxb M, C M M M

M, C M, C M, C M M, C C M, C M, C M, C M, C

Income Taxc

d

M, C

M

M, C M, C M

M

M, C

d

d

M

M

M

M

M M

M, O

M, C C

M, O

M

O M, O

M, C M, C M, C M, C M M, C

M, C

Mf

M

M

C C, O M, Ce M, C, O

M d

C

M M M

M, C

M, C M M, C M, C M, C M, C M, C M, C M, C M M, C M, C M, C M, C M, C M, C M, C M, C

Tobacco Tax

M, C

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Table 3.1 (continued) State

Sales Tax

Meals Tax

Occupancy Tax

“Soda” Marijuana Taxb Taxb

Washington West Virginia Wisconsin Wyoming

M, C, O M, O C, O M, C, O

C

M, C M, C M, C M, C

M

O

Tobacco Tax

Income Taxc M

Notes: M = municipal tax; C = county tax; U = uniform tax (not optional); O = other tax (a special district, frequently a “resort area”). a. The local excise taxes are only considered permitted when they tax the good outside of the sales tax. Also, in many states there are additional restrictions on which local governments can levy these taxes. This table only reports if they are permitted; it does not suggest that they are permitted by all jurisdictions. For example, Maine and New Hampshire do not authorize these taxes. b. These are the states where local governments have implemented a soda tax. With the exception of California, it is only one jurisdiction per state. c. The local income tax also includes states that permit localities to adopt a tax on wages, a payroll tax, and/ or a tax on interest and dividends. d. Local government had previously been authorized to levy this tax and it is still in place for those who had adopted before the law changed. e. Kansas cities and counties may tax gross earnings derived from money, notes, and other evidence of debt having a tax situs (i.e., the place to which a piece of taxable property belongs) in such cities/counties. Kan. Stat. Ann. § 12-1,101. f. G.S. 13-2813. Municipality or a county may impose a sales and use tax on any item that is taxable by the state. Omaha imposes a 3% tobacco occupational privilege tax. Sources:  Afonso (2017a, 2019); Avalara MyLodgeTax (n.d.); Tobacco Control Legal Consortium (2016); State Department of Revenue; Urban Institute (n.d.-a, n.d.-b); Walczak (2017, 2019).

exempt necessities like food and prescription drugs from the sales tax base. However, these exemptions also narrow the tax base, leading to less revenue, a need for higher tax rates, decreased efficiency, and lower adequacy. Exempting necessities makes the tax more elastic and less stable. It may be argued that sales taxes “tax too few household services [and] exempt too many household purchases of goods” (Mikesell, 1997, p. 149). Another common restriction on local autonomy is the earmarking of revenue from local sales taxes for specific functions, such as transportation, public schools, and economic development. There tend to be fewer earmarked sales taxes for municipalities than for counties. For example, in California there are no earmarked sales taxes for municipalities, but counties can levy sales taxes for transportation. While this suggests greater discretionary authority for municipalities, it is not straightforward. It typically signals fewer options for municipalities. Examples of states that allow their municipalities to levy earmarked local sales taxes are Mississippi (transportation), West Virginia (pension relief), and Texas (property tax relief, economic development, street maintenance, and other costs) (Afonso, 2017a). There is some evidence on the impact earmarks have on expenditures and outcomes, but more analysis is warranted (Afonso, 2015a; Kanaan et al., 2022). Economic theory suggests that an increase in sales tax rates will decrease the size of the tax base. One mechanism by which that decrease occurs is the mobility of the sales tax base. “Local governments can try to attract retail sales by keeping sales tax rates low

Local option taxes  ­47

and encouraging residents of other jurisdictions to cross-border shop. This predatory behavior must be balanced against the governments’ desire to raise revenues” (Luna, 2004, p. 43). Research shows that local sales tax revenues and municipal sales tax rates are affected by both vertical competition (countywide rates) and horizontal competition (neighboring jurisdictions’ rates) (Agrawal, 2016; Burge & Rogers, 2011). In fact, the literature suggests that a 1 percentage point increase in tax rate is associated with a decrease in per capita sales along the state border of 1–7 percentage points (Sjoquist, 2015). This reinforces the economic inefficiencies of local sales taxes, which is why public officials must balance the need for revenues against the distortions such increases create, as Luna has pointed out. Similarly, research presumes that urban jurisdictions or regional retail centers have greater revenue-raising capacity (Burge & Piper, 2012; Burge & Rogers, 2011; Rogers, 2004). However, there is evidence that the fiscal disparities created by local sales taxes are not as great as presumed because the revenue capacity of sales taxes might not be correlated with property tax bases (Afonso, 2016; Wang & Zhao, 2011; Zhao & Hou, 2008). One study finds that tourism-rich jurisdictions with low populations had the greatest per capita sales tax capacity, while suburban jurisdictions had the lowest capacity. All statistical differences between urban, suburban, tourism-rich, and rural counties disappeared when property taxes were included in the capacity measure (Afonso, 2016). Another study finds that both tourists and in-commuters are critical portions of the sales tax base (Afonso & Moulton, 2021). This exporting of tax burdens helps to explain the popularity of sales taxes (Afonso, 2018a; Burge & Piper, 2012; Sjoquist et al., 2007). However, there are outcome disparities. A report prepared for the state of Connecticut estimates that the revenue generated by a proposed municipal sales tax would range between US$5 and US$717 per capita across the state (Sjoquist, 2015). Despite many of their drawbacks, sales taxes are administratively and politically feasible. In most states, local sales taxes are collected by the state and distributed back to the taxing jurisdictions (Afonso, 2019). Sales taxes are also politically feasible and have been shown to be a preferred method of taxation. For example, in Georgia, 94 percent of all referendums on local sales taxes earmarked for education have been approved by voters, demonstrating a preference for sales taxes over property taxes (Brunner & Schwegman, 2017). However, two reasons that are often cited for this popularity are reduced tax salience and increased revenue complexity, both of which can cause taxpayers to underestimate their true tax burden (Brunner et al., 2015; Buchanan, 1967; Cabral & Hoxby, 2012; Wagner, 1976). Therefore, sales taxes are not transparent. The cost of administration is typically low for local governments because local sales taxes are often collected by the state. However, there are states where local governments are responsible for the administration of these taxes, which increases the administrative cost of the taxes for local jurisdictions. A tax’s compliance costs also increase when local governments administer the tax or choose the tax base. In fact, the diversity in local rates, bases, and administration is one reason why remote vendors were not required to collect sales or use taxes before South Dakota v. Wayfair (Afonso, 2019). The literature on local sales taxes has grown tremendously since the turn of the century. There has been analysis on drivers of adoption, vertical and horizontal competition, volatility of revenue portfolios, fungibility of earmarked revenues, and tax competition. A review of this literature is outside the scope of this chapter.

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Local Option Excise Taxes Excise taxes can be understood as selective sales taxes, and they fall into three primary categories: luxury, sumptuary or sin,1 and benefit based (Lee et al., 2020). They differ from sales taxes in two primary ways. First, an excise tax has a much narrower base than a sales tax, being imposed on the sale of specific goods or services. Second, there is more variation in administration. Unlike retail sales taxes, excise taxes can be imposed when a good is imported, sold by the manufacturer, sold by the retailer, or used. Excise taxes can also be levied by the unit or, like retail sales taxes, be a percentage of the cost of the good or service (though typically there is little discretion in setting the rate). This subsection proceeds with examples of common and emerging excise taxes that highlight this diversity. Meals taxes Eight states authorize municipalities to levy a local option meals tax, and Rhode Island levies a local meals tax that is uniform across the state and not a LOT (see Table 3.1).2 Meals taxes are luxury taxes that are applied to prepared food purchased at a restaurant and any foodstuffs for immediate consumption. One of the advantages of a meals tax is that the burden can be partially exported to nonresidents. In some states, there are restrictions on which jurisdictions can levy meals taxes. For example, in Washington, only counties with populations over 1 million can levy a meals tax. Only King County, where Seattle is located, meets that criterion. In Florida, there is a municipal resort tax available to select cities that allows them to tax meals at a rate of up to 2 percent. In fact, local governments in Florida can tax meals served at hotels and motels at a higher rate than meals served elsewhere (Walczak, 2017). Meals taxes are not efficient because they tax a small portion of the tax base of food, do not tax substitutions, and are easy to avoid. In most states, unprepared food and groceries go untaxed by both sales and meals taxes. For example, groceries are not subject to sales or meals taxes in Minnesota, but in Minneapolis, taxpayers pay a 7.775 percent sales tax and a 3 percent meals tax, a total of 10.775 percent, on a restaurant meal. This is likely to distort the decision to purchase prepared foods. It may also encourage consumers to seek out meals in jurisdictions with lower taxes. Regarding equity, meals taxes are considered a luxury tax because they tax prepared food and restaurant dining, but it is unclear how progressive they are. As discussed above, sales taxes are typically regressive, especially in the case of food for home consumption. Therefore, meals taxes are likely more progressive than taxes on groceries. 1   It is important to note that many sin taxes are also Pigouvian taxes. Pigouvian taxes are designed to correct for negative externalities, while sin taxes are designed to discourage behaviors and correct for internalities. A classic example of a Pigouvian tax is a carbon tax that corrects for the negative externality of pollution, which creates costs that are not captured by the parties involved in the transaction of fuel. However, tobacco usage and obesity create healthcare costs to society, so it is reasonable to think of many sin taxes as Pigouvian taxes as well. Thus, many sin taxes are efficient by correcting for negative externalities. 2   North Carolina permits local governments to institute a prepared food tax through legislative action by the General Assembly. This is also how local occupancy taxes are levied in North Carolina.

Local option taxes  ­49

Despite the associated concerns, meals taxes are politically feasible. This may be due to factors including the presence of earmarks, the ability to shift burdens to nonresidents, or the overall burdens’ lack of transparency. As with sales taxes, referendums on meals taxes are largely successful, which demonstrates their popularity. Massachusetts began permitting municipalities to levy a meals tax in 2007, and by 2009, 65 had adopted one (Zhao, 2011). Also, there is evidence that earmarks increase the likelihood of a successful referendum (Bowman et al., 1992). Tax exportation may also explain this popularity. For example, in North Carolina, meals tax revenues are earmarked for tourism promotion and cultural amenity expenditures, which suggests that they are viewed as a tool to export tax burdens to nonresidents, though the ability of municipalities to shift the burden of meals taxes to nonresidents varies tremendously by the number of visitors they receive. Occupancy taxes The occupancy tax is available to municipal governments in 43 states, making it the most common LOT available in the United States. Occupancy taxes are known by numerous names, including hotel, lodging, bed, and transient room taxes. Occupancy taxes apply to short-term lodging, like hotels and motels. However, the scope of the tax base has been a contentious topic as Airbnb rentals and online travel companies (such as Priceline) have proliferated while going untaxed (Sonnier & Nichols, 2018). It is unclear how much the inclusion of these new platforms has changed occupancy tax revenues. There are early estimates suggesting that the taxation of Airbnb rentals would generate significant revenue in major urban centers. In 2015, the estimated revenue for taxing Airbnb rentals like hotel rooms was US$28.5 million in New York City and US$25.9 million in Los Angeles, and Airbnb’s market share has only been growing (Shatford, 2016). Much like the impact of the Wayfair ruling on sales taxes, this is an area that should be further explored as laws have caught up with technology.3 However, it should be noted that much like Amazon.com had begun collecting sales taxes prior to the Wayfair ruling, platforms like Airbnb have begun voluntarily collecting and remitting occupancy taxes in jurisdictions where they are not yet required to by law (Airbnb, n.d.-a). Airbnb has agreements with many states and local governments to collect and remit taxes.4 While fiscal disparities and unequal revenue-raising capacity are a concern for all LOTs, they may be especially worrisome for occupancy taxes where some communities have significantly greater levels of tourism and business travelers. However, interjurisdictional differences are not the only revenue concern. The overall size of the tax base is smaller for occupancy taxes than for local sales or income taxes, making occupancy taxes a less adequate tax instrument (Wooster, 1987). Occupancy taxes are more progressive than other local taxes, and their burden is borne by nonresidents, which may help explain their popularity (Sebastian & Kumodzi, 2015). However, occupancy taxes are less popular with the business community because of the concern that they reduce tourism, resulting in fewer stays and less spending while 3   Even without Airbnb and online travel companies, noncompliance was a substantial concern (Crotts & McGill, 1995). 4   For example, in Florida, Airbnb collects transient rental taxes, discretionary sales surtaxes, county tourist development taxes, and resort taxes – which together may equal up to 17 percent of the listing price, including any associated fees (Airbnb, n.d.-b).

50  Research handbook on city and municipal finance

traveling. At the local level, this may result in travelers simply opting to find lodging in a neighboring or peer jurisdiction with lower costs (Lee, 2014). Typically, the revenue generated by occupancy taxes is earmarked for tourism development, which raises questions regarding the need to subsidize tourism and how visitor spending and behavior are influenced by occupancy taxes and other tourism-related local taxes, like the meals tax (Martinez-Gouhier & Hunker, 2018). Regardless, this link makes occupancy taxes not only luxury taxes but also benefit taxes: the revenue must be used to attract tourism or to provide new and subsidized attractions for tourists. Take Texas’s local hotel occupancy taxes (HOTs). Municipalities may levy HOTs and the revenue must be allocated to tourism-related expenditures, such as convention centers, sports facilities, historical preservation related to tourism, and signage for tourists (Texas Comptroller, n.d.). Some point out convention centers’ reliance on occupancy taxes for funding, and question whether the economic benefits of those convention centers justify the taxes (Kalnins, 2006; Sanders, 2014). Local subsidies for sports arenas also receive attention. This is an area where more careful analysis of the costs and benefits of convention centers is warranted. However, the revenues are not just used to improve facilities and fund convention centers. In Texas, cities with over 200,000 residents and under US$2 million in HOT revenue must use 50 percent of the revenue for tourism advertising, which presents similar concerns about the benefit of levying an occupancy tax (Martinez-Gouhier & Hunker, 2018). Tobacco taxes Six states allow municipalities to levy tobacco taxes, which can be either a cigarette or a tobacco product tax (see Table 3.1). The structure of tobacco taxes can vary between taxing all tobacco products or a subset of them. For example, Pennsylvania only levies tobacco taxes on cigarettes, and Philadelphia is the only city that levies the local cigarette tax. Pennsylvania’s local cigarette tax is also an example of the flat per-unit tax. In Philadelphia, the city levies a cigarette tax of US$2 per pack and the state levies a US$2.60 state cigarette tax. In contrast, there is no tobacco tax on large cigars (Pennsylvania Department of Revenue, n.d.-a, n.d.-b). Like many sumptuary taxes, tobacco taxes are regulatory in nature – trying to change behavior by increasing the cost of consuming the good, which adds to their political feasibility.5 However, demand for tobacco products is inelastic, which suggests that increasing the cost will not change demand by as much as it would for a normal good, making tobacco taxes efficient. Still, in states like Pennsylvania, where only some products are taxed, tobacco taxes may encourage people to substitute products that are untaxed or taxed at a lower rate (e.g., cigarettes, cigars, e-cigarettes, and chewing tobacco). Thus, taxing all tobacco products would be more efficient and generate more revenue (increasing adequacy). Tobacco taxes are also regressive. This is especially true for the tobacco taxes that levy a per-unit cost rather than a percentage of the cost. Take the state of New Mexico, which levies a flat per-pack tax on cigarettes and a tax on cigars of 25 percent of the wholesale price, not to exceed US$0.50 a cigar. There is a lot of variability in the cost of cigars   They are also Pigouvian taxes.

5

Local option taxes  ­51

(much like alcoholic beverages). The price averages between US$2 and US$50 per cigar, with some prices well over that range (Holts Clubhouse, 2017). A flat per-unit tax is, in this case, increasing the regressivity of the tobacco tax. Interjurisdictional competition is a problem with all local taxes. There is a robust literature on the practice of evading tobacco taxes by going over state lines and using the Internet as a tax haven (Law, 1954; Licari & Meier, 1997; Manchester, 1976). These concerns are also present at the local level. Soda taxes The “soda” or sugary beverage tax is an example of another sin tax designed to discourage consumption. Only eight cities in the United States have a soda tax.6 In all but two of these cities, the tax only applies to sugar-sweetened beverages. In the other two cities – Philadelphia and Washington, DC – the tax also applies to beverages sweetened with artificial sweeteners (i.e., diet beverages). Some scholars point out that the soda tax can be considered a Pigouvian tax, which corrects for the negative externalities caused by consumption of sugary beverages, including the healthcare costs of obesity. Furthermore, many note that it can help correct for negative internalities: the negative consequences on consumers that are ignored (Allcott et al., 2019). There is a growing body of research related to the soda tax, including how the tax is typically structured. For example, a beverage that is 100 percent fruit juice would not be subject to the tax, which leads to inefficiencies since substitutes escape taxation. In this example, given that the sugar content of 100 percent juice, sugar-sweetened juices, and sodas are comparable, a tax on only sugar-sweetened beverages not only causes distortions in behavior (i.e., inefficiencies) but also fails to capture the negative externalities associated with drinking untaxed sugary beverages and to discourage their consumption. Furthermore, the taxation of the lower-priced sugary beverages and not the higherpriced ones, such as juice, exacerbates the equity concerns regarding the regressivity of the soda tax (Kane & Malik, 2019). Many proponents of the Pigouvian soda tax do not necessarily support local soda taxes but look to states and the federal government to levy them. This is largely because of the concerns over cross-border shopping to avoid the soda tax. For example, a 35-bottle pack of Gatorade in Seattle that was priced by Costco at US$15.99 was marked up to US$26.33 due to the soda tax. Interestingly, Costco was transparent about this pricing and explained the change in price by posting signage that encouraged consumers to consider going to stores in neighboring jurisdictions to avoid it (Pittman, 2018). This is not just anecdotal; there is empirical evidence that tax avoidance is occurring. Bollinger and Sexton (2018) find that approximately half the reductions in the purchases of sugary beverages in Berkeley, California, are substituted with purchases made from retailers right outside Berkeley’s city limits. This same pattern has been observed in Philadelphia, too (Roberto et al., 2019; Seiler et al., 2021).

6   There are also cases in which some states, including California, Arizona, and Michigan, have preempted soda taxes by prohibiting local governments from adopting them.

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Marijuana taxes As states legalize medicinal and recreational marijuana, there is an increasing number of local excise taxes levied on it. Like retail sales taxes, whose tax base often exempts necessities like prescription drugs, these local excise taxes frequently exclude medicinal marijuana. Marijuana can be taxed as a percentage of the price, on the basis of weight, or on the basis of potency. While states currently levy taxes on flowers, gross receipts, and retail sales of products with tetrahydrocannabinol (THC), most states only allow localities to levy excise taxes on retail sales, and rates are often capped, though Colorado also allows localities to levy a cultivator tax (Urban-Brookings Tax Policy Center, 2020). Like many excise taxes, states often restrict how the revenue generated by local marijuana taxes may be used. Frequently the revenues are earmarked for programs in areas related to marijuana use, such as criminal justice, public health, and public safety. There are also examples of earmarks for unrelated expenditures, such as education. Illinois and Virginia each have an unusually complicated set of earmarks. In Illinois, the revenue generated by marijuana taxes is first used to pay for the administrative costs associated with the legalization of marijuana. The remaining revenues are distributed to the general fund, criminal justice reforms, and substance abuse programs (Government of Illinois, n.d.). Virginia will begin permitting the retail sales of marijuana and cannabis products in 2024 and will begin taxing them at that time. The state reports that revenues will be earmarked for prekindergarten programs for at-risk youth, substance abuse, and the Cannabis Equity Reinvestment Fund, which will support communities that have been disproportionately affected by drug enforcement efforts historically.7 The earmarks in these two states demonstrate that marijuana taxes are often loosely benefit taxes. Interestingly, they also demonstrate the trend of using earmarks to promote social equity efforts. Much of the evaluation of marijuana taxes echoes tobacco taxes, though they are new enough that it is not yet clear how elastic the demand for legal marijuana is or how the established illegal networks may continue to affect sales in legal markets – especially as marijuana taxes tend to be high. For example, retail cannabis sales in Virginia will be taxed at 21 percent of the retail price, and local governments will be able to impose an additional 3 percent on top of the state rate (Apfel et al., 2021). Illinois, on the other hand, has a model based on potency. There is a 7 percent excise tax on the gross receipts, a 10 percent tax on less potent products, a 25 percent excise tax on more potent products, a 20 percent excise tax on edibles, and an up to 3 percent tax levied by counties and municipalities. Given how high the combined state and local taxes are, there are concerns that the taxes are counterproductive to the goal of reducing or eliminating the black market. Of course, the elimination of the black market is not the sole goal. There is also evidence that with lower rates there will be more users, including those who are underage, since it is currently estimated that demand for marijuana is relatively elastic (see Pacula & Lundberg, 2014, for an overview of the relevant literature). While it perhaps seems inconsistent to think that states are simultaneously legalizing marijuana and discouraging its use, this is the case. Marijuana taxes are sumptuary taxes, and marijuana is ultimately being treated comparably to alcohol and tobacco.   Whether the state earmarks apply to the local revenues is unclear.

7

Local option taxes  ­53

Local marijuana taxes present similar concerns as other LOTs, such as regressivity, rate differentials, cross-border shopping, and competition. Unreliable revenue capacity has also been an issue. Many anticipated that marijuana taxes would result in revenue windfalls, but for most states they are generating far less revenue than projected and are volatile (Becker, 2019). While many LOTs do not have higher revenue capacity, the difference is that marijuana taxes are misforecasted consistently. Ultimately, how marijuana taxes satisfy the tax criteria is still unclear and an area where important work needs to be done. Local Option Income Taxes In 13 states, local governments levy local income taxes (see Table 3.1).8 In four of those states, the local income tax piggybacks the state tax. In contrast, local governments in eight states levy an earnings or payroll tax that is separate from the state income tax entirely. Earnings and payroll taxes are typically levied as a percentage of wages. They can be levied on the location of employment rather than the taxpayer’s residence. In four states, the local income taxes are levied on employers, not employees (Pinho, 2013). Much like local sales taxes, the nuances of local income taxes by state vary tremendously by state. For example, Ohio’s municipalities administer and collect the local income taxes, but school districts can levy their own local income taxes that are subject to the same “filing, amending, payment, extension, refund requirements, and procedures” as the state income tax, and the state is responsible for administrating those taxes (Ohio Department of Taxation, n.d.-a, n.d.-b). Most local income taxes are self-administrated (Pinho, 2013). The dependence on local income taxes varies from state to state. For example, in Oregon and Kansas, less than 1 percent of own source revenue is generated from the local income tax, while in Maryland, over a quarter of own source revenue is generated by the local income tax (Urban-Brookings Tax Policy Center, 2020). Local income taxes draw a distinct set of concerns. First, there are concerns regarding the effect they have on employment. It is expected that local income taxes have a negative impact on the numbers of hours worked (Feldstein, 1995). However, one study of local income taxes in Indiana finds that taxpayers were unresponsive to small changes in local income tax rates (Yang & Heim, 2017). A second concern about subnational government income taxes is migration (see, e.g., Afonso, 2015b, 2018b; Agrawal & Hoyt, 2018; Giertz & Tosun, 2012; Musgrave, 1969; Oates, 1968).9 While there are concerns about tax-induced migration at the state level, they are amplified at the local level. However, the evidence of local income taxes on migration is conflicting (Grieson, 1980; Inman et al., 1987; Landers, 2008). In fact, Agrawal and Hoyt (2018) examine the impact of state income taxes at the local level for border communities and find that there were substantial responses by high-income earners. Nechyba (1997) introduced a model where local planners can collude and introduce 8   Maryland has local income taxes, but they are not “optional” since the local governments do not choose to levy them. Furthermore, Georgia authorizes local income taxes, but none have been levied. 9   The empirical literature is divided on the impact of subnational taxation on immigration (e.g., Young & Varner, 2011).

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local income taxes simultaneously to minimize efficiency losses like migration – though it would likely require state intervention. The model is tested and evidence suggests that when fiscal competition increases, local income tax use declines (Spry, 2005). Third, there is a concern over double taxation. In many states, income can be taxed by both the jurisdiction of residence and of employment. Without a credit for taxes paid to another jurisdiction (typically applied to the place of residence), this can result in double taxation for commuting earners.10 Last, the administration of a local income tax is costly if it is decoupled from the state’s income tax. For example, in Pennsylvania, home to the oldest local income tax, local governments were responsible for their own administration of the local income tax. Starting in 2012, countywide tax collection agencies began administering the municipal taxes rather than the municipalities. This reduced the number of earned income tax collectors from 560 to 21 (Berkheimer, n.d.).11 Thus, differences in the cost of administration are not attributable simply to the differences between local taxes and state taxes. The structure of taxes at the local level is also a factor. Many of the same LOT concerns remain, such as tax competition between jurisdictions and fiscal disparities. Take fiscal disparities, for example. In 2015, the state of Connecticut commissioned a tax study that considered local tax policies and the impacts they would have on various concerns, like revenue generation, interjurisdictional fiscal capacity, and equity. The study estimates that the distribution of per capita revenues from payroll taxes imposed by place of employment ranged from US$22 to US$872. For the income surtax across municipalities, the estimated range is US$31 to US$1874. Furthermore, the municipalities with the highest potential revenues from local income taxes are the municipalities with the strongest fiscal health (Sjoquist, 2015).

IMPACT OF THE PANDEMIC The global COVID-19 pandemic in early 2020 was incredibly challenging for all levels of government. Typically, local governments are less vulnerable to economic downturns than higher levels of government because of their reliance on more stable and less elastic revenue sources like property taxes and user fees. However, for many cities the post-Great Recession recovery of property tax revenue has been slow (Chernick et al., 2021).12 This has led to increased reliance on other taxes, the largest of which are local sales taxes. In fact, many cities entered the Great Lockdown with dependence on elastic revenue sources at rates not observed previously. Columbus, Ohio, is estimated to receive more than 75 percent of its general fund revenues from elastic revenue sources. Cities like 10   There are many examples of these credits. For example, Michigan has a straightforward process. Residents pay a tax on their income and nonresidents pay a half rate. Then commuters can receive a credit for the taxes paid to the jurisdiction of employment. In contrast, earners in Birmingham, Alabama, must calculate the share of work done in the city to receive the prorated rate. 11   Act 32 also required employers to withhold taxes and made the system more uniform overall. 12   In one recent study, almost 40 percent of budget officers in North Carolina expected property taxes to decrease in fiscal year 2021. This was not due to changes in assessments (which are established January 1 in the preceding fiscal year), but due to concerns of reduced collection rates. Early data suggested that reduced collection rates were uncommon (Afonso, 2021).

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Colorado Springs, Bowling Green, Kentucky, Cleveland, Ohio, and Aurora, Colorado are estimated to receive more than two-thirds of their general fund revenues from elastic instruments (Pagano & McFarland, 2020). Therefore, even ignoring the unique challenges and impacts brought on by the pandemic, this trend has put municipalities in a more precarious financial position. Of course, the Great Lockdown was no ordinary recession. Unemployment spiked immediately, nonessential workers began working from home, tourism halted, schools and universities went remote, and businesses shuttered. There was an instantaneous shock to many municipal revenue instruments. Many of the LOTs discussed in this chapter were especially impacted. For example, local option sales taxes immediately fell. In New York, the average year-over-year change in local sales tax revenue in May 2020 was a decrease of almost a third of sales tax collections, and that number does not account for any projected growth, which would have been expected based on the early months of 2020 (Office of the New York State Comptroller, 2020). Figure 3.1 presents a similar picture, using revenues from North Carolina’s local sales taxes, occupancy taxes, and prepared food taxes. It shows that the impacts on LOTs during the pandemic came at incredible speed and were devastating. These impacts reflect the trends nationwide. It is not at all surprising that food and beverage and occupancy taxes experienced considerable declines, given that restaurants shuttered and tourism halted for much of the year. Another effect of the pandemic was that nonessential workers began to work remotely, which affected the distribution of local sales taxes (Afonso & Moulton, 2021).

20% 10 0% -10 -20 -30 -40

Sales and Use

-50

Prepared Food Occupancy

-60 -70 -80% Nov 2019

Dec

Jan 2020

Feb

Mar

Apr

May

Jun

Jul

Aug

Sep

Oct

Nov

Dec

Figure 3.1  Percentage change in North Carolina tax revenues by month compared to same month in the prior year, November 2019–December 2020

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Fuel taxes were affected, too. Early estimates suggest that 1 billion fewer miles were being driven a day in the United States at the start of the pandemic. In fact, Oregon reports collecting US$27 million less in gasoline taxes than forecasted for between January and August 2020 (National Governors Association, 2020); for states with local fuel excise taxes, like Florida, this is meaningful. Furthermore, the distribution of the impacts has been far from uniform. Some municipalities and counties experienced dramatic declines in LOTs, like the sales tax, but others quickly rebounded and experienced growth. Some of this is likely due to people working remotely in more sparsely populated areas; economic nexus laws requiring online vendors collecting local sales (use) taxes for those no longer shopping in brick-and-mortar retailers; and variation in the economic bases of different jurisdictions (Afonso, 2019; Afonso & Moulton, 2021; BBC, 2021). We typically think of the impact of recessions as short-term changes, though they are critical to the current operations of local governments. However, that does not suggest that the effects of the pandemic will be short term. Business travel decreased tremendously, and it might not rebound to earlier levels. Employees that had not previously been able to work remotely were forced to do so, and this may change how businesses operate moving forward. Employers may allow for increased remote work options, which could save money on office space, parking, and other accommodations. These trends may change where people choose to live. If working remotely is suddenly an option, urban areas may be less attractive to workers who could live in much more low-cost areas that are still accessible to urban centers. Early evidence suggests that this urban flight concern is overblown, and the decreased in-migration is expected to be short-lived (Gascon, 2021; Handbury, 2020). However, even small shifts in migration could have major impacts on government revenues collected from LOTs, especially since high-income earners are the most mobile (Afonso, 2015b; Rork & Wagner, 2012; Wildasin, 1993) and if these trends persist, it may require local governments to reconsider their revenue portfolios. Remote work introduces other complications as well. In Ohio, it became a problem that necessitated immediate policy. Ohio workers may be responsible for paying municipal income taxes in both the city where they reside and the city where they work.13 Workers who typically commuted to different counties found themselves responsible for paying taxes to the community to which they were no longer commuting. The intent behind collecting income taxes based on place of work is to capture tax revenue from those who use municipal services and do not pay for them through traditional mechanisms like the property tax, but this justification does not hold up during a pandemic. However, Ohio state legislators passed House Bill 197 to allow cities to continue collecting municipal income taxes from commuters who are now working remotely, which led to a lawsuit challenging the legislation. “Ohio law permits you to be taxed based on where you live and where you actually perform work. But it doesn’t allow you to be taxed based on ‘Let’s pretend’” (Robert Alt, as quoted in Staver, 2020, n.p.). Thus, if these patterns continue past the pandemic, it is likely that there will be additional policies and lawsuits in this area.

13

  Some jurisdictions in Ohio reduce rates for commuters.

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CONCLUSION There are numerous reasons a state may permit local governments to levy LOTs. LOTs allow for greater fiscal autonomy; increase fiscal health and sustainability; permit greater revenue diversification, which may lead to more stability; and reduce reliance on property taxes. However, there are many concerns about greater reliance on LOTs. They are typically more regressive and less stable than the property tax. They increase interjurisdictional tax competition and exacerbate fiscal disparities. In fact, in two recent state-level policy reports considering the introduction of additional LOTs in Massachusetts and Connecticut, a great deal of time was spent cautioning state officials on the increased use of LOTs, noting issues like the fiscal disparities they create (Sjoquist, 2015; Zhao, 2011).14 Zhao (2011) noted that large cities and high-income, property-rich municipalities would benefit the most from the LOTs being considered by Massachusetts. If these fiscal disparities continued to grow and led to overall high- and low-capacity jurisdictions, there would likely be increased demand for state aid to low-capacity jurisdictions rather than increased access to local taxes. Theory suggests that an increase in the price of a good through taxation results in decreased consumption. This is true for taxes on consumer expenditures such as meals, hotels, and televisions. Furthermore, at the local level, tax competition between neighboring communities can be expected to accompany that reduced consumption. This could result in numerous responses, depending on the type of local tax, including the migration of workers, people shopping in a neighboring jurisdiction, or people vacationing in different towns. There is also conflicting evidence on the influence that greater reliance on LOTs will have on revenue stability. The revenue diversification literature largely finds that greater diversification leads to stability, in keeping with modern portfolio theory (e.g., Carroll, 2009; Jordan et al., 2017). However, there is also evidence that shows that most diversification is a result of moving away from a stable property tax toward greater reliance on elastic sales and income taxes, resulting in greater volatility (Afonso, 2013, 2017b; Holcombe & Sobel, 1995; Hou & Seligman, 2007). Further examination of the impact that increased availability and diversity of LOTs have on revenue portfolios will be important to both scholars and practitioners. This chapter lays out some of the diversity, complex legal structures, and constraints of LOTs. Additional research on how LOT laws impact the adoption, implementation, and expenditures and the impact of LOTs on revenue portfolios and residents is critical to understanding modern municipal finance. The wide variation and complicated nature of the jurisdictional eligibility and the discretionary authority of local option sales taxes across states has led to most analyses being limited to single states.15 However, it would be valuable to understand how these legal structures affect outcomes. For example, one analysis of local option fuel taxes in Florida finds evidence that the rate-setting discretion 14   Afonso (2016) also examines fiscal disparities in terms of combined local sales taxes and property taxes, and does so from the lens of tax leakage. Once she controls for factors likely to affect revenue-raising capacity (e.g., income), she finds that tax leakage created by local sales taxes does not have an impact. Zhao and Hou (2008) have similar findings. 15   See Afonso (2017a) for a discussion of the literature.

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and the ease of adoption (super-majority versus simple-majority) influence the timing of adoption (Chen & Afonso, 2021). The variety of ways that laws affect management, policy, and outcomes is an area where much more work needs to be done – along the lines of the excellent literature on tax and expenditure limitations. Of course, tax structure may be influenced by goals other than revenue. For example, sin taxes are designed to discourage consumption, Pigouvian taxes are intended to correct for negative externalities, and taxes on marijuana pursue numerous goals, including eliminating the black market and correcting past social harms. Further examination of the effectiveness of LOTs at accomplishing these goals and the trade-off with other goals is an area where additional work can be done. For example, what is the most important goal of a soda tax? If it is reducing the consumption of sugar, then a tax based on “potency” (sugar content) would be expected to be the most effective. However, if revenue-raising and ease of administration are the main goals, then the current system, which bases the tax on the beverage’s volume, is the reasonable choice (Francis et al., 2016). Furthermore, cities like Philadelphia and Washington, DC, which are also taxing diet beverages, demonstrate that revenue-raising may be the primary driver rather than reduction in sugar consumption.16 How these choices affect revenues, consumption, equity, and tax leakage is important for policymakers to understand. Last, methodological advances and new sources of data present exciting opportunities for future research. For example, there has been a great deal of research on tax leakage and cross-border shopping, but with mobility data provided through cellphone usage. A recent paper estimates that there is a 1–1.5 percent decline in store visits with a 1 percentage point increase in the local sales tax rate (Miller & Omartian, 2021). Of course, given that most of the literature has focused on local sales taxes, expanding the research to other LOTs is also important.

REFERENCES Afonso, W. B. (2013). Diversification toward stability? The effect of local sales taxes on own source revenue. Journal of Public Budgeting, Accounting & Financial Management, 25(4), 649–674. Afonso, W. B. (2014). Fiscal illusion in state and local finances: A hindrance to transparency. State and Local Government Review, 46(3), 219–228. Afonso, W. B. (2015a). Leviathan or flypaper: Examining the fungibility of earmarked local sales taxes for transportation. Public Budgeting & Finance, 35(3), 1–23. Afonso, W. B. (2015b). State income taxes and military service members’ legal residency choices: Income taxes and legal residency. Contemporary Economic Policy, 33(2), 334–350. Afonso, W. B. (2016). The equity of local sales tax distributions in urban, suburban, rural, and tourism rich counties in North Carolina. Public Finance Review, 44(6), 691–721. Afonso, W. B. (2017a). State LST laws: A comprehensive analysis of the laws governing local sales taxes. Public Budgeting & Finance, 37(4), 25–46. Afonso, W. B. (2017b). Revenue portfolio and expenditures: An examination of the volatility of tax revenue and expenditure patterns during the Great Recession. International Journal of Public Administration, 40(10), 896–905.

16   It appears that the Philadelphia tax may have also been a tool in the feud between city elected officials, an infamous labor leader, and the Teamsters labor union (Boyer, 2019).

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Afonso, W. B. (2018a). Time to adoption of local option sales taxes: An examination of Texas municipalities. Public Finance Review, 46(4), 558–582. Afonso, W. B. (2018b). The effect of a state income tax on migration: The example of Connecticut. Journal of Public Policy, 38(1), 113–140. Afonso, W. B. (2019). The barriers created by complexity: A state-by-state analysis of local sales tax laws in light of the Wayfair ruling. National Tax Journal, 72(4), 777–800. Afonso, W. B. (2021). Planning for the unknown: Local government strategies from the fiscal year 2021 budget season in response to the COVID-19 pandemic. State and Local Government Review, 53(2), 159–171. Afonso, W. B., & Moulton, J. (2021, May 28–29). Using the COVID-19 pandemic to understand local sales tax base and the question of “who pays” [Paper presentation]. Fifth Annual Public Finance Consortium, Bloomington, Indiana. https://oneill.indiana.edu/doc/research/finance2021/afonsomoulton-who-pays.pdf. Agrawal, D. R. (2016). Local fiscal competition: An application to sales taxation with multiple federations. Journal of Urban Economics, 91, 122–138. Agrawal, D. R., & Hoyt, W. H. (2018). Commuting and taxes: Theory, empirics and welfare implications. The Economic Journal, 128(616), 2969–3007. Airbnb. (n.d.-a). In what areas is occupancy tax collection and remittance by Airbnb available? https:// www.airbnb.com/help/article/2509/in-what-areas-is-occupancy-tax-collection-and-remittance-byairbnb-available – section-heading-2. Airbnb. (n.d.-b). Occupancy tax collection and remittance by Airbnb in Florida. https://www.airbnb. com/help/article/2301/occupancy-tax-collection-and-remittance-by-airbnb-in-florida. Allcott, H., Lockwood, B. B., & Taubinsky, D. (2019). Regressive sin taxes, with an application to the optimal soda tax. The Quarterly Journal of Economics, 134(3), 1557–1626. Apfel, D., Jackson, L., & Schuman, B. (2021, April 14). Virginia becomes first southern state and 16th in the U.S. to legalize adult recreational cannabis. Jdsupra.com. https://www.jdsupra.com/ legalnews/virginia-becomes-first-southern-state-3484979. Avalara MyLodgeTax. (n.d.). State lodging tax center: State lodging tax requirements for short-term rental operators. Avalara.com. https://www.avalara.com/mylodgetax/en/resources/state-lodgingtax-requirements.html. BBC News. (2021, April 29). Amazon hopes pandemic habits stick after profits triple. https://www. bbc.com/news/business-56937428. Beale, H. B., Bishop, E. R., & Marley, W. G. (1996). How to pass local option taxes to finance transportation projects. Transportation Research Record, 1558(1), 74–82. Becker, B. (2019, October 14). Cannabis was supposed to be a tax windfall for states. The reality has been different. Politico.com. https://www.politico.com/agenda/story/2019/10/14/marijuana-taxrevenue-001062. Berkheimer Tax Innovations. (n.d.). What is Act 32? https://www.hab-inc.com/act-32. Bird, R. M. (2001). Setting the stage: Municipal and intergovernmental finance. In M. E. Freire & R. Stren (Eds.), The challenge of urban government: Policies and practices (pp. 128–113). World Bank Institute. Bollinger, B., & Sexton, S. (2018). Local excise taxes, sticky prices, and spillovers: Evidence from Berkeley’s soda tax. SSRN. http://dx.doi.org/10.2139/ssrn.3087966. Bowman, J. H., MacManus, S., & Mikesell, J. L. (1992). Mobilizing resources for public services: Financing urban governments. Journal of Urban Affairs, 14(3–4), 311–335. Boyer, D. (2019, January 31). Philadelphia’s 2016 soda tax pushed through for revenge feud, not health benefits, says indictment. The Washington Times. https://www.washingtontimes.com/ news/2019/jan/31/philadelphias-2016-soda-tax-pushed-through-for-rev. Brunner, E. J., Ross, S. L., & Simonsen, B. K. (2015). Homeowners, renters and the political economy of property taxation. Regional Science and Urban Economics, 53, 38–49. Brunner, E. J., & Schwegman, D. S. (2017). The impact of Georgia’s education special purpose local option sales tax on the fiscal behavior of local school districts. National Tax Journal, 70(2), 295–328. Brunori, D. (2020). Local tax policy: A primer. Rowman & Littlefield. Buchanan, J. M. (1967). Public finance in democratic process. University of North Carolina Press.

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Kane, R. M., & Malik, V. S. (2019). Understanding beverage taxation: Perspective on the Philadelphia beverage tax’s novel approach. Journal of Public Health Research, 8(1), 40–45. Landers, J. (2008). Useful data may be right under your nose: Estimating the elasticity of taxable income with local option income tax data. Proceedings: Annual Conference on Taxation and Minutes of the Annual Meeting of the National Tax Association, 101, 228–234. Law, W. A. (1954). Evasion of state tobacco taxes. National Tax Journal, 7(2), 164–176. Lee, R. D., Jr., Johnson, R. W., & Joyce, P. G. (2020). Public budgeting systems (10th ed.). Jones & Bartlett Learning. Lee, S. K. (2014). Revisiting the impact of bed tax with spatial panel approach. International Journal of Hospitality Management, 41, 49–55. Licari, M. J., & Meier, K. J. (1997). Regulatory policy when behavior is addictive: Smoking, cigarette taxes and bootlegging. Political Research Quarterly, 50(1), 5–24. Luna, L. (2004). Local sales tax competition and the effect on county governments’ tax rates and tax bases. Journal of the American Taxation Association, 26(1), 43–61. Manchester, P. B. (1976). Interstate cigarette smuggling. Public Finance Quarterly, 4(2), 225–238. Martinez-Gouhier, C., & Hunker, K. (2018). The hotel occupancy tax in Texas. Texas Public Policy Foundation. https://www.texaspolicy.com/wp-content/uploads/2018/08/2018-04-RR-Hotel-Occ​ upancy-Tax-in-Texas-CEP-MartinezHunker.pdf. Mikesell, J. L. (1997). The American retail sales tax: Considerations on their structure, operations, and potential as a foundation for a federal sales tax. National Tax Journal, 50(1), 149–165. Mikesell, J. L. (2016). Fiscal administration (10th ed.). Cengage Learning. Miller, G. S., & Omartian, J. D. (2021, March 26–27). Foot traffic response to sales tax: Evidence from mobility data [Paper presentation]. 24th UNC Tax Symposium, Chapel Hill, NC, United States. https://www.dropbox.com/s/mc6rf5soibdm5m8/Foot%20Tra%EF%AC%83c%20Respon​ se%20to%20Sales%20Tax%20Evidence%20from%20Mobility%20Data.pdf ?dl=0. Mitchell, A. (2021, February 24). Missoula, Bozeman officials testify in favor of local option sales tax on luxury items. Missoulacurrent.com. https://missoulacurrent.com/missoula-bozeman-salestax. Musgrave, R. A. (1969). Fiscal systems. Yale University Press. National Governors Association. (2020, November 30). Transportation funding and financing during COVID-19 [Memorandum]. https://www.nga.org/center/publications/transportation-fundingfinancing-covid-19. Nechyba, T. J. (1997). Existence of equilibrium and stratification in local and hierarchical Tiebout economies with property taxes and voting. Economic Theory, 10(2), 277–304. Oates, W. E. (1968). The theory of public finance in a federal system. Canadian Journal of Economics/Revue canadienne d’économique, 1(1), 37–54. Office of the New York State Comptroller. (2020, December 16). Dinapoli: Statewide local sales tax collections down 7.1 percent in November [Press release]. https://content.govdelivery.com/accounts/ NYOSC/bulletins/2b1651b. Ohio Department of Taxation. (n.d.-a). School district income tax. https://tax.ohio.gov/individual/ school-district-income-tax. Ohio Department of Taxation. (n.d.-b). Municipal income taxes. https://tax.ohio.gov/wps/portal/ gov/tax/business/municipalities/municipalities. Pacula, R. L., & Lundberg, R. (2014). Why changes in price matter when thinking about marijuana policy: A review of the literature on the elasticity of demand. Public Health Reviews, 35(2), 1–18. Pagano, M. A., & McFarland, C. K. (2020, March 31). When will your city feel the fiscal impact of COVID – 19? Brookings Institution. https://www.brookings.edu/blog/the-avenue/2020/03/31/ when-will-your-city-feel-the-fiscal-impact-of-covid-19/?utm_source=newsletter&utm_medium=​ email&utm_campaign=newsletter_axiosam&stream=top. Pennsylvania Department of Revenue. (n.d.-a). Cigarette tax. https://www.revenue.pa.gov/Tax​ Types/CigaretteTax/Pages/default.aspx. Pennsylvania Department of Revenue. (n.d.-b). Philadelphia cigarette tax. https://www.revenue. pa.gov/TaxTypes/CigaretteTax/Pages/Philadelphia-Cigarette-Tax.aspx. Pinho, R. (2013, October 3). Local option taxes (OLR Research Report No. 2013-R-0345). Connecticut General Assembly. https://www.cga.ct.gov/2013/rpt/2013-R-0345.htm.

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Pittman, T. (2018, January 5). Don’t like Seattle’s sugary drink tax? Costco invites you to shop outside the city. King5.com. https://www.king5.com/article/money/consumer/dont-like-seattles-sugarydrink-tax-costco-invites-you-to-shop-outside-the-city/281-505360199. Reschovsky, A. (2019). The tax autonomy of local governments in the United States. Lincoln Institute of Land Policy. Roberto, C. A., Lawman, H. G., LeVasseur, M. T., Mitra, N., Peterhans, A., Herring, B., & Bleich, S. N. (2019). Association of a beverage tax on sugar-sweetened and artificially sweetened beverages with changes in beverage prices and sales at chain retailers in a large urban setting. JAMA, 321(18), 1799–1810. Rogers, C. L. (2004). Local option sales tax (LOST) policy on the urban fringe. Journal of Regional Analysis & Policy, 34(1), 27–50. Rork, J. C., & Wagner, G. A. (2012). Is there a connection between reciprocity and tax competition? Public Finance Review, 40(1), 86–115. Sanders, H. T. (2014). Convention center follies: Politics, power, and public investment in American cities. University of Pennsylvania Press. Sebastian, S., & Kumodzi, K. (2015). Progressive policies for raising municipal revenue. Localprogress. org. https://localprogress.org/wp-content/uploads/2013/09/Municipal-Revenue_CPD_040815. pdf. Seiler, S., Tuchman, A., & Yao, S. (2021). The impact of soda taxes: Pass-through, tax avoidance, and nutritional effects. Journal of Marketing Research, 58(1), 22–49. Shatford, S. (2016, January 7). 2015 in review – Airbnb data for the USA. Airdna.co. https://www. airdna.co/blog/2015-in-review-airbnb-data-for-the-usa. Sjoquist, D. (2015). Diversifying municipal revenue in Connecticut: Report prepared for the Connecticut Tax Study Panel. In State Tax Panel (Eds.), Connecticut Tax Panel Volume 3 (Ch. 4). https://www.cga.ct.gov/fin/tfs/20140929_State%20Tax%20Panel/Connecticut%20Tax%20Study​ %20Report%20Volume%203.pdf#page=221. Sjoquist, D. L., Smith, W. J., Walker, M. B., & Wallace, S. (2007). An analysis of the time to adoption of local sales taxes: A duration model approach. Public Budgeting & Finance, 27(1), 20–40. Sobel, R. S. (1997). Optimal taxation in a federal system of governments. Southern Economic Journal, 64(2), 468–485. Sonnier, B. M., & Nichols, N. B. (2018). Taxation of OTCs for hotel occupancy taxes: Lessons in statutory construction. Taxes, 96(4), 27–36. Spry, J. A. (2005). The effects of fiscal competition on local property and income tax reliance. B.E. Journal of Economic Analysis & Policy, 5(1), Article 1. Staver, A. (2020, July 9). Should you pay commuter taxes while working from home? Conservative group says no. The Columbus Dispatch. https://www.dispatch.com/story/news/politics/2020/07/09/ should-you-pay-commuter-taxes-while-working-from-home-conservative-group-says-no/1127​ 46530. Swianiewicz, P. (2003). Foundations of fiscal decentralization: Benchmarking guide for countries in transition. Local Government and Public Service Reform Initiative/Open Society Institute. Texas Comptroller. (n.d.). Local hotel occupancy tax overview. https://comptroller.texas.gov/ economy/local/hotel.php. Tobacco Control Legal Consortium. (2016). U.S. local tobacco tax authority: A 50-state review. Public Health Law Center at Mitchell Hamline School of Law. https://www.publichealthlaw​ center.org/sites/default/files/resources/tclc-tobacco-tax-authority-50-state-review-2016.pdf. Urban-Brookings Tax Policy Center. (2020). The Tax Policy Center’s briefing book: A citizen’s guide to the fascinating (though often complex) elements of the federal tax system. https://www.taxpoli​ cycenter.org/sites/default/files/briefing-book/tpc_briefing_book_2021.pdf. Urban Institute. (n.d.-a). Soda taxes. https://www.urban.org/policy-centers/cross-center-initiatives/ state-and-local-finance-initiative/state-and-local-backgrounders/soda-taxes. Urban Institute. (n.d.-b). Cannabis taxes. https://www.urban.org/policy-centers/cross-center-initia​ tives/state-and-local-finance-initiative/state-and-local-backgrounders/marijuana-taxes. US Joint Committee on Taxation (2017, July 14). Overview of the federal tax system and policy considerations related to tax reform: July 14, 2017. JCX-36–17. https://www.jct.gov/getattach​ ment/b7ad4105-58c8-4387-83cf-b585488e3dcb/x-36-17-5015.pdf.

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Wagner, R. E. (1976). Revenue structure, fiscal illusion, and budgetary choice. Public Choice, 25(1), 45–61. Walczak, J. (2017, January 26). Punching the meal ticket: Local option meals taxes in the states (Tax Foundation Fiscal Fact No. 538). https://taxfoundation.org/punching-meal-ticket-local-optionmeals-taxes-states. Walczak, J. (2019, July 30). Local income taxes in 2019 (Tax Foundation Fiscal Fact No. 667). https://taxfoundation.org/local-income-taxes-2019. Wang, W., & Zhao, Z. J. (2011). Fiscal effects of local option sales taxes on school facilities funding: The case of North Carolina. Journal of Public Budgeting, Accounting & Financial Management, 23(4), 507–533. Wildasin, D. E. (1993). State income taxation with mobile labor. Journal of Policy Analysis Management, 12(1), 51–75. Wooster, J. H. (1987). Local non-property taxation: An option for Massachusetts’ cities and towns? Commonwealth of Massachusetts, Special Commission on Tax Reform. Yang, L., & Heim, B. T. (2017). Responsiveness of income to local income taxes: Evidence from Indiana. National Tax Journal, 70(2), 421–446. Young, C., & Varner, C. (2011). Millionaire migration and state taxation of top incomes: Evidence from a natural experiment. National Tax Journal, 64(2), 255–283. Zhao, B. (2011). The fiscal impact of local-option taxes on municipalities: The case of Massachusetts. Municipal Finance Journal, 31(4), 63–86. Zhao, Z., & Hou, Y. (2008). Local-option sales taxes and fiscal disparity: The case of Georgia counties. Public Budgeting & Finance, 28(1), 39–57.

4. The growing role of nontax revenue sources in American cities Min Su

INTRODUCTION The American system of fiscal federalism lays out a normative framework that assigns government functions and the corresponding revenue-raising authority to federal, state, and local governments (Oates, 1999, 2008). At the bottom of the fiscal food chain are over 89,000 local governments – cities, counties, townships, special districts, and school districts (US Census Bureau, 2012). The United States is one of the world’s most decentralized federal systems, in which local governments are granted substantial fiscal autonomy (Conlan et al., 2015). A decentralized fiscal federalism system is believed to foster productive efficiency (producing goods and services at low cost) and allocative efficiency (producing goods and services that reflect different tastes across jurisdictions) (Oates, 1972). Municipal governments are closer to the people and respond to their various needs and demands. They provide a broad range of essential services from police and fire protection, public housing, and sanitation services to parks and recreational facilities, libraries, and others. To carry out these functions, municipal governments collect revenues from sources of their own and intergovernmental transfers from federal and state governments. Figure 4.1 depicts major revenue sources of municipal governments. Municipal own-source revenues consist of tax revenue and nontax revenue. Taxes are compulsory, unrequited payments on income, profits, wealth, transactions of property, and goods and services levied by governments. The mainstay municipal taxes include property taxes, sales taxes, and income taxes. Besides these three commonly used taxes, some cities levy local optional taxes, license taxes, and many other minor taxes. As municipal governments expand their activities to serve a more heterogeneous population, and as the tax burden approaches levels of inefficiency, the idea of financing some municipal services by nontax revenue, such as user charges, gains increasing appeal. Nontax revenue covers a bewildering array of revenue sources not defined as a tax, ranging from user charges, fees, and special assessments to the sale of government assets, interest earnings, and fines and forfeiture. These nontax revenue sources differ dramatically in their nature, mechanism, characteristics, and implementation, making it highly challenging to categorize these nontax revenue sources. This chapter follows the US Census Bureau’s revenue categorizing approach that divides a government’s general revenue as taxes, intergovernmental revenue, current charges, and miscellaneous revenue (US Census Bureau, 2006). Excluding taxes and intergovernmental revenue, a municipal government’s own-source nontax revenue thus includes the total of current charges and miscellaneous revenue. Nontax sources generate substantial amounts of local revenue. Table 4.1 demonstrates the percentage share of the three local government revenue components in the total general revenue by types of local governments. Of the three general-purpose local 64

The growing role of nontax revenue sources in American cities  ­65

Figure 4.1  Municipal revenue sources Table 4.1  Percentage share of local general revenue sources, 2019

Tax Nontax Intergovernmental transfer

City (%)

County (%)

Township (%)

47.0 33.6 19.4

45.9 24.1 30.0

67.4 15.0 17.6

Source:  US Census Bureau’s Annual Survey of State and Local Government Finances (2019) (author’s calculation).

governments – cities, counties, and towns and townships – cities rely on nontax revenue the most. In 2019, cities collected 33.6 percent of general revenue from nontax sources, compared to 24.1  percent collected by counties and 15 percent collected by township governments. Figure 4.2 demonstrates that of the 33.6 percent of general revenue collected from nontax sources, 24.3 percent came from current charges, and 8.9 percent from miscellaneous ­revenues. This chapter examines the major facets of nontax revenue common to municipal governments and surveys the use of nontax revenue by municipal governments in the United

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Source:  US Census Bureau’s Annual Survey of State and Local Government Finances (2019).

Figure 4.2  Percentage share of revenue components in municipal general revenue, 2019 States. Although not exhaustive, this chapter intends to provide helpful background for readers who are interested in using nontax revenue to fund municipal services. The chapter begins by introducing the common sources of municipal nontax revenue. Next, the chapter presents an overview of the growth and significance of nontax revenue in the municipal revenue system. It then discusses the reasons why cities have increased reliance on nontax revenue sources. Next, the chapter introduces municipal use of nontax revenues in the Great Recession and the recent COVID-19 recession. The final section summarizes the roles of nontax revenues in municipal finance.

SOURCES OF MUNICIPAL OWN-SOURCE NONTAX REVENUES All three layers of governments – federal, state, and local – generate revenue from a diverse group of nontax sources. Some nontax sources of revenue fall primarily in the municipal domain. As previously defined, a municipal government’s own-source nontax revenue includes two of the Census Bureau’s revenue categories: current charges and miscellaneous revenue. These two categories both include many subcategories. The space requirement of this chapter has forced a selective approach. Therefore, this section thus selects the top three subcategories in current charges and miscellaneous revenue respectively and introduces their nature, mechanism, characteristics, use, advantages, and limitations. User Charges and Fees User charges and fees are revenues collected “from the public for the performance of specific services which benefit the person charged from the sale of commodities or services

The growing role of nontax revenue sources in American cities  ­67

other than utilities and liquor stores” (US Census Bureau, 2006, pp. 4–32). Most academic literature and government documents refer to the user charges and fees either as one term or use them interchangeably.1 By definition, user charges and fees are synonymous with the Census Bureau’s term “current charges.” The Census Bureau uses “current” to indicate that this revenue category only includes user charges in a government’s general fund. User charges from liquor stores and utility services (e.g., electric power systems, gas supply systems, and public mass transit systems) are excluded and reported in various enterprise funds. User charges and fees are in fundamental contrast to taxes. The former are “levied on consumers of government goods or services in relation to their consumption” (Bird & Tsiopoulos, 1997, p. 39). The latter are compulsory levies through government sovereign taxing power “without consideration of whether the taxpayer will benefit from the services to be funded by the tax” (Reynolds, 2004, p. 379). User charges and fees have the distinguishing characteristic of voluntary exchange. People choose whether to use and pay for a specific government service based on their needs, preferences, and affordability. Government can deny the use of service to nonpayers. User charges and fees are set to fund a particular service partially or fully. Revenue derived from charges and fees cannot be used for general governmental services or any purpose other than that for which the charges and fees were imposed. The amount cannot exceed the funds required to provide the service (League of California Cities, 2019). In effect, charges and fees establish a direct link between the benefits a consumer receives and the costs to a government providing the service. This revenue approach treats government activities like market transactions in a consumer economy, and they “make government behave more like a private business and less like an intractable bureaucracy” (Mikesell, 2017, p. 571). Using charges and fees to fund public services is only appropriate for some services. The Office of Management and Budget (2007, p. 272) provides some guidelines on how to choose the appropriate financing methods: In general, if the benefits accrue broadly to the public, the program should be financed by taxes paid by the public. In contrast, if the benefits accrue to a limited number of private individuals or organizations, then the program should be financed by charges and fees paid by the private beneficiaries.

Among the many services provided by municipal governments, some services benefit the general public, while some services benefit identifiable individuals. Table 4.2 lists a few examples of municipal services within a continuum of the degree of benefit received. Services in the first column are local public goods. These services benefit the general public. Individual beneficiaries are hard to identify. Services in the last column benefit identifiable individuals. Benefits are limited to the individuals who have received them, with little externality that benefits the community at large. Services in the middle column 1   Mikesell (2017) separates user fees from charges and defines user fees as revenues “derived from government sale of licenses to engage in otherwise restricted or forbidden activities” (p. 571), such as building permit fees and admission fees to public parks. He defines user charges as “prices charged for voluntarily purchased, publicly provided services that, although benefiting specific individuals or businesses, are closely associated with basic government responsibilities” (ibid.). This chapter does not make this specification and considers “charges and fees” as one term.

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Table 4.2  Municipal services in relation to benefits received Benefit the General Public

Mixed

Benefit Identifiable Individuals

Police City streets Food inspection

Business improvement districts Public transit Neighborhood streetlights

Building permits Parking City golf course

have identifiable beneficiaries, and the benefits are shed onto the broader municipal economic system. According to Government Accountability Office (GAO) guidelines, services in the first column are best funded through general taxes paid by the public. Services in the last column should be funded by charges and fees paid by identifiable beneficiaries. Services in the middle column of the table could be funded by a mixture of taxes, charges and fees, and other funding sources. Of course, the extent to which a service benefits the general public or identifiable individuals is not always clear-cut. This often sparks debates on the appropriate way to pay for a specific municipal service. State governments have laws to regulate the use of user charges and fees by local governments, either in state constitutional amendments (e.g., California Proposition 218 and Proposition 26) or in state statutes (e.g., Massachusetts General Law, Chapter 40, Section 22F). The Government Finance Officers Association (GFOA) recommends best practices to help local governments establish charges and fees. The GFOA’s website shares examples of local governments’ user fee policies and a user fee policy template.2 Common categories of municipal user charges and fees All three layers of government collect user charges and fees. The federal government collects a considerable amount from postal service fees. State governments collect the most from higher education institutions (e.g., tuition, student activity fees, receipts from charges by dormitories, cafeterias, athletic programs, etc.). Table 4.3 lists the municipal services funded by user charges and fees. These services exemplify Mikesell’s (2017) two criteria for using charges and fees: identifiable beneficiaries and changeability. The changeability criterion means that governments can exclude service beneficiaries who do not pay for the service. The top three municipal services funded by charges and fees are sewerage services, air transportation and airport facilities, and public hospitals, as shown in Table 4.3. Revenue from sewerage services includes user charges for sewage collection, disposal, and sewer connection. Revenue from air transportation and airport facilities includes hangar rentals, landing fees, terminal and concession rents, parking fees at airport lots, sale of aircraft fuel and oil, and other charges for using airport facilities or services associated with their use. Revenue from public hospitals includes charges from patients, private insurance companies, public insurance programs such as Medicare, receipts of hospital canteens and cafeterias, among others. These three categories counted for 58.8 percent of municipal general revenue in 2019.3   These documents can be obtained from https://www.gfoa.org/fpc-user-fees.   The charges and fees in Table 4.3 do not include gross receipts from liquor stores and utility services. They are reported in various enterprise funds. The enterprise funds account for municipal 2 3

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Table 4.3  Common categories of municipal charges and fees in the general revenues, 2019 Source Sewerage Air transportation (airports) Public hospitals Solid waste management Parks and recreation Housing and community development Parking facilities All other general current charges Total

Total (US$ millions)

% of Total Current Charges

32,700 13,300 12,700 8,791 4,864 2,456 2,591 22,300 99,702

32.8 13.3 12.7 8.8 4.9 2.5 2.6 22.4 100.0

Note:  “All other general current charges” is the sum of charges and fees that are not covered in the above categories and categories that accounted for less than 1 percent of total charges and fees. These smaller categories include elementary and secondary education charges, regular and toll highways, natural resources, and port facilities. Source:  US Census Bureau’s Annual Survey of State and Local Government Finances (2019) (author’s calculation).

Advantages of user charges and fees User charges and fees have many advantages in local public financing beyond the pragmatism of producing additional revenues, including efficiency, equity, influencing public behaviors, and political viability. Efficiency The primary economic rationale for using charges and fees is promoting economic efficiency in the public sector. Charges and fees constrain citizens’ excessive demand and wasteful consumption of public goods and services (Mikesell, 2017). If a public service is unpriced – for instance, funded by general taxes – the demand for such a service would be inflated. The political process will be subject to pressure to address the “shortage” of such a service by allocating more public resources. User charges and fees set up a direct link between revenue collected and services provided. They increase citizens’ awareness of the costs of public programs. With costs in mind, citizens are less likely to demand unnecessary public services (Bird & Tsiopoulos, 1997; Duff, 2004). User charges and fees reveal how much citizens are willing to pay for particular services. The price signal provides critical demand information to public sector suppliers to decide what and how much service to provide. Therefore, they increase the efficient allocation of public resources and accountability in the local budgeting process. If private providers of the same service are in the market, the competition puts further pressure on government providers to lower costs or improve service quality. business-type services, which are self-supporting (Governmental Accounting Standards Board [GASB], 2007). Local governments are allowed to retain operating surplus in enterprise funds at year-end rather than closing to the general fund (Massachusetts Department of Revenue, 2020). Because of the many different underlying fiscal behaviors between enterprise funds and the general fund, this chapter only focuses on charges and fees in municipal general funds.

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Equity User charges and fees are the epitome of horizontal equity: people in equal situations are treated equally (Mikesell, 2017). Equal treatment is accomplished when service beneficiaries pay in proportion to the benefit received. Nonusers are treated equally by not having to pay for the service they do not benefit from. User charge-financing grants people the freedom of choice – they can opt out of a service and not pay for it if they do not need it. User charges and fees demonstrate the horizontal equity principle by requiring taxexempt institutions to pay their fair share for municipal services. Many cities use property taxes to finance municipal services such as police and fire protection, road maintenance, streetlights, and sanitation services. Tax-exempt institutions – nonprofit organizations, churches, and educational institutions – do not pay property taxes but use these services. User charges and fees allow cities to extract some revenue from these entities outside the property tax network – if they use the service, they must pay. User charges and fees foster equity by taking nonresidents into account in paying their fair share. For instance, many cities have commercial airports. The primary users of airport services are not city residents but travelers. Using general revenues – property taxes, sales taxes, and/or income taxes – to finance airport operations places an unfair burden on local residents. User charges and fees address this “free rider” problem. This is probably why commercial airports in the United States are largely self-sustaining by raising revenues from fees paid by passengers and airline companies. Influencing public behaviors User charges and fees have the virtue of influencing public behaviors to attain desirable public policy outcomes. One example is congestion pricing. Congestion pricing works by imposing a surcharge on users of congested roads during peak hours to reduce traffic congestion. The economic theory behind this policy is to use the price mechanism to make drivers pay for the congestion and the associated negative externalities they create. The added costs of traveling during rush hours may shift discretionary rush-hour travel to off-peak periods. Thus, congestion pricing manages congestion without increasing supply. The Federal Highway Administration (2006, p. 1) calls congestion pricing “a way of harnessing the power of the market to reduce the waste associated with traffic congestion.” Many cities like London, Singapore, and Stockholm have applied congestion pricing on their urban roads (Cohen, 2021). New York City is the first city in the United States that plans to enact and implement congestion pricing in its central business district. The New York State lawmakers have approved a congestion pricing plan. The bill is pending voter approval (Gold, 2021). Another example is plastic bag fees – imposing fees on plastic bags to discourage their use. For instance, effective on July 1, 2013, the city of Boulder, CO, charges a 10-cent fee for disposable plastic and paper checkout bags at all grocery stores. Retailers keep 4 cents and remit 6 cents to the city government (Government of Colorado, n.d.). Washington, DC, Boulder, CO, and New York City have adopted similar bag fees (National Council of State Legislatures, 2021). Political viability Cities provide an increasingly wide range of public goods and services to a heterogeneous population, and some services are in high demand in some communities but not others.

The growing role of nontax revenue sources in American cities  ­71

Using general taxes to pay for municipal services results in a redistribution effect – people who do not use or have no access to a service share the costs with these direct beneficiaries. Not surprisingly, nonbeneficiaries perceive general taxes as unfair since their tax dollars subsidize direct service beneficiaries. In areas where voters hold anti-redistributive preferences or embrace the idea of small government, charges and user fees are more acceptable than general taxes to fund public services. Limitations of user charges and fees User charges and fees as a public service funding source have some limitations. First, they are an appropriate funding source for some municipal services, but not for all. Services such as public protection, whose benefits accrue broadly to the public, should not be funded by charges and fees. Mikesell (2017) suggested two necessary conditions for the successful implementation of charges: benefit separability and chargeability. The benefit separability asks whether direct beneficiaries of a service can be identified. The chargeability refers to the feasibility of excluding service beneficiaries who do not pay for the service. If there is no economical method to prevent nonpayers from obtaining the service, charges and fees cannot be collected. Second, user charges and fees do not align well with the vertical equity principle despite being the epitome of horizontal equity. Vertical equity is achieved when higher-income people pay more through progressive tax rates (ibid.). With charge financing, everyone who uses the service pays for the proportionate costs regardless of a person’s ability to pay. If a low-income consumer and a high-income consumer pay the same for a service, the low-income consumer pays a larger percentage of their income. As a result, the regressive nature of charges and fees places a heavier burden on low-income individuals and families. Such cases have been found in healthcare financing in developing countries and congestion surcharges in the United States (Ke & Gkritza, 2018; Munge & Briggs, 2014). Nevertheless, governments can mitigate the regressiveness of user charges and fees by offering discount rates or tax credits to targeted groups. Some cities (e.g., the City of Claremont, CA) offer sanitation fee discounts to low-income households.4 Some cities (e.g., the City of Lawrence, KS) allow qualified elderly residents reduced water, sanitary sewer, and sanitation charges.5 Many municipal golf courses have discount programs for senior citizens and students. In New York City’s proposed congestion pricing plan, vehicles belonging to families living inside the Manhattan congestion pricing zone with household earnings of US$60,000 and less per year get the toll charges returned as a tax credit (Gold, 2021). In summary, regressiveness should not be a concern that prevents governments from considering using charges and fees as a revenue source. With proper policy design, governments can mitigate the regressiveness of the financing approach.

4   See “Low-income sanitation fees discount,” City of Claremont, CA webpage, at https://www. ci.claremont.ca.us/government/departments-divisions/financial-services/low-income-sanitationfees​-discount. 5   See “Low-income elderly utility rate,” City of Lawrence, KS webpage, at https://lawrenceks. org/utility-billing/low-income-elderly-application/.

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Miscellaneous Revenues Miscellaneous revenues include all other sources of revenues not attributable to the categories of taxes, intergovernmental transfers, and current charges. Data from the 2019 Census Bureau’s Annual Survey of State and Local Finance shows that state governments collected 13 percent of own-source general revenue from miscellaneous revenues, and municipal governments collected 11 percent. Table 4.4 lists the common categories of miscellaneous revenue in the municipal general fund. The top three categories are interest earnings, fines and forfeits, and special assessments. The interest earnings category includes earnings from interest on interest-bearing deposits and accounts, accrued interest on investment securities sold, interest on funds held for construction, and interest related to public debt for private purposes (US Census Bureau, 2006). Interest earnings is the primary miscellaneous source in all three levels of government. In 2019, 70 percent of federal miscellaneous revenues came from the Federal Reserve’s deposit of earnings (Flynn, 2019). State governments collected 25.6 percent of miscellaneous revenues from interest earnings in the same year, and municipal governments collected 24.7 percent. Miscellaneous revenues include heterogeneous revenue sources that differ dramatically in their nature, mechanism, characteristics, and implementation. Thus, this section takes a different approach to introducing miscellaneous revenue sources. Different from the previous section that introduces user charges and fees as a whole revenue group, this section reviews a few subcategories of miscellaneous revenues rather than considering “miscellaneous revenues” as one category. Since miscellaneous revenues consist of dozens of subcategories, this section discusses two of the top three miscellaneous revenue subcategories in detail. These two subcategories are special assessments revenue and fines and forfeit revenue. Table 4.4  Common categories of municipal miscellaneous sources in general revenues, 2019 Source Interest earnings Fines and forfeits Special assessments Rents and royalties Sale of property All other miscellaneous general revenue Total

Total (US$ millions) % of Total Miscellaneous Revenue 8,629 5,368 4,203 2,035 1,326 13,400 34,961

24.7 15.4 12.0 5.8 3.8 38.3 100.0

Note:  “All other miscellaneous general revenue” includes categories not classified elsewhere and local lottery revenue (Washington, DC, was the only city in 2019 that reported lottery revenue). Source:  US Census Bureau’s Annual Survey of State and Local Government Finances, 2019 (author’s calculation).

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Special assessments Special assessments are compulsory payments from property owners who benefit from specific public improvements. They also include impact fees to fund the extension of water, sewers, roads, and other infrastructure facilities in new developments. Generally, special assessments are proportioned according to the assumed benefits a property owner is estimated to receive. Revenues from special assessments are used to cover all or part of the costs of public improvements (US Census Bureau, 2006). Special assessments share many similarities with property taxes. Both are levied on property, and both are compulsory by nature. However, special assessments differ from property taxes in two important ways: first, special assessments are levied on certain property within a defined geographic area, while property taxes are levied on all property. For instance, Illinois allows its municipalities to establish special service areas (SSAs) that use special assessments (Hendrick, 2016). Owners whose property locates within a designated SSA pay additional ad valorem taxes (i.e., special assessments) for supplemental services. Second, special assessments “reasonably reflect the special services that are extended within the SSA” (ibid., p. 17). In other words, special assessments establish a link between what property owners pay and the services they receive as a return. In this sense, special assessments are similar to charges and fees. In contrast, property taxes support a wide range of public activities. Special assessments are neither new nor rare. They were first used in the United States for public improvement projects in 1691 (Allen & Newstreet, 2000). Currently, all 50 states have legislation enabling local governments to levy special assessments (Wang & Hendrick, 2021). Data from the Census Bureau’s 2019 Annual Survey of State and Local Finance places special assessments as the third largest miscellaneous general revenue category collected by municipal governments. Roughly 12 percent of municipal miscellaneous general revenue came from special assessments (see Table 4.4). Local governments in California and Florida use special assessments most intensively (McCubbins & Seljan, 2020). Originally designed to fund local infrastructure, special assessments are used to fund both the capital financing costs and the ongoing operating costs for a growing number of local public services (Hendrick & Wang, 2018; Kogan & McCubbins, 2009; McCubbins & Seljan, 2020). In a survey of the suburban municipalities in the Chicago area, Hendrick (2016) summarized four primary uses of special assessments: (1) to maintain common areas in residential subdivisions and commercial and industrial areas for stormwater maintenance and drainage; (2) to finance new or significantly upgraded infrastructure, such as water and sewer systems, lighting, paving of alleys, parking facilities, and roads in residential or commercial areas; (3) to pay bonds issued to build basic infrastructure and to support new development; and (4) to finance business improvement districts (BIDs) to a designated commercial area. An important factor that motivates municipal governments to use this financial innovation is that special assessments are not subject to tax and expenditure limitations (TELs). All but four US state governments impose TELs on their local governments as of 2017 (Wen et al., 2020). These state-imposed TELs restrict property taxes, the primary revenue source for municipal governments. However, most TELs do not apply to special assessments or taxes levied in special districts. For instance, the well-known Proposition 13, passed in 1978 by California voters, places many restrictions on property taxes, such as

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the maximum millage rate,6 the growth rate of assessed values, and prohibition from imposing other property taxes (Sexton et al., 1999). This constitutional amendment does not cover special assessments. It was not until the passage of Proposition 218 in 1996 that special assessments started to face restrictions (California Debt and Investment Advisory Commission, n.d.). Researchers generally agree that the rise of special assessments is mainly due to TELs (Kogan & McCubbins, 2008; Sexton et al., 1999). Another reason that explains the popularity of local special assessments is voters’ preference for restricting redistribution. Using property taxes or income taxes to fund a particular public service, taxpayers who pay more taxes do not necessarily receive more or better quality of the service in return. Taxpayers with less valuable property or lower income can enjoy the service they would otherwise not be able to afford. Using special assessments can effectively preclude redistribution. A local community can limit services to a small, heavily gerrymandered geographic area. Services are only accessible to those who live in the area and pay for them with special assessments. It is thus reasonable to expect that cities with a heterogeneous population may favor this financing approach. McCubbins and Seljan (2020) found empirical evidence to support this hypothesis. They found that cities in California with high median incomes and a more diverse ethnic population use special assessments more than their counterparts. Some perceive special assessments as a financial approach prone to misuse (Ayers et al., 2014) because special assessments are not subject to routine examination by legislators and auditors (Caruso & Weber, 2006). Some critics claim that the use of special assessments leads to government expansion. Described as a hidden tax (Brooks, 2007), special assessments increase the complexity of the local tax system, which exacerbates taxpayers’ fiscal illusion. In a complex tax system, taxpayers are likely to underestimate the total costs of government services. Public choice scholars believe that governments have a relentless tendency for expansion. The “Leviathan”-like governments will take advantage of taxpayers’ fiscal illusion and exploit opportunities to expand public programs beyond what taxpayers are willing to pay (Buchanan & Wagner, 1977). Hendrick (2016) challenged this claim. She found that municipal governments in the Chicago metropolitan area did not behave like “Leviathans.” The costs of special assessments and benefits of public improvements were visible to property owners; thus, the fiscal illusion was low. Municipalities were sensitive to the public’s perception of special assessments, and they were risk-averse when using this financing mechanism. Some scholars share this concern that the use of special assessments increases intracity inequality in public service delivery (Briffault, 1999). Affluent neighborhoods in a city that need a supplementary service can afford it with special assessments. In contrast, poor neighborhoods with the same demand for the service would not get it due to their lack of ability to pay. The practice of using special assessments for municipal services perpetuates the wealth-based inequality in public service delivery among neighborhoods within a city. In addition, some criticize the process as undemocratic. In states like Georgia and Pennsylvania, owners of residential properties are not allowed to vote in the planning or decision-making process of the BIDs. The boards of many BIDs or SSAs have low representation of the less privileged class (Morçöl & Patrick, 2006). Advocates of special   An American tax rate calculated in thousandths per dollar.

6

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assessments contest these criticisms, arguing that constituents establish the BIDs or SSAs as a response to municipal governments’ inability to meet constituents’ demand for services. Property owners are able to pay special assessments to “purchase” the needed services not available from the city (Brooks, 2007). Fines and forfeits Fines and forfeits are legal and financial obligations levied on offenders as punishment for wrongdoings. They are the second-largest municipal miscellaneous revenue subcategory. Fines and forfeits include revenue from penalties imposed for violations of law, court-ordered restitution to crime victims, court fees, and forfeits of deposits held for performance guarantees or against damage, such as forfeited bail and collateral (US Census Bureau, 2006). Fines are financial penalties for crimes or violations. The state legislature and Judicial Council set the amount of fines based on the severity of the crime or violation. A fine often comes with various surcharges, assessments, costs, and fees added by state and/or local governments. These additional economic sanctions significantly increase the total amount of a fine. For instance, in California, a traffic i­nfraction  – failure to stop at a stop sign – has a base fine of US$35. After adding surcharges, fees, and assessments, the total cost of a ticket comes to US$238 (Su, 2020). Surcharges, assessments, costs, and fees have grown dramatically in recent decades as cash-strapped governments increasingly depend on these revenue sources to fund the criminal justice system (Bannon et al., 2010). A forfeit refers to property belonging to private citizens seized by government authorities. The two types of forfeits are criminal asset forfeiture and civil asset forfeiture. Civil asset forfeitures do not require a conviction. They have fewer due process protections than criminal asset forfeitures (Colgan, 2017; Williams, 2002). Most states – 42 out of 50 – allow local law enforcement agencies to retain some proportion of seized assets, ranging between 50 and 100 percent (Holcomb et al., 2011). Such institutional setting encourages revenuemotived law enforcement activities (Head, 2021). Researchers find that the local police force responded to the financial incentive of forfeiture gains by shifting effort from crime investigation to more financially lucrative drug searches (Baicker & Jacobson, 2007). Fines and forfeits are the fastest-growing municipal revenue source. As shown in Table 4.5, in 1979, cities collected 4 cents of real per capita fines and forfeits. Fines and forfeits accounted for 6.2 percent of municipal miscellaneous revenue and 0.8 percent of municipal own-source general revenue. In the 2000s, fines and forfeits revenue grew exponentially. In 2019, the average real per capita fines and forfeits increased to US$6.58, with a striking annual growth rate of 13.8 percent over the four decades. In 2019, the percentage share of fines and forfeits was 15.4 percent in municipal miscellaneous general revenue and 1.5 percent in municipal own-source general revenue. The Census Bureau’s “fines and forfeits” category excludes “penalties relating to tax delinquency, library fines, and sale of confiscated property” (US Census Bureau, 2006, pp. 4–40). Since revenue from the sale of the confiscated property is not included, it is reasonable to believe that the Census Bureau’s fines and forfeits data underestimate cities’ total revenues from law enforcement (Graham & Makowsky, 2021). Local governments’ excessive exploitation of fines and forfeits garnered national attention in 2015 following the US Department of Justice’s (DOJ) investigation of the Ferguson Police Department in Missouri. The DOJ revealed a system of law enforcement

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Table 4.5  Growth of fines and forfeits in municipal revenue, 1979–2019 Every Ten Years 1979 1989 1999 2009 2019

Per Capita Fines and Forfeits (US$) 0.04 0.07 0.08 6.47 6.58

% of Total Miscellaneous General Revenues 6.2 5.4 5.6 14.0 15.4

% of Total Municipal Own-source General Revenues 0.8 0.9 0.8 1.6 1.5

Source:  US Census Bureau’s Annual Surveys of State and Local Government Finances, 1979–2019 (author’s calculation).

abusing motorists to generate municipal revenue by issuing traffic tickets and imposing fees by the Ferguson Police Department. Maciag (2019) examined a nationwide sample of local governments using fines and forfeits. He identified 284 cities and towns that collected more than 20 percent of general revenues from fines and fees. These “fines-addicted” localities were concentrated in Southern states, and most of them were small and rural towns. Fines and forfeits, by nature, are a “market-based” policy tool to deter crimes and wrongdoing (Ehrlich, 1996). The primary goal of using fines and forfeits is to improve public safety. However, American cities have become increasingly dependent on fines and forfeits for revenue purposes. Why do they become a common means of municipal revenue source? In the US, voters and state legislators impose many institutional and political constraints on local revenue collections. These constraints include but are not limited to TELs, the balanced budget requirements, voter approval requirements, and voters’ preference for higher spending and lower taxes. Despite these many constraints, cities have ample discretion over two policy areas – local law enforcement and public safety (Gerber & Hopkins, 2011). Mayors or city managers usually appoint police chiefs. City councils oversee the municipal police force and decide local public safety policies. Therefore, cities have a strong influence over fines and forfeits collection. The hypothesis that local governments use law enforcement agencies to generate revenue is supported by empirical research. Studies show that the fiscal condition of a locality influences traffic law enforcement. In cash-strapped towns, drivers were more likely to receive a ticket than a warning (Makowsky & Stratmann, 2009). Following a revenue decline, local governments issued more traffic citations and collected more traffic fines (Garrett & Wagner, 2009; Su, 2020). It seems that when navigating the revenue tightrope, municipal officials welcome any type of revenue source unobstructed by institutional and political constraints. Cities’ dependence on fines and forfeitures as a means of revenue “is not just a function of opportunity but also necessity born of limited alternatives” (Graham & Makowsky, 2021, p. 316). How do local governments influence revenue-motivated policing? Baicker and Jacobson (2007) discovered that local governments used budget authority to capture the gains from forfeiture. An increase in forfeiture gains is associated with a reduction in budgetary allocation to policing. The extra money saved from the police budget was reallocated to other programs. The reallocation was more likely to happen in times of fiscal stress. Su (2021) proved that local governments passed their fiscal stress onto law enforcement

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agencies through budget cuts. Sheriffs’ departments responded to budget cuts by increasing traffic fines collection. Mughan et al. (2020) examined the electoral effect on local law enforcement agencies’ revenue incentives. They hypothesize that city police chiefs, appointed by the mayor or the city manager, are more responsive to their political principal. City police chiefs do not fear electoral reprisal for the politically unpopular assets forfeiture activity as the elected sheriffs do. Their findings confirmed this hypothesis: municipal police departments consistently report more revenue from asset forfeiture than sheriffs’ departments. These studies suggest that when local law enforcement agencies succeed in generating revenues from collecting traffic citations, fees, and assets forfeiture, elected officials perceive them as capable of self-sufficiency. If a local government experiences fiscal stress, elected officials will displace scarce funding from these self-­sufficient law enforcement agencies to other public programs. From this perspective, local law enforcement agencies should probably not bear all the criticism for revenue-motivated policing. Local governments’ reduction in general fund allocations for law enforcement agencies forces them to rely on own-source revenue generation to maintain their budgetary status quo (Graham & Makowsky, 2021). As Worrall and Kovandzic stated (2008, p.  219), “it is difficult to fault financially strapped public agencies for seeking needed resources.” The use of local law enforcement agencies as a municipal revenue source has many negative consequences. First, it compromises law enforcement agencies’ primary role as public safety providers. When cities use police forces to generate revenue, police agencies must shift resources from safety patrol and criminal investigation functions to revenue-generating activities. Evidence shows that crime clearance rates were significantly lower in cities where a greater share of revenues comes from fines, fees, and forfeits (Goldstein et al., 2020). Second, using fines and forfeits as a revenue source disproportionately burdens minorities. Sances and You (2017) found that municipal governments with higher black populations rely more heavily on fines, fees, and forfeits for revenue. Black drivers are more likely to be stopped and searched in traffic stops (Epp et al., 2017; Pierson et al., 2020). As local fiscal stress increases, officers make more arrests of blacks and Hispanics for drugs, driving under the influence, prostitution, and property seizures (Makowsky et al., 2019; Shoub et al., 2021). Revenue-driven policing exacerbates racial disparity in the criminal justice system. Third, the aggressive use of fines and forfeits makes citizens see law enforcement agencies as predators instead of protectors, undermining these agencies’ authority and legitimacy (McBride, 2017). Municipal governments run the risk of being perceived as “predatory governments.” This could seriously undermine citizens’ trust in law enforcement. Fourth, predatory policing jeopardizes employment. In many states, failure to pay traffic fines can result in license suspension. Because the overwhelming majority of Americans drive to work and many occupations require a valid driver’s license, those who have their license suspended may be unable to keep their jobs. The lack of a valid driver’s license and reliable transportation puts obstacles in the way of job search and future employment (Lawyers’ Committee for Civil Rights of the San Francisco Bay Area [LCCR], 2017). Policymakers have recognized local governments’ financial incentive for fines and forfeits revenues manifested in the law enforcement and the criminal justice systems. For instance, the Nevada legislature passed a bill (NV SB219), effective on October 1, 2021,

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that ends the practice of suspending an individual driver’s license due to delinquent fines, assessment, fees, or restitution owed. Colorado passed a similar bill in July 2021 (CO HB 1314). The “Cities & Counties for Fines and Fee Justice,” an activist group with a mission to end “policing for profit,” is working with ten cities across the nation to evaluate and reform their fines and fees systems (Fines & Fees Justice Center, 2021). Limiting the profit-seeking practice in local law enforcement requires joint efforts from local governments, state legislature, and even the federal government. Many states passed laws prohibiting or limiting local retention of the seized forfeiture (Holcomb et al., 2011). However, states’ effort to reduce local profit-seeking practices is compromised by federal policies. Local law enforcement agencies can circumvent states’ restrictions by participating in the Federal Equitable Sharing Program and receiving equitable sharing payments from the federal governments (Holcomb et al., 2018; Worrall & Kovandzic, 2008).

THE GROWTH AND SIGNIFICANCE OF MUNICIPAL OWNSOURCE NONTAX REVENUES Up to this point, this chapter has introduced the major sources of municipal nontax revenue. This section takes all sources of nontax revenue as a group and provides an overview of municipal nontax revenue. Data comes from the US Census Bureau. The Census Bureau has collected state and local finance data since 1957. Every five years, in years ending in 2 and 7, a Census of Governments is conducted. In the intervening years, the Census Bureau surveys a sample of state and local governments. The Census Bureau’s Annual Survey of State and Local Government Finances is the only known comprehensive source of state and local government finance data collected on a nationwide scale using uniform definitions, concepts, and procedures (US Census Bureau, n.d.). Thus, this section uses the Census Bureau’s Annual Surveys of State and Local Government Finances to analyze municipal nontax revenue regarding the current landscape, the growth trend, and the regional variation. The purpose of this section is to present an overall picture of nontax revenue in municipal finance. Most importantly, it aims to help readers understand why municipal revenue structure has evolved into one that increasingly relies on own-source nontax revenue. Devolution and the Growth of Municipal Own-source Revenues Throughout history, the system of fiscal federalism in the United States has gone through several fundamental shifts. From approximately 1960 to 1980, it was marked by federal fiscal expansion (Krane et al., 2004). During this period, the federal government engaged in an unprecedented outpouring of financial aid to subnational governments. Federal aid as a percentage of state and local expenditures reached its peak in the late 1970s and then began a downward trend. From the early 1980s, the federal government shifted a large share of the fiscal and administrative responsibility to state governments and cut federal aid accordingly to state and local governments. This shift is called the “devolution” (Sawicky, 2016). State governments soon followed the federal government’s trend of transferring program responsibilities to local governments. The devolution of powers from state to local governments is called a “second-order devolution” (Krane et al., 2004).

The growing role of nontax revenue sources in American cities  ­79

The devolutionary shift increases the roles and responsibilities of municipal governments. With diminished financial aid from the federal and state governments, municipal governments are forced to raise revenues from sources of their own. Figure 4.3 depicts the history of municipal governments’ revenue shares from intergovernmental transfers and own sources since 1977. The figure demonstrates a clear trend: intergovernmental transfers as a share of total municipal revenues decreased from 42 percent in 1977 to 20 percent in 2019. In contrast, municipalities’ own-source revenues have gained significance. In 2019, 80 percent of municipal revenues were raised from sources of their own. Tax Limits and the Growth of Municipal Own-source Nontax Revenues In the late 1970s, simultaneously with the devolution, a “tax revolt” movement swept across the United States (Skidmore, 1999). Many states adopted TELs to control the increase in government spending and revenue. Most TELs include state-imposed limits on local property tax rates, property value assessment, property tax levies, and general revenue growth (Mullins & Wallin, 2004). Additionally, several municipalities enacted local TELs distinct from (and more stringent than) the fiscal restrictions imposed by their state government (Brooks & Phillips, 2009). These tax limits hamstring municipalities’ ability to raise taxes. However, they have not significantly reduced government size because local policymakers could circumvent these tax limits by turning to revenue sources not subject to TELs. Numerous studies have found that TELs increase local governments’ reliance on nonproperty taxes, charges, user fees, special assessments, and

Source:  US Census Bureau’s Annual Surveys of State and Local Government Finances (1977–2019) (author’s calculation).

Figure 4.3  Municipal own-source revenue as a percentage of general revenues, 1977–2019

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miscellaneous revenues (Hoene, 2004; Mullins & Joyce, 1996; Shadbegian, 1999; Sun, 2014; Wen et al., 2020). Some researchers conclude that TELs shifted local revenue from taxes to nontax revenues (Mullins & Joyce, 1996; Shadbegian, 1999). Table 4.6 shows the shift in municipal revenue structure over the past four decades. In 1977, cities collected 69 percent of own-source general revenues from property, sales, and other taxes. Between 1977 and 1987, 22 states passed some form of constitutional or statutory statewide limitation on their local governments’ property taxes and general revenues (Mullins & Wallin, 2004). During the same time, nontax revenue gained importance in the municipal revenue system. The proportion of nontax revenue in municipal own-source revenues increased from 31 percent in 1977 to 42 percent in 1987 and remained at about this level until 2019. Of the nontax revenue sources, current charges grew remarkably. Their share in municipal own-source revenues tripled over the past four decades. The Variation of Municipal Dependence on Nontax Revenue Devolution and TELs have shaped municipal revenue structure into one that increasingly depends on nontax sources. Besides these two, many factors influence a city’s revenue structure, such as the value of the municipal fiscal base, residents’ income, historical precedent, national economic trends, political ideology, citizens’ support for redistribution, city administration’s preferences, and so on. Because cities in the same geographic region often share similarities in the above factors, the regional similarities may be reflected in their revenue structure. To explore the possibility of regional similarities in municipal revenue structure, I calculate the nontax-to-tax ratio of each city and then take the average ratio at the state level. Figure 4.4 is the 20-year average municipal nontax-to-tax ratio by state, and Figure 4.5 is the average ratio of the recent ten years. A glance at the two figures shows some regional similarities: cities in regions of the Rocky Mountain (ID, MT, WY, UT, and CO) and plains (ND, SD, MN, IA, KS, and MO) rely more on nontax revenue. Cities in the Northeast (except for VT), Southwest, and the West Coast (except for AK) are less dependent on nontax revenue. Table 4.6  Municipal revenue collections from tax and nontax sources, 1977–2019 (every ten years) Proportion in Municipal Own-source General Revenues Tax revenue   Property taxes   Sales taxes   Other taxes Nontax revenue   Current charges   Miscellaneous revenues

1977

1987

1997

2007

2017

2019

0.69 0.45 0.15 0.09 0.31 0.10 0.20

0.58 0.34 0.16 0.08 0.42 0.19 0.22

0.54 0.31 0.16 0.08 0.46 0.26 0.20

0.55 0.30 0.17 0.08 0.45 0.27 0.18

0.59 0.33 0.18 0.08 0.41 0.30 0.12

0.58 0.30 0.20 0.08 0.42 0.31 0.11

Source:  US Census Bureau’s Annual Surveys of State and Local Government Finances (1977–2019) (author’s calculation).

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Source:  US Census Bureau’s Annual Surveys of State and Local Government Finances (1977–2019) (author’s calculation).

Figure 4.4  The 20-year average municipal nontax-to-tax ratio by state, 2000–2019

MUNICIPAL NONTAX REVENUES IN ECONOMIC RECESSIONS The past four decades have seen a trend of municipal revenue structure turning towards nontax revenue sources. This process is accelerated in economic recessions. During recessions, state governments often cut financial aid to local governments due to the pressure to balance budgets. Municipal governments, facing the double whammy of state aid cuts and the economic recession, must seek own-source revenue to fill the budget gaps. Chernick and Reschovsky (2017) found that cities increased own-source revenue to replace the decline in state aid in the Great Recession, and much of the increase in own-source revenue came from sources of nontax revenue. Amid the Great Recession, cities were reported to use charges and fees to fill the budget gaps. Some cities increased current fee levels, and some proposed new fees (Segal, 2009). Cash-strapped cities also turned to traffic and parking fines to raise revenue (Sullivan, 2009). The National League of Cities (NLC) surveyed over 1,000 municipal chief financial officers (CFOs) in 2010 and 2011, respectively. When asked to identify a revenue action their city had adopted the previous year, over 40 percent of the CFOs responded that their cities increased the existing fee levels. Over 20 percent responded that their cities added new fees (Hoene & Pagano, 2010, 2011). Increasing fees, charges, and miscellaneous revenues is not a temporary austerity measure but is likely to be permanent (Pagano, 2012). The NLC surveys suggest that up until the fiscal year 2019, cities’ most common revenue

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Source:  US Census Bureau’s Annual Surveys of State and Local Government Finances (1977–2019) (author’s calculation).

Figure 4.5  The ten-year average municipal nontax-to-tax ratio by state, 2010–19 strategy has been increasing the charges and fees and imposing new fees (McFarland & Pagano, 2019). The most recent economic recession was the COVID-19 recession. This recession lasted two months, from February 2020 to April 2020. Although the National Bureau of Economic Research announced that the recession has ended, the US economy is recovering slowly.7 Researchers in the Brookings Institution projected a total state and local loss of US$155 billion in revenue in 2020 and US$167 billion in 2021 (Sheiner & Campbell, 2020). Municipal nontax revenue sources – charges, fees, and miscellaneous revenues – were projected to experience relatively modest losses considering the stable demand of sewerage services and local hospital reimbursement (Chernick et al., 2020). But the travelrelated nontax revenue sources became the “unexpected casualty of the COVID-19” (Zuker, 2020, n.p.). Due to travel restrictions, US air travel plummeted in 2020, as did municipal revenue from airport fees (Heeb, 2021). The stay-at-home orders led to fewer cars on the street. Cities like Chicago, IL and Baton Rouge, LA experienced a steep revenue loss from parking tickets and traffic fines (Benit, 2020; Speilman, 2020). Different from the Great Recession, there has not been an observed trend of cities turning to charges, fees, and miscellaneous revenues to meet budget needs. This is primarily due to federal intervention. In March 2020, Congress passed the Coronavirus Aid, 7   See NBER on business cycle expansions and contractions at https://www.nber.org/research/ data/us-business-cycle-expansions-and-contractions.

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Relief, and Economic Security (CARES) Act, which provided direct relief to large local governments with a population exceeding 500,000. In March 2021, Congress passed the American Rescue Plan Act (ARPA), providing relief to all cities, towns, and villages across the United States. In the recently released NLC annual survey, federal aid is the most widely cited factor that positively impacts municipal budgets (McFarland & Pagano, 2021). The federal intervention has tempered municipal revenue loss. Without federal aid, municipal revenue would have been catastrophic.

CONCLUSION American cities collect a considerable proportion of general revenue from nontax sources. This chapter uses the Census Bureau’s local government finance data to survey the current landscape and the historical trend of nontax revenue in municipal finance. It selectively reviews categories of municipal nontax sources regarding the definition, characteristics, uses, advantages and limitations, and their roles beyond revenue generation. Such information helps readers better understand the mechanism of a particular nontax source and assess its appropriateness to fund municipal services. This chapter also discusses reasons why the revenue structure of American cities has evolved into one that increasingly depends on nontax revenue sources. A combination of factors contributes to this shift. First, the fiscal devolution has led cities to take on more fiscal and administrative responsibilities, forcing them to collect more own-source revenue. Second, the state-imposed and the locally imposed TELs restrain municipal governments’ taxing authority. Policymakers circumvent the restrictions on taxes by turning to sources of nontax revenue. Third, raising revenue from nontax sources is politically palatable. Politicians often make promises not to raise taxes to attract voters. Once elected, they must keep their campaign promises if they worry about getting reelected at all. In addition to the above factors, many perceive nontax sources as a fair approach to raising revenue. Charges, user fees, and special assessments directly link services received and the costs for these services. They reflect the horizontal equity principle. Nontax revenue works better than general taxes to curb the inflated demand for public services and thus improve efficiency in resource allocation. Charges and user fees sometimes play  a role beyond raising revenue, and they help achieve desirable social outcomes, such as addressing traffic congestion. Overall, nontax revenue sources gain popularity and ­ significance in municipal finance due to institutional and political factors. Moreover, some nontax revenue sources have advantages compared to taxes in certain ­circumstances. Economic recessions pose a challenge for municipal governments when they must balance their budgets with tax revenue decline and state aid deductions. This chapter reviews municipal governments’ use of charges, user fees, and miscellaneous revenue during the recent two economic recessions. Evidence suggests that during and in the aftermath of the Great Recession, municipal governments overwhelmingly chose to raise existing fee levels to plug the budget gaps. In contrast, few cities have been reported to raise charges and miscellaneous revenue during the COVID-19 recession. The federal ­government’s prompt fiscal intervention tempered much of the municipal revenue losses.

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This chapter analyzes the growing significance of nontax revenue in municipal finance in the system of fiscal federalism. Decisions made by federal and state governments inevitably affect local fiscal policies. The state-imposed tax limits and the voter approval requirements reduce local fiscal authority, and most nontax sources are not subject to tax limits or voter approval requirements. Local policymakers can use nontax sources to circumvent the state-imposed institutional constraints and regain some lost local fiscal authority. Thus, dependence on nontax revenue is positively associated with local autonomy. The trend that municipal revenue structure shifts towards nontax sources is not necessarily concerning, as long as the revenue structure aligns with the local economy (McFarland & Pagano, 2021) and reflects local residents’ preferences.

REFERENCES Allen, M. T., & Newstreet, H. C. (2000). Smoothing wrinkles in the spread: Special assessment issues. The Appraisal Journal, 68(2), 201–207. Ayers, S., Eger, R., & Van Assenderp, K. (2014, July). Community development districts: Financial and accountability issues. LeRoy Collins Institute, Florida State University. https://coss.fsu.edu/ collins/wp-content/uploads/sites/28/2020/11/CDD-report-FINAL-Revised-Reformatted-7-03-​ 14.pdf. Baicker, K., & Jacobson, M. (2007). Finders keepers: Forfeiture laws, policing incentives, and local budgets. Journal of Public Economics, 91(11–12), 2113–2136. Bannon, A., Nagrecha, M., & Diller, R. (2010). Criminal justice debt: A barrier to reentry. Brennan Center for Justice, New York University School of Law. Benit, M. (2020, June 27). Pandemic exposes Louisiana’s addiction to fines and fees. The Advocate. https://www.theadvocate.com/baton_rouge/opinion/letters/article_769b1da4-ab3f-11ea-8070-63​ 217cd6f7bf.html. Bird, R. M., & Tsiopoulos, T. (1997). User charges for public services: Potentials and problems. Canadian Tax Journal, 45(1), 25–86. Briffault, R. (1999). A government for our time – business improvement districts and urban governance. Columbia Law Review, 99, 365–477. Brooks, L. (2007). Unveiling hidden districts: Assessing the adoption patterns of business improvement districts in California. National Tax Journal, 60(1), 5–24. Brooks, L., & Phillips, J. (2009). Municipally imposed tax and expenditure limits. Land Lines, 21(2), 8–13. Buchanan, J. M., & Wagner, R. E. (1977). Democracy in deficit: The political legacy of Lord Keynes. Liberty Fund. California Debt and Investment Advisory Commission. (n.d.). CDIAC No. 19-13: Proposition 218 and special assessments. https://www.treasurer.ca.gov/cdiac/publications/special-assessments.pdf. Caruso, G., & Weber, R. (2006). Getting the max for the tax: An examination of BID performance measures. International Journal of Public Administration, 29(1–3), 187–219. Chernick, H., Copeland, D., & Reschovsky, A. (2020). The fiscal effects of the COVID-19 pandemic on cities: An initial assessment. National Tax Journal, 73(3), 699–732. Chernick, H., & Reschovsky, A. (2017). The fiscal condition of US cities: Revenues, expenditures, and the “Great Recession.” Journal of Urban Affairs, 39(4), 488–505. Cohen, S. (2021, October 4). Congestion pricing is slowly coming to New York City. Columbia University. https://news.climate.columbia.edu/2021/10/04/congestion-pricing-is-slowly-coming-​ to-new-york-city. Colgan, B. A. (2017). Fines, fees, and forfeitures. Criminology, Criminal Justice, Law & Society, 18(3), 22–40. Conlan, T., Posner, P., Smith, H., & Sommerfeld, M. (2015). Autonomy and interdependence: The scope and limits of “fend for yourself ” federalism in the United States. In J. Kim & H. Blöchliger

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(Eds.), Institutions of intergovernmental fiscal relations: Challenges ahead (pp. 155–179). OECD Publishing. Duff, D. G. (2004). Benefit taxes and user fees in theory and practice. The University of Toronto Law Journal, 54(4), 391–447. Ehrlich, I. (1996). Crime, punishment, and the market for offenses. Journal of Economic Perspectives, 10(1), 43–67. Epp, C. R., Maynard-Moody, S., & Haider-Markel, D. (2017). Beyond profiling: The institutional sources of racial disparities in policing. Public Administration Review, 77(2), 168–178. Federal Highway Administration. (2006, December). Congestion pricing: A primer. https://ops. fhwa.dot.gov/publications/congestionpricing/congestionpricing.pdf. Fines & Fees Justice Center. (2021). Cities & Counties for Fines and Fee Justice. https://finesandfees​ justicecenter.org/campaigns/counties-and-cities-for-fine-and-fee-justice. Flynn, C. (2019, November 27). Where federal revenue comes from and how it’s spent. Federal Reserve Bank of St. Louis. https://www.stlouisfed.org/open-vault/2019/november/where-federalrevenue-comes-from-how-spent. Garrett, T. A., & Wagner, G. A. (2009). Red ink in the rearview mirror: Local fiscal conditions and the issuance of traffic tickets. The Journal of Law and Economics, 52(1), 71–90. Gerber, E. R., & Hopkins, D. J. (2011). When mayors matter: Estimating the impact of mayoral partisanship on city policy. American Journal of Political Science, 55(2), 326–339. Gold, M. (2021, September 29). Congestion pricing is coming to New York City. Everyone has an opinion. The New York Times. https://www.nytimes.com/2021/09/29/nyregion/nyc-congestionpricing.html. Goldstein, R., Sances, M. W., & You, H. Y. (2020). Exploitative revenues, law enforcement, and the quality of government service. Urban Affairs Review, 56(1), 5–31. Governmental Accounting Standards Board (GASB) (2007, November). Touring the financial statements, part III: The governmental funds. https://gasb.org/page/PageContent?pageId=/referencelibrary/the-users-perspective/nov-2007touring-the-financial-statements-part-iiithe-gover.html&​ isPartialBreadcrumb=true. Government of Colorado (n.d.). Retailer fact sheet: City of Boulder disposable bag fee. https:// bouldercolorado.gov/media/5858/download?inline. Graham, S. R., & Makowsky, M. D. (2021). Local government dependence on criminal justice revenue and emerging constraints. Annual Review of Criminology, 4, 311–330. Head, T. (2021, August 21). Criminal justice for profit? How civil asset forfeiture perverts policing. The Hill. https://thehill.com/opinion/criminal-justice/568692-criminal-justice-for-profit-how-civ​ il-asset-forfeiture-perverts?rl=1. Heeb, G. (2021, February 16). US air travel dropped 60% in 2020 as Covid-19 hammered airlines. Forbes.com. https://www.forbes.com/sites/ginaheeb/2021/02/16/us-air-travel-dropped-60-in-2020​ -as-covid-19-hammered-airlines/?sh=4085bf946978. Hendrick, R. (2016). Use of special assessments by municipal governments in the Chicago metropolitan area: The taming of Leviathan? Illinois Municipal Policy Journal, 1(1), 15–35. Hendrick, R., & Wang, S. (2018). Use of special assessments by municipal governments in the Chicago metropolitan area: Is Leviathan tamed? Public Budgeting & Finance, 38(3), 32–57. Hoene, C. W. (2004). Fiscal structure and the post-Proposition 13 fiscal regime in California’s cities. Public Budgeting & Finance, 24(4), 51–72. Hoene, C. W., & Pagano, M. A. (2010). City fiscal conditions in 2010. National League of Cities. Hoene, C. W., & Pagano, M. A. (2011). City fiscal conditions in 2011. National League of Cities. Holcomb, J. E., Kovandzic, T. V., & Williams, M. R. (2011). Civil asset forfeiture, equitable sharing, and policing for profit in the United States. Journal of Criminal Justice, 39(3), 273–285. Holcomb, J. E., Williams, M. R., Hicks, W. D., Kovandzic, T. V., & Meitl, M. B. (2018). Civil asset forfeiture laws and equitable sharing activity by the police. Criminology & Public Policy, 17(1), 101–127. Ke, Y., & Gkritza, K. (2018). Income and spatial distributional effects of a congestion tax: A hypothetical case of Oregon. Transport Policy, 71, 28–35. Kogan, V., & McCubbins, M. D. (2009). The problem with being special: Democratic values and special assessments. Public Works Management & Policy, 14(1), 4–36.

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Krane, D., Ebdon, C., & Bartle, J. (2004). Devolution, fiscal federalism, and changing patterns of municipal revenues: The mismatch between theory and reality. Journal of Public Administration Research and Theory, 14(4), 513–533. Lawyers’ Committee for Civil Rights of the San Francisco Bay Area (LCCR). (2017). Paying more for being poor: Bias and disparity in California’s traffic court system. https://lccr.com/wp-content/ uploads/LCCR-Report-Paying-More-for-Being-Poor-May-2017-5.4.17.pdf. League of California Cities. (2019). Propositions 26 and 218: Implementation guide. https://www. cacities.org/Prop218andProp26. Maciag, M. (2019, August 16). Addicted to fines. A special report. Governing.com. https://www. governing.com/archive/fine-fee-revenues-special-report.html. Makowsky, M. D., & Stratmann, T. (2009). Political economy at any speed: What determines traffic citations? American Economic Review, 99(1), 509–527. Makowsky, M. D., Stratmann, T., & Tabarrok, A. (2019). To serve and collect: The fiscal and racial determinants of law enforcement. The Journal of Legal Studies, 48(1), 189–216. Massachusetts Department of Revenue. (2020, January). Enterprise funds. https://www.mass.gov/ doc/enterprise-funds/download. McBride, R. A. (2017). Policing for profit: How urban municipalities’ focus on revenue has undermined law enforcement legitimacy. Faulkner Law Review, 9(2), 329–361. McCubbins, M. D., & Seljan, E. C. (2020). Fiscal secession: An analysis of special assessment financing in California. Urban Affairs Review, 56(2), 480–512. McFarland, C., & Pagano, M. A. (2019). City fiscal conditions in 2019. National League of Cities. https://www.nlc.org/wp-content/uploads/2019/10/CS_Fiscal-Conditions-2019Web-final.pdf. McFarland, C., & Pagano, M. A. (2021). City fiscal conditions 2021. National League of Cities. https://www.nlc.org/wp-content/uploads/2021/10/2021-City-Fiscal-Conditions-Report-2021.pdf Mikesell, J. (2017). Fiscal administration (10th ed.). Cengage Learning. Morçöl, G., & Patrick, P. A. (2006). Business improvement districts in Pennsylvania: Implications for democratic metropolitan governance. International Journal of Public Administration, 29(1–3), 131– 171. Mughan, S., Li, D., & Nicholson-Crotty, S. (2020). When law enforcement pays: Costs and benefits for elected versus appointed administrators engaged in asset forfeiture. The American Review of Public Administration, 50(3), 297–314. Mullins, D. R., & Joyce, P. G. (1996). Tax and expenditure limitations and state and local fiscal structure: An empirical assessment. Public Budgeting & Finance, 16(1), 75–101. Mullins, D. R., & Wallin, B. A. (2004). Tax and expenditure limitations: Introduction and overview. Public Budgeting & Finance, 24(4), 2–15. Munge, K., & Briggs, A. H. (2014). The progressivity of health-care financing in Kenya. Health Policy and Planning, 29(7), 912–920. National Council of State Legislatures. (2021, February). State plastic bag legislation. https://www. ncsl.org/research/environment-and-natural-resources/plastic-bag-legislation.aspx. Oates, W. E. (1972). Fiscal federalism. Harcourt Brace Jovanovich. Oates, W. E. (1999). An essay on fiscal federalism. Journal of Economic Literature, 37(3), 1120–1149. Oates, W. E. (2008). On the evolution of fiscal federalism: Theory and institutions. National Tax Journal, 61(2), 313–334. Office of Management and Budget. (2007). Analytical perspectives: Budget of the United States government, fiscal year 2008. https://www.govinfo.gov/content/pkg/BUDGET-2008-PER/pdf/ BUDGET-2008-PER.pdf. Pagano, M. A. (2012, October 17). Why all those new fees your city is charging are likely permanent. Bloomberg.com. https://www.bloomberg.com/news/articles/2012-10-17/why-all-those-new-feesyour-city-is-charging-are-likely-permanent. Pierson, E., Simoiu, C., Overgoor, J., Corbett-Davies, S., Jenson, D., Shoemaker, A., Ramachandran, V., Barghouty, P., Phillips, C., Shroff, R., & Goel, S. (2020). A large-scale analysis of racial disparities in police stops across the United States. Nature Human Behaviour, 4(7), 736–745. Reynolds, L. (2004). Taxes, fees, assessments, dues, and the get what you pay for model of local government. Florida Law Review, 56, 373–445.

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Sances, M. W., & You, H. Y. (2017). Who pays for government? Descriptive representation and exploitative revenue sources. The Journal of Politics, 79(3), 1090–1094. Sawicky, M. B. (2016). The new American devolution: Problems and prospects. In M. B. Sawicky, The end of welfare? Consequences of federal devolution for the nation (pp. 13–34). Routledge. Segal, D. (2009, April 10). Cities turn to fees to fill budget gaps. The New York Times. https://www. nytimes.com/2009/04/11/business/11fees.html. Sexton, T. A., Sheffrin, S. M., & O’Sullivan, A. (1999). Proposition 13: Unintended effects and feasible reforms. National Tax Journal, 52(1), 99–111. Shadbegian, R. J. (1999). The effect of tax and expenditure limitations on the revenue structure of local government, 1962–87. National Tax Journal, 52(2), 221–237. Sheiner, L., & Campbell, S. (2020, September 24). How much is COVID-19 hurting state and local revenues? Brookings.edu. https://www.brookings.edu/blog/up-front/2020/09/24/how-much-iscovid-19-hurting-state-and-local-revenues/. Shoub, K., Christiani, L., Baumgartner, F. R., Epp, D. A., & Roach, K. (2021). Fines, fees, forfeitures, and disparities: A link between municipal reliance on fines and racial disparities in policing. Policy Studies Journal, 49(3), 835–859. Skidmore, M. (1999). Tax and expenditure limitations and the fiscal relationships between state and local governments. Public Choice, 99(1), 77–102. Spielman, F. (2020, October 26). Pandemic plunge: 52% decline in Chicago parking tickets, 42% drop in booting. Chicago Sun-Times. https://chicago.suntimes.com/2020/10/26/21534846/park​ ing-tickets-booting-decline-chicago-coronavirus-covid. Su, M. (2020). Taxation by citation? Exploring local governments’ revenue motive for traffic fines. Public Administration Review, 80(1), 36–45. Su, M. (2021). Discretion in traffic stops: The influence of budget cuts on traffic citations. Public Administration Review, 81(3), 446–458. Sullivan, B. (2009, September 14). Cash-strapped cities pile on the parking fines. NBC News. https:// www.nbcnews.com/business/consumer/cash-strapped-cities-pile-parking-fines-flna6c10406442. Sun, R. (2014). Reevaluating the effect of tax and expenditure limitations: An instrumental variable approach. Public Finance Review, 42(1), 92–116. US Census Bureau. (2006). Revenue. In US Census Bureau, Government finance and employment: Classification manual (pp. 4-1–4-62). https://www2.census.gov/govs/pubs/classification/2006_ classification_manual.pdf. US Census Bureau. (2012, August). Census Bureau reports there are 89,004 local governments in the United States. https://www.census.gov/newsroom/releases/archives/governments/cb12-161.html. US Census Bureau. (n.d.). About annual survey of state and local government finances. https://www. census.gov/programs-surveys/gov-finances/about.html. US Census Bureau. (1977–2019). State & local government finance historical datasets and tables. https://www.census.gov/programs-surveys/gov-finances/data/datasets.html. Wang, S., & Hendrick, R. (2021). Financing urban infrastructure and services under the new normal: A look at special assessments. In D. R. Judd, E. McKenzie & A. Alexander (Eds.), Private metropolis: The eclipse of local democratic governance (pp. 181–218). University of Minnesota Press. Wen, C., Xu, Y., Kim, Y., & Warner, M. E. (2020). Starving counties, squeezing cities: Tax and expenditure limits in the US. Journal of Economic Policy Reform, 23(2), 101–119. Williams, M. R. (2002). Civil asset forfeiture: Where does the money go? Criminal Justice Review, 27(2), 321–329. Worrall, J. L., & Kovandzic, T. V. (2008). Is policing for profit? Answers from asset forfeiture. Criminology & Public Policy, 7(2), 219–244. Zuker, J. (2020, November 25). Parking revenues: The unexpected casualty of COVID-19. Americancityandcounty.com. https://www.americancityandcounty.com/2020/11/25/parking-rev​ enues-the-unexpected-casualty-of-covid-19/.

5. Municipalities in the intergovernmental revenue system: the federal government’s stabilization function? Amanda Kass, Christiana McFarland, Farhad Omeyr, and Michael A. Pagano

INTRODUCTION The fiscal relationship between cities and the federal government has a long and winding history. Fiscal transfers from the federal government to cities amounted to very little until the early 1970s, peaking by the end of the decade, then falling back to around 5 percent of city revenues since the late 1980s, while state aid has hovered around 20 percent of city revenues on average. As a result, cities in the American federal system shoulder the burden of generating nearly three-fourths of all their revenues through their fiscal powers. This changed with the COVID-19 pandemic, when an unprecedented amount of flexible federal aid was allocated to cities, providing them with temporary fiscal relief at least through 2026. The American Rescue Plan Act’s Coronavirus State and Local Fiscal Recovery Funds program represents a break from the federal government’s significant withdrawal from general support to cities, and signals the critical role that federal intervention can play in buoying the fiscal position of cities in times of crisis. The shift in the fiscal relationship between cities and the federal government during the COVID-19 pandemic is momentous. The fiscal stability of cities was shaken to its core by the pandemic in 2020 but has rebounded in large part due to federal activities at the start of the pandemic and in 2021 with passage of the American Rescue Plan Act (ARPA). Both the ARPA and a 2018 Supreme Court decision allowing cities to collect Internet and out-of-state sales taxes have bolstered the fiscal position of cities. However, the question remains as to whether this shift is permanent or temporary. The pandemic may have created the condition by which city policy officials can begin to think about a reimagined city fiscal structure that aligns with its underlying economy and ensures a fair and equitable tax burden on its residents.

HISTORICAL CONTEXT Between the 1930s and 1970s, the composition of total federal, state, and local government spending changed significantly: in the 1930s, local governments accounted for most total government spending and own-source revenue, but by 1970 it was the federal government that accounted for most general expenditures and own-source revenue (Wallin, 1998, p. 3). The New Deal programs followed by the massive wartime effort of World War II positioned the federal government as the key government fiscal actor. The 1960s 88

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through the late 1970s was a period of unprecedented outpouring of aid from federal government to localities, and financed local spending on infrastructure, transportation, and the environment, with the federal government also playing an increased role in the provisioning of welfare services (Krane et al., 2004). During this time, local governments became more dependent on intergovernmental revenue, and it accounted for nearly one-third of cities’ total general revenue by the early 1970s (ibid., p. 4). Most of this aid was categorical, meaning the funds had to be used for specific programs, and cities had little spending discretion. This changed with the launch of the General Revenue Sharing (GRS) program in the 1970s. The GRS was noted as a “revolutionary change in US federal aid policy” when it was enacted in 1972 (ibid., p. xi). Under the GRS program, the federal government provided discretionary aid to state and local governments. When it was originally created (via the State and Local Fiscal Assistance Act of 1972), one-third of the funds were disbursed to state governments, with the remaining amount allocated to local general-purpose governments (ibid., p. 45). Fiscal relations changed again under President Ronald Reagan’s “devolution revolution” in the 1980s, with the federal government shifting responsibilities to state governments, which in turn pushed responsibility onto local governments. With the end of the GRS program in 1986, most federal aid to cities came in the form of the Community Development Block Grant program and through categorical programs. Figure 5.1 shows total intergovernmental transfers (in real dollars) from the federal government to all local governments (the gray line) and general-purpose municipal governments (the black line) between 1977 through 2019 to highlight this history. Importantly, the “local governments” category includes school districts, as well as counties and municipalities. After decreasing significantly between 1978 and 1991, federal transfers to all local governments increased in the late 1990s and 2000s before decreasing again after 2011. While federal transfers to all local governments were nearly the same in 2019 as in 1977 (in real dollars), this was not

Note:  Data unavailable for years 1993–96, 1998–2000, 2004–06, 2008–11, and 2013–16. Source:  US Census Bureau Annual Surveys of State and Local Government Finances (1977–2019).

Figure 5.1  Federal intergovernmental transfers to local governments compared to municipal governments: 1977–2017 (in real, inflation-adjusted dollars)

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the case for municipal governments. In 2017, federal transfers to municipal governments remained far below the peak in 1978. The decline in transfers in federal aid (in real dollars) to local governments between 1977 and 1990 occurred at a time when public discourse positively framed devolution and decentralization as empowering localities to take control over their own destinies (Pagano, 1990; Sagalyn, 1990). The reality, though, was that functional responsibilities were shifted to local governments, but without adequate aid from federal or state governments to support the level of spending needed (Krane et al., 2004). As Pagano and Perry highlight, federal aid to local governments accounted for nearly US$1 in every US$5 of cities’ revenue in 1978, but by 2008 it was only US$1 in US$20 (Pagano & Perry, 2008, p. 33). To fill this void, some states granted local governments “access to other, previously forbidden revenue sources” like income taxes (Pagano, 1990, p. 97). Cities also adjusted their revenue portfolios by imposing and raising fees on services, such that as a percentage of total own-source revenue, fees now generated nearly as much as property taxes (Pagano, 2010). The twin events of federal disengagement from financial support and increased city reliance on fees also took place during a flurry of state-imposed tax and expenditure limitations (TELs), thereby constraining possible fiscal options that cities could have considered (Mullins & Joyce, 1996). These revenue changes had significant impacts on cities’ overall fiscal positions. The National League of Cities (NLC) has tracked cities’ fiscal positions on an annual basis since the mid-1980s, relying on self-reported data on general fund revenue and, since 2010, on data collected from cities’ websites. Using the NLC general fund revenue data, we focus our lens on the post-GRS era, when federal aid was at a low point. One representation of changing fiscal position is the general revenue and expenditure trend over time, as depicted in Figure 5.2. The revenue and expenditure trends tend to follow expectations that revenue changes lag underlying economic conditions due to the relative importance of property taxes in city general fund portfolios. This is because property tax collections lag the business cycle. Expenditure trends move with the business cycles as well, but tend to be more closely aligned temporally. Figure 5.2 paints a picture of the mythical average American city’s revenue and expenditure trends. The diversity of revenue reliance and state authorization to tax certain activities create a much more complicated picture. One approach to understanding the variation in revenue structures and fiscal reliance is outlined in the concept of the fiscal policy space (FPS) of cities (Pagano & Hoene, 2010), which focuses on the wide variation in cities’ legal capacity to make fiscal decisions. For example, nearly every city in the United States has the authority to tax real estate, but only about 10 percent can tax income or wages, while some 55 percent can tax retail sales (ibid.). The authority to tax is controlled by the city’s state and, consequently, cities’ reliance on one or more of these three general taxes (property, income, and sales) depends on whether their states authorize its use. Another constraint on the decision-making authority of cities, which figures prominently in a city’s FPS, is the extent to which state-imposed TELs have a deleterious impact on cities.1 Starting in the late 1970s, “tax revolts” manifested in tax and spending limits, 1   A 2017 report noted, “At the local level, the most common TELs affect property taxes by constraining one or more elements of the revenue structure, including: cap on the property tax rate; limit on the growth in local property assessment; and/or limit on the total levy (revenue) growth

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Figure 5.2  Year-over-year change in general fund revenues and expenditures (2012 base year)

Source:  National League of Cities’ analysis from the annual City Fiscal Conditions survey and annual financial reports.

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especially during and after the Proposition 13 (“Prop. 13”) tax revolt in California, which forced cities to diversify their revenue structures as access to the property tax was constrained (Hoene, 2004). Own-source revenue diversification is most notable by examining the change in revenue reliance on the property tax after 1978, the year of California’s Prop. 13. In 1977, property taxes comprised 21 percent of total municipal revenue, while user charges/fees amounted to 14 percent; only ten years later, property taxes amounted to 16 percent of total municipal revenue, while user fees surged to over 22 percent (Pagano, 2010, p. 119). Even today, and especially for property-tax-dependent cities, TELs continue to impact cities’ fiscal decision-making options. In South Carolina, for example, Act 388 (2006) caps the amount of property taxes that can be raised from year to year, although there are seven exceptions to that cap (DuPuis et al., 2018, p. 21). In cases where exceptions do not apply, South Carolina’s TEL has a large impact on city revenues because of its reliance on the property tax as a key source of own-source revenue (ibid.). To deal with this restriction in the property tax, cities in South Carolina often adjust fiscal policy by raising the fees or taxes of other revenue sources (ibid.). Colorado’s Taxpayer’s Bill of Rights (TABOR), another state-imposed TEL, is a voterapproved amendment to Colorado’s state constitution (Article X, Section 20) designed to limit the size of government. It was approved by Colorado voters in 1992 and requires that all tax increases and debt questions must go before voters (ibid., p. 22). The implications of Colorado’s TABOR for local governments, however, are even more wide-ranging because it imposes annual limits on both local governments’ revenue and spending, creating significant restrictions (ibid.). However, voters can, and do, override these limits (ibid.). In response to restrictive TELs, research has indicated that across the United States, raising the sales tax is a common fiscal policy action taken when a city approaches the ceiling of revenue it can raise from the property tax due to state-imposed TELs (Wang, 2018). Another perspective on understanding cities’ fiscal position over time is captured in Figure 5.3, which shows the ending balance as a percentage of expenditures. As Figure 5.3 highlights, over time, cities have “saved” more in reserves than at the beginning of the post-GRS period. Maintaining an adequate reserve is, according to the Government Finance Officers Association (GFOA), a prudent fiscal management practice. Healthy reserves not only create a cushion for economic cyclical downturns and unexpected natural disasters, they also signal to the municipal bond market that the city is managed prudently, which in turn supports a favorable credit rating. In 2015, the GFOA approved a fund balance policy recommending “that general-purpose governments, regardless of size, maintain unrestricted budgetary fund balance in their general fund of no less than two months of regular general fund operating revenues or regular general fund operating expenditures” (GFOA, 2015, n.p.). The GFOA recommendation roughly translates to 16 percent of general fund expenditures, a figure that on average appears to be exceeded by the municipal sector. The next figure illustrates the long climb back to recovery after the Great Recession. Figure 5.4 shows cities’ aggregate revenue loss over time tied to the 1990, 2001, and 2007 from property taxes from year to year. Adjusting one or more of these components has varying impacts on tax revenue” (DuPuis et al., 2018, p. 20).

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Figure 5.3  Ending balances as a percentage of expenditures

Source:  National League of Cities’ analysis from the annual City Fiscal Conditions survey and annual financial reports.

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Source:  Data from McFarland and Pagano (2020).

Figure 5.4  Cities’ revenue trends during recent recessions recessions. The Great Recession stands out for the length and depth of its impact on local governments’ revenue, with the depth of revenue decline tied to it not occurring until six years after the recession formally started. It was only in 2019 that cities’ general fund revenues returned to pre-Great Recession levels (McFarland & Pagano, 2020). By then, local governments were bracing for the next recession, which many believed was on the immediate horizon (McFarland & Pagano, 2019), although the sudden and unprecedented closing of the economy in 2020 due to the pandemic was not predicted.

COVID CONTEXT Although by 2019 a recession was forecasted, no one predicted the global pandemic and economic downturn known as the “COVID crisis.” The COVID crisis began in China in 2019 with an outbreak of severe acute respiratory syndrome coronavirus (SARSCoV-2), which causes coronavirus disease (COVID-19). The first documented case of COVID-19 in the United States occurred in January 2020 in the State of Washington (Centers for Disease Control and Prevention [CDC], 2021a). While by February of that same year it was becoming clear that COVID-19 posed significant public health and economic risks, there was a lack of a coordinated federal response and President Donald Trump downplayed the situation well into the spring. In the early stage of the pandemic and in the absence of a strong federal response, state and local leaders took actions meant to curb COVID’s spread, ranging from closing schools to issuing official emergency declarations (McDonald et al., 2020). On March 16, 2020, the first shelter-in-place order was issued by six counties in the Bay Area of California, and a statewide order quickly followed (Allday, 2020; State of California Executive Order, N-33-20). Between February and May 26, 2020, there was a flurry of activity, and state and local leaders enacted more than 1,500 policy actions (McDonald et al., 2020).

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The shelter-in-place (or “stay-at-home”) orders disrupted much of everyday life as schools, recreational activities, restaurants, and retail stores were closed. What began as a public health issue quickly morphed into a larger crisis with significant economic disruptions. As COVID-19 spread across the United States and state and local leaders took actions to address the growing public health emergency, it became clear that the pandemic was going to have negative fiscal impacts. State and local governments’ revenues were adversely impacted, and in the spring of 2020, the question was not whether governments would be impacted, but what was the severity and duration of budget shortfalls. At the onset of the pandemic, it was anticipated that state and local governments’ revenue would be negatively impacted by reduced collections, especially of elastic revenue sources like sales and income tax revenue and of tourism-related taxes, such as lodging and amusement taxes (McDonald & Larson, 2020; McFarland & Pagano, 2020). While elastic and tourism-related revenue sources were impacted immediately, the pandemic’s impact on property taxes, a main revenue source for many cities, was unclear during the pandemic’s onset. One of the cities that saw a sharp and dramatic impact on its revenue from the COVID crisis was Akron, Ohio, which is highly dependent on the elastic income tax (57 percent of total general revenue fund). In March 2020, Akron announced that one-third of its municipal workforce would be furloughed (Livingston, 2020). Another city that was impacted early in the pandemic was Seattle, Washington. In March 2020, city officials warned that the pandemic could result in US$100 million in lost revenue for just that year, which would amount to a 7 percent budget reduction (Beekman, 2020). Across the country, anticipated budget deficits led to furloughs, layoffs, and hiring freezes, with local government employment (excluding education) decreasing by 7.9 percent between March and May 2020 (US Bureau of Labor Statistics, 2020; seasonally adjusted employment estimates). States were in no position to provide support, as they too were suffering from the economic slowdown and increased public health needs. While state and local governments were experiencing significant and unexpected revenue losses, there was also increased and new spending for a wide range of needs, like personal protective equipment and rent relief among other items. One of the pernicious aspects of the COVID crisis is how it intertwined with and magnified pre-existing inequities: low-income, black, and brown communities have borne the brunt of the crisis (see Brown, 2020; Romano et al., 2021; Wood, 2020). COVID’s devastating impact was also exacerbated by pre-existing spending needs that had long gone unmet. For example, a 2020 report from the Government Accountability Office (GAO) captured the infrastructure needs of K-12 schools, noting that outdated heating, ventilation and air-conditioning (HVAC) systems that needed extensive repairs or replacement were a widespread problem (GAO, 2020). Proper ventilation is an important COVID mitigation strategy, and the COVID crisis meant that outdated HVAC systems became a pressing issue with clear societal impacts. Because pre-existing inequities have exacerbated and been exacerbated by the COVID crisis, recovery measures and public spending are aimed at the direct health and economic impacts of it and pre-COVID needs.

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FISCAL EFFECTS OF COVID-19 Fiscal rules limit state and local governments’ flexibility during times of crisis in several important ways. First, state laws and constitutions impose balanced budget requirements on governments. Balanced budget requirements mean spending must equal revenue, thus preventing state and local governments from deficit spending. Second, as previously discussed, TELs place constraints on both governments’ revenue-raising capabilities and their spending. Last, state and local laws also place constraints on debt. Because of these restrictions and limitations, state and local governments’ fiscal decisions are constrained in ways the US federal government is not. These constraints also mean state governments are often unable to provide increased aid or support to local governments during moments of crisis. While the federal government is in the best position to enact policies to combat national crises, political divisions over how to handle the COVID crisis, as well as over the seriousness of the issue, stalled a coordinated response during the pandemic’s onset and continued throughout much of 2020. The uncertainty of the pandemic’s trajectory coupled with stay-at-home orders that restricted “nonessential” business activity and individual behavioral changes in response to the uncertainty of the pandemic negatively impacted retail activity, in turn negatively affecting tax collections. At the same time, and as with other crises, there were increased spending needs. For many places, the onset of the pandemic occurred mid-way through fiscal year 2020 and budget seasons for fiscal year 2021. Local governments worked quickly to revise their 2020 budgets and crafted ones for 2021 with conservative revenue assumptions that assumed significant tax ­collection declines. Following the Great Recession, cities made a concerted effort to boost their year-toyear ending balances with the intention of being able to maintain some sort of fiscal stability in future periods of economic downturn. While most cities had substantially built up their reserves before 2020, the pandemic presented a unique set of challenges that cities were not fiscally prepared to respond to. Through the first three months of the pandemic, the City of Baltimore, Maryland lost US$20 million per month in revenue and spent an extra US$5 million per month in emergency costs, using its rainy day fund to close a US$42 million budget deficit (McFarland & Pagano, 2020). From property tax deferment to rental assistance to small business loans, cities had an extreme amount of unanticipated needs and lost revenues. This combination of lost revenue and increased expenditures in a short time period forced many cities to furlough municipal employees and make cuts to critical services like sanitation. Despite early predictions that suggested elastic general tax revenue sources would react to the current pandemic recession as severely as they did after the Great Recession, sales and income taxes (two very elastic tax sources) outperformed these early revenue forecasts (Williams Walsh & Russell, 2021). The sales tax (a major source of general fund revenue for most municipalities) is a very volatile source of revenue that closely reflects the economic cycle and consumer behavior. Naturally, during a recession when the economic activities and consumption decline, sales tax collections decrease as well, and this phenomenon is captured in Figure 5.5. As Figure 5.5 shows, following the Great Recession, sales taxes immediately declined by some 6.5 percent in the following year and another 9.3 percent in 2010.

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Source:  National League of Cities’ analysis from the annual City Fiscal Conditions survey and annual financial reports.

Figure 5.5  Year-over-year change in sales, income, and property tax receipts (2012 base year) Considering the statewide shelter-in-place orders and social-distancing practices that followed the outbreak of the COVID-19 pandemic in the United States, all expectations and revenue forecasts hinted toward a drastic decline in economic activities and in-person shopping, which would then lead to drastic drops in sales receipts and, consequently, sales tax collections. However, as Figure 5.5 shows, this is not entirely what happened. Although the average city experienced a sharp 5.94 percent decline in sales tax receipts in 2020, this decline is not nearly as drastic as those experienced by municipalities after the Great Recession or feared at the very start of the COVID crisis. One major factor is the 2018 US Supreme Court ruling in the South Dakota v. Wayfair, Inc. case (“Wayfair”), which helped cities substitute online sales taxes for their otherwise lost “brick-and-mortar” sales tax revenues. The Wayfair decision allows local governments to collect online and out-ofstate sales taxes from corporations that do not have a nexus within state borders. In other words, as more and more people stayed and worked from home, they shopped online more than ever before and online shopping skyrocketed (Brewster, 2022). Without the Wayfair provision in law, municipal governments would not have been able to collect online taxes from corporations that do not have a physical presence (or “nexus”) within the state. Therefore, by collecting more online sales taxes, the average municipal government did not suffer sales tax revenue loss as much as it did after the collapse of the economy in 2007 when collecting online sales taxes was precluded by earlier court decisions (namely, the US Supreme Court decision in 1967, National Bellas Hess v. Illinois, and its 1992 Quill Corp. v. North Dakota ruling). Although not as common a general fund revenue source as sales and property taxes, income taxes are also considered a major source of revenue in states that allow local

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governments to collect this type of tax (e.g., Ohio). Very similar to sales tax receipts, income tax revenues also closely follow the business cycle and reflect the underlying state of the economy. As Figure 5.5 indicates, the average municipal government experienced a sharp decline in income tax revenues due to a negative impact of the pandemic on employment rates and, consequently, income tax revenues. Like sales tax revenues, income taxes did not fall as much as they did after the Great Recession. This was mostly due to the fact that, unlike the previous recession that impacted almost all sectors of the economy and triggered an economic collapse on a global scale, the COVID-19 recession severely impacted employment in only a select few sectors (e.g., entertainment, hospitality, and tourism sectors), while other sectors that could transform their workforce to a remote format were mostly spared. Therefore, and as Figure 5.5 shows, the income tax receipts did not drop as much as they did after the Great Recession. Another factor that mitigated the expected decline in income tax receipts is that Ohio, the state whose cities are most reliant on the income tax, passed emergency legislation allowing cities in 2020 to continue collecting the income tax (which is levied both at the place of employment and the place of residence) from commuters who had shifted to remote work. Historically, the property tax has been a main revenue source for local governments (see Carroll & Sharbel, 2006; Fisher, 2016; Mikesell, 2017). Unlike sales and income taxes that are very elastic sources of revenue, property tax levies generally lag the business cycle by a few years. This is because property tax levies are based on property assessments that tend to occur every two to three years. Therefore, it often takes a few years for these assessments to reflect a bust or a boom in the economy. Unlike sales and income taxes, property tax revenues experienced mild increases in fiscal year 2020 (as shown in Figure 5.5). This is largely because of the lagged effects of property tax collections, which would not reflect the pandemic’s impact until 2022 or 2023. Yet, it is important to note that most housing markets across the nation experienced drastic increases in house prices as demand for housing increased when more people started to work from home (Duca & Murphy, 2021; Layton, 2021). Looking at fiscal year 2021 estimations (based on budgeted figures) for all three major types of taxes, it appears that the average municipal government has taken a rather conservative approach in forecasting the impacts of the COVID crisis on property, sales, and income tax revenues. Chief financial officers’ budgetary forecasts for fiscal year 2022 were made in April and May of 2021 when residential property values were increasing, employment was increasing, and retail sales appeared to be strong. Those factors, coupled with federal aid from the ARPA, may have contributed to their forecasts, which were not nearly as dire those in 2020 and 2021.

FEDERAL FISCAL INTERVENTION Since March 2020, Congress has passed and the president has signed into law six relief packages.2 While cities’ finances are directly and indirectly impacted by many aspects of 2   As of November 2021. The six relief packages are: the Coronavirus Preparedness and Response Supplemental Appropriations Act, 2020 (March 6, 2020); the Families First Coronavirus Response Act (March 18, 2020); the Coronavirus Aid, Relief, and Economic Security Act (CARES) (March 27, 2020); the Payment Protection Program and Health Care Enhancement Act

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the federal relief packages, we focus on two newly created multipurpose aid programs in this chapter: the Coronavirus Relief Fund for states, tribal governments, and certain eligible local governments (CRF) and the Coronavirus State and Local Fiscal Recovery Funds (CSLFRF). The CRF was created as part of the US$2.2 trillion Coronavirus Aid, Relief, and Economic Security (CARES) Act, which was signed into law on March 27, 2020. As part of the CARES Act, US$150 billion was allocated to state governments, very large counties and cities, US territories, tribal governments, and the District of Columbia. For counties and cities, eligibility for direct CRF aid was limited to places with a population of at least 500,000. Of the total US$150 billion, about 5 percent (or US$7.3 billion) was distributed to 33 cities (author analysis of Treasury payment data – see US Department of the Treasury, 2020a). State governments were encouraged – but not obligated – to share a portion of their CRF monies with local governments. As of August 2020, states reported having spent 25 percent of their CRF allocations, and 25 states reported that they transferred some of the CRF aid to local governments (US Department of the Treasury, 2020b). CRF aid could only be used for necessary expenses incurred on or after March 1, 2020, and that were tied to the “public health emergency with respect to” COVID-19, including economic effects (CRF, 2021). Originally, all the CRF money had to be used by December 30, 2020; however, the spending deadline was extended to December 31, 2021. While the CARES Act broadly outlined how the CRF funds could be used, the more detailed parameters of the program were determined by the Treasury Department. Evolving guidance from the Treasury Department concerning what were allowable expenses contributed to delays in CRF spending (Callahan et al., 2021; Kass & Romano, 2020). Ultimately, states and cities had discretion over how to use the funds, and the funds could be used for a wide range of programs and expenses, including expenses tied to shifting work from in-person to telework, and COVID-19 testing. Although the CARES Act allocated substantial federal aid to states and a limited number of large cities, many places continued to face fiscal uncertainty and were anticipating budget deficits in the near term. It was not until the ARPA was signed into law on March 11, 2021 that city finances appeared to stabilize. As with the CARES Act, a provision of the ARPA, the CSLFRF allocated billions of dollars in multipurpose aid to states, counties, cities, tribal governments, US territories, and the District of Columbia. The CSLFRF is a historic program and differs from the CRF in several important ways. First, the CSLFRF provides US$350 billion in aid, while the CRF allocated US$150 billion. The scale of the CSLFRF program is without precedent in contemporary history. Second, under the CSLFRF, tens of thousands of cities are guaranteed federal funds, while under the CRF, only 33 cities with populations above 500,000 were guaranteed federal aid. Third, CSLFRF funds can be used for a broader range of categories than CRF. In addition to costs tied to the public health and economic effects of COVID-19, the CSLFRF funds can also be used for revenue replacement and “necessary investments in water, sewer, or broadband infrastructure” (CSLFRF, 2021, §35.6). The parameters of the CSLFRF reflect President Joseph Biden’s “Build Back Better” campaign, which aims to tackle immediate needs tied to the COVID crisis and pre-existing inequities that worsened (April 24, 2020); the Consolidated Appropriations Act, 2020 (December 28, 2020); and the ARPA (March 11, 2021).

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the crisis and made its impact uneven. The Biden administration has also encouraged governments to use CSLFRF dollars to address other policy priorities and issues, like public safety and gun violence (The White House, 2021, 2022). As with the CRF program, governments can choose how to spend the fiscal recovery funds, so long as spending fits within one of the broad spending categories. Expenses for the CSLFRF must be obligated by December 31, 2024 and expended by 2026, which means the funds can be used over several budget cycles. Table 5.1 summarizes and compares key provisions of the CRF and CSLFRF programs, specifically for county and city governments. Table 5.1  Comparison of key COVID federal aid programs Coronavirus Relief Fund (CRF)

Coronavirus State and Local Fiscal Recovery Fund (CSLFRF)

Amount of aid for county and city governments

US$27.63 billion

US$130.2 billion

Prime recipient criteria

Population must be at least 500,000

Population must be at least 50,000 or designated a metropolitan city

Number of counties + cities that are prime recipients of aid

154

30,000+

Formula for aid distribution to county and city governments

Population

Metropolitan cities – Community Development Block Grant criteria Counties; other towns and cities – population

Deadline for expending funds

September 30, 2022a

December 31, 2026

Note: a. CRFs must have been obligated by December 31, 2021.

BEYOND FISCAL IMPACTS COVID-19 took municipalities through a roller coaster of fiscal uncertainty. The pandemic also exposed and exacerbated economic and health inequities. The national annual unemployment rate was 8.1 percent in 2020, after peaking near 13 percent in the second quarter of that year (McFarland et al., 2021; Smith et al., 2021; US Bureau of Labor Statistics, 2021). However, unemployment was not even across racial and ethnic groups, and unemployment was 8.7 percent for Asian workers, 11.5 percent for black or African American workers, 10.6 percent for Hispanic workers, and 7.3 percent for white workers (McFarland et al., 2021; Smith et al., 2021; US Bureau of Labor Statistics, 2021). While unemployment rates have gone down in 2021, black, indigenous, and people of color (BIPOC) workers have had a harder time getting back to work because they represent a greater proportion of workers in service-based industries that were more likely to close during the pandemic (Maxwell & Solomon, 2020). Poverty and shrinking household incomes also impacted many marginalized groups more severely throughout the pandemic. Low-income households, overrepresented by BIPOC households, lost more employment

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income than white households since the start of the pandemic (Congressional Research Service, 2020). In addition, the CDC found that COVID-19 cases and fatality rates were disproportionately high among BIPOC communities (CDC, 2021b). Given these realities, the Biden administration has urged governments to spend grant funds, and especially CSLFRF dollars, “in ways that address longstanding racial disparities, inequities and disproportionate harm caused or exacerbated by the pandemic” (Brown & Bauer, 2022, n.p.). Although encouraging governments to prioritize equity is critical, greater CSLFRF allocations to communities that have higher levels of unemployment, COVID-19 mortality, and poverty are also needed to help them bridge these equity gaps. The NLC’s 2021 analysis found that on average, “[C]SLFRF allocates metropolitan cities US$301 per resident; however, the range of per capita allocations spans widely from US$71 per resident in Maple Grove City, MN to US$1563 per resident in East Cleveland City, OH” (McFarland et al., 2021, p. 5). Overall, the NLC researchers found an equitable distribution of CSLFRF among metropolitan cities (ibid.). While targeting CSLFRF dollars to communities in greatest need is vital for an equitable recovery, as McFarland et al. explain, “allocating some level of funds to all communities acknowledges that all places must work to rectify historic inequities” (McFarland et al., 2021, p. 17).

A LOOK BACK TO LOOK AHEAD Over a half century ago, Richard Musgrave (1959) created a three-pronged taxonomy of public finance to explain the activities of governments. One prong was the “stabilization” branch of government, meaning that in the US federal system, the federal government had a responsibility to react to changes in a nation’s economy to balance or stabilize it over some period of time. The stabilization function of the federal government is often operationalized as countercyclical spending, and it includes not just spending on private sector activities but also on public sector activities, which can include transfers to state and local governments. The sudden shutdown of the economy in response to the coronavirus pandemic is an excellent illustration of the use of stabilization activities that the federal government assumed. Both the CARES Act and the ARPA were approved as limited-time investment activities of the federal government to help support and buoy the finances of, among other economic sectors, state and local governments. City governments benefited from a large infusion of federal funds, such that concerns about an imminent fiscal crisis that were pervasive in the early months of the pandemic were muted by the passage of the ARPA in 2021, which had the welcome effect of plugging a fiscal hole. A question for future fiscal policy analysis is, does the ARPA signal a more permanent shift in the city–federal fiscal relationship, especially considering the 2021 Infrastructure Investment and Jobs Act and the proposed Build Back Better bill? After CSLFRF funds are expended, will cities return to the status quo ante or will they have learned how to adapt to a new normal? Or, will they have used this event as a reinvention moment, especially in light of demands for equity and inclusion? If cities are entering a reinvention moment, they must examine their composition of city revenues and what such a new composition ought to look like. The underlying economic base of cities historically has been “fiscalized” in the value of real estate. Yet, a city’s economic base is more than the value of property or even, for sales tax-dependent cities,

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the sum of taxable retail transactions. Realigning the fiscal tools and architecture a city is authorized to impose with its underlying economic base would reflect a reinvention moment. Expanding a city’s FPS would provide cities the decision-making authority, accountability, and responsibility to provide services to its residents. The principal legal constraints on city fiscal autonomy emanate from the state in the form of TELs, restricted access to certain tax authorities (e.g., income or wage taxes), and controlling intergovernmental collaborative activities, among others. No less important are restrictions or mandates by states and the federal government, which tie the fiscal hands of cities. A renewed assessment of tax incidence, especially in light of revelations about racial inequities resulting from tax policies, would create the possibility of reinventing a better, more just, and equitable system of city fiscal policy. Federal and state policies, as they are structured and restructured, must also be aligned with city needs and demands. A better, more perfect intergovernmental revenue system could be a salutary outcome on the heels of a most decimating pandemic.

REFERENCES Allday, E. (2020, March 16). Bay Area orders “shelter in place,” only essential businesses open in 6 counties. San Francisco Chronicle. https://www.sfchronicle.com/local-politics/article/Bay-Areamust-shelter-in-place-Only-15135014.php. Beekman, D. (2020, March 16). Seattle government expecting revenue loss of more than US$100 million as result of coronavirus. The Seattle Times. https://www.seattletimes.com/seattle-news/ politics/seattle-government-expecting-revenue-loss-of-more-than-100-million-as-result-of-coro​ navirus. Brewster, M. (2022, April 27). E-commerce sales surged during the pandemic: Annual retail trade survey shows impact of online shopping on retail sales during COVID-19 pandemic. Census Bureau. https://www.census.gov/library/stories/2022/04/ecommerce-sales-surged-during-pandemic.html. Brown, M., &. Bauer, J. (2022). Working toward an equitable recovery. National League of Cities. https://www.nlc.org/article/2022/02/15/working-toward-an-equitable-recovery. Brown, S. (2020, July 1). The COVID-19 crisis continues to have uneven economic impact by race and ethnicity. Urban Institute. https://www.urban.org/urban-wire/covid-19-crisis-continues-haveuneven-economic-impact-race-and-ethnicity. Callahan, R., Gordon, L., & Morrill, C. (2021). Coronavirus Relief Fund: Review of federal fiscal assistance and of innovative county response strategies. National Academy of Public Administration for the National Association of Counties. https://www.naco.org/sites/default/files/documents/ Coronavirus%20Relief%20Fund%20Review%20of%20Federal%20Fiscal%20Assistance%20and​ %20of%20Innovative%20County%20Response%20Strategies.pdf. Carroll, D. A., & Sharbel, B. J. (2006). The property tax: Past, present and future. In H. A. Frank (Ed.), Public financial management (pp. 151–178). Routledge. Centers for Disease Control and Prevention (CDC). (2021a, August 4). COVID-19 timeline. https:// www.cdc.gov/museum/timeline/covid19.html. Centers for Disease Control and Prevention (CDC). (2021b, September 9). Risk for COVID-19 infection, hospitalization, and death by race/ethnicity. https://www.cdc.gov/coronavirus/2019ncov/covid-data/investigations-discovery/hospitalization-death-by-race-ethnicity.html#footn​ ote01. Congressional Research Service. (2020, November 9). COVID-19 pandemic’s impact on household employment and income. https://crsreports.congress.gov/product/pdf/IN/IN11457. Coronavirus Relief Fund for States, Tribal Governments, and Certain Eligible Local Governments (CRF), 86 FR 4182 (January 15, 2021). Coronavirus State and Local Fiscal Recovery Funds (CSLFRF) (2021), 31 C.F.R. § 35.

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Duca, J. V., & Murphy, A. (2021, December 28). Why house prices surged as the COVID-19 pandemic took hold. Federal Reserve Bank of Dallas. https://www.dallasfed.org/research/econom​ ics/2021/1228.aspx#:~:text=In%20the%20wake%20of%20the,July%202021%20(Chart%201). DuPuis, N., Langan, T., McFarland, C., Panettieri, A., & Rainwater, B. (2018). City rights in an era of preemption: A state-by-state analysis. National League of Cities. https://www.nlc.org/wpcontent/uploads/2017/02/NLC-SML-Preemption-Report-2017-pages.pdf. Fisher, R. (2016). State and local public finance (4th ed.). Routledge. Government Accountability Office (GAO). (2020). School districts frequently identified multiple building systems needing updates or replacement (GAO Publication No. 20-494). US Government Printing Office. Government Finance Officers Association (GFOA). (2015, September 30). Fund balance guidelines for the general fund. https://www.gfoa.org/materials/fund-balance-guidelines-for-the-generalfund. Hoene, C. (2004). Fiscal structure and the post-Proposition 13 fiscal regime in California’s cities. Public Budgeting and Finance, 24(4), 51–72. Kass, A., & Romano, I. (2020). Slow to spend? State approaches to allocating federal coronavirus relief funds. Government Finance Research Center, University of Illinois. https://gfrc.uic.edu/ slow-to-spend-state-approaches-to-allocating-federal-coronavirus-relief-funds. Krane, D., Ebdon, C., & Bartle, J. (2004). Devolution, fiscal federalism, and changing patterns of municipal revenues: The mismatch between theory and reality. Journal of Public Administration Research and Theory, 14(4), 513–533. Layton, D. (2021, January 7). The extraordinary and unexpected pandemic increase in house prices: Causes and implications [Blog]. Joint Center for Housing Studies of Harvard University. https:// www.jchs.harvard.edu/blog/extraordinary-and-unexpected-pandemic-increase-house-prices-cau​ ses-and-implications. Livingston, D. (2020, March 17). Akron furloughs 600 city workers to stop spread of coronavirus. Akron Beacon Journal. https://eu.beaconjournal.com/story/news/coronavirus/2020/03/17/akronfurloughs-600-city-workers/1506536007. Maxwell, C., & Solomon, D. (2020, April 14). The economic fallout of the coronavirus for people of color. Center for American Progress. https://www.americanprogress.org/issues/race/news/2020​ /04/14/483125/economic-fallout-coronavirus-people-color. McDonald, B. D., Goodman, C. B., & Hatch, M. E. (2020). Tensions in state–local intergovernmental response to emergencies: The case of COVID-19. State and Local Government Review, 52(3), 186–194. McDonald, B. D., & Larson, S. E. (2020). Implications of the coronavirus on sales tax revenue and local government fiscal health. Journal of Public and Nonprofit Affairs, 6(3), 377–400. McFarland, C., Brown, M., Bauer, J., & Grabowski, E. (2021, August). Toward an equitable recovery: An analysis of ARPA funds to metropolitan cities. National League of Cities. https://www.nlc. org/wp-content/uploads/2021/12/NLC-Arpa-Analysis-Report.pdf. McFarland, C., & Pagano, M. (2019). City fiscal conditions 2019. National League of Cities. https:// www.nlc.org/wp-content/uploads/2019/10/CS_Fiscal20Conditions202019Web20final.pdf. McFarland, C., & Pagano, M. (2020). City fiscal conditions 2020. National League of Cities. https:// www.nlc.org/wp-content/uploads/2020/08/City_Fiscal_Conditions_2020_FINAL.pdf. Mikesell, J. (2017). Fiscal administration (10th ed.). Cengage Learning. Mullins, D., & Joyce, P. (1996). Tax and expenditure limitations and state and local fiscal structure: An empirical analysis. Public Budgeting & Finance, 16(1), 75–101. Musgrave, R. A. (1959). The theory of public finance. McGraw Hill. Pagano, M. (1990). State-local relations in the 1990s. The Annals of the American Academy of Political and Social Science, 509(1), 94–105. Pagano, M. (2010). Creative designs of the patchwork quilt of municipal finance. In G. K. Ingram, & Y.-H. Hong (Eds.), Municipal revenues and land policies (pp. 116–140). Lincoln Institute of Land Policy. Pagano, M., & Hoene, C. (2010). States and the fiscal policy space of cities. In M. Bell, D. Brunori, & J. Youngman (Eds.), The property tax and local autonomy (pp. 243–284). Lincoln Institute of Land Policy.

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Pagano, M., & Perry, D. (2008). Financing infrastructure in the 21st century city. Public Works Management & Policy, 13(1), 22–38. Romano, S. D., Blackstock, A. J., Taylor, E. V., El Burai Félix, S., Adjei, S., Singleton, C.-M., Fuld, J., Bruce, B. B., & Boehmer, T. K. (2021). Trends in racial and ethnic disparities in COVID-19 hospitalizations, by region – United States, March–December 2020. Morbidity and Mortality Weekly Report, 70(15), 560–565. Sagalyn, L. B. (1990). Explaining the improbable local redevelopment in the wake of federal cutbacks. Journal of the American Planning Association, 56(4), 429–441. Smith, S., Edwards, R., & Duong, H. C. (2021, June). Unemployment rises in 2020, as the country battles the COVID-19 pandemic. United States Bureau of Labor Statistics. https://www.bls.gov/opub/ mlr/2021/article/unemployment-rises-in-2020-as-the-country-battles-the-covid-19-pandemic.htm. State of California Executive Order N-33-20. (2020). https://covid19.ca.gov/img/Executive-OrderN-33-20.pdf. The White House. (2021, June 23). Fact sheet: Biden-Harris administration announces comprehensive strategy to prevent and respond to gun crime and ensure public safety. https://www.whitehouse.gov/ briefing-room/statements-releases/2021/06/23/fact-sheet-biden-harris-administration-annou​ nces-comprehensive-strategy-to-prevent-and-respond-to-gun-crime-and-ensure-public-safety. The White House. (2022, May 13). Fact sheet: President Biden issues call for state and local leaders to dedicate more American Rescue Plan funding to make our communities safer – and deploy these dollars quickly. https://www.whitehouse.gov/briefing-room/statements-releases/2022/05/13/factsheet-president-biden-issues-call-for-state-and-local-leaders-to-dedicate-more-american-rescueplan-funding-to-make-our-communities-safer-and-deploy-these-dollars-quickly/. US Bureau of Labor Statistics. (2020, June 5). The employment situation – May 2020. https://www. bls.gov/news.release/archives/empsit_06052020.pdf. US Bureau of Labor Statistics. (2021, November). Labor force characteristics by race and ethnicity, 2020 (Report No. 1095). https://www.bls.gov/opub/reports/race-and-ethnicity/2020/pdf/home. pdf. US Department of the Treasury. (2020a). Payments to states and eligible units of local government [Dataset]. https://home.treasury.gov/system/files/136/Payments-to-States-and-Units-of-LocalGovernment.pdf. US Department of the Treasury. (2020b). Interim report state & local recipients – costs incurred by spend category through June 30. Data as of August 12, 2020 – revised August 24, 2020. https:// home.treasury.gov/system/files/136/Interim-Report-of-Costs-by-Category-Incurred-by-State-and-​ Local-Recipients-through-June-30.pdf. Wallin, B. (1998). From revenue sharing to deficit sharing: General revenue sharing and cities. Georgetown University Press. Wang, S. (2018). Effects of state-imposed tax and expenditure limits on municipal revenue reliance: A new measure of TEL stringency with mixed methods. Publius: The Journal of Federalism, 48(2), 292–316. Williams Walsh, M., & Russell, K. (2021, March 1). Virus did not bring financial rout that many states feared. The New York Times. https://www.nytimes.com/2021/03/01/business/covid-statetax-revenue.html. Wood, D. (2020, September 23). As pandemic deaths add up, racial disparities persist – and in some cases worsen. NPR.org. https://www.npr.org/sections/health-shots/2020/09/23/914427907/as-pan​ demic-deaths-add-up-racial-disparities-persist-and-in-some-cases-worsen.

6. The role of cities and public health expenditures in the COVID-19 era Yusun Kim

INTRODUCTION Governments at various levels may directly provide healthcare services and/or regulate (or incentivize) individual behaviors. State and local governments in the United States bear a constitutional duty to provide public health services and for financing these activities. While state health departments are primarily responsible for promoting public health, local governments share this responsibility by providing many direct services. In 2019, a year before the spread of the COVID-19 virus was acknowledged in the United States, state and local governments spent US$322 billion (combined) on public health and hospital services (US Census Bureau, 2020). This accounted for approximately 10  percent of total direct general expenditure, similar to the share spent on higher education. According to the US Census Bureau (2020), local governments contributed 55 percent of public health and hospital spending, while state governments provided the remaining 45 percent in the same year. The recent COVID-19 pandemic has brought more attention to what city governments can, and should, do to protect local residents from public health emergencies. The pandemic may put upward pressure on operational expenditure of health departments and public hospitals. Depending on the size of gaps between projected revenue and increased spending, cities may face challenging budgetary decisions. On the other hand, increases in federal and state grants may counter adverse local fiscal decisions in the short term.

PRE-COVID TRENDS IN MUNICIPAL AND LOCAL HEALTH EXPENDITURE Local health departments directly provide healthcare services through local public hospitals and clinics and may also contribute as third-party payers. They are also the primary government agencies responsible for responding to public health crises. There are approximately 2,800 local health departments nationwide as of 2019, with 70 percent operating at the county level, 19 percent operating at the city or town level, and others serving either multiple counties or regional special districts (National Association of County and City Health Officials [NACCHO], 2019). Health and hospital spending accounts for the largest share of the total budget for special health districts (36 percent) and county governments (20 percent), while comprising a relatively smaller share (6 ­percent) for municipalities (US Census Bureau, 2018). Health and hospital spending has increased over time in nominal terms. Figure 6.1 plots the share of total spending, 105

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Source:  US Census Bureau, Annual Survey of State and Local Government Finances (1992–2017).

Figure 6.1  Health and hospital spending, by level of government (percentage share of direct general expenditure) which appears stagnant at most government levels apart from special/health districts.1 The latest statistics for state and local government spending on public health and hospitals accounted for 10 percent of total direct general expenditure in 2019, and 8 percent in 1977. Alfonso and colleagues (2020) report that while national public health expenditure continued to increase annually by 4 percent between 2008 and 2018, the growth rates in state government spending on all public health categories (except for injury prevention) were not statistically different from the 2008 level.2 In addition, state public health spending levels were not restored following budget cutbacks during the Great Recession, which may have compromised state governments’ ability to cope with public health emergencies (ibid.). In fact, the District of Columbia, 17 states and 21 percent of local health departments cut public health spending in the 2018 fiscal year (Bosman & Fausset, 2020). Public health spending is concentrated on operational costs rather than capital costs. In 2019, only 4 percent of total state and local health and hospital expenditures were capital 1   Special/health districts are regional units dedicated to single or a few services, mostly focused on hospital services. The upward trend in health spending at this level since 2012 may be related to the financial incentives under the Affordable Care Act (ACA) that encourages local health departments to collaborate with hospitals, Medicare Accountable Care Organizations, and expand services. 2   Most of the growth in state and local health and hospital spending is driven by a combination of higher healthcare costs due to technological innovation and expansion in health insurance ­coverage, which increases Medicaid spending.

The role of cities and public health expenditures in the COVID-19 era  ­107

Source:  US Census Bureau, Annual Survey of State and Local Government Finances (1992–2017).

Figure 6.2  Municipality spending on public welfare and public health (USD per capita) outlays to finance construction of hospitals. The majority of spending was for community health programs, public hospital operational costs, and regulatory or inspection services. Figure 6.2 plots the average per capita spending on public welfare and health and hospitals among all municipal governments that responded to the US Census Bureau’s Annual Survey of State and Local Government Finances (in years ending in 2 and 7) between 1992 and 2017. Municipal government investment in general public health activities, excluding hospital spending, has remained relatively stagnant since the Great Recession. NACCHO similarly reports that the workforce in local health departments has grown older and smaller since the Great Recession through constant budget cuts, which may have weakened local public health infrastructures and hindered their ability to respond to COVID-19 (NACCHO, 2019). Municipality Spending on Health and Hospitals after the Affordable Care Act The recovery of growth rate in general health spending, as well as public welfare spending between 2012 and 2017, coincide with the period when 31 states expanded their Medicaid programs3 under the Affordable Care Act (ACA). The additional Medicaid costs of providing for the newly eligible were designed to be covered by federal funding between 3   Medicaid-related spending is included in both categories of public welfare and health & ­hospital spending in the Census survey.

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2014 and 2016, such that the expansion would not impose additional restraints on state budgets. Sommers and Gruber (2017) show that the ACA led to no meaningful change in total spending (or other categories of spending) at the state level, among states that expanded Medicaid, by using a difference-in-differences estimation. Most municipal governments do not directly contribute to the non-federal portion of Medicaid costs, with the exception of a few consolidated city-county governments in states that have local sharing requirements such as California, Florida and Indiana. However, the ACA may indirectly affect a municipality’s health spending via multiple demand-side channels, including an increase in demand for public health services, utilization of public hospitals, and changes in intergovernmental transfers to municipal governments and municipalityowned public hospitals. State governments’ adoptions of Medicaid expansion are the primary focus of several studies demonstrating that Medicaid expansion is associated with increased demand for healthcare services, reflected in lower uninsured rates among non-elderly populations (Cohen et al., 2018), and higher utilization of preventive healthcare (Simon et al., 2017; Sommers et al., 2016).4 All these demand shifts may affect public health facilities, including municipality-owned hospitals. Some studies find that the ACA Medicaid expansions were negatively associated with uncompensated care (Blavin, 2016), length of uninsured hospital stays (Nikpay et al., 2016), and volume of patients at community health centers (Cole et al., 2017). While Medicaid covers many new hospitalization costs, it reimburses these hospitalizations at a lower rate than private insurance plans. In addition, while hospitals benefit from reduced uncompensated care costs through Medicaid expansion and individual mandates under the ACA, a provision that reduces the growth rate of Medicare reimbursement may offset some of those gains (Young et al., 2019). However, Blavin (2016) argues that the net effect of the ACA manifests as improved operating margins of hospitals located in states that expanded Medicaid, relative to other states that did not. Existing literature tells us how the ACA may have affected the financial performance of healthcare providers and illustrates the heterogeneity of effects based on population density and hospital ownership. The number of all community hospitals, their admissions, and the number of public hospitals owned by state and local governments has been decreasing since 2017 (Table 6.1).5 Also, the share of all hospitals that are designated as rural hospitals has decreased since 2015. Some studies suggest rural hospitals are more likely to close due to the tighter fiscal constraints of local governments and the narrow market for healthcare services (Holmes et al., 2017; Kaufman et al., 2016; Lindrooth et al., 2018). The existing empirical evidence is mixed on how the ACA Medicaid expansion affects rural and urban hospitals. Using a difference-in-differences approach, Kaufman et al. (2016) show that while uncompensated care costs among urban hospitals are lower after states expanded Medicaid, there is no significant change in uncompensated care costs or operating profit margins among rural hospitals after Medicaid expansion. On the other hand, Lindrooth et al. (2018) report that state Medicaid expansion mitigates the risk of   There is mixed evidence on emergency care utilization.   Earlier evidence suggests that the total volume of admissions in all community hospitals increased in both expansion and non-expansion states (Cole et al., 2017). 4 5

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Table 6.1  US community hospitals Year

FY2015

FY2016

FY2017

FY2018

FY2019

FY2020

Count by ownership Not-for-profit For-profit State & local government Federal government All community hospitals

2,845 1,034 983 212 5,074

2,849 1,035 956 209 5,049

2,968 1,322 972 208 5,470

2,937 1,296 965 209 5,407

2,946 1,233 962 208 5,349

2,960 1,228 951 207 5,346

Urban–rural type Urban (%) Rural (%) Admissions and expenses Admissions (in millions) Expenses (US$ billion)

59.8 36.0

64.3 35.7

61.9 34.3

62.5 35.2

62.4 33.7

62.5 33.6

33.3 851.5

34.0 920.1

34.3 966.2

34.3 1,010.3

34.1 1,056.5

31.4 1,102.3

Source:  American Hospital Association (2022).

hospital closures in rural areas, while Rhodes et al. (2020) find evidence of improved financial performance among both public and rural hospitals following Medicaid expansion. A couple of case studies in Oregon and California also provide supportive evidence of Medicaid expansion benefiting rural populations and rural hospitals (Allen et al., 2018; Duggan et al., 2022). Using a national dataset of hospitals, Zhang and Zhu (2021) confirm that the ACA Medicaid expansion particularly improved operating margins of public hospitals, hospitals located in rural counties, and hospitals in counties with lower income. They argue that these hospitals (and particularly public hospitals owned by local governments) heavily rely on Medicaid reimbursement as their main source of revenue; therefore, hospitals in Medicaid expansion states may have greater incentives to adjust their financial strategies under the ACA. Meanwhile, the literature is sparser on the impacts of the ACA on public health and hospital spending at the municipality level. Perez et al. (2020) treat the ACA reform as an exogenous state-induced price reduction of public hospital service, which may either increase local hospital spending or reduce it (by retreating the role of underwriting hospital provisions and choosing to invest in alternative services or reduce taxes). In their study using a triple difference-in-differences model, they find no significant difference in county or municipality hospital spending between expansion and non-expansion states after the ACA.6 More updated research will be needed, however, given that this study does not utilize the variation in different timings of state Medicaid expansions under the ACA and only includes two post-periods. Later, using a state border pair discontinuity design and county-level data from 2006 to 2012, Perez et al. (2021) find that state Medicaid expansion mitigates the adverse effects of recession on county governments through reducing spending on welfare, health, and hospitals as well as debt. Based on their 6   The authors do find evidence of counties and municipalities increasing hospital spending in states that supported Obama, while Romney-supporting states spent less on hospital and reduced property taxes (Perez et al., 2020).

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estimates from the Great Recession period, they extrapolate their predictions to the COVID-19 recession and report that increasing generosity of Medicaid may reduce safety net expenditures, including health and hospital spending among county governments (ibid.). Local Health Departments and Regionalizing Public Health Service Provision Local health departments have a variety of structures and broad powers. Each state has different requirements for the governance of local health departments. Most are entities of either a single county government or health districts formed by multiple counties or across municipalities. Some states, including Connecticut, Massachusetts, New Jersey, Virginia and Texas, have more decentralized systems, with more than ten independent municipal health departments per state. The state government of Connecticut, for instance, requires health districts and larger municipalities serving a population of at least 40,000 residents to hire a full-time director of health. Most municipalities in Massachusetts have their own local board of health. Local boards of health in larger towns or cities in Massachusetts choose a mix of appointed health commissioner, hired professional staff, and an advisory council, while those in smaller municipalities have elected or appointed board members or volunteer staff members. Local public health officials, in general, have a broad range of authority including administering programs and adopting public health regulations (such as imposing quarantines or employing enforcement tools including fines, permits, and nuisance abatement). Table 6.2 shows the average per capita spending on health and hospitals by each level of government in each state. Massachusetts, which has no functional county governments, has a large number of local boards of health and municipal health departments spread out across 39 cities and 312 towns. On the other hand, states such as Alaska, Indiana, Mississippi, New York, Oklahoma, South Dakota, and West Virginia have just a handful of metropolitan city health departments spending a higher per capita on average than municipal health departments in Connecticut or Massachusetts. Appendix Table 6A.1 shows that municipalities in 18 states either do not own and operate public hospitals or are not responsible for paying hospitals for public services unrelated to Medicaid or Medicare. The public choice literature includes well-developed discussions about under what conditions government provision will lead to an efficient provision of public goods and which level of government should provide them. Many scholars believe that under certain conditions, the local provision of public goods will be fully efficient (Oates, 1969; Tiebout, 1956). Given that the majority of local health expenditure is contributed by health districts, several studies have asked whether resources are more efficiently allocated when public health services are delivered by independent municipal health departments versus regionalized health districts. Using Connecticut data, Bates and Santerre (2013) find that the regionalization of delivering public health services increases local public health spending for municipal governments relative to public education and other municipal services.7 7   They also report that public health services show characteristics of pure public goods in areas with independent local health departments, while resembling quasi-public goods in regionalized health districts.

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Table 6.2  Mean health and hospital expenditure per capita in FY2017, by level of government (2019 real USD)a State Alabama Alaska Arizona Arkansas California Colorado Connecticut Delaware Florida Georgia Hawaii Idaho Illinois Indiana Iowa Kansas Kentucky Louisiana Maine Maryland Massachusetts Michigan Minnesota Mississippi Missouri Montana Nebraska Nevada New Hampshire New Jersey New Mexico New Yorkb North Carolina North Dakota Ohio Oklahoma Oregon Pennsylvania Rhode Island South Carolina South Dakota Tennessee Texas Utah Vermont Virginia

State & Local

State

1,543 985 242 541 1,412 678 735 651 765 739 901 592 438 886 1,431 1,528 802 810 383 416 498 993 678 1,546 1,127 597 747 536 142 574 928 1,293 1,439 380 779 645 1,126 820 311 1,690 416 746 916 1,012 668 943

576 276 81 443 408 267 691 608 263 246 870 146 172 127 661 1,091 532 191 262 317 343 620 154 647 731 349 261 199 127 494 787 472 327 268 402 319 818 564 291 623 234 152 375 776 654 747

Municipality 11 333 1.9 49 116 15 21 N/A 13 3.3 31 7.1 35 252 212 100 58 123 60 21 142 50 102 331 136 13 22 5.3 4.1 15 31 539 2.3 34 34 185 4.3 141 14 2.6 140 72 27 115 0.6 48

County

Health Districts

24 376 43 49 563 70 N/A 43 155 45 N/A 139 189 474 557 261 154 401 0.7 78 0.5 303 379 566 124 128 291 331 0.6 57 68 271 325 54 318 133 203 110 N/A 184 23 523 390 116 N/A 105

931 N/A 116 N/A 325 326 N/A N/A 334 445 N/A 300 41 31 0.6 75 58 96 41 N/A N/A 17 43 N/A 136 107 173 0.9 N/A N/A 42 0.7 784 24 23 8.9 101 2.9 N/A 880 18 N/A 124 5.1 N/A 43

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Table 6.2 (continued) State

State & Local

State

1,506 438 725 3,261 949

823 223 477 1,000 419

Washington West Virginia Wisconsin Wyoming National

Municipality 14 124 36 22 96

County 163 91 209 1,134 257

Health Districts 504 N/A N/A 1,106 176

Notes: N/A indicates not applicable. Delaware has 57 incorporated municipalities that do not report their finances to the US Census. Counties in Connecticut and Rhode Island do not function as local governments and only exist as geographic regions. Counties in Vermont have limited authority in providing public services, which do not include public health. Hospital-related services are provided by municipalities or the state government in Vermont. N/A under the Health Districts column indicates that either there are no functioning special health districts in a given state or data is not available. a. Adjusted for inflation using the Bureau of Economic Analysis government expenditure deflator. b. In New York, all local health departments are part of county governments with the exception of New York City, which has its own municipal health department that spends the highest per capita amount among all municipalities in the country and more than any other county governments in the state. Source:  NACCHO (2019).

The public finance literature provides ample evidence of economies of scale in providing various types of local public services such as education (Duncombe & Yinger, 2007; Tholkes, 1991); fire services and police protection (Duncombe & Yinger, 1993; Wasylenko, 1977); and property tax administration (Sjoquist & Walker, 1999; Wicks & Killworth, 1967). Regionalization, however, may come with a loss of efficiency. The Leviathan theory of budget-maximizing governments would predict that consolidating or centralizing the provision of public services would reduce incentives for intermunicipal competition, leading to higher public health spending that exceeds the efficient level (Brennan & Buchanan, 1980). Bates and Santerre (2013) support this theory through Brueckner’s (1982) test of allocative efficiency and simulations of consolidating municipal health departments into a regional health district. They find that regionalization may lead to substantial loss of efficiency for highly populated areas, due to potential crowding out of public education spending when local governments overspend on public health services. The crowd-out debate in the public finance literature centers around whether there are budgetary trade-offs between health and education services and provides mixed evidence at the state level (Baicker, 2001; Fossett & Wyckoff, 1996).8 Some studies find that compared to other state services, public health spending and Medicaid spending in particular are less susceptible to budget cuts (Berry & Lowery, 1990; Coughlin et al., 1994; McCarty  & Schmidt, 1997). Coughlin et al. (1994) report that state governments, on average, rarely enact large-scale budget cuts in public health services, and adopt alternative budget strategies such as incremental program cutbacks, limiting spending growth on other services, relying on federal grants, and raising state tax rates. 8   On one hand, Baicker (2001) reports that mandated increases in Medicaid spending crowd out other public welfare spending at the state level (ibid.). In contrast, Fossett and Wyckoff (1996) find no evidence of increases in Medicaid spending crowding out K-12 educational spending.

The role of cities and public health expenditures in the COVID-19 era  ­113

Intergovernmental Grants and Hospital Charges Intergovernmental grants (IGGs) are the primary source of local health and hospital spending (Figure 6.3). Municipalities rely more on state grants than federal grants. In 2019, state and local governments funded approximately 91 percent (US$291 billion) of total public spending on health and hospitals, while the rest came from the federal government (US Census Bureau, 1977–2020). The flypaper literature9 has mixed evidence on whether a dollar of exogenous IGG money may increase the recipient government’s spending to a greater extent than an equivalent increase in local citizens’ income (Hines & Thaler, 1995). Earlier studies (Gramlich et al., 1973; Inman, 1971; Weicher, 1972) on city governments have documented various estimates of flypaper effects, ranging from US$0.25–1 change in spending per US$1 change in unconditional block grants provided by federal or state governments. The “stickiness” of grants and spending may be operating in the domain of public health. Bates and Santerre (2013) provide empirical evidence that the demand for public health services is relatively tax-inelastic, but relatively more responsive with respect to intergovernmental aid and independent of community income. Their findings suggest that an increase in IGGs may stimulate local demand for public health services. In addition to receiving IGGs from higher levels of government, municipal governments are increasing their share of revenues from hospital charges. Hospital charges are revenues generated when a hospital owned by a municipal government charges individual patients and private or public insurance plans for its services. Figure 6.4 shows that the per-capita level of hospital charges has been steadily increasing, on average, since the 2000s until 2017. Hospital charges have accounted for approximately 61 percent of municipal hospital spending (US$38 per capita) and 40 percent of health and hospital spending in 2017. The share of combined health and hospital spending belonging to hospital charges has also increased dramatically at the state and local level since the 1970s: the share was 37 percent in 1977, over 50 percent in 2011, and 57 percent in 2019. Disparities in Public Health Spending The disparities in public health investments and health outcomes between urban and rural locations is another key area of concern in health policy. Some studies show that the heterogeneity in mortality, health outcomes, insurance coverage, and utilization of healthcare may be related to population density and race (Murray et al., 1998, 2007). The recent health policy literature suggests that the divergence in mortality rates between urban and rural localities has reversed since the 1980s (Cosby et al., 2008; Cossman et al., 2017; James & Cossman, 2016). While urban counties used to have higher mortality rates and shorter life expectancy than rural counties, health outcomes are now worse in rural areas (Cossman et al., 2017; Singh & Siahpush, 2014). For instance, Singh and Siahpush (2014) report that mortality rates are the highest among poor rural black residents. Cossman et al. (2017) document that the rural mortality penalty has been 9   The so-called “flypaper effect” suggests that the increase in local public spending may be greater per US$1 increase in external source of revenue (such as IGGs), relative to the equivalent amount of increase in local residents’ income (Gramlich et al., 1973; Inman, 1971; Weicher, 1972).

114  Research handbook on city and municipal finance

Source:  US Census Bureau, Annual Survey of State and Local Government Finances (2000–2019).

Figure 6.3  Trend in intergovernmental grants for health and hospitals, urban municipalities

Source:  US Census Bureau, Annual Survey of State and Local Government Finances (1992–2017).

Figure 6.4  Trend in revenue and spending for public hospitals, municipality level

The role of cities and public health expenditures in the COVID-19 era  ­115

growing among black and white populations since the early 1990s and suggest that the role of rural public health infrastructure and investment may vary for different racial groups. These findings about a rural penalty lead to the question of how public resources should be geographically allocated, and what role public health departments at different levels of governments should play. To address such normative questions, we may need a better understanding of how public health spending varies across different regions and sub-populations. Metropolitan cities with populations of more than 50,000 tend to rely heavily on state grants as their main revenue source, compared with smaller cities, and allocate relatively less of their total budget to health and hospitals. Figure 6.5 shows that rural municipalities and non-metropolitan urban municipalities with less than 50,000 population spend a larger share of their total general expenditure on public health services compared with urban areas. Also, the level of general public health spending has increased noticeably among urban municipalities, and particularly among urban cluster municipalities between 2017 and 2019, as shown in Figure 6.6. Effects of Municipal Public Health Spending on Health Outcomes The ultimate objective of public investment on health and hospitals is to improve public health outcomes. The challenge is the endogeneity between the health conditions of a population and changes in public health spending, which makes it difficult to obtain a clear causal picture of this relationship. The literature is long on descriptive evidence of state and local investment in public health being associated with better health outcomes

Source:  US Census Bureau, Annual Survey of State and Local Government Finances (1992–2017).

Figure 6.5  Health and hospitals per capita spending – urban and rural municipalities

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(a)

(b)

Source:  US Census Bureau, Annual Survey of State and Local Government Finances (2000–2019).

Figure 6.6  Health and hospital per capita spending – urban municipalities: (a) health spending per capita in urban areas and urban clusters; (b) hospital spending per capita in urban areas and urban clusters

The role of cities and public health expenditures in the COVID-19 era  ­117

in various service areas.10 Bekemeier and colleagues (2014) suggest that targeted investment in maternal and child health services by local health departments is associated with reduced adverse birth outcomes among counties with high poverty rates. Erwin et al. (2011) find that increases in local health department spending are significantly associated with reduced rates of infectious disease morbidity, and more medical staffing is associated with a decline in cardiovascular disease mortality. Mays and Smith (2011) show that local public health spending is negatively correlated with preventable deaths. However, one of the main challenges in isolating the causal effect of local spending on public health and health outcomes is related to the cyclicality of health outcomes and government spending. In other words, both health outcomes and public health spending may exhibit a cyclical pattern. The empirical literature shows mixed evidence of improvement in birth outcomes during recessions (Dehejia & Lleras-Muney, 2004; Hamersma et al., 2018), or worse outcomes (Margerison-Zilko et al., 2017) during periods of high unemployment. Also, given that Medicaid is a countercyclical policy tool, health spending (including Medicaid costs at the state and local levels) may increase during recession. Under such circumstances, the association between health spending and health outcomes will be confounded. Various policy interventions such as Medicaid reform may also confound the relationship between health spending and health outcomes. Hamersma et al. (2018), for instance, show that the prevalence of adverse birth outcomes is smaller, and the correlation between unemployment rate and adverse birth outcome is weaker, in states with a more generous Medicaid income threshold. Several studies address the need to control for potential endogeneity bias, since rational health departments may make their budget allocation decisions based on previous health outcomes in the community, such as adopting precautionary measures for emerging epidemics or environmental threats (Bishai et al., 2015; Dehejia & Lleras-Muney, 2004). A few recent studies focus on estimating the return on public health investments using county-level data. Using an instrumented static panel model, Brown and Murthy (2020) provide causal evidence of increased county health spending reducing public assistance medical care benefits at the county level in California, between 2006 and 2015. They also emphasize why it is important for governments to invest in public assistance for healthcare relative to Medicare, given that the additional benefits of increasing worker productivity and income are more present when targeting the low-income population that may enter or remain in the labor force.

MUNICIPAL PUBLIC HEALTH BUDGETS AND THEIR IMPACTS IN THE AFTERMATH OF COVID-19 Changes in Public Health Expenditures Municipal governments have reported increases in total spending as well as spending on health and hospitals between FY2019 and FY2020. Most pandemic-related expenditures 10   Most studies at the local level have used either the US Census Bureau Annual Survey of State and Local Government Finances data at the county level or the NACCHO data of local health departments.

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were for various safety measures, including procuring protective equipment in public hospitals and disinfecting public facilities (Gordon et al., 2020; National League of Cities [NLC], 2020). San Francisco city and county government, for instance, reported an increase of US$375 million in such spending in FY2020, while the New York City government budgeted US$2.7 billion for pandemic-related direct spending in FY2020 (San Francisco Office of the Mayor, 2020). One of the major concerns among municipal budget officials was whether COVID-19related spending would crowd out spending on other key functions within the health department and across different departments. For instance, reallocating limited resources on disease control and epidemiology may reduce investments in mental health services or substance use disorders, especially under high uncertainties about the longevity of state and federal grants. The case studies of New York and San Francisco, two large metropolitan city governments included in this chapter, provide examples of the compositional change in municipal health budgets before and after the pandemic. In a descriptive, ­survey-based study of how local health departments responded to the Great Recession between 2008 and 2010, Willard et al. (2012) report that 53 percent of local health departments nationwide had to adopt budget cuts in at least one of their core programs. They report layoffs of over 23,000 full-time-equivalent positions over the first two years of the pandemic. Grants and Other Sources of Revenue The demand and fiscal pressure on municipal governments may partly be ameliorated by IGGs. In response to the pandemic-induced recession, the federal government provided approximately US$280 billion for both state and local governments for FY2020 (Clemens & Veuger, 2020). This included US$1 billion for public health responses as part of the Coronavirus Preparedness and Response Supplemental Appropriations Act, as well as US$150 billion Coronavirus Relief Fund under the Coronavirus Aid, Relief, and Economic Security Act, also known as the CARES Act (Congressional Budget Office [CBO], 2020). The Coronavirus Relief Fund was primarily targeted at state governments, but was also made available to local governments with more than 50,000 residents. These federal payments to local governments were formula based and were provided at the cost of reducing the state share of the federal grant. If metropolitan cities within county boundaries were eligible and had direct access to the fund, federal payment to cities would reduce county allocations (Congressional Research Service [CRS], 2021). Costs incurred between March 1, 2020 and December 31, 2021 were to be reimbursed under the CARES Act. In addition, in March 2021, Congress and the Biden administration delivered US$65.1 billion of federal aid to cities, towns, and villages through the Coronavirus State and Local Fiscal Recovery Fund (CSLFRF) under the American Rescue Plan Act (ARPA). ARPA allocations were divided into two categories based on population size: (1) metropolitan cities with over 50,000 residents; and (2) local governments serving a population of less than 50,000 that are defined as non-entitlement units by the US Department of the Treasury. In FY2021, Congress allocated US$45.6 billion to large metropolitan cities and US$19.5 billion to non-entitlement units of local government (US Department of the Treasury, n.d.). These flexible funds were provided primarily for the following four needs:

The role of cities and public health expenditures in the COVID-19 era  ­119

replacing forgone own-source revenue due to the pandemic; supporting local health communities and local businesses or households; providing premium wage for essential workers in the healthcare industry; and investing in improving water, sewer, and broadband infrastructure. Fiscal Impacts Meanwhile, Gordon et al. (2020) argue that the federal response was insufficient to address the state and local fiscal effects of the COVID-19-induced recession. They emphasize that many local governments operate under balanced budgets with various state-imposed limits on borrowing and taxing, limiting these local governments’ fiscal responses (Gordon, 2012; Rueben & Randall, 2017). As shown in Figure 6.3, municipal governments tend to rely more on state grants than federal grants. If state governments have insufficient resources to finance the additional costs of pandemic responses, leading them to cut intergovernmental spending, then municipal governments would face greater fiscal constraints. The variation in state governments’ decisions about adjusting intergovernmental transfers to municipal governments may provide opportunities to study the effects of intergovernmental aid on municipal fiscal decisions. Furthermore, the fiscal implications of increased intergovernmental aid are particularly relevant to municipal health spending in the aftermath of public health emergencies and natural disasters. The public finance literature on natural disasters shows evidence that additional state or local spending is largely financed by IGGs (Deryugina, 2017; Jerch et al., 2020; Miao et al., 2018). Meanwhile, Deryugina (2017) shows that natural disasters such as hurricanes increase public medical payments and other federal transfers to affected counties through social safety net programs, which are greater than direct disaster aid. Jerch et al. (2020) find that exposure to major hurricane events may have lasting effects on municipal governments’ provision of public service and may significantly increase the default risk of municipal debts. On the other hand, there are uncertainties about how municipal health spending will be affected since pandemic-related state and federal grants are likely to be reduced and ultimately expire. A related case is the previous experience of the 2009 American Recovery and Reinvestment Act (ARRA). In response to the Great Recession, the federal government readily provided US$280 billion under ARRA to state and local governments by using the existing Federal Medical Assistance Percentage formula (Gordon, 2012; Gordon et al., 2020). The downside of this approach was that the ARRA was short-lived and expired during a period of state budget shortfalls (Boyd & Dadayan, 2015; National Association of State Budget Officers [NASBO], 2013), which led to increased state taxes, state budget cuts, and reductions in state aid to local governments (Chernick et al., 2020). Nguyen-Hoang and Hou (2013) find that municipalities in Massachusetts increased their financing of capital projects and saving for future liabilities in response to state grant cuts during the Great Recession. The existing literature provides much evidence for expenditure stimulation effects of IGGs (Bradford & Oates, 1971; Duncombe & Yinger, 2000; Oates, 2011). However, less is known about the fiscal response of recipient governments when grant funds recede. The COVID-19 pandemic also affects hospital spending at the municipality level. The current spending for public health facilities in New York City in FY2021 increased by

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58 percent to US$1.64 billion from the actual spending level in FY2019. In FY2021, a majority of that spending was financed through city funds. National health expenditures have increased at a faster rate following the outbreak of the COVID-19 virus between 2020 and 2021, largely driven by increased Medicaid spending (Centers for Medicare & Medicaid Services [CMS], 2021).11 CMS reports that Medicaid supplemental payments to hospitals and mental health facilities as well as inpatient payments have all increased since 2019. Also, average out-of-pocket spending decreased in 2020 by 3.7 percent, while the average growth rate was approximately 4 percent for the previous two years. This may be partly related to reduced healthcare utilization during the pandemic due to private insurers offering less generous plans with high deductibles and reduced or no cost-sharing requirement for COVID-19 testing and treatment. Additional federal funding was provided to state governments to support small rural hospitals, allowing them to implement data system requirements established under Medicare and to better mitigate the pandemic’s effects. In 2021, the US Department of Health and Human Services spent US$398 million on the Small Rural Hospital Improvement Program (SHIP), which benefited 1,540 rural hospitals with fewer than 50 beds, some of which were owned or funded by municipal governments. The SHIP federal funds were provided to fund operational improvements to expand access to COVID-19 testing in small hospitals and support mitigation efforts that are more catered towards rural communities. In FY2020, 46 state governments received approximately US$12,000 per participating hospital on average. Texas, with the most number of eligible small rural hospitals (115 hospitals), received the largest amount of the fund (US$29.7 million), while Massachusetts, with only six eligible hospitals, received US$1.6 million specifically for the purpose of supporting COVID-19 testing and mitigation (HRSA, 2020). These measures were intended to address the preexisting policy issue of urban–rural divide in public health by targeting financial assistance to rural health facilities with limited infrastructure and capacity. Huang et al. (2021) record whether state and local mitigation efforts were correlated with confirmed infection cases and deaths, as well as how urban areas and rural areas are affected differently, by examining the temporal and spatial county-level patterns over a six-month period in South Carolina. The authors provide suggestive evidence that rural counties with less access to medical care and fewer hospitals and hospital beds had higher COVID-19 deaths. They argue that COVID-19 mitigation policy efforts should be locally customized to better address the inherent ­heterogeneity in capabilities between urban and rural areas.

11   The increase in Medicaid enrollment was associated with lower private health insurance coverage rate, which is akin to the crowd-out phenomenon induced by state Medicaid expansion between the 1980s and 2000s, as described in the earlier literature (Gruber & Simon, 2008). More recent studies found no or little evidence of crowd-out effect from the Massachusetts plan (Kolstad & Kowalski, 2016) or the ACA (Abraham et al., 2016; Sommers et al., 2018).

The role of cities and public health expenditures in the COVID-19 era  ­121

HEALTH SPENDING DURING THE COVID-19 PANDEMIC: CASES OF SAN FRANCISCO AND NEW YORK The City Government of New York New York City was the country’s largest spender on public health and hospitals among all municipalities in FY2019 spending – more than any other local government (US Census Bureau, 2020). New York City has two main organizations that are responsible for promoting public health. The first is the New York City Department of Health and Mental Hygiene (DOHMH), which is responsible for inspecting restaurants and small businesses, managing clinics, preventing the spread of infectious diseases, and issuing pet licenses. The department is led by the health commissioner and members of the New York City Board of Health who are appointed by the mayor. The total DOHMH budget in the first year of COVID in FY2020 was US$1.78 billion, while the adopted budget for FY2021 increased to US$1.86 billion, which is less than 2 percent of the total city budget (Council of the City of New York, 2021). The total department budget grew at a slower rate between 2019 and 2020 than in previous years before the pandemic. The slower growth in total budget may be related to the changes in the revenue structure during the pandemic and city government’s pressure to minimize budget gaps through a citywide savings program. Given that the largest source of revenue for the department is city funding, the moderate increase in health spending may be partly related to the city’s saving program. The Program to Eliminate the Gap (PEG) is a program first implemented in 2008 after the Great Recession to improve government efficiency by reducing city-funded spending. Overall, PEG reduced the amount of budget allocated to the DOHMH from city funding by US$29.4 million and US$10.3 million in FY2020 and FY2021, respectively. Under PEG, each agency of the city government had to find measures to either cut spending or increase other revenue sources in the budgeting process. Efforts using the former approach are reflected in staffing reductions. In fact, actual full-time headcounts within the DOHMH decreased since FY2020, as shown in Table 6.3. The personal services budget for health administration and family and child health services also declined during the pandemic. In response to the New York State’s executive order “New York State on Pause” in FY2020, in-person services at health immunization clinics and offices for childcare programs were suspended until the end of the public emergency.12 In FY2022, the new mayor, Eric Adams, ordered city agencies to identify new savings targets of approximately 3 percent of their total budget for the next fiscal year (ibid.). Overall, NYC government relied heavily on own-source revenue during the first two  years of the COVID-19 pandemic. However, under the pressure to cut spending with  PEG restrictions, the city had to rely on IGGs to prevent further layoffs or ­furloughs.

12   Other services such as administration of birth or death records and permit processing were modified to virtual online services, while licenses and permits became extended until the end of the public emergency.

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Table 6.3  NYCDOHMH detailed budget, by function Service (millions of dollars)

FY2017 FY2018 FY2019 FY2020 FY2021a

Personal services Health administration Disease control Family and child health services Environmental health services Early intervention Office of Chief Medical Examiner Prevention and primary care Mental hygiene management services Epidemiology

56 92 117 58 15 53 14 31 16

62 99 127 64 16 56 16 39 17

65 102 137 68 15 63 16 46 19

64 126 127 71 15 70 21 47 19

59 140 116 74 17 73 28 53 18

Other services Health administration Disease control Family and child health services Environmental health services Early intervention Office of Chief Medical Examiner Prevention and primary care Mental hygiene management services Epidemiology Mental health services Developmental disability Chemical dependency and health promotion

126 210 65 40 246 19 61 49 5 244 15 91

137 192 67 32 255 21 53 61 5 257 16 109

137 186 66 36 271 22 62 70 4 268 15 114

146 218 60 32 261 41 9 55 4 291 14 119

127 483 58 32 238 80 63 45 6 349 13 115

1,699 (4.7%) 6,858

1,783 (4.9%) 6,935

1,860 (4.3%) 6,907

Agency total (Increment) Headcount Note: 

a.

1,622 (11.8%) 6,577

2,186 (17.5%) 6,542

The reported figures for FY2021 are projected budget amounts.

Source:  Council of the City of New York (2021).

City tax revenue continued to finance the majority of the department’s total budget, which was 51 percent in FY2021, while state grants funded 32 percent and federal funding covered the remaining 17 percent in FY2021 executive budget (ibid.).13 After additional federal funding became available when planning the department’s FY2022 budget, federal grants increased from US$245.9 million to US$633.6 million, accounting for 17.5 percent of the total budget, while the city share of fund decreased to 49.7 percent.14 Increased federal aid was dedicated to replacing revenue losses attributed to the pandemic, financing vaccines and COVID-19 supplies, short-term reimbursement for recovery of the local 13   In addition, source of funding varies between two main program areas: the main source of funding for general public health in FY2022 is city tax revenue (48.1 percent), while the largest source of mental health spending is state grant (49.3 percent). 14   The share of state and federal grants varies by program. For instance, general public health relies more on federal funding, while mental health programs receive more state funding partly due to a New York State mandate for contracting with mental health service providers.

The role of cities and public health expenditures in the COVID-19 era  ­123

economy, and school fiscal relief. According to New York City Mayor’s Office of Management and Budget (NYCOMB) FY2022 projections, 24 percent of total ­COVID-19-related federal relief (US$8.8 billion) is allocated for public health service use, most of which is nonrecurring costs15 (NYOSC, 2022).16 Increased federal aid enabled the city to reduce the city tax levy fund by 2 percent to US$472.5 in FY2021. As a result, the city government’s own-source revenue as a share of total revenue decreased in FY2022 relative to the ten-year average prior to the pandemic, falling to 66 percent (US$68.2 billion) from 72 percent. At the same time, the DOHMH faced greater uncertainties about the availability of state grants. The COVID-19 recession reduced the reimbursement rate through state grants for the General Public Health Works program, which reimburses city spending on six areas including health assessment, communicable disease control, chronic disease prevention, family health, emergency preparedness, and environmental health (Council of the City of New York, 2020). In addition, the New York State government proposed reducing local assistant payments for non-Medicaid costs under the Office of People with Developmental Disability by 5 percent. However, despite concerns about potential cuts, state grants increased in terms of level and share of the department’s total executive budget in FY2022 (32.4 percent). The other agency sharing the city government’s public health responsibility is the New York City Health + Hospitals (NYCH+H) Corporation, which runs a public health plan and manages public health facilities, mostly located in low-income communities. NYCH+H is also the country’s largest municipal healthcare delivery system. The facilities in the system include 11 acute care hospitals, five post-acute care or long-term care facilities, and a network of 29 community-based health clinics. NYCH+H is also a public benefit corporation and its operating budget is separate from the city government budget (Table 6.4). Figure 6.7 shows the trend in NYCH+H spending as share of total city spending and the per capita level of spending, where there is a hike in FY2016. This sudden increase in spending may be related to how the city’s healthcare delivery system was reformed in 2016, when the preexisting New York City Health + Hospitals Corporation was replaced by NYCH+H, unifying over 70 healthcare locations and expanding scope of service. In response to the pandemic, NYCH+H was responsible for expanding the capacity of its intensive care units, hiring additional healthcare personnel, conducting telehealth visits, administering COVID-19 vaccines across various sites, and operating the city’s Test and Trace Corps (T2) (Council of the City of New York, 2021). Since the pandemic, the NYCH+H also runs NYC Care, a healthcare access program that provides public health insurance for low-income New Yorkers and raised US$75 million in city funds in 2021. The total operating budget in FY2021 was US$11 billion with a headcount of 37,272 full-time employees. In FY2021, the two largest sources of funding for the agency’s 15   Total federal relief for NYC in FY2022 includes US$3.4 billion in fiscal relief funds, US$3.3 billion in education aid, US$1.5 billion in Federal Emergency Management Agency (FEMA) reimbursement and US$572 million in public health grants (NYOSC, 2021). 16   Federal funding for public health service use is estimated to fall to 6 percent of total ­pandemic-related federal aid (US$2.3 billion) in FY2023.

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Table 6.4  NYC Health + Hospitals Corporation expenditure Expenditure Type (millions of dollars)

FY2017

FY2018

FY2019

FY2020

FY2021a

Salaries and wages Other employee benefits Professional services contracts Supplies and materials Other operating expenditures Bond principal & financing Interest and other financing charges

2,935 1,363 1,767 722 2,709 88 0

2,796 1,637 1,791 736 2,976 70 34

2,991 1,617 1,890 764 3,823 127 136

3,038 1,687 1,911 959 3,942 94 25

2,891 1,647 1,932 810 3,708 89 22

Total expenditures

9,583

10,039

11,348

11,654

11,099

Note:  a. The reported figures for FY2021 are projected budget amounts. Other categories with no expense include subsidies to other public authorities, capital asset outlay, grants and donations, and other nonoperating expenditures. Source:  Council of the City of New York (2021).

operating budget were city funds (56 percent) and federal aid (37 percent). City contribution to current spending for NYCH+H in FY2021 (US$1.64 billion) increased by 58 percent from actual spending in FY2019 (US$1.03 billion). NYCH+H also received COVID-related federal grants including US$1.2 billion through the US Department of Health and Human Services (HHS) Provider Relief Fund as well as US$199 million from the Federal Emergency Management Agency (FEMA) as reimbursement for various functions such as vaccine administration in FY2021. However, the nature of federal assistance is temporary, while a number of pandemic mitigation measures such as increasing healthcare personnel and healthcare access are long-term responses. NYCH+H ended the second year of the pandemic with a deficit of US$137.7 million, and a projected loss of US$294.5 million for FY2022. The contribution of federal funding, however, is projected to decrease to 0.1 percent of total operating budget in FY2022, as more city funds become available. In addition to grants provided by the city government, NYCH+H spending is also largely financed through Medicaid and Medicare payments, which accounted for 24 and 14 percent of total revenue in 2021, respectively. When including supplemental Medicaid payments such as Disproportionate Share Hospital fund, approximately 63 percent of total revenue was financed through Medicaid and Medicare programs. Due to this revenue structure, the agency’s financial sustainability depends largely on state government policy to contain Medicaid costs and provision of supplemental Medicaid payments. Overall, the uncertainties about the duration of IGGs such as FEMA aid, coupled with reduced availability of city funding, lead to increasing concerns about the sustainability of the city’s public healthcare delivery system. City and County Government of San Francisco California is a state where counties are responsible for preserving and protecting public health at the local level, according to California Health and Safety Code § 101025. The county-run public health departments are primarily responsible for public services such

The role of cities and public health expenditures in the COVID-19 era  ­125

(a)

(b)

Note:  Health spending combines annual expenditure from both NYCDOHMH and NYCH+H. Social service spending refers to expenditure by the NYC Department of Social Services. Source:  Council of the City of New York (2021).

Figure 6.7  Trend in New York City spending on health, hospital, and social services: (a) trend in New York City spending on health and hospitals; (b) New York City spending on health and social services

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as prevention and control of chronic or infectious diseases, food safety, environmental health, laboratory services, inmate healthcare in county jails, and managing vital records and statistics (California Department of Public Health, 2018).17 Since the early 1900s, most municipality-level health departments were centralized to the county level with the exception of four cities (Berkeley, Long Beach, the City of Pasadena, and Vernon City). In 2019, CA county governments spent US$563 per capita (40 percent of total state and local spending) and more than twice the national average level of county health spending. Meanwhile, municipality governments in California spent US$116 per capita (8 percent of state and local spending) on health and hospitals, which is 20 percent higher than the national average of municipal health spending. The San Francisco Department of Public Health (DPH) under the authority of the City Administrator is the core agency responsible for promoting public health among local residents. The Health Commission is the governing and policy-making body of the San Francisco DPH, led by the appointed commissioner. San Francisco DPH also consists of two agencies: the San Francisco Health Network, which oversees an integrated delivery system of clinics and hospitals, and the Population Health Division, which provides public health services such as keeping integrated electronic health records and coping with public health emergencies. The Disease Prevention and Control Branch (DPC) under the Population Health Division is mainly responsible for control of communicable diseases through public health clinics, a public diagnostic testing laboratory, and hiring a team of epidemiology specialists. San Francisco has a rolling two-year budget. Each fiscal year starts in July and ends the following calendar year in June, which means that FY2020–21 is the first year COVID-19 responses were actively reflected in the budget. The total budget of the San Francisco DPH increased by over 14 percent between FY2019–20 and FY2020–21 (Table 6.5), which is substantially greater than average annual increments of 2 percent during the preceding three years. This surge was largely driven by the shift in citywide priorities following COVID-19 and increased role of the Population Health Division, the spending of which more than doubled between FY2020 and FY2021. Some of the relevant activities of the Population Health Division include inspecting restaurants, tracking disease cases, public health education, contributing population health data, and data analysis for the San Francisco Health Network. Meanwhile, the Behavioral Health Service department spending also noticeably increased in FY2021 by 20 percent. At the beginning of the pandemic, San Francisco DPH was supported by a separate citywide Emergency Operations Center until the city government unified both agencies to a COVID Command Center in June 2020. Later, the city ordered integrating most COVID-19 response functions to regular departmental operations of DPH and other relevant city departments such as the Human Services Agency and the Department of Emergency Management from April 2021. One of the major budgeting concerns was how to finance additional spending related to the pandemic while addressing the long-term challenge of structural budget deficits (San Francisco Office of the Mayor, 2021). San Francisco allocated US$375 million for 17   Eleven small CA counties contract with the state health department and share legal responsibility to provide services such as mental healthcare, substance abuse treatments, and immunizations.

The role of cities and public health expenditures in the COVID-19 era  ­127

Table 6.5  San Francisco Department of Public Health operating expenditure, by division Division (millions of dollars) Public Health Administration Behavioral Health Zuckerberg SF General Hospital Health at Home Jail Health Laguna Honda Hospital Health Network Services Primary Care Population Health Division DPH total Share of city total budget Note: 

a.

FY2018–19

FY2019–20

FY2020–21

FY2021–22a

143.3 393.8 952.4 8.2 35.9 330.4 295.9 101.0 108.9

157.9 446.4 990.9 8.7 37.0 298.8 263.6 101.3 122.5

180.6 535.5 996.8 8.2 37.9 307.4 296.7 115.0 297.7

157.6 606.8 1,050.2 8.8 38.4 321.1 335.2 111.5 191.7

2,370 23.7%

2,427 19.7%

2,776 23.2%

2,821 21.5%

The reported figures for FY2021–22 are proposed budget amounts.

Source:  San Francisco Office of the Mayor (2021).

COVID-related expenditure items, which included testing, outbreak management, vaccination, community outreach, managing isolation, and quarantine units (San Francisco Department of Public Health [SFDPH], 2020). Approximately US$113.5 million of the COVID-related expenditure was financed by the city’s COVID Response and Economic Loss contingency reserve. Between FY2020–21 and FY2021–22, seven existing reserves were consolidated into one COVID Response and Economic Loss contingency reserve. The reserve balance was reduced from US$507.4 million at the beginning of the pandemic to US$113.5 million by FY2022–23. The larger portion of COVID-related expenditure was financed through increased federal and state grants including US$50 million reimbursed through the Federal Emergency Management Administration (San Francisco Office of the Mayor, 2020). Meanwhile, San Francisco also introduced mandatory budget reductions in FY2020–21. General fund support for the DPH budget in particular was reduced by US$75.5 million in FY2020–21 (San Francisco Office of the Mayor, 2021). One of the noticeable changes in DPH’s operating expenditure during the pandemic is a substantial increase in programmatic projects from US$74.9 million to US$339 million in FY2020–21, which scaled down in the following year, as shown in Table 6.6. This included annual allocation of US$10.9 million for a city grant program that finances community-based health operations such as focused outreach, supporting mobile test sites, case investigation and contact tracing, and provision of care for positive patients (SFDPH, 2020). Debt service expenditure also decreased during the pandemic. The mandatory budget reduction was replaced by budget instructions from the mayor’s office requesting budget cuts in FY2021–22, with a mandatory 7.5 percent reduction in adjusted general fund support and an additional 2.5 percent contingency from the mayor’s office (US$59.5 million reduction with a US$19.9 million contingency). As a consequence of the budget cut and short staffing, the DPH temporarily had to scale down screening and testing services by reducing testing hours at affiliated sites.

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Table 6.6  San Francisco Department of Public Health operating expenditure, by uses Expenditure Item (millions of dollars)

FY2018–19

FY2019–20

FY2020–21

FY2021–22a

Salaries Mandatory fringe benefits Non-personnel services City grant program Capital outlay Debt service Facilities maintenance Intra-fund transfers payment Materials and supplies Operating transfers – out Overhead and allocations Programmatic projects Services of other departments Unappropriated rev. retained Transfer adjustment – uses

815.9 335.5 811.4 0.0 38.0 15.9 4.4 42.3 134.0 121.7 1.4 97.7 111.7 3.7 (164.0)

867.4 368.0 793.8 0.0 14.9 32.8 3.5 22.8 142.4 108.8 1.2 74.9 125.9 2.2 (131.6)

899.8 398.0 824.1 10.9 13.9 12.7 3.7 20.3 142.7 110.5 2.2 339.0 122.0 6.6 (130.8)

996.7 409.1 919.4 10.9 26.3 14.6 3.9 13.1 160.2 89.4 4.2 132.1 136.8 7.3 (102.5)

Total

2,370

2,427

2,776

2,821

Note:  a. The reported figures for FY2021–22 are proposed budget amounts. Aid assistance is omitted from total expenditure, which was US$25,000 for both FY2019 and FY2020. Source:  San Francisco Office of the Mayor (2021).

San Francisco is one of the largest spenders on public health and hospitals among local governments in the US. Since 2010, San Francisco has been spending more than twice than New York City on public health and hospitals, as shown in Figure 6.8. In fact, San Francisco’s spending on health and hospital services exceeded US$3,000 per capita from 2016. In California, county governments are required to contribute approximately half the non-federal cost for Medicaid mental health services, as well as Medicaid administrative costs and long-term care services that incur at the county level. In 2021, California renewed its Section 1115 Medicaid Waiver, CalAIM (previously Medi-Cal), which expands coverage in terms of types of services and population. This renewal meant that services that were primarily supported by the city general fund will be financed by additional federal grants through programs focused on outpatient, primary, and preventive care (SFDPH, 2020). Mayoral instructions for FY2022–23 were to utilize the existing budget without increasing any general fund subsidy, and focusing on improving the delivery of core services.

CONCLUSION This chapter provides an overview of roles of municipality governments in promoting public health by looking at how they spend on healthcare services before and after the COVID-19 pandemic. The two cases of New York and San Francisco illustrate what types of measures city officials took to respond to COVID-19 related to public health

The role of cities and public health expenditures in the COVID-19 era  ­129

Source:  US Census Bureau Annual Survey of State and Local Government Finances (2000–2019).

Figure 6.8  Health and hospital spending in New York and San Francisco, 2000–2019 (USD per capita) functions, and potential implications of the changes in public health spending induced by pandemic responses. Stylized facts presented in this chapter show that New York and San Francisco city governments did not reduce their health spending during the pandemic, which supports earlier findings from the literature that health spending is relatively immune to negative income shocks during recessions. Additional federal aid for financing COVID-related activities was conducive to the city government of New York, by replacing losses in city funds at the beginning of the pandemic and enabling the city to reduce the tax levy the following year. For municipalities that are challenged by structural budget deficits such as San Francisco, however, mandatory budget reductions may become inevitable, especially during the initial period of a public health emergency and after federal grant programs expire. Further research may be helpful to see how municipal governments altered budget allocation by scaling down or suspending provision of other public services in the aftermath of the pandemic. Furthermore, the fiscal implications of increased temporary intergovernmental aid as well as its removal need further academic attention. The case of New York and San Francisco provides anecdotal evidence that additional spending related to emergency response, and increased demand for public health service and hospitals, are largely financed by IGGs. Earlier evidence from the Great Recession period shows that the removal of temporary federal aid under the ARRA led state governments to reduce total budget and intergovernmental expenditure to local governments, while increasing taxes (Chernick et al., 2020). Furthermore, the transitory nature of federal aid means that the financial and health impact of municipality response to public emergency will be different depending on whether they employ short-term budgetary responses (including delaying

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payments, shifting in-person services to virtual services, hiring freeze) or long-term measures (such as terminating programs or closing public health facilities).18 In addition to financial assistance from the federal and state governments, state-federal programs such as Medicaid may also be an important channel through which to support municipal governments in financing public hospitals and health facilities. Municipalities that own and operate public hospitals tend to rely heavily on Medicaid and Medicare payments, as shown in the case of the country’s largest municipal healthcare delivery system in New York City. The recent literature on ACA health policy reform is also informative on how state Medicaid expansion may affect public health spending, the financial performance of hospitals, as well as various health outcomes, mostly at the state or county level. However, less is known about the financial implications of state-induced Medicaid expansion on health and hospital spending at the municipal level. Another issue raised after COVID is related to the question of what level of government should be responsible for providing public health services. One caveat for future research on local public spending behaviors is to be cautious about the underlying assumptions of the median voter model when using post-pandemic periods for empirical analysis. In a democracy using the voting mechanism to select the level of public spending, the Hotelling–Downs model of political competition (Downs, 1957) posits that candidates will ultimately converge their platform towards the median voter’s preferred platform to maximize their vote shares. The decentralization literature has predominantly relied on using the decisive median voter’s preference, which is grounded on single-peaked preferences (Oates, 1999, 2011). As long as voters have a monotonic preference for either higher or lower spending, the median voter’s preferred level of spending will best represent the community’s choice. Recent survey research (Egan, 2014), however, provides counterevidence against this assumption of single-peaked preferences, suggesting that voters’ preferences may become double-peaked when there are exogenous adverse shocks that raise public concern about a policy domain. Whether the pandemic does change voters’ preferences for public services in this fashion may be an important empirical question to address to provide directions for future studies on local governments’ financial behavior. During the pandemic, state and local governments have adopted a wide variety of mitigation measures ranging from less restrictive policies that focus on screening and testing, while others have mandated large-scale social distancing such as lockdowns. The common policy challenge was to balance two contending policy objectives – that is, preserving livelihoods versus lives while trying to contain infections. In counties or health districts with stringent restrictions, individual county or municipal governments started to look for alternative options. The city of West Covina in California and Douglas County in Colorado are two examples of local health departments that are shifting to creating their own independent health departments. In West Covina, the city council voted to establish its own municipality health department in response to stringent public health orders by county health departments that restricted utilization of restaurant services.19 18   Conant et al. (2012) provide a useful framework for comparative qualitative study on state budgetary response to a recession, using two dimensions of long versus short term and expenditure versus budget. 19   West Covina is waiting (as of the time of this writing in March 2022) for the state approval to terminate its relationship with the Los Angeles County health department. West Covina decided

The role of cities and public health expenditures in the COVID-19 era  ­131

Recent empirical evidence on rural mortality penalty and racial disparity also suggests that more research is needed on how various policy interventions alter allocation of public health spending across different regions and sub-populations. We will also need to develop our understanding about the health effects of changes in public spending on health and hospitals through more causal designs. Research in these areas may provide important policy implications to address normative questions about what the role of public health departments should be at different levels of government and how public health insurance programs such as Medicaid and Medicare should be designed.

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National Association of County and City Health Officials (NACCHO). (2019). National profile of local health departments. https://health.gov/healthypeople/objectives-and-data/data-sources-andmethods/data-sources/national-profile-local-health-departments-naccho-profile. National Association of State Budget Officers (NASBO). (2013). State expenditure report. https:// www.nasbo.org/reports-data/state-expenditure-report/state-expenditure-archives. National League of Cities (NLC). (2020) Fiscal impact of the pandemic recession on cities, towns and villages. https://www.nlc.org/wp-content/uploads/2021/02/Impact-of-COVID-19-on-Cities-Brief-​ Final.pdf. New York City Mayor’s Office of Management and Budget (NYCOMB). (2022). Financial plan statements for New York City for July 2022. https://www.nyc.gov/assets/omb/downloads/pdf/fpsjul-2022.pdf. Nguyen-Hoang, P., & Hou, Y. (2013). Local fiscal responses to procyclical changes in state aid. Publius: The Journal of Federalism, 44(4), 587–608. Nikpay, S., Buchmueller, T., & Levy, H. G. (2016). Affordable Care Act Medicaid expansion reduced uninsured hospital stays in 2014. Health Affairs, 35(1), 106–110. Oates, W. E. (1969). The effects of property taxes and local public spending on property values: An empirical study of tax capitalization and the Tiebout hypothesis. Journal of Political Economy, 77(6), 957–971. Oates, W. E. (2011). Fiscal federalism. Edward Elgar Publishing. (Original work published 1972) Oates, W. E. (1999). An essay on fiscal federalism. Journal of Economic Literature, 37(3), 1120–1149. Office of the New York State Comptroller (NYOSC). (2021). Review of the financial plan of the City of New York: Report 16-2022. https://www.osc.state.ny.us/files/reports/osdc/pdf/report-16-2022. pdf. Office of the New York State Comptroller (NYOSC). (2022). Review of the financial plan of the City of New York: Report 4-2023. https://www.osc.state.ny.us/files/reports/osdc/pdf/report-4-2023. pdf. Perez, V., Benitez, J. A., & Ross, J. (2021). Too small to fail: The role of Medicaid in mitigating pandemic-related fiscal strain on local governments. Public Budgeting & Finance, 41(3), 74–97. Perez, V., Ross, J. M., & Simon, K. I. (2020). Do local governments represent voter preferences? Evidence from hospital financing under the Affordable Care Act (Research Briefs in Economic Policy No. 205). Cato Institute. Rhodes, J. H., Buchmueller, T. C., Levy, H. G., & Nikpay, S. S. (2020). Heterogeneous effects of the ACA Medicaid expansion on hospital financial outcomes. Contemporary Economic Policy, 38(1), 81–93. Rueben, K. S., & Randall, M. (2017). Balanced budget requirements: How states limit deficit spending. Policycommons.net. https://policycommons.net/artifacts/631299/balanced-budget-requirem​ ents/1612586. San Francisco Department of Public Health. (2020). Annual report for fiscal year 2020–2021. https:// sf.gov/sites/default/files/2021-10/05%20ZSFG%20FY%20Annual%20Report%202020-2021.pdf. San Francisco Office of the Mayor. (2020). Budget outlook update FY 2019–20 through FY2023–24. https://sfcontroller.org/sites/default/files/Documents/Budget/Budget%20Outlook%20Report%20​ FY20-FY24.pdf. San Francisco Office of the Mayor. (2021). San Francisco proposed budget FY2021–22 and ­FY2022–23. https://sfmayor.org/budget-documents. Simon, K., Soni, A., & Cawley, J. (2017). The impact of health insurance on preventive care and health behaviors: Evidence from the first two years of the ACA Medicaid expansions. Journal of Policy Analysis and Management, 36(2), 390–417. Singh, G. K., & Siahpush, M. (2014). Widening rural–urban disparities in all-cause mortality and mortality from major causes of death in the USA, 1969–2009. Journal of Urban Health, 91(2), 272–292. Sjoquist, D. L., & Walker, M. B. (1999). Economies of scale in property tax assessment. National Tax Journal, 52(2), 207–220. Sommers, B. D., Blendon, R. J., Orav, E. J., & Epstein, A. M. (2016). Changes in utilization and health among low-income adults after Medicaid expansion or expanded private insurance. JAMA Internal Medicine, 176(10), 1501–1509.

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APPENDIX Table 6A.1  Health and hospital expenditure per capita in FY2017, by subcategory (2019 real USD) State Wyoming South Carolina Mississippi Alabama Kansas Iowa North Carolina Washington New York California Utah Indiana Missouri Texas Oregon New Mexico Louisiana Virginia Alaska Kentucky Tennessee Nebraska Michigan Colorado Georgia Florida Ohio Hawaii Arkansas Wisconsin Connecticut Minnesota Idaho Nevada Pennsylvania Oklahoma New Jersey West Virginia Illinois Massachusetts Maine South Dakota

Hospital

Health

State and local

Municipality

State and local

Municipality

2,176 1,398 1,387 1,350 1,285 1,284 1,037 938 909 786 760 714 708 686 679 669 651 650 641 581 581 555 543 518 506 485 454 452 446 438 419 416 407 382 361 345 302 273 263 240 165 157

N/A 0.3 328.9 6.3 83.5 196.2 0.1 N/A 472.5 35.9 90.4 227.0 110.7 5.0 0.6 9.1 105.9 0.1 291.6 25.3 59.7 3.7 45.0 N/A N/A N/A 18.0 0.0 28.8 N/A N/A 69.2 N/A N/A N/A 154.3 N/A 120.8 21.6 131.1 47.8 115.5

1,085 292 159 193 243 147 402 568 384 626 252 172 419 230 447 259 159 293 344 221 165 192 450 160 233 280 325 449 95 287 316 262 185 154 459 300 272 165 175 258 218 259

21.8 2.3 2.5 4.6 16.5 16.0 2.2 14.4 66.8 80.4 24.1 24.6 25.2 21.7 3.7 21.6 16.6 47.7 41.1 32.7 11.8 18.5 5.4 15.4 3.3 13.3 15.9 31.3 20.3 35.5 20.9 32.4 7.1 5.3 141.4 30.4 14.8 3.1 13.4 10.4 12.1 24.5

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Table 6A.1 (continued) State

Hospital State and local

Montana Arizona Maryland Delaware North Dakota Rhode Island New Hampshire Vermont United States

155 117 102 90 75 61 48 37 617

Note:  N/A indicates not applicable. Source:  US Census Bureau (1977–2018).

Health

Municipality

State and local

Municipality

N/A 0.1 N/A N/A N/A N/A N/A N/A 61.4

442 125 314 561 305 250 94 631 332

12.7 1.8 20.5 N/A 33.6 13.9 4.1 0.6 34.4

7.  Spending on physical infrastructure: is it enough? Yonghong Wu

INTRODUCTION Is spending on America’s physical infrastructure enough? The answer is likely far from being optimistic. A recent comprehensive assessment of America’s infrastructure conveys a mixed message: our infrastructure scored a C– in 2021, up from a D+ in 2017 (American Society of Civil Engineers [ASCE], 2021a). According to the report, 11 of the 17 infrastructure categories remained in the D range, four categories (bridges, drinking water, energy, and solid waste) moved up to C range, and ports and rail categories scored B– and B, respectively (ibid.). Although the capacity and condition of the nation’s physical infrastructure has been gradually improving in recent years, the overall picture is still pessimistic. The ASCE also estimated the additional investment needed to achieve a grade of B. The recent estimates show an infrastructure investment gap of US$2.59 trillion over a ten-year period, up from US$2.1 trillion in its 2017 report (ASCE, 2021b). Another recent estimate put the price tag at US$150 billion per year to meet the country’s infrastructure needs (Woetzel et al., 2016). The aging and deteriorating infrastructure has significant consequences to the economy and quality of life. Compared to the baseline forecasts for 2020–39, the deficient infrastructure is predicted to result in a loss of US$23.3 trillion in aggregate economic output, and an average annual loss over US$3,300 per household (ASCE, 2021b). In addition, the inadequate infrastructure has negative impacts on public health and the environment. The water crisis in Flint, Michigan is an example of infrastructure failure of a fiscally distressed municipality. The drinking water for the city was contaminated with lead from aging pipes (Kennedy, 2016). Murphy (2019) notes that the Flint water crisis demonstrates the urgent need for sufficient and innovative funding of municipal infrastructure. As the pandemic-induced recession continues to disturb government finances, underinvestment in infrastructure is expected to persist unless massive resources are made available in this critical arena.

INFRASTRUCTURE CONDITION IN AMERICA’S MAJOR CITIES The ASCE’s infrastructure assessment is based on a complex set of criteria including capacity, condition, current funding, and future need. While such a national assessment is helpful, it is too general to understand the actual condition of physical infrastructure at the municipal level. There have been occasional news reports about catastrophic local infrastructure failures such as the Flint water crisis and the collapse of a Minnesota bridge in 2007 that killed 13 people and injured 145. However, there is no systemic survey 138

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or study on the condition of public capital assets and physical infrastructure across municipalities in the US. The lack of systematic assessment of local infrastructure is primarily due to limited capacity to collect and report relevant data about capital assets. Although local governments regularly publish the data of capital outlays, the annual outlay data are not sufficient to measure their capital stock. The cumulation of capital outlays increases the capital stock, while the depreciation reduces the capital stock as capital and infrastructure assets age over time. Unfortunately, the data of capital assets and associated depreciation were not available before state and local governments implemented the Governmental Accounting Standards Board’s (GASB) Statement No. 34 in early 2000s. The new financial reporting model under GASB Statement No. 34 requires the preparation of government-wide financial statements using the full accrual basis of accounting (Mead, 2013). The consolidated government-wide financial statements provide comprehensive information about long-term capital assets and depreciation expenses. The data make it possible to evaluate the level and trend of a city’s capital assets and compare infrastructure condition across municipal governments. Rivenbark et al. (2010) developed an indicator of capital assets condition ratio to measure the remaining useful life of capital assets being depreciated. The ratio subtracts accumulated depreciation divided by capital assets being depreciated from 1. The ratio ranges from 0 (no life remaining) to 1 (full life remaining). In other words, a value of 0.8 means that a city’s capital assets have 80 percent of their useful lives remaining. One of the notes to basic financial statements of governments’ Annual Comprehensive Financial Reports (ACFRs) provides a summary of a city’s capital assets for the ­government-wide financial statements. The data include the end-of-year balances of depreciable assets and corresponding accumulated depreciation for governmental and business-type activities.1 We calculate the infrastructure condition ratio for the 25 most populous cities in the US for which the data are available from 2006 to 2020.2 The line graphs of the infrastructure condition ratio are shown in Figures 7.1–7.5 for governmental activities of all 25 cities. We only have data to calculate the ratio for business-type activities for ten of the cities, and the values are presented in Figures 7.6–7.7. We first look at the most recent infrastructure condition in the 25 cities. For governmental activities, the infrastructure condition ratio in 2019 ranges from 0.15 to 0.74, and the mean and median values are 0.48 and 0.51, respectively. The top five cities are San Francisco (0.74), Columbus (0.67), Phoenix (0.65), Boston (0.63), and Dallas (0.62), and the bottom five cities include San Jose (0.30), Philadelphia (0.27), Detroit (0.25), Indianapolis (0.23), and Portland (0.15). The data show that, on average, the 1   Infrastructure listed under governmental activities is often used to meet primary government functions such as public safety, transportation, public health, public works, cultural and recreational services. Infrastructure listed under business-type activities is usually used to deliver services such as water, sewers, stormwater, and airports. The designation of governmental and businesstype activities varies somewhat across the cities. 2   For the 25 cities included in this analysis, infrastructure assets are depreciated using the straight-line method over their estimated useful lives. The annual depreciation is determined by dividing an asset’s depreciable cost by its estimated life, and the same amount of depreciation is taken each year. The accumulated depreciation is the sum of annual depreciations for the years an asset has been used.

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Source:  Annual Comprehensive Financial Reports.

Figure 7.1  Governmental activities infrastructure condition ratio for Phoenix (AZ), Los Angeles (CA), San Diego (CA), San Francisco (CA), and San Jose (CA)

Source:  Annual Comprehensive Financial Reports.

Figure 7.2  G  overnmental activities infrastructure condition ratio for Denver (CO), Jacksonville (FL), Indianapolis (IN), Baltimore (MD), and Boston (MA)

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Source:  Annual Comprehensive Financial Reports.

Figure 7.3  G  overnmental activities infrastructure condition ratio for Chicago (IL), Detroit (MI), Charlotte (NC), New York (NY), and Oklahoma City (OK)

Source:  Annual Comprehensive Financial Reports.

Figure 7.4  G  overnmental activities infrastructure condition ratio for Columbus (OH), Portland (OR), Austin (TX), Dallas (TX), and Milwaukee (WI)

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Source:  Annual Comprehensive Financial Reports.

Figure 7.5  G  overnmental activities infrastructure condition ratio for Philadelphia (PA), Fort Worth (TX), Houston (TX), San Antonio (TX), and Seattle (WA)

Source:  Annual Comprehensive Financial Reports.

Figure 7.6  B  usiness-type activities infrastructure condition ratio for Phoenix (AZ), San Francisco (CA), Baltimore (MD), Columbus (OH), and Oklahoma City (OK)

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Source:  Annual Comprehensive Financial Reports.

Figure 7.7  B  usiness-type activities infrastructure condition ratio for Portland (OR), Philadelphia (PA), Dallas (TX), Fort Worth (TX), and Houston (TX) governmental infrastructure assets only have about half of their useful lives remaining. It means that these cities have fallen far behind investing in their infrastructure to keep up with depreciating pace. The business-type infrastructure condition is better than the governmental infrastructure condition. For the ten cities for which we have complete data, their business-type infrastructure condition ratio ranges from 0.38 to 0.85, higher than the range of 0.14–0.73 for their governmental infrastructure condition in 2020. The cities with the largest condition ratios are Baltimore (0.85), Portland (0.78), Columbus (0.69), Fort Worth (0.67), and Phoenix (0.63). At the other end of the spectrum, three cities’ condition ratios are below 50 percent, including Oklahoma City (0.38), Philadelphia (0.46), and Houston (0.47). Because depreciation reduces the useful life of infrastructure assets, the only way a city can maintain or even increase the useful life of its infrastructure is to make necessary new capital investments. A declining condition ratio simply means that cities have not made enough investment in new capital additions and improvements to counter the depreciation. We conduct a trend analysis on the infrastructure condition over the past ten years to demonstrate how well the cities have invested in their infrastructure assets recently. The trends show that infrastructure assets continued to depreciate faster than resources being invested in them. For governmental activities, there is a clear downward trend for 19 of the 25 large cities in the recent decade. The condition ratio declined by over 10 percent in 14 cities, including Portland (–62.9 percent), San Jose (–40.2 percent), Jacksonville (–35.7 percent), Indianapolis (–31.4 percent), Charlotte (–22.8 percent), Oklahoma City (–17.7 percent), Baltimore (–16.5 percent), San Francisco (–16.2 percent),

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Austin (–13.4 percent), Chicago (–12.4 percent), San Diego (–11.9 percent), Denver (–10.9 percent), Los Angeles (–10.2 percent), and Phoenix (–10.1 percent).3 Six of the 25 cities show an upward trend in this condition ratio, and only two of them saw over 10 percent increase during 2010–20: Detroit (13.4 percent) and San Antonio (12.2 percent). It should be noted that both Detroit and San Antonio grew from quite low levels of the ratio at the beginning of this period. The recent trends of infrastructure condition are even worse for business-type activities than governmental activities. Among the ten cities for which business-type infrastructure data are available, nine of them show declining trends in infrastructure condition. As illustrated in Figures 7.6–7.7, the declining rate is over 10 percent during 2010–20 in five cities such as Oklahoma City (–28.9 percent), San Francisco (–18.9 percent), Columbus (–14.3 percent), Phoenix (–11.7 percent), and Houston (–11.2 percent). Only Baltimore increased its business-type infrastructure condition ratio by 26.5 percent during the recent decade.

GOVERNMENT CAPITAL SPENDING IN THE US The overall deteriorating physical infrastructure is often attributable to lagging government investment. State and local governments are the main providers of infrastructure services and account for over three-quarters of public spending on transportation and water infrastructure in 2017 (Congressional Budget Office, 2018).4 This section focuses on the pattern and trend of government capital spending in the United States. The Trends of Local Spending on Infrastructure Figure 7.8 shows the trends of total local government capital outlays, capital spending on construction, and other capital outlays on a per capita basis from 1980 to 2018.5 The total local capital outlays per capita and local spending on construction per capita show an overall growing trend during 1980–2009, declined from 2009 to 2014, and rebounded modestly after 2014. In real 2012 dollars, the total local capital outlays per capita and construction outlays per capita in 2009 grew by about 75 percent from the amounts in 1984. After 31 and 29 percent declines during 2009–14, the two per capita capital outlays rebounded by 8–9 percent during 2014–18. The size of other capital outlays at the local level is much smaller than the total or construction outlays but shares a similar trend of change. It was US$114 per capita in 1980, hit the peak at US$211 in 2008, plummeted to US$132 in 2014, and rebounded to US$152 per capita in 2018.

3   Due to unavailability of data in 2020, the percentage change is calculated for 2010–19 for the following cities: Denver, Jacksonville, Chicago, and Indianapolis. The changes of other cities are for 2011–20. 4   State and local governments account for 59 percent of capital spending, and 90 percent of spending on operation and maintenance (Congressional Budget Office, 2018). 5   The data of capital outlays cover construction of facilities, purchase of land and existing structures, and purchase of equipment. Repair and maintenance costs are included in the current operations rather than the capital outlays (US Census Bureau, 2016).

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Source:  Author’s analysis of US Census Bureau data, https://www.census.gov/programs-surveys/govfinances/data.html.

Figure 7.8  Per capita total local capital outlays, by type of spending

The local capital outlays cover capital spending by various local governments including counties, municipalities, townships, school districts, and special districts. Figure 7.9 illustrates the trends of capital outlays from those local governments separately. Among different types of local government, municipal governments spend the largest amounts on capital projects: US$255 per capita in 2017, about 39 percent of total local capital outlays. The aggregate municipal capital outlays in constant dollars per capita increased steadily from 1992 through 2007 but declined from 2007 through 2017. This is likely an impact of the Great Recession on municipal government decisions on capital spending. The prolonged period of decline after the 2007 recession raises a concern about the capacity of municipal governments in making capital and infrastructure investment that is critical to their service delivery and economic prosperity. School districts spend less than municipalities on capital assets, accounting for about 21–28 percent of total local capital outlays. There is a steady increase in special districts’ capital spending, from US$111 per capita (17 percent of total local capital outlays) in 1992 to US$127 per capita (over 19 percent of total local capital outlays) in 2017. County governments’ share declined from 18.7 percent of total local capital outlays in 1992 to 15.5 percent in 2017. Township governments represent the smallest share of local capital spending, accounting for 3 percent or below. Figure 7.10 shows the average per capita capital outlays of 150 major American cities from 1980 to 2017. The data of total capital outlays is the sum of general capital outlays and utility capital outlays. The general capital outlays include education, hospitals, highways, correction, natural resources, parks and recreation, sewerage, solid waste

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Source:  Author’s analysis of US Census Bureau data, https://www.census.gov/programs-surveys/govfinances/data.html.

Figure 7.9  Per capita total capital outlays, by type of local government

Source:  Author’s analysis of Lincoln Institute’s Fiscally Standardized Cities (FiSC) data, https://www. lincolninst.edu/research-data/data-toolkits/fiscally-standardized-cities/search-database.

Figure 7.10  Average per capita capital outlays of 150 major US cities

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management, and other general capital outlays.6 The average per capita total and general capital outlays show a similar pattern – an overall growing trend during 1980–2009 and a decline after 2009. In constant dollars, the average per capita capital outlay was US$490 in 2017, close to the amount in 1999. The downward trend in capital spending after 2009 reveals that major cities had been grappling with fiscal strain in investing in capital and infrastructure projects in the aftermath of the Great Recession. City governments’ spending on infrastructure will likely continue a downward trend due to the budgetary impact of the COVID-19 pandemic. According to a recent report by the National League of Cities, most cities are facing increased demands for services (e.g., health and safety) along with decreased revenues, thereby being likely to cut costly capital spending (Pine et al., 2020). A survey of over 1,100 cities, towns, and villages shows that 65 percent of cities are postponing or canceling capital outlays and infrastructure projects (ibid.). The American Road & Transportation Builders Association (ARTBA) also reports that transportation-related revenue sources have significantly declined: US$12 billion in state and local transportation projects were deferred or cancelled, while US$141 billion worth of funding initiatives or ballot measures were vetoed, cancelled, or delayed (Black, 2020). Declining Federal Infrastructure Funding The federal role has been declining in providing the nation’s critical infrastructure services, while states and cities become increasingly important in this arena. As illustrated in Figure 7.11, the federal spending on transportation and water infrastructure has been largely stable since 1980. During the same period, the state and local spending on the infrastructure has increased from US$184 to US$342 billion in 2017 dollars. As a result, the federal share of total public spending on transportation and water infrastructure has dropped by about 15 percentage points from 1980 to 2017, while state and local government share has risen to fill the gap left by federal government. Except for the American Recovery and Reinvestment Act (ARRA), the federal government has reduced its financing of capital projects and shifted the burden of funding infrastructure onto subnational governments (Kane & Tomer, 2019). Figure 7.12 shows the share of state and local spending on transportation and water infrastructure, by source of funds, from 1980 to 2017. The trend clearly illustrates the diminishing role of federal grants in financing state and local outlays on transportation and water infrastructure projects. In the early 1980s, federal grants account for about 37 percent of state and local spending on transportation and water infrastructure. The federal share declined to under 20 percent after 2006, except 2010–11 when ARRA provided additional funds. In other words, over 80 percent of state and local infrastructure spending came from their own sources of funding. It should be noted that investment in new infrastructure and maintenance for existing infrastructure are two different categories of spending on infrastructure. State and local governments spend a lot more on operating and maintaining transportation and water

6   Fiscally Standardized Cities (FiSC) database. http://www.lincolninst.edu/research-data/ data-toolkits/fiscally-standardized-cities/search-database.

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Source:  Author’s analysis of Congressional Budget Office data, https://www.cbo.gov/publication/54539.

Figure 7.11  Public spending on transportation and water infrastructure, by level of government

Source:  Author’s analysis of Congressional Budget Office data, https://www.cbo.gov/publication/54539.

Figure 7.12  Share of state and local spending on transportation and water infrastructure, by source of funds

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infrastructure than the federal government. As Figure 7.13 indicates, state and local governments spent a total of US$342 billion on transportation and water infrastructure in 2017: US$102 billion (or 30 percent) was spent on capital and US$240 billion (or 70 percent) was spent on operation and maintenance. In the same year, the federal government only spent 27 percent of its US$98 billion on operation and maintenance, while 73 percent of the funding was invested in capital. While the share of federal funding on operation and maintenance of transportation and water infrastructure has been fairly stable within the 27–29 percent range, the share of state and local spending on operation and maintenance has been steadily increasing during the recent decade. Although state and local governments are the main providers of infrastructure services and making large shares of capital outlay, a strong role of federal government in infrastructure financing is necessary to address spatial spillover effects, achieve economies of scale, allow for equitable access to infrastructure, and help alleviate infrastructure funding challenges at the subnational levels. There are various federal grant programs to help finance state and local infrastructure projects. For instance, federal highway grants, made through the Highway Trust Fund (HTF), are among the largest federal grant programs to states and localities, providing billions of dollars to support state and local highway construction and maintenance (Congressional Budget Office, 2020a). The Fixing America’s Surface Transportation Act (FAST Act) was enacted in 2015 to extend federal highway and transit funding from fiscal year 2016 to 2020 to support state and local transportation-related development activities and increase transportation modes. In addition, the Community Development Block Grant (CDBG) program is designed to improve community infrastructure (e.g., water and wastewater improvements,

Source:  Author’s analysis of Congressional Budget Office data, https://www.cbo.gov/publication/54539.

Figure 7.13  State and local spending on transportation and water infrastructure, by category of spending

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community/public facilities, public housing, and smaller public works projects). Seventy percent of CDBG funds are provided to over 1,200 metropolitan city and county governments (Daniel, 2021). The HTF receives revenues from a federal tax on motor fuels and related excise taxes. However, the current tax rates cannot sustain the expected expenditures. According to Congressional Budget Office (2020a), the cumulative shortfall in the HTF would be nearly US$189 billion by 2030 if the taxes credited to the fund were maintained at their current rates, and funding for highway and transit programs would increase annually at the rate of inflation. Grants from the HTF are not sufficient for state and local capital needs (Mallett & Driessen, 2016). The CDBG funding is also decreasing and the funding in real 2016 dollars has dropped since 1979 from US$15.0 billion to US$3.0 billion, and the program is less than half the size it was in 1995 (Theodos et al., 2017).

MAJOR BARRIERS TO SUFFICIENT MUNICIPAL INFRASTRUCTURE INVESTMENT Both engineering assessment and financial analysis reveal that the nation’s physical infrastructure is in an unsatisfactory condition and government investment in capital and infrastructure assets has been insufficient particularly since the Great Recession. Besides the significant cutback of federal funding, there are also some major bottlenecks in making necessary investment for maintaining and improving public infrastructure condition. Following is a brief discussion about some major barriers to sufficient municipal infrastructure investment to help understand why we are confronted with an overall deteriorating infrastructure now and provide insights into how to move forward in this critical arena. Politics in Capital Budgeting Interfere with Rational Response Some economists tend to believe that government decisions on capital spending are rational reactions adapting to changing economic and demographic conditions (HoltzEakin & Rosen, 1989; Hulten, 1984; Hulten & Peterson, 1984; Inman, 1983). History has shown that most of the American infrastructure systems were constructed when the population significantly increased during the 1960s (McBride & Moss, 2021). Several empirical studies demonstrate that population and economic growth have driven public infrastructure and capital expenditures (Fisher & Wassmer, 2015; Hulten & Peterson, 1984; Temple, 1994). However, the rational reaction model is not a realistic description of government decision-making process. Empirical research has revealed that rational tools and techniques such as cost–benefit analysis are not widely used by governments in making capital decisions (Srithongrung, 2010). Based on a survey of 120 cities, Forrester (1993) finds that few municipal governments use a rational decision-making process for capital budgeting; in fact, the process is largely unstructured and political. Because the public capital budgeting process is often complicated with political and managerial concerns, Nunn (1990) claims that the components of rational budgeting should be distinguished from non-rational process: the non-rational process is influenced by external (e.g., citizens and development interests) and internal (e.g., public officials) capital demands along with formal and informal pressures (Forrester, 1993; Nunn, 1990).

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The political influence on capital budgeting varies across municipal governments of various forms of governance. It is assumed that professionally managed cities tend to support formal fiscal procedures, employing managerial approaches promoting efficiency more than other forms of government. Using data from a survey of 851 cities, Doss (1987) finds that council-manager cities are more likely to adopt formal capital budgeting processes than mayor-council cities. Nunn (1996) compares seven Indiana mayor-council cities and seven Texas council-manager governments, and finds that, unlike Indiana mayor-council governments, Texas council-manager governments followed a more formal and professional approach to capital budgeting. Wang and Wu (2018) use a data set of 100 large cities and report that council-manager governments often have higher levels of capital spending per capita compared with their mayor-council counterparts. Institutional Constraints Restrict Capital Spending In the literature, the median voter model is often used to explain the demand-driven capital spending at the local level. One of the limitations of this model is that it does not consider institutions and their influences on government fiscal decision-making. Bailey and Connolly (1998) argue that institutions should be integrated into the median voter theory to capture the influence of institutional dynamics in determining public expenditures. Several empirical studies reveal that institutional constraints hamper government infrastructure investments. Wang and Wu (2018) and Chen et al. (2019) find that debt limitations on general obligation bond and tax and expenditure limitations (TELs) restrict capital spending of municipal governments. These findings suggest that institutional factors may have caused the lagging of municipal infrastructure investment. Like fiscal institutions, government regulations may also influence government decisions on infrastructure investment. For example, federal mandates and regulations increase the cost of infrastructure spending, suppressing the private sector’s ability to finance public infrastructure projects (Aiello, 2020). Voter approval requirements can be an additional obstacle that limits infrastructure funding. For example, voters in Pulaski County, Arkansas, recently disapproved a quarter-percentage-point sales tax increase dedicated to transit, which was estimated to raise US$18 million annually for creating bus lanes and expanding bus services (Oman, 2016). According to DuPuis and McFarland (2016), eight states require voter approval to levy a local option fuel taxes or motor vehicle fee. Limited Fiscal Capacity Hinders Sufficient Infrastructure Investment The level of capital spending largely depends on a government’s fiscal capacity. Fiscal capacity of a government such as own-source revenue capacity and intergovernmental aid matters to infrastructure investment (Bates & Santerre, 2015; Congleton & Bennett, 1995; Fisher & Wassmer, 2015; Pagano, 2002). Analyzing the municipal-level data from 1993 to 2000, Pagano (2002) finds that greater-than-expected revenues enabled many cities to pursue infrastructure projects, and the growth in cities’ own-source revenue capacity and ending balances have a significant and positive impact on growth rate in capital spending. Similarly, Wang and Wu (2018) show that a higher municipal fund balance has a positive association with capital spending. This suggests that larger fund balances help alleviate budget constraints caused by fiscal institutions, thereby allowing city

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governments to spend more on infrastructure projects (Wang & Wu, 2018). The empirical results of Chen et al. (2019) also demonstrate that cities with greater own-source revenue capacity tend to have greater road capital investment. In addition to own-source revenue capacity, intergovernmental aid also matters to municipal capital spending. Bartle (1996) demonstrates that cities with large aid cuts reduce capital spending and cash balances as well as increase taxes and user fees. Other studies report a significant and positive association between intergovernmental aid and capital spending of subnational governments (Bates & Santerre, 2015; Chen et al., 2019; Congleton & Bennett, 1995; Fisher & Wassmer, 2015; Wang & Wu, 2018). The literature also suggests that fiscally distressed governments behave myopically, funding more visible public services at the expense of budget for capital maintenance, which is less visible. Compared with operational expenditures, capital maintenance expenditures are often considered as “easy targets” (Borge & Hopland, 2015). Using expenditure data from 42 city budgets, Bumgarner et al. (1991) find that fiscally distressed cities have significantly lower capital and maintenance expenditures relative to expenditures on current services. When in a harsh fiscal condition, a government prefers to postpone expensive but “less visible” capital and maintenance expenditures and focus all resources on less expensive but more visible current expenditures to maintain an acceptable level of vital services such as police and fire (Bifulco et al., 2012).

THE IMPACT OF THE COVID-19 PANDEMIC AND POTENTIAL SOLUTIONS TO INFRASTRUCTURE INVESTMENT SHORTFALLS The ongoing COVID-19 pandemic has created and will continue to create significant challenges to the government fiscal landscape. When governments are faced with fiscal stress, they cannot have sufficient revenues to invest in capital projects. Several empirical studies demonstrate that governments tend to rely on cutback strategies including reducing their capital spending during economic recessions (Bartle, 1996; Bumgarner et al., 1991; Ho, 2008). Survey research has revealed that local citizens are more likely in favor of cutting capital expenditures instead of service cuts, layoffs, and furloughs because they do not want to have reduced service levels (Jimenez, 2014; Skidmore & Scorsone, 2011). In Hoene and Pagano’s (2011) report of city fiscal conditions, the most common expenditure cuts used by cities are reducing personnel costs and delaying or cancelling capital expenditures. In a survey of Georgia and California county commissioners, Afonso (2014) reports that delaying or canceling capital projects was the most frequently used alternative in responding to the shock of the Great Recession. Municipal governments have been struggling with insufficient funding as federal and state governments drastically decrease their investment rates. The COVID-19 pandemic will result in revenue shortfalls from both own-sources and intergovernmental transfers. To overcome the lack of funding for public capital and maintenance projects, local governments need to explore alternative financing techniques such as debt financing and public–private partnerships.

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Borrowing and Debt Financing Borrowing has been regarded as an important financing tool for infrastructure investment for local governments. Municipal bonds include general obligation (GO) bonds, revenue bonds, tax credit bonds, grant anticipation bonds, private activity bonds, and special tax bonds (BATIC Institute, 2020). GO bonds and revenue bonds are regarded as traditional municipal bonds: GO bonds refer to the long-term obligations of local governments with repayment from their general tax revenues; revenue bonds are non-guaranteed debt to fund public facilities that have revenue streams to service the debt. Tax credit bonds provide federal tax credits of up to 100 percent of the interest amount in addition to partial interest payment and full repayment of principal upon its maturity (ibid.). Grant anticipation bonds refer to tax-exempt securities issued by state and local agencies and supported by federal grants anticipated to be received in the future (Mallett & Driessen, 2016). Private activity bonds (PABs) are issued by governments on behalf of a private entity to construct infrastructure projects (e.g., highway and freight transfer facilities, water facility upgrades). PABs allow private users to benefit from the government’s status as a “tax-exempt entity” and have lower interest rates (Chen & Bartle, 2017). Special tax bonds refer to a municipal bond with debt service limited to the revenues generated by a specific tax (e.g., a gasoline tax, a special assessment, incremental sales tax, or property tax) (Scott, 2003). The advantages and disadvantages of each bond differ from one another. GO bonds cost less than revenue bonds, but they are constrained by constitutional debt limits and public vote as well as shifting the burden of a debt obligation onto future taxpayers. In contrast, revenue bonds are free from constitutional debt limits and voter approval but have higher risk because of the uncertainty of generated revenues, thereby leading to higher costs (Chen & Bartle, 2017). Unlike GO bonds that have unlimited ability to raise taxes, the issuers of special tax bonds are limited by the specific source of revenue to pay the bonds (BATIC Institute, 2020). PABs have the advantage of promoting private sector investment in infrastructure projects (Chen & Bartle, 2017). However, the disadvantage of PABs is that a federally imposed cap limits the annual amount of PABs (Puentes, 2012). The main advantage of tax credit bonds is low credit risk because a project is supported by a reliable repayment source, such as federal interest subsidy. However, the authority to issue all tax credit bonds was eliminated starting in 2018 according to the Tax Cuts and Jobs Act (Driessen, 2021). Municipal bonds are less expensive and more reliable than private bonds or private bank loan, but the federal government bears the costs of tax exemption. The interest on municipal bonds that are exempt from federal income taxes is estimated to decrease federal revenues by US$187.7 billion over 2015–19 (Mallett & Driessen, 2016). Some scholars argue that state and local governments need to take on more debt to meet infrastructure needs (McNichol, 2019) as well as develop the capacity to manage long-term debt (Yilmaz & Ebel, 2020). However, weak economic conditions caused by the ­COVID-19 pandemic are hitting the municipal bond market, thereby aggravating the problems of existing infrastructure (Black, 2020; McBride & Moss, 2021). As economic recession is continuing, Moody’s Investors Service assessed that the outlook for US local governments

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in 2021 is negative.7 Given a more negative credit outlook for local government GO debt, financing options for local governments will be more expensive over the next years, likely affecting infrastructure projects. Public–Private Partnerships Public–private partnerships (PPPs) are agreements or contracts between a private party and a government entity that are intended to encourage private parties to provide public services more efficiently (Congressional Budget Office, 2020b). Under this model, private firms get a concession from subnational governments to construct infrastructure (e.g., a highway) and the right to charge tolls or user fees on it in exchange for the responsibility of operating infrastructure (McBride & Moss, 2021). The federal government offers tax credits to private investors who help government operate or finance a project (Auxier & Iselin, 2017). Unlike private contracts with government, PPP projects involve transfer of risk to private parties depending on how a PPP project is structured. The structure of a PPP is characterized as different combinations of multiple stages of a project – designing, building, financing, operating, and maintaining. Under a design-build contract, the private party accepts most or all the risk of cost increases associated with the project. When a design-build contract includes private financing, it moves public infrastructure spending to the private sector but exposes the private party to the risk associated with generating revenue to repay the loan. A successful PPP requires reasonable control over some of the potential risks and incentivizes private parties to be more efficient in the process. In the US, five toll roads are leased under a long-term PPP concession agreement. The PPP leases of the Chicago Skyway and the Indiana Toll Road are the most well-known (Poole, 2020). The city of Chicago owns the Skyway and the state of Indiana owns the Indiana Toll Road, although they are part of the interstate highway system (ibid.). The Congressional Budget Office (2020b) estimates that PPPs have accounted for 1–3 percent of spending for highway, transit, and water infrastructure since 1990. To relieve strain on government budgets, PPPs have been considered as an alternative financing technique because of the following advantages. First, they allow faster access to capital especially when subnational governments face statutory or constitutional limits on their ability to issue debt, faster completion of projects, and lower taxpayer cost (Auxier & Iselin, 2017). This is because PPPs tend to reduce design and building stages and decrease operation and maintenance costs, while improving compliance with regulatory standards (ibid.). In addition, private financing probably facilitates infrastructure projects especially when subnational governments are faced with budgetary limits or legal constraints on spending or borrowing, as such projects are paid for using taxes or user fees (ibid.). However, a 2011 report by the Brookings Institution finds that “in practice [PPPs] have been dogged by contract design problems, waste, and unrealistic expectations” (Engel et  al., 2011, n.p.). Brown (2017) argues that privatization of public assets leads to an 7   Moody’s Investors Service (2020, December 4). Outlook for US local governments remains negative as revenue remains under pressure in 2021, https://www.moodys.com/research/MoodysOutlook-for-US-local-governments-remains-negative-as-revenue--PBM_1255805?showPdf=true.

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increase in costs of infrastructure services, which are charged through local taxes and regressive user fees like tolls (Brown, 2017). Brown (2017) suggests that the federal government could directly cover the costs of the upgrades and repairs to infrastructures without the need to borrow any money at all. McBride and Moss (2021) also suggest that PPPs may not be appropriate for the US. Instead, Brown (2017) supports creating and using public depository banks for infrastructure projects at the federal level or a state-by-state network, estimating that such public banks can decrease financing costs by about US$1.18 trillion. This is because such public banks can lend money for infrastructure projects at a lower rate, while the interest earned on such loans will return to the public.

CONCLUSION Given all the bottlenecks and challenges, it seems doubtful whether there will be enough government spending on America’s physical infrastructure in the foreseeable future. After a lengthy and difficult negotiation, President Biden finally signed the US$1 trillion infrastructure bill into law on November 15, 2021. It will provide US$550 billion federal funds to improve the nation’s physical infrastructure in transportation, utilities, and broadband. This is a long-waited response to addressing the infrastructure deficit that has lingered for so long. In addition to funding of new infrastructure projects and services, tens of billions of dollars are allocated to repair bridges, transit and passenger rail infrastructure, and states are given additional funds and a wide latitude on how to use them to meet repair needs on their roads, bridges, and highways (Davis, 2022).8 This will become a major milestone toward filling the massive infrastructure investment gap and moving the nation toward a network of infrastructure that serves the needs of future economic growth and quality of life for all.

REFERENCES Afonso, W. B. (2014). Local government capital spending during and after recessions: A cause for concern? International Journal of Public Administration, 37(8), 494–505. Aiello, T. (2020, April 16). With targeted reforms, COVID-19 response can unleash private sector infrastructure investment [Issue brief]. National Taxpayers Union. https://www.ntu.org/publica​ tions/detail/with-targeted-reforms-covid-19-response-can-unleash-private-sector-infrastructureinvestment. American Society of Civil Engineers (ASCE). (2021a). A comprehensive assessment of America’s infrastructure: 2021 report card. https://www.infrastructurereportcard.org/wp-content/uploads/​ 2020/12/2021-IRC-Executive-Summary.pdf. American Society of Civil Engineers (ASCE). (2021b). Failure to act: Economic impacts of status quo investment across infrastructure systems. https://infrastructurereportcard.org/the-impact/ failure-to-act-report. Auxier, R. C., & Iselin, J. (2017). Infrastructure, the gas tax, and municipal bonds. Urban Institute. https://www.urban.org/research/publication/infrastructure-gas-tax-and-municipal-bonds. 8   For example, the bill provides US$43 billion to repair bridges, and US$53.5 billion to improve the state of repair, improve performance, or expand or establish new intercity passenger rail service, and US$3.5 billion to repair or replace a wide variety of transit infrastructure (Davis, 2022).

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Bailey, S. J., & Connolly, S. (1998). The flypaper effect: Identifying areas for further research. Public Choice, 95(3–4), 335–361. Bartle, J. (1996). Coping with cutbacks: City response to aid cuts in New York State. State and Local Government Review, 28(1), 38–48. Bates, L. J., & Santerre, R. E. (2015). The demand for municipal infrastructure projects: Some evidence from Connecticut towns and cities. Public Finance Review, 43(5), 586–605. BATIC Institute. (2020). Transportation funding & financing. http://www.financingtransportation. org/funding_financing. Bifulco, R., Bunch, B. S., Duncombe, W., Robbins, M. D., & Simonsen, W. (2012). Debt and deception: How states avoid making hard fiscal decisions? Public Administration Review, 72(5), ­659–667. Black, A. P. (2020). Impacts of COVID-19 on state and local transportation revenues and construction programs. American Road & Transportation Builders Association. https://www.artba.org/wpcontent/uploads/2020/11/202010.23_ARTBA_COVID19RevImpact_v22.pdf. Borge, L. E., & Hopland, A. O. (2015). Investments and maintenance: Easy targets when governments cut budgets? Proceedings: 108th Annual Conference on Taxation. https://ntanet. org/2015/11/108th-annual-conference-proceedings-2015. Brown, E. (2017). Rebuilding America’s infrastructure [Policy brief]. The Next System Project. https://thenextsystem.org/rebuilding-americas-infrastructure. Bumgarner, M., Martinez-Vazquez, J., & Sjoquist, D. L. (1991). Municipal capital maintenance and fiscal distress. The Review of Economics and Statistics, 73(1), 33–39. Chen, C., & Bartle, J. R. (2017). Infrastructure financing: A guide for local government managers (Public Administration Faculty Publications No. 77). https://digitalcommons.unomaha.edu/ pubadfacpub/77. Chen, C., Han, Y., & Frank, H. A. (2019). What drives municipal capital investment? A long-panel data analysis of U.S. central cities. State and Local Government Review, 51(3), 168–178. Congleton, R. D., & Bennett, R. W. (1995). On the political economy of state highway expenditures: Some evidence of the relative performance of alternative public choice models. Public Choice, 84(1–2), 1–24. Congressional Budget Office. (2018). Public spending on transportation and water infrastructure, 1956 to 2017. https://www.cbo.gov/publication/54539. Congressional Budget Office. (2020a). Reauthorizing federal highway programs: Issues and options. https://www.cbo.gov/publication/56346. Congressional Budget Office. (2020b). Public-private partnerships for transportation and water infrastructure. https://www.cbo.gov/publication/56003. Daniel, D. (2021). Support local development and infrastructure projects: The community development block grant (CDBG) program [Policy brief]. National Association of Counties. https://www. naco.org/resources/support-local-development-and-infrastructure-projects-community-develop​ ment-block-grant-1. Davis, S. (2022, February 2). The infrastructure bill’s limited state of repair funding and policies [Blog]. Transportation for America. https://t4america.org/2022/02/02/the-infrastructure-billslimited-state-of-repair-funding-and-policies. Doss, C. B. (1987). The use of capital budgeting procedures in U.S. cities. Public Budgeting & Finance, 7(3), 57–69. Driessen, G. A. (2021). Tax credit bonds: Overview and analysis. Congressional Research Service. https://fas.org/sgp/crs/misc/R40523.pdf. DuPuis, N., & McFarland, C. K. (2016, February 25). Paying for local infrastructure in a new era of federalism: A state-by-state analysis. National League of Cities. https://www.nlc.org/wp-content/ uploads/2016/12/NLC_2016_Infrastructure_Report.pdf. Engel, E., Fischer, R., & Galetovic, A. (2011). Public-private partnerships to revamp U.S. infrastructure. Brookings Institution. https://www.brookings.edu/research/public-private-partnerships-torevamp-u-s-infrastructure. Fisher, R. C., & Wassmer, R. W. (2015). An analysis of state-local government capital expenditure during the 2000s. Public Budgeting & Finance, 35(1), 3–28. Forrester, J. P. (1993). Municipal capital budgeting: An examination. Public Budgeting & Finance, 13(2), 85–103.

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Ho, A. T. (2008). State highway capital expenditure and the economic cycle. International Journal of Public Administration, 31(2), 101–116. Hoene, C. W., & Pagano, M. A. (2011). Research brief on America’s cities: City fiscal conditions in 2011. National League of Cities. Holtz-Eakin, D., & Rosen, H. S. (1989). The “rationality” of municipal capital spending: Evidence from New Jersey. Regional Science and Urban Economics, 19(3), 517–536. Hulten, C. (1984). Productivity change in state and local governments. The Review of Economics and Statistics, 66(2), 256–266. Hulten, C. R., & Peterson, G. E. (1984). The public capital stock: Needs, trends, and performance. The American Economic Review, 74(2), 166–173. Inman, R. P. (1983). Anatomy of a fiscal crisis. Business Review (Federal Reserve Bank of Philadelphia), September/October, 15–22. Jimenez, B. S. (2014). Raise taxes, cut services, or lay off staff: Citizens in the fiscal retrenchment process. Journal of Public Administration Research and Theory, 24(4), 923–953. Kane, J. W., & Tomer, A. (2019, May 10). Shifting into an era of repair: US infrastructure spending trends. Brookings Institution. https://www.brookings.edu/research/shifting-into-an-era-ofrepair-us-infrastructure-spending-trends. Kennedy, M. (2016, April 20). Lead-laced water in Flint: A step-by-step look at the makings of a crisis. NPR.org. https://www.npr.org/sections/thetwo-way/2016/04/20/465545378/lead-lacedwater-in-flint-a-step-by-step-look-at-the-makings-of-a-crisis. Mallett, W. J., & Driessen, G. A. (2016). Infrastructure finance and debt to support surface ­transportation investment. Congressional Research Service. https://fas.org/sgp/crs/misc/R43308. pdf. McBride, J., & Moss, J. (2021). The state of U.S. infrastructure. Council on Foreign Relations. https://www.cfr.org/backgrounder/state-us-infrastructure. McNichol, E. (2019). It’s time for states to invest in infrastructure. Center on Budget and Policy Priorities. https://www.cbpp.org/research/state-budget-and-tax/its-time-for-states-to-invest-ininfrastructure. Mead, D. M. (2013). The development of external financial reporting and its relationship to the assessment of fiscal health and stress. In H. Levine, J. B. Justice, & E. A. Scorsone (Eds.), Handbook of local government fiscal health (pp. 77–124). Jones & Bartlett Learning. Murphy, A. (2019). In service of creditors: Emergency financial management and poison water in Flint, Michigan. Public Finance and Management, 19(3), 200–231. Nunn, S. (1990). Budgeting for public capital: Reinterpreting traditional views of urban infrastructure provision. Journal of Urban Affairs, 12(4), 327–344. Nunn, S. (1996). Urban infrastructure policies and capital spending in city manager and strong mayor cities. The American Review of Public Administration, 26(1), 93–112. Oman, N. (2016, March 6). Tax defeat trips up transit plans. Arkansas Democrat Gazette. http:// www.arkansasonline.com/news/2016/mar/06/tax-defeat-trips-up-transit-plans-20160. Pagano, M. A. (2002). Municipal capital spending during the “Boom.” Public Budgeting & Finance, 22(2), 1–20. Pine, J., McFarland, C., & Kohler, B. (2020). The big costs of infrastructure cutbacks. National League of Cities. https://www.nlc.org/article/2020/07/09/the-big-costs-of-infrastructure-cut​backs. Poole, R. W. Jr. (2020). Should governments lease their toll roads? Reason Foundation. https:// penniur.upenn.edu/uploads/media/should-governments-lease-their-toll-roads.pdf. Puentes, R. (2012, October 25). Promoting infrastructure investment through private activity bonds. Brookings Institution. https://www.brookings.edu/blog/the-avenue/2012/10/25/promoting-infra​ structure-investment-through-private-activity-bonds. Rivenbark, W. C., Roenigk, D. J., & Allison, G. S. (2010). Conceptualizing financial condition in local government. Journal of Public Budgeting, Accounting & Financial Management, 22(2), 149–177. Scott, D. L. (2003). Wall Street words: An A to Z guide to investment terms for today’s investor (3rd ed.). Harper Business. Skidmore, M., & Scorsone, E. (2011). Causes and consequences of fiscal stress in Michigan cities. Regional Science and Urban Economics, 41(4), 360–371.

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8. Mitigating fiscal risk through municipal cybersecurity Douglas A. Carr

INTRODUCTION Municipalities are attractive targets for cybersecurity attacks. Not only do municipal computer networks store a variety of personally identifiable information that is attractive to hackers, but ransomware attacks also have the potential to directly generate revenue for attackers if municipalities pay a ransom to regain control of their networks. Furthermore, as remote work has increased since the outbreak of COVID-19, so has the risk of cybersecurity incidents. Recovering from a cybersecurity attack can be very costly. Recovering data and addressing security weaknesses in response to a cybersecurity attack can cost millions of dollars. Sensitive data may be stolen, creating a financial burden for the individuals whose data was compromised. Service provision may be also interrupted while a municipality does not have access to its own networks. Municipalities play fiscal roulette if they do not prepare for cybersecurity threats. While all risk cannot be eliminated, steps can be taken to significantly mitigate this risk. First, steps should be taken to reduce the likelihood of a successful attack. Many of these actions are not highly technical or costly, yet they can significantly reduce the likelihood of a cybersecurity breach. Second, municipalities should prepare for the possibility of a successful cybersecurity attack. While the probability of a successful attack can be reduced, municipalities should not assume that this risk can be eliminated. It is critical to also prepare for such an attack. Proper preparation can significantly mitigate the cost of an attack, greatly reducing the fiscal risk. Cybersecurity is a critical issue for municipalities, yet it is often underappreciated. By focusing on municipal finance, this chapter responds to the need for interdisciplinary approaches to municipal cybersecurity (Preis & Susskind, 2022). The emphasis on the fiscal implications of cybersecurity is also designed to frame discussion of municipal cybersecurity around values beyond security alone, using evidence from recent cybersecurity incidents to motivate and guide action (De Bruijn & Janssen, 2017).

ANATOMY OF CYBERSECURITY INCIDENTS Many recent cybersecurity attacks have been ransomware attacks. In a ransomware attack, the attackers encrypt the municipality’s computer systems and lock all users out. A ransom is then demanded in exchange for the decryption keys necessary to regain access to the affected systems. The affected municipality may be left unable to conduct daily 159

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business until system access is restored. Atlanta, Georgia suffered a ransomware attack in March of 2018 that the mayor called a “hostage situation” (Blinder & Perlroth, 2018). While some functions such as 911 calls and wastewater treatment were able to continue, other systems were unavailable for an extended period. For example, online water bill payment was not restored until May, and the Municipal Court online payment system and docket boards were not restored until June (Douglas, 2018). In addition to ransomware attacks, municipalities are attractive targets for other cybersecurity threats. For example, data theft can be lucrative to attackers. Sacramento County, California was the victim of such a data breach in 2021. Attackers sent phishing emails asking county employees to log in to a fraudulent website; five employees entered their login information. As a result, 2,096 records containing protected health information and 816 records of personal identification information were exposed. The county offered victims free credit monitoring, credit resolution, and identity restoration services (Moleski, 2022). Data theft can also be combined with ransom demands. Florence, Alabama was the victim of such an attack in 2020. Attackers threatened to publish or sell personally identifiable data taken from the city unless a ransom was paid. The city hired a security firm that negotiated the ransom demand from US$378,000 down to US$291,000, which the city decided to pay in an attempt to prevent release or sale of those records (Coble, 2020). The increase in remote work since the start of the COVID-19 pandemic has increased municipal risk exposure to cybersecurity threats. The quick transition to remote work has largely not been accompanied by review and revision of municipal cybersecurity policies. As employees use their own computers and mobile devices on their personal computer networks for municipal business, municipal computer systems become dependent on the cybersecurity of these personal devices and networks. Not only does this create additional risks for a cybersecurity breach, it can also increase the impact of a breach. In a global study of data breaches, organizations that implemented significant digital transformation for remote work during the pandemic experienced 15 percent lower costs on average from a data breach than organizations that did not engage in digital transformation (IBM, 2021). Furthermore, social engineering scams take advantage of remote work, and the FBI has seen an increase in such scams related to the COVID-19 pandemic (FBI, 2020). Most municipal staff are not expected to be IT experts, yet employees have increased technological responsibilities when working outside of a traditional office. While high-tech malicious attacks pose a threat, the weakest link in an organization’s cybersecurity is often well-intentioned employees. Social engineering attacks, in which the attacker uses social skills to gain sensitive information or access to the network, are common. For example, numerous organizations have experienced phishing attacks that have tricked employees into emailing W-2 (wage and tax statement) forms directly to attackers. Sometimes the simplest way to steal sensitive data is to just politely ask an unsuspecting employee.

FISCAL RISK Recovery from a cybersecurity breach can be very costly. The theft of personally identifiable information harms the individuals whose data was stolen, and it is also costly for the

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government or organization from which the data was stolen. A single security breach can expose sensitive data; for example, unauthorized access to a Benton County, Washington employee email account exposed the names, Social Security numbers, driver’s license numbers, medical and treatment information, health insurance information, financial account information, and student identification numbers of 820 people (Kraemer, 2021). Responding to a data breach includes costs for detection and forensic investigation to determine what data was compromised; notification, credit monitoring, and identity protection services for individuals whose data was compromised; and remediation of the breach itself. Social engineering attacks can also be costly. Liberty Hill, Texas, a growing community with 3,600 residents, lost almost US$170,000 in two incidents at the end of 2021. In both instances, scammers convinced the city to update the banking information for a vendor with an invoice due. The city updated the banking information and paid both invoices to scammers instead of the vendors (Madison, 2021). Ransomware attacks create unique costs. Victims of a ransomware attack must decide whether to pay the ransom. Some municipalities do pay the ransom, and this can cost tens of thousands to hundreds of thousands of dollars. For example, over two weeks in June of 2019, two cities in Florida used insurance policies to pay large ransoms to recover control of their networks. Riviera Beach, a city with a population of about 35,000, paid US$592,000 in Bitcoin (Mazzei, 2019a) and Lake City, with a population of 12,000, paid US$460,000 in Bitcoin (Mazzei, 2019b). While ransom demands in ransomware attacks receive a lot of attention in the press, they only account for one component of the total cost. Even if access is regained to a network, the security of that network remains compromised. Forensic analysis is necessary to identify and prevent a continued security breach. Hardware may need to be replaced. And some data might not be recovered. The Lansing Board of Water & Light in Michigan experienced a ransomware attack in April 2016. A ransom of US$25,000 was paid to avoid replacing all infected hardware and software, which could have cost US$10 million. However, recovery from the attack still cost US$2.4 million; much of this was covered by insurance (Smith, 2016). Municipalities may also decide not to pay a ransom. Paying a ransom does not guarantee a municipality will regain access to their network or recover all their data, and subsequent ransom demands may be made after an initial ransom payment. Also, making a ransom payment could encourage future ransomware attacks. For these reasons, the FBI does not support paying a ransom (FBI, 2022). Restoring compromised systems can be costly, even without paying a ransom. In 2018, Atlanta refused to pay a US$52,000 ransom, and initial recovery costs in the first two weeks totaled over US$2.6 million for incident response, digital forensics, extra staffing, and Microsoft Cloud expertise (Newman, 2018). Similarly, Baltimore refused a US$76,000 ransom demand in 2019 and spent about US$5.3 million to recover from the attack (Comeau et al., 2021). Furthermore, credit rating agencies pay attention to the fiscal impact of cybersecurity attacks on local governments. Recovery from a successful attack can require significant expenditures, a credit negative (Moody’s, 2019); cybersecurity risk assessment is used as a stress-testing scenario when determining credit scores (Commins, 2015).

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RISK MITIGATION It is critical that municipalities mitigate the fiscal risk created by cybersecurity threats. A cybersecurity breach can necessitate very high expenditures, creating extensive fiscal stress. Fortunately, there are a number of ways municipalities can reduce exposure to this fiscal threat. In a nationwide survey of local governments, Norris et al. (2019) find that the average local government is not effectively addressing cybersecurity. The remainder of this chapter provides guidance to municipalities that can significantly improve municipal cybersecurity and mitigate the fiscal risk of an attack. The following best practices do not eliminate the possibility of a cybersecurity breach, but instead mitigate the fiscal threat posed by a successful attack. This mitigation is achieved using two strategies. First, the likelihood of a successful attack is reduced through defensive best practices. These policies and procedures address both highly technical threats and social engineering threats. Technical threats can be limited through policies and procedures that implement cybersecurity best practices, and mitigating social engineering threats requires employee education. Second, the fiscal burden of a successful attack can also be reduced. While proper security practices can significantly reduce the likelihood of a cybersecurity incident, the possibility of a cybersecurity breach remains. The fiscal impact of such an incident can be significantly mitigated through proper preparation. Some of these practices can be implemented for a minimal cost. Others carry a more significant cost. Municipalities facing significant resource constraints should not give up on cybersecurity, believing effective cybersecurity is too expensive. Some inexpensive cybersecurity practices can significantly mitigate the fiscal risk of a breach. Security is not an all-or-nothing endeavor; municipalities must determine the appropriate extent of security measures. Municipalities do not build a moat around city hall, but they do lock the front door when the building is closed. Potential security measures should be evaluated by comparing costs and benefits. The costs of cybersecurity practices are financial and operational; in addition to monetary costs, some cybersecurity practices can complicate digital access for employees or residents. For example, multiple factor authentication mitigates the risk of a compromised password by requiring the user to provide another means of authentication, such as a text message or an app on a mobile device. While the financial and operational burden of multifactor authentication is not trivial, it is typically recommended because the risk mitigation is so great. However, other risks are often considered acceptable. While eliminating online payment for bills and fees would remove one system that could be attacked, the benefit of online payment is typically considered to outweigh the risk posed by a properly secured online payment system. Risk Assessment A number of strategies for reducing the likelihood of a successful cybersecurity attack are available to municipalities. Municipalities should begin with a risk assessment. Before cybersecurity improvements can be identified or prioritized, the vulnerabilities present must be identified. The external sources of threats, internal vulnerabilities, and consequences of a successful attack should be understood. Specific cybersecurity risk

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mitigation strategies can then be evaluated in light of this assessment; appropriate cybersecurity policies will effectively address external threats, protect internal vulnerabilities, and mitigate the consequences of an attack (Ganin et al., 2020). When assessing internal vulnerabilities, attention should be paid to the physical security of digital assets, the digital security of systems, and the social domain of cybersecurity (ibid.). Physical security is particularly important for mobile devices and removable media such as flash drives. Because physical access to a device can bypass some forms of digital security, municipalities should pay attention to methods of physical access to sensitive information. For example, the general public and volunteers should not have access to internal computer systems, and sensitive data should not be stored on personal mobile devices. Cybersecurity policies and procedures should be developed to address the digital security of municipal systems. For example, security updates should be applied to software as soon as they are available. Note that while digital security is often thought of as the centerpiece of cybersecurity, it is only one aspect of effective cybersecurity. The social domain of cybersecurity is critical. Employee education can address social engineering attacks such as phishing. The hiring process can emphasize the importance of hiring trustworthy employees – for example, mitigating the risk of a rogue network administrator who maliciously locks the municipality out of their own computer systems, as happened in San Francisco in 2008. This city lost access to its network for more than ten days until the mayor met with the network administrator in jail and was given the correct passwords. The city also spent hundreds of thousands of dollars to recover from the incident (Vijayan, 2010). Correct user access control can be implemented, such as promptly revoking access to terminated employees. Acceptable use policies stipulating recourse for inappropriate network use can dissuade disgruntled employees from harming the municipality. Relatively low-tech policies and procedures can significantly reduce the social vulnerabilities of a municipality’s digital systems. A vendor with risk assessment expertise can be hired to identify a municipality’s cybersecurity needs. The risk assessment should include developing an inventory of hardware, software, and data within the municipality. This will help ensure that a cybersecurity plan does not ignore an area of vulnerability. Risk assessment is not a one-time activity. Risks will change as external threats and internal vulnerabilities change over time. Risk assessments should be revisited on a regular schedule so that new risks are not missed. Failure to assess cybersecurity risks can leave a municipality vulnerable to significant fiscal risk. Once cybersecurity risks have been identified, an appropriate response to the risks can be developed. This response should both reduce the likelihood of a cybersecurity incident and mitigate the consequences should such an incident occur. Prevention A municipal cybersecurity risk assessment will guide strategies to prevent a cybersecurity breach. Key areas to pay attention to include human resource capacity, cybersecurity policies and procedures, and vendor management.

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Human resource capacity A focus on cybersecurity human resource capacity emphasizes the importance of security throughout a municipal government. Cybersecurity should not be an afterthought at the top levels of the organizational chart. Municipalities with larger staffs and extensive information systems should consider hiring a chief information security officer (CISO) in addition to a chief information officer (CIO). A CISO with full-time responsibility for security will promote a comprehensive approach to cybersecurity throughout a municipal government. When hiring a CISO is not feasible, responsibility for cybersecurity should still be established. This can be particularly challenging for small municipalities. However, inadequate attention to cybersecurity can still be fiscally devastating for them. Limited IT capacity does increase the likelihood of a security breach (Caldarulo et al., 2022). Keep in mind that preventing cybersecurity breaches extends far beyond maintenance-oriented activities such as updating antivirus software. Municipalities need to consider their human resource weaknesses, technical threats, and risks in vendor contracts that need to be managed. An employee responsible for making sure these threats are addressed should be identified. Cyber awareness is essential in municipal administration. The need for this awareness is not limited to the employees responsible for developing security protocols, but extends to all municipal employees. The weakest link in a municipality’s cybersecurity is often wellintentioned employees. Regular employee training is necessary to reduce the likelihood of a successful social engineering attack. For example, employees should understand how to recognize a phishing scam and how to correctly safeguard sensitive data, such as W-2 forms. Municipalities should provide employees with regular cybersecurity training. Instead of relying on a single training event, ongoing training allows for new threats to be addressed as they develop. Free resources, such as the cybersecurity awareness toolkit developed by the Cybersecurity & Infrastructure Security Agency (CISA, 2022), can help focus employee training on current threats. Also, municipalities can contract with vendors to provide ongoing training. In addition to general training, phish testing services, through which employees periodically receive fake phishing emails to check whether employees respond to the emails, are useful. A municipality’s choice of training methods will reflect employee needs and municipal resources. It is tempting for resource-constrained municipalities to forgo employee cybersecurity training. Unfortunately, doing so results in greater risk exposure. While employee training requires a resource commitment, a lack of training brings a risk of much greater fiscal loss. Cybersecurity policies and procedures Maintaining current cybersecurity policies and procedures is a critical step in risk reduction. Some of these practices simply require uniform application of available resources and do not add to the budget. For example, software should be kept up to date to ensure security patches are promptly applied, and only trusted software should be installed. This is true for both desktop and mobile devices. Implementing such policies sounds simple, but becomes difficult when employees use personal devices for municipal business. It is easy for employees to blend home and

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work when working remotely. However, it is important to maintain separation between personal life and work when it comes to computers and devices. Personal devices are not the free resource they appear to be. If employees are using their own personal devices for municipal business, it is important to ensure those devices are properly secured. In addition to maintaining software updates, only trusted apps should be installed on these devices. Enforcing security policies on personal devices can be costly in terms of staff time and security management software expenses; in general, it is best to restrict municipal business to devices that are owned and managed by the municipality. Municipal work should occur on devices and software accounts secured specifically for municipal work. Also, municipal devices should only be used for business purposes; family members should not be using these devices, and municipal computers and devices should not be used for personal access. This practice will help safeguard the security of municipal devices. Employee training is necessary to achieve this. The training should be evidence based and connect with public service values beyond security alone, helping employees to understand their personal role in safeguarding municipal services (De Bruijn & Janssen, 2017). Remote work has become more common for municipalities, and securing network connections for remote employees is important. A virtual private network (VPN) encrypts the connection between the employee’s computer and the municipal network, preventing employee work from being monitored by third parties. Make sure that you trust the VPN employees are using. Avoid free VPN services; those services likely harvest and sell data from users. Likewise, any paid VPN service should be reputable and contracted with the municipality. Employees should not use their own VPN service, paid or free, because doing so would send municipal data through an untrusted third party administering the VPN. User access should incorporate multi-factor authentication (MFA) instead of simply requiring authentication with a user name and password. Passwords are often a weakness in an organization’s security when employees experience security fatigue; employees become tired of memorizing an increasing number of strong passwords and instead look for an easy way to remember passwords. Employees tend to choose a weak password that is easy to remember or reuse a password they have used from another system. If a username and password are compromised from a security breach on one system, other systems using the same username and password are no longer secure (Boonkrong, 2021, pp. 134–135). Cybersecurity policies should address physical and electronic data security. Because laptops and mobile devices can be lost or stolen, it is important to consider the physical security of these devices. In addition to setting computers and mobile devices to automatically lock if left unattended, full disk or device encryption should be used on all devices. Encryption will protect data on a device in the event it is lost or stolen. Also, it is best to avoid storing municipal data on thumb or flash drives because of the risk of losing them. Employees should avoid using personal data storage accounts, such as Dropbox or Google Drive, for municipal work. Cloud storage of municipal data should be limited to official municipal accounts. If personal accounts are used for municipal data, the municipality is dependent on the security of those personal accounts. Separately, access to data,

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such as in response to Freedom of Information Act (FOIA) or eDiscovery requests, is complicated when personal accounts are used. Vendor management A municipality’s cybersecurity risk is closely tied to its vendor management practices. Vendors are playing an increasingly important role in providing municipal IT functionality as cloud-based solutions replace locally installed and managed software and data management. This trend includes functions such as email service, geographic information system (GIS) processing, word processing, and data storage. Furthermore, many local governments outsource traditional IT services, contracting with local companies to provide maintenance and user support. The cybersecurity practices of these vendors greatly affect a municipality’s risk exposure. Effective vendor management is necessary to understand and minimize this risk exposure. Vendors should demonstrate cybersecurity competence, compliance with legal and contractual obligations, and engender trust that appropriate security practices will be followed (Dhillon et al., 2017). First, municipal vendor management begins with selecting vendors capable of identifying and mitigating cybersecurity threats. When municipal data storage and information systems are provided through cloud services, the vendors providing those services must have the capacity to appropriately secure those systems. Bids should be evaluated not only on price and functionality offered, but also on the ongoing commitment to security demonstrated by the bidder. Providers of cloud-based software and services should be committed to maintaining appropriate security. Municipalities contracting out IT services should pay close attention to cybersecurity competence when selecting a company to provide these services. While these contractors are often viewed as primarily providing services such as fixing printers and other end-user support, they are also responsible for implementing appropriate security practices in the systems they support. Instead of looking for a low-cost bid to just provide end-user support and equipment maintenance, municipalities should also evaluate the capability of potential vendors to understand and address cybersecurity threats. Failing to do this can leave security gaps if responsibility for supporting equipment and employees is assigned to someone with insufficient ability to recognize and correct security risks. A vendor cybersecurity assessment can be conducted by the municipality when selecting a vendor or renewing a contract. Such an assessment should consider a vendor’s external threats, internal vulnerabilities, and the consequences of a cybersecurity breach. For example, to what extent does a vendor use hardware or software that is vulnerable because it is obsolete, and to what extent is the vendor committed to ongoing ­cybersecurity training for its own employees (Ganin et al., 2020)? If the vendor is responsible for municipal data, will a sufficient disaster recovery plan be implemented to ensure the availability of backup data? Municipalities can also use Cyber Third-Party Risk Management (C-TPRM) risk scores to assess the cybersecurity competence of potential vendors. Similar to a credit score, these proprietary risk scores provided by private companies are designed to provide a cybersecurity risk assessment (Keskin et al., 2021). It is necessary to ensure vendor compliance with legal and contractual obligations. Not only is it important to select a capable vendor, but it is also critical to verify that necessary security measures are actually implemented. Vendor contracts should include

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s­ ervice-level agreements that provide a framework for validating contractual compliance. This includes monitoring vendor performance to ensure promised services are being delivered. Unfortunately, contracting out IT services does not eliminate the in-house burden for ensuring cybersecurity best practices are being implemented. Mitigation Cybersecurity breach prevention strategies are important and can significantly reduce exposure to fiscal risk. However, municipalities should not expect to eliminate all risk. Instead, municipalities should prepare in advance to mitigate the effects of a cybersecurity incident. In the event of a cybersecurity breach, an incident response plan will guide a municipality’s actions and limit additional fiscal risk. Effective disaster recovery procedures will reduce downtime and recovery costs. And cyber insurance will cover recovery costs, preventing significant shocks to municipal budgets. Incident response planning Once a cybersecurity breach is detected, an incident response needs to be put into action immediately. An incident assessment will identify the scope of the attack and guide the immediate response. Once a breach has been identified, the breach must be contained. For example, employees may be notified to immediately turn off computers to limit further damage by preventing the compromise of additional computers and systems. The threat should be mitigated before computers are allowed back online. Once the breach has been contained, it can be eradicated. All malware is removed from affected systems, and compromised user accounts are reset. Only after eradication can data be recovered and systems restored. It is important to plan in advance for responding to a cybersecurity incident. Municipalities should identify the individuals responsible for managing an incident response, develop procedures for the incident response team to follow, establish policies for communicating with external parties, identify contact information the incidence response team will need, such as for legal counsel, law enforcement, and vendors contracted to assist with an incident response, and provide the incident response team with training (Cichonski et al., 2012). Developing an incident response plan in advance will enable a municipality to respond to a cybersecurity incident quickly and effectively. Disaster recovery procedures A robust disaster recovery policy can effectively protect against lost data. In addition to protecting against events like fires and natural disasters, disaster recovery procedures can mitigate many of the concerns created by a cybersecurity breach. For example, data encrypted in a ransomware attack does not need to be decrypted if a separate backup copy of that data exists. This was the case for Orange County, North Carolina. After experiencing a ransomware attack in March 2019, most systems were restored within 36 hours from backup data. In contrast, Jackson County, Georgia experienced a ransomware attack the same month, but did not have a data backup and paid a US$400,000 ransom to regain access to their data. The existence of effective backup procedures greatly reduces the pressure to pay a ransom to regain access to data that has been encrypted

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(Moody’s, 2019). Depending on disaster recovery procedures in place, some data may not be otherwise recoverable. The city of Cockrell Hill, Texas, with a population of 4,200, experienced an attack in December 2016 in which all files in the police department were encrypted; when the city refused to pay the US$4,000 ransom, police records back to 2009 were lost (Cliff, 2017). Development of disaster recovery procedures should start with a data inventory. This will ensure data does not fall between the cracks and become unintentionally excluded from municipal data backups. It is also important to maintain a current backup; backups should be created frequently if they are to be a viable option for restoring data. In most cases, backups should be created at least daily. Data backups must be stored separately from the systems they are protecting. If these backups are connected to municipal networks, the backups themselves are vulnerable to the same attacks they are intended to protect against. Instead, backup data should be stored off-site and disconnected from all municipal systems. Data restoration from the backup copy should also be periodically tested. It is important to verify that data backups actually contain what they should. When it is known that an effective data backup does exist, municipal officials can confidently rely on the data backup to restore affected systems. Cyber insurance Cyber insurance can insulate municipalities from much of the fiscal shock of a cybersecurity incident. This insurance can cover not only ransom payments, but also replacing equipment and contracting with a firm to manage the details of the incident response and recovery. Practicing other mitigation strategies does not eliminate the need for cyber insurance. While the risk of a cyber incident can be reduced, the risk still remains. A successful cyber-attack can cost a municipality millions of dollars, creating a significant fiscal shock. Cyber insurance can save a municipality from extensive fiscal shock in the event of a cybersecurity incident. For example, while disaster recovery procedures are designed to limit the damage of an incident, they do not eliminate the financial consequences of an incident. While robust disaster recovery procedures can alleviate the pressure to pay a ransom in the event of a ransomware attack, a ransom accounts for only a small portion of recovery costs. Compromised systems may need to be rebuilt or replaced, generating significant personnel and equipment expenses. Replacing hardware, recovering data, updating networking infrastructure, and rebuilding cloud infrastructure are time intensive and costly. In 2018, this cost Atlanta over US$2.6 million in the two weeks following a ransomware attack (Newman, 2018). Conversely, purchasing cyber insurance does not eliminate the need to practice robust cybersecurity. Insurance policies have an upward limit in coverage and do not provide unlimited risk mitigation. These policies also exclude a variety of incidents from coverage. There is significant variation in exclusions across policies, so municipalities should consider both the coverage limit and covered losses when selecting a cyber insurance policy (Romanosky et al., 2019). Furthermore, not all consequences of a cybersecurity incident are financial. Public services can be unavailable for an extended period of time, especially if other mitigation

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strategies are not practiced. Also, important resources can be lost in an attack. Atlanta lost years of police dashcam footage after suffering a ransomware attack in 2018. This potentially compromised many court cases, including driving-under-the-influence (DUI) cases (Trubey, 2018).

MUNICIPAL RESPONSE Cybersecurity is essential for reliable municipal public service delivery. The fiscal shock of a cybersecurity incident has the potential to debilitate a local government. Unfortunately, this creates another demand on already limited resources. However, this is a demand that cannot be ignored. Cyber-attacks affect all types and sizes of municipalities. Recent successful attacks have targeted both large governments with significant information technology resources and small governments with more limited resources. Local officials should not think that a particular municipality is beyond the scope of cyber threats. All municipalities should recognize the extensive fiscal risk of a cybersecurity incident and plan ahead to mitigate that risk. Even if a municipality contracts out all IT functions, the municipal government is still responsible for the fiscal risk of a cybersecurity incident. Contracting out IT functions does not remove the municipal responsibility to respond to and resolve cyber-attacks. That response is often very costly, and those costs exist regardless of whether IT functions are provided by a vendor or by municipal employees. If IT services are contracted out, the municipality must still make sure that cybersecurity risks are assessed and mitigated. Because of this, municipalities contracting out all IT functions should include cybersecurity in the contract; the role of the vendor in this case must extend beyond maintenance and end-user support. At least one municipal official or employee should be designated to monitor cybersecurity. If providing cybersecurity is part of a vendor contract, this individual should monitor the vendor’s performance. Municipalities must take ownership of their cybersecurity posture because they already own the risk of a cyber-attack. While municipalities now have the added burden of maintaining cybersecurity, they are not on their own in addressing this challenge. Private associations provide valuable cybersecurity services to members. For example, the Multi-State Information Sharing and Analysis Center (MS-ISAC) provides members with threat prevention protection services and incident response and recovery services (Preis & Susskind, 2022). State governments provide municipalities with a variety of cybersecurity assessments, training, and toolkits. Ward and Brunner (2020) provide descriptions of these services for specific states, along with a call for more state collaboration with local governments. The National League of Cities has also developed specific cybersecurity guidance (Funk et al., 2019; McFarland et al., 2020). Municipalities that have yet to mitigate this significant fiscal risk have an array of resources available to assist them in preventing a significant fiscal shock resulting from a cybersecurity incident. Future research is needed identifying the most effective practices for municipalities with limited IT capacity. These municipalities face an increased risk of a cybersecurity incident (Caldarulo et al., 2022), and efficient use of their limited resources is critical to

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mitigate this risk. Research is also needed to address the growing cybersecurity demand from the Internet of Things (IoT), especially relating to smart cities that rely on IoT devices (Chatfield & Reddick, 2019; Li & Liao, 2018). An interdisciplinary approach in research continues to be important, both when framing cybersecurity issues (De Bruijn & Janssen, 2017) and identifying best practice (Preis & Susskind 2022).

REFERENCES Blinder, A., & Perlroth, N. (2018, March 28). Atlanta hobbled by major cyberattack that mayor calls “a hostage situation.” The New York Times. Boonkrong, S. (2021). Authentication and access control: Practical cryptography methods and tools. Apress. Caldarulo, M., Welch, E. W., & Feeney, M. K. (2022). Determinants of cyber-incidents among small and medium US cities. Government Information Quarterly, 39(3), Article 101703. Chatfield, A. T., & Reddick, C. G. (2019). A framework for Internet of Things-enabled smart governments: A case of IoT cybersecurity policies and use cases in U.S. federal government. Government Information Quarterly, 36, 346–357. Cichonski, P., Millar, T., Grance, T., & Scarfone, K. (2012). Computer security incident handling guide: Recommendations of the National Institute of Standards and Technology (Special Publication No. 800-61, Revision 2). National Institute of Standards and Technology, US Department of Commerce. Cliff, G. (2017, May 31). Growing impact of cybercrime in local government. ICMA.org. https:// icma.org/articles/pm-magazine/growing-impact-cybercrime-local-government. Coble, S. (2020, June 10). Alabama city to pay cyber-ransom. InfoSecurity Magazine. https://www. infosecurity-magazine.com/news/alabama-city-to-pay-cyberransom. Comeau, D., Tang, Z., Manage, S. M., & Hu, Y. (2021). “All your files have been encrypted!” Ransomware attack at Keystone Insurance. Journal of Applied Business and Economics, 23(2), 210–216. Commins, J. (2015, November 25). Cybersecurity a factor in hospital credit ratings. Health­ leadersmedia.com. https://www.healthleadersmedia.com/innovation/cyber-security-risk-factorhospital-cred​it-ratings. Cybersecurity & Infrastructure Security Agency (CISA). (2022). CISA cybersecurity awareness program toolkit. https://www.cisa.gov/publication/cisa-cybersecurity-awareness-program-toolkit. De Bruijn, H., & Janssen, M. (2017). Building cybersecurity awareness: The need for evidence-based framing strategies. Government Information Quarterly, 34, 1–7. Dhillon, G., Syed, R., & de Sá-Soares, F. (2017). Information security concerns in IT outsourcing: Identifying (in)congruence between clients and vendors. Information & Management, 54, ­452–464. Douglas, T. (2018, September 25). What can we learn from Atlanta? Govtech.com. https://www. govtech.com/security/what-can-we-learn-from-atlanta.html. FBI. (2020, March 2020). FBI sees rise in fraud schemes related to the coronavirus (COVID-19) pandemic [Public service announcement]. https://www.ic3.gov/Media/Y2020/PSA200320. FBI. (2022). How to respond and report. https://www.fbi.gov/scams-and-safety/common-scamsand-crimes/ransomware. Funk, K., Martin, C., DuPuis, N., Shark, A., & Bowen, D. (2019). Protecting our data: What cities should know about cybersecurity. National League of Cities. https://www.nlc.org/sites/default/ files/2019-10/CS%20Cybersecurity%20Report%20Final_0.pdf. Ganin, A. A., Quach, P., Panwar, M., Collier, Z. A., Keisler, J. M., Marchese, D., & Linkov, I. (2020). Multicriteria decision framework for cybersecurity risk assessment and management. Risk Analysis, 40(1), 183–199. IBM. (2021). Cost of a data breach report: 2021. https://www.ibm.com/downloads/cas/OJDVQGRY. Keskin, O. F., Caramancion, K. M., Tatar, I., Raza, O., & Tatar, U. (2021). Cyber third-party risk management: A comparison of non-intrusive risk scoring reports. Electronics, 10(10), 1168–1186.

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Kraemer, K. (2021, November 9). Hundreds in Washington County linked to recent data breach. Govtech.com. https://www.govtech.com/security/hundreds-in-washington-county-linked-to-rec​ ent-data-breach. Li, Z., & Liao, Q. (2018). Economic solutions to improve cybersecurity of governments and smart cities via vulnerability markets. Government Information Quarterly, 35, 151–160. Madison, R. (2021, December 29). City loses over $169,000 in two cyber crimes. Liberty Hill Independent. Mazzei, P. (2019a, June 20). Florida city pays $600,000 ransom to computer hackers. The New York Times. Mazzei, P. (2019b, June 28). Another city in Florida pays a ransom to computer hackers. The New York Times. McFarland, C., Rivett, B., Funk, K., Kim, R., & Wagner, S. (2020). State and local partnerships for cybersecurity: A state-by-state analysis. National League of Cities. https://www.nlc.org/wp-con​ tent/uploads/2020/04/SML_2020Report_web-1.pdf. Moleski, V. (2022, January 22). Sacramento County phishing scam data breach exposed health and personal information. The Sacramento Bee. Moody’s. (2019, October 2). Ransomware attacks highlight importance of IT investment and response planning. Moody’s Investors Service. Newman, L. (2018, April 23). Atlanta spent $2.6m to recover from a $52,000 ransomware scare. Wired. Norris, D. F., Mateczun, L., Joshi, A., & Finin, T. (2019). Cyberattacks at the grass roots: American local governments and the need for high levels of cybersecurity. Public Administration Review, 79(6), 895–904. Preis, B., & Susskind, L. (2022). Municipal cybersecurity: More work needs to be done. Urban Affairs Review, 58(2), 614–629. Romanosky, S., Ablon, L., Kuehn, A., & Jones, T. (2019). Content analysis of cyber insurance policies: How do carriers price cyber risk? Journal of Cybersecurity, 5(1), 1–19. Smith, R. (2016, December 30). How a U.S. utility got hacked: Michigan utility paid $25,000 ransom to get back into its systems after hackers from overseas took over its computers. The Wall Street Journal. Trubey, S. J. (2018, June 1). Atlanta police recovering from breach, “years” of dashcam video lost. The Atlanta Journal-Constitution. Vijayan, J. (2010, April 28). After verdict, debate rages in Terry Childes case. Computerworld.com. https://www.computerworld.com/article/2757262/after-verdict--debate-rages-in-terry-childs-case.​ html. Ward, M., & Brunner, M. (2020). Stronger together: State and local cybersecurity collaboration. National Governors Association & National Association of State Chief Information Officers. https://www.nga.org/wp-content/uploads/2020/01/NASCIO_NGAStatesLocalCollaboration.pdf.

PART II FISCAL ORGANIZATION STRUCTURE, BUDGETING, AND FINANCIAL CONDITION

9. The role of special districts and intergovernmental constraints Christopher B. Goodman

INTRODUCTION The United States’ federal system is awash with local governments. As of 2017, the year of the last complete Census of Governments, there are 90,075 independent units of local government. Among the various forms of local government is a form of special-purpose local government called a special district. These districts are often single function (but sometimes not), sometimes conform to city or county boundaries (but sometimes not), and overlap all other forms of local government, including other special districts. The services provided by special districts are typically not unique; general-purpose local governments often provide the same services in other areas. The three most common special district functions include fire protection, housing and community development, and water supply – all functions provided by general-purpose local governments. The initial setup begs the question: why do special districts exist? Moreover, perhaps more pressing, what are the implications for local fiscal outcomes? The answers to the first question are not straightforward. Special districts often possess unique features that make them highly adaptable. This quality allows them to fulfill several roles that general-purpose local governments may find challenging. The answer to the second question is more straightforward but largely depends on how the prevalence of special districts is measured. The literature is full of ways to enumerate special districts in an area with little consensus on the proper method of measuring special district prevalence. Because of this, the empirical literature on the effects of special districts on fiscal outcomes is often confusing. The objective of this chapter is threefold: first, to explain the unique features of special districts that may make them attractive to help solve public problems; second, to outline the potential reasons for why local actors create special districts, with a specific emphasis on the constraints placed on general-purpose local governments; third, to chart the impact of special districts on fiscal outcomes at the local level.

WHAT ARE SPECIAL DISTRICTS? The US Census Bureau defines special districts (and all independent units of local government) by two forms of independence: administrative and fiscal. Special districts specifically are “special-purpose governmental units that exist as separate entities with substantial administrative and fiscal independence from general-purpose local governments” (US Census Bureau, 2019, p. 5). Fiscal independence is the ability of a unit of government to determine its budget without review from other governments, including 173

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setting levels of taxation, determining the appropriate levels of user fees, and issuing debt without interference from other governments. Administrative independence is determined by having a popularly elected governing body, a governing body representing two or more local governments, or an appointed governing body that is substantially different from the creating government (US Census Bureau, 2019). The US Census Bureau notes that administrative independence is the key component. Units of government may have substantial fiscal independence but lack administrative independence; therefore, these units of government are classified as “dependent” or “subordinate agencies,” and their data is combined with the sponsoring unit of government. Data derived from the Census of Governments is one of the most popular datasets to analyze special districts. As noted above, the strict requirements for independence imposed by the US Census Bureau necessarily eliminate some special districts from the potential analysis. Leigland (1990) notes that the undercounting of dependent special districts is problematic because it hides some potentially beneficial activities (mainly, the oversight of special district spending or debt issuance by outside bodies) and also some potentially detrimental activities (the off-books circumvention of state rules on general-purpose governments). Because these dependent districts are enfolded into the sponsoring government for data purposes, it is impossible to examine them. Sacks (1990) responds by saying that the Census of Governments is the best data we have, and at the very least, it is consistent across states. Indeed, many states have their own, often statutory, definitions of independent and dependent special districts1 with little consistency across state lines. Many authors have noted the problems with the Census of Governments data as it pertains to the definition of special districts (see Foster, 1997, for a much-expanded explanation); however, it remains the case that the Census of Governments provides the only nationally comprehensive database of special districts and continues to dominate research to this day. Unique Features of Special Districts Beyond the data-specific definitions of special districts explained above, most special districts enjoy several features that set them apart from general-purpose local governments. Perhaps the prime feature distinguishing special districts from other local governments is their ability to take on nearly any geographic form. This extreme territorial flexibility can take multiple forms (Bollens, 1957). First, special districts are often used to solve cross-boundary issues at larger than the municipal scale. The demand for some local government functions does not necessarily perfectly align with existing municipal boundaries. In these cases, the ability of special districts to take on forms larger than a single unit of government provides the flexibility to solve public problems without necessarily engaging the lengthy (and uncertain) process of consolidating local governments.2 Second, special districts can be flexible tools for solving sub-municipal problems. Demand for public services is likely not uniform across space; therefore, some areas will demand more or different public services than others, even within the same municipality. The territorial flexibility of special districts can be used to provide some areas of a municipality   California and New York state are prime examples.   For example, the City of Macon and Bibb County, GA, consolidated in 2012; however, the first attempt at consolidation occurred in 1933 and subsequently in 1960, 1972, and 1976. 1 2

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with the services they demand without necessarily burdening the rest of the municipality with the cost of providing such services. Another unique feature is that many special districts fall outside the traditional restrictions imposed on general-purpose local governments (ibid.). This feature can include many different rules imposed by the state: tax and expenditure limitations (TELs), debt limits, or rules on creation. This feature makes special districts attractive means to circumvent the law (a concept I will return to in the next section) and makes their creation easier than general-purpose local governments. As Bollens (1957) notes, special districts are often exempt from requirements to have a minimum (aggregate) assessed value within their borders, minimum territorial size, or minimum population size – all common requirements for establishing new municipalities. Special districts are exempt from the one person/one vote requirements imposed on other local governments (Briffault, 1993; Burns, 1994).3 Because of this freedom, special districts are easier to create than general-purpose local governments and are often free of the legal restrictions defining municipal choices. Last, special districts often overlap other forms of local government, including other special districts (Berry, 2008; Bollens, 1957). The ability to overlap other local governments is related to territorial flexibility; however, it brings a distinct set of challenges. Residents consume public services in a bundled manner since the choice of a home brings with it a collection of overlapping jurisdictions (Berry, 2008). However, the financing of services from a variety of overlapping governments is unbundled – each individual government is independently setting their own tax rates. This situation leads to a potential fiscal common-pool problem, with many uncoordinated service providers taxing and spending on the same residents. Because each individual jurisdiction does not internalize the taxing and spending decisions of all the other jurisdictions, each jurisdiction can grow unnecessarily large, beyond what is socially optimal (ibid.). Many of these unique features contribute to the growth of special districts in the United States. Summary Statistics Special districts are the most common single form of local government in the United States. In addition to being the most common form of local government, special districts have proliferated over time. While many local governments have grown slowly or declined over the past 75 years, special districts have consistently increased in numbers over the same period. While growth has slowed in recent years (Figure 9.1), it shows little sign of completely stalling. There are currently (as of the US Census Bureau, 2017) 35,542 independent special districts (Table 9.1), and due to the issues outlined previously, this is a significant undercounting of all the special districts (independent or dependent) in the United States. It is clear from the data and the unique features of special districts that such districts are a popular means of solving public problems. Questions about the exact factors associated with the growth in special districts over time linger. Which factors are the most important?

3   Salyer Land Co v. Tulare Basin Water Storage District, 410 U.S. 719 (1973) and Ball v. James, 451 U.S. 355 (1981).

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Source:  US Census Bureau (2017).

Figure 9.1  US local governments over time Table 9.1  Local governments in the United States, 2017 Type Counties Municipalities Towns/townships Independent school districts Special districts Total Source:  US Census Bureau (2017).

Number 3,031 19,495 16,253 12,754 38,542 90,075

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INSTITUTIONS AND THEIR INFLUENCE ON SPECIAL DISTRICTS Burns (1994) sets out the modern understanding of essential factors in creating local governments. Burns argues that citizens, businesses, and other interest groups create special districts to access their powers to provide services. This process is fundamentally different from creating cities because cities have the power to zone and therefore the power to exclude individuals from their jurisdiction via the zoning code. For Burns, the actors involved are attempting to enshrine their private values into public institutions via the creation of new local governments. An allied perspective, building from the political economy approach of Burns, posits that the status of state rules about general-purpose local governments should influence the creation of special districts (Sbragia, 1996). By essentially adding another actor to Burns’s theory, general-purpose local governments may attempt to circumvent state laws restricting their autonomy by creating special ­districts – governments that often fall outside such restrictions. The lack of restrictions may make special districts more attractive as service delivery vehicles relative to their general-purpose cousins (Carr, 2006). Theoretical Perspectives Foster (1997) suggests that three groups are involved in creating a special district, and each must appropriately weigh the costs of creating such a government with the benefits derived. Local residents, the primary beneficiaries and funders of special district services, must trade the benefits of territorial flexibility and functional specialization with the costs of lower political accountability, visibility, and responsiveness. Foster argues similarly to Bollens (1957) that territorial flexibility can more closely match preferences for public services. The single-function nature of special districts leads them to focus more intensely on service provision and somewhat insulates them from service cuts that affect all services in a general-purpose local government (but are unrelated to the service). Overall, these lead to better-matched and potentially better public services for residents. To access these benefits, residents must accept that special districts are less likely to have elected boards than general-purpose local governments and have fewer incentives to respond to residents because of their relatively lower profile than general-purpose local governments. Local government (elected) officials, according to Foster (1997), must trade off several potential benefits – territorial flexibility, specialization, lower political visibility, and administrative and financial flexibility – with the cost of losing control of service delivery decisions. The primary motivation for elected officials is re-election. To the extent that some features of special districts can better provide public services or provide them political cover, these officials should benefit.4 For example, tax increases are often politically unpopular but may be vital for continuing service delivery. A tax increase by a ­general-purpose government is highly visible and may impose political costs; however, a similar tax increase by a special district may fly under the radar. Thus, exporting this

4   Importantly, there is little research on this exact topic. The effects discussed are theoretical in nature and likely vary widely.

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service to a special district can allow the service to continue unimpeded (satisfying residents) and minimize the cost to elected officials. However, local government officials must sacrifice direct control over service provision decisions. Control provides some benefits; therefore, this may be a trade-off officials do not want to make. Last, private developers use most of the features of special districts to attempt to maximize financial gains. According to Foster (1997), nearly all the facets of special districts (specialization, territorial flexibility, low political visibility, and financial and administrative flexibility) provide immense benefits; however, the one attribute that special districts do not have – the power over land-use decisions – may not be worth the trade-off. To the extent that private developers need access to land use decision-makers, a special district may not provide the necessary benefits for it to be worthwhile. However, if landuse decisions are not of concern, special districts provide many benefits to private developers to maximize profits. The desires of these three groups – residents, local officials, and private developers – form the core of how special districts are analyzed. Much of the literature focuses on local officials, and their potential desire to circumvent state laws; however, demands for services are often included. In the next section, I outline the empirical literature focusing on the circumvention argument. Empirical Evidence As Goodman and Leland (2019) explain, the literature examining the circumvention argument connecting state limitations on general-purpose local governments to special district creation, usage, and dissolution is inconsistent. This inconsistency is due mainly to many different measurement methods on both sides of the equation being inconsistent over time. As a result, the literature contains many different conclusions about circumvention. The literature overview is organized around different types of fiscal institutions that general-purpose local governments may seek to circumvent – TELs, debt limitations, and various forms of home rule.5 Table 9.2 summarizes all the findings discussed in the following paragraphs. Most credit MacManus (1981) with beginning the literature on circumvention (Carr, 2006; Goodman & Leland, 2019). MacManus examines the relationship between TELs and property-taxing special districts in metropolitan regions. She finds a positive relationship between the two, suggesting a circumvention-like relationship; however, the results are purely correlational. In what is likely the first regression-based analysis of fiscal institutions and special districts, Nelson (1990) finds a positive relationship between TELs imposed on municipal governments, and the number of special districts in a metropolitan area. McCabe (2000) finds results like Nelson (1990) using state-level data – there is a 5   The Advisory Commission on Intergovernmental Relations (ACIR, 1981) defines local autonomy as a four-dimensional concept – structural, functional, financial, personnel. Structural autonomy allows a local government to alter its charter or other founding documents with little interference from the state. Functional autonomy allows a local government to provide an array of services without the express permission of the state. Financial autonomy allows a local government to set tax, expenditure, and debt policies without interference from the state. And finally, personnel autonomy allows a local government to alter fundamental arrangements around personnel issues.

179

Count of special districts Tax limits; debt limits; COG; SMSAs (multiple aggregations) “broad home rule powers”

Count of special districts Tax limits; debt limits; COG; SMSAs (multiple aggregations) “broad home rule powers”

Log count of special districts

Fragmentation index

Newly created special districts

Count of special districts

Count of special districts Tax limits; debt limits, (multiple aggregations) structural home rule; functional home rule

Log count of special districts (special district DV)

Foster (1996)

Foster (1997)

Frant (1997)

Lewis (2000)

McCabe (2000)

Bowler and Donovan (2004)

Carr (2006)

Berry (2009)

Tax limits (institutional measure)

Tax limits

Tax limits; debt limits

Proposition 13

Debt limits

Debt limits

Count of state-level authorities

Bunch (1991)

Positive (when interacted with ease of initiative usage)

Positive (tax and debt limits)

No relationship

No relationship

Negative (property tax limits) Positive (debt limits; “broad home rule powers”)

Negative (property tax limits) Positive (debt limits; “broad home rule powers”)

Positive (general + revenue debt limits)

Positive (tax limits; structural home rule)

Positive (tax and debt limits)

1992–2002 Positive (though contingent on interaction of city and county variables)

1977–97

1977–92

1972–92

1982

1987

1987

1982

1982

1972–77

Result

COG; state (sample and unit 1942–2002 No relationship of analysis)

COG; state

COG; state

COG; state

COG; California counties

Modified COG; state

Moody’s, COG; state

COG; SMSAs

Tax limits; debt limits; structural home rule; functional home rule

Count of special districts

COG; Southern states; SMSAs

Sample and Unit of Analysis Date

Nelson (1990)

Institutional Measure Restrictions on property taxation; restrictions on borrowing

Special District DV

MacManus (1981) Property-taxing special districts

Authors

Table 9.2  Empirical studies of the impact of institutions on special district creation or reliance

180

Count of special districts Tax limits (multiple aggregations)

Newly created special districts

Newly created special districts

Count of special districts Tax limits (multiple aggregations)

Count of special districts Tax limits; debt limits; COG; state (multiple aggregations) “broad home rule powers”

Share of special district spending

Special district expenditure per capita

Newly created special districts

Newly created special districts

Billings and Carroll (2012)

Bauroth (2015)

Leon-Moreta (2017)

Shi (2017)

Goodman (2018)

Shi (2018)

Goodman and Leland (2019)

Park and Park (2021)

Positive (though contingent on interaction of city and county variables)

Positive (though moderated by interaction with functional home rule)

1972–2002 No relationship

1972–2007 Positive (taxing districts)

1997–2007 Positive (revenue limits) Negative (revenue limits for larger districts; debt limits)

COG; counties

1977–2012 Positive

COG; urban counties; MSAs 1972–2012 Conditional (tax limits; functional home rule for cities)

1962–2012 Positive (tax limits [expenditures]; debt limit [outstanding debt]) Negative (home rule [expenditures])

COG; counties (border pairs) 1972–2012 Negative (municipal debt limits)

COG; counties

COG; counties

Note: DV = dependent variable; COG = Census of Governments; SMSA = Standard Metropolitan Statistical Area; MSA = Metropolitan Statistical Area.

Tax limits

Tax limits; debt limits; functional home rule

2002

2002–07

Result

State of Colorado; Colorado 1993–2004 No relationship counties

Tax limits; debt limits; COG; state “broad home rule powers”

Tax limits; debt limits; functional home rule

Tax limits; debt limits; functional home rule

Successful Taxpayer Bill of Rights (TABOR) override votes

COG; counties

COG; counties

Carr and Farmer (2011)

Tax limits; debt limits, structural home rule; functional home rule

Count of special districts

Sample and Unit of Analysis Date

Farmer (2010)

Institutional Measure

Special District DV

Authors

Table 9.2 (continued)

The role of special districts and intergovernmental constraints  ­181

positive correlation between TELs (imposed on both cities and counties) and the creation of new special districts in a state. This finding extends Nelson (1990) to include limits on counties, and the findings still hold. Leon-Moreta (2017) finds general limitations (applied to revenues or expenditures) on cities and counties associated with increased taxing special districts over the 1972­–2007 period. Last, Park and Park (2021) find TELs positively associated with special district creation, and the effect is more pronounced for highly asset-specific special districts (those with assets not easily transferred to other uses). This finding suggests that TELs on general-purpose local governments push more expensive and specialized functions onto special districts. The remaining positive findings are contingent upon the interaction between two factors. Carr (2006) finds a positive relationship between TELs imposed on cities and the number of special districts in a state across several aggregations and subtypes; however, when the independent variable is interacted with TELs imposed on counties, the results change. The interaction term is negative, suggesting a slight decline in the relationship previously found, although the overall positive finding survives. Carr and Farmer (2011) find similarly contingent results; however, the results are most pronounced for countywide special districts. When both cities and counties are fiscally restricted, the number of countywide special districts increases. Farmer (2010) finds a contingent relationship between TELs and special districts; however, the contingency is with functional home rule. The results are like previous findings – TELs increase special districts, but the ability of counties to provide additional services moderates this effect. Goodman and Leland (2019) echo these results, finding a contingent TEL × functional home rule relationship for cities. For cities with broad functional home rule, the imposition of a TEL significantly increases the number of special districts created in an urban county or metropolitan area. Foster (1996, 1997) finds a negative relationship, pushing against the circumvention argument, between moderate to heavy property tax limits and the usage of special districts without property-taxing powers in metropolitan areas. There is no relationship between such variables and special districts with property-taxing powers. Bauroth (2015) finds similar results. While he finds a positive association between property tax revenue limits on cities and new special districts, the results are uniformly negative when special districts are broken down by size. Property tax rate limits are associated with fewer new small special districts, and property tax revenue limits are associated with fewer new large special districts. Last, Berry (2009), Billings and Carroll (2012), Lewis (2000), and Shi (2017) find no relationship between TELs and special district creation. The empirical literature on debt limits begins with Bunch (1991). Bunch finds a positive relationship between general obligation and revenue debt limits and the number of state public authorities (state-level special districts). Foster (1996, 1997) corroborates this finding at the local level, finding that moderate to heavy debt limits are positively associated with sub-county special districts. McCabe (2000) finds further evidence of a positive relationship between debt limits and special district creation. More recently, Shi (2018) finds debt limits positively associated with the level of special district debt, suggesting that general-purpose local governments use special districts as a mechanism to circumvent debt limits. The literature is not uniformly behind the idea that debt limits increase special district usage. Bauroth (2015) finds a negative relationship between local bond referendum

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requirements and special district creation. Goodman (2018) echoes this finding, and finds a similarly negative relationship between debt limits imposed on counties and special district reliance. Frant (1997) finds no empirical relationship between debt limits and special district creation. As with the TEL-based circumvention literature, the findings for debt limits are similarly mixed. Consistent with the previous two kinds of institutions discussed, the influence of ­general-purpose local governments’ functional6 or structural7 home rule powers on special district creation is mixed. Nelson (1990) is among the first to analyze this question. He finds a positive relationship between structural home rule and special districts in a metropolitan area. This finding is the opposite of the circumvention argument – additional home rules should reduce the need for special districts. There is no relationship between functional home rule and special districts. Foster (1996, 1997) focuses on municipalities’ functional home rule powers. She finds a positive relationship between functional home rule and special districts, particularly for regional and sub-county special districts. Goodman (2018) finds no relationship between the functional home rule of cities or counties and the reliance of special districts in border county pairs. The remaining findings are conditional with functional home rule interacted with TELs. Farmer (2010) finds broad functional home rule positively associated with the count of special districts in a county; however, restrictions on the number of services counties are allowed to provide (essentially a limitation on functional home rule) are positively associated with special districts. The latter finding is consistent with circumvention. The interaction between TELs applied to counties and limitations on service choices is negative; increasing constraints on service choices lead to higher special district formation in the face of TELs. Goodman and Leland (2019) echo this latter finding. They find that when cities in an area have broad functional home rule, the imposition of a potentially binding TEL leads to the creation of new special districts. Last, Shi (2018) finds that the home rule powers of cities and counties decrease the spending of special districts. This finding is consistent with the circumvention argument. Overall, the older literature in this area finds a positive relationship between home rule and special districts, consistent with the circumvention argument. More recent analyses find just the opposite. Home rule powers of general-purpose local governments are negatively associated with special district creation; however, this relationship is often contingent on the fiscal restrictions applied to ­general-purpose governments.

FURTHER INFLUENCES ON FISCAL POLICY The influence of special districts on various fiscal outcomes is as scattered as the influence of fiscal institutions on special districts. Goodman (2019) notes that this is primarily the result of a lack of agreement in the extant literature on measuring special districts. Each analysis operationalizes special districts in a slightly different manner, making tracking findings over time difficult. Theoretically, there are two camps on how special districts   Functional home rule is the power to choose which services a government will provide.   Structural home rule is the power to alter the fundamental governing documents of ­organization such as the charter. 6 7

The role of special districts and intergovernmental constraints  ­183

influence fiscal outcomes. The institutionalists, who generally advocate for fewer, larger local governments, suggest that special districts are a source of duplication and inefficiency in the public service landscape; therefore, per capita expenditures (and by association, revenues) will be higher than they would otherwise be (ibid.). The polycentrists, who generally advocate for more, smaller local governments, suggest that special districts are a source of efficiency due to their functional specialization and ability to cross traditional political boundaries and should at least have no influence on per capita spending (Hall et al., 2018).8 The most common means of measurement of special districts in this literature is special districts per capita. Some scholars criticized this measure as not wholly capturing the overlapping nature of special districts; however, it is the most consistently used and allows for tracking over time. In general, the relationship between special districts per capita and per capita (all government) spending at the local level is positive (Goodman, 2015; Hendrick et al., 2011; Stansel, 2006; Zax, 1988). Another common measure – the share of special districts as a percentage of all local governments – is typically unrelated to per capita spending (Goodman, 2015; Hendrick et al., 2011). These results suggest that the proliferation of special districts is not a source of efficiency or spending restraint. Instead, the uncoordinated nature of many overlapping jurisdictions leads to duplication and other inefficiencies that drive up the per capita cost of local government. Examining the overlap issue more specifically, Berry (2008, 2009) attempts to directly measure special district overlap by operationalizing the concept as special districts ÷ ­municipalities within a county. While this operationalization does not measure overlap precisely (some classes of special districts do not overlap, for example), it attempts to eliminate the problems with prior operationalizations. Berry’s findings corroborate the prior findings; an increase in special district overlap is associated with increased per capita revenues and per capita current expenditures. Furthermore, these findings hold when applied to common-function expenditures, which are frequently provided by local governments across the US, suggesting that special districts are used to increase the spending of core local government functions rather than capital spending or more heavily specialized spending. Taken together, the results presented in this section suggest that special districts generally increase overall local government spending. The likely cause is inefficiency. As Berry (2008) explains, single-function governments face no internal budgetary competition for spending; therefore, spending can grow inefficiently large relative to a multi-function municipality. The size of the inefficiency need not be large as it compounds across many special districts in an area. The individual inefficiency may be slight, but the compounded inefficiency can add up to more spending than would otherwise occur.

8   This general argument has been covered many times in the extant literature. See Goodman (2019); Hall et al. (2018); Jimenez and Hendrick (2010); Kim and Jurey (2013); or McCabe (2004) for a full description.

184  Research handbook on city and municipal finance

DISCUSSION AND CONCLUSION This chapter asks two primary questions: why do special districts exist, and what are the effects of such a governance arrangement? Special districts have many unique features that make them attractive to myriad actors at the local level. Their territorial flexibility allows them to tackle problems that are extra-municipal, intra-municipal, and everywhere in between. Districts’ exemption from many state laws governing the fiscal affairs of general-purpose local governments makes them attractive vehicles to avoid such restrictions. Last, their overlapping nature allows for many different combinations of public services in an area. To access these attributes, local actors must weigh the costs and benefits. Increasing the complexity, different actors face different costs and benefits (more specifically, the different factors may be a cost or a benefit depending on the actor). This feature necessarily leads to some disagreement among actors. The answer to the second question focuses squarely on the local official, who often wishes to circumvent restrictions placed on them by the state. If local officials wish to continue to provide public services at the current level and are willing to sacrifice some decision-making power to do so, special districts provide an attractive alternative. The literature is somewhat mixed on this question. Different forms of restrictions on generalpurpose local governments influence the creation of special districts in different ways. The more modern literature from the last decade trends toward a contingent explanation – combinations of restrictions matter for special district creation. This situation could take the form of multiple simultaneously restricted local actors, increasing the usefulness of special districts (Carr & Farmer, 2011). Alternatively, it could take the form of restricting certain local government types in multiple ways, typically fiscally and functionally, and special districts become a valuable tool to continue to provide public services (Goodman & Leland, 2019). Either explanation ultimately legitimizes Burns’s (1994) claim that special districts exist to access the services they provide. The connection between circumvention and fiscal outcomes is important. If state policy (or combinations of state policy) is driving the creation of special districts, the fiscal outcome of this relationship is negative for taxpayers. The proliferation of special districts is associated with higher per capita spending, inefficiently higher than would likely occur in multi-function general-purpose local governments. The second-order effects of state policy should concern state policymakers. If the intended effect of restricting generalpurpose local government is to restrain the growth of local government, circumvention via special district does not achieve the goal. The growth of local governments continues, only in a different form. Similarly, it is unlikely that higher than expected spending is the goal of fiscal restrictions on local governments. What is largely missing from this literature is a discussion of mechanisms. In the face of fiscal restrictions, which functions are more likely to be transferred to special districts? Park and Park (2021) begin this conversation by analyzing special districts by their asset specificity and service measurability, but more work is necessary. Much of this work needs to be done at the individual state level, focusing on individual restrictions. No two TELs or debt limits are precisely alike, and no two states have the same enabling legislation for special districts. Similarly, each state has its own local government culture (or cultures) that makes these decisions unique. State-level analyses should also allow data quality issues to be solved more readily. Overall, the future of special

The role of special districts and intergovernmental constraints  ­185

district research is likely at the state level, barring a significant change in federal data collection practices.

REFERENCES Advisory Commission on Intergovernmental Relations (ACIR). (1981). Measuring local discretionary authority. Government Printing Office. Bauroth, N. G. (2015). Hide in plain sight: The uneven proliferation of special districts across the United States by size and function. Public Administration Quarterly, 39(2), 295–324. Berry, C. (2008). Piling on: Multilevel government and the fiscal common-pool. American Journal of Political Science, 52(4), 802–820. Berry, C. R. (2009). Imperfect union: Representation and taxation in multilevel governments. Cambridge University Press. Billings, S. B., & Carroll, D. A. (2012). “Debrucing” the link between tax and expenditure limits and special district governments. Growth and Change, 43(2), 273–303. Bollens, J. C. (1957). Special district governments in the United States. University of California Press. Bowler, S., & Donovan, T. (2004). Evolution in state governance structures: Unintended consequences of state tax and expenditure limitations. Political Research Quarterly, 57(2), 189–196. Briffault, R. (1993). Who rules at home? One person/one vote and local governments. The University of Chicago Law Review, 60(2), 339–424. Bunch, B. S. (1991). The effect of constitutional debt limits on state government use of public authorities. Public Choice, 68(1), 57–69. Burns, N. (1994). The formation of American local governments: Private values in public institutions. Oxford University Press. Carr, J. B. (2006). Local government autonomy and state reliance on special district governments: A reassessment. Political Research Quarterly, 59(3), 481–492. Carr, J. B., & Farmer, J. L. (2011). Contingent effects of municipal and county TELs on special district usage in the United States. Publius: The Journal of Federalism, 41(4), 709–733. Farmer, J. L. (2010). Factors influencing special purpose service delivery among counties. Public Performance & Management Review, 33(4), 535–554. Foster, K. A. (1996). Specialization in government: The uneven use of special districts in metropolitan areas. Urban Affairs Review, 31(3), 283–313. Foster, K. A. (1997). The political economy of special-purpose government. Georgetown University Press. Frant, H. (1997). Reconsidering the determinants of public authority use. Journal of Public Administration Research and Theory, 7(4), 571–590. Goodman, C. B. (2015). Local government fragmentation and the local public sector. Public Finance Review, 43(1), 82–107. Goodman, C. B. (2018). Usage of specialized service delivery: Evidence from contiguous counties. Publius: The Journal of Federalism, 48(4), 686–708. Goodman, C. B. (2019). Local government fragmentation: What do we know? State and Local Government Review, 51(2), 134–144. Goodman, C. B., & Leland, S. M. (2019). Do cities and counties attempt to circumvent changes in their autonomy by creating special districts? The American Review of Public Administration, 49(2), 203–217. Hall, J. C., Matti, J., & Zhou, Y. (2018). Regionalization and consolidation of municipal taxes and services. Review of Regional Studies, 48(2), 245–262. Hendrick, R. M., Jimenez, B. S., & Lal, K. (2011). Does local government fragmentation reduce local spending? Urban Affairs Review, 47(4), 467–510. Jimenez, B. S., & Hendrick, R. M. (2010). Is government consolidation the answer? State & Local Government Review, 42(3), 258–270.

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Kim, J. H., & Jurey, N. (2013). Local and regional governance structures: Fiscal, economic, equity, and environmental outcomes. Journal of Planning Literature, 28(2), 111–123. Leigland, J. (1990). The Census Bureau’s role in research on special districts: A critique. Political Research Quarterly, 43(2), 367–380. Leon-Moreta, A. (2017). Special district formation: Evidence from panel data. Public Administration Quarterly, 41(3), 462–495. Lewis, P. G. (2000). The durability of local government structure: Evidence from California. State and Local Government Review, 32(1), 34–48. MacManus, S. A. (1981). Special district governments: A note on their use as property tax relief mechanisms in the 1970s. The Journal of Politics, 43(4), 1207–1214. McCabe, B. C. (2000). Special-district formation among the states. State & Local Government Review, 32(2), 121–131. McCabe, B. C. (2004). Special districts: An alternative to consolidation. In J. B. Carr & R. C. Feiock (Eds.), City-county consolidation and its alternatives: Reshaping the local government landscape (pp. 131–152). Routledge. Nelson, M. A. (1990). Decentralization of the subnational public sector: An empirical analysis of the determinants of local government structure in metropolitan areas in the U.S. Southern Economic Journal, 57(2), 443–457. Park, H., & Park, H. J. (2021). Outsourcing services: A theory of special district incorporation. Public Performance & Management Review, 44(6), 1215–1238. Sacks, S. (1990). “The Census Bureau’s role in research on special districts: A critique”: A necessary rejoinder. Political Research Quarterly, 43(2), 381–383. Sbragia, A. M. (1996). Debt wish: Entrepreneurial cities, U.S. federalism, and economic development. University of Pittsburgh Press. Shi, Y. (2017). The rise of specialized governance in American federalism: Testing links between local government autonomy and formation of special district governments. Publius: The Journal of Federalism, 47(1), 99–130. Shi, Y. (2018). An empirical assessment of local autonomy and special district finance in the U.S. Local Government Studies, 44(4), 531–551. Stansel, D. (2006). Interjurisdictional competition and local government spending in U.S. metropolitan areas. Public Finance Review, 34(2), 173–194. US Census Bureau (2017). 2017 Census of Governments – organization [Tables]. https://www.census. gov/data/tables/2017/econ/gus/2017-governments.html. US Census Bureau (2019). Individual state descriptions: 2017 [Released April 2019]. https://www. census.gov/content/dam/Census/library/publications/2017/econ/2017isd.pdf. Zax, J. S. (1988). The effects of jurisdiction types and numbers on local public finance. In H. S. Rosen (Ed.), Fiscal federalism: Quantitative studies (pp. 79–106). University of Chicago Press.

10.  Municipal financial risks: special-purpose district financial health during COVID-19 Temirlan T. Moldogaziev, Marc Joffe, and Allan Wheeler

INTRODUCTION Special-purpose districts (SPDs) are organized around narrow service delivery tasks and are ubiquitous at the municipal level in the United States (Goodman, 2015, 2019; Trussel & Patrick, 2013). Often, SPDs are legally and administratively separated from generalpurpose governments (states, counties, or cities), with their own service and fiscal authority, though the degree of political separation is altogether a separate matter and may vary from one jurisdiction to another. A proliferation of specialized organizational forms of governance at the local level has also been observed in many other countries, specifically tied to top-down decentralization processes (AbouAssi & Bowman, 2017; Awortwi & Helmsing, 2014), as well as to bottom-up urban and regional development strategies (Arase, 1999; Hooghe & Marks, 2003; Judd & Smith, 2007). Overall, SPDs are not a monolithic form of a specialized local governance regime – task environments and institutions, including political and policy considerations at the local level, may play a significant role in actual financial outcomes for SPDs. The use of SPDs, therefore, is not unusual or special in the delivery of key municipal government services. In recent years, the public finance literature has seen an uptick in municipal financial distress and default research, especially since the financial crisis of 2008–09 (e.g., Barbera et al., 2016; Canuto & Li, 2010; Coe, 2008; Yang, 2019a; Yang & Abbas, 2020). Municipal general-purpose government financial distress studies emerged from both the US context (Clark, 2015; Gorina et al., 2018; Kloha et al., 2005; Levine et al., 2012; Maher, Oh & Liao, 2020; Rivenbark et al., 2010; Trussel & Patrick, 2009) and elsewhere around the world (Brusca et al., 2015; Carmeli, 2008; Czupich, 2020; García-Sánchez et al., 2012; Jones & Walker, 2007). However, studies of municipal special-purpose government financial distress continue to be primarily from the United States (Jones, 1984; Kim & Sorensen, 2019; Kovari, 2020; Racheva-Sarabian et al., 2015; Trussel & Patrick 2013). This is consistent with the fact that over 50 000 special-purpose governments exist in the US (Goodman, 2019; Johnson et al., 2021a). In general, the literature on municipal financial health or risks tends to focus on municipal governments on a piecemeal basis (i.e., “industry” by “industry” basis, whether focusing exclusively on cities, counties, airport authorities, or municipal utility districts, etc.). On the other hand, studies that focus on general-purpose governments vs SPDs do not always invest in evaluating the critical distinctions between and within their types. When this is done, major governance and institutional factors in organizational contexts could be ignored, and so the generic municipal financial risk variables must be tested against different types of SPDs. This is not to say that there is unlikely to be an overlap in municipal financial health measures between different types of municipal organizational forms; 187

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rather, what could work as a good measure of financial risk for one municipality type may need to be tested for fit and appropriateness for another type. We do so with an eye on the distinct task and policy environments of community college districts (CCDs) and healthcare districts (HCDs) in California during the first year of the COVID-19 pandemic. As special forms of local public education service delivery, the CCDs in California are offering services to about 1.8 million students from 116 campuses around the state.1 While each CCD is legally a separate entity from the state and local governments, governed by a locally elected board of trustees, the overall system is overseen by a political subunit of California. This does not mean that the state extends its full-faith-and-credit (unlimited and unconditional) support to CCDs, yet it can be viewed as a form of a moral support obligation. Proposition 98 sets out certain support levels for K-14 education in California, which includes community college education.2 Full- and part-time employees of CCDs also have access to California’s pension and post-employment benefit schemes.3 HCDs in California were created to offer services in communities with insufficient healthcare provider coverage, primarily in rural areas.4 They are governed by an elected board of trustees. Though HCDs may be subject to oversight from county governments, such oversight does not mean that there is full-faith-and-credit support from a county government to a district. At the same time, changes in health insurance provision in the Affordable Care Act in the US offered important changes to revenues of HCDs in California, increasing resources through an expansion of the Medicaid program to eligible patients. Both CCDs and HCDs in California were directly affected by the pandemic, albeit in distinct ways. Healthcare organizations, whether private or public, are at the forefront of combating the COVID-19 pandemic (Azar et al., 2020; Devereaux et al., 2022; Myers et al., 2020). Financially speaking, such a colossal effort requires resources from all sources – not only for HCDs to meet current service demands but to survive. Community colleges, on the other hand, felt the largest impact of the pandemic through the loss of student enrollment and the loss of ability to pay among those who were already enrolled in different degree programs (Brymner, 2020; Bulman & Fairlie, 2021). This, added to the need to facilitate courses on virtual or hybrid instructional platforms – an issue faced by all educational institutions in California and elsewhere, required the use of all possible resources to weather the brunt of the pandemic and to ensure subsequent organizational survival (Harper, 2020; Hart et al., 2021).

SPECIAL-PURPOSE DISTRICTS AND FINANCIAL DISTRESS Measurement and timely detection of financial risks is critical for the management of public sector organizations. This is especially true for SPDs delivering critical social services. The immediate and most direct impact of COVID-19 on local government finances   Additional details on California CCDs are available at https://www.cccco.edu/.   Additional details on Proposition 98 in California are available from https://lao.ca.gov/2005/ prop_98_primer/prop_98_primer_020805.htm. 3   Additional details on California State Teachers Retirement System (CalSTRS) are available from https://www.calstrs.com/calstrs-at-a-glance. 4   Additional details on California HCDs are available from https://www.achd.org/achd-message. 1 2

Special-purpose district financial health during COVID-19  ­189

has been evaluated both in the context of the US and other countries (Acharya et al., 2021; Ahrens & Ferry, 2020; Dzigbede et al., 2020; Maher, Hoang & Hindery, 2020; Padovani & Iacuzzi, 2021). Other research shows the steps and coordination efforts that central governments took to help local governments to deal with the pandemic, especially with financial resources (Huang, 2020; Nemec & Špaček, 2020). Evidence on whether and how any of these efforts had an impact on SPDs’ financial health is only now ­emerging. Composite models of general-purpose local government fiscal distress have existed for several decades (e.g., Clark, 2015; Coe, 2007; Kloha et al., 2005), as has the related literature on government defaults and bankruptcies. The latter offers descriptive and historical reviews of local government default types and bankruptcies (Landry & Landry, 2009; Lewis, 1994; McConnell & Picker, 1993; Tung, 2002; Yang & Abbas, 2020), while empirical research offers evidence on antecedents of bankruptcies and fiscal defaults of both general- and special-purpose governments (Gillette, 2012; Joffe, 2012; Landry & Landry, 2009; Racheva-Sarabian et al., 2015). The literature on fiscal defaults and bankruptcies also offers evidence on fiscal and financial outcomes of such extreme events (De Angelis & Tian, 2013; Moldogaziev et al., 2017; Yang, 2019a, 2019b). An article by Trussel and Patrick (2013)5 presents a fiscal distress model designed specifically for SPDs, in which the authors report addressing differences in district functions, sources of district financing, and legislation governing them. While certainly an improvement from previous models, the approach in the article is based on a short- to medium-term fiscal horizon, judging by the operationalization of fiscal distress as three consecutive years of operating deficits exceeding 5 percent of total revenues. In broader accounting research, such analyses of fiscal distress are generally known as the commonsize analysis studies. The key conclusion in this research is that “the most important indicator of fiscal distress is a low level of capital expenditures relative to total revenues and bond proceeds” (Trussel & Patrick, 2013, p. 589). Specifically, with regard to both public and private institutions of higher education, including CCD financial risk, a Composite Financial Index (CFI) has been developed and used by the Council of Independent Colleges (e.g., Chessman et al., 2017). First developed in the early 1980s, the CFI seeks to offer managers and policymakers a framework for a relatively comprehensive tool to understand (the components of) organizational financial risks and means to plan for solutions and communicate financial information to key stakeholders. The appeal of this measure is that it can address organizational solvency with regard to operating needs, non-operating needs, long-term obligations, and the return on assets. This index has been applied outside the US as well (Mavlutova & Ziemele, 2012; Mohanlingam & Linh, 2013). Mohanlingam and Linh (2013) reviewed the financial health of Australian universities post-2008 financial crisis and concluded that no adverse effects were felt by them in the aftermath of the crisis. They wrote: The findings show that most universities in Australia had strong financial health in 2011 indicating that there has been no adverse financial impact due to unfavorable events. Further, the study also reveals that financial health of Australian universities in 2011 was not influenced by factors 5   The focus in Trussel and Patrick (2013) is on indicators of revenue size, revenue risk, revenue concentration, capital balance, debt to cash and debt to revenues ratios.

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such as university size, rank of university, ratio of international students, ratio of graduate students, number of undergraduate programs offered, number of graduate programs offered, number of employees, ratio of teachers, and ratio of staff. (Mohanlingam & Linh, 2013, p. 67)

With regard to healthcare sector organizations, numerous studies exist on the measurement of financial risk (Holmes et al., 2013; Kim, 2010; Ozmeral et al., 2012; Pink et al., 2006; Ramamonjiarivelo et al., 2014; Zinoviev et al., 2020). Suarez et al. (2011) offered a review of financial indicators used in the literature and advocated for their adoption by local public health agencies. However, given dozens of indicators that have been in use, Zinoviev et al. (2020) reviewed over 200 financial indicators and produced a Yale Hospital Financial Score. The most prominent of these financial indicators boil down to profit margin, returns on assets and equity, debt burden measures, and cash flow factors.

DATA AND MEASUREMENT OF THE COMPOSITE FINANCIAL INDEX We evaluate financial risk for two types of special-purpose governments in California – CCDs and HCDs. There are 73 CCDs and 79 HCDs in California, both ostensibly organized around important (social policy-oriented) service delivery tasks. Annual Comprehensive Financial Reports (ACFRs) for all 73 CCDs are available for FY2019 and FY2020. However, for HCDs, only 48 districts (61 percent of the total population) provided their ACFR, either on their webpages or in response to our requests.6 Using district- and context-level data for FY2019 and FY2020, we evaluate the SPD financial risk factors for a panel of 242 CCD- and HCD-year observations. Users of financial information in ACFRs, however, must consider the latest recommended accounting practices relevant to special-purpose organizations. A key consideration is to account for component units of CCDs and HCDs. In several cases in the sample, an ACFR already contains aggregated financial information. When SPD component units exist and aggregated values are not reported, we collect data on such units and aggregate them with the core SPD financial data. We must also consider the role of other post-employment benefits (OPEBs) and pension obligations for alternative specifications of long-term liabilities. This is directly relevant to CCDs, which have access to state pension and post-employment social security schemes that are not available to HCDs.7

6   Many HCDs do not meet thresholds for filing ACFRs that include issuing municipal bonds and/or expending more than US$750 000 of federal grant funds annually. HCDs that do not meet ACFR filing requirements are often those that have sold their hospitals to private operators and provide relatively limited services to district area residents. 7   A discussion of how accurately or diligently CCDs or HCDs in California follow Governmental Accounting Standards Board (GASB) standards is beyond the scope of this chapter. Overall, CCDs report financial information that is comparable. Some HCDs, about 10 percent in the included sample, appear to follow GASB standards of reporting. While this may create issues for comparability of individual asset and liability items between HCDs, we believe that the reported totals are sufficient for the construction of financial ratios we utilize in CFI.

Special-purpose district financial health during COVID-19  ­191

The CFI for CCDs, which we also apply to HCDs for consistency and comparability, is of the form expressed in equation (10.1). This measure is a composite metric of financial risk that combines the strengths and the weak spots along several core financial indicators, each addressing a critical financial management objective. In a nutshell, the CFI seeks to find a reasonable balance between concerns for operating solvency, non-operating solvency, long-term solvency, and the return on assets. Care should also be given to the question of what should (or should not) be measured when individual financial ratios comprising the CFI are computed. “This combination, using a reasonable weighting plan, allows a weakness or strength in a specific ratio to be offset by another ratio result, thereby allowing a more holistic approach to understanding the institution’s total financial health” (Chessman et al., 2017, p. 35, citing Tahey et al., 2010, emphasis added). We remind scholars and policymakers that they must determine what “a reasonable weighting plan” is, considering heterogeneity in service environments and institutions of SPDs they seek to evaluate. For weight factors presented below, we follow the convention established in the industry for assessing financial resiliency of institutions of higher education both in the US and elsewhere: PR​R​  ​​ Strengt​hPR​ ​  R​  ​​ ​​ × Weigh​tPR​ ​  R​  ​​​​

V​R​  ​​ Strengt​hV​ ​  R​  ​​ ​​ × Weigh​tV​ ​  R​  ​​​​

it it      ​ CF​Iit  ​  ​​  = ​ ____________________        ​  + ​ ___________________       ​​ it

it

it

it

ROA​Rit​  ​​ NO​RR​ it​​ ______________________   ​ +       ​   ​ + ​ ______________________        ​​ Strengt​hROA​ ​  R​  ​​ ​​ × Weigh​tROA​ ​  R​  ​​​​ Strengt​hNO​ ​  RR​  ​​ ​​ × Weigh​tNO​ ​  RR​  ​​​​ it

it

it

(10.1)

it

In equation (10.1), ​PR​Rit​  ​​​is the primary reserve ratio rescaled by a strength factor of 0.133 and the weight factor of 0.35. The main role of this measure is to offer information on whether an SPD has sufficient and flexible resources to meet its primary functions. Since the operations of SPDs are highly capital intensive (Mullin, 2009; Scott et al., 2018), the resources required for them must be sufficient to meet both operating and capital needs. “The Primary Reserve Ratio (PRR) measures the financial strength of the institution by comparing expendable net assets to total expenses. Expendable net assets represent those assets the institution can access quickly and spend to meet its operating and capital requirements” (Chessman et al., 2017, p. 32). Service environments and institutions, however, can either enable or constrain an SPD’s ability to access expendable, unrestricted assets. Equation (10.2) that estimates ​PR​Rit​  ​​​ is presented below: U​D​  ​​ + RN​P​  ​​

it it  ___________ ​ PR​Rit​  ​​  = ​        ​​, TO​E​  ​​ + IEC​D​  ​​ + TF​F​  ​​ it

it

it

(10.2)

where ​U​Dit​  ​​ ​is the unrestricted deficit (or surplus); ​RN​Pit​  ​​ ​is the restricted net position excluding capital (plant); ​TO​Eit​  ​​ ​is the total operating expense; ​IEC​Dit​  ​​  ​is the interest expense on capital related debt; and T ​ F​Fit​  ​​ ​is the transfer flow to fiduciary funds. Next, equation (10.3) estimates V ​ ​Rit​  ​​​, which is the viability ratio with a strength factor of 0.417 and the weight factor of 0.35. VR focuses on the debt management function of an SPD, including its long-term lease and contract obligations. An important policy consideration here is the inclusion of long-term liabilities such as the pension liabilities and OPEBs. It is also worth noting that although greater levels of debt represent a risk to fiscal sustainability, maintaining a low debt burden is not necessarily a good financial

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practice, especially if primary reserves are restricted, capital expenditures are limited, but demand for infrastructure as part of an SPD’s core service responsibilities remains. “The Viability Ratio is a statement of net assets or balance sheet measure that indicates debt capacity and generally is regarded as governing the institution’s ability to issue new debt” (ibid., p. 12): U​D​  ​​ + RN​P​  ​​

it it  ​ V​Rit​  ​​  = ​ ___________  ​​,     LT​L​  ​​ it

(10.3)

where ​U​Dit​  ​​ ​is the unrestricted deficit (or surplus); ​RN​Pit​  ​​ ​is the restricted net position excluding capital (plant); and L ​ T​Lit  ​  ​​​is the combined current and non-current portions of long-term liabilities, excluding OPEBs and pensions. Equation (10.4) estimates the ​ROA​Rit​  ​​​component, or the return on assets ratio with a strength factor of 0.020 and the weight factor of 0.20. The return on assets ratio focuses on an SPD’s asset management and performance. Due to generally higher capital intensity levels of SPD operations, decreases or increases in net assets will directly impact their overall ability to meet service needs. The return on assets ratio, however, must be considered in the context of factors such as the age and maintenance of facilities, facilities burden, as well as continued replacement and reinvestment in capital facilities and equipment. At the least, this ratio should show whether an SPD is continually replacing its physical assets to meet its critical operating needs: dN​P​  ​​

it  ​ ROA​Rit​  ​​  = ​ _  ​​  , N​P​  ​​ it 

(10.4)

where d​ N​Pit  ​  ​​​is the change in net position, while​ N​Pit​  ​​ ​is the net position in the beginning of the fiscal year. Finally, equation (10.5) estimates N ​ O​RR​ it​​​, which is the net operating revenues ratio with a strength factor of 0.007 and the weight factor of 0.10. The role for this ratio is straightforward, as it seeks to show whether an SPD is operating within available resources: ​(O​Lit​  ​​ + IEC​Dit​  ​​ + TF​Fit​  ​​)​ + TNO​Rit​  ​​ ___________________________ ​ NO​RR​ it​​  = ​         ​​, TO​R​  ​​+ TNO​R​  ​​ it 

it

(10.5)

where ​O​Lit​  ​​ ​is the operating loss (or gain); ​IEC ​Dit​  ​​​is the interest expense on capital-related debt, as before; ​TF​Fit​  ​​ ​is the transfer flow to fiduciary funds; while ​TO​Rit​  ​​ ​is the aggregate of operating revenues; and T ​ NO​Rit​  ​​ ​is the aggregate of non-operating revenues. A positive operating surplus will generally mean that other components of the overall composite financial risk measure will be positive. An important backdrop for consideration here is the source of revenues (own-source fees and revenues vs third party contributions) and the distribution of revenues by operating expense categories. We note that the strength factors for each component of CFI serve for rescaling purposes. After bringing the four components to a comparable scale, the policy task is to decide how much weight each should have in the composite index. We reiterate once more that given task and policy environments specific to SPDs, as well as for robustness and sensitivity purposes, a variety of reasonable and sensible weights should generally be tested in addition to the weights reported above.

Special-purpose district financial health during COVID-19  ­193

THE COMPOSITE FINANCIAL INDEX MEASUREMENT RESULTS The CFI for CCDs and HCDs, stated in equation (10.1), is presented in Figure 10.1 for FY2019 and FY2020, respectively. When comparing Panels A and B, one can observe that, financially speaking, there are fewer SPDs in severe financial condition in FY2020 than in FY2019. Generally, there appear to be more CCDs with very severe financial health relative to HCDs in both 2019 and 2020. On the flip side, there are more exceptionally healthy HCDs vs CCDs in both fiscal years. When the same comparisons are completed by adding OPEBs and pension liabilities in the CFI (added in the VR estimates) the same observations remain, as seen in Panels C and D. Figure 10.1, Panels C and D, offers additional insights, however. The inclusion of OPEBs and pension liabilities in the CFI does not appear to augment financial risks of SPDs in severe financial condition (or draw down those with exceptional financial health). The overall conclusion is that SPD financial risks for California CCDs and HCDs are unaffected by the inclusion of such outstanding fiduciary obligations. There are very few outliers to this, as seen in Figure 10.2. In terms of substantive changes, Los Angeles CCD and Alameda Health System HCD appear to benefit from the inclusion of OPEBs and pension fiduciary positions. The correlation between the CFI without and with OPEBs and pension liabilities is 0.96. As an alternative approach, we estimated CFIs without the VR (Chessman et al., 2017). This assumes the possibility that long-term liabilities, both the current and noncurrent portions, could be pushed down by SPDs during the initial uncertainty of the impact of COVID-19 in the first wave of the pandemic. The weights in the resultant composite construct are geared toward primary reserves (0.55), with the remainder

Panel A

Panel B

Panel C

CCD with CFI < -10.00: 9 districts HHD with CFI < -10.00: 4 districts

CCD with CFI < -10.00: 5 districts (Change from FY2019: 5 districts improved; 2 districts weakened) HHD with CFI < -10.00: 3 districts (Change from FY2019: 1 district improved)

CCD with CFI < -10.00: 8 districts HHD with CFI < -10.00: 2 districts

CCD with CFI > 10.00: None HHD with CFI > 10.00: 21 districts

CCD with CFI > 10.00: None HHD with CFI > 10.00: 19 districts

CCD with CFI > 10.00: 7 districts (Change from FY2019: 7 districts improved) HHD with CFI > 10.00: 15 districts (Change from FY2019: 5 districts improved; 11 districts weakened)

Note:  Financial data extracted from ACFRs for FY2019 and FY2020 (N = 242).

Figure 10.1  CFI for CCDs and HCDs, by FY2019 and FY2020

Panel D

CCD with CFI < -10.00: 3 districts (Change from FY2019: 6 districts improved; 1 district weakened) HHD with CFI < -10.00: 1 district (Change from FY2019: 1 district improved) CCD with CFI > 10.00: 7 districts (Change from FY2019: 7 districts improved) HHD with CFI > 10.00: 13 districts (Change from FY2019: 5 districts improved; 10 districts weakened)

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Note:  Financial data extracted from ACFRs for FY2019 and FY2020 (N = 242).

Figure 10.2  CFI vs CFI with OPEB and pension liabilities included, FY2019 and FY2020 distributed between the return on assets ratio (0.30) and net operating revenues (0.15). The distributions of this measure for FY2019 and FY2020 are presented in Figure 10.3, Panels A and B. Here as well, in substantive terms, the conclusions made above remain. The correlation between the CFI with and without the VR is 0.86. In Panels C and D of Figure 10.3, we re-weighted the original CFI toward net operating revenues (0.35) and less so on the VR (0.10). The main distinction here is that doing so pushes more SPDs into the exceptional financial condition category. Interestingly, no SPDs with severe financial position improve, however. The same outliers with severe financial condition continue to exist, no matter the alternative specifications, which is most readily seen in Figure 10.4. Therefore, whatever the problems are for these SPDs, they do not appear to be driven by operating expenses or revenues. Who are the outliers with the most severe financial health and what may explain their extremely poor financial health? Table 10.1 presents key financial information for these SPDs. In FY2019 there were nine CCDs and four HCDs in this category and in FY2020 there were five CCDs and three HCDs. By far, the most problematic area in the CFI appears to be the return on assets ratio.8 Thus, asset management and performance appears to be the most critical component of the composite financial risk for these financially weaker SPDs.

  The distributions of the component ratios of CFI are presented in the Appendix.

8

Special-purpose district financial health during COVID-19  ­195

Panel A

Panel B

Panel C

CCD with CFI < -10.00: 11 districts HHD with CFI < -10.00: 3 districts

CCD with CFI < -10.00: 4 districts (Change from FY2019: 8 districts improved; 1 district weakened) HHD with CFI < -10.00: 2 districts (Change from FY2019: 1 district improved)

CCD with CFI < -10.00: 9 districts HHD with CFI < -10.00: 3 districts

CCD with CFI > 10.00: 2 districts HHD with CFI > 10.00: 21 districts

Panel D

CCD with CFI > 10.00: None HHD with CFI > 10.00: 26 districts

CCD with CFI > 10.00: 11 districts (Change from FY2019: 10 districts improved; 1 district weakened) HHD with CFI > 10.00: 22 districts (Change from FY2019: 9 districts improved; 8 districts weakened)

CCD with CFI < -10.00: 3 districts (Change from FY2019: 6 districts improved; 1 district weakened) HHD with CFI < -10.00: 1 district (Change from FY2019: 1 district improved) CCD with CFI > 10.00: 7 districts (Change from FY2019: 7 districts improved) HHD with CFI > 10.00: 28 districts (Change from FY2019: 9 districts improved; 7 districts weakened)

Note:  Financial data extracted from ACFRs for FY2019 and FY2020 (N = 242).

Figure 10.3  Alternative specifications of the CFI for CCDs and HCDs, by FY2019 and FY2020 Panel A

Panel B

Note:  Financial data extracted from ACFRs for FY2019 and FY2020 (N = 242).

Figure 10.4  CFI vs alternative specifications of CFI, FY2019 and FY2020

196

2020 2020 2020 2020 2020 2020 2020 2020

Lassen Community College District CCD Riverside Community College District CCD San Jose Evergreen Community College District CCD Sierra Joint Community College District CCD Siskiyou Joint Community College District CCD Alameda Health System, Public Authority HHD Cambria Community Healthcare District HHD Tehachapi Valley Healthcare District HHD

> −10 3 > −10 > −10 > −10 > −10 > −10 > −10 > −10 −1 −7 > −10 > −10 −4 > −10 > −10 > −10 > −10 −3 −9 > −10

CFI > −10 > −10 > −10 > −10 > −10 > −10 > −10 > −10 > −10 > −10 > −10 > −10 > −10 > −10 > −10 > −10 > −10 > −10 > −10 > −10 > −10

Note:  Financial data extracted from ACFRs for FY2019 and FY2020.

2019 2019 2019 2019 2019 2019 2019 2019 2019 2019 2019 2019 2019

Fiscal Year

Glendale Community College District CCD Lassen Community College District CCD Marin Community College District CCD San Joaquin Delta Community College District CCD San Jose Evergreen Community College District CCD San Mateo County Community College District CCD Sierra Joint Community College District CCD Solano Community College District CCD Yosemite Community College District CCD Alameda Health System, Public Authority HHD Cambria Community Healthcare District HHD Kern Valley Healthcare District HHD Tehachapi Valley Healthcare District HHD

Special Purpose District CFI with OPEBs/Pensions

Table 10.1  Severe financial health SPDs, by FY 2019 and FY2020

CFI without VR −5 > −10 > −10 > −10 > −10 −3 > −10 > −10

> −10 6 > −10 > −10 > −10 > −10 > −10 > −10 > −10 −1 > −10 > −10 > −10

CFI with NOR Focus −7 > −10 > −10 > −10 > −10 −7 > −10 > −10

> −10 −3 > −10 > −10 > −10 > −10 > −10 > −10 > −10 −5 > −10 > −10 > −10

PRR −0.94 −0.98 −1.18 −2.30 −0.62 −1.19 −5.86 > −10

−1.26 −1.24 −0.37 −1.66 −0.98 −2.61 −2.60 −0.63 −1.83 −1.15 −5.79 0.54 > −10

VR > −10 −0.42 −0.07 −0.42 −0.21 > −10 > −10 −0.20

−0.38 > −10 −0.02 −0.23 −0.10 −0.20 −0.49 −0.07 −0.24 > −10 > −10 0.39 −0.18

VR with OPEBs/Pensions −0.43 −0.20 −0.07 −0.42 −0.12 −1.01 −0.87 −0.20

−0.24 −0.58 −0.02 −0.23 −0.08 −0.17 −0.49 −0.06 −0.24 −0.69 −0.73 0.39 −0.18

ROAR −3.10 −9.58 > −10 > −10 −8.72 −0.79 0.91 0.27

> −10 5.56 > −10 > −10 > −10 > −10 −7.99 > −10 > −10 1.18 0.30 > −10 0.53

0.43 −0.78 −2.05 −0.25 −0.53 −0.17 −3.16 1.24

−1.71 −0.45 −1.84 −0.21 −1.34 0.98 −0.07 −2.22 −1.63 −0.43 −0.97 1.25 2.60

NOR

Special-purpose district financial health during COVID-19  ­197

CONCLUSION Using district-level data for FY2019 and FY2020, we constructed and evaluated composite financial risk measures for CCDs and HCDs in California. This study, however, shows only what financial shape the SPDs were in immediately before COVID-19 and how they fared in the first wave of the pandemic. The next step is to undertake the same research task for FY2021, and likely, FY2022, which would show how a prolonged impact of the pandemic may shape CCD and HCD financial risks in California. Nevertheless, the CFI measures appear to perform consistently both for CCDs and HCDs and indicate that asset management and performance are important for SPD financial health. Given the generally higher capital intensity levels of SPD operations, weaknesses in this area will hinder their ability to maintain sound financial positions. Thus, an asset management focus will likely help the laggards in the sample to improve their overall financial health. This is a distinct concern compared to existing studies on public organizational fiscal health, where research tends to focus on primary balance and debt burden factors as the main culprits of financial problems. While undoubtedly important, these factors do not appear to be the most pressing for SPD financial health in the sample of California CCDs and HCDs, certainly in the first wave of COVID-19. The most direct question that remains unanswered is whether and in what ways the SPDs have adjusted to service demand changes in their immediate task environments. CCDs had to adjust to an online form of instruction, just like all other educational institutions in the state. They also reported significant losses in student enrollment, some as high as 50 percent.9 Whether these losses are temporary or not remains to be seen. HCDs, on the other hand, on occasion were overwhelmed with COVID-19 related service pressures. They had to set up additional patient care centers, screening and testing facilities, and significant changes in the processes of service provision.10 At the same time, many elective services in the usual service portfolio were either postponed or cancelled. How did these changes in services and revenues from typical and atypical sources affect the finances of SPDs? Another important question is whether and how the state vs county (and city) approaches to managing services that CCDs and HCDs provide change. Did the generalpurpose governments take on more of the financing of SPD services or did these SPDs assume or expand their fiscal autonomy? This change concerns not only the provision of services but also access to direct and indirect revenue sources. Given revenue pressures, where did the critical cash flows come from? The role of federal rescue packages and their utilization by SPDs is the natural next step in understanding the current financial standing of CCDs and HCDs in California. Consequently, and ultimately, how did all the above changes impact the financial risk levels of SPDs? In terms of related core financial concerns, did the changes in financial risk levels influence CCD and HCD credit risk, access to and the cost of borrowing in the  9   Additional details are available from https://edsource.org/2021/californias-community-col​ leges-at-crit​ical-crossroads-as-more-students-opt-not-to-attend/652637; https://edsource.org/2021/ california-community-college-enrollment-drops-below-2-million-students-more-than-previouslyreported/663225. 10   Additional details are available from https://www.achd.org/healthcare-district-news-covid-19.

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capital market? This is not a trivial question as the provision of special-purpose government services is capital intensive and requires a skillful management of own-source service revenues as well as external resources, be that from public or capital market sources.

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Dzigbede, K., Gehl, S. B., & Willoughby, K. (2020). Disaster resiliency of U.S. local governments: Insights to strengthen local response and recovery from the COVID-19 pandemic. Public Administration Review, 80(4), 634–643. García-Sánchez, I.-M., Cuadrado-Ballesteros, B., Frías-Aceituno, J.-V., & Mordan, N. (2012). A new predictor of local financial distress. International Journal of Public Administration, 35(11), 739–748. Gillette, C. P. (2012). Fiscal federalism, political will, and strategic use of municipal bankruptcy. The University of Chicago Law Review, 79(1), 281–330. Goodman, C. B. (2015). Local government fragmentation and the local public sector: A panel data analysis. Public Finance Review, 43(1), 82–107. Goodman, C. B. (2019). Local government fragmentation: What do we know? State and Local Government Review, 51(2), 134–144. Gorina, E., Maher, C., & Joffe, M. (2018). Local fiscal distress: Measurement and prediction. Public Budgeting and Finance, 38(1), 72–94. Harper, S. R. (2020). COVID-19 and the racial equity implications of reopening college and university campuses. American Journal of Education, 127(1), 153–162. Hart, C. M. D., Alonso, E., Xu, D., & Hill, M. (2021). COVID-19 and community college instructional responses. Online Learning, 25(1), 41–69. Holmes, G. M., Pink, G. H., & Friedman, S. A. (2013). The financial performance of rural hospitals and implications for elimination of the Critical Access Hospital program. Journal of Rural Health, 29(2), 140–149. Hooghe, L., & Marks, G. (2003). Unraveling the central state, but how? Types of multi-level governance. The American Political Science Review, 97(2), 233–243. Huang, I. Y.-F. (2020). Fighting against COVID-19 through government initiatives and collaborative governance: Taiwan experience. Public Administration Review, 80(4), 665–670. Joffe, M. D. (2012). Drivers of municipal bond defaults during the Great Depression [master’s dissertation, San Francisco State University]. https://ssrn.com/abstract=2189889. Johnson, C. L., Luby, M. J., & Moldogaziev, T. T. (2021a). State and local financial instruments (2nd ed.). Edward Elgar Publishing. Johnson, C. L., Moldogaziev, T. T., Luby, M. J., & Winecoff, R. (2021b). The Federal Reserve Municipal Liquidity Facility (MLF): Where the municipal securities market and fed finally meet. Public Budgeting and Finance, 41(3), 42–73. Jones, L. R. (1984). The WPPSS default: Trouble in the municipal bond market. Public Budgeting and Finance, 4(4), 60–77. Jones, S., & Walker, R. G. (2007). Explanators of local government distress. Abacus, 43(3), 396–418. Judd, D. R., & Smith, J. M. (2007). The new ecology of urban governance: Special-purpose ­authorities and urban development. In R. Hambleton & J. S. Gross (Eds.), Governing cities in a global era: Urban innovation, competition, and democratic reform (pp. 151–160). Palgrave Macmillan. Kim, T. H. (2010). Factors associated with financial distress of nonprofit hospitals. The Health Care Manager, 29(1), 52–62. Kim, Y., & Sorensen, L. C. (2019). Caught in the crunch: School district financial condition and performance. State and Local Government Review, 51(2), 104–112. Kloha, P., Weissert, C. S., & Kleine, R. (2005). Developing and testing a composite model to predict local fiscal distress. Public Administration Review, 65(3), 313–323. Kovari, J. (2020). Predicting TIF distress: A statistical analysis of tax incremental finance districts in Wisconsin. Public Budgeting and Finance, 40(1), 70–90. Landry, A. Y., & Landry, R. J. III. (2009). Factors associated with hospital bankruptcies: A political and economic framework. Journal of Healthcare Management, 54(4), 252–271 and discussion 271–272. Levine, H., Scorsone, E. A., & Justice, J. B. (2012). Handbook of local government fiscal health. Jones & Bartlett Publishers. Lewis, C. W. (1994). Municipal bankruptcy and the states. Urban Affairs Quarterly, 30(1), 3–26. Maher, C. S., Hoang, T., & Hindery, A. (2020). Fiscal responses to COVID-19: Evidence from local governments and nonprofits. Public Administration Review, 80(4), 644–650.

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Maher, C. S., Oh, J. W., & Liao, W.-J. (2020). Assessing fiscal distress in small county governments. Journal of Public Budgeting, Accounting & Financial Management, 32(4), 691–711. Mavlutova, I., & Ziemele, A. (2012). Composite Financial Index as a method to improve financial management at higher education institutions. Journal of Business Management, 6(3), 114–125. McConnell, M. W., & Picker, R. C. (1993). When cities go broke: A conceptual introduction to municipal bankruptcy. The University of Chicago Law Review, 60(2), 425–495. Mohanlingam, S., & Linh, N. T. P. (2013). Financial health of Australian universities as measured by Composite Financial Index. Advances in Management and Applied Economics, 3(6), 67–80. Moldogaziev, T. T., Kioko, S. N., & Hildreth, W. B. (2017). Impact of bankruptcy eligibility requirements and statutory liens on borrowing costs. Public Budgeting and Finance, 37(4), 47–73. Mullin, M. (2009). Governing the tap: Special district governance and the new local politics of water. MIT Press. Myers, L. C., Parodi, S. M., Escobar, G. J., & Liu, V. X. (2020). Characteristics of hospitalized adults with COVID-19 in an integrated health care system in California. JAMA: The Journal of the American Medical Association, 323(21), 2195–2198. Nemec, J., & Špaček, D. (2020). The Covid-19 pandemic and local government finance: Czechia and Slovakia. Journal of Public Budgeting, Accounting & Financial Management, 32(5), 837–846. Ozmeral, A. B., Reiter, K. L., Holmes, G. M., & Pink, G. H. (2012). A comparative study of financial data sources for Critical Access Hospitals: Audited financial statements, the Medicare cost report, and the Internal Revenue Service form 990. The Journal of Rural Health, 28(4), 416–424. Padovani, E., & Iacuzzi, S. (2021). Real-time crisis management: Testing the role of accounting in local governments. Journal of Accounting and Public Policy, 40(3), Article 106854. Pink, G. H., Holmes, G. M., D’Alpe, C., Strunk, L. A., McGee, P., & Slifkin, R. T. (2006). Financial indicators for Critical Access Hospitals. The Journal of Rural Health, 22(3), 229–236. Racheva-Sarabian, A., Ryvkin, D., & Semykina, A. (2015). The default of special district financing: Evidence from California. Journal of Housing Economics, 27, 37–48. Ramamonjiarivelo, Z., Weech-Maldonado, R., Hearld, L., & Pradhan, R. (2014). Public hospitals in peril: Factors associated with financial distress. Journal of Health Care Finance, 40(3), 14–30. Rivenbark, W. C., Roenigk, D. J., & Allison, G. S. (2010). Conceptualizing financial condition in local government. Journal of Public Budgeting, Accounting & Financial Management, 22(2), 149–177. Scott, T. A., Moldogaziev, T. T., & Greer, R. A. (2018). Drink what you can pay for: Financing infrastructure in a fragmented water system. Urban Studies, 55(13), 2821–2837. Suarez, V., Lesneski, C., & Denison, D. (2011). Making the case for using financial indicators in local public health agencies. American Journal of Public Health, 101(3), 419–425. Trussel, J. M., & Patrick, P. A. (2009). A predictive model of fiscal distress in local governments. Journal of Public Budgeting, Accounting & Financial Management, 21(4), 578–616. Trussel, J. M., & Patrick, P. A. (2013). Predicting fiscal distress in special district governments. Journal of Public Budgeting, Accounting & Financial Management, 25(4), 589–616. Tung, F. (2002). After Orange County: Reforming California municipal bankruptcy law. Hastings Law Journal, 53, 1–60. Yang, L. (2019a). Not all state authorizations for municipal bankruptcy are equal: Impact on state borrowing costs. National Tax Journal, 72(2), 435–464. Yang, L. (2019b). The impact of state intervention and bankruptcy authorization laws on local government deficits. Economics of Governance, 20(4), 305–328. Yang, L., & Abbas, Y. (2020). General-purpose local government defaults: Type, trend, and impact. Public Budgeting and Finance, 40(4), 62–85. Zinoviev, R., Krumholz, H., Ciccarone, R. A., Antle, R., & Forman, H. (2020). A publicly available score for evaluating hospital financial standing. BMJ Open. https://bmjopen.bmj.com/content/​ 11/7/e046500.

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APPENDIX Panel A

Panel B

Note:  Financial data extracted from ACFRs for FY2019 and FY2020 (N = 242).

Figure 10A.1  Distribution of primary reserve ratio, FY2019 and FY2020

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Panel A

Panel B

Panel C

Panel D

Note:  Financial data extracted from ACFRs for FY2019 and FY2020 (N = 242).

Figure 10A.2  Distribution of VR with and without OPEBs and pension liabilities, FY2019 and FY2020

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Panel A

Panel B

Note:  Financial data extracted from ACFRs for FY2019 and FY2020 (N = 242).

Figure 10A.3  Distribution of return on assets ratio, FY2019 and FY2020 Panel A

Panel B

Note:  Financial data extracted from ACFRs for FY2019 and FY2020 (N = 242).

Figure 10A.4  Distribution of net operating revenues ratio, FY2019 and FY2020

11.  Municipal budgets, balance sheets, and acute fiscal shock Robert S. Kravchuk

INTRODUCTION Not every municipal emergency can be adequately prepared for in advance. Acute fiscal shocks occur when governments face unexpected disasters or emergencies beyond their control, including hurricanes, tornados, tsunamis, volcanic eruptions, firestorms, earthquakes, and floods. A distinguishing feature of these events is that they adhere to Zipf’s Law: the frequency of their occurrence is inversely proportional to their severity.1 Their nature, timing, and severity generally provide little or no opportunity to liquidate sufficient resources to address them; they are nearly always beyond the ability of government officials to control; and their financial consequences may be great.2 A clear example is provided by the response to Hurricane Katrina by the City of New Orleans. By definition such low-probability events occur in the ultra-short run, a time period too short to prepare for in advance. Frank Knight’s (1921) distinction between risk and uncertainty applies here. Risky events occur with sufficient frequency to permit estimating the probability of their occurrence. For uncertain events, however, no data are available to compute their frequency. Events of uncertain frequency and magnitude are difficult to provide for. Municipal officials may not be able to justify idle cash and other liquid assets as contingencies against events that may not actually occur. Consequently, Vito Tanzi (2022) observed recently that governments find it convenient to ignore such uncertainties as uncontrollable “Acts of God.” Gordon Donaldson (1986) addressed some such events facing the corporate sector in terms of “management’s capacity to act.” Donaldson focused on what he termed the organization’s “financial mobility,” which has three dimensions: recognition of a problem, time to act, and capacity to act. Recent research on municipal fiscal stress concludes that there remains an element of unpredictability, even where municipal fiscal indicators and “early warning” systems are in place (Clark, 2015; McDonald & Maher, 2020; Stone et al., 2015). Problem recognition, then, often does not occur until the emergency is immanent. This chapter focuses, therefore, on Donaldson’s other two dimensions: timing and financial capacity. We argue that the two are inexorably intertwined. 1   Many minor tremors occur frequently and imperceptibly to most people. Large, damaging earthquakes occur with a frequency that follows a mathematical power function, with larger ones occurring quite infrequently. 2   According to the concept of acute fiscal shock employed here, the recent COVID-19 pandemic fails to qualify as such: epidemics are not rare throughout human history, and the fiscally relevant responses (masking, social distancing, and lockdowns, especially) were within g­ overnments’ decision set.

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Considering the relationship of time to financial resources, the accepted dividing line is between the short and the long run. The precise threshold depends on time required to reconfigure the assets, as between fixed and liquid assets. In the long run, all assets are considered easy to liquidate at little or no cost. The short-run condition is one where at least one asset class, such as property, plant and equipment, are fixed, and unchangeable without significant loss. Rarely discussed is the ultra-short run, where all, save the most liquid assets, are fixed and illiquid.3 Acute fiscal crisis is an ultra-short-run problem, affording mere hours, or perhaps days, in which to respond. Only immediately liquid or liquefiable assets will permit a timely response to acute crisis in the ultra-short run. These may include budgetary reserves, revenue stabilization funds, and compensating balances in commercial banks. Such funds may be insufficient to address fiscal needs of great magnitude, however. Consistent with Tanzi’s observation, much of the existing literature on municipal finance and financial indicators does not directly address acute fiscal crisis (Kloha et al., 2005; Leiser & Mills, 2019; Rivenbark et al., 2010; Wang et al., 2007). Likewise, much of the existing literature on government decline and cutback management finds little application to such extreme events occurring in the ultra-short run (Levine, 1978, 1980; Levine et al., 1981; Schick, 1980). Most of the extant writing focuses on short- to long-run fiscal liquidity and solvency issues, much of it suggesting certain action steps that municipalities can take to meet crises as they emerge (Brien et al., 2021; Dethier, 2013; Dzigbede et al., 2020; Liu & Waibel, 2008). Further, most fiscal crises may take months or years to emerge, and thus require remedial actions that can only be implemented over the intermediate to long run (Congressional Budget Office [CBO], 2010). Preventatively, some studies recommend various fiscal monitoring systems (Gianakis & McCue, 1999; Gorina & Maher, 2016; Hendrick, 2011; Kriz & Funderburg, 2019; The Pew Charitable Trusts, 2016).4 The most highly recommended is the Financial Condition Index (FCI), benchmarked comparatively against some relevant peer group, generally assuming “normal” operating conditions (Groves et al., 2003; Mead, 2018). However, Clark (2015) and McDonald and Maher (2020) cast serious doubts on the efficacy of the FCI. With notable exceptions, many of the recommended measures are oriented more towards operating statement items, rather than the balance sheet. This orientation requires re-examination if we are to make sense of management’s preparatory alternatives. To explore the connections between municipal balance sheets and fiscal emergency preparedness, we will employ concepts from somewhat unexpected sources, the late John Maynard Keynes and the Nobel laureate John R. Hicks. Hicks argued that “the social function of liquidity is that it gives time to think” (1974, p. 57). That is, greater liquidity confers a wider set of options when problems are pressing and the nature and timing of outcomes are uncertain. These are conditions analogous to those that Schick (1980) refers to as total scarcity. Governments in emergencies will find it necessary to liquidate and/or borrow against the assets already on their balance sheets, and/or appeal to third 3   By convention, in accounting and finance circles, the short run is any period of less than one year; the long run is greater than one year; and the intermediate run is a transitional period between the two. 4   The literature is far too vast to summarize here, which in any case is not the intent of the present chapter.

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parties (state and federal governments) for disaster assistance. Revenue action and/or expenditure cuts will avail them little in the ultra-short run, as these require weeks or months to capture any additional resources. In connection with the analysis of an entity’s balance sheet, Donaldson (1986, pp.  276–280) proposed taking an inventory of “financial mobility resources.” Hicks (1967, 1974, 1982, 1989) presented a useful classification of assets, according to their intended use and relative liquidity. Hicks’s framework is revealing, insofar as it connects to management’s motives for holding liquid assets. The pertinent question is, what shall be the basis on which a municipality will hold resources in various classes of assets in the short run? Despite the seeming irrelevancy of longer-term notions of fiscal soundness in an emergency, the strength of an entity’s balance sheet depends upon the soundness of its pre-emergency fiscal decisions. We argue below that the best way to prepare for an emergency is to always operate the government’s finances in a manner that promotes fiscal soundness and financial health.

THE RELEVANCY OF MUNICIPAL FINANCIAL CONDITION Existing literature on municipal fiscal health largely emerged from research into distressed localities in the 1970s and 1980s. The “poster child” of the era was the 1975 New York City bankruptcy (Auletta, 1979; Phillips-Fein, 2017). The literature in recent decades has been less general, and more focused on specific events or issues (e.g., the bankruptcy of Orange County, CA, and defaults at Washington Public Power Supply System, Jefferson County, AL, Harrisburg, PA, and Stockton, CA). A notable exception has been Hendrick (2011). In her comprehensive review of the literature, Hendrick concluded that, “it is impossible to construct a valid, comprehensive measure of financial condition that takes into account all dimensions and uses of the concept” (p. 19). Gianakis and McCue (1999, p. 120) had previously argued that local factors, politics, and idiosyncratic circumstances render extremely difficult the task of developing an overarching conception of municipal financial condition.5 Certain other notable studies bear mention. Clark and Ferguson (1983) broadly conceive financial condition as an equilibrium between the government’s fiscal policies, and the local economy that supports it. The idea is to achieve a state of homeostasis, rather than maximizing revenues. Contextual and local factors will naturally predominate. Ladd and Yinger (1989) also focused on balance, but with an eye to a “standardized” city whose fiscal health permits a level and mix of public services common to a large number of peers. Fiscal health is conceived as the balance between standardized revenues and expenditure needs. The concept they propose is mainly useful as a benchmark 5   Hendrick offers a very broad and encompassing definition that is far too general for present purposes. Her definition of financial condition is “the state of equilibrium or balance that exists between different dimensions or components of government’s financial sphere of spending pressures and obligations, external fiscal resources, revenues and internal resources, and actual spending” (2011, p. 22). She adds the qualification that, “the definition is very broad and vague precisely because it can only be defined specifically for particular types of solvency or particular contexts” (ibid.). By “types of solvency,” she appears to refer to the typology found in Groves et al. (2003).

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measure, as few cities are nearly as “standard” as their standardized city (Mallach & Scorsone, 2011). Research sponsored by the now defunct US Advisory Commission on Intergovernmental Relations (ACIR) examined methods and means of measuring and monitoring municipal fiscal condition (Bahl, 1984; Tannenwald & Cowan, 1997). The main focus was on external factors. Municipal policies and procedures – management choices – were largely ignored. In contrast, Berne and Schramm (1986) incorporated internal attributes of municipal management and governance to estimate the probability that a given government would be able to meet its financial obligations to its creditors, taxpayers, and employees as they came due. They also advanced the literature by conceiving municipal fiscal health as an intertemporal feature – one involving a chain of financial decisions across time. The clear implication is that fiscal health has both short- and long-run dimensions. Hendrick (2011) explicitly embraced the temporal element in her study, defining fiscal health as “both a state of being and an ongoing process that reflects the extent to which a government fiscal structure is adapted to the environment and whether government maintains or improves this balance in the future” (p. 22). This is a dynamic working definition, as is its opposite, fiscal stress: according to Hendrick, this is an “event that occurs when governments experience decreasing revenues or increasing spending pressures that move it off or out of fiscal equilibrium” (ibid.).6 Low levels of solvency (essentially, longterm fiscal sustainability) placed her governments in conditions analogous to Schick’s (1980) notion of total scarcity.7 In ultra-short-run fiscal stress, resource scarcity entails a degree of vulnerability to disaster.

PATTERNED RESPONSE TO FISCAL STRESS The existing literature on organizational decline and cutback management does not appear entirely useful in addressing ultra-short-run fiscal distress. Based on the organizational research of March and Simon (1958) and Cyert and March (1963), the late Charles E. Levine argued that entities respond to fiscal crisis in a fairly sequential pattern, the  extent of which will depend on the depth, breadth, and duration of the resource decline (Levine, 1978, 1980; Levine & Rubin, 1980; Levine et al., 1981). In the initial response phase, governments generally adopt a “wait and see” posture; at this point 6   Hendrick also encompasses by her definition of fiscal stress, either “the worsening of financial condition, or even the threat of a worsening of financial condition” (ibid.). 7   Schick’s (1980) categories of resource scarcity are not directly applicable to ultra-short-run circumstances. These may be characterized as follows. Chronic scarcity is where funds are sufficient to continue services at existing levels, but insufficient to permit program expansion, growth in demand for services, or new initiatives. Modest budget slack may exist, so that cuts may be avoided. The budgetary focus is on controlling costs. Under the condition of acute scarcity, governments lack sufficient resources to absorb even minor, incremental cost increases. Such governments are barely coping to maintain service levels and quality. The budgetary focus is on cost control. Finally, in relaxed scarcity, governments experience no fiscal distress, having sufficient resources to meet cost increases deriving from growth, inflation, and program expansion. The budgetary focus is on planning across several future years.

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they are unsure as to the nature, severity, and likely duration of the crisis (Kravchuk & Stone, 2010). Drastic measures make little sense absent clear indications of seriousness. Consequently, at an early stage, localities will eschew severe spending cuts or revenue action, preferring instead to first employ any reserves they may have accumulated. Should the crisis persist, governments will enter a second phase, as a broad consensus emerges favoring more serious actions to meet the crisis. In this phase, governments will “stretch” resources – to “do more with less” – and resist deep spending cuts and unpopular tax increases. The easiest measures will be taken first, by “picking the low-hanging fruit.” In the final phase, it becomes clear that the crisis is of a more persistent and painful nature. More decisive action thus appears necessary. Less well-managed governments will adopt “across-the-board” cuts, while more enlightened entities will pursue more targeted cuts and equitable revenue measures. Hendrick (2011, p. 67) describes the process: “Essentially governments begin coping with changes in financial condition by pursuing options that are easiest to implement, least intrusive to operations…and least visible to the public.” They follow the “path of least resistance.” Levine’s patterned response to crisis, however, refers to time periods that may extend for years. They address long-term fiscal health of the government, and are most useful for understanding recovery once the fiscal distress has passed. In the immediacy of sudden disaster, the government will most certainly experience an acute need for cash.

THE LIQUIDITY DIMENSION How can municipal governments best meet the challenges of acute fiscal crises? The importance of access to cash and liquid assets cannot be overstated (Wray, 2006). Longrun sustainability loses most of its meaning; access to money and credit becomes all (Bibow, 1995). Cities in sudden fiscal distress look not to their tax capacity per se, but to their balance sheets. We must therefore consider in some detail why liquidity is important in general terms, but especially during periods of stress. More basically, just what do we mean by a liquid asset? Hicks writes that, “every asset is held for its yield; if it was not profitable to hold it, it would not be an asset” (1974, p. 47). This much seems obvious, but Hicks also noted that most entities hold an assortment of different assets, some more widely tradable than others (marketable securities), some less liquid (property, plant & equipment), some more easily sold, and others involving substantial costs of disposal. Simply put, entities have choices to make in allocating their economic resources across different asset classes. The value of liquid assets in emergencies lies in their use as an immediate means of payment. This begs the question of the basis on which entities will manage their underlying asset structures. In Volume 1 of his Treatise on Money (1930a, p. 114), Keynes employs the term liquidity roughly synonymously with availability; some assets can be liquidated relatively easily, and others are not so readily convertible into liquid form. In the second volume of the Treatise (1930b, p. 67), Keynes states that “liquid assets” are those that are “more realizable at short notice without loss.” Positions in more liquid assets are also much more easily unwound, as Hicks writes, “the acquisition of an easily marketable asset…can be easily revoked… That, I suggest is precisely what we mean by saying that the m ­ arketable asset

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possesses liquidity” (1974, p. 42). Essentially, Hicks agrees with Keynes: liquid assets are “realizable at short notice” (Keynes, 1930b, p. 67). “Realizability” signifies convertibility into cash. While most economists take the desire for rapid convertibility largely for granted, Hicks (1989, p. 61) attaches greater importance to the desire for cash, precisely because it is in money that the entity’s liabilities are expressed, for, “we would want to consider the claims against which the assets are held” (1982, p. 262). Obviously, demands for immediate payment must be met; however, advances that are not cashable “at short notice” are not immediately payable, and therefore are of little use. Municipal governments may, at times during the fiscal year, possess substantial “near-monies”: highly liquid assets that are convertible to cash virtually immediately at little cost, but which cannot serve as means of payment until they are so converted. The critical concern is that they be immediately marketable. Hicks thus conceives a spectrum of assets having differing degrees of liquidity. The logic is straightforward: any portfolio that consists entirely of cash is “perfectly liquid.” By inference, any balance sheet that contains cash plus any other asset(s) must be less than perfectly liquid, liquidity being a relative concept. Municipal management cannot help but be aware of its “spendable” (liquid) assets.

THE MUNICIPAL BUDGET CONSTRAINT Liquidity becomes more of a concern the “harder” a government’s budget constraint. This raises the importance of a government’s access to money and credit, where “credit” is understood to be a substitute for money. Most localities operate with “hard” budgets. Based on work by Kornai (1992), McKinnon (1994, 1997), Vickrey (1996), and Weingast (1995) “soft” budget constraints are associated with the availability of alternative means of financing expenditure (“backdoor,” “off-budget,” or “shift-able” expenditures). Monetarily sovereign national governments face relatively soft budget constraints. Subnational governments, however, face similarly hard budget constraints as households and firms (Kravchuk, 2020). The basic attributes of a “hard” municipal budget constraint are: 1.  Targeted borrowing – borrowing is strictly confined to capital items. Borrowing to finance current expenditure on consumable items is eschewed. Self-funded capital or current items with sinking funds may be exceptions, however, subject to restriction. 2.  Watertight finances – the sharing of intergovernmental revenue, grants and subventions and/or intermingling of revenues with other governments is either prohibited or insignificant. 3.  Externally imposed fiscal limits ­– existence of state-imposed tax and expenditure limitations (TELS), balanced budget requirements, and other restrictions. 4.  Open borders – there is free movement of labor and capital across jurisdictional boundaries, without hindrance. 5.  Intergovernmental competition – competition among governmental jurisdictions for industry, labor, capital, tourism, and so on (i.e., the tax base) is unrestricted. Conditions (1) through (3) are the essence of a “hard” budget constraint, as they strictly rule out the possibility of significant access to “backdoor” financing of g­ overnment

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­ rograms (for example, side-stepping the ordinary appropriations process, or hiding the p true cost of the government benefits they receive). The basic notion is that long-run deficit financing is unsustainable; while temporary, unplanned shortfalls may occur, budgets are to be balanced in the long run. It is essential to recognize that in the ultra-short run, most municipal budgets are highly constrained.

PRIMACY OF BALANCE SHEETS IN A CRISIS The “central” fiscal problem for governments is to discover or develop instruments that permit adjustment of their balance sheets in a fairly continuous fashion, in response to adverse developments and fresh opportunities. This is not a trivial problem, owing to “the cost of transferring assets from one form to another” (Hicks, 1967, p. 67). Owing to transactions costs and asset specificity, assets are not easily substitutable (Williamson, 1975). What makes money special is that “there is no such cost – it is already means of payment – and that is the fundamental reason people hold it” (Mehrling, 2018, p. 113). But money is not the only asset that entities carry on their balance sheets; the allocation of resources among asset classes requires explanation. Hicks’s approach permits us to inspect municipal balance sheets according to their relative degrees of liquidity, where liquidity is taken to be a rough indication of funds availability. Again, this is akin to Donaldson’s (1986) notion of an “inventory” of useful assets. Hicks’s contribution, from his 1935 “Simplifying Theory” to his 1989 Market Theory, was to conceive of economic relations as sequences of debit and credit entries in a dense and complex web of interlocking balance sheets. Actors adjust their money holdings dynamically, as Mehrling (2018, p. 112) puts it, “by spending and selling, lending and borrowing, repaying and redeeming their debts, in light of their expectations about a future that is not just risky but also uncertain,” in a Knightian sense. The embeddedness of economic entities in a credit economy is implicit throughout (Klamer, 1989). All entities, governmental and nongovernmental, exist in a dense, complex web of mutual indebtedness, where one entity’s liabilities are others’ assets, and where some assets are better suited to discharging their debts than others. Inspecting balance sheets thus becomes an essential tool for understanding an entity’s financial position, which always is relative to others. Hicks observed that Keynes’s major insight was that “money is an asset, which can be weighed up against other assets in a balance sheet, substituted for them or substituted by them” (Hicks, 1974, p. 36). So far, so good. But unlike Keynes, Hicks would regard it as “insufficient to consider the substitution as simply between money [noninterest-bearing instrument] and bonds [interest-bearing]. Rather, the balance sheet must be considered much more generally” (ibid., p. 37). Hicks would have us consider an entity’s balance sheet comprehensively, with an eye to the allocation of resources across the entire range of assets. In this vein, Hicks found the established theory of portfolio choice to be inadequate.8 He argued that “we need something more than a portfolio selection theory; we need a 8   Acknowledging the “well-established theory” of asset portfolio choice (Hicks, 1967, pp. 103–25; Tobin, 1958), Hicks changed his mind by 1974, as he came to believe that m ­ aximization

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theory of liquidity” (1974, p. 37). Liquidity in general, and balance sheet liquidity specifically, would not be a property of a single choice at a snapshot in time, but “a matter of a sequence of choices…concerned with the passage from the known to the unknown” (ibid., p. 39, emphasis added). He inquires, on what basis might it be said that one balance sheet is judged to be “more liquid” than another? Hicks sought to establish guidelines for making such determinations (1962, p. 794). Specifically, he points to the degree of liquidity possessed by different assets. “One state of a balance sheet may be judged to be more liquid than another…sometimes with greater propriety” (ibid.). The reason is that the economist’s usual posing of the question as one between money versus securities “does not in practice arise” (ibid., p. 795). He points out, correctly, that “it is therefore entirely possible that the liquidity demand for money from a particular [entity]…should be zero” (ibid.). An entity may already possess sufficient liquid assets to meet its current and anticipated future needs. Hicks thus cautions against confusing liquidity with an entity’s cash balance. It is imperative to examine all of an entity’s assets, and its unavoidable obligations, as they change with time. Hicks therefore proposed a unique classification scheme.

AN ASSET CLASSIFICATION SCHEME Hicks provided a much neglected, but useful classification scheme for the asset structure of an entity’s balance sheet, albeit subject to some modification. His framework evolved much over time.9 Hicks’s categorization of assets is “related to the accountant’s classification,” but, “it is by no means the same.” It is more of a Keynesian classification – that is, “by function, or by purpose” (Hicks, 1967, p. 38).10 Hicks had originally intended to develop a theory of asset allocation – a portfolio theory – that links to Keynes’s three motives for holding money (the “first triad”). It does not align precisely with Keynes’s framework, however. This limits its practical usefulness, and therefore necessitates some adjustment to the original. Hicks’s first categories (1967, pp. 35–38; 1974, pp. 46–48) were three in number (the “second triad”) – running assets, reserve assets, investment assets – to which he added a fourth category (1989, p. 74) – earning assets. These bear only a loose correspondence to current and noncurrent (fixed) assets, in accounting terms. Hicks elaborates that “some kinds of assets are financial claims; others are property rights in real goods” (ibid., p. 66). Each category in Hicks’s conception thus contains both financial and real, or physical, assets. As a consequence, the categories cannot be neatly arrayed according to their ­relative degrees of liquidity. Briefly: of mean returns for a given variance would not be the sole determinant of asset allocation in some important cases. Since portfolio selection theory is concerned with choice under uncertainty, and not merely risk – in the sense that Frank Knight (1921) or Keynes (1921) would argue – the absence of liquidity from portfolio selection theory was a serious shortcoming.  9   The initial attempt was made in the third essay of his “two triads” (1967, pp. 38–60), but a revised version was provided in “Solidity, Fluidity, and Liquidity,” an original chapter published in the second volume of his Collected Essays (1982, pp. 256–265). 10   Hicks’s inspiration in this scheme is apparently drawn from the discussion in Keynes’s Treatise on Money, Vol. 1 (1930a, pp. 114–118).

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Running assets – assets required for running the entity, in operational terms. Running assets are employed in the normal course of business (Hicks, 1967, p. 38; 1974, pp. 46, 47). They are related to current assets, but are of mixed properties and attributes; some are physical assets, and do not qualify as working capital. These also contain supplies and material resources, inventories of work-in-process, and finished goods. Some such physical assets are not so easily liquidated; thus, Hicks’s running assets can diverge substantially from net working capital (current assets less current liabilities), which are generally regarded as the most liquid category of assets (cash and deposits in banks being the most liquid). In the aggregate, “the individual running assets are a bundle of complements, not at all easily substitutable for one another” (Hicks, 1982, p. 264). ● Reserve assets – assets held as a buffer against fluctuating activity levels, or to meet contingencies. They secure the entity against unknown and unforeseen occurrences. Such “assets are not normally used, but kept because they may be wanted” (Hicks, 1974, p. 47). Examples are free cash and marketable securities, which can be sold for cash (literally, overnight). This category also includes real assets held as a buffer against unforeseen fluctuations in activity levels; for instance, to meet an unusual spike in demand. In physical form, some will constitute excess productive capacity. ● Earning assets – assets held in relatively liquid form, above and beyond what may be required to meet unforeseen contingencies. These may include “excess reserves.” Generally, such assets are held for the returns they earn (Hicks, 1989, p. 74). Hicks added this category late, upon observing that some entities held assets purely in order to augment or diversify their income streams: “For it cannot be then denied that extra bonds [or other financial securities] might be held, not as reserve assets, but as sources of income, accumulated out of savings” (ibid.). ● Investment assets. Investment assets are conceived as those acquired through savings or leverage: an entity spends down savings and/or incurs debts in acquiring control over these assets. Such assets are geared towards production, profit-making, or performing a service (Hicks, 1967, p. 39). Examples of financial assets held as investments are the inventories of securities dealers and/or brokerage houses. Nonfinancial entities and governmental agencies do not generally leverage themselves in order to acquire financial assets; they may hold significant physical assets, however.11 For most governments, investment consists of infrastructure and noninfrastructure fixed assets that are employed in governmental operations. Table 11.1 is based on Hicks’s asset classification framework (1989, pp. 66–68), with some (loose) indication of the relative liquidity of the assets as described in the table, to be discussed further, below. 11   Such leveraged investments in financial assets may be considered arbitrage for tax purposes under the Tax Reform Act of 1986 and subsequent amendments. Consequently, an arbitrage rebate to the US Internal Revenue Service may apply. Otherwise, a government’s tax-exempt debt status may be under threat. Most governments will also have financial policies that prohibit anything other than the investment of short-term idle cash balances. In any case, such investments are opportunistic in nature, and quite ancillary to the primary purposes of government. Thus, one would expect that such balances would be either nonexistent or negligible for most US governments.

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Table 11.1  A Hicksian taxonomy of balance sheet assets More Liquid

Financial Assets

Less Liquid Running Assets

Reserve Assets

Earning Assets

Investment Assets

Highly liquid working capital:

Financial reserves:

Stakes held in other entities

Investment portfolio:

Cash on hand

Bank credit lines

(acquisition method):

Financial securities held for yield

Receivables Marketable securities

Cash reserves Other access to credit

Outright ownership

Prepaid items

Credit extended to customers & clients Overdraft privilegesa

Real Assets

Short-term physical assets:

Excess plant capacity:

Stakes held in other entities

Supplies inventory

Idle property, plant & equipment

(equity method):

Work-inprocess Finished goods inventories

Buffer stocks of material and labor

Proportionate ownership

Physical assets productively employed: Property Plant Equipment

Less Liquid Note:  a. Includes so-called “invisible assets” net of certain “invisible liabilities,” such as those that are contingent on occurrence of certain events, such as standing lines of credit and credit guarantees (Hicks, 1989, p. 66).

Hicks’s original thrust in the “two triads” was to link his original three categories to Keynes’s three motives for holding money (1936/1964, p. 170): the transactions, precautionary, and speculative motives. Keynes subsequently added a fourth motive, the finance motive (1937a, 1937b). In his framework, Keynes distinguishes the motives for holding one’s resources in the form of cash money, instead of other assets:12

12   British economist Roy F. Harrod regarded Keynes’s analysis of the demand for money as “a study in the depth of a magisterial quality not matched in the present century” (Harrod, 1969, p. 151). Paul Davidson describes it as “the most important breakthrough in our insight into the operations of money in a modern market-oriented economy” (Davidson, 1978, p. 160). Such accolades may be attributed to Keynes explicitly conceiving of money demand as a function of expectations of future states of the world, and the need to protect one’s interests from the ravages of uncertainty. Without taking anything away from Keynes’s monumental achievement, in terms of monetary theory, this writer would rank the earlier writings of A. Mitchell Innes (1913, 1914) as being at least as significant an intellectual feat as Keynes’s.

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1. Transactions motive – the convenience of having cash on hand when necessary for transactions involving current expenditures.13 2. Precautionary motive – a desire for security in future periods, with respect to the purchasing power needed to meet unforeseen events (much like a “rainy day fund”). 3. Speculative motive – the object of securing a profit by, precisely, “outguessing” the market with respect to future asset price movements. 4. Finance motive – a refinement of the transactions motive, this embraces the idea that economic units hold cash, not only for current exchange (the “pure” transactions motive), but also in order to finance future investment (to purchase capital goods).14 These four “layers” of motivation for demanding cash form a composite that for entities appears to be a single asset “pool.” It is convenient for analytical purposes that we postulate that there may be as many as four separable aspects of the demand for liquidity, while in many instances, only two or three of the four may be dominant.

THE SPECTRUM OF ASSETS As may be inferred from Table 11.1, there is some confusion in Hicks’s classification of physical assets as between the classes. Some of it can be resolved by examining the motives for holding assets. But motives may not be very apparent from even the closest examination of entity balance sheets. Financial decision-makers themselves may be unable to articulate their motives for allocating resources among asset classes. Hicks appears to take a lot for granted. The problem is one of a general incoherence in application; depending upon the circumstances that apply in individual cases, an asset may be placed in any one of the four categories: ●

As a running asset – Asset A held to operate the entity for the purposes for which it was established is properly classified as a running asset. ● As a reserve asset – if Asset A should become redundant in the operation of the entity, it becomes “excess capacity,” thus to be held in reserve, or disposed of. Planned or unplanned shortfalls in volume would trigger such automatic reclassification, which may be temporary. ● As an earning asset – should Asset A be devolved to another entity that is owned, either in whole or in part, by the originating entity, it would be subject to ­re-­categorization as an earning asset.

13  In The General Theory (1936, pp. 195–196), Keynes breaks the transactions motive into the “income motive,” as it pertains to households, and the “business motive,” as it pertains to firms. The business motive would apply to governments. 14   Keynes originally held that the first three motives above formed an exhaustive set of motives for demanding money (Davidson, 1965). In response to criticisms from Dennis Robertson (1936, 1937) and Bertil Ohlin (1937a, 1937b), Keynes would come to see that his transactions motive actually conflated two motivations: purchase of productive capital assets to generate revenue, and that of ordinary operating transactions. There will thus be some volume of planned capital investment, for which balances of cash will be necessary; this is the finance motive.

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Table 11.2  Revised Hicksian taxonomy of balance sheet assets Less Liquid

More Liquid Running Assets Assets Highly liquid working capital: Cash on hand Receivables Marketable securities

Reserve Assets

Earning Assets

Investment Assets

Financial reserves:

Stakes held in other entities

Physical assets productively employed:

Cash reserves Bank credit lines Other access to credit

(acquisition method):

Property

Outright ownership Plant, equipment

Inventories (marketable items only) Prepaid items Credit extended to customers & clients Overdraft privilegesa Note:  a. Includes so-called “invisible assets” net of certain “invisible liabilities,” such as those that are contingent on occurrence of certain events, such as standing lines of credit and credit guarantees (Hicks, 1989, p. 66). ●

As an investment asset – when Asset A is constructed or otherwise acquired by an entity, it is indisputably an investment asset. But when it passes into service as part of the entity’s fixed assets, Hicks would classify it as a running asset.

The rather blurred distinction between running assets and investment assets is the greatest source of confusion in the scheme. It is clear that any fixed asset may qualify as either a running, reserve, earning, or investment asset, depending upon circumstances, which may be far beyond the control of the entity’s management. This obviously limits the practical applicability of the original framework, necessitating some judgement. The solution consists in reorganizing Hicks’s scheme according to the relative liquidity of assets: first, by abandoning his insistence on the inclusion of physical assets in each of the four asset classes, and restricting fixed assets to the investment class, whether they be redundant or not. Further, all financial assets, which in government are largely marketable securities, as well as credit and overdraft privileges, are to be counted as running assets, insofar as they constitute working capital, or means to temporarily augment it. Asset classes organized according to their relative liquidity are provided in Table 11.2.

CONCLUSION: VIRTUES OF STRONG BALANCE SHEETS The problem we have been dealing with is fundamentally one of allocating resources across assets in the face of an uncertain future. Hicks (1967, p. 68) counsels that the relative liquidity of assets is a sound means for allocating assets, with the relative amounts depending on three factors: the date at which future payments are to be made; the cost of holding liquid assets in the meantime; and the expected gains from advance preparation.

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But mainstream economic theory will be of little avail to municipal officials.15 The theory of value holds that proportional holdings of various assets – the asset structure – will depend on their relative marginal utility. Under emergency conditions in the ultra-short run, cash is king; more liquid assets are preferred. This is where sound judgment must come in; calculations of marginal utility will matter little. Municipal officials will need to make explicit their expectations about the likelihood of extreme disasters occurring, and to allocate assets accordingly. But ultra-short-run emergencies are inherently difficult to prepare for. To secure the future advantages of flexibility to address rapidly changing needs, municipalities would need to generate liquid reserves, potentially depriving the community of necessary services in the present. It does not seem politically prudent to make investments in disaster response capabilities, while other community needs may go unmet. It is thus difficult in the extreme to prepare for these calamities. The political and economic costs of fiscal flexibility can be very high. As Edward J. Blakely and Nancey G. Leigh (2009, p. 263) put it, “No community can afford to sit on its assets.” As a consequence, New Orleans was not prepared for Hurricane Katrina, New York and suburban New Jersey were not prepared for Superstorm Sandy, and cities probably won’t be adequately prepared for the next disaster, either. In the ultra-short run, no government may be adequately prepared for fiscal distress. It is also apparent that Hicks’s formulation may be useful as an analytical device, but does little to render easy what is fundamentally a political decision. Having a strong balance sheet will permit governments to borrow when emergencies demand it. Fortunately, the very same measures that municipalities take to strengthen their balance sheets under normal operating conditions will serve to prepare them for emergencies. The principles of sound finance, rigorously applied, will secure the appropriate balance sheet strength required to gain access to credit when it is needed. In the end, the problem of preparing for disaster resolves itself into the basic problem that municipal officials face every day: managing the finances in a sound, prudent, and fiscally responsible manner. Access to credit to meet the acute fiscal distress of a disaster will then take care of itself.

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15   Neoclassical economics posits that there is no marginal utility to holding money per se. It is merely a convenient medium of exchange, a “veil” over the real economy. This is obviously ­incorrect; in emergencies, money confers options that other assets cannot.

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Clark, T. N., & Ferguson, L. C. (1983). City money: Political processes, fiscal strain and retrenchment. Columbia University Press. Congressional Budget Office (CBO). (2010). Fiscal stress faced by local governments. CBO. Cyert, R. M., & March, J. G. (1963). A behavioral theory of the firm. Prentice-Hall. Davidson, P. (1965). Keynes’s finance motive. Oxford Economic Papers, 17(1), 47–65. Davidson, P. (1978). Money and the real world (2nd ed.). Macmillan. Dethier, J.-J. (2013). Coping with urban fiscal stress around the world (Policy Research Working Paper No. 6693). The World Bank. https://elibrary.worldbank.org/doi/abs/10.1596/1813-9450-6693. Donaldson, G. (1986). Strategy for financial mobility. Harvard Business School Press. Dzigbede, K. D., Gehl, S. B., & Willoughby, K. (2020). Disaster resiliency of U.S. local governments: Insights to strengthen local response and recovery from the COVID-19 pandemic. Public Administration Review, 80(4), 634–643. Gianakis, G., & McCue, C. P. (1999). Local government budgeting: A managerial approach. Praeger. Gorina, E., & Maher, C. (2016). Measuring and modeling determinants of fiscal stress in US municipalities (Mercatus Working Paper). Mercatus Center at George Mason University. Groves, S. M., Nollenberger, K., & Valente, M. G. (2003). Evaluating financial condition: A handbook for local government. International City/County Management Association. Harrod, R. (1969). Money. Macmillan. Hendrick, R. M. (2011). Managing the fiscal metropolis. Georgetown University Press. Hicks, J. R. (1935). A suggestion for simplifying the theory of money. Economica, 2(5), 1–19. Hicks, J. R. (1962). Liquidity. Economic Journal, 72(288), 787–802. Hicks, J. R. (1967). Critical essays in monetary theory. Clarendon Press. Hicks, J. R. (1974). The crisis in Keynesian economics. Basic Books. Hicks, J. R. (1982). Money, interest & wages: Collected essays on economic theory, vol II. Harvard University Press. Hicks, J. R. (1989). A market theory of money. Clarendon Press. Innes, A. M. (1913). What is money? The Banking Law Journal, 30(5), 377–408. Innes, A. M. (1914). The credit theory of money. The Banking Law Journal, 31(2), 151–168. Keynes, J. M. (1921). A treatise on probability. Macmillan. Keynes, J. M. (1930a). A treatise on money, vol. 1: The pure theory of money. Macmillan. Keynes, J. M. (1930b). A treatise on money, vol. 2: The applied theory of money. Macmillan. Keynes, J. M. (1937a). The general theory of employment. The Quarterly Journal of Economics, 51(2), 209–223. Keynes, J. M. (1937b). Alternative theories of the rate of interest. Economic Journal, 47(186), 241–252. Keynes, J. M. (1964). The general theory of employment, interest, and money. Harcourt Brace Jovanovich (Original work published 1936). Klamer, A. (1989). An accountant among economists: Conversations with Sir John R. Hicks. Journal of Economic Perspectives, 3(4), 167–80. Kloha, P., Weissert, C. S., & Kleine, R. (2005). Developing and testing a composite model to predict local fiscal distress. Public Administration Review, 65(3), 313–323. Kornai, J. (1992). The socialist system: The political economy of communism. Princeton University Press. Knight, F. (1921). Risk, uncertainty, and profit. University of Chicago Press. Kravchuk, R. S. (2020). Post-Keynesian public budgeting & finance: Assessing contributions from modern monetary theory. Public Budgeting & Finance, 40(3), 95–123. Kravchuk, R. S., & Stone, S. B. (2010). How and when do structural deficits reveal themselves? The case of Indiana. Journal of Public Budgeting, Accounting & Financial Management, 22(2), ­487–510. Kriz, K. A., & Funderburg, R. (2019). Measuring fiscal sustainability of local governments: A stress testing approach using Illinois municipalities (Working Paper No. 19-01). Institute for Illinois Public Finance, University of Illinois. Ladd, H. F., & Yinger, J. M. (1989). America’s ailing cities: Fiscal health and the design of urban policy. Johns Hopkins University Press.

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Vickrey, W. (1996). Fifteen fatal fallacies of financial fundamentalism: A disquisition on demand side economics [Unpublished manuscript]. http://www.columbia.edu/dlc/wp/econ/vickrey.html. Wang, X., Dennis, L., & Tu, Y. S. (2007). Measuring financial condition: A study of US states. Public Budgeting & Finance, 27(2), 1–21. Weingast, B. R. (1995). The economic role of political institutions: Market-preserving federalism and economic development. Journal of Law, Economics, and Organization, 11(1), 1–31. Williamson, O. E. (1975). Markets and hierarchies, analysis and antitrust implications: A study in the internal organizations. The Free Press. Wray, L. R. (2006). Keynes’s approach to money: An assessment after 70 years. (Working Paper No. 438). Levy Economics Institute of Bard College.

12.  Understanding financial success: an exploration of the determinants of fiscally healthy cities Bruce D. McDonald III and Michaela E. Abbott

INTRODUCTION Research into the fiscal health of local governments has made significant progress over the past few decades. Since the Advisory Commission on Intergovernmental Relations (ACIR) (1973) first began to measure the financial condition of cities, the literature has expanded to include a variety of models and measurement systems of fiscal health (see Kleine et al., 2003; McDonald & Maher, 2019; Stone et al., 2015), explanatory capacity of what influences fiscal behavior (see Hendrick, 2004; Skidmore & Scorsone, 2011), and the implications that a government’s fiscal health can have on the community around it (see Chernick & Reschovsky, 2017; Honadle et al., 2004). The challenge of this literature is that it primarily focuses on the state of being fiscally unhealthy. It was Tolstoy (1878/2000) who wrote that “happy families are all alike, but every unhappy family is unhappy in its own way” (p. 3). Does this mean that our knowledge of unhappy families does not necessarily apply to happy ones? Or, in the context of fiscal health, might it suggest that what we know about fiscally unhealthy cities is not necessarily applicable to healthy ones? Given the focus of the literature towards understanding financially unhealthy cities, there is a growing need to also explore the factors behind healthy ones. It is this issue that we seek to answer in this study. In this study, we explore the measurement of and factors behind fiscally healthy cities. Using a dataset of the 150 largest cities in the United States from 1990 to 2017, we test several approaches to measuring fiscal health to determine the best approach for fiscally healthy cities. We also consider what factors contribute to a city’s fiscal health status. Through our analysis, we find that the factors that contribute to a city’s fiscally healthy status differ from those that influence positions of fiscal stress. Specifically, the capacity of a city to manage its spending, regardless of debt, plays a significant role in this outcome, as does its demographic composition and geographic location. Having established the focus of this study, the remainder of this chapter is as follows. First, we introduce and define the notion of fiscal health, with a brief discussion about the influences of fiscal health more broadly. Then we review the public finance literature as it pertains towards fiscally healthy cities. In the following section, we introduce the model, data, and methodological approach used to explore the determinants of fiscally healthy cities, followed by a section on the results with an exploration of what they mean. The chapter concludes with a discussion of the implications of the findings and ­recommendations for future research.

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UNDERSTANDING FISCAL HEALTH To understand what drives a financially healthy city, we must first clarify what fiscal health is. In its most simple form, fiscal health refers to the capacity of an organization to pay its bills with the resources it has available (Arnett, 2014; Hendrick, 2004; Jacob & Hendrick, 2013; Trussel & Patrick, 2013). An organization is considered fiscally healthy if its available resources meet or exceed its obligations. Conversely, if there are not enough resources to meet the obligations, the organization is fiscally unhealthy, a financial position that is commonly referred to as fiscally stressed (Maher et al., 2022; McDonald & Maher, 2019). Understanding the capacity of a government is important to the concept of public administration as financial resources are critical to the capacity of a city to provide public services and programs (Maher et al., 2020). As the field of public administration has developed in the United States, the notion of fiscal health has remained a constant consideration, beginning with the creation of the New York Bureau of Municipal Research in 1906 (McDonald, 2010), continuing through the financial troubles of New York City in the 1970s (Groves et al., 1981), and lasting until today (Gorina et al., 2018; McDonald, 2019). While the literature on fiscal health is vast, it generally agrees that the fiscal health of a government can be viewed through four dimensions: (1) the capacity of a government to meet its immediate or short-term financial obligations; (2) the capacity of a government to meet its financial obligations over the budgeted fiscal year; (3) the capacity of a government to meet its long-term financial obligations; and (4) the capacity of a government to finance its core services and programs, as required by law (see Jacob & Hendrick, 2013; McDonald, 2018; Wang et al., 2007). The advantage of this multi-dimensional view is that it allows us to balance where a government is in terms of its future needs and in terms of the needs of its citizens. The multi-dimensional approach also allows us to understand the ability of a government to withstand future financial shocks, such as an economic recession, natural disaster, or change in its tax base. Our understanding of what fiscal health is and how it is measured is largely based on fiscally stressed organizations. Initial attempts to understand financial condition began in the 1890s as a tool for lending decisions by commercial banks (Horrigan, 1968). The challenge in this era was that hundreds of financial ratios quickly emerged, but which measurement mattered? Financial ratios provide a perspective on the fiscal health of an organization but relying upon the wrong ratio might give an incorrect perspective. This challenge led scholars such as Wall (1919) and Altman (1968) to seek out clarification on which ratios matter for our understanding of fiscal health. To help in this determination, however, they relied upon the only definitive financial condition they had at their disposal – that is, whether an organization has declared bankruptcy, which signals the complete absence of fiscal health. Attention to the fiscal health of governments in the United States largely began because of the looming financial crises of the 1970s (Maher et al., 2022). During this time, local governments such as New York City and Cleveland faced difficulty in meeting their obligations. As public administrators worked alongside the politicians to address the challenge, attention was also given to the forecasting of future fiscal stress among local governments. Needing a basis on which to build a model of fiscal health for local governments, the early researchers turned to the accounting literature and the work of early scholars such as Wall and Altman.

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In the decades since, our understanding of fiscal health, including its measurement and influences, has developed significantly. Studies such as those by Stone et al. (2015), McDonald (2017), Gorina et al. (2018), and McDonald and Maher (2019) have sought to clarify how fiscal health is best measured. What this literature shows us is that while several measurement systems have been developed, our best understanding of fiscal health comes from systems that rely on disaggregated measures. To gain this understanding, the literature has also explored the non-financial drivers behind fiscal health. Briefly, the drivers can be categorized as governmental and political, economic, and demographic in nature (Maher, et al., 2022).1 On the governmental and political side, every government provides its own set of services, adheres to its own institutional structure, and has its own political dynamic. According to Maser (1985, 1998), the different combinations of these characteristics can change how a government behaves and what services it provides (see also Flink & Molina, 2021; Hood & Piotrowska, 2023). For example, the dynamic may shift how the administration–politics dichotomy is viewed, which can increase or decrease an administrator’s capacity to advise and manage (Young et al., 2020). Additionally, both Decker (2023) and Goodman et al. (2021) note that the governmental and political side of a local government can also be driven by its relationship with the state, such that more direct oversight or involvement by the state can limit the capacity of a local government to respond to crises, such as challenges to the financial stability of the government. Fiscal health is also tied to the economic conditions of a government. A key focus in public economics and public finance is the development of government policies that allow for the economy to grow and the community to prosper (Jones, 2001). Given the tax structure used by local governments in the United States, the amount of revenue a city receives is directly tied to the community’s economic performance. As the economy improves, the amount of tax revenue collected by the government should also increase. The inverse is also true. As the economy declines, so does the collected revenue. This relationship directly impacts the financial condition of a city as revenue is necessary to provide services and meet liability payments. The final set of characteristics that has been shown to drive fiscal health is demographic in nature. Every demographic has different household priorities and a different expectation of services from its representative government. For example, elderly populations tend to be interested in governments that provide health services, while younger populations are more interested in education (McDonald & Maher, 2019). Demographic groups can form coalitions to encourage a city to provide a set of preferred services or to change its financial policies (see Wiley et al., 2021). Ideally, such advocacy would be done in the context of what the government is able to afford in the long term; however, as Kim et al. (2022) note, the pressure on local officials to win reelection often encourages service provision and expansion over financially practical decisions. In the absence of a specific literature that focuses on the determinants of a fiscally healthy city, we are relying upon the broader literature about fiscal health to develop our understanding and expectations in this study. Specifically, given the relationship between 1   Due to limited space, these categories and how they influence the fiscal health of a government are only briefly discussed here. For a more comprehensive understanding of fiscal health, its drivers, and the literature behind those drivers, we would encourage you to read Honadle et al. (2004) or Maher et al. (2022).

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fiscal health and the governmental/political, economic, and demographic characteristics of a city, we anticipate that these relationships will continue to hold in our study. Our expectation, however, is that the directionality of some factors may change to account for the change in direction of our interest (fiscally healthy cities instead of stressed cities).

MODEL, DATA, AND METHODS The intention of this study is to understand the factors that lead to financially healthy cities. To accomplish this goal, we adopted a methodological approach built around event history analysis (EHA). EHA is a methodological approach that focuses on the patterns and causes of qualitative changes at a point in time.2 The changes are referred to as “events.” The intention is to determine how a variable, or set of variables, affected the probability that an organization would transition into a new social state. We accomplish the EHA in two steps. In the first step, the risk set of the analysis needs to be defined. In the second step, the event model needs to be established. The risk set defined for this study is based on the 150 largest municipalities in the United States, as represented in the Lincoln Institute of Land Policy’s Fiscally Standardized Cities (FiSC) database. The time period of consideration in this sample is 1990 through 2017, creating a final risk set of 4200 observations. Turning attention towards the event model, several approaches to modeling fiscal health have been used within the extant literature (see McDonald, 2018, 2019). There has been a growing consensus that an open-systems approach is the most appropriate (see Hendrick, 2004; McDonald, 2015; McDonald & Maher, 2019; Nollenberger et al., 2003). In an open-systems approach, cities are viewed as open organizations – that is, they both influence their environment, and the policies and decisions made by the city are influenced by the environment (see also Cyert & March, 1963). Accordingly, the behavior of a government and the policies it produces are viewed as a function of the environment from the community in which it resides, as well as the institutions that frame its structure and guide its governance. From this literature, we use the following model of an EHA of municipal bankruptcy:

​​Bi,t ​  ​​  =  Ѱ​(​ε​ 1​​ ​Hi,t − 1 ​  ​​  + ​ε​ 2​​ ​Gi,t − 1 ​  ​​  + ​ε​ 3​​ ​Ei,t − 1 ​  ​​  + ​ε​ 4​​ ​Di,t − 1 ​  ​​)​​, (12.1)

where the dependent variable Bi,t is the hazard rate of the probability that municipality i will be financially healthy in year t. H reflects the fiscal health of the municipality. The variables G, E, and D capture the governmental, economic, and demographic conditions of the municipality in the given year. Furthermore, Ψ denotes the cumulative normal distribution of the model. The hazard rate is measured as a dummy variable, where a “0” or a “1” were used to signify whether the municipality is fiscally healthy. To determine whether a city is fiscally healthy, we relied upon Brown’s (1993) “10-point test.” Brown’s test uses ratio analysis to capture the fiscal health of a government across five dimensions 2   We only briefly discuss EHA and its mechanics in this chapter. For more information, we recommend that you read Berry and Berry (1990), Box-Steffenmeier and Jones (1997), and McDonald and Gabrini (2014).

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Table 12.1  Brown’s 10-point test Indicator

Type

Measurement

Total revenues per capita

Revenue

Intergovernmental revenues/total revenues percentage

Revenue

Property tax or own-source tax revenues/total revenues percentage Total expenditures per capita

Revenue

Operating surplus or deficit/ operating revenues percentage

Operating position

Total revenues for all governmental funds (excluding capital project funds)/ population Intergovernmental revenues for the general fund/total general fund revenues Total tax revenues levied locally for the general fund/total general fund revenues Total expenditures for all governmental funds (excluding capital project funds)/ population General fund operating surplus or deficit/total general fund revenues

General fund balance/general fund revenues percentage

Operating position

Enterprise funds working capital coverage percentage

Operating position

Long-term debt/assess value percentage Debt service/operating revenues percentage Post-employment benefit assets/ liabilities percentage

Debt

Expenditure

Debt Unfunded liability

General fund unreserved fund balance/total general fund revenues Current assets of enterprise funds/current liabilities of enterprise funds Long-term general obligation debt/assessed value General obligation debt service/ total general fund revenues Funded ratio (i.e., actuarial value of plan assets/actuarial accrued liability)

Source:  Adapted from Maher and Nollenberger (2009, p. 62).

(see also Maher & Nollenberger, 2009). An overview of the dimensions and their measurements is provided in Table 12.1. To calculate the fiscal health score, each dimension is given a quartile score based on where it falls in comparison to other cities included in our dataset. A dimension is given a score of “–1” for the first quartile, ranging to a “2” for the fourth across all the ratios. The result is a score of fiscal health that ranges between “–10” and “20.” The interpretation of the score is relative to the peer group included in the study, such that a score of “10” or more places the government among the best, and a score of “–5” or under among the worst. Given the focus of this study on whether a city is fiscally healthy, the score is recoded such that cities with a score of 10 or more are coded as fiscally healthy and all other cities are coded as fiscally unhealthy. This is reflected in the “0” or “1” of the model’s hazard rate. Accordingly, a pooled time-series cross-­ sectional probit approach is used to estimate the event history model. The FiSC database

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Table 12.2  Wang et al.’s solvency test Indicator

Dimension

Measurement

Cash ratio

Cash solvency

Quick ratio

Cash solvency

Current ratio Operating ratio Surplus (deficit) per capita Net asset ratio

Cash solvency Budget solvency Budget solvency Long-run solvency

Long-term liability ratio

Long-run solvency

Long-term liability per capita

Long-run solvency

Tax per capita Revenue per capita Expenses per capita

Service solvency Service solvency Service solvency

(Cash + cash equivalents + investments)/current liabilities (Cash + cash equivalents + investments + receivables)/current liabilities Current assets/current liabilities Total revenues/total expenses Total surplus (deficit)/population Restricted and unrestricted net assets/total assets Long-term (non-current) liabilities/ total assets Long-term (non-current) liabilities/ population Total taxes/population Total revenues/population Total expenses/population

Source:  Adapted from Wang et al. (2007, pp. 8–9).

provided the data necessary to estimate this measurement and the other financial measures used in this study.3 Following the discussion in the previous section, two approaches are tested here to see how they predict a city’s fiscal health status. These include ratio analysis and Wang et al.’s (2007) solvency test, measured both as the individual dimensions and as the total Financial Condition Index (FCI). An overview of the measurement and dimensions of Wang et al.’s solvency test is provided in Table 12.2.4 An issue emerged in the fiscal health calculations related to the ratio analysis and which ratios should be included in the study. Financial ratios tend to exhibit high levels of correlation, creating the potential for multicollinearity within the results. To overcome this challenge, we turned to the literature on fiscal health and adopted the most recommended ratios. Next, we followed the recommendation of the statistics and econometrics literatures of reducing the number variables to remove the problem (see Silvey, 1969; Zhang & Ibrahim, 2005). This produced a final set of four ratios that helps reflect the different dimensions of the financial behavior of a local government. The four ratios included in this study are the efficiency ratio, debt service ratio, cash ratio, and current ratio. In this study, we used four variables to account for the influence of governmental and economic conditions on a city’s financial condition. These are: form, Dillon’s 3   When using the FiSC dataset, we used the non-standardized data for the cities to ensure we appropriately captured city dynamics. 4   For details on the calculation of the measurement process of the solvency tests, see Wang et al. (2007).

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Rule, governor party, and tax limitations. The first variable in the model represents the form of government that a municipality follows. Measurement of the variable follows the International City/County Management Association’s (ICMA) typology and is retrieved from the ICMA’s municipal yearbooks. Form of government is reflected as two dummy variables – council-manager and mayor-council – with cities adhering to the commission form serving as the reference group. Dillon’s Rule5 controls for whether the state where the city is located is a Dillon’s Rule state. The variable is coded such that a “1” reflects that the city is in a Dillon’s Rule state and a “0” reflects that it is not. Information on a state’s adherence to Dillon’s Rule is from the National Association of Counties (2004). To address the issue of political influence within the governmental conditions, we relied upon the political affiliation of the governor as a reflection of local political beliefs.6 The political affiliation of the governors from 1990 to 2011 are from Klarner’s (2013) Governors Dataset. Data on the affiliations for the years 2012 to 2019 are from websites of each state. The variable is measured as a dummy, where “0” was assigned for a Democrat-controlled governorship and “1” for Republican controlled. In several instances, gubernatorial control changed from one party to the other during the year. In years that a change occurred, party affiliation was assigned based on which party maintained control during most of the year. Finally, we accounted for the tax and expenditure limitations (TELs) imposed by the state, as previous research into TELs has shown that they can limit a local government’s access to revenue (Decker, 2023; McDonald & Maher, 2019). To account for TELs in our model, we used Maher et al.’s (2016) TEL index, as measured by Park (2018). The index gives each state a score along a continuous scale of how strict of a TEL the state has imposed. Accordingly, a state with a score of “0” indicates the absence of a TEL during the year. Alternatively, a score of “1” and up represents increasing strictness of the TEL (for a more thorough description of the TEL index, see Decker, 2023 and Maher et al., 2016). In the final set of conditions, we follow the literature of fiscal health and control for the influence of a city’s demographics (see Maher et al., 2016; McDonald, 2015, 2017; McDonald & Maher, 2019). The inclusion of demographic controls allows us to account for how the preferences of the respective community members may differ. The variable Male accounts for the logged share of the city’s population that identified themselves as male and the variable Hispanic for the logged Hispanic share of the population. The age of a city’s population is captured with two variables. These are 0 to 17 and 66 and over, where each variable reflects the log of the share of the population aged within the variable’s brackets. The population estimates necessary for these measurements were obtained from 5   Dillon’s Rule is derived from a written decision by Judge John F. Dillon of Iowa in 1868. The rule is the principle that local governments can only exercise (1) powers expressly granted by the state; (2) powers necessarily and fairly implied from the grant of power; and (3) powers crucial to the existence of local government. 6   This approach has some limitations. We acknowledge that political trends observed at the state level are not necessarily reflective of the political trends observed within municipalities. Unfortunately, local data are not available for all the cities and years that are included in our sample. When faced with such limitations, the extant literature argues that state-level political data may provide a sufficient reflection of municipal trends when used as a control variable (see Kim et al., 2018; Maser, 1998; McDonald & Gabrini, 2014).

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the US Census Bureau. Where Census data were not available, estimates from the Woods & Poole Economics database were used. Last, we included the Census region of each municipality. These regions are reflected as five dummy variables (Midwest, Northeast, Pacific, West, and South), with municipalities placed in the West region serving as the reference group. Table 12.3 offers the simple statistics for the study variables.

RESULTS Table 12.4 presents the results of estimating the EHA of our model for fiscally healthy cities. Overall, the open-systems approach to understanding fiscal health was statistically significant, with the log likelihoods indicating that the model fits the data well. The influence of the control variables remained relatively stable across each of the models, suggesting that the model, and its subsequent results, is robust. There are three sets of interesting results. The first set relates to the measurement of fiscal health in the context of cities being fiscally healthy. The second set relates to the factors that drive a city to be fiscally healthy. The third set relates to the comparison of the estimates to previous studies that sought to explain fiscal stress. Table 12.3  Sample statistics Variable

Mean

Dependent variable Fiscally healthy

0.0412

0.1987

1.0352 1.3536 0.0089 0.0291 0.1124 0.0156 −0.0400 0.0033 0.1334 0.4331 0.5107 0.7667 0.5440 7.5273 0.4894 0.1143 0.2549 0.6228 0.2133 0.1400 0.1600 0.3667

0.5036 1.0019 1.1335 1.4616 1.2479 1.2383 0.0150 0.0920 0.1171 0.4956 0.4999 0.4230 0.4981 6.2623 0.0101 0.1433 0.0341 0.0467 0.4097 0.3470 0.3666 0.4819

Independent variables Efficiency ratio Debt service ratio Cash ratio Current ratio FCI Cash solvency Budget solvency Long-run solvency Service solvency Council-manager Mayor-council Dillon’s Rule Governor party TEL index Male Hispanic 0 to 17 66 and over Midwest Northeast Pacific South

Std. Dev.

Min. 0 −8.6572 −17.3023 −0.0382 −0.03818 −0.2446 −0.0382 −0.2452 −0.0763 0.0001 0 0 0 0 0 0.4649 0.0029 0.1336 0.0187 0 0 0 0

Max 1 22.3619 23.6039 64.9709 76.9894 68.9512 68.9770 0.0559 0.6695 1.3723 1 1 1 1 27 0.5389 0.8218 0.4150 0.3926 1 1 1 1

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Table 12.4  Event history analysis results

Efficiency ratio Debt service ratio Cash ratio Current ratio FCI Cash solvency Budget solvency Long-run solvency Service solvency Council-manager Mayor-council Dillon’s Rule Governor party TEL index Male Hispanic 0 to 17 66 and over Midwest Northeast Pacific South Constant Log likelihood

Ratio Analysis

FCI

Dimensions of FCI

−1.0687*** 0.4056*** 0.2338 −0.1898 – – – – – 4.2916 4.6106 0.1597* −0.1491** 0.0009 19.0258*** −2.2606*** −2.9741** −2.6445** 0.2926* 0.7699*** 0.4707*** 0.5188*** −14.3235 −471.2127

– – – – –0.0559 – – – – 8.0054 8.3932 0.0725 −0.1729* 0.0054 31.6991*** −1.4279 0.4287 0.3794 0.9793* 1.4013* 0.4143 1.1577* −27.5954 −484.1432

– – – – – −0.0987* 6.2654*** −1.6452 6.2515*** 6.0401 6.1925 −0.0146 −0.1454* 0.0128 37.1777*** −2.4792** 10.7749** 2.0329 0.9310* 1.2361* −0.0614 0.9519* −31.5105 −457.3723

Note:  * p < 0.10; ** p < 0.05; *** p < 0.01.

Regarding the measurement of fiscal health in the context of fiscally healthy cities, the estimates provide mixed support. In the first, which reflects the use of ratio analysis in predicting fiscally healthy cities, there are conflicting results. Of the four financial ratios included in the study, two showed strong statistical significance, while the other two showed no significant relationship. Both the efficiency ratio, which reflects the ability of a government to use its resources to generate revenue, and the debt service ratio, which reflects the capacity of a government to generate sufficient revenue to pay its debt service for interest, principal, and lease payments, showed significant impacts. The effect of the efficiency ratio was negative, such that as the ratio increases the likelihood of a city being fiscally healthy decreases. Given that the efficiency ratio is measured as the ratio of expenditures to revenue, this effect is in line with what we would expect to see. Similarly, the debt service ratio showed a positive effect, such that as the debt service ratio increases, so does the likelihood of a city becoming fiscally healthy. Conversely, both the cash and current ratios showed no significant impact on the likelihood of fiscal healthiness. Intuitively, the results, while surprising, are appropriate. The cash and current ratios reflect the outstanding liabilities of a government. As McDonald and Maher (2019) note, both ratios are central to the prediction of fiscal stress as they reflect increasing hardship for a government, whether this is due to growth in its outstanding liabilities or a reduction in the resources to meet those liabilities.

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The second and third models reflect Wang et al.’s (2007) FCI and its individual dimensions, respectively. The results of the analysis show two sides of the same picture. From one perspective, the FCI showed no significant effect, suggesting that the FCI is not a sufficient means of capturing whether a local government is fiscally healthy. From another perspective, three of the four dimensions show significant influence. Based on the results, budget solvency and service solvency both have a significant and positive effect on fiscal health. Conversely, cash solvency has a negative but significant effect. Given the findings of the first model, which used ratio analysis to understand fiscally healthy cities, the results are in line with what would be expected. Budget solvency uses the operating ratio and surplus per capita as its measurement base, both of which reflect the pattern we previously saw with the efficiency ratio – that is, fiscally healthy cities have either lower expenditures or higher revenue. This same pattern is then reflected in the service solvency dimension. The negative impact of the cash solvency dimension reflects the capacity of the organization to meet its current liabilities. The interesting finding here is that while the ratio analysis showed no significant influence for the cash and current ratio, the cash solvency dimension also incorporates the quick ratio, which accounts for receivables due to the city. Given the previous finding from the ratio model, it is expected that the significance of this dimension is directly related to those receivables. It should be noted, however, that one challenge in using the FCI and its dimensions to understand fiscal health is that it does not always provide consistent results. McDonald and Maher (2019) noted that the measurement approach suffers from an aggregation problem, such that the actual measurement of a government’s financial condition may become lost as multiple variables are aggregated together. This may explain why most of the dimensions have an effect, while the aggregated measure of FCI sees those effects diminished. Clark (2015) demonstrated similar difficulties in finding a consistent effect using the FCI measures. The second set of interesting results relates to the factors that drive a city to be fiscally healthy. Previous research into fiscal health argued that the governmental/political, economic, and demographic conditions of a government help to drive its status. Although this may be true for measuring fiscal stress, the findings of this study suggest that it may not be true for measuring fiscal healthiness. In all three models, the form of government variables, which capture whether a city has a council-manager or mayor-council form of government, were not significant. We also found that whether a city was under the umbrella of a Dillon’s Rule state had an effect in only one model, and even then, the effect was minimal. The financial independence of a city, as captured by the TEL index, also showed no significant results across the three models. We do find that the presence of a Republican governor in a state reduces the likelihood of a city being fiscally healthy. Where we do find the most significant results is by looking at the demographic characteristics. The share of population who identify as male has a consistent positive influence on fiscal healthiness, such that cities with larger male populations are more likely to be fiscally healthy. Conversely, we found the share of the population who identify as Hispanic to have a negative influence on fiscal healthiness. The effect of the measures for population age varied slightly, though the results do give a general understanding that the younger the population, the less fiscally healthy it is. What we expect is happening is that the more homogeneous a population, the lower the demand for services, with the expectation that more diverse populations bring with them more diversity in their

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expectations for services. Additional research in this area is needed to help clarify the relationship between demographics, public service needs, and fiscal health. The results also suggest that geography has an impact on fiscal health. Cities in the South, Northeast, and Midwest showed consistent and positive effects across all three models. Conversely, cities in the Pacific only have a significant effect on the model for ratio analysis. The findings suggest that cities in the West and Pacific regions of the United States are at more of a disadvantage than others when it comes to their likelihood of being fiscally healthy. These findings may point towards several things, including cultural and expectation differences across the country, or towards the gift of resources and experience (or age). The final set of interest results is in the comparison of the results to previous studies. In many ways, the study being conducted here is an extension of McDonald (2017) and McDonald and Maher (2019). These two previous studies looked at the factors that influenced the decision of a city to file for bankruptcy. As fiscal health is on a spectrum, a fiscally healthy city lies on one end and a stressed city lies on the other. Given that the study here uses similar data and models to these earlier studies, this allows us to compare the results to see how drivers may vary based on what aspects of fiscal health we are trying to predict or understand. Looking at the model for ratio analysis, our results show an opposite finding to earlier work. McDonald and Maher (2019) found the cash and current ratios to be influential in predicting municipal bankruptcy, with no effect coming from the efficiency and debt service ratios. We found that the cash and current ratios had no effect on fiscal healthiness, while the efficiency and debt service ratios were important in predicting that fiscally healthy state. While our findings confirmed the lack of use of the aggregated FCI measure, when looking at the dimensions we found an interesting comparison. In our study, cash solvency reduces the likelihood of being fiscally healthy, and budget and service solvency increase it. In McDonald and Maher (2019), budget solvency was seen to increase bankruptcy decisions, and long-run solvency was seen to decrease it. Neither cash nor service solvency had any effect. What we believe that these findings show is that the fiscal behavior of a fiscally healthy city is not the same as the fiscal behavior of a stressed one. As a result, one model of fiscal health may be unable to capture the full range of fiscal health.

DISCUSSION AND CONCLUSION The focus of this study is to improve our understanding of the determinants of fiscally healthy cities. One of the ongoing struggles for local governments is the management of their resources and the understanding of how that management influences organizations’ fiscal health. To date, however, the literature on fiscal health has primarily focused on fiscal stress. In this chapter, we have used a study of 150 cities in the United States from 1990 to 2017 to push the literature on fiscal health forward. We accomplish this using an EHA, where the event in question was whether the city was financially healthy according to Brown’s 10-point test. The result of our analysis is findings that show that the measurement and prediction of fiscally healthy cities is inherently different than that of their financially stressed counterparts. Fiscal health is commonly viewed in the context of the ability of an organization to meet its liabilities (Arnett, 2014; Hendrick, 2004; Jacob & Hendrick, 2013;

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Trussel & Patrick, 2013). This understanding has served the literature well, particularly given its focus on fiscal stress as a calibration tool for measuring fiscal health. As McDonald (2017) and McDonald and Maher (2019) point out, this approach has resulted in a measurement of fiscal health that reflects the liability concern – that is, the measurement of fiscal health is driven by an organization’s debt and the impact of that debt on its financial ratios. When using fiscally healthily cities to calibrate our understanding of fiscal health, we found that the role of debt is limited. Rather, regardless of how much debt a city has, its fiscal health is driven by its ability to have a budget surplus. If we envision fiscal health as a spectrum where cities can fall between the extremes of fiscally healthy and fiscally stressed (Figure 12.1), the findings of this study do make sense in relation to the previous work. As cities become financially strapped, the capacity to continue to pay on their debt becomes more important as issuing new debt is a way of accessing cash when revenue streams are insufficient. As that debt grows, so does the inability of the government to make payments towards the debt, forcing cuts in the city’s budget to accommodate. Alternatively, as cities become financially stable, the importance of debt decreases. Debt can then be used as a tool, but its impact is seen in the broader picture of a city’s finances. In the context of the fiscal health spectrum, a city in the middle of the spectrum would balance its budget and pay towards liabilities without any excess revenue. This city would be neither healthy nor stressed, but rather balanced. As revenue decreases or liabilities increase, the balanced city begins to lose its positioning and becomes stressed. Alternatively, if the city experienced either a decline in expenditures or an increase in revenue, creating a budget surplus, the balanced city would improve upon its positioning and become healthier. This provides an opportunity and a challenge for public budgeting and finance scholars in that we need to explore and understand both sides of this spectrum. For example, we need to know at what point the importance of surplus versus debt takes place and we need to understand how we can measure the spectrum and where governments fall. In addition to different financial drivers of health status, we also found a difference in the role of the government, economic, and demographic characteristics. While the government and economy are key players in the financial problems of stressed cities, they showed no significant impact for healthy cities. Rather, after the financial drivers, healthy cities are largely influenced by the demographics of their residents. This effect suggests troubling concerns about social equity among local governments. The importance of demographics to understanding a city’s healthiness follows the literature about citizen engagement and population homogeneity. The more homogeneous a population, the fewer services that population will request from the government. Conversely, as the population becomes increasingly diversified, so does the expectation of services. This is because different communities have different

Figure 12.1  The spectrum of fiscal health

232  Research handbook on city and municipal finance

needs. The concern is what implications this has. Social equity is a key concern within public administration (Berry-James et al., 2021) and we know that financial policies and budgets can influence the equity of our communities, but the role of social equity in public budgeting and finance is little understood (Rubin & Bartle, 2023; McDonald & McCandless, 2021). If a city is financially healthier because its homogeneity allows it to reduce expenditures and create a surplus, does this mean that diverse cities are being financially penalized for their diversity? And if so, how can this be overcome to allow all cities and all residents equal opportunity? We ask these questions knowing that there is currently no answer. The absence of an answer suggests a need within our research to explore the role of fiscal health on social equity. At the same time, we would encourage research into the broader issue of public budgeting and finance as it relates to social equity as well. It is worth noting that the relationship between demographics and fiscal health does bring some consideration of the relationship between citizen participation and budgeting. As Shybalkina (2022) reminds us, participation in government leads to budget decisions that benefit those who participated (see also Tuxhorn et al., 2022). This opens the door for a consideration of whether it is population homogeneity that leads to reduced services and expectations, or rather, is the reduction in response to those who can be civically involved? Even if this is not an issue of homogeneity, this remains a social equity concern as the administrative burdens tied to citizen engagement often exclude diverse communities from participation (see Madsen et al., 2022). This chapter began as an exercise to see what would happen if we considered the factors that influence fiscal health from the perspective of financially healthy cities. What we have found is that fiscal health is a more complicated issue than we have previously thought, and the challenges of fiscal health as a spectrum of conditions that may have differing influences only complicates the issue further. Certainly, the research into fiscal health has significantly advanced in recent years, but we still have a way to go. As we have pointed out, there is more we need to know about the underlying behavior of healthy cities. In addition to the questions raised above, we would encourage future research to also reconsider what we mean when we talk about fiscal health. Specifically, whether the current definition of fiscal health as the capacity to pay liabilities is sufficient or whether it needs to be expanded to account for the possibility of the fiscal health spectrum.

REFERENCES Advisory Commission on Intergovernmental Relations (ACIR). (1973). City financial emergencies: The intergovernmental dimension. Government Printing Office. Altman, E. I. (1968). Financial ratios, discriminant analysis and the prediction of corporate bankruptcy. Journal of Finance, 23(4), 589–609. Arnett, S. (2014). State fiscal condition: Ranking the 50 states. Mercatus Center, George Washington University. Berry, F. S., & Berry, W. D. (1990). State lottery adoptions as policy innovations: An event history analysis. American Political Science Review, 84(2), 395–415. Berry-James, R. M., Blessett, B., Emas, R., McCandless, S., Nickels, A. E., Norman-Major, K., & Vinzant, P. (2021). Stepping up to the plate: Making social equity a priority in public ­administration’s troubled times. Journal of Public Affairs Education, 27(1), 5–15. Box-Steffenmeier, J. M., & Jones, B. S. (1997). Time is of the essence: Event history models in political science. American Journal of Political Science, 41(4), 1414–1461.

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Brown, K. W. (1993). The 10-point test of financial condition: Toward an easy-to-use assessment tool for smaller cities. Government Finance Review, 9(6), 21–26. Chernick, H., & Reschovsky, A. (2017). The fiscal condition of U.S. cities: Revenues, expenditures and the “Great Recession.” Journal of Urban Affairs, 39(4), 488–505. Clark, B. Y. (2015). Evaluating the validity and reliability of the Financial Condition Index for local governments. Public Budgeting and Finance, 35(2), 66–88. Cyert, R. M., & March, J. G. (1963). A behavioral theory of the firm. Prentice Hall. Decker, J. W. (2023). An (in)effective TEL: Why county governments do not utilize their maximum allotted property tax rate. Public Administration, 101(2), 376–390. Flink, C., & Molina, A. L. (2021). Improving the performance of public organizations: Financial resources and the conditioning effect of clientele context. Public Administration, 99(2), 387–404. Goodman, C. B., Hatch, M. E., & McDonald, B. D. (2021). State preemption of local laws: Origins and modern trends. Perspectives on Public Management and Governance, 4(2), 146–158. Gorina, E., Maher, C., & Joffe, M. (2018). Local fiscal distress: Measurement and prediction. Public Budgeting and Finance, 38(1), 72–94. Groves, S. M., Godsey, W. M., & Shulman, M. A. (1981). Financial indicators for local governments. Public Budgeting and Finance, 1(2), 5–19. Hendrick, R. (2004). Assessing and measuring the fiscal health of local governments: Focus on Chicago suburban municipalities. Urban Affairs Review, 40(1), 78–114. Hood, C., & Piotrowska, B. M. (2023). Who loves input controls? What happened to “outputs not inputs” in UK Public Financial Management, and why? Public Administration [Special issue], 101(1), 303–317. Honadle, B. W., Costa J. M., & Cigler, B. A. (2004). Fiscal health for local governments: An introduction to concepts, practical analysis, and strategies. Elsevier. Horrigan, J. O. (1968). A short history of financial ratio analysis. The Accounting Review, 43(2), 284–294. Jacob, B., & Hendrick, R. (2013). Measuring and predicting local government fiscal stress: Theory and practice. In H. Levine, J. B. Justice, & E. A. Scorsone (Eds.), Handbook of local government fiscal health (pp. 11–41). Jones & Bartlett Learning. Jones, C. I. (2001). Introduction to economic growth (2nd ed.). Norton. Kim, J., McDonald, B. D., & Lee, J. (2018). The nexus of state and local capacity in vertical policy diffusion. American Review of Public Administration, 48(2), 188–200. Kim, J., Shon, J., & McDonald, B. D. (2022). Does school district board type affect fiscal conditions? Examining debt positions. Public Performance and Management Review, 45(1), 30–53. Klarner, C. (2013). Governors dataset. Harvard Dataverse. https://doi.org/10.7910/DVN/PQ0Y1N. Kleine, R., Kloha, P., & Weissert, C. S. (2003). Monitoring local government fiscal health: Michigan’s new 10-point scale of fiscal distress. Government Finance Review, 19(3), 18–23. Madsen, J. K., Mikkelsen, K. S., & Moynihan, D. P. (2022). Burdens, sludge, ordeals, red tape, oh my! A user’s guide to the study of frictions. Public Administration, 100(3), 375–393. Maher, C. S., Deller, S. C., Stallmann, J. I., & Park, S. (2016). The impact of tax and expenditure limits on municipal credit ratings. American Review of Public Administration, 46(5), 592–613. Maher, C. S., Ebdon, C., & Bartle, J. R. (2020). Financial condition analysis: A key tool in the MPA curriculum. Journal of Public Affairs Education, 26(1), 4–10. Maher, C. S., & Nollenberger, K. (2009). Revisiting Kenneth Brown’s “10-point test.” Government Finance Review, 25(5), 61–66. Maher, C. S., Park, S., & Harrold, J. (2016). The effects of tax and expenditure limits on municipal pension and OPEB funding during the Great Recession. Public Finance and Management, 16(2), 121–146. Maher, C. S., Park, S., McDonald, B. D., & Deller, S. C. (2022). Understanding municipal fiscal health: A model for local governments in the USA. Routledge. Maser, S. M. (1985). Demographic factors affecting constitutional decisions: The case of municipal charters. Public Choice, 47(1), 121–162. Maser, S. M. (1998). Constitutions as relational contracts: Explaining procedural safeguards in municipal charters. Journal of Public Administration Research and Theory, 8(4), 527–564.

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McDonald, B. D. (2010). The Bureau of Municipal Research and the development of a professional public service. Administration and Society, 42(7), 815–835. McDonald, B. D. (2015). Does the charter form improve the fiscal health of counties? Public Administration Review, 75(4), 609–618. McDonald, B. D. (2017). Measuring the fiscal health of municipalities (Working Paper No. WP17BM1). Lincoln Institute of Land Policy. McDonald, B. D. (2018). Local governance and the issue of fiscal health. State and Local Government Review, 50(1), 46–55. McDonald, B. D. (2019). The challenges and implications of fiscal health. South Carolina Journal of International Law and Business, 15(20), 78–99. McDonald, B. D., & Gabrini, C. J. (2014). Determinants of county charter decisions: An event history analysis of Florida counties. Journal of Public Administration Research and Theory, 24(4), 721–739. McDonald, B. D., & Maher, C. S. (2019). Do we really need another municipal fiscal health analysis? Assessing the effectiveness of fiscal health systems. Public Finance and Management, 19(4), ­268–291. McDonald, B. D., & McCandless, S. (2021). Incorporating social equity. In B. D. McDonald & M.  Jordan (Eds.), Teaching public budgeting and finance: A practical guide (pp. 231–251). Routledge. National Association of Counties (NACo). (2004). Dillon’s Rule or not? [Research brief]. NACo. Nollenberger, K., Groves, S. M., & Valente, M. G. (2003). Evaluating financial condition: A handbook for local government, International City/County Management Association. Park, S. (2018). Game-theoretic thinking of state-imposed tax and expenditure limitations: Rule design, institutional diversity, and municipal fiscal outcomes [Unpublished doctoral dissertation, University of Nebraska at Omaha]. Rubin, M., & Bartle, J. (2023). Gender-responsive budgeting: A budget reform to address gender inequity. Public Administration, 101(2), 391–405. Shybalkina, I. (2022). Toward a positive theory of public participation in government: Variations in New York City’s participatory budgeting. Public Administration, 100(4), 841–858. Silvey, S. D. (1969). Multicollinearity and imprecise estimation. Journal of the Royal Statistical Society: Series B, 31(3), 539–552. Skidmore, M., & Scorsone, E. (2011). Causes and consequences of fiscal stress in Michigan municipal governments. Regional Science and Urban Economics, 41(4), 360–371. Stone, S. B., Singla, A., Comeaux, J., & Kirschner, C. (2015). A comparison of financial indicators: The case of Detroit. Public Budgeting and Finance, 35(4), 90–111. Tolstoy, L. (2000). Anna Karenina. Random House (Original work published 1878). Trussel, J. M., & Patrick, P. A. (2013). The symptoms and consequences of fiscal distress in municipalities: An investigation of reductions in public services. Accounting and the Public Interest, 13(1), 151–171. Tuxhorn, K. L., D’Attoma, J., & Steinmo, S. (2022). Assessing the stability of fiscal attitudes: Evidence from a survey experiment. Public Administration, 100(3), 633–652. Wall, A. (1919). Study of credit barometrics. Federal Reserve Bulletin, 5(3), 229–242. Wang, X., Dennis, L., & Tu, Y. S. (2007). Measuring financial condition: A study of U.S. states. Public Budgeting and Finance, 27(2), 1–21. Wiley, K., Searing, E. A. M., & Young, S. L. (2021). Utility of the advocacy coalition framework in a regional budget crisis. Public Policy and Administration, 36(3), 401–426. Young, S. L., Wiley, K. K., & Searing, E. A. M. (2020). Squandered in real time: How public management theory underestimated the public administration–politics dichotomy. American Review of Public Administration, 50(6–7), 480–488. Zhang, J., & Ibrahim, M. (2005). A simulation study on SPSS ridge regression and ordinary least squares regression procedures for multicollinearity data. Journal of Applied Statistics, 32(6), 571–588.

13.  State intervention in local government fiscal distress Lang (Kate) Yang

INTRODUCTION Although local governments in the United States are often considered “creatures of the state,” they enjoy considerable fiscal and policy autonomy. Localities adopt budgets, set tax rates, and make borrowing decisions. Notably, American fiscal decentralization is not accompanied by frequent fiscal crises or higher-level government bailouts, due to factors that contribute to a hard budget constraint. These include a fairly efficient municipal bond market that disciplines government borrowers, mobile labor and capital markets that induce intergovernmental competition, and a functional municipal bankruptcy framework (Inman, 2003). However, not all recent stories of local fiscal governance in the US are successful. The bankruptcy of Detroit in 2013 marked the largest municipal bankruptcy filing in history, with investors of Detroit bonds eventually taking a “haircut” in debt repayment and bearing much of the cost. In the 2014 Flint water crisis, the state-appointed emergency manager’s decision to switch the city’s water source led to water contamination and a public health crisis. The fact that both Detroit and Flint are located in the state of Michigan suggests that local fiscal distress is likely not random. Moreover, both cities have gone through the state intervention program that appoints an emergency manager in fiscally distressed local governments to design and implement recovery plans. Although the Flint experience shows how state intervention can go wrong when cost-cutting measures flagrantly ignore local residents’ welfare, 13 states have written into their statutes similar intervention programs. The 2007 Great Recession exposed the fiscal fragility of many American local governments, and the COVID-19 pandemic disproportionately affects areas reliant on tourism and other service economies. Future national and regional recessions will continue challenging state policymakers about what can be done when hard budget constraints fail in local governance. This chapter focuses on the approaches states take in intervening in local fiscal distress and their impact on local government financial management. Drawing on the fiscal decentralization literature, I discuss why horizontal fiscal imbalance – that is, the differential local government capacities to finance public services – means that local fiscal distress is likely concentrated in some regions and presents unique challenges to states in these regions. Most of the states with intervention laws are in the Great Lakes and Northeast regions of the United States, where the decline of the manufacturing industry has led to significant population losses. Most intervention programs are state-centric, meaning that once triggered, they halt autonomous local fiscal decision-making. I examine whether local governments are deterred by the adoption of state intervention legislations and act to avoid the triggering condition of intervention: deficit spending, high debt, and financial mismanagement. 235

236  Research handbook on city and municipal finance

FISCAL DECENTRALIZATION AND FISCAL DISTRESS The fiscal autonomy of subnational governments is a defining feature of the intergovernmental fiscal relationship in the United States. Due to the 10th Amendment to the US Constitution that gives states all powers not specifically granted to the federal government, the federal government cannot directly regulate local governance, unless substantive federal grants are involved. Not only do states enjoy sovereignty, state laws also generally provide local governments with the ability to set their own tax rates, spending priorities, and borrowing plans. Admittedly, state preemptions, such as tax and expenditure limits (Mullins, 1995; Ross et al., 2015) and bans on certain local taxes (Crosbie et al., 2019), represent constraints on local autonomy. Most local governments are nevertheless not subject to a regular approval process by the state for adopting budgets. Much of the early literature on fiscal decentralization focuses on the efficiency gained by locally financing public goods that match the preferences of local residents (Oates, 1972/2011, 1999). Despite its merits, fiscal decentralization is potentially accompanied by horizontal fiscal imbalance and localized fiscal distress. Horizontal fiscal imbalance describes the variation in the capacities of local governments to provide a certain level of public service (Bird, 1993; Rodden, 2006). This is not to negate the variation in local preferences and impose absolutely equal public services. Rather, with the same tax effort – that is, tax rate – tax-base-rich localities can raise more revenue and finance more public goods and services, creating a “fiscal gap” between tax-base-rich and tax-base-poor jurisdictions. Horizontal fiscal imbalance often arises from heterogeneity in institutional, economic, and social endowments, which is then reinforced by rich jurisdictions competing for and attracting mobile resources in a decentralized system (Liu et al., 2017). To close the fiscal gap, almost all developed federations have adopted formal systems of equalization transfers (Bird, 1993). The US does not have nationwide equalization transfers but provides federal funding for specific purposes, such as public healthcare for low-income families and interstate highway construction. Although the federal transfers to subnational governments for specific, means-tested programs such as Medicaid have steadily increased in the past decades, the fiscal disparity across communities remains apparent (National Research Council, 1999). Governments may be able to provide public goods despite low revenue capacities by borrowing.1 Balanced budget requirements attempt to prohibit governments from deficit financing, but evidence from the United States shows that the institutional design of such fiscal rules matters for its efficacy, and they are often circumvented (Hou & Smith, 2010). Even in countries where local governments have no legal access to debt, circumventions occur through quasi-governmental financing vehicles (Lu & Sun, 2013) or accounting gimmicks (Letelier Saavedra, 2011). Continuous deficit financing leads to fiscal distress in the long run, as the government is unable to pay back the debt or debt 1   State and local governments in the United States often borrow to finance capital projects such as infrastructure investment. To the extent that future tax collection is sufficient to pay back the debt, such borrowing is not a trigger of fiscal distress. Deficit financing here describes borrowing for either capital or operational purposes that exceed the ability of a government to repay with reasonable tax efforts.

State intervention in local government fiscal distress  ­237

payments crowd out other needed public spending. Nollenberger et al. (2003) categorize the manifestation of fiscal distress into four types of insolvencies: (1) cash insolvency where a liquidity-constrained government cannot pay bills; (2) budgetary insolvency where total expenditure, regardless of whether having been paid in cash, exceeds total revenue earned; (3) long-term insolvency where the government fails to meet long-term obligations; and (4) service-level insolvency – that is, the difficulty in financing services demanded by the constituents. When the decentralized spending responsibilities are not supported by a sufficient revenue-generating capacity, subnational governments may face insolvencies. Further, if the opportunity to seek a bailout is ripe, they may “raid the fiscal commons” by asking higher-level governments to step in and address the local insolvencies. A focus of “second-generation fiscal federalism” is the hard budget constraint, which prescribes the importance of relying on own-source revenue, instead of excessive intergovernmental transfer or debt, for financing decentralized budgets (Oates, 2005; Qian & Weingast, 1997). A well-developed market economy and fiscal institutions contribute to hard budget constraints, along with a sound political system and suitable historical and cultural background of a nation (ibid.). The United States is generally regarded as an example of a well-managed federal fiscal system, having seen fewer large-scale fiscal crises (Inman, 2003). A generally efficient municipal bond market, where state and local governments borrow, provides an important source of discipline. Insolvencies result in reduced access to credit and higher interest rates, which in turn diminish localities’ ability to deficit finance. Capital and labor are largely mobile, inducing inter-jurisdictional competition and encouraging responsible local fiscal decision-making. Fiscal rules such as balanced budget requirements and debt limits, even though not perfect, are prevalent among subnational governments. The federal and state governments have not provided major bailouts to local governments in recent decades. This is at least partly related to the welldesigned municipal bankruptcy system that many state governments have no problem making available to their localities (more on this later). This does not mean that subnational governments in the United States have not encountered fiscal distress. Quite the contrary, large local governments such as Jefferson County, Alabama and the city of Detroit, Michigan declared bankruptcy in recent years, indicating significant fiscal problems even though the costs were more directly borne by bond investors as opposed to taxpayers. The state of Illinois has billions in unpaid bills, only to be continuously rolled over through borrowing. Increasingly sophisticated financial instruments marketed by Wall Street to local governments and improved transparency brought by changing accounting standards regarding long-term liabilities including unfunded pensions expose the financial weaknesses of many local governments. The problems might predate the 2007–09 Great Recession, but the recession highlighted the fragility and disparity in the financial conditions of many American local governments. When localities fail to provide essential public services, states are ultimately responsible for ensuring the safety and welfare of local residents. Many states have enacted laws to intervene in local fiscal distress, and the following sections describe and discuss such programs.

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STATE RESPONSES TO LOCAL FISCAL DISTRESS The Great Depression in the early 1930s caused over 1,000 local governments to default on their debt and prompted Congress to pass the Federal Bankruptcy Code in 1934. Chapter 9 of the Code addresses how “instrumentalities of the states” – that is, a wide range of local governments – can file for debt readjustment in court. States, however, have to enact legislation allowing local governments within their boundary to take advantage of the municipal bankruptcy process. Many states have done so in the two decades after 1934. Municipal bankruptcy filings have been rare since the enactment of the Bankruptcy Code, likely due to the lack of needs, the political and financial stigma associated with bankruptcy, and the unwillingness of local and state policymakers (Spiotto, 2012). New York City nearly defaulted on its debt in 1975. This marks another major local fiscal crisis, eventually resolved through support from the state Emergency Financial Control Board and federal loans. Scorsone (2014) argues that some states enacted municipal fiscal emergency laws – that is, state intervention programs – following the New York City playbook, which includes the appointment of a board or an emergency manager for approving budgets and financial decisions of distressed local governments. New York was not the only city experiencing fiscal problems in the 1970s, along with Cleveland in 1978 and many older cities in the Northeast (Berman, 1995). Most of the legislated state intervention programs were adopted in the 1970s to 1990s.2 The intervention legislation often spells out criteria for declaring a local fiscal emergency and the process of developing and implementing a corrective plan. Following the 2007–09 Great Recession, many local governments have experienced fiscal difficulties. Some were placed under state intervention and others filed for bankruptcy. These cases lead to policy and academic interests in programs that not only respond to fiscal distress but also administer a process through which at-risk localities are identified and assisted so that any issues are addressed before they deteriorate into fiscal distress that requires more intrusive intervention. These “early warning” programs are different from the monitoring states have already been conducting for fiscal oversight. To provide early warnings, the state government must regularly review the financial condition of all local governments based on a set of criteria, instead of relying on self-identified issues by local governments or ad hoc audits. The implementation of Governmental Accounting Standards Board (GASB) Statement 34 in the early 2000s, establishing a blueprint for state and local government financial reporting, ensures the technical feasibility of early warning. Localities following the GASB standards report financial data for not only individual funds but also the government as a whole, and accrual accounting enables the quantification and comparison of long-term assets and liabilities.3

2   This chapter focuses on state intervention programs that are codified in state laws. It is, however, important to acknowledge that states like New York and Massachusetts intervene on a case-by-case basis, without any general legislation. 3   Not all local governments in the United States follow generally accepted accounting principles (GAAP) set by GASB. A total of 36 states have laws or regulations that require at least some of their political subdivisions to follow GAAP (Mead, 2008). When GAAP is not required, local governments can voluntarily choose to be compliant, due to their desire to improve transparency or to access the credit market.

State intervention in local government fiscal distress  ­239

Figure 13.1 presents the framework of state response to local government fiscal distress. Even though the arrows indicate the general flow of actions, a state may not adopt all three types of policies. In fact, a blanket, unconditional authorization for municipal bankruptcy may be at odds with state intervention. If a local government can freely file for bankruptcy and does so, the state is largely left out of the bankruptcy process and can no longer use bankruptcy authorization as leverage for imposing austerity measures on the locality. Indeed, none of the states with legislation providing unconditional bankruptcy authorization to local governments have intervention programs in place. These states take a “hands-off ” approach to local fiscal distress, allowing localities to file for bankruptcy without any state involvement. For states with conditional bankruptcy authorizations, many condition the local government access to federal bankruptcy courts on going through the state intervention program first. These conditions greatly improve the state’s bargaining power with localities in imposing responsible and sustainable financial management practices with or without providing state financial aid (Yang, 2019a). Moreover, a state may adopt an early warning system without legislating about intervention, and vice versa. For example, if a state’s focus is on monitoring, and local governments within the state rarely encounter severe fiscal distress, then an early warning program may be desirable but state intervention is unnecessary. This chapter focuses on enacted state intervention programs. While numerous recent studies have examined the bankruptcy authorization laws (Gao et al., 2019; Moldogaziev et al., 2017; Yang, 2019a, 2019b) and early warning systems (Nakhmurina, 2018), the research on intervention legislation is scarce and done mostly through case studies. First, a tabulation of the 13 intervention states is presented in Table 13.1, grouped by the Census division of regions. All but one intervention program were adopted between 1970 and 2000. Many of these programs enable the state to intervene in all local governments experiencing fiscal distress, but some allow only intervention in municipalities. Most, but not all, of these states also have early warning systems in place. These are relatively new undertakings: most started after 2000. Early warning systems are often administrative initiatives – that is, not codified in state laws. Therefore, state agencies in charge of early warning must balance the coverage of their reviews with the cost of such activities, mostly

Figure 13.1  A framework of state response to local government fiscal distress

240

Adoption year

1988

1979

1987

1999

1987

1993

Michigan

Ohio

(Northeast) Maine

New Jersey

Pennsylvania

Rhode Island

2007

Indiana

(East North Central) Illinois 1990

State (Region)

Municipality

Municipality, county

Municipality

Municipality

Municipality, county

All

Municipality, special district

All home rule

Targeted locality

Intervention

2016

2014

*

N/A

2016

2002–06

N/A

N/A

Adoption year

No

No

No

Yes

Yes

Benchmark

1988

N/A

N/A

Municipality

Municipality

Municipality

2010

1987

1938

N/A

Conditional

Conditional

Conditional

Conditional

Conditional

Permission type

Municipality, fire district

Municipality, county

All

All

All

 

Targeted locality

Bankruptcy Authorization Adoption year

Municipality, county, Before school district 1953

Municipality, county

Targeted locality

Early Warning

Table 13.1  States with legislations on local fiscal distress intervention

241

1971

1995

1979

1990

North Carolina

Tennessee

Florida

Louisiana

All

All

Municipality, county, utility district

All

All

2013

2003

*

*

2015

No

Yes Municipality, special district

Municipality, county 1950

1979

Municipality, county, N/A utility district

1939

Municipality, county

Yes No

Municipality, county, N/A school district

No

Conditional

Conditional

Conditional

All

All

All

 

Sources:  Intervention and bankruptcy authorization data compiled from state laws. Intervention data cross-checked with The Pew Charitable Trusts (2013) and Scorsone (2014), neither of which contains the year of adoption data. The following states in The Pew Charitable Trusts (2013) are excluded here: Texas only allows courts to appoint receivers; New York and Massachusetts take ad hoc approaches; New Hampshire legislation was dated and never invoked; New Mexico only legislates about audits, not intervention; and Oregon’s relevant clause has been repealed. Early warning data was cross-checked with The Pew Charitable Trusts (2016), Scorsone and Pruett (2020), and Nakhmurina (2018).

Notes: The term “locality” refers to all local governments with taxing authority. The administrative structure of local governments differs across states. The term “municipality” loosely refers to cities, towns, and villages. Some nonintervention states also have early warning (NY, MA, CO, CA, and WA) or bankruptcy authorization (see Yang, 2019a). * The adoption year of the early warning program unknown, and thus defaulted to the adoption year of intervention legislation.

1995

(Other) Nevada

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focusing on municipalities. Some early warning states make their data publicly available, as captured in the “Benchmark” column, which enables the comparison across localities. Therefore, compared to early warning systems where underlying analyses are not made public, the benchmarking effort may improve the transparency of government financial information (Yang, 2022). Finally, out of the 13 intervention states, five do not provide authorization for municipal bankruptcy and the other eight condition their authorization either on the state intervention or on the approval of a designated state agency. Empirically, this chapter addresses the following research question: how have local government budgetary outcomes and financial management changed following the adoption of intervention laws? This is different from looking at the impact of actual intervention in distressed local governments, which is empirically under-examined and could be a fruitful research topic by itself. Instead, this chapter focuses on how local governments may behave differently, knowing that the intervention laws provide a legal framework under which the state intervenes in local governance if the locality were to experience distress. If state intervention involves a loss of local autonomy and thus is undesired by local officials, one may hypothesize that localities will work toward avoiding triggering a designation of fiscal distress. Cahill et al. (1994) categorize the criteria used to declare fiscal distress into three groups. First, debt factors most commonly include default on a bond. Second, budgetary solvency issues focus on the revenue–expenditure imbalance, but may also include the failure to pay certain expenses and declines in tax collection. Last, management issues include the failure to file financial reports or audits, as well as unfavorable audit findings. Given data availability, the chapter examines debt burden, deficit condition, as well as financial reporting and audit outcomes to assess how local governments respond to the enactment of state intervention legislation. Local government response to state intervention laws may depend on the prospect of local autonomy loss implied by the legislation. Three factors are relevant. First, while state governments may recommend or impose austerity measures (stick) to put local finances back on track, they may also provide financial assistance (carrot) as part of the process. The Pew Charitable Trusts (2013) reports that except for North Carolina, Ohio, and Rhode Island, all intervention states authorize enhanced credit backing, loans, or grants for distressed local governments. The authorization nevertheless does not mean appropriation of funding. How much state financial assistance will be available is uncertain a priori. Second, state legislation may enable austerity policies that are difficult to adopt without state intervention. Some of such tools may appear attractive to local officials. For example, Michigan and Pennsylvania allow the states to make unilateral changes in wages, benefits, and work rules defined in union contracts. Nevada and Pennsylvania laws allow for new taxes beyond existing laws. These expenditure reductions and revenue-raising options may not be available to the local governments without state intervention (Scorsone, 2014). On the other hand, local officials may be averse to other tools authorized, including mandatory state approval of local budgets, which is prevalent across state intervention laws. The last and perhaps the most important question regarding the threat to local autonomy is who possesses the decision-making authority in the intervention process. Table 13.2 examines each step in the intervention process and categorizes states into “local-centric” versus “state-centric.” First, in four states, only local governments can initiate the process and request the state to designate them as in distress. That is, the

243

Develop plans to address fiscal issues

Identify fiscal emergency

FL: Locality prepares a plan of action IL: Locality submits a detailed financial plan NJ: Locality develops a financial plan. The director-appointed Financial Review Board approves the plan, budgets, and contracts OH: Local governing body submits a financial plan, upon approvals from the Financial Planning and Supervision Commission

FL: Local governments meeting set criteria notify the Governor and the Legislative Audit Committee IL: Local governments petition the Governor to establish a financial planning and supervision commission if the locality is in default IN: A political subdivision files a petition to the Distressed Unit Appeal Board for distress designation TN: Local governing body requests a state loan guarantee

Local-centric Approach

Table 13.2  State- or local-centric approach to intervention

IN: Emergency manager exercises the authority of the political subdivision and develops a financial plan in consultation with local officials LA: Trial court appoints a fiscal administrator, who drafts budget amendments ME: Board-appointed commissioners approve all appropriations and debt MI: Local government officials shall not exercise any power of the office except as authorized in writing by the emergency manager

LA: Legislative auditor, attorney general, and state treasurer jointly decide ME: Board of Emergency Municipal Finance initiates an audit for localities MI: The Governor appoints a review team if the local government requests or the state treasurer determines that a serious financial problem exists NC: A local government remains in default on any debt for 90 days NJ: Director of Local Government Services determines fiscal stress NV: Department of Taxation recommends severe financial emergency be made, or the local governing body submits a request OH: State auditor determines whether fiscal emergency conditions are met PA: Department of Community and Economic Development determines whether fiscal stress exists upon request of local government or its creditors, auditors, or electors RI: Department of Administration finds that the local government bond rating is below investment grade and there is an imminent threat of default

State-centric Approach

244

Implement recovery plans

IN: Emergency manager oversees implementation ME: The commissioners direct local governance MI: Emergency manager reports to the governor and legislative leader NC: Local governing board implements the refinancing plan. The commission can approve or reject the annual budget NJ: The Financial Review Board implements and enforces the plan NV: The committee implements the plan. The local government may make recommendations to the department or the financial manager PA: If a receiver is appointed, the receiver implements the financial plan TN: All budgets need to be approved by the state comptroller, who requires periodic information from and audits of local governments

NC: A state commission may develop a refinancing plan NV: The Department establishes a management policy and a financing plan. PA: The Governor may exercise the authority of the elected or appointed local officials. The Department develops an emergency action plan. RI: State-appointed commission issues a report on findings and recommendations

TN: Local government submits a plan, subject to approval by the state funding board

FL: A state board oversees activities of local government but cannot make direct changes IL: Commission submits revisions to the plan to the locality for approval and implementation LA: Local government must adopt and implement the budget amendments OH: Locality implements the plan. The Commission reviews budgets, approves expenditure levels, and approves debt RI: Locality retains governance. The Commission has powers to impose taxes and make appropriations for a balanced budget

State-centric Approach

Local-centric Approach

Table 13.2 (continued)

State intervention in local government fiscal distress  ­245

state cannot unilaterally place a locality under intervention. In the other nine states, the power to start intervention rests within state agencies. Second, five states allow distressed local g­ overnments to draft the recovery plan, while the other states appoint a board or an emergency manager to do so. While the plan may be subject to later revision and approval, local governments arguably play a bigger role in shaping the recovery strategy if they draft the plan themselves. The most extreme loss of local autonomy can be seen in Michigan where local officials cannot exercise any power of the office except as authorized by the state-appointed emergency manager. Last, a majority of states allow the emergency board or manager to either directly implement or oversee the implementation of the recovery plan by approving local budgets. Only in four states do local governments implement the recovery plan without having to seek approval for all budget items. Throughout all three steps, Florida and Illinois stand out as the only states where local governments are in the driver’s seat and the state provides know-how support. Intervention programs in other states conspicuously increase the state’s role in local fiscal governance.

ADOPTION OF INTERVENTION LAW AND DECLINE OF INDUSTRIAL HUBS This section explores why states adopt intervention policies in the first place. Not only does this question further our understanding of state intervention, but it is also essential in testing the impact of intervention legislation. If intervention states are intrinsically different from those that do not have such policies, establishing causality will be difficult. Understanding these differences will at least shed light on the possible direction of bias in an empirical analysis. Scorsone (2014) is the only study empirically testing for factors associated with intervention adoption. He hypothesizes that intervention policies are more likely to be contested based on home rule in states where local government autonomy is strong. Further, if tax and spending limits on localities and public sector collective bargaining laws contribute to local insolvency, such limits could be correlated with state intervention laws. Last, previous fiscal emergencies could compel states to enact intervention legislation. Scorsone (2014) fails to identify a clear correlation between any of these factors and state intervention, and calls for more research “in the areas of adoption and policy effectiveness” (p. 39). This chapter argues that the fundamental economic change within some regions of the United States and the decline of the manufacturing industry may be the main factor contributing to the necessity of state intervention. Table 13.1 shows that most of the intervention states are located in the Great Lakes and Northeast parts of the country, sometimes loosely referred to as the “Rust Belt.” These regions have experienced industrial decline starting around half a century ago. The economic shift is accompanied by population loss and urban decay, greatly reducing the tax base in the local jurisdictions (David et al., 2013). Many face high legacy costs, such as retirement benefits for public employees who were hired during the peak and near-peak years of the cities. The revenue decline accompanied by the stickiness of expenditure contributes to local government budget insolvency. Since the 1990s, many of these areas see a further decline in labor

246  Research handbook on city and municipal finance

0

% change in per capita income 1 2

3

demand and income due to increased import competition from China; as a result, local government revenue and spending decrease, and the quality of public services worsens (Feler & Senses, 2017). The need for state intervention could therefore be pronounced as more local governments in these regions encounter fiscal challenges. In-depth case studies of distressed municipalities also identify the predominant cause of fiscal imbalance to be the significant changes in underlying economic conditions (Cahill et al., 1994). Using data from the Bureau of Economic Analysis, I explore how the population and income changes differ between the Rust Belt states – hereby defined as states in the Census’s East North Central region and Northeast region – versus other states, by focusing on the metropolitan statistical areas (MSAs) within each state. Specifically, the MSA-level changes in population and real per capita income during the half-century from 1969 to 2019 are calculated and presented in the scatter plot in Figure 13.2. Rust Belt states are marked by darker shades. Intervention states are represented by circles and nonintervention states by diamonds. It is immediately clear that Rust Belt states concentrate on the left side of the figure, indicating that they have experienced a slower

0

5

% change in population

Other region, not intervene Rust Belt, not intervene

10

15

Other region, intervene Rust Belt, intervene

Note:  Each marker represents an MSA. The “% change” is the rate of change from 1969 to 2019. Rust Belt states include those in the East North Central region and the Northeast region as defined by the Census Bureau. Source:  Data from the Bureau of Economic Analysis’ Regional Economic Accounts.

Figure 13.2  Change in per capita income and population by region and intervention type

State intervention in local government fiscal distress  ­247

increase, and in some cases, a decrease, in population, as compared to the rest of the country. Most of the MSAs in the lower left quadrant – that is, low income increase and low population growth – are located in the Rust Belt states with intervention programs. The MSAs often consist of a large number of local governments, some of which have a large budget. If they systematically suffer from population and income declines, the state may adopt intervention policies because the need is widespread and ad hoc responses are insufficient given the sheer size of distressed local governments. In contrast, Rust Belt states without intervention programs have MSAs that saw a higher increase in per capita income, despite similarly slow population growth. The relative expansion in local income and thus tax base mean that local governments in those states are less likely to require the state to step in, relative to the intervention states in the region. The correlation between the underlying economic condition and state intervention policies has important implications. First, it suggests that unless state intervention can fundamentally change the economic decline in the area, local fiscal challenges are likely to persist. Even if local governments garner the political will to constrain expenditure and balance budgets, the need to provide high-quality public services and maintain service solvency may be compromised. Second, the adoption of state intervention is not an exogenous event. Causally establishing the impact of state intervention laws is difficult because one cannot fully observe or control for all factors leading to the policy adoption. Municipal data from the US Census Bureau’s Annual Survey of State and Local Government Finances show that changes in the regional economy translate into lower government revenue. I focus on municipal governments because all state intervention programs apply to them but not necessarily to other local governments. Specifically, based on data from the Census years (years ending in 2 and 7) between 1972 and 2017, the per capita municipal revenue and expenditure in each state group are calculated and scaled by the 1972 level.4 Figure 13.3 shows the trends in per capita revenue (panel a) and per capita expenditure (panel b) for each group of states. Prior to the Great Recession, Rust Belt states saw a consistently slower increase in per capita revenue than other regions. Within the Rust Belt, intervention states outperformed nonintervention states during the 1980s and 1990s, but they have converged since. However, the per capita expenditure figure (panel b) shows that nonintervention states in the Rust Belt controlled expenditure increase more heavily than intervention states in the region. The latter experienced a sharp increase in per capita local expenditure from 1997 to 2002, which was more likely due to the implementation of GASB Statement 34 in 2002–03 and thus better financial disclosure than actual spending adjustments. Despite lower revenue growth, local governments in the Rust Belt intervention states maintained an expenditure increase similar to that seen in other regions, suggesting possible deficit financing.

4   The per capita value for each state group is calculated by summing up the total municipal government revenue in the state group then dividing it by the sum of population served. Therefore, the value will be smaller as the degree of municipal government (city, town, village, etc.) overlap is stronger in a state group, because the population served by the overlapping localities will be double-counted in the denominator. However, as the per capita value is scaled by its 1972 level, any cross-state group differences due to different degrees of municipal government overlap should be netted out by the scaling process.

248  Research handbook on city and municipal finance

1

Per capita revenue normalized to 1972 1.2 1.4 1.6 1.8

2

(a)

1972

1977

1982

1987

1992

1997

2012

2017

Other region, intervene Rust Belt, intervene

Per capita expenditure normalized to 1972 1 1.2 1.4 1.6 1.8

(b)

2007

2

Other region, not intervene Rust Belt, not intervene

2002

1972

1977

1982

1987

1992

Other region, not intervene Rust Belt, not intervene

1997

2002

2007

2012

2017

Other region, intervene Rust Belt, intervene

Note:  Rust Belt states include those in the East North Central region and the Northeast region as defined by the Census Bureau. Source:  Data from Annual Survey of State and Local Government Finances responses from Census years ending in 2 and 7.

Figure 13.3  Trends in per capita municipal government revenue (a); and expenditure (b)

State intervention in local government fiscal distress  ­249

LOCAL FISCAL OUTCOMES This section examines the association between state intervention legislation and local government deficit as well as debt levels. Data are from the Census Annual Survey of State and Local Government Finances 1972–2017.5 Only municipalities are included because counties are not subject to state intervention in many states. A few important notes are warranted to understand the advantages and constraints of this data. First, local governments have different bases of accounting. Different accounting practices across governments and over time due to the adoption of new GASB standards may  compromise comparability between observations. Second, certain financial accounts valuable for assessing financial condition, such as general fund reserves and unfunded post-employment benefits, are not available. The most significant advantage of the Census data is its broad coverage of even very small localities over a long period. Because Rust Belt states face unique economic changes compared to states in other regions of the country, I include only Rust Belt states in the empirical analysis. This sample mitigates the issue of omitted variables, as local governments within the same region are likely to be similar in many unobserved characteristics. However, it does not resolve the issue of potential endogeneity caused by, for example, unobserved factors such as intra-regional economic differences that contribute to the adoption of state intervention and at the same time correlate with local fiscal outcomes. Therefore, the estimates in this chapter should not be interpreted as causal. In sum, I estimate whether state intervention laws are associated with changes in local outcomes by comparing local outcomes before and after the enactment of state laws, while controlling for differences between intervention and nonintervention states. Deficit and debt represent two fiscal outcomes local governments may care about in response to state intervention legislations, as they are often the triggering conditions of intervention. I measure deficit by the operation ratio – that is, the natural logarithm of the ratio between total expenditure and total revenue. A positive value represents deficit spending.6 Debt is measured by the natural logarithm of the ratio between total debt outstanding and total revenue (plus one to enable taking the log for localities with zero debt). The scaling using total revenue adjusts, albeit imperfectly, for the ability to repay debt.

5   The Census Bureau conducts a census of local governments in years ending in 2 or 7; in other years, the Bureau conducts a representative survey and thus not all localities are included in the data every year. The following data-cleaning steps are performed. First, observations with zero or negative total revenue or expenditure are dropped. Second, to mitigate outlier problems, I eliminate observations where the per capita revenue (expenditure) is larger than 1.5 times the 95th percentile, or lower than half of the 5th percentile revenue (expenditure) among the state-year-population quartile group. Third, observations with negative total debt outstanding are excluded. 6   One caveat in interpreting the operation ratio is that many local governments borrow to fund capital investments. If they do not follow full accrual accounting as required by GASB Statement No. 34, the reported expenditure may exceed revenue as a result and does not necessarily indicate deficit financing for current operation. However, this does not necessarily lead to bias in the empirical analysis, as the locality fixed effects, as explained later, will control for time-invariant local ­characteristics, including a locality’s choice of accounting basis.

250  Research handbook on city and municipal finance

The following two-way fixed effects are estimated for locality government i​ ​in state ​s​ on the two outcome variables y​ ​: ​​y​ ist​​  = ​α0​  ​​  + ​α1​  ​​  interven ​est​  ​​  + ​α2​  ​​  othe​rst​  ​​  + ​α3​  ​​ ​Xit​  ​​  + ​ηi​  ​​  + ​τt​  ​​  + ​ϵist ​  ​​,​

(13.1)

where i​ntervene​is an indicator variable representing whether the state has a legislated intervention program in year t​ ​. The vector o​ ther​includes the indicator variables for the other state policies regarding distressed local governments, bankruptcy authorization, and early warning. The vector X ​ ​includes two control variables, county-level per capita income and the local jurisdiction’s population, both entering in logged form, to control for local economic conditions. Local government fixed effects (​​η​ i​​​) control for localityspecific, time-invariant factors such as local institutions and endowments.7 Year fixed effects (​​τt​  ​​​) flexibly control for secular time trends. Standard errors are clustered at the policy level – that is, by state. The association between state intervention legislation and local fiscal condition may differ depending on whether a local government is already fiscally stressed – that is, at a higher likelihood of being intervened. A locality facing a chronic deficit and high debt may respond differently to the enactment of state intervention laws than another fiscally sound locality in the same state. To this end, I estimate the following quantile regression at either the median (q = 0.5) or the high deficit/debt level (q = 0.9) of the outcome variables: ​​y​ ist​​  = ​β0​  ​(​​q​  ​)​​​  + ​β1​  ​(​​q​  ​)​​​  interven ​est​  ​​  + ​β2​  ​(​​q​  ​)​​​  othe​rst​  ​​  + ​β3​  ​(​​q​  ​)​​​ ​Xit​  ​​  + ​μ​  ​(s​​q​  ​)​​​  + ​Tt​  ​(​  ​​q​)​​​  + ​eist ​  ​(​​q​)​  ​​​​.

(13.2)

Quantile regressions enable the examination of relationships at a given location of the outcome distribution, while estimating an ordinary least squares (OLS) regression using the subsample selected on the outcome will be inconsistent. For example, a quantile regression at the 90th percentile (median) of the debt ratio distribution will tell us how localities facing high (median) debt respond to the state intervention legislation. Quantile regressions are estimated by solving the minimization problem regarding a weighted function of the predicted error term. However, the inclusion of a large number of locality fixed effects could lead to the incidental parameters problem and requires strong assumptions (Machado & Silva, 2019). Instead, the state indicators μ ​ ​are included, along with year indicators​ T​. Standard errors again are clustered at the state level. Table 13.3 presents the results and shows that the enactment of state intervention laws is not associated with notable changes in local government fiscal outcomes. State intervention legislation is not statistically significantly associated with changes in local government operation or debt ratio at the mean, median, or highest decile. The point estimates from median regressions, less sensitive to outliers, are also small and very close to zero. Bankruptcy authorizations do not exhibit a statistically significant correlation with the two ratios: the point estimates regarding operation ratio are similar to but the standard errors much larger than that in Yang (2019a). Early warning systems are not statistically significantly associated with either ratio. This contradicts findings   Replacing local government fixed effects with state fixed effects generates similar findings.

7

State intervention in local government fiscal distress  ­251

Table 13.3  Regression results on local government operation and debt ratios, 1972–2017  

Operation Ratio

Debt Ratio

OLS

Quantile (q = 0.5)

Quantile (q = 0.9)

OLS

Quantile (q = 0.5)

Quantile (q = 0.9)

(1)

(2)

(3)

(4)

(5)

(6)

Intervention

−0.0195 (0.0389)

−0.0023 (0.0253)

0.0070 (0.0329)

−0.111 (0.0657)

−0.0173 (0.0137)

−0.186 (0.121)

Bankruptcy authorization

0.0137 (0.0416)

0.0038 (0.0299)

−0.0117 (0.0487)

0.124 (0.0689)

0.0164 (0.0163)

0.321 (0.169)

Early warning

−0.0130 (0.0369) −0.0781 (0.0647)

−0.0231 (0.0263) −0.0254** (0.0091)

−0.0345 (0.0340) −0.0284* (0.0128)

0.0271 (0.0379) 0.0829 (0.0529)

0.0022 (0.0164) 0.0813*** (0.0195)

0.0473 (0.0517) 0.246** (0.0769)

County per capita income, logged Population, logged

–0.0173 (0.0096)

0.0073*** (0.0015)

–0.0239*** (0.0043)

0.0402 (0.0235)

0.0369** (0.0118)

0.0309 (0.0196)

Locality indicator Year indicator State indicator

Yes Yes No

No Yes Yes

No Yes Yes

Yes Yes No

No Yes Yes

No Yes Yes

Note:  The number of observations is 327,718 for each regression. Operation ratio is calculated as the natural logarithm of the ratio between total expenditure and total revenue. Debt ratio is calculated as the natural logarithm of one plus the ratio between total debt and total revenue. Standard errors are clustered at the state level. * p < 0.05; ** p < 0.01; *** p < 0.001.

from Nakhmurina (2018) that early warning programs lead to spending cuts and thus higher operating margins, but is in line with the null findings from a single state study in Spreen and Cheek (2016). Moving on to the covariates, a higher per capita income is c­ onsistently associated with less deficit, signifying the fiscal importance of a strong economic base. Municipalities with richer residents also have higher debt levels. Population growth is associated with higher deficits and debt at the median; however, governments with relatively high deficits improve budget solvency with population increases.

LOCAL FINANCIAL MANAGEMENT OUTCOMES While changing budgetary decisions and fiscal outcomes requires policy actions and may be politically difficult, state laws regarding local government distress may induce administrative improvements in financial management without policy shifts. In some states, local governments’ failure to file audited financial reports on time or receipts of adverse audit findings are criteria for state intervention (Cahill et al., 1994). When a state implements an early warning program, it often starts with collecting audited financial reports and reviewing independent auditors’ findings (Scorsone & Pruett, 2020). These state actions may encourage local governments to improve financial reporting efficiency

252  Research handbook on city and municipal finance

and accounting compliance to avoid triggering state intervention or to receive a favorable review from the state’s early warning program. The Federal Audit Clearinghouse provides single audit data on all recipients of large amounts of federal transfers (US$750,000 or more as of 2021). The sample of municipal governments in the Rust Belt states is collected from this database, covering the fiscal year 2001 through 2019. Smaller municipalities that do not receive a large amount of federal funding are thus excluded. In sum, out of the more than 16,000 municipal governments in the region, 3,530 are included in the single audit data. The analysis focuses on two dimensions of financial management: efficiency in reporting and soundness of accounting practices. Many local governments struggle to produce audited financial reports shortly after the fiscal year-end. When a report is released many months or even years later, its usefulness to the public, policymakers, and bond market investors is limited (Payne & Jensen, 2002). Specifically, I calculate the number of days between fiscal year-end and the audited financial report date, referred to as the audited report lag in the literature (Yang, 2021). A longer lag signifies inefficiency in financial reporting. Second, one may not be concerned by the marginal differences in the lag, but rather, whether the government meets the nine-month deadline as required by the Federal Audit Clearinghouse. An indicator variable “late audited report” equals one if the audit lag is more than nine months. Further, audit findings provide data on the soundness of local government accounting practices, captured by two variables. First, an indicator variable represents whether the local government prepares and presents its financial report following GAAP, and the variable equals zero when the auditor gives a “qualified opinion.” Second, an indicator variable signifies whether the auditor finds the locality to have good internal control practices without deficiencies. Even though auditor findings are not perfectly objective measures of government accounting quality (ibid.), they provide a third-party assessment of local financial management. Because the adoption of intervention legislations largely predates the sample period, a random effects instead of fixed effects model is estimated for locality government ​i​ in state s​ ​in year t:8 ​​y​ ist​​  = ​γ0​  ​​  + ​γ1​  ​​  interven​est​  ​​  + ​γ2​  ​​  othe​rst​  ​​  + ​γ3​  ​​ ​Zist ​  ​​  + ​θt​  ​​  + ​εist ​  ​​,​

(13.3)

where ​y​represents the four financial management outcomes explained earlier. Standard errors are again clustered on the state level. Two covariates are controlled for through the vector Z ​ ​. First, I calculate the natural logarithm of the dollar threshold for determining the federal grant program type for the single audit. The threshold is higher if the amount of federal awards received is larger. Therefore, “log threshold” is a proxy for the size of the local government and the amount of scrutiny it receives in single audits. Second, an audit is deemed high risk when the locality has previously received adverse audit findings. Thus, the “high risk” indicator variable controls for the prior financial management quality of the government. 8   The random effects allow for heterogeneity across localities that is constant over time, but the consistency of the estimate rests on the assumption that the locality heterogeneity is uncorrelated with the independent variables.

State intervention in local government fiscal distress  ­253

Table 13.4 presents the results. The odd-numbered columns are based on the full sample, while the even-numbered columns include only high-risk audits where the auditee localities are more likely to be subject to state intervention. State intervention legislations are not statistically significantly associated with either local government reporting efficiency or accounting soundness. This is true for the full sample but also for local governments that have received unfavorable prior audit findings. Similarly, there is no statistically significant correlation between bankruptcy authorization laws and local financial management. However, early warning systems are consistently associated with a faster production of audited financial reports, although the estimates are not statistically significant at the 5 percent level (it is significant at the 10 percent level in column 1). The regular state review of local finances could have incentivized or required local governments to efficiently produce financial information. More importantly, state early warning systems are associated on average with a 7.4 percentage point increase in good local internal control. The relationship is stronger among local governments with adverse prior audits, at 10.2 percentage points. To put the estimates in context, consider that the sample average probability of a local government that has sound internal control is 63.3 percent. The sizable positive correlation between state early warning and local internal control shows that regular state reviews may be beneficial for strengthening local financial management. The mechanism behind this relationship is not immediately clear. Local governments may proactively improve their financial management to avoid unfavorable findings from the state. Alternatively, by implementing the early warning program, the state may have provided technical assistance to localities that lack the internal capacity to adopt sound accounting practices.

CONCLUSION The industrial shifts and the unequal impact of globalization have led to a geographic divergence in the regional economies within the US (Moretti, 2012). Local governments that struggle with population losses and income declines are also more likely to see their public finance in distress. A general framework emerges for tackling local fiscal distress where the state government monitors local financial conditions for detecting early signs of stress, intervenes in severe local fiscal stress, and authorizes municipal bankruptcy to allow for local government debt restructuring. This chapter shows that state intervention legislation was adopted in the 1970s to 1990s, coinciding in timing with the economic decline in the Rust Belt regions. Intervention states are more likely to have urban areas that experience population losses and slow income growth and have lower government revenue collections as a result. Despite signifying a significant loss of local autonomy, state intervention legislations have not deterred local governments, including those under potential stress, from deficit financing and incurring debt. The null finding is not surprising. If the underlying economic challenge is the main reason behind local government fiscal distress, the prospect of state intervention may not be sufficient for turning things around. Cutting legacy costs or other expenses remains politically infeasible or detrimental to constituent welfare. The empirical analysis focuses on the general deterrence effect of intervention legislation

254

Yes 21,586

5.020 (22.86) 4.374 (22.80) −16.15 (9.027) 17.42 (9.822) 23.28*** (4.507) Yes 13,420

0.805 (25.50) 1.321 (26.51) −18.28 (14.16) 22.58 (13.61)

(2)

(1)

Yes 13,420

−0.0464 (0.0547) −0.0051 (0.0621) −0.0269 (0.0370) 0.0208 (0.0415)

−0.0259 (0.0501) −0.0001 (0.0553) −0.0376 (0.0279) 0.0089 (0.0325) 0.0916*** (0.0172) Yes 21,586

(4)

High risk

(3)

All

Late Audited Report

Yes 21,586

−0.0300 (0.0626) 0.0613 (0.0483) 0.0002 (0.0234) 0.0216 (0.0227) −0.0831*** (0.0082)

(5)

All

Yes 13,420

−0.0353 (0.0738) 0.0778 (0.0589) −0.0267 (0.0323) 0.0353 (0.0312)

(6)

High risk

Unqualified Opinion

Yes 21,586

−0.0583 (0.0556) 0.0131 (0.0514) 0.0740* (0.0313) −0.0500* (0.0246) −0.185*** (0.0174)

(7)

All

Yes 13,420

−0.0551 (0.0652) 0.0160 (0.0591) 0.102** (0.0362) −0.0397 (0.0263)

(8)

High risk

Good Internal Control

Note:  Random effects regressions are estimated, allowing for dependence between observations at the locality level. Log threshold is the natural logarithm of the threshold for determining the type of federal grant program a locality received funding from; it is a proxy for the amount of federal awards received. High risk is an indicator variable representing whether an audit is considered high risk; it is a proxy for previous adverse audit findings. Standard errors are clustered at the state level. * p < 0.05; ** p < 0.01; *** p < 0.001.

Year indicator N

High risk

Log threshold

Early warning

Bankruptcy authorization

Intervention

High risk

All

Audited Report Lag

Table 13.4  Regression results on local government financial reporting, 2001–19

State intervention in local government fiscal distress  ­255

instead of actual state interventions. More research is needed to understand whether state intervention works and which aspects of the program design are the most effective in helping distressed localities. The lack of a deterrence effect does not negate the value of having a systematic approach to local distress. A successful state intervention program requires effectively identifying local distress. Ad hoc or reactive audits are administratively less arduous and less intrusive to local autonomy, but regular state reviews of all local governments are likely to be more effective in detecting early signs of stress. Empirical results show that state early warning systems are associated with improvements in local government internal control. The federal stimulus efforts in response to the COVID-19 pandemic have brought an unprecedented level of federal funding to the state and local governments. Because much of the funding is passed through the states to small local governments, such localities are not subject to federal audit requirements. State monitoring through the early warning program not only serves a distress-detecting role but may also strengthen the financial management integrity of its local governments.

REFERENCES Berman, D. R. (1995). Takeovers of local governments: An overview and evaluation of state policies. Publius: The Journal of Federalism, 25(3), 55–70. Bird, R. M. (1993). Threading the fiscal labyrinth: Some issues in fiscal decentralization. National Tax Journal, 46(2), 207–227. Cahill, A. G., James, J. A., Lavigne, J. E., & Stacey, A. (1994). State government responses to municipal fiscal distress: A brave new world for state-local intergovernmental relations. Public Productivity & Management Review, 253–264. Crosbie, E., Schillinger, D., & Schmidt, L. A. (2019). State preemption to prevent local taxation of sugar-sweetened beverages. JAMA Internal Medicine, 179(3), 291–292. David, H., Dorn, D., & Hanson, G. H. (2013). The China syndrome: Local labor market effects of import competition in the United States. American Economic Review, 103(6), 2121–2168. Feler, L., & Senses, M. Z. (2017). Trade shocks and the provision of local public goods. American Economic Journal: Economic Policy, 9(4), 101–143. Gao, P., Lee, C., & Murphy, D. (2019). Municipal borrowing costs and state policies for distressed municipalities. Journal of Financial Economics, 132(2), 404–426. Hou, Y., & Smith, D. L. (2010). Do state balanced budget requirements matter? Testing two explanatory frameworks. Public Choice, 145(1–2), 57–79. Inman, R. P. (2003). Transfers and bailouts: Enforcing local fiscal discipline with lessons from US federalism. In J. A. Rodden, G. S. Eskeland, & J. I. Litvack (Eds.), Fiscal decentralization and the challenge of hard budget constraints (pp. 35–84). MIT Press. Letelier Saavedra, L. E. (2011). Theory and evidence of municipal borrowing in Chile. Public Choice, 146, 395–411. Liu, Y., Martinez-Vazquez, J., & Wu, A. M. (2017). Fiscal decentralization, equalization, and intraprovincial inequality in China. International Tax and Public Finance, 24(2), 248–281. Lu, Y., & Sun, T. (2013). Local government financing platforms in China: A fortune or misfortune? International Monetary Fund. Machado, J. A., & Silva, J. S. (2019). Quantiles via moments. Journal of Econometrics, 213(1), 145–173. Mead, D. M. (2008). State and local government use of generally accepted accounting principles for general purpose external financial reporting. Governmental Accounting Standards Board. Moldogaziev, T. T., Kioko, S. N., & Hildreth, W. B. (2017). Impact of bankruptcy eligibility requirements and statutory liens on borrowing costs. Public Budgeting & Finance, 37(4), 47–73.

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Moretti, E. (2012). The new geography of jobs. Houghton Mifflin Harcourt. Mullins, D. R. (1995). Tax and expenditure limits on local governments (Vol. 19). Center for Urban Policy and the Environment, Indiana University. Nakhmurina, A. (2018). Does fiscal monitoring make better governments? Evidence from US municipalities (Working Papers No. 284). George J. Stigler Center for the Study of the Economy and the State, University of Chicago. National Research Council. (1999). Equity and adequacy in education finance: Issues and perspectives. National Academies Press. Nollenberger, K., Groves, S. M., & Valente, M. G. (2003). Evaluating financial condition: A handbook for local government. International City/County Management Association. Oates, W. E. (2011). Fiscal federalism. Edward Elgar Publishing (Original work published 1972). Oates, W. E. (1999). An essay on fiscal federalism. Journal of Economic Literature, 37(3), 1120–1149. Oates, W. E. (2005). Toward a second-generation theory of fiscal federalism. International Tax and Public Finance, 12(4), 349–373. Payne, J. L., & Jensen, K. L. (2002). An examination of municipal audit delay. Journal of Accounting and Public Policy, 21(1), 1–29. Qian, Y., & Weingast, B. R. (1997). Federalism as a commitment to reserving market incentives. Journal of Economic Perspectives, 11(4), 83–92. Rodden, J. (2006). Hamilton’s paradox: The promise and peril of fiscal federalism. Cambridge University Press. Ross, J. M., Farrell, M., & Yang, L. (2015). Indiana’s property tax caps: Old idea, new approach, and surprising incentives. Public Budgeting & Finance, 35(4), 18–41. Scorsone, E. (2014). Municipal fiscal emergency laws: Background and guide to state-based approaches [Working paper]. Mercatus Center, George Mason University. Scorsone, E., & Pruett, N. (2020). Assessing existing local government fiscal early warning system through four state case studies: Colorado, Louisiana, Ohio and Pennsylvania [Working paper]. Michigan Center for Local Government Finance & Policy, Michigan State University. Spiotto, J. E. (2012). Chapter 9: The last resort for financially distressed municipalities. In S. G. Feldstein & F. J. Fabozzi (Eds.), The handbook of municipal bonds (pp. 145–190). Wiley. Spreen, T. L., & Cheek, C. M. (2016). Does monitoring local government fiscal conditions affect outcomes? Evidence from Michigan. Public Finance Review, 44(6), 722–745. The Pew Charitable Trusts. (2013, July 23). The state role in local government financial distress. https://www.pewtrusts.org/en/research-and-analysis/reports/2013/07/23/the-state-role-in-localgovernment-financial-distress. The Pew Charitable Trusts. (2016). State strategies to detect local fiscal stress: How states assess and monitor the financial health of local governments. Pew. Yang, L. (2019a). The impact of state intervention and bankruptcy authorization laws on local government deficits. Economics of Governance, 20(4), 305–328. Yang, L. (2019b). Not all state authorizations for municipal bankruptcy are equal: Impact on state borrowing costs. National Tax Journal, 72(2), 435–464. Yang, L. (2021). Auditor or adviser? Auditor (in)dependence and its impact on financial management. Public Administration Review, 81(3), 475–487. Yang, L. (2022). Fiscal transparency or fiscal illusion? Housing and credit market responses to fiscal monitoring. International Tax and Public Finance, 29(1), 1–29.

14. The fiscal structure of county governments from 2002 to 2019: the impact of the Great Recession and the run-up to the COVID-19 pandemic Craig L. Johnson, Luis Navarro, and Andrey Yushkov

INTRODUCTION County government is one of the oldest forms of government in the United States, dating back to 1634 in Virginia. It still plays a critical role in delivering vital services and remains an essential component of the intergovernmental fiscal system in the US. County governments across the United States fulfill different roles and are responsible for a wide variety of essential services, including community health and management; human services; justice and public safety; transportation; and infrastructure. While the structure and nature of county government services varies across and within states, in each case counties are responsible for delivering certain essential services to county residents. Indeed, our understanding of the important role counties play in supporting the well-being of people throughout the US has only been enhanced from the recent social justice movement and the COVID-19 pandemic. County governments operate across distinct geographical boundaries established by the state government. Within these boundaries, board members and executives are elected by county voters. Counties are fundamentally different than cities and towns. From a legal intergovernmental perspective, counties may be primarily viewed as administrative agents of the state government. They are established by the state government as administrative units to carry out particular state functions, which vary from state to state, making each of the over 3,000 counties a unique administrative and political unit (National Association of Counties [NACo], 2019). County governments require monetary resources to provide goods and services. County governments receive funds from other levels of government and they have the capacity to raise funds from their own county-level resources as well. They obtain ownsource resources to finance operations through collecting taxes, fees, licenses, and charges applied to certain activities. Fiscal intergovernmental arrangements in the United States permit county governments to decide the level of taxation they levy on their citizens, of course within state-imposed fiscal limitations, leading to heterogeneity in the composition of county government revenues across the country. In this chapter, we focus on analyzing the structure of county revenues and expenditures, and the financial condition of counties from 2002 to immediately prior to the COVID-19 pandemic. This will help us answer the question: were county governments fiscally ready to handle the financial responsibilities associated with the COVID-19 pandemic and social justice movement in 2020? We believe this is especially important because community health capacity and spending have been essential in the governmental response to the pandemic, and there were likely strains on transportation and ­infrastructure, justice and 257

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public safety, county management, and human services as well. We believe this chapter makes an important contribution to the literature by comprehensively describing the pre-pandemic fiscal structure of all US county governments. Moreover, there is a scarcity of research analyzing the fiscal structure of county governments. Most local government fiscal structure research is on cities (Brown, 1993; Chernick et al., 2011; Clark, 2015; Gorina et al., 2018; Hendrick, 2004; Hoene & Pagano, 2009; Stone et al., 2015), not counties. While we can find no prior work analyzing the fiscal structure of all US county governments, our work builds upon several strands in the research literature. There are very few research articles that focus exclusively on county government fiscal structure. Most studies analyze some aggregated version of local governments (cities and counties, special districts and general governments, for example). Most papers that do focus on counties, focus on accounting for fiscal stress and/or use only a sub-sample of the entire nation, focusing on one or a few states only (Brien et al., 2021; Clark, 2015; Coe, 2007; Gorina et al., 2018; Hendrick, 2004; Xu & Warner, 2016). While we draw on this research, our focus is on county fiscal structure across all states prior to the COVID-19 pandemic. We also highlight changes to county government fiscal structure leading up to, during, and after the Great Recession.

DATA DESCRIPTION The analysis presented in this chapter uses data from the Annual Survey of State and Local Government Finances, a survey collected by the US Census Bureau that contains information on local governments’ revenues, expenditures, and debt. The survey is the most comprehensive local government finance information available. According to the Census Bureau, a comprehensive Census is conducted every five years (years ending in 2 and 7), then a sample of state and local governments is used to collect data in the intervening years. In other words, the survey provides a full snapshot of local governments’ finances only in years ending in 2 and 7. We use the data to conduct two different analyses. The first is an analysis from 2002 to 2017, using data collected in five-year increments: 2002, 2007, 2012, and 2017. The second analysis uses 2019 data to conduct a more limited analysis of county government revenues prior to the COVID-19 fiscal shock of 2020. While the Annual Survey of State and Local Government Finances provides a thorough look at subnational finances, it may be underutilized due to the complex process of data cleaning, management and interpretation involved. Addressing this concern, Pierson et al. (2015) compiled a coherent dataset that encompasses all the available information on the survey. One of the main advantages of using this dataset is that it provides a comparable panel of observations for all local governments in the United States, allowing a look at detailed measurements of revenues, expenditures, and aggregate debt across governments and time. The analysis presented in this chapter is based on their dataset.

COUNTY FISCAL STRUCTURE: 2002 TO 2017 We provide a descriptive analysis of county government fiscal structure in the United States from 2002 to 2017. To ensure the descriptive analysis in this section is as

The fiscal structure of county governments from 2002 to 2019  ­259

Table 14.1  County governments in the sample by year Year

Counties

2002 2007 2012 2017

3,034 3,032 3,031 3,029

c­ omprehensive and comparable as possible, we use observations covering only the years when the Census was collected for all county governments: 2002, 2007, 2012, and 2017. The final dataset includes 12,126 observations at the county year level, with observations from over 3,000 counties in each year, as shown in Table 14.1.

MAIN VARIABLES Following the categorization made by Pierson et al. (2015), which is based on the concepts of the Census survey, we divide local government revenues into three main categories: (1) tax revenue; (2) intergovernmental revenue; and (3) charges and miscellaneous revenue. To analyze expenditures, we use the NACo categorization that broadly divides expenditure variables into five groups: transportation and infrastructure; community health; justice and public safety; human services; and county management.1 Figures on the tables in the following sections are expressed in 2017 constant dollars. The inflation adjustment was done using the “Consumer Price Index for All Urban Consumers,” which considers all items in the “US City Average” reported by the Federal Reserve Bank of St. Louis in the Federal Reserve Economic Data (FRED).

REVENUES In this section, we analyze county revenues from 2002 to 2017. County governments in the US have a broad revenue base. We provide a breakdown of county government revenues by sources of revenues including taxes, intergovernmental revenues, and charges and miscellaneous. We break down the sources of tax revenue into property, sales, license, and income, and we break down intergovernmental revenue by whether it originates at the federal or state level of government. After robust total revenue growth from 2002 to 2007, revenues registered a real net decrease from 2007 to 2012. Most, though not all the loss was made up from 2012 to 2017 (see Table 14.2). As a result, total revenue losses from the Great Recession had not been fully made up as of 2017, eight years after the recession officially ended.

  See the Appendix for a description of NACo defined variables using Census data.

1

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General Sources of Revenue: Taxes, Intergovernmental Revenues, Charges and Miscellaneous Tax revenues reflect the own-source capacity of county governments in the fiscal system. Such revenues are determined by the type and structure of taxes that are levied and collected by counties. It includes the direct and indirect collection of revenues from county-levied taxes. Indirect collection, for instance, refers to county taxes collected by the state government and then allocated to county governments (e.g., local option sales and income taxes). This revenue is net of administration costs faced by the collecting government. Intergovernmental revenues capture the fiscal relationship between county governments and other governments. This concept comprises monies received from other governments to enable or improve the provision of public goods and services by the county government. For example, it includes grants, shared taxes, contingent loans, and advances for general financial support. However, it excludes revenues from selling assets to other governments, as well as payments for the provision of utility services to other governments, which are registered along with all utilities’ revenues (i.e., not part of general revenues). Charges and miscellaneous revenues describe revenues from the public performance of specific services (e.g., fees at public hospitals, highways, housing and community development charges, etc.). Tables 14.2 and 14.3 show the general sources of revenue for county governments by year. Tax revenue is the largest source of revenue across county governments in the United States, with an average of US$55.8 million per county government in 2017.2 From 2002 to 2017, the data show a significant increase in real average county government tax revenue from US$40 million to nearly US$56 million. There was only a slight increase from 2007 to 2012, 1.65 percent, likely the impact of the Great Recession. Taxes were the only general category of revenues to increase from 2007 to 2012; both intergovernmental and charges and miscellaneous revenues decreased. Such growth in tax revenues is jointly driven by growth in the tax base, as well as changes in the county’s tax structure (e.g., rates, exemptions, deductions). Tax revenues also stand out for showing a stronger recovery in the post-Recession years than intergovernmental revenues and charges and miscellaneous revenues. From 2012 to 2017, tax revenues increased by 9 percent, charges and miscellaneous revenues increased 5 percent, and intergovernmental revenues only 1.5 percent. The share of total revenues also changed significantly. Average tax revenue, as a percentage of total county revenue, increased by 6 percent, from almost 42 percent to 2   It should be noted, however, that the distribution of revenue variables for county governments is heavily skewed to the right, hence the mean is larger than the median in most cases. An empirical implication of this characteristic is that the mean is a statistic more representative of larger counties (in terms of their revenues), while the median better describes smaller county governments. For this analysis we will use the sample average (i.e., the mean) as the main statistic, hence the results better represent the stance of large county governments. While the form of the distribution stays relatively stable, some of the trends observed in the data by looking at the mean are not as pronounced when looking at the median instead. We checked for differences in the trends using both the mean and median and there are only two changes that modify the descriptions given in this chapter. First, the mean shows that total revenue decreased from 2007 to 2012, while the median points towards a steady increase, but a decrease in 2017. Second, charges and miscellaneous revenues, and health expenditures, show increases based on means, while they show decreases according to medians.

The fiscal structure of county governments from 2002 to 2019  ­261

Table 14.2  County governments revenue by year (county average, thousands of constant 2017 dollars) State

Total Revenue

Taxes

Intergovernmental Revenue

Charges and Miscellaneous

2002 2007 2012 2017

116,841 142,599 133,744 141,208

40,325 50,202 51,034 55,828

44,519 47,248 46,190 46,789

31,823 44,940 36,288 38,219

Table 14.3  County governments revenue by year (county average, percentage of total revenue) Year

Total Revenue

Taxes

Intergovernmental Revenue

Charges and Miscellaneous

2002 2007 2012 2017

100.00 100.00 100.00 100.00

41.74 43.11 44.81 47.55

32.69 31.34 31.4 30.05

25.53 25.51 23.75 22.35

Note:  Totals might not sum to 100 due to rounding.

47 percent, between 2002 and 2017, while intergovernmental revenues and charges and miscellaneous revenues, both decreased. While the decreases are not dramatic, they do illustrate the growth in taxes as the dominant source of county government revenues. Nevertheless, intergovernmental revenue (i.e., all revenues from federal and subnational government sources, such as grants and shared revenues) and charges for services and miscellaneous revenues are still essential components of total county government revenue. While intergovernmental revenue grew much more slowly than tax revenue from 2002 to 2017, 5 percent compared to 38 percent, and dropped as a percentage of total revenues from 32 percent in 2002 to 30 percent in 2017, it still made up one-third of county government revenue on average. The primary source of county intergovernmental revenue comes from state governments. In 2017, state governments accounted for 82 percent of intergovernmental revenues, and the federal government only 10 percent. These figures are likely less skewed in 2020–21 when county governments received significant amounts of intergovernmental revenue directly from the federal government in response to the COVID-19 pandemic. Relative to traditional state transfers to county governments, federal revenues represent only a small proportion of total county revenue. In 2017, federal transfers were 2.91 percent and direct state transfers were 25.20 percent of total revenues. As a share of total revenues, charges and miscellaneous revenues have declined from 25 percent in 2002 to 22 percent in 2017. But they still added, on average, over US$38 million to county governments in 2017. That total, however, is down by 15 percent since 2007. Both charges for services and miscellaneous revenues and intergovernmental revenues were adversely affected by the Great Recession. County governments on average experienced a drop in real intergovernmental revenues in 2007–12. The slight increase that followed in 2012–17 was not enough to make up for the decline of the ­previous five years.

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Charges for services and miscellaneous revenues experienced explosive growth from 2002 to 2007, increasing by 41 percent, but then declined by US$8 million (23 ­percent) from 2007 to 2012. Nevertheless, they rebounded in 2012–17, increasing by US$2 million. Specific Sources of Revenues County governments’ tax revenue comprises a broad set of property taxes, sales taxes, license taxes, and income taxes. Property taxes not only account for most tax revenue, but also most of total county revenue – 35 percent of total county revenue in 2017 (Tables 14.4 and 14.5). From 2002 to 2017, each source of tax revenue saw an increase, but as a percentage of total revenue, property taxes grew the most with an increase of almost 5 percentage points from 2002 to 2017. On average, sales taxes make up an important 9.28 percent of total revenues. Though doubling in significance from 2002 to 2007, the income tax is only a very small percentage of average county revenue, which dipped over the Great Recession and thereafter. Both sales and property taxes have consistently increased since 2002, despite the Great Recession.

EXPENDITURES County governments across the United States are responsible for providing several types of essential services. We analyze county general government total spending from 2002 to Table 14.4  County governments revenue by year (county average, thousands of constant 2017 dollars) Year Property Taxes

Sales Taxes

2002 2007 2012 2017

8,863 10,787 10,585 12,107

27,894 34,591 36,679 39,461

License Income Fed. IG State IG General Misc. Others Taxes Taxes Revenue Revenue Charges Revenue 353 2,031 1,409 1,670

1,485 2,793 2,362 2,590

2,485 3,653 4,727 4,087

38,967 40,513 38,062 39,395

21,085 24,409 25,942 29,290

9,573 9,841 6,847 6,785

5,235 13,353 6,794 5,823

Note: IG = intergovernmental.

Table 14.5  County governments revenue by year (county average, percentage of total revenue) Year 2002 2007 2012 2017

Property Sales License Income Taxes Taxes Taxes Taxes 30.58 31.11 32.99 35.57

7.96 8.60 8.89 9.28

1.16 1.89 1.52 1.42

Note: IG = intergovernmental.

0.70 1.51 1.41 1.28

Fed. IG Revenue

State IG Revenue

General Charges

Misc. Revenue

Others

2.84 3.12 3.87 2.91

28.10 26.73 25.89 25.20

15.69 15.32 16.33 15.33

9.22 9.13 6.58 6.38

3.74 2.58 2.53 2.63

The fiscal structure of county governments from 2002 to 2019  ­263

Table 14.6  County governments expenditures by year (county average, thousands of constant 2017 dollars) Year 2002 2007 2012 2017

Total Transportation Community Justice and Human County Others Expenditure and Infrastructure Health Public Safety Services Management 119,689 138,149 141,204 143,654

15,306 17,178 17,825 18,016

19,979 22,254 24,905 26,805

22,001 25,196 26,095 28,008

34,262 37,608 37,447 34,966

13,085 14,969 14,362 14,788

12,208 25,394 13,110 18,625

Table 14.7  County governments expenditures by year (county average, percentage of total expenditure) Year 2002 2007 2012 2017

Total Transportation Community Justice and Human County Others Expenditure and Infrastructure Health Public Safety Services Management 100.00 100.00 100.00 100.00

12.79 12.43 12.62 12.48

16.69 16.11 17.64 18.75

18.38 18.24 18.48 19.55

28.63 27.22 26.52 24.36

10.93 10.84 10.17 10.25

12.58 15.16 14.57 14.61

Note:  Numbers computed as the distribution of expenditures according to the figures in Table 14.6.

2017 and break down expenditures into five areas that counties are typically responsible for according to NACo: transportation and infrastructure; community health; justice and public safety; human services; and county management (Tables 14.6 and 14.7). County government expenditures show a consistent upward trend since 2002, with explosive real growth from 2002 to 2007, before the Great Recession. Expenditures consistently increased from 2007 to 2012, but at a much slower rate. This may be a result of the countercyclical measures implemented during and after the Great Recession, albeit modest measures, enacted by local governments to cope with the effects of the economic downturn. In contrast, average total revenue decreased significantly from 2007 to 2012, during and in the aftermath of the Great Recession. Expenditure by Function Throughout the 2002–17 period, human services spending was the largest category of spending, followed by justice and public safety, community health, transportation and infrastructure, and county management. Community health along with justice and public safety expenditures displayed notable increases from 2007 to 2017. Transportation and infrastructure expenditures observed modest growth during the same period. Human services and county management spending decreased slightly from 2007 to 2012, and while community management increased slightly, human services continued to decline through 2017. While from 2002 to 2017, human services was the largest category of spending, its share decreased over time. In contrast, justice and public safety, and community health expenditures have increased slightly.

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Capital Expenditures Thus far, we have only discussed county operating expenditures. But county governments also spend money on capital projects and improvements. Capital outlays represent government spending to finance long-term physical infrastructure assets while current expenditures support annual (short-term) government operations and service provision. Tables 14.8–14.9 display capital expenditures from 2002 to 2017. Average capital outlays, as a percentage of total expenditures, decreased consistently from 2002 to 2017. The share of capital outlays in 2017 is lower than it was in 2002. Roughly 9.7 percent of county spending was channeled through capital outlays in 2002, but that decreased to 7.86 percent in 2017. Most capital spending per capita is on transportation and infrastructure. Transportation and infrastructure spending grew from 2002 to 2012, but decreased sharply from 2012 to 2017. Community health spending grew from 2002 to 2012, but also decreased from 2012 to 2017. Justice and public safety spending increased from 2002 to 2007, dropped from 2007 to 2012, but increased back to 2012 levels in 2017. Human services spending, in contrast, has declined precipitously from 2002 to 2017. Human services and community health receive the lowest levels of per capita capital spending.

OPERATING POSITION Taking together revenues and expenditures, we can describe a broader perspective on county government financial position. If a government collects more revenues than its Table 14.8  County government expenditure composition (county average, percentage of total expenditure) Year

Current Expenditure

Capital Outlays

2002 2007 2012 2017

90.31 90.92 91.17 92.14

9.69 9.08 8.83 7.86

Note:  Relationship between the variables: total expenditure = current expenditure + capital outlays.

Table 14.9  County governments per capita capital outlays by year (county average, constant 2017 dollars) Year 2002 2007 2012 2017

Total Transportation Community Justice and Human County Others Expenditure and Infrastructure Health Public Safety Services Management 137.27 156.31 177.04 158.36

50.52 60.26 77.51 70.08

8.42 14.60 17.88 12.06

13.80 16.06 14.99 16.10

22.51 19.16 13.74 12.87

18.41 20.23 21.20 16.07

23.60 26.01 31.72 31.18

The fiscal structure of county governments from 2002 to 2019  ­265

Table 14.10  County governments operating position by year (county average, thousands of constant 2017 dollars) Year

Operating Position

2002 2007 2012 2017

–2848  4450 –7460 –2446

Note:  Operating position computed as the difference between total revenues and total expenditures.

actual expenditures, it is able to accrue positive balances and improve the net position of the government. In contrast, as expenditures exceed revenues, governments’ operating position becomes negative and net position is reduced. Table 14.10 shows the average operating position of county governments. Historically, on average, counties have greater annual expenditures than revenues, resulting in a negative operating position. It stands out, however, that county governments entered the Great Recession with positive operating positions, suggesting healthy and sustainable pre-Great Recession finances. Following the recession, county government operating positions declined significantly. They have since slightly recovered, but their average operating position in 2017 is below the 2002 level.

FISCAL STANCE TOWARDS 2020 In this chapter we have examined the characteristics of county governments’ finances between 2002 and 2017, covering the onset and aftermath of the financial crisis and Great Recession, both of which undoubtedly affected the paradigm under which county governments carry out their activities. During 2020, the COVID-19 pandemic put the world under lockdown, creating one of the largest healthcare and economic shocks in history. County governments were not exempt from the effects of this crisis and expected revenue shortfalls and new expenditure pressures. In this section, we examine the threeyear trend in county government revenues directly before the onset of the pandemic. We use data from the Annual Survey of State and Local Governments for the last three years before the COVID-19 pandemic to carry out this analysis. However, we should note that for both 2018 and 2019, the Census survey does not include all county governments in the United States, which is why we limit our analysis using this data. They still provide an informative representation of county revenues during this period. Table 14.11 recalls some of the revenue indicators used in previous sections, showing the trend in revenues. Own-source revenues represent 70 percent of total revenues and have been stable between 2017 and 2019. Tax revenues remain at similar levels (around 45 percent of total revenues), with respect to 2017 data. In general, we do not observe significant changes in the revenue structure.

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Table 14.11 Main revenue indicators: 2017–19 (county average, percentage of total revenue) Year

Taxes

Intergovernmental Revenue

Charges and Miscellaneous

2017 2018 2019

47.50 45.39 45.54

30.09 30.44 29.68

22.37 24.13 24.72

DISCUSSION AND CONCLUSION While county government revenues grew significantly from 2002 to 2007, they were hit hard by the Great Recession. After robust total revenue growth from 2002 to 2007, revenues registered a real net decrease from 2007 to 2012. Most, but not all the loss was made up between 2012 and 2017. Revenue losses from the Great Recession had not fully recovered by 2017, eight years after the recession officially ended. In terms of own-source revenues, charges and miscellaneous revenues make up a smaller portion of total revenues in 2017 than in 2002. Tax revenues, in contrast, make up a significantly larger share of total revenues in 2017 than in 2002. The share of intergovernmental revenues as a percentage of total revenues decreased from 2002 to 2017. The intergovernmental revenue share started dropping before the Great Recession, stabilized from 2007 to 2012 with a slight increase in additional federal support, then decreased again from 2012 to 2017. Going into fiscal year 2018, the county government sector had less intergovernmental support as a share of total revenues, and was more reliant on its own tax revenues than in 2002. County government expenditures show a consistent upward trend since 2002, with explosive real growth from 2002 to 2007 before the Great Recession. Expenditures consistently increased from 2007 to 2012, but at a modest rate, likely from countercyclical measures implemented during and after the Great Recession limiting significant cuts in expenditures across the sector. Expenditure growth significantly outpaced average total revenue growth from 2007 to 2012. This shows that the Great Recession resulted in a structural imbalance in county government revenues and expenditures. Historically, county governments annually spend more money than they take in, resulting in a negative operating position. However, county governments entered the Great Recession with positive operating balances, suggesting healthy and sustainable pre-Great Recession finances. Post-Great Recession this is not the case: the county government sector operating position is negative. Following the recession, county government operating positions declined significantly. They have since slightly recovered, but operating position in 2017 is below 2002 levels, and well below that of 2007. The share of capital outlays in 2017 is lower than it was in 2002. County government capital outlays as a percentage of total expenditures decreased consistently from 2002 to 2017. Most capital spending per capita is on transportation and infrastructure. Human services and community health per capita capital spending is by far the lowest among all county government capital spending categories. County government finances took a beating from the financial crisis and Great Recession. There are a few bright spots going into the pandemic with own-source revenue

The fiscal structure of county governments from 2002 to 2019  ­267

stable, and growth in total expenditures. But by most indicators, 2017 looks a lot like 2007, indicating a lost decade of county government finances and the high opportunity costs of the Great Recession. This research has produced several areas for future research. An analysis of county fiscal trends using medians, rather than means, might produce different results for several important variables. In addition, future research could look at county fiscal structure in terms of population, socio-demographic and economic variables to analyze the differential impact of the Great Recession and COVID-19 pandemic era across race, ethnicity, region, and so on. Also, researchers could further analyze the countercyclical spending behavior of county governments to show the correlation, if any, between changes in government spending and local employment, capital expenditures, and overall economic activity.

REFERENCES Brien, S. T., Eger, T. J. III, & Matkin, D. S. T. (2021). The timing of managerial responses to fiscal stress. Public Administration Review, 81(3), 414–427. Brown, K. W. 1993. The 10-point test of financial condition: Toward an easy-to-use assessment tool for small cities. Government Finance Review, 9(6), 21–26. Chernick, H., Langley, A., & Reschovsky, A. (2011). Revenue diversification and the financing of large American central cities. Public Finance and Management, 11(2), 138–159. Clark, B. Y. (2015). Evaluating the validity and reliability of the Financial Condition Index for local governments. Public Budgeting and Finance, 35(2), 66–88. Coe, C. K. (2007). Preventing local government fiscal crises: The North Carolina approach. Public Budgeting & Finance, 27(3), 39–49. Gorina, E., Maher, C., & Joffe, M. (2018). Local fiscal distress: Measurement and prediction. Public Budgeting & Finance, 38(1), 72–94. Hendrick, R. (2004). Assessing and measuring the fiscal health of local governments: Focus on Chicago metropolitan suburbs. Urban Affairs Review, 40(1), 78–114. Hoene, C., & Pagano, M. (2009). City fiscal conditions in 2009. Research brief on America’s cities. National League of Cities. National Association of Counties (NACo). (2019). Counties matter: Stronger counties, stronger America. County history and diversity. https://www.naco.org/about/counties-matter Pierson, K., Hand, M., & Thompson, F. (2015). The government finance database: A common resource for quantitative research in public financial analysis [Open access]. PLoS ONE. https:// doi.org/10.1371/journal.pone.0130119 Stone, S., Singla, A., Comeaux, J., & C. Kirschner. (2015). A comparison of financial indicators: The case of Detroit. Public Budgeting and Finance, 35(4), 90–111. US Census Bureau (2000). Government finance and employment classification manual. https://www2. census.gov/govs/class/classfull.pdf Xu, Y., & Warner, M. E. (2016). Does devolution crowd out development? A spatial analysis of US local government fiscal effort. Environment and Planning A: Economy and Space, 48(5), 871–890.

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APPENDIX: VARIABLES DESCRIPTION According to the US Census Bureau’s Government Finance and Employment Classification Manual (2006), revenue is defined as: “all amounts of money received by a government from external sources (i.e., those originating from ‘outside the government’), net of refunds and other correcting transactions, proceeds from issuance of debt, the sale of investments, agency or private trust transactions, and intragovernmental transfers” (p. 4-1). Total revenue is defined as the sum of tax revenue, total intergovernmental revenue, and charges and miscellaneous revenue. For the purpose of this analysis, total utility revenue and revenue from insurance trusts is included in the charges and miscellaneous revenue. Definitions stemming from NACo categorize spending in five groups, as shown in Table 14A.1. Table 14A.1  NACo defined variables using Census data NACo Definition

Calculation Using Census

Transportation and infrastructure

Roads and bridges, airports, public transportation, construction of public facilities, utilities, solid waste recycling, water, sewage, and telecommunications

Regular highways, toll highways, sewerage, solid waste management, utilities, water management, and air transport

Community health

Hospitals, health clinics, public health, behavioral and mental health, substance abuse treatment, immunizations and prevention, indigent healthcare, health code inspections, nursing homes

Health expenditure and total hospital expenditure

Justice and public safety

Sheriff ’s departments, county police departments, county courts, jails & correctional facilities, juvenile detention and justice services, emergency management personnel, paid & volunteer firefighters, district attorneys, public defenders, and coroners

Police protection, correctional, judicial, fire protection, and inspections

Human services

Financial assistance, violence prevention, food and nutrition services, early childhood development, workforce training and development, veteran services, senior services and elder care, behavioral and physical health services, medical coverage, parent education and support, child welfare, foster care and adoption, homelessness and housing support, and services for individuals with disabilities

Public welfare, education, unemployment compensation, and retirement payments

The fiscal structure of county governments from 2002 to 2019  ­269

Table 14A.1 (continued)

County management

NACo Definition

Calculation Using Census

Record-keeping, tax assessments & collection, 911 call centers, elections and polling places, recreation and parks, arts programs, housing, and community and economic development

General public buildings, housing, libraries, parking, parks and recreation, financial administration, central staff, natural resources, social security administration, and miscellaneous activities

PART III DEBT AND PENSIONS

15. The security, structure, and market of municipal debt: recent trends, research, and developments W. Bartley Hildreth and Justina Jose

INTRODUCTION Debt is not a bad four-letter word. American subnational governments issue debt in the municipal securities capital market primarily to finance public projects or build infrastructure that facilitates economic growth over time, such as roads and bridges, water and sewerage systems, and governmental buildings. Issuing debt provides subnational governments with a financing option that allows them to pay for costly infrastructure projects by spreading the cost over the beneficial life of the project. In fact, borrowing money to be repaid over time preserves intergenerational equity among those enjoying project benefits while avoiding lumpy payment burdens. There is widespread use of this financing method, with about half of the 90,000 subnational governments issuing debt.1 State governments and state authorities are the largest issuers of debt, with cities and towns comprising about 13 percent of the total market average annual par value of US$396 billion during 2007–20.2 Local governments, broadly defined, comprise about the same size revenue system as state governments but account for about 60 percent of all state and local capital outlays,3 the primary use of borrowed funds. By mid-2021, there was just over US$4 trillion in total outstanding municipal securities.4 Bonds issued by subnational governments are eventually sold to investors ranging from individuals, banks, insurance companies, trusts, mutual funds, hedge funds, and corporations, among others. Although traditionally considered a “buy and hold” market, individual investors in municipal bonds account for only 43 percent of outstanding securities, meaning that institutional investors such as mutual fund managers, banking institutions, and insurance companies buy and trade most municipal securities.5 An i­ndicator of

1   The Census of Governments provides the number of jurisdictions (https://www.census.gov/ content/dam/Census/library/visualizations/2019/econ/from_municipalities_to_special_districts_ america_counts_october_2019.pdf), and the 2012 Government Accountability Office (GAO) report on municipal securities (https://www.gao.gov/assets/gao-12-265.pdf) cites approximately 46,000 municipal issuers (p. 6). 2  See The Bond Buyer’s “A decade of municipal bond finance” (various issues) based on Refinitiv data. 3   See the 2017 State & Local Government Finance Tables at https://www.census.gov/data/ tables/2017/econ/gov-finances/summary-tables.html. 4   Securities Industry and Financial Markets Association (SIFMA) (2021, October 4), “US municipal bonds: Issuance, trading volume, outstanding, holders,” https://www.sifma.org/resour​ ces/research/us-municipal-bonds-statistics. 5  Ibid.

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market liquidity is an average daily number of trades of 38,000 and an average daily par value of trades of US$13 billion (during 2007–20).6 As these numbers suggest, the municipal securities market is a significant feature of the financing of subnational governments and it contributes to a robust capital market used by all types of investors. Investors demand an adequate return on (and return of) their investment. An issuer’s goal is to obtain the investment at the lowest possible rate of return consistent with public policy (Hildreth, 1993). These formulas for success rest upon a realistic view of the issuer’s credit profile, an appreciation for the nuances of debt issuance and management, and an understanding of market dynamics. The purpose of this chapter is to help issuers, investors, and market intermediaries find relevant research that can guide their market-oriented choices and to assist the research community in framing new research to unlock the hidden gems of this unique capital market. Over the past 15 years,7 the municipal market has evolved to deal with threats to the security undergirding debt instruments, disruptions to alternative debt structures, and material changes in the regulatory environment facing issuers as they seek to access the capital markets. For each of these three sections – security, structure, and market – this chapter traces recent developments and related literature, and pinpoints significant research findings. The chapter closes with research and policy opportunities.

SECURITY To borrow imposes the obligation to repay. Security refers to the revenues and assets for bondholder protection, including actions to assure payment of debt service. Bond investors assume credit risk, or the risk that investors will not be paid in full and on time. Accordingly, this section opens by specifying the basic security arrangements and then explores the credit risks associated with changes in the fiscal architecture of state and local governments, the rise in emphasis of environment, social, and governance risk factors, the role of state leadership in shaping local conditions, and the growth, collapse, and early efforts to renew the value of bond insurance. Promises to pay are either guaranteed or contingent. Full-faith-and-credit obligations,8 referred to as general obligation (GO) bonds, offer bondholders the security tied to the jurisdiction’s taxing power. Contingent obligations, referred to as revenue bonds, pay bondholders only under the narrow terms embedded in the transaction covenants. As Figure 15.1 shows, other than around the period leading up to and including the Great Recession (2006–08) when revenue bond volume grew while budget-stressed GO debt

 Ibid.   This chapter seeks to extend the work of Hildreth and Zorn (2005) so it covers the period since then. 8   The term “full faith & credit” is generally used to describe the commitment of the issuer to repay to the bonds from all legally available funds, including a commitment to use its legal powers to raise revenues to pay the bonds. For a detailed definition, please see MSRB Glossary of Municipal Securities Terms (3rd ed.), August 13, 2013 at https://www.msrb.org/sites/default/ files/2022-08/MSRB-Glossary-of-Municipal-Securities-Terms-Third_Edition-August-2013.pdf. 6 7

The security, structure, and market of municipal debt   ­273 350 300

Billions of Dollars

250 200 150

GO

100

Revenue

50

20

18

20

16

14

20

20

10

12

20

20

08

20

06

20

04

20

00

02

20

20

20

98 19

19

96

0

Year

Source:  Securities Industry and Financial Markets Association (SIFMA) (2021), https://www.sifma.org/ resources/research/us-municipal-bonds-statistics.

Figure 15.1  GO vs revenue bonds declined, the two types of bonds moved roughly in tandem, with revenue bonds comprising about 60 percent of the municipal bond market as of 2020.9 Despite the widely repeated aspect of GO bonds as the most secure debt instrument, they do not always meet the full-faith-and-credit standard (Doty, 2013; Hildreth, 2013). Moreover, as the bankruptcy court ruled on the City of Detroit’s Chapter 9 filing in 2014, GO bonds are unsecured debt unless the pledge of the taxing power is supported by a statutory lien or dedicated revenues. By this standard, unsecured GO bonds are on the same level as unpaid bills to any vendor of services. In contrast, revenue bonds are secured by a dedicated revenue stream. Fiscal Architecture Credit quality, an indicator of credit risk, reflects the influence of economic, demographic and institutional factors, termed the “fiscal architecture” of state and local finance (Wallace, 2012). These factors are “largely outside the control of governments, but they put pressure on expenditures and revenue sources of state and local governments and may constrain options for reforming public finances” (Wallace, 2012, p. 156). Wallace addresses the fiscal architecture through recent and future trends in personal income, population, employment/output, and consumption. For each, she examines the anticipated impact on state and local government budgets and options for reform such as broadening the income and sales tax bases, among other revenue structure options. 9   SIFMA (2021, October 4), “US municipal bonds: Issuance, trading volume, outstanding, holders,” https://www.sifma.org/resources/research/us-municipal-bonds-statistics.

274  Research handbook on city and municipal finance

Credit quality of a particular jurisdiction rests upon its adept handling of its particular economic, demographic, and institutional architecture. It is not easy. Many governments faced budget instability due to the Great Recession10 and then had to face the COVID-19 pandemic that constrained the ability of subnational governments to repay their borrowing.11 At the peak of the pandemic, governments faced high health-related expenditures with constrained revenues due to delayed tax-filing deadlines that most governments allowed, leading to doubts among investors about the ability of an issuer to repay their debt, which eventually led to their withdrawal from the market.12 But problems with the fiscal architecture predated these events, such as the undermining of traditional revenue systems by the growth of online commerce and other economic changes (Government Finance Officers Association [GFOA], 2023). Political pressures leading to tax cuts and rate freezes further stress debt security, while there persists an almost insatiable demand for more spending to cover current and future operations (Shin et al., 2020). Then there is the fiscal reckoning to deal with long overlooked liabilities, including deferred infrastructure maintenance (Benson & Marks, 2016; Miller et al., 2020; Wang & Wu, 2018) and unfunded pension obligations (Benson & Marks, 2016; Mead et al., 2015; Mier, 2017). Pension obligation bonds emerged as a controversial way to generate upfront cash proceeds for use in long-term investments with the hope of earning more over time than the upfront cost of capital and its ongoing debt service (Calabrese & Ely, 2013). Substantial federal programs enacted in 2020 and 2021 not only helped state and local governments deal with health pandemic costs but even fueled efforts to cut taxes (Romm, 2022). The pandemic elevated concerns about central city property tax on underused office buildings and public parking garages, and the need for a viable public health community. Highlighting this last point, another public health crisis, the opioid crisis, negatively affect municipal credits (Cornaggia et al., 2022).13 For these and other reasons, fissures in the fiscal architecture supporting municipal financing constitute a material credit risk. ESG Risks A relatively new collection of credit risks focuses on environmental, social, and governance issues, collectively labeled as ESG. These factors can influence budgetary balance, financial management, and the provision of basic infrastructure.14 10   Symposium issues of the Municipal Finance Journal analyzed the impact on state and local governments early in the period (2009, 29(4)), on six big cities through the crisis (2011, 32(1)), and, then, seven states in their recovery from the Great Recession (2019, 40(1–2)). 11   Symposium issues of the Municipal Finance Journal examined the impact of COVID-19 on ten states (Conant & Simonsen, 2020) and eight large cities (Su, 2021). 12   Brookings Institution (2022, July 11), “What’s going on in the municipal bond market? And what is the Fed doing about it?”, https://www.brookings.edu/blog/up-front/2020/03/31/ whats-going-on-in-the-municipal-bond-market-and-what-is-the-fed-doing-about-it. 13   Cornaggia et al. (2022) suggest that the opioid crisis has constrained municipal cash flow. Counties with high-opioid deaths have lower revenues and higher expenditures than their closely matched counties in terms of urbanization, wealth, and economic development. The combination of high expenditures and lower revenues stresses the budget of counties, leading to higher offer yields, lower credit ratings, and reduced bond issuance. 14   See S&P Global Ratings (2021, October 10), “General criteria: Environmental, social, and governance principles in credit ratings,” https://www.spglobal.com/ratings/en/research/

The security, structure, and market of municipal debt   ­275

Environmental risks include physical risks that arise from the changes in weather and climate and transition risks that are a result of transitioning an economy that is reliant on fossil fuel to a low-carbon economy (Basel Committee on Banking Supervision, 2021). Climate-related events, from the 2005 Hurricane Katrina disaster (Bourdeau-Brien & Kryzanowski, 2018; Denison, 2006; Fowles et al., 2009; Hildreth et al., 2011; Marlowe, 2006) to the drought and fire conditions of 2021 raise substantial credit concerns.15 Jerch et al. (2020) find that in the decade following a major hurricane, local revenue and expenditures fell between 5 and 6 percent. Communities with low-income, large-minority, and low-educated population face the largest revenue and expenditure cutbacks after a hurricane. Additionally, if these communities are dependent on one industry such as the coal industry, which projections show will face production declines by 75 percent in the 2020s, they face the risk of losses in tax revenue as the country transitions to alternate forms of energy (Morris et al., 2019). Such environmental risks have implications for debt issued by state and local governments, especially GO bonds backed by general taxes. Debt backed by revenues from utilities such as water and sewerage could also face risk as there could be a disruption in revenues due to infrastructure damage caused by sea-level rise or flooding. A report by BlackRock suggests that within a decade, the economic losses due to climate-related events would be 0.5–1.0 percent of gross domestic product (GDP).16 Painter (2020) and Goldsmith-Pinkham et al. (2021) find that the greater the likelihood of being affected by climate change the greater the issuance costs. However, an analysis by RiskQ found “no evidence that event-based physical climate risk is being systematically ‘priced in to’ the interest rate cost of debt for issuers” (Hamel, 2021, n.p.). One potential reason for the mixed results could be the lack of disclosure by issuers about the climate risks that they face (Bolstad et al., 2020), preventing investors from getting a clear understanding of the risks that an issuer is exposed to. Social issues range from educational attainment and income distribution to social equity and the extent of broad stakeholder involvement in policy discussions (Kroll Bond Rating Agency [KBRA], 2021). Demographic changes presage policy debates about taxing and spending priorities (Butler & Yi, 2022; Byrd et al., 2015; Molin et al., 2018; Stowe et al., 2012).17 Bruno and Henisz (2022) found differences in bond yields at the county level by race using a wide range of ESG factors, including social justice outcomes such as housing prices, public safety allocations, and toxic waste exposure. Other research suggests that the municipal bond prices reflect ethnic and religious fractionalization

articles/211010-general-criteria-environmental-social-and-governance-principles-in-credit-ratings-​ 12085396. 15   See S&P Global Ratings (2021, August 18), “Could the western U.S. drought threaten municipal credit stability?” at https://www.spglobal.com/ratings/en/research/articles/210818-couldthe-we​stern-u-s-drought-threaten-municipal-credit-stability-12082229. 16   BlackRock (2019, April 4), “Investors underappreciate climate-related risks in their portfolios,” https://www.blackrock.com/corporate/newsroom/press-releases/article/corporate-one/ press-releases/investors-underappreciate-climate-related-risks-in-their-portfolios. 17   Also see S&P Global Ratings (2021, October 10), “General criteria: Environmental, social, and governance principles in credit ratings,” https://www.spglobal.com/ratings/en/research/ articles/211010-general-criteria-environmental-social-and-governance-principles-in-credit-ratings-​ 12085396.

276  Research handbook on city and municipal finance

(Bergstresser et al., 2013). Thus, the influence of social issues on the municipal bond market deserves more attention. Governance considerations, while incorporated into the ESG package, have typically been a part of credit risk analysis. These factors include the governance framework, fiscal decision-making, and transparency and disclosure (GFOA, 2023). The policies and practices that are associated with highly rated governments overlap with effective “ESG credit drivers.”18 Market disclosure documents (such as the “Official Statement” on a bond transaction) and credit ratings fail to fully incorporate ESG risks yet (Morris et al., 2019). Investors are keen to understand how state and local governments plan to identify, assess, and report ESG-related risks and opportunities. A transparent planning and budgeting process that reflects an issuer’s long-term strategy and financial planning is key to maintaining investor confidence. In fact, Crifo et al. (2017) find that ESG ratings significantly decrease sovereign borrowing costs. Better disclosure by an issuer allows governments to tell their story of the issues that they face and how they are addressing these issues. It provides investors with complete information required to make a judgment about the credit risk associated with an issuer. Organizations such as the GFOA19 and the Municipal Securities Rulemaking Board (MSRB)20 are contributing towards the dialogue around ESG factors, its impact on the financial health of state and local governments, and how issuers can improve efforts related to information disclosure. A related area of governance concern is cybersecurity. In 2019, 966 local government agencies, educational establishments, and healthcare providers faced ransomware attacks at a potential cost in excess of US$7.5 billion.21 Local governments are the target of these attacks as they store considerable amounts of sensitive information without the state-of-the-art cybersecurity technology. These technological attacks on critical infrastructure (e.g., the gas pipeline ransomware in 2020) illustrate the impact such cybersecurity losses (however temporary) can have on society and the economy. State Leadership Governance, even as a part of ESG, recognizes that every local government is a creature of its respective state government. Therefore, states play a critical role in maintaining the fiscal health of their local governments. Moreover, due to the interdependent nature of state and local fiscal relations, declining local fiscal health could create adverse spillover effects for the states. A Pew report suggests that preventing stigma, credit downgrades, and contagion, preserving public health and safety, and economic growth and stability are all drivers of state monitoring (The Pew Charitable Trusts, 2013). These state

18   S&P Global Ratings (2021, June 29), “The top 10 management characteristics of highly rated state and local borrowers: Through the ESG lens,” https://www.spglobal.com/ratings/en/ research/articles/210629-the-top-10-management-characteristics-of-highly-rated-state-and-localborrowers-through-the-esg-lens-12021520. 19   See GFOA (2023), “ESG disclosure,” https://www.gfoa.org/esg. 20  See https://www.msrb.org/Making-Impact-ESG-Investing-and-Municipal-Bonds. 21   See International City/County Management Association (ICMA) (2021, July 14), “A look at local government cybersecurity in 2020,” https://icma.org/articles/pm-magazine/ look-local-government-cybersecurity-2020.

The security, structure, and market of municipal debt   ­277

actions influence local fiscal behavior and, thus, the credit quality of local government ­borrowers. States vary in the extent of the fiscal monitoring of local borrowing and budget behavior, influencing local fiscal space and flexibility to tax and spend. Some actions can be rules in the form of fiscal limits such as tax and expenditure limitations (TELs), balanced budget requirements (BBRs), and debt limits, while others can be more proactive, especially during local fiscal distress, where state fiscal emergency laws impose strict oversight control on local governments. Fiscal rules and limits are intended to constrain the behavior of government officials. Johnson and Kriz (2005) suggest that these rules are based on prudent fiscal principles and could lead to exceptional financial performance. On the other hand, they could also be viewed negatively by the financial markets if they increase the default risk of debt issues. Generally, those rules that increase the likelihood of debt repayment lead to high creditworthiness and low borrowing costs, while rules that limit a local government’s ability to repay debt (such as limits on revenue) lead to higher borrowing cost. Therefore, stringent BBRs that limit the size of deficits and expenditure limits that control expenditures are viewed more favorably by the capital markets, leading to lower borrowing costs (Johnson & Kriz, 2005; Lowry, 2001; Poterba & Rueben, 1999). Tax limits, on the other hand, might be viewed as interfering with a government’s ability to repay. Restriction in the amount of revenue that a government can collect might constrain a government’s fiscal flexibility, increasing the default risk and borrowing costs (Johnson & Kriz, 2005; Lowry, 2001). There is mixed evidence regarding the impact of debt limits on borrowing costs. Some researchers such as Johnson and Kriz (2005) find that debt limits were associated with higher interest rates, but Poterba and Rueben (1999) find that there is no significant relationship between debt limits and bond yield differences. Table 15.1 includes a brief overview of research that examines the impact of fiscal institutions on state or local government cost of borrowing, credit rating, and overall borrowing. Some states adopt a more proactive approach towards local government finances to detect early signs of fiscal distress, allowing them to intervene in times of crisis. A Pew report suggests that New York City (1975), Cleveland (1978), and Philadelphia (1991) avoided bankruptcies because their states intervened with direct aid, loans, and oversight structures.22 Proactive monitoring involves active review of financial information of local governments to assess fiscal condition or identify distress (The Pew Charitable Trusts, 2016). One of the advantages of such monitoring is that it allows states to intervene in a less intrusive manner than would be necessary if there was a fiscal crisis. Moreover, credit rating agencies assign higher ratings to troubled localities with strong state oversight (ibid.). If a local government does face bankruptcy, then states have established rules through which they can file for bankruptcy under the Federal Bankruptcy Code Chapter 9. Some examples include the imposition of a financial control board over New York City in 1975 by New York State or when Michigan appointed financial emergency

22   The Pew Charitable Trusts (2015), After municipal bankruptcy: Lessons from Detroit and other local governments, https://www.pewtrusts.org/-/media/assets/2015/08/after-municipal-bank​ ruptcy-pdf.pdf.

278

Debt limits on long-term GO debt are associated with low borrowing costs, point estimates weak State debt limits are associated with low interest costs because the limits lead to high credit ratings

Poterba and Rueben (1999) Johnson and Kriz (2005)

States with strict BBRs have low interest costs

Note:  The descriptions in column 1 are general descriptions. For more detail, see Hou and Smith (2006); Kioko (2008, 2011).

Debt limits: rules that restrict the issuance of GO debt

States with BBRs experience lower borrowing costs

Johnson and Kriz (2005)

TELs have a negative impact on local government use of taxsupported debt

Kioko and Zhang (2019)

Lowry (2001)

Restrictive TELs have a negative impact on municipal credit ratings

Maher et al. (2016)

States with weak BBRs have higher borrowing costs than states with strict BBRs

Restrictive revenue limits are associated with low credit ratings and expenditure limits are associated with high credit ratings

Stallmann et al. (2012)

Poterba and Rueben (1999)

States with revenue limits are associated with high interest costs and expenditure limits are associated with low interest costs

Johnson and Kriz (2005)

Balanced budget requirements (BBRs): rules that prohibit spending more than revenue collected

States with revenue limit face high borrowing costs and states with an expenditure limit face low borrowing costs

Poterba and Rueben (1999)

Tax and expenditure limitations (TELs): limitations placed on revenues, expenditures, or appropriations

Findings

Literature

Fiscal Institution

Table 15.1  Brief overview of literature on fiscal institutions and its impact on borrowing

The security, structure, and market of municipal debt   ­279

managers in the cities of Detroit (2013–14) and Flint (in 2002–04 and then in 2011–15).23 These rules are activated when local governments face the threat of insolvency, not only with respect to sufficient cash-flow but also when they fail to deliver services (also known as service delivery insolvency).24 Municipal bonds issued by municipalities where states have established proactive oversight systems during emergencies have lower yields than those local bonds issued by municipalities that have unconditional access to Chapter 9 bankruptcy (Gao et al., 2019; Moldogaziev et al., 2017). Examining state governments’ borrowing costs, Yang (2019) finds that bankruptcy authorizations conditional on interventions are associated with a ten-basis-point cost saving. However, despite state involvement, there is a likelihood of fiscal distress among local governments, leading to defaults in payments. These could be due to macroeconomic forces that could trigger revenue losses, investment losses, and increases in demand for services. States could also reduce the aid they provide to their local governments especially in times of weak economic conditions. Low state aid combined with increased demand for services could lead to fiscal difficulties.25 Moreover, with the increasing incidence of disaster events, local governments could face sudden changes in tax base or revenue losses along with high costs associated with addressing these disasters (Duguid, 2021).26 Prior to the 2008 Great Recession, issuers frequently used bond insurance as a credit enhancement tool to support both issuers and investors against multiple sources of credit risk. Bond Insurance The demand for municipal bond insurance accelerated after the New York City defaults in 1975 shifted investor perceptions of risk associated with municipalities. Bond insurance became an integral part of the municipal market with more than half of all new issues insured in 2007, with state and local governments paying more thanUS$1.5 billion annually in premiums (Kriz & Joffe, 2017). Bond insurance allowed issuers to enhance the marketability of their bonds to riskaverse investors. With bond insurance, issuers with a sub-AAA27 credit rating rented the rating of an AAA insurer for an up-front cash premium. This financial guarantee was especially useful for smaller and lower-quality municipal issuers as it increased their access to the capital markets. However, during the Great Recession, bond insurance companies either became insolvent or faced credit downgrades due to the numerous claims on their limited capital. At the beginning of 2008, there were seven bond insurers with an 23   See Michigan Live (2018, January 16), “Flint’s history of emergency management and how it got to financial freedom,” https://www.mlive.com/news/flint/2018/01/city_of_the_state_flints_histo. html. 24   A bankruptcy court in the Detroit filing expanded the definition of insolvency under Chapter 9 to include failure to provide services; see Brimer et al. (2014). 25   Congressional Budget Office (CBO) (2010, December), Fiscal stress faced by local governments (Economic and Budget Issue Brief), https://www.cbo.gov/sites/default/files/111th-con​gress2009-2010/reports/12-09-municipalitiesbrief.pdf. 26   NOAA National Centers for Environmental Information (2023), “Billion-dollar weather and climate disasters,” https://www.ncei.noaa.gov/access/billions/time-series. 27   We are using this label as a generic triple-A when in fact different credit rating firms employ different labels (such as Aaa).

280  Research handbook on city and municipal finance

AAA rating, but by the end of 2010, none of them carried this rating, resulting in a 64 percent decline in bond insurance volume (Slavin, 2018). For the next decade, borrowers found no significant interest cost reduction from municipal bond insurance, unless it was needed for market access (Kriz & Joffe, 2017; Lai & Zhang, 2013). With the COVID-19 pandemic, state and local government issuers are facing a drop in creditworthiness and are now returning to the financial guarantee industry to reduce borrowing costs (Gillers, 2020). According to Municipal Market Analytics, the overall share of insured municipal debt rose 7.13 percent in the second quarter of 2021, up from an average of 4.72 percent in the decade before the pandemic (ibid.). Investors, too, are seeking out insured bonds. This uptick in bond insurance reflects increased issuance of taxable bonds and strong interest from international investors, leading to a broader investor base. However, it is not expected that the bond insurance penetration will reach 2007 levels any time soon (Weitzman, 2021).

STRUCTURE There are alternatives in structuring a borrowing instrument to meet the issuer’s repayment preference and the expectations of potential investors. Accordingly, this section explores the structure of long-term debt transactions.28 Paying the principal and interest on new debt impacts any existing debt, necessitating policies and practices on debt affordability. Traditionally, issuers structure their transactions as fixed income, taxexempt debt, but the rationale for taxable municipal bonds has attracted new attention in recent years. Refinancing of old debt constituted a significant segment of the market until Congress put a stop to it. In response to all these (and other) issues, there remains a constant search for low-cost financing alternatives. Debt Affordability Almost always, new debt must overlay existing debt service obligations. The exceptions would be for a debt-free governmental entity entering the market for the first time or, perhaps, debt attached to a new revenue source, but, even then, there is likely other debt by that issuer that must be taken into consideration. New debt must wrap around existing debt maturity, although the average maturity of bonds overall has declined (Cortes et al., 2022). New debt may be issued with the same security as the old debt, as would be the case for unlimited GO debt. Senior and junior lien revenue bond structures exist, especially for enterprise operations. Given the connection between old and new debt, large and frequent debt issuers prepare debt affordability reports (Bartle et al., 2008; Miller & Hildreth, 2007; The Pew Charitable Trusts, 2016, 2017; Weiner, 2013a, 2013b). The Pew Charitable Trusts (2017) highlights that debt affordability studies “help states determine, among other things, if there is available capacity for borrowing, understand debt levels 28   Not addressed here is the use of short-term debt (Lofton & Kioko, 2021; Su & Hildreth, 2018), although the Great Recession led to liquidity problems and an increase in its use (Fisher & Wassmer, 2014). Nevertheless, this was not the case during the early stages of the COVID pandemic (Johnson et al., 2021).

The security, structure, and market of municipal debt   ­281

relative to peer states, and how much a debt issuance may constrain other spending, and tie debt to capital planning and budgeting processes” (p. 6). Credit rating agencies place value on the establishment and use of debt affordability measures in assessing ESG risks.29 Tax Treatment A key consideration in structuring a transaction concerns the treatment of interest for tax purposes, either tax-exempt or taxable. Municipal securities gain their prime market presence due to the income tax exemption enjoyed under federal tax law. Moreover, in 2008, the US Supreme Court, in Department of Revenue of Kentucky v. Davis (553 U.S. 328), upheld as constitutional the ability of a state with a state income tax to exempt interest received from only in-state municipal bonds, thereby discriminating against out-of-state bond issuers (Denison et al., 2009). Considering the value of tax exemption, any federal tax law change is fraught with concern. For example, capping state and local tax deductions can hinder tax increases to preserve credit quality, while federal tax rate reductions reduce the relative value of a tax-exempt instrument (Aikman et al., 2012; BLX Group LLC, 2013; Kitain et al., 2020). However, due to the tax exemption, the federal government foregoes billions of dollars of revenue each year. Two forces merged after the Great Recession. Federal lawmakers were concerned about the widening federal deficit while at the same time took notice about the liquidity constraints faced by state and local government unable to issue debt for necessary projects. The answer was to turn to giving state and local governments a taxable bond option (TBO), an idea advocated by many economists since the 1940s. The concept of the TBO is that instead of eliminating tax-exempt bonds, issuers would gain the option to issue taxable bonds with a direct subsidy by the federal government to compensate for the added cost of capital. As in previous TBO debates, there were concerns about how this new structure would impact the borrowing costs of state and local governments. One side argued that the current tax exemption was crucial to attract investors and therefore eliminating it would reduce demand and subsequently increase the borrowing costs of local governments. The countervailing argument was that taxable bonds would expand the investor base to pension plans and foreign investors who do not have taxable status, thereby increasing the demand and lowering the borrowing cost for state and local government. A taxable bond option, labeled the Build America Bond (BAB) program, was enacted on February 17, 2009 as part of the 2010 Dodd-Frank Act (DFA). The BAB program provided a direct federal subsidy equal to 35 percent of each interest payment made on a BAB transaction issued in 2009 and 2010 (the program ended in 2010). BABs quickly became very popular, and in 2010 accounted for nearly a quarter of state and local government borrowing (Fisher & Wassmer, 2014). Nontraditional investors such as pension funds, corporations, and foreign nationals that are exempt from US income tax entered 29   S&P Global Ratings (2021, June 29), “The top 10 management characteristics of highly rated state and local borrowers: Through the ESG lens,” https://www.spglobal.com/ratings/en/ research/articles/210629-the-top-10-management-characteristics-of-highly-rated-state-and-localborrowers-through-the-esg-lens-12021520.

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the market due to higher yields than comparable Treasury and highly rated corporate bonds, resulting in a broader investor base (Ang et al., 2010). Ang et al (2010) interpreted the BAB program as a wealth transfer from natural holders of municipal bonds, who are individual investors (either directly or through mutual fund holdings) to corporations, pension funds, and foreign investors not subject to individual US income taxes. The BAB program provided an opportunity to scholars to test the impact of a taxable bond option on borrowing cost. The evidence is mixed. Some scholars argue that the BAB issuers saved more on taxable bonds than traditional tax-exempt bonds (Gamkhar & Zou, 2014). Others argue that there would be a decrease, for both GO and revenue bonds (Ang et al., 2010; Daniels et al., 2014; Eizenga & Hanlon, 2011; Liu & Denison, 2014; Luby, 2012). Ang et al. (2010) find that issuers sold BABs at a cost 54 basis points lower than if they had sold tax-exempt municipal bonds. On the other hand, Luby et al. (2021) argue that the borrowing cost benefits cited in previous studies may be overstated since they do not account for the call optionality of tax-exempt bonds. The call option allows calling the bonds early at par, leading to interest cost savings. With taxable bonds, issuers must exercise a “make whole call,” meaning that the issuer must make a lump sum payment based on the net present value of future coupon payments that will not be paid as a result of the bonds being redeemed. In contrast, tax-exempt bonds typically allow issuers to pay only the principal amount called. Using the concept of “refunding adjusted yield” on 43 matched pairs of tax-exempt and taxable California bonds, the authors find that the capital cost benefit associated with taxable bonds is substantially smaller than in previous studies. A broader question is, who benefits from tax exemption? High marginal taxpayers are direct beneficiaries (Riegel, 2021). Once the use of the debt proceeds is considered (such as a reduction in school construction costs), tax incidence analysis finds that lowincome households benefit (Galper, Rosenberg et al., 2014). In terms of type of issuer, Riegel (2021) finds that the tax exemption benefits general purpose municipalities the most. As Figure 15.2 shows, in recent years, taxable bonds have flourished, especially for the longer-term maturities, due to the demand by foreign investors, hedge funds, and others and the elimination of tax-exempt refunding bonds in 2017. US$137.9 billion worth of taxable bonds was issued in 2020 and US$101.9 billion was issued between January and November of 2021 (33 percent of all municipal bonds issued during this period), up from US$67.3 billion in 2019 and US$25.1 billion in 2018.30 Pension obligation bonds are issued as taxable bonds since the proceeds are invested in higher-yielding instruments, which is not possible under the arbitrage rules applicable for tax exemption. Refunding Bonds Refunding bonds are bonds issued to refinance outstanding bonds. Advance refunding is when refunded bonds remain outstanding for more than 90 days after the refunding bonds are issued, while a current refunding is when the refunded bonds are redeemed

30   SIFMA (2021, October 4), “US municipal bonds: Issuance, trading volume, outstanding, holders,” https://www.sifma.org/resources/research/us-municipal-bonds-statistics.

The security, structure, and market of municipal debt   ­283 450 400

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Tax Exempt

150

Taxable

100 50

20

18

20

14

16

20

20

12

10

20

20

08

06

20

20

04

20

02

00

20

20

98

20

19

19

96

0

Year

Source:  Securities Industry and Financial Markets Association (SIFMA) (2021), https://www.sifma.org/ resources/research/us-municipal-bonds-statistics.

Figure 15.2  Bonds issued by tax type within 90 days of the issuance of the refunding bonds. Current law eliminates advance refunding bonds, as will be discussed below. Why refinance at all? The most common reason, known as economic refinancing, is to issue new bonds at a lower interest rate than existing debt, using the proceeds to pay off the old high interest rate bonds and reduce interest payments (Wood, 2012). The feature of existing debt that permits refinancing is the embedded “call option” (usually stated as a “ten-year call”) that issuers insert into their new transactions to permit the issuer to call and repay bondholders holding older than ten-year maturities. Using the proceeds of the new refunding debt to retire existing debt allows issuers to alter the structure of their debt. As a result, they can change their amortization schedule to lower annual principal and interest payments in the near term, thereby gaining short-term budgetary relief and operating budget flexibility (Luby, 2012). A few governments used the “scoop and toss” refinancing maneuver that results in lower current debt service obligations (and sometimes even new upfront cash) by tossing the repayment burden to future generations of payers (Luby, 2014; The Volcker Alliance, 2017). In fact, after the Great Recession, there was a spike in the number of refunding bonds issued (Figure 15.3).31 According to the GFOA, between 2007 and 2017, there were over 12,000 tax-exempt advance refunding issuances, which generated over US$18 billion in savings for tax and ratepayers.32 Another reason for issuing refunding bonds is to modify restrictive bond covenants

 Ibid.   See GFOA (2020), “Frequently asked questions: Advance refunding of municipal bonds,” https://www.nasact.org/files/News_and_Publications/White_Papers_Reports/2020_11_Advance_ Refunding_of_Municipal_Bonds.pdf. 31 32

284  Research handbook on city and municipal finance 0.9 0.8 0.7

Shares per Year

0.6 0.5 New Capital

0.4

Refunding

0.3 0.2 0.1

20

18

20

14

16

20

20

12

10

20

20

08

06

20

20

04

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02

00

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20

98

20

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Source:  Securities Industry and Financial Markets Association (SIFMA) (2021), https://www.sifma.org/ resources/research/us-municipal-bonds-statistics.

Figure 15.3  New capital vs refunding bonds associated with a revenue bond program; however, bonds issued for this purpose are less frequent (Ang et al., 2017; Hildreth 1996; Moldogaziev & Luby, 2012).33 Practitioners and scholars alike debate the cost savings associated with advanced refundings. Typically, these transactions lead to interest cost savings; however, after considering the value of the call option forfeited in the advanced refunding transaction, scholars have found that advanced refundings do not always lead to savings. Ang et al. (2017) estimate that nearly 85 percent of all advance refunding transactions between 1995 and 2013 resulted in a loss of value for the municipality. Dzigbede (2017) finds that the average option value loss on average exceeded savings by 3.28 percent of the face amount of the refunded bonds examined. Despite the mixed evidence regarding cost savings, taxexempt advance refundings were a common practice in the municipal market.34 Federal law provides no limitation to the number of times a municipal bond issuance can be refunded on a current basis, but the Tax Cut and Jobs Act of 2017 eliminated advance refundings for tax-exempt (but not taxable) bonds.35 This restriction is mainly due to the federal government’s concern related to providing multiple subsidies to tax-exempt bond issues financing a project. This left issuers without their staple way of achieving interest rate savings. To take advantage of the low interest rate environment, issuers used taxable bonds to advance refund their existing bonds even though the savings 33   See GFOA (2023), “Best practices: Refunding municipal bonds,” https://www.gfoa.org/ materials/refunding-municipal-bonds. 34  Ibid. 35   See California State Treasurer (n.d.), “Restructuring debt service,” https://www.treasurer. ca.gov/cdiac/debtpubs/primer/chapter7a.pdf.

The security, structure, and market of municipal debt   ­285

may not be as high as that associated with tax-exempt refunding. This was one of the reasons for the spike in taxable bond issuance after 2018 (see Figure 15.2). Kalotay (2021) finds that the issuance of taxable advance refunding bonds leads to a US$15 billion loss to municipal issuers as taxable bonds extract only 70 percent of the option value, while the federal government benefits from the decline in implied federal subsidy due to the reduction in tax-exempt bonds.36 To substitute for the tax-exempt advanced refunding, various other alternatives have been proposed. Sobel and League (2020) provide a survey of alternatives that include forward delivery refundings, rate locks, Cinderella Bonds, and synthetic selling of call rights.37 With each alternative structure it is important for any local government to weigh the savings that are achievable in the current low-interestrate environment against the potential savings that may be achievable as the call date approaches. Alternative Structures Debt issuers search for the lowest cost of capital given their ability and willingness to pay. This financial imperative continues to lead public officials into debt structures other than traditional fixed-rate GO bonds. Sometimes this is to avoid legal limits on long-term obligations. Interest reset instruments such as auction rate securities and variable rate debt obligations repackage long-term debt as short-term securities (Marlowe, 2011; Singla, 2018; Singla & Luby, 2020; Vetter & Hlavin, 2020). Variable rate securities have interest rates that fluctuate in response to market movements, while auction rate securities have interest rates that are periodically set through auctions. Both types of instruments were undermined by the Great Recession, as Figure 15.4 shows.38 Auction rate securities lost their value due to the demise of bond insurance (Cole, 2010; Municipal Securities Rulemaking Board [MSRB], 2010). Many big banks that offered letters of credit that backed variable rate deals were downgraded. Issuers are also turning to alternative structures such as green, sustainability, and social bonds to access a broader range of investors (Webster, 2021). Moody’s assigned its first US municipal green bond assessment (labeled “GB1,” its highest) in 2016 to a regional water system revenue bond for achieving “positive environmental outcomes” (Hume, 2016, n.p.). ESG issuances for 2021 through mid-August (including only deals over US$100 million) are US$11.5 billion, and of that US$5.51 billion are social bonds. This segment of the market is expected to grow due to market demand. Bank loans emerged as a viable borrowing method, motivated, in part, by such instruments not being considered “securities” and thus not directly regulated by the US Securities and Exchange Commission (SEC) (Bergstresser & Orr, 2014; Johnston et al., 2015). Private placements increased as well, with evidence of economic advantage given certain ­conditions 36   See GFOA (2023), “Best practices: Refunding municipal bonds,” https://www.gfoa.org/ materials/refunding-municipal-bonds. 37   For definitions, see Sobel and League (2020), Update on tax-exempt advance refunding alternatives [Webinar], Orrick.com, https://media.orrick.com/Media%20Library/public/files/insights/ bond-buyer-webinar-update-on-advance-refunding-alternatives.pdf. 38   SIFMA (2021, October 4), “US municipal bonds: Issuance, trading volume, outstanding, holders,” https://www.sifma.org/resources/research/us-municipal-bonds-statistics.

286  Research handbook on city and municipal finance 500 450 400 Billions of Dollars

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Auction Rate

200 150

Fixed Rate

100 50 0 2020

2018

2016

2014

2012

2010

2008

2006

2004

2002

2000

1998

1996

Variable Rate Long

Year

Source:  Securities Industry and Financial Markets Association (SIFMA) (2021), https://www.sifma.org/ resources/research/us-municipal-bonds-statistics.

Figure 15.4  Bonds issued by coupon type (Moldogaziev et al., 2019). Public–private partnerships fostered the development of needed public buildings and transportation projects by incorporating private equity into the financing mix (Murphy & Howard, 2007; Woodruff, 2012). However, there is limited market disclosure on the use of municipal bond issuers’ private debt (Ivanov et al., 2022).

MARKET After state and local governments structure their instruments with the appropriate repayment guarantees, they seek to sell the debt instruments to willing purchasers. Issuers seldom sell debt directly to investors.39 Instead, debt issuers must access the regulated capital market. In America, the SEC is empowered by Congress to ensure a fair and efficient market. Congress further established the Municipal Securities Rulemaking Board (MSRB) as the principal regulator of this specialized market. Issuers sell the entire issue amount to one or more SEC-registered securities underwriters (i.e., a broker-dealer) through a bond purchase agreement. Underwriter reputation matters in securing a lower borrowing cost (Butler, 2008; Daniels & Vijayakumar, 2007; Luby & Moldogaziev, 2013; Moldogaziev & Luby, 2016). In selling their securities to underwriters, issuers use either a competitive auction or negotiation. Despite a preponderance of evidence suggesting that issues gain a lower borrowing cost through a competitive sale (such as Guzman & Moldogaziev, 2012), 39   A few, such as the City of Denver, Colorado, do use, in part, a direct sale method, termed a mini-bond program (Ely & Martell, 2016) at a higher cost of capital while seeking policy goals that are harder to value.

The security, structure, and market of municipal debt   ­287

negotiated sales constitute a larger share of the market. Part of the reason is because revenue bonds are usually sold by negotiated sale, and revenue bond volume exceeds GO bond volume. Even GO bonds are too often sold through negotiation (Robbins & Simonsen, 2007, 2008). In the actual debt transaction, the purchasing underwriter (or syndicate), as a financial intermediary, transfers its money to the debt issuer in return for the evidence of the issuer’s repayment obligation (i.e., the debt instrument). Once the sale is consummated with the issuer getting cash from the underwriter (syndicate), the issuer has no economic interest in whether the underwriter can resell the debt instruments, although that is the underwriter’s intent. Actually, the underwriter only sells the beneficial interest of the debt instruments to the ultimate investor(s) because the legal title rests in the name of the securities depository.40 Underwriters have little interest in keeping the purchased debt on their books. However, underwriters get a risk premium, referred to as the “underwriting fee,” as compensation for buying the debt that they might not be able to resell (Johnson et al., 2014; Raineri et al., 2012). After the financial guarantee firms collapsed at the start of the Great Recession, state and local governments found it hard to issue debt as market liquidity froze (Martell & Kravchuk, 2012). Moreover, the loss of bond insurance undermined the auction rate securities market and, by extension, the financing of Jefferson County, Alabama, which then had to file for bankruptcy protection. Questions emerged about that county’s financings and its financial advisors as not sufficiently independent of particular underwriters. In 2009, leading members of both political parties concluded that the municipal market needed more attention. For example, the minority leader of the House Committee on Financial Services, Spencer Bachus, Republican representative of Alabama, stated: “I want to give the SEC real authority to oversee the municipal securities market (because) it presents itself to the public as safe, stable, and secure for all investors. It should welcome more sunlight, consistency, and thorough disclosures that apply across the asset classes and commonsense modernization.”41 Recognizing the imperative, the SEC pronounced rule changes in 2010 that enhanced the primary and continuing disclosure expectations for issues to agree to before regulated entities (the broker/dealers) could buy the bonds (Walter, 2012).42 This effectively imposed a contractual obligation on issuers instead of a direct requirement imposed on state and local government by a federal regulator, which by law the SEC could not do anyway since it is prohibited from commanding the timing and content of municipal disclosures. In addition, Congress passed the DFA of 2010, which empowered the SEC and the MSRB to regulate “municipal advisors” (the new legal name for the “financial advisors” to debt issuers). Importantly, the law imposed on municipal advisors a fiduciary duty to their clients. The thrust of the legislation was to ensure that subnational governments   In the case of municipal securities, it is the Depository Trust Company’s nominee Cede & Co.  In Legislative proposals to improve the efficiency and oversight of municipal finance: Hearing before the Committee on Financial Services, U.S. House of Representatives, 111th Congress, first session, May 21, 2009, Serial No. 111-37, p. 4, https://www.congress.gov/111/chrg/CHRG111hhrg51596/CHRG-111hhrg51596.pdf. 42   Also see SEC (2010), Amendment to municipal securities disclosure, https://www.sec.gov/ rules/final/2010/34-62184a.pdf. 40 41

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received “independent” advice on their financial activities and that any conflicts of interest were fully disclosed and navigated (Gaffney et al., 2016; Johnson, 2013; Luby & Hildreth, 2014; Moldogaziev & Luby, 2016). Those rules specified new registration, compliance, and education responsibilities for municipal advisors. As a result, there was a decline in registrations. Most of the decline was in the number of small firms (Bergstresser & Luby, 2018). In December 2021, the MSRB reported that there were 474 municipal advisor firms with a required municipal advisor principal, a prerequisite for any firm in the municipal advisor business.43 Examining the implication for municipal borrowers, Ivonchyk (2019) finds that the DFA had a significantly negative impact on borrowing costs. These effects were larger for negotiated sales where there were more advisory activities. Daniels et al. (2018) find similar results, showing that the borrowing costs after the passage of the DFA were lower. Moreover, issues that used high-quality financial advisors are significantly lower than those that did not. The authors also find that the regulatory framework established through the DFA enhanced the liquidity faced by issuers. Garrett (2021) compares issuances with “dual” advisors – advisors who also offer underwriting services – with bonds issued with advice from an independent advisor. He finds that removal of dual advisor– underwriter decreases municipal borrowing costs by decreasing asymmetric information and increasing competition among underwriters. Although the DFA intended to ensure independent and high-quality financial advice, it mainly prevented “related-party transactions.” An example of such a transaction is where the municipal advisor hired by a municipality is directly associated with the underwriter on the same transaction. An exception to this restriction is if the state and local government has an “independent registered municipal advisor” (IRMA) that the government can rely upon to assess the advice provided by underwriters. However, there exist natural entanglements since municipal advisors and underwriters belong to a common industry, which could affect the quality of advice provided to the municipality. Moldogaziev and Luby (2016) find that the higher levels of relationship intensity between municipal advisors and underwriters compromise independence, which in turn increases borrowing costs.44 Interestingly, the DFA directed the Government Accountability Office (GAO) to undertake a study of the municipal market and to examine disclosure alternatives.45 In addition, the SEC held field hearings (2010–11) before issuing its 2012 report on the municipal market.46 The SEC report, in part, called for legislative changes to give it 43   See December 16, 2021 press release, “MSRB announces results of Series 54 examination for municipal advisor principals,” https://www.msrb.org/Press-Releases/MSRB-Announces-ResultsSer​ies-54-Examination-Municipal-Advisor-Principals. 44   As first defined by Miller (1993), this focus on the debt management network – for example, the underwriters, municipal advisor, and bond counsel – is a promising avenue for research in the primary market (Marlowe, 2013; Winecoff, 2022), as is a focus on the network of dealers in the secondary market (Li & Schürhoff, 2019). 45   GAO (2012, January), Municipal securities: Overview of market structure, pricing, and regulation, https://www.gao.gov/assets/gao-12-265.pdf; GAO (2012, July), Municipal securities: Options for improving continuing disclosure, https://www.gao.gov/assets/gao-12-698.pdf. 46   See SEC (2012, July 31), Report on the municipal securities market, https://www.sec.gov/news/ studies/2012/munireport073112.pdf.

The security, structure, and market of municipal debt   ­289

authority to require municipal issuers to prepare and disseminate official statements and disclosure during the outstanding term of the securities, establish the form and content of financial statements, provide a safe harbor for forward-looking statements (i.e., interim reports and forecasts), and other changes regarding disclosure. As of now, none of those legislative changes have occurred. Existing authority has led to several efforts to enhance pre- and post-trade price transparency. Failures to provide the market with material information led to several notable SEC enforcement actions. The first political jurisdiction charged by the SEC with securities fraud for misrepresenting and failing to disclose material information (on the unfunded liabilities of its pension plans) was the State of New Jersey in August 2010 (Clark et al., 2012).47 Building on these public pension liability credit issues, on September 28, a stock market analyst with no municipal background issued a report on the top 15 state government credits with this provocative opening: “We believe the fiscal challenges facing states could be the next systemic risk within the US financial markets” (Whitney, 2010, p. 2). Highlighting the alarm, that analyst asserted that a federal bailout was not out of the question. Then, a month later, the TV show 60 Minutes gave wider credence to that analyst’s views, resulting in a temporary negative shock to the municipal market as “headline risk” became a market concern (Bloomberg, 2014; Burger et al., 2012; Cohen et al., 2017).48 Public pension liabilities continued to garner negative credit attention until the stock market runup in recent years reduced the unfunded liabilities.49 In other enforcement actions, in 2013, the SEC charged the City of Miami and its former budget director with municipal bond offering fraud.50 The trial verdict upheld the charges, which was “the first federal jury trial by the SEC against a municipality or one of its officers for violations of the federal securities laws.”51 State and local finance officials are now on notice that they can be held personally liable for misrepresenting finances (by omission or commission). Due to their contract with bond underwriters, issuers must submit their initial offering document (the “Official Statement” or OS) and subsequent continuing and event disclosures, since July 1, 2009, to the MSRB and its Electronic Municipal Market Access (EMMA) website. For the 15 previous years, those documents were sent to the “black hole”52 of multiple Nationally Recognized Municipal Securities Information Repository (NRMSIR). EMMA gives free public access to municipal securities documents and data, including credit ratings, trading history, yield curves, and a calendar of upcoming offerings. EMMA highlights the evolution of the MSRB since it was created by Congress in 47   See SEC (2010, August 18), “SEC charges state of New Jersey for fraudulent municipal bond offerings,” https://www.sec.gov/news/press/2010/2010-152.htm. 48   But see the working paper from Gospodinov et al. (2014) showing no systemic (or contagion) effect from the Detroit and Puerto Rico bankruptcies. 49   See Aubry and Crawford (2017); Benson and Marks (2016); Burson et al. (2014); Cohen et al. (2017); Hallman and Khurana (2015); Klingler and Sundaresan (2019); Martell et al. (2013); Novy-Marx and Rauh (2009, 2011); Wang and Peng (2018). 50   See SEC (2013, July 19), “SEC charges city of Miami and former budget director with municipal bond offering fraud,” https://www.sec.gov/news/press-release/2013-130. 51   See SEC (2016, September 14), “Statement on jury’s verdict in trial of the city of Miami and Michael Boudreaux”, https://www.sec.gov/news/statement/ceresney-statement-2016-09-14.html. 52   Watkins in Aikman et al. (2012, p. 20).

290  Research handbook on city and municipal finance

1975 to build on its primary focus as a market regulator to become an information repository critical for market efficiency (Greer et al., 2018; Hildreth et al., 2016; MSRB, 2018). Investors need timely information to make informed trades. The importance of disclosure by issuers increased after the Great Recession due to the decline in trust towards credit rating agencies, whose profoundly wrong ratings on bond insurance had played a decisive role in the Great Recession in the first place. Efforts to improve issuer disclosure practices continue to progress, both by regulatory efforts, voluntary disclosures, and market research (Abbas, 2022; Crawshaw-Lewis et al., 2019; Cuny, 2016, 2018; Robbins & Simonsen, 2010; Sherrill & Yerkes, 2018; Yu et al., 2022). Even though the rating agencies still provide ratings on about 92 percent of municipal bonds, market participants must rely on their own credit analysis rather than rely on a third party (Slavin, 2018). Despite the obligation of regulated entities to ensure that issuers agreed to provide continuing disclosures, the SEC concluded that too many of the required disclosures were missing from EMMA. As a strong incentive for those parties to catch up on their filings, in 2014 the SEC initiated its Municipalities Continuing Disclosure Cooperation Initiative (MCDC Initiative). This regulatory notice offered a safe harbor window, after which enforcement actions would commence, effectively spurring effective remedial action to update disclosures (Deaton et al., 2016; Washburn et al., 2017). In essence, this created a prisoner’s dilemma between underwriters and issuers since both groups were put on regulatory notice to voluntarily come clean, making cooperation the best strategy to correct “material misstatements and omissions in municipal bond offering documents.”53 During the two years the MCDC Initiative was in effect, the SEC entered into 143 stand-alone enforcement actions, thereby sending a strong signal to the market that complying with the contractual disclosure obligations is a serious obligation for issuers and underwriters to complete in a timely manner.54 The COVID-19 pandemic has renewed the emphasis on disclosure especially during an emergency. Questions regarding the adequacy of disclosures and the impact of the pandemic on municipal credits led to recent calls for enhanced emergency event disclosures.55 Investors While state and local governments design and sell their debt instruments, the transaction only works when investors (bondholders) buy these municipal securities. However, trades are made between parties instead of a centralized exchange (like the stock market). Given its decentralized design, the municipal bond market is opaque and dealers have the advantage since they provide the quotes. Compounding this market complexity is the bespoke nature of municipal bonds and the sheer variety of issuers, credit risks, and transaction structures. 53   See SEC Division of Enforcement (2017), Annual report: A look back at fiscal year 2017 (p. 6), https://www.sec.gov/divisions/enforce/enforcement-annual-report-2017.pdf. 54   See SEC Division of Enforcement (2018), Annual report: Division of Enforcement (p. 9), https://www.sec.gov/divisions/enforce/enforcement-annual-report-2018.pdf. 55   National Federation of Municipal Analysts (NFMA) (2021), White paper on guidance & insights regarding emergency event disclosure affecting state & local governments: COVID-19 focus, https://www.nfma.org/assets/documents/position.stmt/WPCovidDraftMarch%202021.pdf.

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Retail investors buy bonds directly through their financial advisors or indirectly through the purchase of shares of municipal bond mutual funds. These mutual funds constitute a significant segment of the outstanding supply of municipal bonds (Bagley et al., 2022) and their elasticity of demand matters (Azarmsa, 2022). When state and local governments faced short-term liquidity issues in dealing with the COVID pandemic, Congress and the Federal Reserve authorized emergency lending facilities to deal with outflows from mutual funds and the borrowing needs of municipal issuers (Johnson et al., 2021). As an over-the-counter market, the municipal bond market is weak in terms of price discovery and liquidity (Green et al., 2007, 2010; Harris & Piwowar, 2006). Smaller retail investors are especially disadvantaged. Customers for new bonds often have to pay a premium over the stated reoffering price. However, centralized trade reporting and the MSRB public website (EMMA) have reduced these markups. These and other steps have made the municipal market more transparent, thereby helping to reduce transaction costs to investors, which reflects market liquidity and volatility (Schultz, 2012; Wu & Ostroy, 2021; Wu & Vieira, 2019). Still, investors wanting to trade bonds can face a liquidity issue and a lack of timely information on market prices and material disclosures about the credit (Bessembinder et al., 2020). Trading costs are higher for retail-size trades and for bonds of smaller par values (less than US$10,000), from issuers with lower credit quality, and transactions with complex structures (Harris & Piwowar, 2006). Research has revealed the extent of market power available to market dealers as well as the impediments of debt structures. One solution touted to lower borrowing for state and local governments is through CommonMuni, a potential collective effort among issuers to standardize the debt structure and the information transparency necessary for an efficient market to function (Ang & Green, 2013; Smith, 2013). Should issuers be concerned about how their debt is traded in the secondary market? After reviewing the evidence (Johnson et al., 2014, p. 121) state the “economic rationale” this way: “The OTC [over-the-counter] market structure and the resulting prices are associated with true interest costs, competition among underwriters for municipal bonds, and an overall efficiency in the allocation of capital resources.”

DISCUSSION: RESEARCH AND POLICY OPPORTUNITIES Municipal securities provide state and local governments with a means for obtaining capital market financing. To achieve this goal, issuers must present a debt instrument with sufficient security to attract buyers while meeting public market expectations. The policies and practices of debt issuance and management have evolved to meet real challenges over the past 15 years, many of which were propelled by the Great Recession and the COVID-19 pandemic. Academic research has moved in step with these developments and has pulled back the curtain on this huge market through its significant findings. In recent years, research on the municipal securities market has advanced by two significant steps. First, in 2006, the MSRB started providing its trade data to academic institutions through Wharton Research Data Services (WRDS). These data are now available to scholars from a wide variety of disciplines on the same research platform where they

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obtain equity and other fixed income datasets. As a result, the array of interesting questions that can be addressed with primary and secondary market data continues to blossom. Second, research gatherings are proliferating. The Association for Budgeting & Financial Management (ABFM) has a long history of annual meetings for issuer-focused debt research, but new opportunities have emerged. The Brandeis Municipal Finance Conference, started in 2012 and now continuing with the support of the Brookings Institution, annually brings together scholars and market leaders to discuss cutting-edge research. Working paper sessions organized by several university consortiums provide additional settings for research presentations (e.g., Indiana University–Georgia State University, and Notre Dame–University of Pennsylvania). The aim of this chapter is to trace the recent developments in the security, structure and market for municipal securities while highlighting the research that has examined these developments. A topic that has continually received attention over the years is that of credit risk of issuers where at different points in time, various aspects of credit risk have attracted the attention of the municipal bond market. With the fall of credit rating agencies during the Great Recession, institutional investors in the post-Recession era are no longer willing to defer to the assessments by credit rating firms. Instead, they are making their own judgments, thereby increasing the importance of disclosure by issuers. Furthermore, GO bonds have lost their invincible image, as the City of Detroit’s bankruptcy filing showed the fallacy of assuming that all GO bonds were the most secure instruments. In recent times, there is an expanded view of the factors that could affect the security of these instruments. This includes ESG risks – environment, social, and governance – that are now influencing institutional investors. Until now, academic research has focused largely on governance factors such as organizational structure, legal requirements, and financial and budget management practices. Research has only recently started examining the environmental and social risks and therefore has not caught up with these developments. Issuers have learned that they can attract different investors by structuring debt instruments to meet market demand. For example, investor concerns about ESG risks, especially physical environment risks, have led to a vibrant interest in green bonds, although still a small market segment. State and local governments flocked to the taxable bond option when Build America Bonds were allowed. The BABs experiment opened a robust research agenda while providing debt officials with positive evidence that a taxable bond option could work, if only the federal appropriation cutback (due to sequestration) could be avoided in the future. While the BABs experiment showed the positive aspect of a change, two market practices were effectively closed during this period. Bond insurance firms overextended their business model and now enjoy only a sliver of the market penetration they enjoyed before the Great Recession. By Congress eliminating the issuer’s option for advance refunding of tax-exempt bonds, another major segment of the market was closed. Noteworthy, too, is that the prominent research agendas built around these two topics have dissipated as well. Congress may also revisit the municipal market with tax exemption and the Tower Amendment (which restricts the SEC from directly regulating state and local governments as debt issuers) at risk. Given the loss of federal revenue through continuation of the tax-exempt interest along with the potential for federal fiscal sustainability to become

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a more potent election issue, there is a risk that Congress may revisit tax exemption for municipal securities. Therefore, the question is whether federal fiscal sustainability will supersede a core element of our current state of fiscal federalism. Financial disclosure by subnational governments is a topic that gained steam during and post the Great Recession and is now experiencing renewed attention after the COVID-19 pandemic. Municipal securities’ disclosure regimes are tightening due to market expectations and regulatory demands. Primary and secondary market disclosure practices demand vigilant attention by elected and appointed officials. The risk of failure is now one of personal liability. There is every reason to expect continuation of a fulsome enforcement environment. For issuers, manifested in the actions of elected officials and finance managers, to move the disclosure equilibrium forward, enhanced disclosure must create value for the issuer. There is emerging empirical support for effective disclosures. What is needed is a strong indicator that elected office (and a finance career) is advanced by promoting enhanced disclosure. Tight budgets may not support the extra costs of stronger disclosure regimes. Ultimately, voters must reward enhanced market disclosure policies and practices to move the needle significantly toward change. The municipal securities market has produced the current publicly built environment enjoyed by residents. That is not to say that municipal bond financing and market participants have met the best standards over time. Evidence indicates that municipal bonds have served to disproportionately reward the wealthy through tax-exempt interest (Galper, Rosenberg et al., 2014; Galper, Rueben et al., 2014), foster segregated neighborhoods (Caro, 1974; Jenkins, 2021; Yinger, 2010), penalize predominantly minority universities (Dougal et al., 2019), perpetuate racial disparities (Jenkins, 2021; Norris, 2021) and even worse.56 The capital market has provided subnational governments with the ability to finance their long-term infrastructure projects. This market is continually adjusting to the demands placed on it by its participants as well as the economic environment that surrounds it. The evolution of the market over the years has led to increased knowledge about what makes the market more efficient, allowing reconsideration of sources of inefficiencies. Issuers and investors will need to keep up with these changes to ensure the best possible outcomes for each, access to the market at the lowest cost for the former, and the return on (and return of) their investment for the latter.

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Maher, C. S., Deller, S. C., Stallmann, J. I., & Park, S. (2016). The impact of tax and expenditure  limits on municipal credit ratings. The American Review of Public Administration, 46(5), 592–613. Marlowe, J. (2006). Volume, liquidity, and investor risk perception in the secondary market: Lessons from Katrina, Rita, and Wilma. Municipal Finance Journal, 27(2), 1–37. Marlowe, J. (2011). Municipal credit default swaps: Implications for issuers. Municipal Finance Journal, 32(2), 1–28. Marlowe, J. (2013). Structure and performance in municipal debt management networks. https:// papers.ssrn.com/sol3/papers.cfm?abstract_id=2254756. Martell, C. R., Kioko, S. N., & Moldogaziev, T. (2013). Impact of unfunded pension obligations on credit quality of state governments. Public Budgeting & Finance, 33(3), 24–54. Martell, C. R., & Kravchuk, R. S. (2012). The liquidity crisis: The 2007–2009 market impacts on municipal securities. Public Administration Review, 72(5), 668–677. Mead, D. M., Wagner, M. V., & Boyd, D. J. (2015). Staying afloat in a sea of pension numbers. Municipal Finance Journal, 35(4), 1–27. Mier, C. (2017). Public pensions: Complex systems still in flux. Municipal Finance Journal, 38(1), 27–55. Miller, B., Pallasch, B., & Knopman, D. (2020). What infrastructure crisis? Municipal Finance Journal, 40(4), 53–72. Miller, G. J. (1993). Debt management networks. Public Administration Review, 53(1), 50–58. Miller, G. J., & Hildreth, W. B. (2007). Local debt management. In A. Shah (Ed.), Local public financial management (pp. 109–155). The World Bank. Moldogaziev, T. T., Greer, R. A., & Lee, J. (2019). Private placements and the cost of borrowing in the municipal debt market. Public Budgeting & Finance, 39(3), 44–74. Moldogaziev, T. T., Kioko, S. N., & Hildreth, W. B. (2017). Impact of bankruptcy eligibility requirements and statutory liens on borrowing costs. Public Budgeting & Finance, 37(4), 47–73. Moldogaziev, T. T., & Luby, M. J. (2012). State and local government bond refinancing and the factors associated with the refunding decision. Public Finance Review, 40(5), 614–642. Moldogaziev, T. T., & Luby, M. J. (2016). Too close for comfort: Does the intensity of municipal advisor and underwriter relationship impact borrowing costs? Public Budgeting & Finance, 36(3), 69–93. Molin, T., Bovino, B. A., Ricchiuto, S., & Vitner, M. (2018). 21st century demographic trends: Potential impacts on municipal credit. Municipal Finance Journal, 39(1), 13–38. Morris, A. C., Kaufman, N., & Doshi, S. (2019). The risk of fiscal collapse in coal-reliant communities. Brookings Institution. https://www.brookings.edu/wp-content/uploads/2019/07/RiskofFisca lCollapseinCoalReliantCommunities-CGEP_Report_080619.pdf. Municipal Securities Rulemaking Board (MSRB) (2010). Municipal auction rate securities and variable rate demand obligations: Interest rate and trading trends. MSRB. Municipal Securities Rulemaking Board (MSRB) (2018). Milestones in municipal market transparency: The evolution of EMMA. MSRB. Murphy, D. P., & Howard, B. (2007). Public–private leasing arrangements and tax incentives: Creative alternatives to traditional financing of school construction. Municipal Finance Journal, 28(1), 1–18. Norris, D. (2021). Embedding racism: City government credit ratings and the institutionalization of race in markets. Social Problems, Article spab066. https://doi.org/10.1093/socpro/spab066. Novy-Marx, R., & Rauh, J. D. (2009). The liabilities and risks of state-sponsored pension plans. Journal of Economic Perspectives, 23(4), 191–210. Novy-Marx, R., & Rauh, J. (2011). Public pension promises: How big are they and what are they worth? The Journal of Finance, 66(4), 1211–1249. Painter, M. (2020). An inconvenient cost: The effects of climate change on municipal bonds. Journal of Financial Economics, 135(2), 468–482. Poterba, J. M., & Rueben, K. S. (1999). Fiscal rules and state borrowing costs: Evidence from California and other states. Public Policy Institute of California. Raineri, L., Robbins, M., Simonsen, B., & Weaver, K. (2012). Underwriting, brokerage, and risk in municipal bond sales. Municipal Finance Journal, 33(2), 87–103.

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Riegel, K. A. (2021). Solving the muni puzzle: Who benefits from tax exemption of government debt? Public Finance Review, 49(1), 71–105. Robbins, M. D., & Simonsen, B. (2007). Competition and selection in municipal bond sales: Evidence from Missouri. Public Budgeting and Finance, 27(2), 88–103. Robbins, M. D., & Simonsen, B. (2008). Persistent underwriter use and the cost of borrowing. Municipal Finance Journal, 28(4), 1–14. Robbins, M. D., & Simonsen, B. (2010). Build America Bonds. Municipal Finance Journal, 30(4), 53–77. Romm, T. (2022, July 5). Republican states are trying to use federal covid aid to cut taxes. The Washington Post. Schultz, P. (2012). Municipal bonds: One market or fifty. University of Miami. Sherrill, D. E., & Yerkes, R. T. (2018). Municipal disclosure timeliness and the cost of debt. Financial Review, 53(1), 51–86. Shin, A., DiSalvo, D., & Anzia. F. (2020). Paradigm shift of municipal credit analysis. Municipal Finance Journal, 41(1), 73–108. Singla, A. (2018). The rise and fall of the municipal swaps and derivatives market. Municipal Finance Journal, 39(3), 33–59. Singla, A., & Luby, M. J. (2020). Financial engineering by city governments: Factors associated with the use of debt-related derivatives. Urban Affairs Review, 56(3), 857–887. Slavin, R. (2018, October 23). 10 years later: Less-trusted rating agencies maintain their central role. The Bond Buyer. https://www.bondbuyer.com/news/rating-agencies-lost-trust-after-global-finan​ cial-crisis. Smith, W. (2013). Discussion of “Lowering borrowing costs for states and municipalities through CommonMuni” by Andrew Ang and Richard C. Green. Municipal Finance Journal, 34(3), 95–99. Sobel, L., & League, B. J. (2020). Update on tax-exempt advanced refunding alternatives. Orrick.com. https://media.orrick.com/Media%20Library/public/files/insights/bond-buyer-webinar-update-on-​ advance-refunding-alternatives.pdf. Stallmann, J. I., Deller, S., Amiel, L., & Maher, C. (2012). Tax and expenditure limitations and state credit ratings. Public Finance Review, 40(5), 643–669. Stowe, S., Gillaspy, T., Tosun, M., & Rhondes, S. (2012). Aging and its impact on municipal credit. Municipal Finance Journal, 33(3), 33–55. Su, M. (2021). Introduction to the special issue: The impact of COVID-19 on big cities’ budgets. Municipal Finance Journal, 42(1), 1–4. Su, M., & Hildreth, W. B. (2018). Does financial slack reduce municipal short-term borrowing? Public Budgeting & Finance, 38(1), 95–113. The Pew Charitable Trusts. (2013). The state role in local government financial distress. The Pew Charitable Trusts. The Pew Charitable Trusts. (2016). How states can assess the affordability of their debt: Regular and consistent studies can provide clear evidence – a fact sheet. The Pew Charitable Trusts. The Pew Charitable Trusts. (2017, June 4). Strategies for managing state debt: Affordability studies can help states decide how much to borrow. The Pew Charitable Trusts. The Volcker Alliance. (2017). Truth and integrity in state budgeting: What is the reality? The Volcker Alliance. Vetter, J., & Hlavin, S. M. (2020). TOB [tender option bonds]: More than meets the eye. Municipal Finance Journal, 41(1), 109–136. Wallace, S. (2012). The evolving financial architecture of state and local governments. In R. D. Ebel & J. E. Petersen (Eds.), The Oxford handbook of state and local government finance (pp. 156–175). Oxford University Press. Walter, E. B. (2012). The SEC and the municipal securities market. Municipal Finance Journal, 32(4), 1–6. Wang, Q., & Peng, J. (2018). Political embeddedness of public pension governance: An event history analysis of discount rate changes. Public Administration Review, 78(5), 785–794. Wang, W., & Wu, Y. (2018). Why are we lagging behind? An empirical analysis of municipal capital spending in the United States. Public Budgeting & Finance, 38(3), 76–91.

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Washburn, L., Kane, J., Decker, M., McLaughlin, R., Daly, B., & Watkins, J. B. (2017). Industry roundtable. Municipal Finance Journal, 37(4), 39–56. Webster, K. (2021, October 5). Green bond deal is set for schools in San Diego. The Bond Buyer. Weiner, J. (2013a). Assessing the affordability of state debt. Federal Reserve Bank of Boston. Weiner, J. (2013b). A guide to state debt affordability studies: Common elements and best practices. Federal Reserve Bank of Boston. Weitzman, A. (2021, June 3). Bond insurance uptick driven by COVID concerns, taxable growth. The Bond Buyer. https://www.bondbuyer.com/news/bond-insurance-uptick-driven-by-covideffects-taxable-growth. Whitney, M. (2010). Tragedy of the commons: Launching ratings on the top 15 states. Meredith Whitney Advisory Group LLC. Winecoff, R. (2022). Do intermediary networks help reduce government borrowing costs? Evidence from nationwide data. Indiana University. Wood, W. H. (2012). Municipal bond refundings. In S. G. Feldstein & F. J. Fabozzi (Eds.), The handbook of Municipal Bonds (pp. 235–246). Wiley. Woodruff, T. (2012). Indiana toll road lease learns from history, protects future generations. Public Administration Review, 72(6), 864–865. Wu, S. Z., & Ostroy, N. J. (2021). Transaction costs during the COVID-19 crisis: A comparison between municipal securities and corporate bond markets. MSRB. Wu, S. Z., & Vieira, M. (2019). Mark-up disclosure and trading in the municipal bond market. MSRB. Yang, L. (2019). Not all state authorizations for municipal bankruptcy are equal: Impact on state borrowing costs. National Tax Journal, 72(2), 435–464. Yinger, J. (2010). Municipal bond ratings and citizens’ rights. American Law and Economics Review, 12(1), 1–38. Yu, J., Chen, X., & Robbins, M. D. (2022). Market responses to voter-approved debt. National Tax Journal, 75(1), 93–119.

16. The status of municipal financial intermediaries after the financial crisis and Dodd-Frank: underwriters, insurers, advisors, and credit rating agencies Martin J. Luby and Joshua E. Terkel

INTRODUCTION Through the process of financial intermediation, underwriters, bond insurers, municipal advisors, and credit rating agencies serve a critical function in the raising of capital for state and local governments in the United States. At its most basic level, financial intermediation is the process by which one group transfers its excess financial resources to another group in need of additional resources. Essentially, financial intermediaries serve as “middlemen” between entities with slack financial resources (i.e., investors with resources freely available to take up opportunities), and those in need of financial resources (i.e., issuers of securities). In the context of the municipal market, investors, through the assistance of the broader Wall Street financial services community, represent the groups with slack financial resources, and state and local government units include the groups in need of capital resources. This chapter takes a broad view of financial intermediaries and discusses the role of the primary actors that provide financial services that enable the intermediation process. Financial intermediation is important in all capital markets but especially the decentralized, over-the-counter municipal market. The heterogeneity of the market in terms of types of issuers, issue structures, tax status, creditworthiness, project types, repayment pledges, and legal structures necessitates a robust and quality network of financing participants. These differences naturally lead to the possibility of significant information asymmetries between the issuers and buyers of these securities. These intermediaries play an important part in reducing this information poverty for the purpose of enhancing the overall efficiency and functioning of the municipal market. From the perspective of state and local governments and investors, reducing information asymmetry can benefit each party by revealing the true risk of the security offering. This chapter focuses on research advancements post the 2007/2008 financial crisis and the subsequent passage of the seminal 2010 Dodd-Frank Financial Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) that shed new light on the roles, regulation, and efficacy of financial intermediaries such as underwriters, insurers, advisors, and credit rating agencies in the municipal securities market.1 The chapter begins by detailing the 1   The chapter does not include a discussion of municipal bond attorneys. Bond attorneys play an important role in the sale of municipal securities related to establishing the legality and structure of the debt instruments and these securities’ tax-exempt status (Hildreth, 1993). However, because

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specific roles and responsibilities of these four financial intermediaries in the municipal market including impacts on these entities post the 2007/2008 financial crisis. It then proceeds to offer a short discussion on arguments for the existence and benefits of financial intermediaries with a theoretical lens. Then, the bulk of the chapter details findings from recent research on municipal financial intermediaries. The chapter concludes with a short synthesis of the recent research in terms of some public financial management implications.

ROLES AND RESPONSIBILITIES OF MUNICIPAL FINANCIAL INTERMEDARIES Municipal market financial intermediaries operate within a larger debt management network that aims to successfully raise capital for state and local governments. The network is complex, with many participants and layers of overlapping principal–agent relationships (Miller, 1993; Simonsen & Hill, 1998). Fundamentally, at the extremes, the top of the network consists of the government issuer in need of capital resources and at the bottom is the investor providing such capital. Underwriters, bond insurers, municipal advisors, and credit rating agencies work within the middle of the network to bridge the resource goals of the government and investor effectively and efficiently. Underwriters are either commercial or investment banks that directly connect the investor with the government entity (West, 1967). In a negotiated offering, the underwriter leads efforts related to the structuring, marketing, pricing, and disclosure activities of the securities offering. One of the primary activities of the underwriter in a negotiated sale is the search and identification of potential investors (Benson, 1979; Leonard, 1998). In a competitive sale, investment banks bid against each other and the bonds are awarded based on an auction at the lowest cost. Underwriters need to deal fairly with the government in bringing municipal securities to market, but they do not possess a fiduciary responsibility to the government whereby they must act in their best interest. Municipal advisors, on the other hand, do have a fiduciary responsibility to the government entities while advising on their municipal securities offerings. This fiduciary responsibility was established as part of the Dodd-Frank Act, which was a response to long-standing concerns of municipal advisors carrying conflicts of interest or not having the requisite financial expertise to advise on capital market financings (Luby & Hildreth, 2014). In terms of specific services, municipal advisors advise on various strategic and tactical aspects of a government’s debt issuance from start to finish. In a competitive sale, municipal advisors often take the lead in managing the offering process and absorb some of the activities that the underwriter does in a negotiated sale related to the structuring of the financing. In a “live” bond sale, they are often used as “pricing advisors” to ensure that the government is getting fair market value in the sale. Bond insurers enhance the credit quality of the municipal securities offering by providing an additional repayment pledge in the event repayment is impaired due to fiscal stress experienced by the government. Credit enhancement can be offered in the form of letters there is very little empirical research on municipal bond attorneys and the fact that the Dodd-Frank Act did not impact municipal bond attorneys in terms of direct regulation, we chose to exclude these financing participants in our discussion.

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of credit on floating rate securities, or through bond insurance on fixed rate financings. By allocating its capital to providing credit enhancement/support, the bond insurers provide a signal of the credit quality of the government’s offering. Credit rating agencies (CRAs) provide an independent third-party assessment of the creditworthiness of a bond issue and bond issuer through the assignment of credit ratings. Credit ratings on enhanced/supported bond issues carry two ratings: the rating considering the insurance or credit support; and the underlying rating of the issuer selling the bonds. The credit rating includes both the government’s ability and willingness to repay the debt and is used by investors and insurers to make a decision related to bond buying or credit enhancing, respectively. The three largest rating agencies in the municipal market are Moody’s, Standard & Poor’s, and Fitch. For various reasons, not all governments decide to seek credit ratings. Common examples include the desire to avoid the cost of obtaining ratings, or deciding to privately place a bond issue with pre-selected investors. Compared to the corporate finance industry, financial intermediaries are unique in the municipal securities market given that they operate in an overtly political environment. For example, as described above, there was widespread concern in the municipal market prior to the financial crisis that municipal advisors were getting hired based on their political connections to government clients or because of blatant pay-for-play schemes rather than their independent financial acumen (Luby & Hildreth, 2014). Others had asserted (and the Securities and Exchange Commission [SEC] had charged) that some municipal advisors engaged in work for government entities while they had conflicts of interest, either intentional or unintentional, and that these conflicts led to suboptimal outcomes in terms of some government debt management practices (Van Voris, 2014). The Dodd-Frank Act and the regulation of municipal advisors were a direct response to these concerns. Financial intermediaries also reside in a government ecosystem in which they must respond to political decisions made by governments both out of their control and perhaps only tangentially related to their financial expertise and the services they offer. For example, in 2002, the City of Chicago required investment banks, insurers, and other financial firms wanting to earn city contracts (including underwriting or insuring city municipal bonds) to disclose their company’s historical ties to slavery. If the firm were not forthright in disclosing their ties, they would be barred from working on bond deals (Miller & Washburn, 2002). More recently, the 2021–22 Texas legislature passed Senate Bill 19, which requires banks and underwriters to support the firearms industry in order to be eligible to participate in state or local government underwritings in Texas (Williamson, 2021). The law requires that firms verify in writing that they have no policy that “discriminates against members of the lawful firearms or ammunitions industry” (ibid., n.p.). These examples help to illustrate the unique political environment municipal financial intermediaries operate within and must respond to. In addition to being impacted by exogenous political forces, all four of the financial intermediaries discussed in this chapter were affected by the financial crisis and the Dodd-Frank Act passed in response. Of these financial intermediaries, the bond insurance industry may have been impacted the most. Prior to the financial crisis, nine firms actively participated in this part of the municipal industry, providing almost half of all municipal bonds with bond insurance (Johnson et al., 2014). However, the value

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proposition of using these firms on municipal bond sales dropped dramatically after issuers’ credit ratings were cut due to their financial exposure to toxic mortgage-backed securities sold before the financial crisis. As such, as of 2012, only two firms remained active in insuring municipal bonds, and only about 5 percent of municipal bond issues were insured (ibid.). With investors’ concerns renewed in the context of COVID-19, this amount has increased to 10 percent, but this is still a significant drop-off from prefinancial crisis levels (Moran, 2020). The Dodd-Frank Act passed in response to the financial crisis directly impacted municipal advisors, underwriters, and the CRAs. As discussed above, the Dodd-Frank Act regulated financial advisors for the first time, and enacted new requirements to enhance advisor quality and competency. These financial advisors, referred to as “municipal advisors” in the legislation, carried a fiduciary responsibility to government issuers. As directed under the regulations promulgated under the Dodd-Frank Act, municipal advisors must act with a duty of care and duty of loyalty to their government clients. They must also register with the SEC and pay annual fees, pass an initial competency exam (Series 50), and regularly engage in continuing education. Principals in these municipal advisory firms must also pass a principal competency exam (Series 54), with additional, significant individual and firm-wide administrative and record-keeping requirements under the regulation. The regulations under Dodd-Frank also created a new role for municipal advisors known as the independent registered municipal advisor (IRMA), which has a direct impact on underwriters – namely, except for responding to requests for proposals or being contractually engaged on a transaction, underwriters could no longer provide financing ideas to governments unless the government specified that it was relying on the advice of an IRMA. The “independent” aspect related to these municipal advisors not having any conflicts of interests with underwriters such as having employees previously employed by the underwriter in the last two years (Moldogaziev & Luby, 2016). The IRMA role was a way for the federal government to mitigate concerns of undue influence of underwriters on the financial decisions of governments. If an underwriter provided a financing idea to a government and the government did not have an IRMA in place, the underwriter would be treated as a municipal advisor and would not be eligible to underwrite the debt for the government. The reputational capital of the CRAs was dealt a significant blow as a result of the financial crisis that was not foreseen by the CRAs, as indicated in their ratings. There has been an ongoing issue with the rating agencies in terms of how they are compensated and how that impacts their ratings. Specifically, there was a concern that the rating agencies were incentivized to inflate ratings prior to Dodd-Frank because they are compensated by issuers who desire higher ratings to reduce their borrowing costs (Stolper, 2009). ­Dodd-Frank enhanced federal oversight of credit ratings in general and required that rating agencies develop, maintain, and enforce policies that (1) assess the probability that an issuer will default or not make timely repayments; (2) clearly define and disclose rating symbols; and (3) apply the rating symbols consistently across securities sectors (Johnson, 2013). The first requirement is related to the municipal market in that it required the rating agencies to objectively and justifiably rate debt that allowed comparisons between issues. The third requirement also directly relates to the municipal securities market and the widespread criticisms the rating agencies received before the financial crisis for

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“underrating” municipal borrowers compared to their corporate peers (ibid.). In 2010, both Fitch and Moody’s Investors Service recalibrated their ratings to address these concerns related to rating consistency.

THEORETICAL BACKGROUND ON FINANCIAL INTERMEDIARIES Over the last several decades, scholars have advanced various theoretical arguments for the existence of financial intermediaries, many of which are based on two primary factors: transaction costs and information asymmetries. Gurley and Shaw (1960) argued that intermediaries are needed as they reduce the transaction costs in asset evaluation compared to individuals making investment decisions on their own. Benston and Smith (1976) also emphasized the existence of financial intermediaries being related to the reduction of transaction costs, with the role of the financial intermediary to create specialized financial commodities. Diamond (1984) argued that financial intermediaries provide additional ex-post transaction cost advantages through delegated monitoring of the specific terms of loan contracts between lender and borrower. As part of a broader theoretical literature, including the seminal work by Akerlof (1970), Leland and Pyle (1977) extended the justification for financial intermediaries beyond transaction costs. Leland and Pyle argued that a financial intermediary can reduce information asymmetries between buyers and sellers through signaling its “informed status” by investing its own financial resources in the project being financed by investors. These foundational theories have led to a robust academic literature that tests various aspects of these two factors to analyze the justification and efficacy of financial intermediaries. In terms of empirically testing or extending the theories of financial intermediation on the four financial intermediaries discussed in this chapter, there are a few early seminal studies that stand out. Booth and Smith (1986) evaluated whether underwriters could serve to certify the true price of a new securities offering (i.e., whether pricing was consistent with inside information). They found that an underwriter’s reputation serves as a certification mechanism in which more reputable underwriters are associated with security offerings that are more closely priced at their true value. Thakor (1982) proposed that information asymmetry could be relieved through the production of information by thirdparty information producers. Thakor’s model utilized debt insurers as an example of a third-party information producer, and specifically cited AMBAC, a bond insurer active in the municipal securities market. Millon and Thakor (1985) attempted to explain the existence of non-funding ­information-gathering agencies (IGAs), including CRAs, in an environment of asymmetrical information and moral hazard. The firm reveals its true value by employing CRAs whose evaluations are judged by investors ex post facto, thus providing incentive to the rating agencies to produce reliable information. Finally, Forbes et al. (1992) was the first study that empirically evaluated whether financial advisors reduce information asymmetries by providing certification benefits on municipal securities offerings. They found limited support for additional certification benefits related to reoffer yields but did find other transaction benefits to government debt issuers from the use of financial advisors related to borrowing costs and underwriting fees.

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RECENT RESEARCH ON MUNICIPAL MARKET FINANCIAL INTERMEDIARIES The municipal securities market enjoyed increased attention from researchers between the 1970s and the financial crisis of 2007/2008. Much of this research focused on financial intermediaries in the municipal securities market that built on previous research in the corporate finance literature. Some of the topics covered during this time included bond method of sale (negotiated versus competitive), underwriter reputation, underwriter location, underwriter independence, use of municipal advisors, municipal advisor reputation, municipal advisor independence, value of credit ratings, number of credit ratings, and value of bond insurance. Johnson et al. (2014) provide a summary overview of these studies and their research findings with a focus on research prior to the 2007/2008 financial crisis. Although the empirical findings from this body of research were not unanimous, a succinct summary might be the following: (1) the benefit of one bond method of sale over the other is contingent on issuer, issue, and market conditions; (2) underwriter and municipal advisor reputation and location matter in terms of borrowing costs; (3) financial advisor-turned-underwriter arrangements negatively impact governments on their bond sales; (4) the use of municipal advisors (especially independent municipal advisors) provide financing benefits; and (5) credit ratings and bond insurance reduce information asymmetry and provide additional certification to the benefit of governments. This part of the chapter extends this existing body of research by discussing studies on municipal financial intermediaries completed after the financial crisis and passage of the 2010 Dodd-Frank Act. Underwriters Underwriters are the primary intermediary between government issuers and investors. As such, intrinsic aspects of underwriters and the sale mechanisms related to their participation in financial intermediation (e.g., bond method sale) continued to be a focus of municipal securities research after the financial crisis. Guzman and Moldogaziev (2012) analyzed various effects across several industries to guide issuers toward an efficient funding option. The significant findings in this study provide useful data to decisionmakers whose goal is most often to obtain the lowest cost of financing. The study expands on previous literature on underwriters that has largely been restricted to a single industry or risk category, by including both a broad range of bonds by issuing purpose, as well as both high- and low-risk bonds. The authors used a final sample of 3,621 California bonds issued between 2000 and 2007 to test whether debt purpose, debt purpose risk, and method of sale influence the true interest cost (TIC) of bonds. Guzman and Moldogaziev (2012) used debt for public purposes as their base and found that the TIC for purposes including “health care, transportation, higher and K-12 education, as well as the ‘other purposes’ do not appear to be significantly different from the costs of public facilities debt” (p. 93). Conversely, they found that borrowing costs for other uses were significantly different, with debt for development and housing costing 5 and 17 basis points (bps) more, respectively, compared to public purposes, while utilities and environmental services purposes cost 19 and 34 bps less, respectively, than public purposes. The authors further show that riskier bond purposes including housing and development also pay a premium in

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their TIC. Finally, the authors conclude that the bond method of sale is statistically significant, with competitive sales being the more efficient option for financing. Negotiated sales on average cost 21 bps more than competitive sales in the California sample. Luby and Moldogaziev (2013) estimated the factors that influence gross underwriter spreads. Their data included a sample of 8,958 State of Texas municipal bonds issued between 1999 and 2010. The authors empirically tested several hypotheses that seek to explain how financial intermediaries contribute to underwriter fees, in a post-Great Recession environment. The authors found that all else held equal, underwriter spreads are higher (1) with greater financial advisor–underwriter familiarity; (2) for issues without a financial advisor; (3) for issues with underwriters who were formerly financial advisors; and (4) when reputable underwriters are used. They also found that use of a local financial advisor and negotiated method of sale were associated with lower fees. Luby and Moldogaziev note that although the empirical results of their study used a dataset that included only Texas bonds, the results may be generalizable to other geographies because Texas is a market setter in the municipal bond industry. Ivonchyk and Moldogaziev (2019) conducted research to identify important debt structure and timing factors that can lead to optimal efficiency for city and county issuers in competitive auctions. Prior research shows that borrowing costs for issuers tend to decrease as the number of bids increase for competitive sales; therefore, identifying the factors that influence the outcome variable could be instructive to issuer decision-making. The authors used Texas city and county competitive bid auction data between 1999 and 2009. The final dataset included 1,137 deals, and controlled for factors including debt size, call options, and credit quality. The authors found that several factors tend to increase the number of competitive bids. First, larger issues tend to attract significantly more bids than smaller issues – approximately 30 percent more. Second, bank-qualified bonds receive 70  percent more bids compared to non-bank-qualified bonds. Third, federally taxable bonds tend to attract 30 percent more bids than tax-exempt issues. Finally, the safest bond type (double-barreled) tended to receive more bids than general obligation (GO) bonds, and GO bonds received more bids than revenue bonds. Conversely, bonds with a sinking fund tend to have 10 percent fewer bids. Interestingly, bond characteristics including maturity, call option, insurance, and refunding purpose do not have an association with auction competitiveness. Although this analysis was conducted on a sample limited to a single state, the findings are informative and should be considered by issuers seeking to minimize their cost of issuance. Raineri et al. (2012) used descriptive analysis of 15 cases of primary offering municipal bond issues in California to analyze differences that distinguish between underwriting and brokerage sales and trading activities. The authors sought to determine whether differences exist in the degree of risk taking by the underwriting firms, and to offer definitions for these differing behaviors. Underwriting activities are exposed to reoffering risk during the deal since the bonds are purchased from the issuer and resold to investors, and in the process, underwriters face potential fluctuations in interest rates and market demand. In this scenario, the risk assumed by underwriters may justify compensation to offset these uncertainties. On the other hand, brokerage activities are characterized by the placement of bonds based on pre-sale subscriptions to the bond issue. Therefore, when underwriters act as brokers when reselling bonds, extra compensation may not be justified, since they are not exposed to the same risks as a true intermediate investor in the bonds.

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The 15 deals used for analysis in Raineri et al. (2012) were issued between approximately 2008 and 2011 and were chosen to represent common bond types and purposes, methods of sale, and issuer profiles. The authors categorized the bonds as either underwriting or brokerage activities based on the difference between the stated price when the bonds were first offered in the primary market, and the final resale price. Larger price differences were then categorized as riskier, while smaller differences were categorized as carrying less risk. The authors found evidence that supports a clear distinction between underwriting and brokerage activities for many of the bond issues. They note that competitive sale issues are typically exposed to resale risk, and therefore are assumed to have factored this compensation into their bid. Alternatively, underwriters in negotiated sales have more time and incentive to subscribe investors. In the case of negotiated sales, issuers could therefore research marketplace spreads on comparable competitively sold issues. Moldogaziev et al. (2019) expanded on the relatively little empirical research that has been done on private placement sales in the municipal market. Though the vast majority of issues are sold through either competitive or negotiated sales, private placements may be an increasingly important alternative for certain issuers, under advantageous market conditions. Private placements are often conducted without the use of an underwriter and other key financial intermediaries, and therefore have the potential to save the issuer on associated marketing and regulatory costs. The authors used a sample of 9983 bonds issued in Texas from 2007 to 2014 to test whether private placements could lead to issuance cost savings compared to the more traditional methods of sale. Using two-stage regression models to calculate arbitrage yield (AY) and issuance cost (IC), the authors determined that compared to competitive sales, private placements have a 206 bps lower AY and 84 percent lower IC, and compared to negotiated sales, private placements have a 65 bps lower AY and 69 percent lower IC. Based on these findings, the authors emphasize the need for sound public debt management practices to evaluate decisions on municipal debt methods of sale. Bond Insurers Credit enhancement offered by bond insurers is a critical component to ensuring governments have cost-efficient access to the capital markets. The impact of the financial crisis on the municipal bond industry offered ample research opportunities for municipal finance scholars over the last decade. Adelson and Butcher (2015) discuss the status of the market for municipal insurance following the financial crisis and propose an alternative model for bond insurance that would create real value for those seeking credit enhancement in the current environment. The authors first explain the recent history of municipal yields and spreads. They state that despite an overall downward trend in municipal yields in the past 35 years, credit spreads have widened significantly. In fact, spreads widened between the periods from 1995 to 2005 and 2010 to 2014, across almost all tenors and maturities in the municipal bond market. Adelson and Butcher put forward that today’s larger credit spread environment suggests there is still investor appetite for bond insurance. The current business model for credit enhancement has not changed much since prior to the financial crisis, and the model is inherently flawed, according to Adelson and Butcher (2015). Today’s model relies on the faulty logic that bond insurers are able to efficiently raise claims-paying resources after the onset of a credit event – logic that was

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proven false in the wake of the financial crisis. Further, issuers seeking credit enhancement have seen a decrease in its benefits, post-crisis. Adelson and Butcher (2015) note that while newly insured bond spreads prior to the crisis were roughly equivalent to “natural doubleA-rated general obligation bonds (GOs),” current spreads are closer to “natural singleA-rated GOs” (p. 27). The new business model suggested by Adelson and Butcher is instead anchored by a higher ratio of claims-paying resources to insured risks, and the use of contingent capital securities. Also suggested is the use of computer simulation to test the insurer’s ability to take on additional risk with the issuance of each new policy, as well as using simulation to model and match the cash flows for high-quality assets versus risks over time. Cornaggia et al. (2019) empirically tested the benefits of bond insurance for issuers, and ultimately, their taxpayers. Existing literature in this area of research has focused primarily on states with the highest frequency of issuance, which is not representative of the heterogeneity in the municipal bond market. Additionally, the research has been restricted to specific time periods and secondary market effects. In contrast, the authors of this study referenced the Mergent Municipal Bond Securities database to understand the broad effect of credit enhancement on the costs of issuance, and their final dataset includes 760 084 GO bonds issued between 1985 and 2016. Their paper therefore analyzes the effect of bond insurance over time, including pre- and post-financial crisis. They conclude that between 1985 and 2007 (pre-crisis), bond insurance provided an average of 9 bps benefit across the sample of bonds; however, post-crisis, there is almost no benefit to most issuers. Conversely, investors post-crisis through present day do benefit from credit enhancement, but only for bonds carrying a lower credit rating compared to the insurer. Bond insurance for highly rated bonds showed a negative value, or yield inversion, and the choice to insure may be driven by underlying agency problems. Bergstresser et al. (2010) also found evidence of bond insurance having a negative implication on the bonds’ value during the financial crisis. They tested the hypothesis that the yield inversion was caused in part by (1) the actions of mutual funds and other insurers who sold insurer municipal debt following the collapse of the insurance market; and (2) liquidation of tender option bond (TOB) programs (16,356 underlying bonds). The authors used Mergent as a primary data source and included 2.37 million bonds in their initial sample, and supplemented mutual fund holdings with information from the CRSP Mutual Funds Portfolio database. They tested these hypotheses empirically, using regression models, and found no evidence for either point as a driver of the yield inversion. Moldogaziev (2013) analyzed bond portfolio risk exposure of the nine firms that provided credit enhancement in the municipal market between 1995 and 2010. This analysis and an examination of the regulatory environment provide insight into the situation before and after the financial crisis, and support policy recommendations going forward. Moldogaziev plotted the data to visualize several trends in the industry during the period leading up to, and just after, the financial crisis. First, he plotted the relationship between all insurers and the asset mix of bonds (by industry and purpose) each firm held over time. He found that despite significant growth in the total volume of insured bonds during the time period for all firms, six of the industry’s firms continued to hold more secure types of municipal debt, such as GO and special tax-backed bonds. Second, to assess whether there was any convergence in the industry towards riskier products in their public finance portfolios, he plotted the proportion of all industry firms’ portfolios that were high

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(greater than 40 percent), moderate (approximately 30 percent), and low risk (less than 20 percent), between 1995 and 2010. The author found no definitive evidence of convergence in riskier assets during the period for public finance portfolios. Third, he assessed whether convergence in structured finance products took place, finding significant increases in commercial and mortgage asset-backed security (ABS) holdings across most firms. Together, these trends showed a marked increase in the volume of insured instruments, as well as an increase in structured finance products for all but one firm, to between 20 and 80 percent of their total insured exposure. Municipal Advisors Relationships between and among stakeholders in municipal debt financing can have a significant effect on an issuer’s borrowing costs, which can ultimately impact their overall financial health. The role of municipal advisors has arguably been elevated since the Great Recession and the resultant Dodd-Frank Act, leading to a rise in municipal advisor quality and a continued increasing reliance on municipal advisors by issuers. By 2014, 70 percent of all municipal deals involved the use of a municipal advisor (Luby & Hildreth, 2014). As a result of this newfound elevation in status, the role of municipal advisors as advisors to state and local governments has become more important and distinct. Luby and Hildreth (2014) authored a descriptive analysis of the municipal advisor landscape following the Dodd-Frank Act for entities to register as municipal advisors beginning in 2010. The authors based their analysis on information filed by 1,180 registrants on Form MA-T2 with the SEC, under the temporary definition of a “municipal advisor,” between 2010 and 2012. The information submitted on the forms contained general characteristics of the advisors’ location and past registration information, as well as details regarding the registrants’ municipal advisory activities. Using this information, Luby and Hildreth found several trends in the data that can inform issuer decision-making. First, the authors found that although municipal advisors were dispersed throughout the US, the states with the greatest annual long-term bond sales by par issuance had the highest concentration of municipal advisor registrants. They reason that this concentration could reflect issuers’ preference for local or regional advisors, who may have better insight into state regulations and issuer needs, as well as more convenient access to services, compared to less localized municipal advisors. Second, the authors find that only 38 of the 1,180 original registrants (or 3.2 percent) were members of the National Association of Independent Public Finance Advisors (NAIPFA), while 28 percent of registrants were categorized as broker-dealers and 10 percent as investment advisors by the SEC, and nearly 40 percent were registered with the Financial Industry Regulatory Authority (FINRA). Additionally, 6 percent of registrants were registered with all three entities. These findings underscore a potential violation of independence and an inherent conflict of interest among the municipal advisors in this sample. Third, the authors found a balance of the types of services offered among municipal advisors, with 67 percent of registrants offering issuance advising, 47 percent offering advice related to investment of proceeds, and 45 percent offering guaranteed investment contracts.   Municipal Advisor Temporary Registration Form.

2

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Notably, a third of all registrants also offered services for the solicitation of municipal entities for third parties – in other words, they offer “finder fee” types of services, unrelated to financial advice. Further, these registrants were also more likely to have had two or more regulatory violations compared to those not engaged in solicitation services. Fourth, 92 percent of firms that offer issuance advisory also engage in derivatives advice, which could compromise the integrity of the issuance advice. Together, these trends profile the municipal advisor landscape following Dodd-Frank, revealing that a significant portion of the market is much more than simply deal transactors, and provides practical information to guide issuers. Another suggested outcome resulting from the Dodd-Frank Act is that the quality of advice improved because the legislation addressed previous deficiencies in training and overall qualification in the municipal advisor market. Ivonchyk (2019) found empirical evidence to support this theory by analyzing a dataset of 2,744 long-term bonds issued in California between 2013 and 2015. The author hypothesized two possibilities resulting from the financial reform: (1) disciplining municipal advisors would result in betterqualified advisors, sounder advice, and likely result in lowered TICs; or (2) enhanced regulation could dissuade potential municipal advisors from registering with the SEC and the Municipal Securities Rulemaking Board (MSRB), leading to a restriction of information flowing to potential issuers, and triggering a possible negative impact on TICs. Ivonchyk used a difference-in-differences model to test these hypotheses and controlled for quarter fixed effects to estimate the effect of municipal advisor services on the TIC of borrowing. The author concluded that municipal advisors have a significant negative impact on borrowing costs, with an average decrease of 16 bps for both competitive and negotiated sales, and a 19 bps decrease in only negotiated sales. Ivonchyk concludes that the lowered TIC effect in the sample of California bonds is likely due to increased transparency from more stringent requirements for record-keeping, as well as the fiduciary responsibility now applied to municipal advisors. Daniels et al. (2018) found further evidence for lowered borrowing costs from the passage of Dodd-Frank, which increased municipal advisor quality, resulting in positive signaling to investors regarding issuer quality. They utilized a large sample of 562,998 competitively bid revenue bonds issued between 1998 and 2012. To the authors’ knowledge, this is the first study that explores the effect of municipal advisor quality on municipal market liquidity. In their experiment, the authors defined a high-quality advisor as one who completes a high proportion (greater than 90 percent) of the par value of all issues in the state where they are located. The authors concluded from their empirical results that increased transparency and enhanced municipal advisor quality provided positive feedback about issuer quality to potential investors, which translates to improved liquidity, and a lowered cost of borrowing. Bergstresser and Luby (2018) offer an updated descriptive and empirical analysis of the municipal advisor industry post-Dodd-Frank. The authors used three primary sources of data including the MSRB (A-12 and G-37 filings), the SEC (MA-A and MA-I filings),3 3   The MSRB (A-12 and G-37) and SEC (MA-A and MA-I) filings are required of all registered municipal advisor firms and detail various aspects of these firms’ organizational form and locations, composition, employee names and backgrounds, professional services offered, client names, previous regulatory actions, political contributions, and so on.

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and the Mergent fixed income database to describe trends in the makeup of the municipal advisor market, characteristics of municipal advisor firms, and trends in the mix of services provided. An important finding of the municipal advisor market based on MSRB and SEC data was that there were material discrepancies between the two regulatory bodies in the number of municipal advisors who passed the Series 50 qualifying exam. Further, many firms registered with the SEC had stale data going back between two and four years at the time of this report. Another finding from Bergstresser and Luby (2018) was the trend in the number of registered municipal advisor firms over time. There was a sharp increase in the number of firms between 2010 and 2013 (544 to 931), and a decline between 2014 and 2018 (812 to 561). This trend was expected, and can be explained by the timeline of important, relevant events, including the passage of Dodd-Frank in 2010, the finalization of MSRB rules in 2014, and the Series 50 examination requirement in 2017. Further, the volatility in the number of municipal advisor firms over time was primarily driven by smaller advisors, which consist of fewer than 20 employees, and constitute the majority of municipal advisor firms. The number of municipal advisor employees who work at firms described previously shows a concentration among the top ten firms. The top ten firms illustrate a dominance in the industry, employing around one-third of all municipal advisor employees, and representing 34–45 percent of all clients. However, this data must be scrutinized, given the issue with stale SEC data. Finally, there is a range of services offered by municipal advisor firms across the industry, but the most common service provided is bond issuance, with over 80 percent of firms offering the service. Investing bond proceeds is the second most common service, with approximately 50 percent of firms, followed closely by advising on escrow investing. Other investment advice, guaranteed investment contracts, and derivatives services were offered by approximately one-third of all firms. The municipal advisor and underwriter relationship The municipal advisor role is dynamic and goes beyond simply the relationship between an advisor and the government debt issuer. The municipal advisor and underwriter relationship is one that has changed significantly since Dodd-Frank, and also has important implications for the cost of issuance and borrowing. As described above, an important aspect of the regulation coming out of the financial crisis was the fiduciary obligation bestowed on municipal advisors. Above, we discussed the relationship between municipal advisors and government issuers, noting that municipal advisors were often located near their clients for both ease of access and increased knowledge of local markets. However, recent research shows that the intensity of the relationship between an issuer’s municipal advisor and their underwriter also affects the borrowing cost of financings. Moldogaziev and Luby (2016) analyzed how the relationship intensity between municipal advisors and underwriters can affect borrowing costs for negotiated debt. The authors use a theory from economics called round-trip transactions (RTTs) to frame their primary hypothesis, which is that benefits from arm’s length transactions are diminished as the relationship intensity between municipal advisors and underwriters increases. The data used for analysis included 5,200 negotiated sale bonds issued in Texas between 2000 and 2010, which represented 43 percent of all listed issues over the time period. The authors find that when a municipal advisor collaborates with a given underwriter on 20 percent or

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more of their annual issues, the associated positive impact on TIC is significant – between approximately 6 and 11 bps. This finding is consistent with previous studies concerning the municipal advisor–underwriter relationship and lends credence to the regulatory concerns addressed by Dodd-Frank. Bergstresser and Luby (2018) also empirically analyzed the implications of underwriter–municipal advisor linkage intensity on average bond price. Their regression results showed that more intense relationships between municipal advisors and underwriters have negative implications for issuers, including an association with underpricing the bonds. Liu (2015) found similar evidence in his research on the relationship impact between municipal advisors and underwriters prior to the financial crisis. The author used a sample of 3,479 California-issued bonds from 2001 to 2006 to explore how familiarity between issuers and municipal advisors, as well as between advisors and underwriters, can impact the cost of borrowing. Liu’s sample contained both competitive and negotiated issues, with nearly all the competitive sales utilizing municipal advisors, compared to only 56 percent for negotiated sales. To calculate an effect size, Liu regressed TIC on a variety of explanatory variables, including familiarity between issuer and municipal advisor and between municipal advisor and underwriter, issuer experience, and municipal advisor prestige. The author found that for the issuer–municipal advisor relationship, only negotiated sales had a significant pricing effect, where a familiar relationship between entities resulted in an 11 bps decrease. Conversely, familiarity between municipal advisor and underwriter resulted in a higher cost of borrowing – for each additional deal between the same municipal advisor/underwriter pair within the previous two-year span, the TIC increased by 3.6 bps. Garrett (2020) used panel data to compare interest costs on bonds issued by underwriters that filled the dual role of advisor (advisor underwriters) on deals prior to DoddFrank, versus interest costs following the regulation that banned this practice. The author used the framework of competition to analyze and explain his findings. Specifically, he assessed whether the regulation that was designed to prevent conflicts of interest between underwriting and advisory services actually had a limiting effect on competition, which could put upward pressure on issuing costs. The author concluded that after Dodd-Frank, issues that utilize former advisor underwriters have an 11.4 bps lower interest cost (5.3 percent average) after 2011, compared to independently advised issues. This result is explained by the fact that competition for underwriting services actually increased after November 2011 – although municipal advisors were no longer bidding for those services, many more independent bidders entered the market and created a net increase in ­competition. Credit Rating Agencies Investors in municipal bonds often refer to the issuer’s credit rating when making investment decisions. Credit ratings can help reduce information asymmetries, acting as a signal of quality to investors, and increase its marketability. Therefore, a strong credit rating can provide issuers direct benefits by decreasing the cost of borrowing. Greer (2016) found that CRAs evaluate cities and municipalities differently. Further, they also differentiate between general purpose and special district forms of government. This distinction often drives the CRAs’ rating assignment because the underlying form of

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government dictates its potential revenue sources and influences its overall financial health. The author analyzed a sample of 9,238 bonds issued from 2000 to 2010, obtained from the Texas Bond Review Board. First, Greer calculated the propensity to be rated by each of the top three CRAs (Standard & Poor’s, Moody’s, Fitch), while controlling for variables known to be associated with rating choice. The author then ran multiple regressions and found several interesting and statistically significant relationships between the type of government and the choice of CRA: (1) certain local government types have a high propensity to be rated by a particular CRA (cities and Standard & Poor’s; school districts and Moody’s; health districts and Fitch); (2) Standard & Poor’s was the greatest source of variability in choice of CRA among local governments; (3) those with bond insurance are more likely to be rated by Standard & Poor’s and Moody’s; (4) a higher tax rate increases the propensity to be rated by Fitch, and decreases the propensity to be rated by Standard & Poor’s and Moody’s; (5) increased debt outstanding also increases the propensity to be rated by Fitch, and decreases the propensity to be rated by the other two CRAs; (6) larger par amounts increase the propensity to be rated by Standard & Poor’s and Moody’s; and (7) unobservable factors play a significant influence in the choice to be rated by either Standard & Poor’s or Moody’s, and Moody’s or Fitch. This analysis provides evidence of significant variation within local government types, often categorized broadly as “special districts.” These entities may drive their choice of rating agency mix based on the CRAs’ differing methods of evaluation and rating systems. Yang and Abbas (2020) used a comprehensive dataset from the Bloomberg Default Event Calendar and supplemented with Electronic Municipal Market Access (EMMA) and Ipreo4 data to analyze trends in local government defaults from 2009 to 2015. They described the number of bond defaults following the financial crisis as greater than previously reported, since the majority of the defaults occurred with non-rated entities, and CRAs only report on rated issues. Although municipal bond defaults remain rare (415 during the period) and are not increasing overall, this was a significant finding. Most of the defaults can be categorized as non-technical (nearly 90 percent), meaning they were not the result of a missed payment of principal or interest. Premonetary defaults were the most common default type directly following the financial crisis, from 2009 through 2012, after which monetary defaults became the most prevalent. Yang and Abbas empirically estimated yields from 2009 through 2015 using a difference-in-differences model. They found that non-GO debt defaults had no impact on yields of future issues from the same issuer. In other words, the authors found no statistically significant evidence of a spillover effect to GO debt, which is in line with the credit segmentation hypothesis. Collins (2014) analyzed government bond ratings credibility on a sample of bonds rated from 1975 through 2002. The author used Granger causality and vector autoregression analysis to analyze yield spreads in order to test their hypothesis of a possible link between institutional innovations (dual ratings) and a coordinated response in more favorable credit ratings. Collins finds evidence to suggest that across the timeframe studied, CRAs have inflated credit ratings as a response to increased competition in the CRA industry and a desire for those firms to have a reputation for optimism.

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Martell et al. (2013) tested the relationship between and sensitivity of changes in the financial health of state-administered pension funds and their underlying credit rating. To test this, the authors used logit and probit models and regressed credit ratings on fund ratios for 356 bonds between 2002 and 2011. The authors found that for states with a fund ratio equal to or above 1 (pension assets cover liabilities), Standard & Poor’s is unlikely to assign a rating below AA+, and Moody’s had similar implications. They also find evidence of the probability of a negative credit rating outlook to be sensitive to the prevailing fund ratio, with a one standard deviation increase in the ratio leading to a “200 percent decrease in odds of a negative outlook” (Martell et al., 2013, p. 41). Ely et al. (2013) studied a large sample of bonds (11,986 observations) from the Texas Bond Review Board from 2000 to 2009 to explain the determinants of fees paid for credit ratings – one of the components of the overall cost of issuance. Using OLS regression models, they found that the rating fees were driven by deal size and complexity. According to the authors, for each 1 percent increase in par value, the fees for ratings increase by 0.55  percent. Additionally, fees for multiple ratings significantly reduced the issuer’s average fee compared to only a single credit rating: by 9.2 percent for a second rating, and by 19 percent for a third rating. Fees were also affected by the existence of a prior relationship between the issuer and the CRA, leading to a 7.7 percent decrease in fees. These findings could prove valuable to issuers, and represent the first study to empirically describe the factors that influence credit rating fees.

PUBLIC FINANCIAL MANAGEMENT IMPLICATIONS Municipal market financial intermediaries play a vital role in the capital-raising process for state and local governments. Financial intermediaries can help lower transaction costs and reduce asymmetric information that often plagues the capital markets. These intermediaries are challenged by the political ecosystem in which they exist, while also being heavily impacted by market and exogenous financial events. As examples, the financial crisis, the Great Recession that followed, and the passage of the landmark federal DoddFrank Act have impacted all four of the financial intermediaries discussed in this chapter. The research completed over the last decade and discussed in this chapter sheds new light on these intermediaries and offers some public financial management implications for governments that employ them, as discussed below. In terms of underwriters, there is increasing evidence for the borrowing cost superiority of the competitive bond sale method over negotiating directly with underwriters, although context, issue/issuer characteristics, and market factors still impact relative performance. There also seems to be a potential benefit to the private placement approach for certain types of financings that governments may have overlooked in the past. Finally, governments should continue to evaluate the actual activities which underwriters perform and not compensate them for services that they are not really providing (e.g., brokerage versus underwriting). The benefit of using municipal advisors, and especially higher-quality ones in terms of reducing borrowing costs, continues to be evidenced in the recent research. As the professionalization of this industry grows with a more seasoned regulatory framework, it seems reasonable for these benefits to remain and perhaps grow. As such, governments should

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continue to seek out municipal advisor services where appropriate. However, there is some nuance to the use of municipal advisors – namely, there is also recent research that shows that repeatedly using the same underwriter and advisor in transactions can have  a  detrimental impact on borrowing costs (Moldogaziev & Luby, 2016). Thus, a healthy rotation of advisors and underwriters may be a wise approach for governments to take. Finally, governments need to be smarter in managing their costs related to purchasing bond insurance and credit ratings. The value of bond insurance has become more debatable over the last decade. It remains valuable to investors but there is some evidence that it does not provide a benefit to government issuers of debt except perhaps for lower-rated debt. As such, governments with the help of their municipal advisors need to perform significantly more analytics on their “live” deals as they consider buying bond insurance. In terms of credit rating fees, it appears that governments can reduce fees based on the number of ratings they solicit as well as developing relationships with the CRAs. Also, it appears that the rating agencies have a strong bias towards pension funding in terms of driving rating actions and levels, which further underscores the importance of pensions to government financial condition.

REFERENCES Adelson, M., & Butcher, G. H. (2015). Bond insurance: Introducing a better business model. Municipal Finance Journal, 36(2), 25–44. Akerlof, G. (1970). The market for “lemons”: Qualitative uncertainty and the market mechanism. Quarterly Journal of Economics, 84(3), 488–500. Benson, E. (1979). The search for information by underwriters and its impact on municipal interest cost. The Journal of Finance, 34(4), 871–885. Benston, G. J., & Smith, C. W. (1976). A transaction cost approach to the theory of financial intermediation. Journal of Finance, 31(2), 215–231. Bergstresser, D., Cohen, R., & Shenai, S. (2010). Financial guarantors and the 2007–2009 credit crisis (Working Paper No. 11-051). Harvard Business School. Bergstresser, D., & Luby, M. J. (2018). The evolving municipal advisor market in the post DoddFrank era [Working paper]. Booth, J. R., & Smith, R. L. (1986). Capital raising, underwriting and the certification hypothesis. Journal of Financial Economics, 15(2), 261–281. Collins, B. K. (2014). Credit and credibility: State government bond ratings, 1975–2002. American Review of Public Administration, 44(1), 112–123. Cornaggia, K. R., Hund, J., & Nguyen, G. (2019). The price of safety: The evolution of municipal bond insurance value (Working Paper No. 52). Hutchins Center on Fiscal & Monetary Policy at Brookings. Daniels, K., Dorminey, J., Smith, B., & Vijayakumar, J. (2018). Does financial advisor quality improve liquidity and issuer benefits in segmented markets? Evidence from the municipal bond market. Journal of Public Budgeting, Accounting & Financial Management, 30(4), 440–458. Diamond, D. (1984). Financial intermediation and delegated monitoring. Review of Economic Studies, 51(3), 393–414. Ely, T. L., Martell, C. R., & Kioko, S. N. (2013). Determinants of the credit rating fee in the municipal bond market. Public Budgeting & Finance, 33(1), 25–48. Forbes, R. W., Leonard, P. A., & Johnson, C. L. (1992). The role of financial advisors in the negotiated sale of tax-exempt securities. Journal of Applied Business Research, 8(2), 7–14. Garrett, D. G. (2020). Conflicts of interest in municipal advising and underwriting [Unpublished doctoral dissertation, Duke University].

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Greer, R. A. (2016). Local government risk assessment: The effect of government type on credit rating decisions in Texas. Public Budgeting & Finance, 36(2), 70–90. Gurley, J. G., & Shaw, E. S. (1960). Money in a theory of finance. Brookings Institution. Guzman, T., & Moldogaziev, T. T. (2012). Which bonds are more expensive? The cost differentials by debt issue purpose and the method of sale: An empirical analysis. Public Budgeting & Finance, 32(3), 79–101. Hildreth, W. B. (1993). State and local governments as borrowers: Strategic choices and the capital market. Public Administration Review, 53(1), 41–49. Ivonchyk, M. Y. (2019). The impact of Dodd–Frank on true interest cost of municipal bonds: Evidence from California. Public Budgeting & Finance, 39(1), 3–23. Ivonchyk, M. Y., & Moldogaziev, T. T. (2019). Explaining bids in first-price bid competitive auctions for city and county debt. Municipal Finance Journal, 39(4), 1–27. Johnson, C. L. (2013). Understanding Dodd-Frank’s reach into the financing of Main Street. Journal of Public Budgeting, Accounting & Financial Management, 25(2), 391–410. Johnson, C. L., Luby, M. J., & Moldogaziev, T. T. (2014). State and local financial instruments: Policy changes and management practices. Edward Elgar Publishing. Leland, H. E., & Pyle, D. H. (1977). Informational asymmetries, financial structure, and financial intermediation. Journal of Finance, 32(2), 371–387. Leonard, P. (1998). Competitive bidding for municipal bonds: New tests of the underwriter search hypothesis. Municipal Finance Journal, 19(4), 18–37. Liu, G. (2015). Relationships between financial advisors, issuers, and underwriters and the pricing of municipal bonds. Municipal Finance Journal, 36(1), 1–25. Luby, M. J., & Hildreth, B. (2014). A descriptive analysis of the municipal advisors market. Municipal Finance Journal, 34(4), 69–98. Luby, M. J., & Moldogaziev, T. T. (2013). An empirical examination of the determinants of municipal bond underwriting fees. Municipal Finance Journal, 34(2), 13–50. Martell, C. R., Kioko, S. N., & Moldogaziev, T. T. (2013). Impact of unfunded pension obligations on credit quality of state governments. Public Budgeting & Finance, 33(3), 24–54. Miller, G. (1993). Debt management networks. Public Administration Review, 53(1), 50–58. Miller, S. L., & Washburn, G. (2002, October 3). New Chicago law requires firms to disclose slavery links. Chicago Tribune. https://www.chicagotribune.com/news/ct-xpm-2002-10-03-0210030033story.html. Millon, M. H., & Thakor, A. V. (1985). Moral hazard and information sharing: A model of financial information gathering agencies, The Journal of Finance, 40(5), 1403–1422. Moldogaziev, T. T. (2013). The collapse of the municipal bond insurance market: How did we get here and is there life for the monoline industry beyond the Great Recession? Journal of Public Budgeting, Accounting & Financial Management, 25(1), 199–233. Moldogaziev, T. T., Greer, R. A., & Lee, J. (2019). Private placements and the cost of borrowing in the municipal debt market. Public Budgeting & Finance, 39(3), 44–74. Moldogaziev, T. T., & Luby, M. J. (2016). Too close for comfort: Does the intensity of municipal advisor and underwriter relationship impact bond borrowing costs? Public Budgeting & Finance, 36(3), 69–93. Moran, D. (2020, June 26). Municipal bond insurance industry busier than ever after decade long slump. Insurance Journal. https://www.insurancejournal.com/news/national/2020/06/26/573599.htm. Raineri, L., Robbins, M., Simonsen, B., & Weaver, K. (2012). Underwriting, brokerage, and risk in municipal bond sales. Municipal Finance Journal, 33(2), 87–103. Simonsen, B., & Hill, L. (1998). Municipal bond issuance: Is there evidence of a principal-agent problem? Public Budgeting and Finance, 18(4), 71–100. Stolper, A. (2009). Regulation of credit rating agencies. Journal of Banking & Finance, 33(7), 1266–1273. Thakor, A. V. (1982). An exploration of competitive signaling equilibria with third party information production: The case of debt insurance. The Journal of Finance, 37(3), 717–739. Van Voris, B. (2014, March 12). Ex-CDR chief Rubin spared prison in muni bid-rigging case. Bloomberg.com. https://www.bloomberg.com/news/articles/2014-03-12/ex-cdr-chief-rubin-spa​ red-prison-in-muni-bid-rigging-case?leadSource=uverify%20wall.

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West, R. (1967). Determinants of underwriters’ spreads on tax exempt bond issues. The Journal of Financial and Quantitative Analysis, 2(3), 241–263. Williamson, R. (2021, June 1). Texas passes $24B budget, targets underwriters over gun support. The Bond Buyer. https://www.bondbuyer.com/news/texas-passes-248b-budget-targets-underwrit​ ers-over-gun-support. Yang, L., & Abbas, Y. (2020). General-purpose local government defaults: Type, trend, and impact. Public Budgeting & Finance, 40(4), 62–85.

17. The structure of county government debt from 2002 to 2020: the financial crisis, the Great Recession, and the COVID-19 pandemic Craig L. Johnson, Andrey Yushkov, and Luis Navarro

INTRODUCTION In the American system of fiscal federalism, county governments are often unheralded but play a unique role in providing physical infrastructure and delivering essential services. Counties are established by their state government as administrative units to carry out particular state functions within a distinct geographical boundary established by the state. County functions vary from state to state, making each county government a unique administrative unit. County governments in the United States are responsible for providing several types of essential services, from transportation and infrastructure to community health, justice and public safety to social welfare services (National Association of Counties [NACo], 2019). Most of the physical infrastructure assets supporting the provision of services are financed with county debt sold in the municipal securities market. From 2002 to 2020, county government issuance averaged US$63 billion per year (Ipreo MuniAnalytics, 2020). Despite the size of the county debt market and the importance of the capital outlays it finances, we find no descriptive analysis of the characteristics of US county government debt in the research literature. Most studies on annual debt issuance and outstanding debt levels focus on state-level debt or the combined state–local sector (Bahl & Duncombe, 1993; Clingermayer & Wood, 1995; Ellis & Schansberg, 1999; Trautman, 1995). The only debt study at the county level was limited to California counties (Wang & Kriz, 2015). This chapter focuses on how county governments finance the physical infrastructure supporting the delivery of services to county residents. We describe the structure and issuance of county debt in the United States of America from 2002 to 2020. This time period covers the financial crisis and the Great Recession, the lead-up to the COVID-19 pandemic, and debt issuance over the early pandemic era. We analyze county government outstanding debt and debt issuance by sales, tax status, type of security, uses of proceeds, maturity, type of offering, insurance, and top ten issuers. We also analyze the quarterly flow of debt over the COVID-19 pandemic compared to the financial crisis and the Great Recession. Given that we are still going through the COVID-19 pandemic as of this writing, our results can only be considered preliminary. However, we do have data for all of 2020, which covers the fiscal shock from the initial declaration of a public health emergency and national lockdown in March 2020. One goal of the chapter is to see whether the general pattern of county debt issuance is similar or different across the fiscal shocks. In research terms, we investigate the null hypothesis of no difference in county debt issuance across fiscal shocks. 319

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THE BASIC CHARACTERISTICS OF THE COUNTY GOVERNMENT DEBT MARKET: 2002–20 Our descriptive analysis uses primary market debt data at the county level collected through Ipreo MuniAnalytics, IHS Markit’s proprietary data source licensed to Indiana University. Our data include 315,001 bonds issued by 4,724 unique government-level entities: county general governments, consolidated city-counties, and various authorities, commissions, and corporations established by single or multiple counties, between January 1, 2002, and December 31, 2020.1 Each maturity of an issue represents a separate observation in the dataset (“scale” level). For instance, if a bond issue contains ten maturities, we will have ten different observations for this issue. Some characteristics, however, are only available for the whole issue (“series” level) since they do not vary across maturities. This comprehensive dataset allows us to aggregate data at various levels (primarily, by state and year) and draw broad conclusions about the county bond market over the last 18 years.

TOTAL COUNTY ISSUANCE, 2002–20, DOLLAR AMOUNT, NUMBER OF ISSUES, AVERAGE ISSUE SIZE, TAX STATUS Table 17.1 shows real (in constant 2017 dollars) county debt issuance from 2002 to 2020. Total annual issuance grew from US$55 billion in 2002 to US$88 billion in 2010, despite dipping slightly in 2004 and 2006. From 2006 to 2010, annual county issuance grew 26 percent, before decreasing precipitously to US$49 billion in 2011. The decrease in 2011 is largely due to the reduction in taxable bonds issued under the federal Build America Bond (BAB) program. For counties, taxable volume peaked in 2010 at US$23.58 billion and dropped to US$5.01 billion in 2011 (Table 17.2), with the sunsetting of the BAB program. In terms of total municipal bond issuance, BAB new issues accounted for 15.65 percent in 2009,2 27.27 percent in 2010, and zero in 2011. For counties, BABs were 13 percent of the total market in 2009 and 27 percent in 2010. After 2011, total county issuance went up and down over the next several years, finally stabilizing at approximately US$55 billion annually from 2017 to 2020. This is well below the US$78 billion average annual debt issuance from 2005 to 2010. The impact of the financial crisis and the Great Recession was to place county debt issuance on a new, and lower, level. When looking at county debt issuance in terms of the number of new issues coming to market, we see a somewhat different picture. The number of debt issues peaked in 2004, 1   In total, counties issued 28,870 bonds from 2002 to 2020. General county governments constituted 52 percent of the market, authorities established by county governments 22 percent, and other types of county issuers 26 percent (Source: Ipreo MuniAnalytics). 2   The 15.65 percent figure is especially impressive since it is based on only nine calendar months in 2009 given that the first BAB issuance was in April of 2009. The program was signed into law by President Barack Obama on February 17, 2009, as part of the American Recovery and Reinvestment Act (ARRA).

The structure of county government debt from 2002 to 2020  ­321

Table 17.1  Annual county debt issuance, 2002–20: total issuance, number of issues, average issue size (constant 2017 USD)

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

Total Issuance (USD billion)

Number of Issues

Average Issue Size (USD million)

55.65 62.65 61.49 74.86 70.14 76.37 77.18 80.09 88.73 49.46 60.59 54.52 43.98 51.90 63.86 59.92 53.95 55.03 58.00

1,613 1,877 2,018 1,965 1,783 1,821 1,549 1,568 1,831 1,287 1,641 1,326 1,174 1,311 1,441 1,217 971 1,148 1,329

34.50 33.38 30.47 38.10 39.34 41.94 49.83 51.08 48.46 38.43 36.93 41.11 37.46 39.59 44.32 49.24 55.56 47.93 43.64

Source:  Ipreo MuniAnalytics.

well before the financial crisis. While the number of issues declined from 2004 to 2008, and stayed steady in 2009, average issue size went way up from US$30 million per issue in 2004 to US$51 million in 2009. Counties appear to have strategized to increase the issue size of deals brought to market in response to the financial crisis and during and immediately after the Great Recession in 2008–10. BABs also played a role in raising the average issue size in 2009 and 2010. The number of issues tumbled from 2017 to 2018, from 1,217 to an historic low of 971. This is a direct result of the reduction in the amount of tax-exempt debt issued in 2017 and 2018, from US$53.94 billion to US$39 billion in 2018. This is likely due to the elimination of the tax-exempt refundings in the federal Tax Cuts and Jobs Act (TCJA) signed by President Trump on December 22, 2017 (Congress, 2017). While taxable issuance increased significantly from 2017 to 2018, it did not increase enough to offset the drop in tax-exempt issuance. From 2018 to 2020, dollar volume grew, as did the number of issues, but the average issue size decreased.

COUNTY PRIMARY DEBT MARKET ISSUANCE, QUARTERLY Figure 17.1 shows real quarterly primary debt market issuance at the county level in 2002–20 and the trend component of the same time series estimated using the

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Table 17.2  County debt issuance by tax status Tax Exempt Total amount 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

48.78 56.16 54.88 67.86 62.42 66.68 67.56 69.58 65.15 44.45 54.73 49.10 39.46 46.49 58.29 53.94 39.02 44.83 41.19

88% 90% 89% 91% 89% 87% 88% 87% 73% 90% 90% 90% 90% 90% 91% 90% 72% 81% 71%

Taxable

Number of issues 1,395 1,649 1,744 1,706 1,508 1,490 1,385 1,323 1,302 1,128 1,422 1,141 1,012 1,159 1,268 1,041 825 987 1,015

86% 88% 86% 87% 85% 82% 89% 84% 71% 88% 87% 86% 86% 88% 88% 86% 85% 86% 76%

Total amount 6.87 6.49 6.61 7.00 7.71 9.70 9.62 10.52 23.58 5.01 5.86 5.42 4.52 5.40 5.57 5.98 14.93 10.20 16.81

12% 10% 11% 9% 11% 13% 12% 13% 27% 10% 10% 10% 10% 10% 9% 10% 28% 19% 29%

Number of issues 218 228 274 259 275 331 164 245 529 159 219 185 162 152 173 176 146 161 314

14% 12% 14% 13% 15% 18% 11% 16% 29% 12% 13% 14% 14% 12% 12% 14% 15% 14% 24%

Note:  For each tax status, the first column in “Total amount” presents total issuance per year in constant 2017 USD billion, while the second column shows the percentage share of the respective tax status in total issuance. Source:  Ipreo MuniAnalytics.

Hodrick-Prescott (HP) filter.3 Several trends are noteworthy. First, the US counties issue less debt now than they did before the Great Recession. Based on the inflation-adjusted data (in constant 2017 dollars), total county issuance peaked in the second quarter of 2007 at about US$29.9 billion, staying above the trend until the end of 2010. Issuance started declining after the global financial crisis before reaching the level of US$26.7 billion in the fourth quarter of 2017, a level of sales not reached since the fourth quarter of 2010. Second, the trend component of total county issuance, clean from the cyclical fluctuations from quarter to quarter, reached its peak in the second quarter of 2008 at US$19.1 billion, and steadily declined until the second quarter of 2015 when it reached its trough at US$13.3 billion. Then it started slowly increasing again and reached US$15 billion in the first quarter of 2020. Despite the fiscal shock from the federal declaration of the COVID-19 pandemic in March 2020 (Executive Office of the President, 2020), county debt issuance continued its upward trajectory throughout 2020. In relation to the financial crisis and Great 3   The Hodrick-Prescott filter is a mathematical decomposition often used in macroeconomics to separate the cyclical component and the trend component of a time series. We use it primarily to assess the long-term trend in primary debt issuance at the county level.

The structure of county government debt from 2002 to 2020  ­323

Source:  Ipreo MuniAnalytics.

Figure 17.1  Quarterly county debt issuance, 2002–20, 2017 USD million Recession, in contrast, real quarterly issuance peaked in the second quarter of 2007, and the trend component peaked in the second quarter of 2008. Moreover, the effect of the financial crisis and Great Recession was not only immediate, but it was also long term. In fact, debt issuance did not regain a positive trend until 2015. Looking at Figure 17.1, there is no indication that county debt issuance was negatively affected by the pandemic. Next, we examine quarterly issuance by tax status. Figure 17.2 shows quarterly tax-exempt and taxable county issuance. Before C ­ OVID-19, taxable issuance was the highest in 2010 with the BAB program. When BABs ended in 2011, taxable issuance went back to its pre-financial crisis level of 11 percent of the market. In 2018, taxable issuance picked up again, likely due to the elimination of taxexempt advanced refundings from the TCJA, and taxable debt sales have continued to increase during the pandemic in 2020. Taxable issuance stood at 29 percent of total county issuance in 2020, which is a very large portion of the market. The recent trend started in 2018, with a slight decrease in 2019, but the 29 percent figure in 2020 is an historic high.

COUNTY DEBT ISSUANCE BY STATE While looking at the US county debt market as a whole is informative, we must note that the reliance on public debt varies greatly across states. Figure 17.3 provides a map of county per capita debt issuance by state, categorizing county debt into four groups: high (> US$4,000), medium (US$2,000–4,000), low (< US$2,000) and no debt data. There is

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Source:  Ipreo MuniAnalytics.

Figure 17.2  Quarterly county debt issuance by tax status, 2002–20, 2017 USD million no county debt recorded for Alaska and Vermont, and almost no debt recorded for Massachusetts and Rhode Island.4 Eighteen states fit into the category of high, 11 states are medium, and 19 states are low per capita county debt states. Most large states are high county debt states (i.e., California, New York, Texas), but not all; Illinois and Michigan are low county debt states. County debt issuance is obviously important in the MidAtlantic states, since each Mid-Atlantic state is a high county debt state. In contrast, most of the Midwest, Great Lakes, and Upper Plains region states are either low or medium county debt states. The highest per capita county debt issuance in 2002–20 was in Hawaii (US$11,431), Nevada (US$8,962), Maryland (US$7,710), and Tennessee (US$7,180). While the detailed structure of county debt in each state is beyond the scope of this chapter, one important point is that high county debt states have different priorities depending on their socio-demographic structure, economic development, and the state of infrastructure. In particular, counties in Hawaii spend most of their bond proceeds on general-purpose issues, utilities, and transportation, while counties in Tennessee primarily use bond proceeds to finance general-purpose issues, healthcare, and education.5

4   Please note that while some states issue no or very little county debt, there may be other entities within the state at the subnational government level like cities or special districts that issue debt. 5   Other structural aspects of counties across states that may differentiate debt issuance include the number of counties and the number of home-rule counties in a state, as well as the functions assigned to counties in a state.

The structure of county government debt from 2002 to 2020  ­325

Sources:  Ipreo MuniAnalytics; US Census Bureau.

Figure 17.3  Per capita county debt issuance by state, 2002–20, 2017 USD

COUNTY DEBT ISSUANCE AND CAPITAL OUTLAYS The municipal bond market is the main source of funds for supplying state and local government infrastructure in the United States. Local governments leverage tax revenues with debt financing from the municipal securities market to increase public capital expenditures, thus expanding the provision of public goods and services. In this sense, it is relevant to examine the relationship between debt issuance by county governments and capital outlays. To do so, we use the novel dataset compiled by Pierson et al. (2015), which compiles and consistently organizes the Annual Survey of State and Local Government Finances, a survey collected by the US Census Bureau with information on local governments’ revenues and expenditures. Thus, we compare capital outlays and ­ debt ­issuance per capita by state, taking the average across counties between 2002 and 2019. Figure 17.4 shows these two variables are highly positively correlated (ρ = 0.6945). This suggests that, on average, counties that issue more debt are more likely to have greater capital outlays, which translates into more infrastructure development. For example, counties located in Nevada and Hawaii stand out by showing high levels of both debt issuance and capital outlays expenditure, quite above the average observed in the rest of states. In contrast, counties in states like Massachusetts, Maine, and South Dakota report relatively small capital outlays along with a similar level of debt issuance.

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Sources:  Ipreo MuniAnalytics; Pierson et al. (2015); US Census Bureau.

Figure 17.4  Per capita county debt issuance and capital outlays, 2002–19, 2017 USD

COUNTY DEBT ISSUANCE BY USES OF PROCEEDS Table 17.3 summarizes county bond issuance by general uses of proceeds (in USD billion and as a percentage of the total market). General-purpose bonds have traditionally occupied the largest share of the market, although their share went down from 54 percent in 2002 to 34 percent in 2018–19, but bounced back to 44 percent (US$25 billion) in 2020, indicating that the pandemic had no adverse impact on county general-purpose financing. Annual general-purpose financing, however, has never been over 50 percent of the market since 2003, indicating that for the last 16 years, county infrastructure development has focused less on financing general government (public) projects. One of the most significant changes in uses of proceeds happened during the Great Recession when the total amount and share of transportation and healthcare bonds increased, dramatically peaking in 2008 at 15 percent and 24 percent, respectively. This shows that during the previous crisis, county governments continued to sell debt for long-term capital projects supporting essential services even if it was backed largely by nontax revenue sources. Healthcare financing stood at only 13 percent in 2020, the 2009–20 average. Most healthcare funding is for hospitals (Table 17.4). Transportation financing stabilized at 12 percent from 2009 to 2017, growing to an historic high of 28 percent in 2018,6 6   The spike of 2018 is partly explained by increased activity among the largest county issuers. In particular, the City and County of Denver issued large-scale Elevate Denver bonds aimed at revitalizing transport infrastructure in the city, while the Airport Commission of the City and

327

29.93 33.51 28.99 35.62 30.01 30.26 23.17 36.87 36.44 22.95 26.99 22.50 20.71 23.72 25.94 23.80 18.28 18.94 25.63

54% 53% 47% 48% 43% 40% 30% 46% 41% 46% 45% 41% 47% 46% 41% 40% 34% 34% 44%

5.71 6.77 5.77 7.19 8.69 7.45 8.48 8.92 12.00 7.53 6.02 9.54 5.26 8.91 10.46 7.74 3.94 7.85 9.74

10% 11% 9% 10% 12% 10% 11% 11% 14% 15% 10% 17% 12% 17% 16% 13% 7% 14% 17%

Utilities 2.88 3.71 6.08 5.38 4.02 6.14 5.97 4.10 3.09 3.03 4.78 3.00 2.13 4.36 3.97 5.43 3.77 3.41 3.96

5% 6% 10% 7% 6% 8% 8% 5% 3% 6% 8% 6% 5% 8% 6% 9% 7% 6% 7%

Education 1.40 1.27 2.30 1.80 2.41 2.55 2.67 1.81 1.57 0.94 1.31 1.10 1.48 1.46 1.39 1.56 1.61 1.12 1.77

3% 2% 4% 2% 3% 3% 3% 2% 2% 2% 2% 2% 3% 3% 2% 3% 3% 2% 3%

Public Safety 4.98 6.57 6.78 10.27 11.19 13.29 18.80 14.02 13.98 5.37 9.39 6.10 5.09 5.79 11.61 9.22 7.17 7.79 7.69

9% 10% 11% 14% 16% 17% 24% 18% 16% 11% 15% 11% 12% 11% 18% 15% 13% 14% 13%

Healthcare 4.88 5.72 5.23 6.69 5.66 7.92 11.25 9.31 13.28 5.58 8.74 8.15 6.08 4.81 6.49 7.64 14.90 12.30 5.53

9% 9% 8% 9% 8% 10% 15% 12% 15% 11% 14% 15% 14% 9% 10% 13% 28% 22% 10%

Transport 3.22 2.76 4.18 4.40 4.97 5.15 2.66 1.97 5.02 1.81 1.16 2.38 1.25 1.65 2.51 2.84 1.93 2.64 2.16

6% 4% 7% 6% 7% 7% 3% 2% 6% 4% 2% 4% 3% 3% 4% 5% 4% 5% 4%

Economic Development 2.64 2.32 2.17 3.51 3.18 3.61 4.19 3.08 3.35 2.26 2.20 1.74 2.00 1.20 1.49 1.68 2.34 0.98 1.52

5% 4% 4% 5% 5% 5% 5% 4% 4% 5% 4% 3% 5% 2% 2% 3% 4% 2% 3%

Other Purposes

55.65 62.65 61.49 74.86 70.14 76.37 77.18 80.09 88.73 49.46 60.59 54.52 43.98 51.90 63.86 59.92 53.95 55.03 58.00

Total Issuance

Source:  Ipreo MuniAnalytics.

Note:  For each use of proceeds, the first column presents total issuance per year in constant 2017 USD billion, while the second column shows the percentage share of the respective use of proceeds in total issuance.

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

General Purpose

Table 17.3  County debt issuance by general use of proceeds, 2002–20 (in USD billion and as a percentage of the total market)

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Table 17.4  County debt issuance by specific use of proceeds Specific Use of Proceeds

Total Issuance (USD billion)

Share (Within category)

Number of Issues

Utilities Water & sewer Electric and public power Combined utilities Other

111.83 12.91 8.37 14.84

76% 9% 6% 10%

2,414 279 165 355

Transport Airports Toll roads/highways/streets Mass/rapid transit Other

80.28 32.37 20.85 16.64

53% 22% 14% 11%

487 804 137 323

Healthcare Hospitals Lifecare/retirement centers Nursing homes Other

153.31 18.67 2.08 1.04

88% 11% 1% 0%

1,941 420 121 9

47 45 5 3

1,020 559 304 85

Education Higher education Primary & secondary education Libraries & museums Other

37.20 35.87 3.93 2.23

Note:  Ipreo does not provide disaggregation for general-purpose bonds. Source:  Ipreo MuniAnalytics.

­ ropping to 22 percent in 2019, and then falling sharply to only 10 percent in 2020. Most d transportation funding involves airports, toll roads, highways, and mass transit. The concentration of the transportation debt market is extremely high compared to other uses of proceeds: top ten issuers that include large city-counties (Denver, Miami-Dade) and airport authorities of San Francisco and Wayne County occupy more than 66 percent of the total market. Utilities financing reached a high of 17 percent of market share in 2013, 2015, and 2020, indicating no slowdown of utilities financing during the pandemic. The vast majority of utilities funding goes towards water and sewer projects, while only a small share of total county government debt issuance involves primary and secondary education, including financing community colleges, and libraries and museums.

County of San Francisco issued almost US$900 million in fixed rate securities to implement the airport’s capital improvement program.

The structure of county government debt from 2002 to 2020  ­329

COUNTY DEBT ISSUANCE BY TYPE OF SECURITY Table 17.5 presents real annual county debt issuance by security type: revenue, unlimited general obligation (GO), limited GO, and all other securities. The structure of county debt changed considerably over the 2002–20 timeframe. While the share of revenue debt has always been at least 56 percent of market volume, its market share peaked at 70 percent in 2008. Unlimited GO debt issuance went from 24 percent in 2008 to 34 percent in 2009, in the middle of the Great Recession. In 2010, the total annual issuance of revenue bonds peaked at US$55 billion right after the financial crisis and the trough of the Great Recession, and then declined significantly before stabilizing at about US$35 billion annually from 2017 to 2020. The amount of unlimited GO bonds backed by a US county government full-faith-andcredit (unlimited and unconditional) pledge peaked shortly after the Great Recession in 2010 at US$28.5 billion (32 percent of market volume). Limited GO bonds became more popular after the global financial crisis. Their annual issuance increased from US$3–4 billion in 2002–08 to US$5–6 billion in 2015–19. In 2018, limited GO debt peaked at 12 percent of the market. During the financial crisis and the Great Recession, and the beginning of the pandemic, the share of unlimited GO debt increased and revenue debt decreased. This is Table 17.5  County debt issuance by type of security Revenue Bonds 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

36.83 42.48 37.40 48.10 46.01 52.34 53.68 46.94 55.64 28.10 35.37 33.78 24.46 29.18 40.51 35.52 33.39 35.05 34.98

66% 68% 61% 64% 66% 69% 70% 59% 63% 57% 58% 62% 56% 56% 63% 59% 62% 64% 60%

Unlimited GO Bonds 15.12 17.12 20.13 22.01 20.07 20.61 18.37 27.08 28.49 16.12 17.61 15.86 14.95 17.14 17.85 17.55 13.90 13.92 17.47

27% 27% 33% 29% 29% 27% 24% 34% 32% 33% 29% 29% 34% 33% 28% 29% 26% 25% 30%

Limited GO Bonds 3.28 2.91 3.95 4.74 4.03 3.30 4.90 5.92 4.51 5.19 7.49 4.82 4.55 5.33 5.32 6.28 6.56 5.55 4.96

6% 5% 6% 6% 6% 4% 6% 7% 5% 11% 12% 9% 10% 10% 8% 10% 12% 10% 9%

Other Bonds 0.42 0.14 0.01 0.00 0.02 0.12 0.24 0.16 0.09 0.05 0.12 0.06 0.03 0.25 0.19 0.58 0.10 0.51 0.59

Note:  For each type of security, the first column presents total issuance per year in constant 2017 USD billion, while the second column shows the percentage share of the respective security type in total issuance. Source:  Ipreo MuniAnalytics.

1% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 1% 0% 1% 0%

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likely an indication that issuers and investors view the local property tax as a strong source of repayment for unlimited GO debt even during a fiscal shock, whether the shock is caused by a real estate implosion or a public health pandemic.

COUNTY DEBT ISSUANCE BY TYPE OF SALE County debt is usually sold via a competitive or negotiated method of sale. On average, about two-thirds of the market consists of negotiated offerings, while bonds sold via the competitive method of sale occupy one-third of the market (Table 17.6). From 2007 to 2008, the share of negotiated bond sales increased significantly, with market share peaking at 77 percent in 2008, and competitive sales hitting a low point at 22 percent. Somewhat surprisingly, we do not see the same pattern from 2019 to 2020. From 2019 to 2020, competitive sales increased slightly from 30 percent to 31 percent, and negotiated sales actually decreased slightly from 69 percent to 68 percent. The share of private placements at the county level was relatively low and fluctuated around 1 percent of the market. In recent years, annual private placements have stabilized between US$280 and US$400 million. Table 17.6  County debt issuance by type of sale Competitive 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

18.05 18.28 16.80 19.58 23.92 25.81 17.26 25.21 27.53 19.26 18.19 16.19 15.01 16.52 18.50 20.09 15.61 16.64 18.05

32% 29% 27% 26% 34% 34% 22% 31% 31% 39% 30% 30% 34% 32% 29% 34% 29% 30% 31%

Negotiated 37.58 44.32 44.52 55.14 45.20 50.37 59.79 54.88 60.99 30.04 42.17 38.00 28.58 35.32 44.88 39.55 38.05 38.08 39.54

68% 71% 72% 74% 64% 66% 77% 69% 69% 61% 70% 70% 65% 68% 70% 66% 71% 69% 68%

Private Placement 0.01 0.04 0.16 0.14 1.02 0.18 0.13 0.01 0.22 0.17 0.24 0.32 0.40 0.06 0.48 0.28 0.28 0.31 0.40

0% 0% 0% 0% 1% 0% 0% 0% 0% 0% 0% 1% 1% 0% 1% 0% 1% 1% 1%

Note:  For each type of sale, the first column presents total issuance per year in constant 2017 USD billion, while the second column shows the percentage share of the respective type of sale in total issuance. Source:  Ipreo MuniAnalytics.

The structure of county government debt from 2002 to 2020  ­331

COUNTY DEBT ISSUANCE BY MATURITY Table 17.7 shows that average bond maturity is related to the economic cycle (higher economic growth rates are associated with a higher average maturity). The amount of shortterm county debt peaked at US$12 billion in 2010 and market share peaked at 20 percent in 2011. In contrast, the share of long-term bonds with a maturity of ten years or more declined from 70 percent in 2008 to 46 percent in 2011, the lowest in our timeframe. The average term to maturity declined from about 130 months in 2007 to less than 105 months in 2011. During the pandemic, the same pattern emerged with a decrease of the longestterm bonds, offset by an increase in shorter-maturity debt. However, the pattern was not nearly as pronounced as after the Great Recession. The average term to maturity only declined from 125 to about 115 months in 2019–20. In 2020, there was only a 2 percent increase in debt with a maturity of one year or less. Compare this to the 5 percent increase from 2008 to 2009, and 6 percent increase from 2010 to 2011. After 2011, very short-term annual issuance dropped significantly, averaging only 7 percent of the market from 2012 to 2019. In contrast, longer-term debt issuance picked up in 2012, and by 2018 averaged 63 percent, which is comparable to pre-Great Recession levels. Overall, in the pandemic we see a shift from very longterm to shorter-term county debt, but the shift was not as great as during the Great Recession. Table 17.7  County debt issuance by maturity Less than One Year 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

4.95 4.88 4.87 6.84 9.22 7.10 7.12 10.99 12.17 10.04 8.77 7.18 4.94 4.58 4.61 4.13 4.07 3.56 4.81

9% 8% 8% 9% 13% 9% 9% 14% 14% 20% 14% 13% 11% 9% 7% 7% 8% 6% 8%

One to Three Years 5.88 6.12 5.20 4.76 4.97 7.39 5.05 7.66 7.02 5.39 5.88 6.24 6.43 6.58 6.07 6.49 6.27 5.99 6.98

11% 10% 8% 6% 7% 10% 7% 10% 8% 11% 10% 11% 15% 13% 10% 11% 12% 11% 12%

Three to Ten Years 10.69 14.09 11.78 13.18 9.37 10.37 10.76 15.68 14.81 11.50 14.80 11.99 10.63 13.89 15.68 13.78 9.43 12.39 14.97

19% 22% 19% 18% 13% 14% 14% 20% 17% 23% 24% 22% 24% 27% 25% 23% 17% 23% 26%

Ten Years and More 34.13 37.54 39.65 50.08 46.57 51.51 54.24 45.77 54.72 22.53 31.15 29.11 21.99 26.85 37.49 35.52 34.18 33.10 31.24

61% 60% 64% 67% 66% 67% 70% 57% 62% 46% 51% 53% 50% 52% 59% 59% 63% 60% 54%

Note:  For each maturity, the first column presents total issuance per year in constant 2017 USD billion, while the second column shows the percentage share of the respective maturity in total issuance. Source:  Ipreo MuniAnalytics.

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COUNTY DEBT ISSUANCE BY INSURANCE Before the global financial crisis of 2007–09, bond insurance had long been one of the most important forms of credit enhancement in the municipal bond market. As Johnson et al. (2014, p. 187) note, “the Great Recession … brought the meltdown of the entire bond insurance industry and catastrophic change to the industry.” The county bond market was no exception. While almost half of all issued county bonds were insured in 2002–07, this trend changed drastically in 2008 and 2009 when their share dropped first to 18 percent and then to 9 percent (Table 17.8). The bond insurance market at the county level has not recovered to pre-financial crisis levels, with the share of insured securities fluctuating between just 3 percent and 7 percent between 2011 and 2019. But from 2019 to 2020, the share of insured debt doubled from 3 percent to 6 percent, indicating that the pandemic may have enhanced the value proposition provided by private insurance firms, and that the county muni market for insurance is still alive, though at substantially reduced levels.

TOP TEN COUNTY ISSUERS BY VOLUME AND MARKET SHARE, AND USES OF PROCEEDS The county debt market has been a highly concentrated market dominated by relatively large issuers. As Table 17.9 demonstrates, the top ten county issuers (0.2 percent of total market participants) occupied more than 18 percent of the market from 2002 to 2020 and Table 17.8  County debt issuance by insurance, percentage of total issuance

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Source:  Ipreo MuniAnalytics.

Insured Bonds (%)

Uninsured Bonds (%)

42 48 51 54 47 43 18 9 8 5 4 5 7 7 5 4 4 3 6

58 52 4 46 53 57 82 91 92 95 96 95 93 93 95 96 96 97 94

The structure of county government debt from 2002 to 2020  ­333

Table 17.9  Top county issuers by volume and market share, and uses of proceeds, 2002–20 County/Issuer 1 2 3 4 5 6 7 8 9 10

Miami-Dade County (FL) Harris County (TX) County of Suffolk (NY) City and County of Denver (CO) Clark County (NV) County of Los Angeles (CA) Airport Commission of the City and County of San Francisco (CA) Nassau County (NY) King County (WA) Public Utilities Commission of the City and County of San Francisco (CA)

Total

Total Volume (2017 USD billion) 34.1 32.2 29.6 24.6 23.8 17.2 15.5 14.1 13.7 11.8 216.6 (18% of the market)

Source:  Ipreo MuniAnalytics.

issued more than US$216 billion in total debt. Predictably, they are located in some of the most populous counties. Los Angeles with 10 million residents, Harris with 4.7 million residents, Miami-Dade with 2.7 million residents, as well as Suffolk, Nassau, Clark, and King all with more than 1 million residents were among the top issuers. General county governments, on average, issued more debt than corporations, authorities, and other entities created by county governments. Among the top ten issuers, there is only one exception: the City and County of San Francisco issued more debt through its Airport Commission (US$15.5 billion) and Public Utilities Commission (US$11.8 billion) than directly through its general government (US$10 billion). Market share is highly concentrated in certain sectors. The transportation sector, as pointed out earlier in this chapter, is the most concentrated, followed by utilities, healthcare, education, and general purpose. Transportation issuance is carried out mostly by authorities and general governments and is large and highly concentrated in the south (Texas), southwest (Florida), and west (California, Nevada, and Colorado), all states with rapidly growing populations. The top ten issuers in healthcare and utilities constitute over 30 percent of the market. The utilities sector consists of county general governments, authorities, and special districts. The healthcare sector also consists of authorities and general governments, but includes corporations and not special districts.

CONCLUSION The impact of the financial crisis and the Great Recession was to place county debt issuance on a new, and lower, level. While US counties issue less debt now than they did before the Great Recession, county debt issuance continued its upward trajectory throughout 2020, despite the fiscal shock from the federal declaration of the COVID-19 pandemic in

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March 2020. During the financial crisis and the Great Recession, and the beginning of the pandemic, the share of unlimited GO debt increased and revenue debt decreased. This shows that issuers and investors view the local property tax as a strong source of repayment for unlimited GO debt even during a fiscal shock, whether the shock is caused by a real estate implosion or healthcare pandemic. Several changes happened to county debt in 2020. One change was in the increased share of insured debt. The pandemic may have enhanced the value proposition provided by private insurance firms. The county muni market for insurance is still alive, though at substantially reduced levels than before the financial crisis. Also, during the pandemic there was a shift from longer-term to shorter-term debt, but the shift was not as great as during the Great Recession. During the pandemic, issuers sold more taxable debt, despite there not being a BAB program or similar taxable debt facility during the pandemic. While taxable debt had increased significantly from 2017 to 2018, likely a result of the elimination of tax-exempt advanced refundings in the federal TCJA, it decreased significantly from 2018–19, prior to the large increase in 2019–20. Overall, the county debt market has demonstrated much greater resiliency to the pandemic shock of 2020 than it did to the fiscal shocks caused by the financial crisis and the Great Recession.

REFERENCES Bahl, R., & Duncombe, W. (1993). State and local debt burdens in the 1980s: A study in contrast. Public Administration Review, 53(1), 31–40. Clingermayer, J. C., & Wood, B. D. (1995). Disentangling patterns of state debt financing. American Political Science Review, 89(1), 108–120. Congress of the United States of America. (2017). Public Law No. 115-97 – Dec. 22, 2017: An act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018. Ellis, M. A., & Schansberg, D. E. (1999). The determinants of state government debt financing. Public Finance Review, 27(6), 571–587. Executive Office of the President. (2020). Declaring a national emergency concerning the novel coronavirus disease (COVID-19) outbreak. Proclamation 9994 of March 13, 2020. Federal Register, 85(53), 15337–15338. Ipreo MuniAnalytics (2020). Comprehensive municipal securities database. IHS Markit. Johnson, C. L., Luby, M. J., & Moldogaziev, T. T. (2014). State and local financial instruments: Policy changes and management. Edward Elgar Publishing. National Association of Counties (NACo). (2019). Counties matter: Stronger counties, stronger America. County history and diversity. https://www.naco.org/about/counties-matter. Pierson, K., Hand, M. L., & Thompson, F. (2015). The government finance database: A common resource for quantitative research in public financial analysis. PLoS ONE, 10(6), Article e0130119. Trautman, R. (1995). The impact of state debt management on debt activity. Public Budgeting & Finance, 15(2), 33–51. Wang, J. Q., & Kriz, K. A. (2015). Determinants of debt burdens: Evidence from California ­counties. Public Finance and Management, 15(2), 91–107.

18. The impact of fiscal rules on local debt: credit ratings, borrowing costs, and debt levels Sungho Park, Craig S. Maher, and Steven C. Deller

INTRODUCTION Local governments throughout the US use both long- and short-term debt financing for a range of policies and services. Long-term debt is often used to finance new infrastructure investments or economic development programs, while short-term debt can be used to mitigate lost revenues during economic downturns or help to manage dayto-day cash flow. The amount of local debt has steadily increased over the last few decades. In 2017, US local governments had over US$1.9 trillion in outstanding debt, issued US$253.2 billion in new long-term debt, and retired US$237.4 billion (US Census Bureau, 2017). The cost of this debt can be a major source of spending for local governments; interest payments on this debt amounted to US$76.2 billion in 2017 alone. The recent COVID-19 pandemic, unfortunately, has placed upward pressure on local debt levels and/or the cost burden of borrowing in order to address fiscal and policy challenges (Cipriani et al., 2020). Policies governing local debt influence, either directly or indirectly, the amount and borrowing costs associated with this debt. One set of policies that can impact the amount and cost of debt is state-imposed fiscal rules such as tax and expenditure limitations (TELs), debt limitations, and balanced budget requirements (BBRs). Focusing only on municipalities (city, village, and equivalence), 44 states have some form of TELs limiting the flexibility of those municipalities (Maher, Park & Harrold, 2016). States with the most stringent municipal TELs include Arizona (under California’s Proposition 13) and Colorado (Taxpayer’s Bill of Rights [TABOR]) (Amiel et al., 2009). Colorado and Arizona have the most restrictive combination of fiscal rules because the states impose debt limitations and BBRs on municipal governments in addition to TELs (Park, 2018). Other types of local governments such as counties and school districts are also subject to such limits in several states (Advisory Commission on Intergovernmental Relations [ACIR], 1993; Lincoln Institute of Land Policy, 2020). While the specifics vary across states, a common rationale for state policymakers enacting these fiscal limits centers on imposing fiscal discipline. The expectation is that fiscal rules can force local governments to be more efficient in their operations. This seems politically rational, but it remains unclear whether these policies have the intended outcome of making local governments more efficient. The literature, unfortunately, is mixed, suggesting conflicting evidence of fiscal rules’ discipline effects and unintended consequences such as increasing the costs of debt through higher interest rates. For example, Maher, Deller, et al. (2016) in a study of municipal credit ratings found that more restrictive TELs on revenue-generating abilities hindered credit ratings, resulting in higher interest costs. TELs on expenditures, in contrast, tended to have the opposite effect. 335

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This study contributes to addressing these inconclusive questions. To that end, we review and synthesize the extant literature on fiscal rules and suggest empirical evidence of the impact of fiscal rules on municipal credit ratings, borrowing costs, and debt levels. The first section provides an overview of the three most common fiscal institutions – TELs, debt limitations, and BBRs. The second section reviews extant studies on the impacts of fiscal rules on local credit ratings and borrowing. In the third section, we focus specifically on municipalities and offer a unique empirical analysis of the effects of fiscal rules on credit ratings, borrowing costs, and debt levels. This study concludes with implications for research and policymakers, particularly in an era when there is both greater fiscal uncertainty and federal efforts to invest in the nation’s infrastructure.

STATE-IMPOSED FISCAL RULES ON LOCAL GOVERNMENTS Tax and Expenditure Limitations State-imposed TELs on local governments range from simply requiring citizen approval of tax rate increases (e.g., referendum) to fixed rules determining the degree to which specific tax rates or bases can increase for specific units of government (e.g., for property taxes how fast assessed values and/or the mill rate1 can increase from one year to the next), to strict limits on growth in revenues and expenditures. Historically, TELs have largely been adopted in response to state officials’ perceptions of voter frustration with property taxes. While property taxes are typically the primary focus, TELs can include multiple provisions such as requiring public notice when tax increases are proposed (i.e., truth in taxation requirements). The longest existing TEL (one that has not changed) is Wyoming’s, which dates to 1911. Written into the state’s constitution, property tax rates for counties, municipalities, and school districts are limited to 12, 8, and 25 mills, respectively. There is, however, an exemption for debt service since the state does not want local governments defaulting on debt. California’s limit, through Proposition 13 in 1978, focuses on property taxes and has spurred structural shifts to greater dependency on sales taxes. The result is that California municipalities have a strong incentive to promote retail development perhaps through unsustainable sprawl. Michigan, through the Headlee Amendment of 1978, limits growth in property tax levies to the rate of inflation. Virginia’s TEL only requires its local governments to advertise the information pertaining to property tax rates and/or amount. More recent state-imposed local TELs have moved beyond the property tax and have sought to limit other forms of revenues and, in some cases, expenditures. One of the most frequently studied is Colorado’s TABOR. Adopted in 1992, the TABOR requires local governments to obtain voter approval for any new taxes or increases in tax rates, restricts expenditure growth, limits budget carryovers, and limits debt (Colorado Constitution, Article X, Section 20). Enterprising local government officials have pursued alternative sources of revenue such as sales taxes and fees/charges to circumvent these limits 1   The amount of tax payable per dollar of the assessed value of a property. It is a figure that represents the amount per US$1000 of the assessed value of the property, which is used to calculate the amount of property tax.

The impact of fiscal rules on local debt  ­337

(Brown, 2001). Nebraska, as another example, has a state-imposed limit on annual growth in local general revenues. Interestingly, Nebraska’s revenue limit law also exempts revenue growth dedicated to interlocal collaboration (e.g., shared health departments) and there is evidence suggesting that local governments have taken advantage of this exemption (Park et al., 2020). As discussed, state-imposed local TELs are overwhelmingly on local revenues and only four states limit local government expenditures – Arizona, California, Colorado, and New Jersey (Lincoln Institute of Land Policy, 2020). In Arizona, for example, counties and municipalities are subject to an expenditure limit, which is adjusted each year to reflect inflation and population growth. The state limit on school districts is also adjusted each year for changes in the student population and inflation. Each local government in Arizona can override the expenditure limit through voter approval. California’s Proposition 13 also limits growth in local expenditures to the inflation rate and population growth, but it excludes local debt service expenditures. Clearly, the level of restrictiveness of TELs on the operations of local governments varies significantly across the states. The literature on state-imposed local TELs has grown significantly in the past several years and has congealed around three different arguments. First, state adoption of TELs has an immediate negative impact on the size and growth of property taxes (Blom-Hansen et al., 2014; James & Wallis, 2004; Joyce & Mullins, 1991; Sun, 2014). Second, the impact of TELs and overall local revenues and expenditures is still unclear (Preston & Ichniowski, 1991; Shadbegian, 1998, 1999; Skidmore, 1999; Sun, 2014). The third argument builds on the second, and focuses on local reliance on nonproperty tax sources such as intergovernmental aid and charges and fees as a result of TELs (Abrams, 1982; Lowery, 1983; McCubbins & Moule, 2010; Sun, 2014). In the end, the structure of how the TEL is constructed plays a significant role in explaining outcomes given that no two states have structured their TELs on local governments in the same way. State-imposed Debt Limitations States’ desire to limit the financial exposure of both state and local governments to excessive debt burdens has a long history. In 1841 and 1842, Florida, Mississippi, Arkansas, Indiana, Illinois, Maryland, Michigan, and Pennsylvania defaulted on their interest payments (Oates, 2008). Other states, including Alabama, New York, Ohio, and Tennessee narrowly avoided default. As a result, several states re-wrote their constitutions and included restrictions on debt levels (i.e., debt ceilings) and/or how debt can be assumed (i.e., debt restrictions) (Wallis, 2005). Indeed, constitutional limits on state and local debt are the oldest form of an explicit fiscal control dating from the 19th century. More recent examples of local debt problems include the City of Harrisburg, Pennsylvania, Jefferson County and the City of Fairfield, Alabama, the City of Vallejo and the City of San Bernardino, California, and the City of Detroit Michigan, where bankruptcy has occurred or is being considered because of excessive debt burdens. States have employed either/or a combination of two different ways to control their municipalities’ debt capacity: (1) debt ceilings placing caps on the maximum amount of debt incurred, generally as a percentage of the property tax base; and (2) debt restrictions constraining the process of debt issuance such as debt purposes, maximum bond life, and interest ceilings (Wagner, 1970; Yusuf et al., 2012). A total of 46 states currently have debt

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ceilings (exceptions are Florida, Pennsylvania, Tennessee, and Texas) and all states have had at least one type of debt restrictions since 1990 (Park, 2018). Thus, debt limitations, specifically debt ceilings and/or restrictions, are prevalent across states. The one type of debt restriction that generates most variation in municipal debt management is the existence of referendum requirements on bond issues. Currently, referendum requirements exist in 39 states (Connecticut, Delaware, Hawaii, Indiana, Iowa, Kentucky, Maryland, New Jersey, Oklahoma, Rhodes Island, and Vermont are the exceptions). Under bond referendum requirements, municipal decision-makers must obtain voter approval to issue general obligation (GO, which is backed solely by the credit and taxing power of the issuing jurisdiction rather than the revenue from a given project) or other types of bonds. ACIR (1961) described the operation of a bond referendum as limiting “the power of the governing bodies of local governments” through “direct popular authorization” (p. 31). State-imposed Balanced Budget Requirements Although “the norm of balance” in local budgeting has been prolific since the 1990s (Lewis, 1994), the implementation of BBRs can shape local fiscal outcomes. States developed BBRs as early as 1933 (Kansas) and 1965 (Nevada). Lewis (1994) reported that as of 1992, 20 states require their municipal governments to balance their budgets.2 A recent review of state constitutions and statutes has updated this record: as of 2016, a total of 24 states have anti-deficit rules at the municipal level (Park 2018).3 Despite a few exceptions, state-imposed requirements in most cases are a form of regulation precluding a negative balance in the adopted budget. Taking Idaho as an example: The city council of each city shall … pass an ordinance to be termed the annual appropriation ordinance, which in no event shall be greater than the amount of the proposed budget … not exceeding in the aggregate the amount of tax authorized to be levied … in addition to all other anticipated revenues. (Idaho Statutes 50-1003)

Some states have not applied BBRs to all local governments. For example, only municipalities with populations over 500 000 are subject to the control of balanced budget rules in Illinois. Further, a few states focus on constraining general fund deficits (e.g., Utah), while some states prohibit deficits in all municipal funds (e.g., Arizona, Colorado, and Wyoming). States generally have exemption clauses for emergency expenditures such as a natural disaster. Compared to bond referendum requirements, two prominent features characterize state-imposed anti-deficit rules. One is that their constraining effects cover a broader range of deficit financing tools, unlike bond referendum requirements that only target the issuance of debt. In fact, studies have examined the role of balanced budget rules in terms of managing debt burdens (e.g., Heun, 2014; Sneed, 2002) and fund balances (e.g., 2   The number of states that had municipal BBRs in the 1990s is somewhat unclear. In fact, ACIR (1993) stated that only 11 states imposed BBRs on local governments as of 1990. 3   States with municipal BBRs: Alabama, Arizona, Colorado, Georgia, Florida, Idaho, Illinois, Kansas, Kentucky, Louisiana, Massachusetts, Michigan, Missouri, Montana, Nebraska, Nevada, North Carolina, Oklahoma, Oregon, Rhodes Island, Utah, Washington, Wisconsin, and Wyoming.

The impact of fiscal rules on local debt  ­339

Bohn & Inman, 1996; Hou & Smith, 2010). In addition, BBRs may play a more stringent and preemptive role than bond referendum requirements by forbidding the gap between revenues and spending.

FISCAL RULES AND LOCAL DEBT FINANCING: WHAT DOES THE LITERATURE TELL US? Fiscal Rules, Credit Ratings, and Borrowing Cost Access to credit and debt markets is vital for the functioning of local governments. Local governments need access to short-term credit to finance day-to-day operations, as tax revenues ebb and flow over the course of the fiscal year. Local governments also need access to long-term debt markets, generally through the bond markets, to finance often expensive capital improvements. Borrowing costs include interest payments and other costs related to debt issuance. Such costs, which have a significant impact on the viability of capital projects and local fiscal health, largely hinge on the perceived risk associated with the ability to repay the debt. Key is how markets, or more specifically, the potential buyers of the debt, determine risk levels. One invaluable piece of information that the markets use is the credit ratings offered by Moody’s or Standard & Poor’s and more recently Fitch. Liu and Thakor (1984) maintained that the markets rely extensively on these credit ratings because the ratings agencies have access to information that the general public does not. This information requires costly search and processing efforts, and credit and bond ratings are the screening mechanism for the markets (Kaplan & Urwitz, 1979). In an early study of corporate bond interest rates, West (1973) found that the ratings systematically affect the yields or interest rates of bonds even after controlling for firm-specific factors. Benson and Marks (2004) identified similar results in their examination of 593 school district and 964 city bonds. There are two ways that rating agencies might treat fiscal rules in determining creditworthiness. One perspective is that they serve as forms of fiscal discipline. A lack of flexibility forces local governments to adopt more conservative, and hence less risky, fiscal policies; such policies can reduce the risk of default (Bayoumi et al., 1995; Johnson & Kriz, 2005). Alternatively, imposing restrictions on the flexibility of local governments could affect public officials’ ability to adjust their financing to meet short- and long-term needs (Kioko, 2010; Lowry & Alt, 2001). If local governments are limited in their ability to raise revenues to repay credit or debt, the risk of default is higher, thus leading to lower credit ratings and higher interest costs. Further, new economic development opportunities may require local governments to make immediate investments in infrastructure to enable that development. If fiscal rules imposing fiscal discipline create roadblocks that limit short-term flexibility, they can hinder economic growth and development.4 In the case of a fiscal emergency, such as those flowing from an economic crisis or natural disaster including public health crises such as 4   One mechanism that many states allow is the use of tax increment financing (TIF) districts where future property taxes generated by the development are used to finance debt. Such districts tend to be regulated by the state and impose certain limitations.

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the COVID-19 pandemic, local governments lack the flexibility to respond in a timely manner. Conversely, recent congressional passage of a US$1 trillion infrastructure bill (Cochrane, 2021) could offer an opportunity to improve local capital plants that may be thwarted by debt limits. There is limited literature specifically examining how limitations imposed on revenues and expenditures affect the creditworthiness and borrowing costs of local governments (e.g., Beebe, 1979; Benson, 1980; Maher, Deller et al., 2016; Poterba & Rueben, 1999a, 1999b; Stallmann et al., 2012; Wagner, 2004). Benson (1980), for example, focused on the determinants of interest costs for a sample of bond issuances in California before and after the adoption of Proposition 13. He found strong evidence that lower credit ratings are consistent predictors of higher interest costs. He also found that the imposition of Proposition 13 increased the interest costs of GO bonds, and investors shifted to other government bonds that were not as dependent on property taxes, the focus of Proposition  13, for future repayment (such as public utility bonds). More recently, Johnson and Kriz (2005), in their state-level study, found that TELs that limit the ability to raise revenue increase bond yields, while TELs focusing on the growth of expenditures may reduce or have no clear impact. This finding makes intuitive sense: limiting the ability to raise necessary revenues is considered a threat to meeting debt obligations but limiting the ability to raise spending is not. Interestingly, Moldogaziev et al. (2017) show similar results with regard to revenue TELs. The authors also find no statistically significant influence of expenditure TELs on municipal borrowing costs. Our study (Maher, Deller et al., 2016) of 566 US municipal governments over the 2007–10 time period revealed that the presence of TELs tends to be associated with lower credit ratings. We found that more restrictive limitations on municipal revenues are linked to lower credit ratings. Less restrictive components of TELs, such as property tax rate limits and full disclosure requirements, are less important in determining creditworthiness. Unlike the theoretical expectation that fiscal discipline imposed by TELs can improve creditworthiness, TELs limit fiscal flexibility and weaken credit ratings according to our findings. Because credit ratings are directly tied to borrowing costs (i.e., interest rates), states that impose more restrictive TELs on municipalities may increase the cost of borrowing for municipalities, all other things being equal. In other words, municipal governments with more fiscal flexibility may have a lower likelihood of defaulting on their obligations; more restrictive TELs may remove that flexibility. This is consistent with the findings of Palumbo and Zaporowski (2012) on the effects of revenue-focused TELs. This is inconsistent, however, with the work of both Marlowe (2011) and Lee et al. (2021), who reported no significant impact of TELs on municipal credit ratings. Unfortunately, the sparseness of studies examining the implications of state-imposed BBRs and debt limitations on local creditworthiness and borrowing cost leaves a gap in our understanding of the implications of these requirements. Hence, the discussion of the requirements on local governments primarily builds on the existing literature of state-level BBRs and debt limitations. One exception is Rundle (2009), who analyzed 410 municipal bond issues from 27 states and offered evidence that state-imposed debt limitations have no significant impact on municipal true interest costs. At the state level, Sneed (2002), along with Lowry and Alt (2001), found BBRs are likely to improve government credit ratings and may contribute to lowering interest costs. Johnson and Kriz (2005) found

The impact of fiscal rules on local debt  ­341

similar results with regard to BBRs and credit ratings, but they reported an opposite direction for debt limitations. Fiscal Rules and Debt Levels There are competing theoretical perspectives on the role of fiscal rules and debt issuance. Starting with TELs, it is relatively straightforward to imagine that TELs depressing local fiscal capacity may constrain an entity’s ability to finance public services. Local governments may rely more on debt financing to fill such resource gaps. If the implementation of TELs is associated with higher credit ratings, it may help local governments issue more debt at a lower level of interest costs. On the other hand, TELs could result in lower credit ratings, as discussed above. They may prevent local governments from issuing more debt due to higher borrowing costs. These results, however, may vary depending on the specific structure of TELs. Further, other fiscal rules such as BBRs and debt limitations may generate greater uncertainty because they could also have separate effects on credit ratings and the extent to which each local government needs debt financing. The empirical evidence on fiscal rules and local debt levels is mixed. Bennet and DiLorenzo (1982) found that debt incurred by special-purpose districts increased as stateimposed TELs become more restrictive. They found that during the initial phase of tax revolts in the 1970s, state and local governments were able to circumvent these fiscal constraints by shifting expenditures and debt to special-purpose districts (see also Zhang, 2018). When Illinois imposed strict limits on municipal debt levels, there was a spike in the creation of special districts with the specific goal of side-stepping the debt limits (Bollens, 1986). Cope and Grubb (1982) and Rothenberg and Smoke (1982) also found immediate local debt increases after the state adoption of TELs in Texas and Massachusetts, respectively. In a more recent study of local TELs and debt issuance, Kioko and Zhang (2019) studied the relationship between TEL structures and county-level tax-supported debt. The authors found that tax-supported debt was depressed in counties with limits on assessed valuation and property tax levy growth. Interestingly, general revenue and expenditure limits appeared to have no effect on county-level debt. Further, reflecting the need to understand TEL design, Kioko and Zhang (2019) reported a positive relationship between property tax rate limits and county debt, but when combined with limits on assessed valuation, the direction becomes negative. Park (2018) further elaborated on this institutional design idea. His findings indicate that when state-imposed TELs on municipal revenues are coupled with other rules such as BBRs and debt limitations, they may lead municipal governments to incur a lower level of GO debt. Farnham (1985) offers one of the few studies that provide direct evidence of the impact of debt limitations on local debt. The author focused on 2,087 communities with populations over 10,000 in 1975 and found that state-imposed debt limitations have a significant negative impact on the three different categories of debt: gross debt, long-term debt, and GO debt. Rundle (2009), in his examination of 772 metropolitan counties across 42 states, found similar results that state-imposed debt limitations have a negative impact on local GO debt levels. Park (2018) also reported that municipal governments with state-imposed debt limitations tend to have lower GO debt compared with their counterparts that only have revenue TELs.

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Scholars of local public finance (e.g., Arvate et al., 2009) have argued that voters are more risk-averse than their representatives, thus they favor imposing some form of fiscal discipline on those local officials. From this point of view, bond referendum requirements can contribute to curbing the level of municipal bond issues (Feld & Kirchgässner, 1999, 2001; Kiewiet & Szakaly, 1996). In fact, Feld and Kirchgässner (1999) showed that for municipalities in Switzerland, the presence of bond referendum requirements contributes to total municipal debt being approximately 24 percent lower than those of municipalities without bond referendum. Kelly and Massey (1996) studied the effects of bond referendum requirements in the US context, and found no difference in debt levels between municipalities with and without referendum requirements. The authors asserted that municipal officials have been effective in persuading voters to vote favorably on debt issues through voter education or public advertisements. Maher and Skidmore (2008), in their study of school funding referenda in Wisconsin, suggested that school officials are adept at judging the preferences of the voters and will only go to referendum if the likelihood of passage is perceived as high. The available state-level research has generally agreed (except for Albritton & Dran, 1987) that the implementation of anti-deficit rules significantly contributes to a lower level of budgetary deficits and debt. Hou and Smith (2010), along with Poterba (1995), found that BBRs generally lead to lower annual deficits, though it depends on the specific structure of BBRs and different measures of government deficits. Krol (1996) surveyed some of the existing studies on BBRs and state deficits, and found that there is a general agreement with the deficit reduction effect of BBRs and their subsequent result of lower debt issuance. While there has been some interest in studying the impacts of different fiscal rules on local debt financing, we are clearly in need of more research to develop a robust understanding of fiscal rules and local debt financing. As noted by Kioko and Zhang (2019), “the far-reaching influences of TELs on a locality’s choice of debt instruments also provide a robust area for future research” (p. 426). In our view, this argument is not only valid for TELs, but is also applicable to other types of state-imposed fiscal rules such as BBRs and debt limitations.

EMPIRICAL EVIDENCE ON THE IMPACT OF FISCAL RULES ON DEBT FINANCING Empirical Modeling A focal point of this study is to offer additional evidence of the impact of state-imposed fiscal rules on various characteristics of municipal debt financing. To do so, we build our analysis on the credit rating model of Maher, Deller et al. (2016) but extend it in two major ways. First, we employ some additional debt measures, in addition to municipal credit ratings, to capture different municipal debt financing characteristics such as borrowing costs and debt levels. Second, while Maher, Deller et al. (2016) focused heavily on the years affected by the Great Recession of 2008–09, our analysis covers more recent years to offer more generalizable findings and implications. Our model can be expressed as:

​​Di, t ​  ​​  = β · ​Ij, t − 1 ​  ​​+ γ · ​Si, t − 1 ​  ​​  + α · ​Fi, t − 1 ​  ​​+ μ + π + ε,​ (18.1)

The impact of fiscal rules on local debt  ­343

where ​​Di, t ​  ​​​ represents government debt financing characteristics in municipality i in year t; ​​Ij, t − 1 ​  ​​​ indicates different state-imposed fiscal rules each sample municipal government in state j faces in year t – 1; ​​Si, t − 1 ​  ​​​ is a set of socioeconomic control variables for each sample municipality in year t – 1; and ​​Fi, t − 1 ​  ​​​ captures municipal fiscal condition or fiscal risk factors. We also include year (​μ​) and regional (​π​) fixed effects and a traditional wellbehaved error term (​ε​). We employ six different dependent variables: credit ratings, debt service expenditures, total debt outstanding, long-term debt outstanding, GO debt outstanding, and shortterm debt outstanding. The municipal credit rating is measured based on Moody’s underlying rating assigned to the issuer’s long-term GO debt, which reflects each municipal government’s underlying creditworthiness absent any additional enhancement or insurance. In our dataset, Moody’s ratings range from Aaa to Ba2. We code the strongest credit rating of Aaa as 1 and the weakest rating of Ba2 as 12, so a higher number indicates a weaker rating. The most frequent ratings are Aa2 (30 percent of total observations) and Aa3 (21 percent of total observations). Debt service expenditures, available from the Government Financial Officers Association’s (GFOA) Municipal Financial Indicators database, do not capture true interest costs. However, this could be at least a partial measure of municipal borrowing costs: the driving consideration for a household making a mortgage or car loan payment is more the value of the interest than the actual interest rate. The total debt outstanding, long-term debt outstanding (with maturities greater than one year), and short-term debt outstanding (with maturities less than one year) variables are measured using the US Census Bureau’s Annual Surveys of State and Local Government Finances. GO debt outstanding data, which is expected to indicate the specific structure of municipal long-term debt financing, come from the GFOA’s Municipal Financial Indicators database. All variables except for credit ratings are measured in real per capita and are log transformed.5 Our key independent variables are expected to reflect fiscal rules encountered by each sample of municipalities. TELs are measured using the restrictiveness index developed by Maher, Park and Harrold (2016). The authors built their index in the spirit of Amiel et al. (2009) but modified it to be applicable to municipalities. Specifically, we use two different specifications of the TEL index. One is the index for TELs that constrains the revenue side of the ledger (i.e., property taxes and general revenues). The other is the index for TELs that limits both municipal revenues and expenditures. These are the same measures used in Maher, Deller et al. (2016). To measure state-imposed bond referendum requirements and BBRs, we use a binary measure and a sample municipality with each rule is coded as 1, otherwise 0. Data come from Park (2018), where the author updated the fiscal rule information reported through ACIR (1993) up to 2016. We include a total of seven control variables. The first four control variables are expected to capture municipal socioeconomic characteristics: population (log transformed), median household income (inflation adjusted and log transformed), ethnicity (white population relative to total population), and educational attainment (population with high school graduate or higher relative to population aged over 25). Though we do

5   We converted zeros in the debt variables into a small positive value before the logarithmic transformation.

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not offer any specific hypotheses behind these control variables, prior research has found them to be important determinants of credit ratings and overall debt levels (see, for example, Marlowe, 2011). As with the socioeconomic variables, prior research has demonstrated that municipal fiscal condition is one important determinant of municipal debt financing (see, for example, Capeci, 1991). As such we include three measures capturing municipal fiscal condition or fiscal risk factors: general fund unreserved-undesignated balances (or unassigned balances since 2012 due to Government Accounting Standards Board [GASB] Statement No. 54) as a percentage of general fund expenditures (GFUFB), general fund taxes as a percent of general fund revenues (GFTAX), and governmental funds expenditures as a percentage of total revenues (GEXPRE). All fiscal condition variables are log transformed.6 Overall, we have an unbalanced panel of more than 2,000 observations across the US from 2008 to 2017 (2008 to 2016 for the GO debt and debt service expenditure models due to limited data availability). Given the ordinal structure of the credit rating variable, we report negative binomial estimators for the credit ratings model, while OLS estimators are reported for the remaining models. Analysis Results As reported in Table 18.1, all models are statistically significant at the 99 percent level and the models predict between 2.05 and 24.30 percent of the variation in the dependent variables. The highest variance inflation factor (VIF) across the models is 4.00; we have no clear evidence that our models are subject to the multicollinearity issue. For brevity we focus our discussion on the policy variables of interest and leave the interpretation of the control variables to the reader. Also, for brevity we do not report out the results on the year and regional fixed effects. Recalling that higher values of the credit rating variable are associated with lower credit ratings, the results suggest that more restrictive TELs (capturing restrictions on both revenues and expenditures) tend to lower credit rating. This may suggest that credit rating agencies consider state-imposed limits both on revenues and expenditures as most harmful in limiting municipal fiscal flexibility and ability to repay debt. This finding runs counter to Marlowe’s (2011) finding of no significant impact of TELs on municipal credit ratings and Palumbo and Zaporowski’s (2012) finding of higher credit ratings as a result of expenditure limits. TELs that focus on revenues only, however, are statistically insignificant, suggesting that the focus of the TEL matters in understanding credit risk proxied by credit ratings. This is somewhat inconsistent with Maher, Deller et al.’s (2016) finding that state-imposed revenue TELs may lead to lower municipal credit ratings. The authors’ findings may be time-specific. As discussed, Maher, Deller et al. (2016) focused on the years when the impact of the Great Recession was prevalent. During that period, limits on revenues might be stringent enough to limit municipal fiscal flexibility. As we consider the fiscal shock

6   We converted zeros in the fiscal condition variables into a small positive value before the logarithmic transformation.

345

−0.012 (0.008) 0.010 (0.007) −0.030 (0.116) −0.153** (0.062) 0.114*** (0.031) 0.183** (0.088) −0.002 (0.002) 0.021*** (0.005) −0.069** (0.031) 0.010 (0.048) 1.106*** (0.157) −6.654*** (0.577) 2096 20.29*** 0.1667

−0.028** (0.013) 0.004 (0.013) −0.626*** (0.150) −0.178 (0.115) 1.034*** (0.070) −0.736*** (0.225) 0.014*** (0.005) 0.038*** (0.014) −0.131** (0.057) −0.087 (0.114) 0.575 (0.421) −15.024*** (1.355) 2315 16.40** 0.2430

−0.030** (0.013) 0.003 (0.013) −0.604*** (0.150) −0.168 (0.115) 1.037*** (0.070) −0.720*** (0.225) 0.015*** (0.005) 0.038*** (0.014) −0.130** (0.057) −0.096 (0.114) 0.554 (0.419) −15.106*** (1.353) 2315 16.45*** 0.2430

−0.035** (0.014) −0.058*** (0.015) −0.891*** (0.232) −0.299** (0.120) 0.181*** (0.057) 0.548*** (0.154) −0.005 (0.004) 0.038*** (0.010) −0.176*** (0.054) −0.176*** (0.054) 0.476*** (0.163) −9.187*** (1.145) 2096 17.36*** 0.1773

0.061*** (0.015) 0.011 (0.011) −1.113*** (0.197) −0.123 (0.128) 0.212*** (0.055) −0.526*** (0.155) 0.001 (0.004) −0.016* (0.009) −0.109* (0.061) 0.327*** (0.117) 0.138 (0.301) −8.209*** (0.900) 2315 8.03*** 0.1119

Real per Capita Real per Capita Real per Capita Real per Capita Real per Capita Short-term Debt GO Debt Long-term Debt Total Debt Debt Service Outstanding Outstanding Outstanding Outstanding Expenditures (ln; US$1,000) (ln; US$1,000) (ln; US$1,000) (ln; US$1,000) (ln; US$1,000)

Note:  Unstandardized coefficients are reported; robust standard errors are in parenthesis. * p < 0.10; ** p < 0.05; *** p < 0.01

0.002 (0.003) Revenue and expenditure TELs (index) 0.006** (0.003) Bond referendum requirements (dummy) −0.069 (0.043) BBRs (dummy) −0.021 (0.027) Population (ln; persons) −0.039*** (0.013) Real median household income (ln; US$1000) −0.198*** (0.041) Ethnicity (%) 0.001 (0.001) Educational attainment (%) −0.003 (0.002) GFUFB (ln; ratio) −0.026** (0.012) GFTAX (ln; ratio) 0.053* (0.027) GEXPRE (ln; ratio) −0.044 (0.077) Intercept 2.754*** (0.228) N 2315 Wald χ2 or F 239.11*** Pseudo R2 or R2 0.0205 Year and regional fixed effects Included

Revenue TELs (index)

Credit Ratings (1–18)

Table 18.1  Regression results: impacts of fiscal rules on municipal debt financing

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caused by the COVID-19 pandemic, we may need to revisit the findings of Maher, Deller et al. (2016) during this period. The two TEL variables are not significant in the debt service expenditure model. These findings are generally inconsistent with prior evidence such as Benson’s (1980) observation of higher local interest costs after Proposition 13 and Moldogaziev et al.’s (2017) finding of the positive impact of state-imposed TELs on municipal bond yields. This can be attributed to our limited measure of borrowing costs, which includes payment both for principal and interest. If TELs lead to reduced principal amounts, which is supported by the results of the other models in Table 18.1, that could offset an increase in borrowing costs as a result of TELs. The negative coefficients of the revenue TEL variable are statistically significant in relation to the total debt, long-term debt, and GO debt outstanding models. Our findings support Kioko and Zhang’s (2019) county-level findings of lower tax-supported debt outstanding as a result of state-imposed TELs. But the findings are inconsistent with Bennet and DiLorenzo (1982), Cope and Grubb (1982), and Rothenberg and Smoke (1982), who commonly found increased debt as a result of TELs at the local level. The latter idea of increased municipal reliance on debt financing as a response to TELs, however, may be true for some particular types of debt given the significant positive coefficient of the variable in the short-term debt outstanding model (see also Poterba & Rueben, 1999b; Sharp & Elkins, 1987). There are two possible explanations of these results. First, revenue TELs often represent taxpayers’ concern about property taxes and their growth. Hence, municipal officials may take revenue TELs as a political signal and be motivated to reduce reliance on property taxes even lower than the given limit to satisfy their political principals (Springer et al., 2009). Though property taxes for debt service purposes are often exempted from limitations, lower debt (particularly GO debt) and subsequent less reliance on property taxes for debt purposes could be one option for municipal officials to reduce property taxes. Second, studies have observed that municipal governments have successfully generated unconstrained own-source revenues enough to make up for or even greater than their loss in property taxes (McCubbins & Moule, 2010; Sun, 2014). From this relatively longterm point of view, municipal governments under revenue TELs may generally have less need to rely on debt. The revenue and expenditure TEL variable is significant only in the GO debt outstanding model, indicating that limitations both on revenues and expenditures could lead to a reduced level of municipal GO debt. However, the variable is not statistically significant in the other debt outstanding models. Given that long-term debt represents a sum of GO and revenues debt, the variable’s insignificance in the total and long-term debt outstanding models suggest that TELs may motivate municipal governments to switch from GO debt to revenue debt. A similar pattern of increasing revenue debt as a response to TELs has been reported in Kioko (2010) and Sharp and Elkins (1987). Sharp and Elkins (1987) described this pattern of debt financing as municipal circumvention or unintended consequences of TELs. We found evidence that state-imposed bond referendum requirements have no significant impact on municipal credit ratings and debt service expenditures. Studies have suggested that credit rating agencies may view bond referendum requirements as an indicator of lower or higher government default risk (Johnson & Kriz, 2005). However, our results

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support Rundle’s (2009) findings that state-imposed limitations on municipal debt financing have no clear effects. The bond referendum requirement variable is negatively associated with municipal debt levels, as shown in the four debt outstanding models. This makes sense given that bond referendum requirements and, more broadly, debt limitations, aim to control municipal excessive use of debt financing. These findings are consistent with Feld and Kirchgässner’s (1999) findings in Switzerland, but run counter to Kelly and Massey’s (1996) findings of no direct impact of bond referendum requirements on debt levels. We found no significant effects of BBRs across all models except for the debt service expenditure and GO debt outstanding models. The existing state-level findings of BBRs lowering deficits and debt (Krol, 1996) may be applicable to certain aspects of debt financing at the municipal level. One potential reason for this insignificance may come from two of Lewis’s (1994) observations on local budget balancing practice. First, regardless of state-imposed BBRs, most local governments are already motivated to balance their budgets because “the norm of balance” is pervasive and/or their own local laws may already include some budget balancing requirements. Thus, especially in determining municipal credit ratings and debt levels, BBRs may not generate significant variations. Second, balancing budgets typically has several different meanings such as balanced adopted budgets or balanced year-end balances. Hence, local governments can find some ways – for example, withdrawing budget savings or accounting gimmicks – rather than relying on debt for the purpose of budget balancing. If this is the case, we may observe no significant impact of BBRs on municipal debt financing.

DISCUSSION AND CONCLUSION In this chapter we described the breadth of fiscal controls imposed by states on local governments, specifically municipalities, including TELs, debt limitations (specifically bond referendum requirements), and BBRs. These policies have been put in place over the years in the name of fiscal prudence, particularly at the bequest of voters. The driving motivation is voters’ frustrations with the property tax, historically the primary source of funding for local governments. The critical question for policymakers must be, to what extent have these fiscal instruments affected local fiscal behavior and, more specifically for the purpose of this discussion, local debt financing? Do these policies have the intended outcome of imposing fiscal discipline on local governments or do they have serious unintended consequences that undermine their intent? In aggregate, we know that local governments are no different from states and the national government – debt issuance is growing. This study offered some observations on the roles of fiscal policies and municipal debt actions. From the perspective of credit ratings and borrowing costs, imposing limits on both revenues and expenditures negatively affects credit ratings (i.e., lower credit ratings), while bond referenda and BBRs are not associated with credit ratings. These findings make intuitive sense – rating agencies worry about substantial limits on municipal fiscal flexibility. We also found that revenue TELs are associated with lower debt levels. Thus, if the policy aim were to limit municipal reliance on debt, these fiscal instruments appear to be working. However, revenue and expenditure TELs are associated only with lower GO

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debt outstanding, while they have no impact on a broader range of debt such as long-term debt. It may suggest a rule design issue that stringent TELs could motivate municipal governments to rely on some other types of debt such as revenue debt. As expected, bond referendum requirements are associated with a lower level of municipal debt outstanding. We only found limited evidence of the impacts of BBRs on municipal debt financing. When we look at the specific effects of these fiscal policies, two general themes are emerging. The first is that credit rating agencies appear to consider the effects of TELs on the ability of borrowers to pay back debt. We see this play out in the cited research and the new findings presented here. State-imposed TELs on both revenues and expenditures have a negative impact on credit ratings. The rating agencies do not seem to care as much if a local government operates under revenue limits, as evidenced by this study. The second theme is that there is a gap in the literature when it comes to the effects of other fiscal policies. There is limited examination of the effects of bond referenda and BBRs on municipal debt financing. This, undoubtedly, is where we can see the clear contribution of this study. In the context of recent fiscal and social shocks caused by COVID-19 and its various strains, what is the takeaway from these findings? We know that the pandemic has been most disruptive on municipalities heavily reliant on tourism. With reductions in tourism, those communities not only lose revenues generated from non-residents but the tax burden also shifts to residents. At a time when borrowing costs are at record lows, there is great need for capital investment and the federal government has recently committed US$1 trillion to invest in the nation’s infrastructure, the question remains, particularly for those municipalities under state-imposed restraints, whether local governments will be capable of seizing the moment.

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Sneed, C. (2002). An examination of the effects of balanced budget laws on state borrowing costs. Journal of Public Budgeting, Accounting & Financial Management, 14(2), 159–173. Springer, J. D., Lusby, A. K., Leatherman, J. C., & Featherstone, A. M. (2009). An evaluation of alternative tax and expenditure limitation policies on Kansas local governments. Public Budgeting & Finance, 29(2), 48–70. Stallmann, J. I., Deller, S., Amiel, L., & Maher, C. (2012). Tax and expenditure limitations and state credit ratings. Public Finance Review, 40(5), 643–669. Sun, R. (2014). Reevaluating the effect of tax and expenditure limitations: An instrumental variable approach. Public Finance Review, 42(1), 92–116. US Census Bureau. (2017). Annual survey of state and local government finances. https://www.census. gov/programs-surveys/gov-finances.html. Wagner, G. A. (2004). The bond market and fiscal institutions: Have budget stabilization funds reduced state borrowing costs? National Tax Journal, 57(4), 785–804. Wagner, R. E. (1970). Optimality in local debt limitation. National Tax Journal, 23(3), 297–305. Wallis, J. J. (2005). Constitutions, corporations, and corruption: American states and constitutional change, 1842 to 1852. The Journal of Economic History, 65(1), 211–256. West, R. R. (1973). Bond ratings, bond yields and financial regulation: Some findings. The Journal of Law & Economics, 16(1), 159–168. Yusuf, J., Fowles, J., & Grizzle, C. (2012). State fiscal constraints on local government borrowing – effects on scale and cost. In H. Levine, E. A. Scorsone, & J. B. Justice (Eds.), Handbook of local government fiscal health (pp. 475–504). Jones & Bartlett Publishers. Zhang, P. (2018). The unintended impact of tax and expenditure limitations on the use of special districts: The politics of circumvention. Economics of Governance, 19(1), 21–50.

19. Do municipal pensions matter? A review of pensions’ impact on US local governments Gang Chen

INTRODUCTION In the United States, government-sponsored pension plans are the main source of retirement income for local government employees when they retire. Funding for these pension plans comes from government and member contributions as well as investment gains from pension assets invested in capital markets. At the local level, governments’ annual contributions to pension plans take up a significant portion of a local government’s budget. For many local governments, the year-to-year fluctuation in the contribution amount creates challenges for their administrators to budget for these contributions. If pension plans do not receive enough contributions or investment returns to cover their costs, unfunded liabilities would accumulate in the plan. The poor financial condition of pension plans is a concern for many local governments, and in some cases, governments’ credit ratings could be downgraded because of poor pension funding. Although we generally understand the importance of municipal pensions for local governments and their employees, there has not been a systematic review of these impacts and the empirical evidence to support these impacts. Prior studies on public pensions mostly focus on large pension plans, especially those that are administered by state governments. Studies that exclusively focus on municipal pensions are limited and also constrained by available data from local-level plans. Municipal pensions are important and deserve special attention for several reasons. First, local governments, especially small ones, might not have enough professional staff or experienced administrators to navigate the complexity of pension management. Poor decisions in their pension management could lead to serious fiscal issues. Because of the lack of capacity, many local governments join the state-administered pension systems. In that case, they do not have enough influence over the pension systems’ policies. Pension management at the local government could face some unique challenges. Second, compared to state governments, local governments spend a relatively larger portion of their budget on personnel expenses. Therefore, contributions to pension plans also take up a significant portion of their budget. Because pension funds invest a large portion of their assets in capital markets, the volatility of investment returns creates uncertainty for the annual required contribution amount for local governments, which poses further challenges for municipal budgets. A sudden increase in pension contributions could bring serious fiscal stress to local governments, while state governments, because of the size of their budget, could be more resilient to external shocks. Third, the lack of studies on municipal pensions is because of the lack of data. Most studies on US public pensions use large-scale public pension datasets such as Public Plans Data (PPD) (2001–20). In the PPD database, most of the plans are state-administered pension plans or large local 352

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pension plans, such as New York City Employees’ Retirement System (NYCERS). Small local plans are usually excluded from large datasets and therefore studies on small local pensions are limited. Recent studies have used newly constructed datasets or case studies to study local pensions. To fill the gap in the literature, this chapter provides a summary of the impact of municipal pensions on local governments and their employees based on a comprehensive review of recent studies on municipal pensions in the United States. The rest of the chapter is organized as follows. In the next section, the current status of municipal pensions in the United States is described. In the third, fourth and fifth sections, the literature on the impact of municipal pensions on local governments is reviewed, including the impact on local budgets, the fiscal risks, and the impact on government employees. In the sixth section, the recent reforms and changes in municipal pensions are examined. The last section provides a discussion on pension-related issues for local administrators to consider and points out several directions for future research on municipal pensions.

MUNICIPAL PENSIONS IN THE UNITED STATES For most public employees, the majority of retirement income comes from governmentsponsored pension plans. There are 5,043 local pension systems (which might include more than one plan) in the United States (US Census Bureau, 2020). These local systems vary in terms of their size, structure, and coverage. In Pennsylvania, there are 1,571 local pension systems, which cover a total of 237,206 members (including 115,419 active employees and 121,787 inactive members or beneficiaries). In New York State, only six local pension systems (mostly in New York City) cover a total of 812,571 members (including 396,458 active employees and 416,113 inactive members or beneficiaries). In 2020, state and local governments contributed US$38,796 million to these local pension systems, while employees contributed US$9,426 million (ibid.). Most local pension plans are defined benefit plans, in which pension benefits are predetermined by a benefit formula. These benefits are also protected by state laws and contracts (Monahan, 2010). Only a small portion of local employees and pension assets are included in defined contribution plans (Munnell et al., 2014). Some local governments join state-administered cost-sharing multi-employer pension systems. In the cost-sharing systems, the local pension assets and liabilities are pooled and shared with other employers (i.e., the state government as well as other participating local governments). Thus, benefits for local employees in these systems are determined by state-level policies. The governance of these systems, including contribution and investment policies, is centralized at the state level. Cost sharing can reduce the administrative cost and potentially increase investment returns, but by joining these systems, local governments might lose the independence of pension policies. Some governments establish their own pension plans. In this way, they have more control over the benefit, contribution, and investment policies in their pension plans. However, their administrative cost might be high and investment options might be limited because of the small size of the plan. Also, they could face challenges in making responsible and well-informed decisions on pension policies. Depending on whether they join cost-sharing plans or establish their own singleemployer plans, local governments have different responsibilities and face different

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challenges. With state-level cost-sharing plans, local governments need to regularly report their demographic and payroll information to the cost-sharing pension system. They are also required to pay the annual contribution amount that is set by the state system for all participating employers. With locally administered single-employer plans, local governments will need to set their own benefit provisions, contribution policies, and investment decisions within the legal framework established at the state level. Most local governments establish an independent pension governing board, which usually consists of members appointed by the executive as well as members elected by active employees and retirees, to make decisions for their pension plans. The governing board hires actuaries, investment managers, and other consultants to inform their decisions. In recent years, many defined benefit pension plans at the local level have faced serious challenges in their funding status. As shown in a recent report (Aubry & Wandrei, 2020), the 2019 aggregate funded ratio, which is the ratio of pension assets to liabilities, is around 72.1 percent for local pension plans, which is lower than the 73 percent funded ratio for state plans. The ratio means that local plans only have enough assets to cover 72.1 percent of the liabilities. This underfunding issue is attributable to factors such as benefit increases in earlier years, insufficient contributions from governments and employees, investment losses in recessions, and actuarial assumptions that are more optimistic than actual experiences. A pension plan’s actuarial funded ratio is calculated by plan actuaries based on economic and demographic assumptions such as investment return assumptions, inflation rates, and mortality tables. If these assumptions are not accurate, the underfunding issue might be more serious than is shown by the actuarial funded ratio. The underfunding gap has short-term and long-term impacts on governments’ budgets, credit ratings, and their employees’ financial security in retirement years. In the next three sections, empirical evidence from previous studies is summarized to show the impact of municipal pensions on local governments and their employees.

HOW DO MUNICIPAL PENSIONS AFFECT GOVERNMENT BUDGETS? Pension Contributions and Local Budgets Pension system contribution policies differ as to defined benefit and defined contribution plans in terms of the annual contribution amount that governments should make to fund the pension plans. In defined benefit plans, the actuarially determined contribution, or ADC, is always calculated by the system’s actuary using economic and demographic assumptions. ADCs should be sufficient to cover both the annual normal cost (i.e., the benefits employees accrued in the current year) and the supplemental cost (i.e., the cost to pay down unfunded liabilities). The normal cost is relatively stable, but the supplemental cost is influenced by the investment returns and actuarial experiences in a specific year. When investment returns are lower than expected, unfunded liabilities are created, and thus the employer’s contribution cost is increased. If the other economic or demographic assumptions, such as the mortality rates, the salary growth rate, or the inflation rate, are different from the plan’s actual experiences, unfunded liabilities will also be created.

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Most public pension plans, if they follow Governmental Accounting Standards Board (GASB) standards, are required to calculate and report the ADC. Most sponsoring governments are also expected to make contributions according to the ADC. However, not all governments are required to fully pay ADCs every year, and in most cases, not fully paying ADCs in one year will not have an immediate consequence because most pension funds are prefunded and benefit payments to retirees can be made through the current pension funds. On the other side, governments’ contributions to pension plans take up a significant portion of a local government’s annual budget. A recent National Association of State Retirement Administrators (NASRA) report (Brainard & Brown, 2023) shows that state and local contributions to pension funds account for 5.19 percent of government general spending and that as a percentage of total spending, cities spend approximately 31 percent more than states, which is due to the fact that personnel salaries and benefits account for a large portion of local budgets. Governments have the need to balance their budget and stabilize their year-to-year contributions to pension plans. Asset smoothing and amortization of unfunded liabilities are usually used in public plans’ contribution policies to reduce the volatility of the ADC. Some contribution policies specify fixed-amount or fixed-percentage (of payroll) contributions, which might deviate from the ADC. Contributions to pension plans might crowd out governments’ other important spending. Based on data from more than 400 US municipalities and counties, Anzia (2019) found that 88 percent of the cities and counties in the sample experienced rising pension costs in the study period from 2005 to 2016. The median increase in the total annual pension contribution amount was 56 percent and the median increase in annual contributions per employee was US$1,419 from 2005 to 2016. Anzia (2019) further shows that the rising pension costs do not lead to increasing revenues, but are associated with a decrease in employment in local governments, indicating pension costs crowding out spending on the personnel budget. Eide (2015) also shows that retirement benefit costs increased at a rate that is higher than local taxes, fees, and charges from 2004 to 2014, which means that governments must cut other spending due to the increased pension costs. Pension costs’ crowd-out effect is salient in California localities as the rising benefits are associated with changes in personnel and basic infrastructure maintenance spending (ibid.). Local ­government salaries in California have increased five percentage points more slowly than private sector salaries from 1998 to 2013, mainly due to the rising pension and health benefit costs (ibid.). Pension costs also interact with economic cycles, which intensifies the effect of pensions on government budgets during recessions. Most pension plans invest a significant portion of their assets in capital markets. During economic downturns, investment losses are likely to lead to unfunded liabilities that drive up required contributions for governments. While pension plans expect governments to increase their contributions to pay down the unfunded liabilities, governments are already experiencing revenue losses during the downturn. The tension between rising pension costs and decreasing revenues makes it especially challenging to manage public pensions during recessions. This intensified impact can be observed in local governments’ responses to the Great Recession in 2008–09 and the COVID-19 pandemic in 2020.

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The Impact of the Great Recession on Municipal Pensions The Great Recession has caused a series of fiscal challenges for municipal pension plans, which have been discussed in many studies. Brainard and Brown (2020) show that because of the 2008–09 financial crisis, public pension assets were reduced by more than 20 percent, which increased both unfunded liabilities and required contributions, although most plans smoothed and amortized the impact of the investment losses. Based on a study of 61 cities, a Pew report shows that the aggregate funding level of their pension plans dropped by five percentage points from 79 percent to 74 percent during the time period from 2007 to 2009 (The Pew Charitable Trusts, 2013). The increased pension costs and liabilities due to the Great Recession have also triggered many changes to state and local pension plans. An Equable (2020) analysis shows that between 2008 and 2010, state governments reduced their contributions from 93 percent to 79 percent of the ADC, reduced the assumed rates of return, and increased member contributions. At the local level, a Center for Retirement Research brief (Aubry & Crawford, 2017) shows that 57 percent of local pension plans reduced employees’ pension benefits after the Great Recession. These benefit changes were made by increasing employee contributions, adjusting the benefit formula and eligibility rules, reducing cost-of-living adjustments (COLAs), and introducing defined contribution or hybrid pension plans (ibid.). Local governments with higher ADCs are more likely to implement these changes (ibid.). Maher et al. (2016) find that during the Great Recession, municipalities with mayor-council forms of government and stricter tax and expenditure limitations were able to sustain better funding in their pensions than municipalities with manager-council forms of government. The Impact of the COVID-19 Pandemic on Municipal Pensions The impact of the COVID-19 pandemic on municipal pensions has changed over time as the status of the pandemic changes. At the beginning of the pandemic, the severe losses in the stock market, coupled with the soaring unemployment rate and businesses shutting down, caused pension funds to worry about declining assets and increasing costs, while many of them already had poor funding as they entered the pandemic. Local governments were also concerned about revenue losses and increasing expenditures for responding to the pandemic. These concerns faded away, to some degree, with the rapid market recovery and federal stimulus aid for individuals and state and local governments. Although none of the COVID-related federal stimulus funds were specifically intended to pay for pension costs, they pay for other essential services and potentially free up some resources for pension plans (Deloitte, 2021). The pandemic and its aftermath will have a continuing impact on pension plans’ demographic experiences, investment returns, and governments’ financial conditions. First, while some studies (for example, Andrasfay & Goldman, 2021) show that the 2020 US life expectancy at birth has been reduced by 1.13 years due to COVID, other analysts suggest that the pandemic-caused demographic changes would not significantly change pension plans’ demographic experiences and reduce their long-term liabilities (Richmond, 2021). Due to its fast-developing status, it is still unclear how COVID would affect mortality and disability rates in the long run, although it is reasonable to expect that plans with more high-risk populations and workplaces with more exposure to COVID risk would see a

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more significant impact than others. Retirement and termination rates might also be affected by the pandemic, especially among those who are close to retirement (American Academy of Actuaries [AAA], 2020). Second, the recovery and the rise of the stock market after March 2020 have somewhat reduced the concern that the pandemic will create massive solvency issues in public pension plans. Most pension plans have recovered from the initial impact of COVID and showed no change in their average funded ratio in the FY2020 report (Aubry & Wandrei, 2020). However, the long-term impact of the pandemic on the economy at both the domestic and international levels is still unknown. It is also unclear what the state and local budgets would look like as the pandemic continues. There is still a concern that the high investment returns are not sustainable, and that investment returns in the next decade would be lower than expected (Chen et al., 2021). Third, there is a great variation in the pandemic’s impact on local governments, so it is reasonable to expect that some governments might make changes in their pensions because of the pandemic but others will not. How local governments’ budgets are affected by the pandemic depends on factors such as their revenue structure and the jurisdiction’s industry mix (Richmond, 2021). Richmond (2021) suggests that those governments experiencing revenue losses due to COVID-19 would make changes in their pension systems in order to lower pension costs. If governments keep experiencing revenue shortfalls due to the impact of and the response to COVID-19, they will be under more pressure to reduce pension costs and free up resources for other services. Aubry and Wandrei (2020) also project that local pension contributions post-COVID will follow the pattern observed after the Great Recession – to slow down for a few years before returning back to previous levels. As a result, the funded ratio for local pension plans is projected to drop to 64.6 percent in the expected return scenario and 61.7 percent in the lower return scenario (ibid.).

HOW DO MUNICIPAL PENSIONS AFFECT FISCAL RISKS AND CREDIT RATINGS? Short-term and Long-term Fiscal Risks Pensions create short-term and long-term fiscal risks for governments (for more discussion on pension risks, see Blome et al., 2007 and Kessler et al., 2019). One of the most important short-term risks for the sponsoring government is the contribution risk, which is due to the uncertainty in the annual required contribution amount. For example, although New York State maintains one of the best funded state and local pension systems in the US, its participating local governments saw an increase in contribution rate of more than 500 percent between 2002 and 2012, following the dot-com bubble and the 2008 financial crisis (Johnson et al., 2015). The volatility in employer contributions is due to the unexpected gains and losses in investment returns. The dramatic increase in contributions helped to maintain the pension system’s financial status but created challenges for the municipal budgets. To better assess and report the contribution risk and mitigate its impact on the government’s budget, some plans have conducted a sensitivity analysis of plan liabilities and scenario analysis with forward-looking projections of pension ­contributions (Kessler et al., 2019).

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The long-term fiscal risk is the solvency risk, which is the risk that the pension plan’s assets fall short of its liabilities. If a pension plan’s funded ratio falls under a certain level, there will be some concerns over the plan’s solvency. For example, a funded ratio of 80 percent has been used by the US Government Accountability Office (GAO) in 2007, Pew in 2010, and Bloomberg in 2011, among others, as a benchmark to determine a public pension plan’s financial health, although many still argue that all plans should achieve 100  percent funding (AAA, 2012). Unfunded liabilities in pension plans is one of the major issues that create budgetary or financial stress for local governments. Applying the 80 percent standard to analyze funded ratios in the Public Plans Data (PPD) database, we see that in 2020, 59 out of 85 local-administered plans (including cities, counties, and school districts) that are included in this database have a funded ratio that is below 80 percent. Pensions and Governments’ Credit Ratings Because of the fiscal risks that pensions bring to governments, it is reasonable to expect that the funded ratio of pension plans affects the credit ratings of municipal governments. Rating agencies usually look at both the plan’s funded ratio as well as the government’s contribution cost to determine the impact of pensions on the government’s credit ratings. “[B]oth the current and future state of pension liabilities and plan management” are included in the rating framework used by Moody’s, Fitch, and Standard & Poor’s (Aon Hewitt, 2017, p. 2). Pensions not only affect governments’ debt and liability but also impact other areas such as financial management, budgetary performance, and governance and operating factors, as indicated in rating agencies’ methodology (ibid.). The impact of pensions on credit ratings is mostly through how pension liabilities add to a government’s general debt and liability, but rating agencies also consider pensions’ other impacts on the annual budget and general management. In Standard & Poor’s (S&P) rating methodology (2011), it considers a pension funded ratio of 80 percent to be “above average” and 60 percent or below to be weak. S&P also views “a funded ratio below 80 percent by Governmental Accounting Standards Board (GASB) 67 and 68 standards to have elevated unfunded obligations” (S&P, 2017, p. 4). It further considers three main areas related to pension: (1) “exposure to large unfunded obligations”; (2) “risk of acceleration of payment obligations”; and (3) “magnitude of the budgetary stress due to increasing payments” (ibid.). Fitch (2012, 2021) considers not only the size of the current pension liability but also its expected trajectory. The key considerations related to pensions include the magnitude of the liability, the funded ratio, the resource base for making the contributions, the government’s historical commitment to pension funding, and actuarial assumptions (Fitch, 2012). We should also note that because of the different actuarial assumptions pension plans used, rating agencies have used their own approaches to calculate adjusted pension liabilities when deciding credit ratings for governments (Aon Hewitt, 2017). Empirical studies have tested the impact of pension funding on municipal credit ratings (see a summary in Benson & Marks, 2016). An earlier study by Marks and Raman (1987) examined a sample of 85 cities and counties in Pennsylvania in 1981 and found that pension underfunding negatively affects bond ratings. A more recent study by Martell et al. (2013) examined state governments’ credit ratings and state pension funding from

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2002 to 2011 with a similar finding. One recent study specifically examined municipal pension funding and municipal bond ratings (Benson & Marks, 2016). They collected data from 269 city general obligation (GO) bond issues in Texas between 2004 and 2008 and looked at how pension unfunded liabilities and the funded ratio affected both bond insurance premiums and bond ratings. They found that pension funding significantly affected bond ratings, which suggests that credit rating agencies consider pension funding information when making rating decisions for municipal governments. When the issuing government’s credit rating goes down, the interest cost on municipal bonds goes up and further adds a fiscal burden to the government’s financial stress. Aubry et al. (2017, p. 6) further show that after the Great Recession, “a one-standard-deviation increase in unfunded liability as a percentage of revenue (about 75 percentage points) is associated with borrowing costs that are 8 basis points higher.” Case studies also show that rating agencies have downgraded local governments due to concerns over the fiscal risks created by their pension plans. In Aubry et al.’s (2017) summary, from 2009 to 2017, 13 major cities have been downgraded by Moody’s, in part due to pension concerns. The most notable ones include Chicago’s downgrade from Aa3 to Ba1 during 2013–15, due to “expected growth in the city’s highly elevated unfunded pension liabilities” (Moody’s, 2015, n.p.). Hartford, CT was downgraded during 2010–16 from Aa3 to B2, and Newark, NJ has been downgraded during 2010–14 from A2 to Baa1, partially due to concerns over pensions (Aubry et al., 2017).

HOW DO MUNICIPAL PENSIONS AFFECT PUBLIC EMPLOYEES? Pension Benefit Risk for Employees For most local government employees, benefits from local pension plans are their major income source when they retire. Assuming 20 to 30 years of service, with a 2 percent benefit factor in a defined benefit plan, employees can receive around 40 percent to 60 percent of their pre-retirement income as their retirement benefit. Besides public pensions, some public employees also receive social security benefits, which further enhance their financial security during retirement. In comparison, although private sector employees also receive social security benefits, they receive lower benefits from their employersponsored plans, compared to their public sector counterparts. Benefit generosity is usually measured by the replacement rate, which is the ratio of pension benefits to preretirement income. Using this measurement, private sector pensions (plus social security benefits) provide replacement rates that are around 15 to 20 percentage points lower than the rates provided by public pensions (plus social security benefits), according to an early study (Foster, 1997). As mentioned before, public pensions also have more legal protection through state laws or labor contracts than private pensions, which gives public employees more financial security (Monahan, 2010). Although public pension benefits are perceived to be sufficient and secure, employees still bear benefit risk. Benefit risk is the risk associated with the possibility that pension benefit might be reduced to become lower than promised. It is very rare for pension plans to cut benefits that employees have already accrued in previous years because of the legal

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protection mentioned above. However, when the funded ratio of a pension plan is severely low or when the sponsoring governments have trouble paying back their debt, employees would still worry about the benefit risk. Benefit cutting is usually done through several ways such as creating a new tier with reduced benefits for new employees, reducing the cost-of-living adjustments, or increasing employee contributions (and thus reducing their total take-home income). Governments could also try to limit the total maximum benefits by applying a cap on the amount of salary to be included in the benefit formula, and thus reduce the so-called “pension spiking” in retiree benefits (Dolan, 2020). How Do Pensions Affect Employees’ Decisions? Sufficient, stable, and secure pension benefits are one of the ways to create incentives for public employees to join and stay in public sector positions. Empirical studies show that pension benefits are an influential factor to attract high-quality employees and reduce turnover rates. When governments make changes to reduce pension benefits or ask their employees to increase contributions, pension changes could also influence employees’ decisions to quit or retire from the public sector. Empirical evidence shows that pension benefits and their changes (either cuts or enhancements) affect government employees’ recruitment, retention, and turnover. Using 150 state and local defined benefit plans from 2001 to 2012, Munnell et al. (2015) measure benefit generosity by the pension normal costs. They find that pension benefit generosity in state and local governments can reduce the quality gap between the public sector and the private sector. Using the same dependent variable (quality gap) and a similar dataset in different years (2005–14), Quinby et al. (2018) find that after benefit cuts (including increasing vesting/retirement age, increasing final-average-salary period, reducing COLA, reducing benefit multiplier, or increasing employee contributions), the quality gap increased. Quinby et al. (2018, p. 3) suggest that “the public sector had trouble hiring and retaining the same type of workers it used to after a benefit cut.” Gorina and Hoang (2020) also find that after pension reforms, public employee turnover rates go up. Although Gorina and Hoang’s study used state-level pension system data, it is reasonable to expect that similar effects could also be observed at the local level. Involving government employees in making decisions regarding their pension plans may reduce the negative impact of pension changes on employees. Studies find that having more government employees represented on pension governing boards to make pensionrelated decisions is helpful in reducing political influences, reducing risks, and improving funding (Chen et al., 2015; Harper, 2008; Wang & Peng, 2018). Equity Issues in Municipal Pensions While in most public pension plans, employees’ benefits are determined by a pre-set benefit formula, the equity issue over pension benefits still exists for two reasons. First, intergenerational equity could be an issue when there is a disparity across different generations in terms of the benefits they receive and contributions they make, and/or when one generation’s pension benefits are paid by another generation (Clements et al., 2014; Kashiwase & Rizza, 2014). As mentioned before, pension plans are funded by contributions from employers and employees as well as investment returns earned by pension

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assets. When investment returns are higher than expected and government finances are in a good condition, governments tend to provide higher benefits to their employees. Due to the defined benefit feature in public plans, the promised benefits remain in effect as long as those employees stay in the same pension plan. When investment returns are lower than expected and pension systems face increasing liabilities and contribution costs, governments might reduce benefits by creating a tier for new employees or increasing employee contributions. The consequence of these benefit and contribution changes is a large disparity in the costs and benefits of pensions for employees joining the public workforce at different times. An example of the intergenerational equity issue can be found in the different tiers in the New York State and Local Retirement System (NYSLRS), which is the state-­ administered system that covers employees in state agencies and all New York local governments except those in the New York City region. NYSLRS has six tiers of benefits depending on when a member joins the system. Tiers 1 to 4 were created before 2009 and all of those provide generous benefits, although the benefits have been reduced over time from earlier tiers to later tiers. After the recession, Tier 5 (effective 2010) and Tier 6 (effective 2012) were created when the system faced increasing costs and liabilities due to the financial crisis. Both tiers provide lower benefits with a longer vesting period, higher employee contributions, and increased retirement ages compared to earlier tiers (NYSLRS, n.d.). The second equity issue is associated with defined contribution plans, which some governments have created in their pension systems to replace or supplement their main defined benefit plans. If employees primarily rely on defined contribution plans to receive benefits, their decisions on how much to contribute to their individual pension accounts and how to invest their assets will decide their final pension benefits. Due to the different levels of financial knowledge and the employee’s personal financial situation, there could be a great variation in the level of benefits individual employees eventually receive from defined contribution plans. Because of the well-known gap in financial literacy due to racial, gender, and other socioeconomic status (Lusardi & Mitchell, 2011), it is reasonable to expect that the gap might lead to different levels of benefits in defined contribution plans. For example, if employees have an option to contribute to a voluntary defined contributions plan, the lack of financial literacy may lead to low contribution rates or naive investment decisions that might reduce potential benefits. Studies have also shown that workplace financial education can help to improve financial literacy and retirement planning (Hira & Loibl, 2005; Lusardi & Mitchell, 2007).

RECENT PENSION REFORMS AND THEIR IMPACTS Facing increasing costs and risks, many governments have implemented pension reforms to reduce their contribution costs and unfunded liabilities. In the US, there has been a growing number of pension reforms at both the state and local levels since the Great Recession (Aubry & Crawford, 2017). Most pension reforms focus on creating new benefit tiers, reducing cost-of-living adjustments, increasing employees’ contributions, adjusting asset smoothing or amortization period, and other measures to reduce benefits or decrease employers’ contributions.

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Governments have different degrees of success in implementing these pension reforms. Studies show the pension reforms were driven by several factors, such as fiscal stress of the sponsoring government, political influences, unionization of the employees, contribution volatility, and the financial status of the plan (Chen, 2018; St. Clair & Guzman 2018). An Urban Institute (2021) report shows that “[a]mong the most frequent reforms are reduced benefit levels, longer vesting periods, increased age and service requirements, limited cost-of-living adjustments, and increased employer and employee contributions” (n.p.). Gorina and Hoang (2020) categorize pension reforms according to perceived effects on benefits: explicit, implicit, or neutral. Explicit benefit reductions include COLA reductions, benefit reductions, the introduction of a defined contribution plan, and increases in employee contributions, because these actions explicitly reduce the value of benefits. Implicit benefit reductions include adjusting benefit eligibility rules or altering benefit calculations because these changes do not necessarily reduce benefits for all workers. Benefit-neutral reforms include increasing the vesting period or increasing employer contributions. They found that reductions in benefits or COLAs, increases in retirement requirements (eligibility rules), and increases in employee contributions were the most common ones for governments to adopt from 2002 to 2015. Most reforms occurred after 2007 and reached their peak in 2010–11, the time period after the Great Recession. The reforms to reduce benefits and increase contributions have several goals to balance. Although the primary goal is to reduce the pension risks, costs, and liabilities for the government, these changes will also create equity issues and affect employees’ motivations and decisions. Reforms might encounter resistance from employees’ unions and some of them would also face legal challenges. All these goals, constraints, and possible influences should be considered when implementing reforms in public employees’ pension plans. Besides these above approaches to reduce benefits, there are two reform approaches that are worth more discussion: risk-sharing options and pension obligation bonds (POBs). Risk-sharing options are ways to share investment, inflation, and/or longevity risks between employers and employees. Most public pension plans in the US are defined benefit plans, in which the governments bear all the investment and other risks, while members’ benefits are decided by a formula. The risk-sharing approach responds to the concern that the risks and costs in these plans are too high for the governments so plans should share the risks and costs with their members. Risk sharing can be done through contingent benefits, contingent employee contributions, and hybrid plans (Boyd et al., 2020; Brainard & Brown, 2014; The Pew Charitable Trusts, 2017). With contingent benefits or contingent employee contributions, when a plan’s funded ratio or investment performance is lower than a certain level, members would receive lower benefits or make more contributions to their plans. With a hybrid plan, some defined contribution features are brought into the traditional defined benefit plan so that members would receive a fixed portion of benefits and a variable benefit portion that depends on investment ­performance. Most risk-sharing policies were implemented in state-administered pension systems, but some are also applied to local pensions. For example, in 2018 Maine adopted a risk-sharing plan for the municipal employees (the “Participating Local District [PLD] Consolidated Retirement Plan”) in the Maine Public Employees Retirement System. Employee and employer contribution rates are subject to changes based on a 55/45 percent split of

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investment gains and losses (Brainard & Brown, 2018; Braun, 2018). Employer and employee contribution rates are capped at 12.5 percent and 9 percent, respectively. When the required contributions exceed the gaps, retirees’ COLAs can also be reduced according to a predetermined formula (Brainard & Brown, 2018). The goal of this reform is to share risk more equitably between employers, active employees, and retirees, while preserving the plan’s funded status and keeping plan costs manageable (ibid.). POBs are a fiscal tool to use borrowing to cover part or all of the unfunded liabilities, while future contributions and investment returns will be used to pay back the borrowing. POBs have been an attractive tool for many years but became especially popular after the outbreak of the COVID-19 pandemic when the interest rate was low and potential investment returns, as assumed by pension plans, could be high. A Pew report shows that governments issued US$6 billion in POBs in 2020, “with the majority of issues sold by cities, towns, and counties in California” (Mennis et al., 2021, n.p.). Although POBs enable governments to pay down unfunded pension liabilities in the short term, whether issuing POBs offers cost savings over the long run is controversial. When the interest rate is low, governments might see issuing POBs as an arbitrage opportunity, but POBs expose the issuing governments to more fiscal risks because future returns are uncertain and could be lower than the borrowing costs. As an example of municipal pension plans considering POBs, in the City of San Jose’s two pension plans (the Police and Fire Department Retirement Plan and the Federated City Employees’ Retirement System), the funded ratios stayed at 53 percent and 74.3 percent in 2019, respectively, despite the fact that the city has been making significant contributions to the plans (28 percent of general fund expenditures in 2022 will go into pension plans). In 2021, the city released a Retirement Stakeholder Solutions Working Group report (RSSWG, 2021), in which it reviewed six options for pension reform, ranging from asset allocation changes, dedicated taxes, amortization change, and pension obligation bonds. In the final report, the group showed that all other options are either difficult to implement or would not have a significant impact on unfunded liabilities. According to its assessment, issuing POBs is an option that has a “moderate” level of difficulty to implement and has a “significant” impact to reduce pension unfunded liabilities and achieve financial savings. The group also noted the high risk with POBs. Although the interest rates are low at the time of discussion, “there is always the possibility of a market recession or economic downturn” (RSSWG, 2021, p. 17), and if investment earnings are lower than the fixed borrowing costs of POBs, the city would have increased debt because of issuing POBs.

DISCUSSION AND CONCLUSION This chapter summarizes the impact of municipal pensions on local governments’ budgets, fiscal risks, credit ratings, employees, and the possible reform options based on a review of current literature. As of 2021, financial issues in municipal pensions are still a major challenge for many local governments in the United States. It is expected that this challenge will continue in the near future. This section summarizes what we have learned from the studies on municipal pensions and lays out several important policy implications and directions for future studies.

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Municipal pensions influence local governments in many ways. Local administrators should consider these influences when making their decisions. First, contributions to pension plans account for a significant portion of a local government’s budgets. Required contributions are decided by current and previous pension policies as well as the investment returns from pension assets. The increase in contributions to pension plans could crowd out other important government spending, especially personnel spending. Insufficient contributions could undermine the fiscal health of the pension plan, accrue unfunded liabilities in the plan, and possibly lead to more required contributions in the future. Recognizing the impact of pension contributions on the budget, appropriately planning for future pension contributions, and ensuring sufficient and stable contributions to pension plans are all good practices in designing pension contribution policies. Second, unfunded pension liabilities, pension contribution burdens, and the government’s commitment to manage pension costs are all important factors that influence a government’s credit rating. The mismanagement of pension plans could bring fiscal risks to a government and negatively affect its credit rating. Investment risk, inflation risk, and longevity risk in pension management could lead to solvency risk and contribution risk for the government and benefit risk for the plan members. In terms of risk management, governments could consider important questions such as what is the appropriate level of risk to take; how to assess and report fiscal risks associated with pensions; and how to mitigate risks for governments and employees. Third, while pensions bring in costs and liabilities for the governments, pensions could also serve as an effective tool to recruit and retain quality employees. Empirical studies show that employees consider pension benefits as a motivation, while changes in pensions could influence their decisions. Pension benefits and eligibility rules could be designed to achieve personnel management goals, such as attracting young employees or retaining midcareer employees. While pension reforms aim to control the cost of pensions, their potential negative consequences could include increased turnover rates and early retirements. Providing information to employees and keeping them involved in pension management could help them make better financial management decisions, plan for their retirement, and potentially influence how they accept pensions with a sustainable benefit level. Finally, the success of pension reforms depends on how the several goals of public pension management are balanced. Pension management should aim to provide sufficient pension benefits to public employees in a sustainable way without undermining the government’s financial capacity to provide other public services. Irresponsible and shortsighted decisions in the past, such as granting benefit increases to an unaffordable level or using optimistic actuarial assumptions, create unfunded liabilities that governments are still paying off today. In some pension plans that have serious unfunded liabilities, some difficult decisions must be made. Pension reforms are also necessary for some governments that are finding it challenging to meet their pension funding targets. What we have learned from pension reforms after the Great Recession is that reforms that have a longterm perspective and consider the interests of all stakeholders of pension plans are more likely to succeed. To better address the challenges governments are facing and fill the gaps in the literature on municipal pensions, future studies can further explore the following directions. First, the impact of COVID-19 on public pension management should continue to be explored. As many of us expect, although the pandemic is still developing, it is likely

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that COVID-19 will shape our lifestyle and governments’ policies for years to come. As for pensions, on the liability side, the pandemic might change life expectancy and influence employees’ decisions on retirement. On the asset side, the pandemic could have a long-term impact on capital markets in which public pensions invest their assets. Such impact could trigger changes in investment strategies and return assumptions in pension plans. Second, the equity issue at the individual level can be further examined. Very limited studies on public pensions have used individual-level data or paid attention to the equity of pension benefits across employee cohorts or groups. Within defined benefit plans, the underfunding issue and the tiers with different contribution and benefit levels could cause inequity across generations. Within defined contribution plans, pension benefits are ­determined by individuals’ decisions on contribution and investment, which are further determined by their financial literacy. The racial or gender gap in financial literacy could cause inequity in pension benefits. The value of equity in pension policies should receive more attention. Third, municipal pensions could be examined in the context of state and local relations. In municipal pension management, an important decision is whether to join state-level pension systems or create their own single-employer pension plans. What are the advantages and disadvantages of local governments having their own pension plans and making their own decisions on benefit provisions, contribution amounts, investment strategies, and actuarial assumptions? If small local governments have their own plans, how to improve the quality of decision-making and achieve accountability in those decisions? These are important questions to be answered. Fourth, what are the sustainable reform options for municipal pension plans? This is always an important question to be answered by scholars and practitioners. In this chapter, we see that while we all agree that pension performance is important, there has not been a consensus on the ideal level of pension funding and the sustainable contribution policy. During a recession, how to balance the need of providing essential services and the need to sustain funding for pension plans is still a question to be answered in future studies. Finally, the influence of pensions on employees’ motivations and decisions should be further explored. Providing sufficient retirement benefits to employees when they retire is an important goal of pension plans that could be sacrificed if a pension reform only focuses on a single goal of reducing pension costs for governments. Pension policies should consider both the financial capacity of the governments and the needs of their employees. Future studies could also explore better approaches to inform employees and involve them in pension management.

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New York State & Local Retirement system (NYSLRS). (n.d.). Comparison of ERS benefits. https:// www.osc.state.ny.us/retirement/employers/comparison-ers-benefits. Quinby, L. D., Sanzenbacher, G. T., & Aubry, J. P. (2018). How have pension cuts affected public sector competitiveness? (State and Local Pension Plans No. 59). Center for Retirement Research at Boston College. https://crr.bc.edu/briefs/how-have-pension-cuts-affected-public-sector-com​ petitiveness. Retirement Stakeholder Solutions Working Group (RSSWG). (2021, April 2). Retirement Stakeholder Solutions Working Group final report. City of San Jose. https://www.sanjoseca.gov/ home/showpublisheddocument/71005/637532955430930000. Richmond, L. (2021, February). COVID-19 response and public pensions: How today’s policy choices can drive long-term risks (Build America Mutual White Paper). https://buildamerica.com/wpcontent/uploads/2021/02/BAM-WP-Pension-Series-COVID-19-Response-and-Public-PensionsHow-Todays-Policy-Choices-Can-Drive-Long-Term-Risks.pdf. Standard & Poor’s (S&P) (2011, November 8). U.S. state ratings methodology. https://www.nasra. org/Files/Topical%20Reports/Credit%20Effects/StateRatingsMethodology.pdf. Standard & Poor’s (S&P). (2017). Local government pension and other postemployment benefits analysis: A closer look. https://www.standardandpoors.com/ratingsdirect. St. Clair, T., & Guzman, J. P. M. (2018). Contribution volatility and public pension reform. Journal of Pension Economics and Finance, 17(4), 513–533. The Pew Charitable Trusts. (2013, January 16). A widening gap in cities: Shortfalls in funding for pensions and retiree health care. https://www.pewtrusts.org/en/research-and-analysis/reports/​ 2013/01/16/a-widening-gap-in-cities. The Pew Charitable Trusts. (2017). Cost-sharing features of state defined benefit pension plans: Distributing risk can help preserve plans’ fiscal health. https://www.pewtrusts.org/en/research-andanalysis/reports/2017/01/cost-sharing-features-of-state-defined-benefit-pension-plans. Urban Institute. (2021). State and local government pensions. https://www.urban.org/policy-centers/ cross-center-initiatives/state-and-local-finance-initiative/projects/state-and-local-backgrounders/ state-and-local-government-pensions#question5. US Census Bureau. (2020). 2020 annual survey of public pensions: State & local tables. https://www. census.gov/data/tables/2020/econ/aspp/aspp-historical-tables.html. Wang, Q., & Peng, J. (2018). Political embeddedness of public pension governance: An event history analysis of discount rate changes. Public Administration Review, 78, 785–794.

PART IV CITY AND MUNICIPAL FINANCE ACROSS THE GLOBE

20.  Municipal finance in federalist systems Chris Thayer, Alex Hathaway, and Jorge Martinez-Vazquez

Municipal finances are shaped by the surrounding governmental structure. National governments can be placed along a spectrum from unitary – where sovereignty is present in a single body and delegated to subnational units in decentralized settings (e.g., France) – to confederal, in which the national entity’s only powers are those granted by its member states (e.g., Switzerland before 1848). Between these extremes are federal regimes, with sovereignty jointly shared between national and subnational entities. The typical federal configuration is a two-layer sovereignty structure consisting of a national entity and subnational states (provinces, regions, etc.), with local governments as purely state creations.

FEDERAL MOTIVATIONS The motivations for selecting a federal system of government are numerous.1 For the United States, the first federal system, the drives can be summarized as a history of confederation, a desire for compromise, and a need for differing scales of government. The budding nation spent the decade after its independence as a confederation of fully sovereign states. The experience of such state autonomy led to developing a form of government that compromised between unitary and confederate elements – for example, balancing strictly population-based (unitary, treating the nation as a whole) versus statebased (confederate, treating the state as the unit of sovereignty) representation. Finally, the crafters of American federalism valued what might be called “government at the speed of life”: a distributed government sufficiently close to population centers to understand and quickly respond to local conditions, long before instant communication technologies (Beeman, 2015). This latter drive may be seen as an early expression of the subsidiarity principal – that a given matter should be handled by the most immediate government feasible – enshrined in both the European Union’s general principles and the classic canon of decentralization literature (see, e.g., United Nations Development Programme [UNDP], 1999). While some other federal countries share the aforementioned drivers, many other motivations exist. One, for instance, is peace. As Haccius (2018, p. 9) puts it, “Many scholars see federalism as a solution or remedy to bring stability in divided societies,” such as those with deep linguistic, ethnic, or religious differences, as it “allows subnational units 1   Although we are speaking strictly of federal systems, many of the reasons and institutions discussed here apply to unitary systems with decentralized regional and local government public finances. The main difference between federal and decentralized unitary systems is where sovereignty formally resides. In practice, some federal states may have less decentralized fiscal systems than unitary countries.

370

Municipal finance in federalist systems  ­371

to organize a part of their existence in accordance with their culture and tradition.” This drive is sometimes characterized as a “holding-together” federalism – where federalist subnational autonomy allows otherwise fractious countries to remain intact – in contrast to the “coming-together” mode classically embodied by the American example (Anderson, 2016; Bulmer, 2017). Countries often cited as embracing federalism from a solidifying drive are Belgium (Van der Linden & Roets, 2017), Ethiopia (Lashitew, 2021), and India (Stepan, 2001).2 In other cases, federalism was imposed, a “putting-together” federalism (O’Leary, 2021; Stepan, 2001). The imposer may be internal (e.g., a civil war’s winner, a dissolving military government, etc.) or external, such as an occupying force, exiting colonial government, or significant donor/diplomacy organization. Countries with putting-together dynamics include Brazil (Stepan, 2000), Bosnia and Herzegovina (Cohen, 2002), Iraq (Haccius, 2018), Nigeria (Suberu & Diamond, 2002), and Somalia (Tawane, 2017; Thomas, 2017).

CURRENT FEDERAL COUNTRIES AND THEIR COMPONENTS Whatever their motivations, 26 countries currently use a federalist system of government. Table 20.1 presents their first-level federating (and equivalent) units, their capitals, and their municipality systems. Note that this table does not include the many strongly decentralized countries (“quasi-federations”) that are nominally unitary, such as Indonesia (Sung & Hakim, 2019), Spain (Santana, 2018), South Africa (Organisation for Economic Co-operation and Development/United Cities and Local Governments [OECD/UCLG], 2016), and the United Kingdom (Harvey, 2019). Regardless, there is at least one federal country in every inhabited continent and at least one having each economic status (World Bank, 2021). Indeed, an estimated 41 percent of the world’s population as of 2020 lives in a federal country (United Nations Department of Economic and Social Affairs [UNDESA], 2019). As Table 20.1 demonstrates, most federal countries give their capitals a special status apart from normal municipalities. In these countries, the capital or its special region is equal to a federating unit in significance, though some countries allow their capital less autonomy than their other federating units. Many of these special-status cities were founded as capitals. Due to their complex standing and history, these special entities will not be considered when discussing the general operation of municipalities in their respective countries. Unsurprisingly, such diverse countries vary in their conceptual frameworks and implementations of federalism. Many are highly devolved; others are semi-federalist: structurally federalist but functionally highly centralized, such as India (Singh, 2019), Iraq (Al-Mawlawi, 2019), Malaysia (OECD/UCLG, 2019a), and Nigeria (Wodu, 2020). Countries may move along the unitary–confederate spectrum and different ­governance 2   Deep decentralization reforms in unitary countries like Indonesia or Spain over the last several decades and provisions for asymmetric federalism – providing some subnational units with more fiscal powers than others – have also been interpreted as holding-together efforts. See, for example, Martinez-Vazquez (2007).

372

Brussels Hoofdstedelijk Gewest

3 gewesten [regions] + 3 ­gemeenschapen [linguistic ­communities] (geographic overlap) Bosnia and 1 republika [republic] + 1 federacija [fedHerzegovina eration] + 1 distrikt [district]

Addis Abeba [Addis Ababa] Berlin

New Delhi,b National Yes, full union territory with Two to three levels, one or Capital Territory of some additional state-like more of which is nearly Delhi powers territorially complete

10 kililoch [regions] + 2 astedader ­akababiwach [chartered cities]

16 Länder [states]

28 states + 8 union territories

Germany

India

Yes, full land whose governor is both city mayor and state president

Yes, chartered city with less autonomy than a state

Two to three levels, one or more of which is territorially complete

Most local government exclusively administrative

Two to three levels, one or more of which is nearly territorially complete

Ethiopia

No

Ottawa

10 provinces + 3 territories

Single level, territorially complete

Canada

Yes, hybrid state-municipal region

Região Administrativa de Brasíliab

Two to three levels, one or more of which is territorially complete

Two to three levels, one or more of which is territorially complete

26 estados [states] + 1 região ­administrative [admin. region]

No

Yes, full region

Single level, territorially complete

Single level, nearly territorially complete

Large areas with no local government

Municipality System

Brazil

Sarajevo

Wien [Vienna]

9 Bundesländer [federated states]

Austria

Belgium

Canberra, Australian Yes, ACT Legislative Capital Territoryb Assembly acts as both city council and territory government

6 states + 10 territories

Australia

Yes, full Bundesland separately run as a city and state by the same people

Ciudad Autónoma de Yes, autonomous city with Buenos Aires fewer powers than a full province

23 provincias [provinces] + 1 ciudad autónoma [autonomous city]

Argentina

Special Status Capital

Capital

Federating Units (and Equiv.)

Nation

Table 20.1  Federal countries, federating units, national capitals, and municipality systemsa

373

Kathmandu Abuja,b Federal Capital Territory Islamabadb Capital Territory

Muqdisho, Banaadir Gobol [Mogadishu] Juba

7 pradeśharū [provinces]

36 states + 1 federal territory

4 provinces + 1 interim provinceg + 1 territory + 1 federal territory

Gorod Federal’nogo 85h subyekty federatsii [federal Znacheniya Moskva subjects]: 22 respubliki [republics] + 9 krays [territories] + 46 oblasti [regions] [Moscow] + 3 gorod federal’nogo znacheniya [city of federal ­significance] + 4 ­avtonomnyye okruga [auton. areas] + 1 ­avtonomnaya oblast’ [auton. region] Basseterre

4 states

2 islands

5i dowladaha [states] + 1 gobol [region]

10 states + 2 special administrative areas + Abyei condominium

Micronesia (Federated States of)

Nepal

Nigeria

Pakistan

Russian Federation (the)

Saint Kitts and Nevis

Somalia

South Sudanj

Palikirb

Ciudad de México [Mexico City]

31 estados [states] + 1 Ciudad de Méxicof

Mexico

Single-level, territorially complete

Single level, territorially complete

Single level, territorially complete

Single level, territorially complete

Two to three levels, one or more of which is territorially complete

No

Yes, municipal admin. Unit outside any state

No

Yes, full federative subject

Yes, federal territory

Single-level, territorially complete

Two to three levels, one or more of which is territorially complete

No local governments

Two to three levels, one or more of which is territorially complete

Two to three levels, one or more of which is nearly territorially complete

Yes, territory with a Single level, territorially federally appointed minister complete

No

No

Yes, sui generis federating unit

Wilayah Persekutuan Yes, full federal territory Kuala Lumpur/ Putrajayab,e

13 negeri [states] + 3 wilayah persekutuan [federal territories]

Malaysia

Yes, full governorate with unique structure

Muḥāfaẓät Baġdādb,d [Baghdad governorate]

19c muḥāfaẓāt [governorates], 4 of which are under Herêma Kurdistanê (Kurdistan Region)

Iraq

374

50 states + 6 territories + 1 federal district

No

No

No

Special Status Capital

Two to three levels, one or more of which is nearly territorially complete

Large areas with no local government

Two to three levels, one or more of which is territorially complete

Single-level, territorially complete

Municipality System

Notes: a. This listing notably does not include Comoros. Formerly federal, the new (2018) constitution removes federal elements from the nation’s structure and explicitly names it a unitary state (Constitute Project, 2021c; Kuoppamäki, 2018). b. Indicates a planned city, founded to be the capital. c. Many international sources still cite 18 governorates (United Nations Office for the Coordination of Humanitarian Affairs [OCHA], 2021), as the 19th was created by the autonomous Kurdistan Region in 2014 (Rudaw, 2014) and was still only semi-acknowledged by the central government by 2021 (Middle East Monitor, 2021). As a rule, the authors record de facto administration at the time of writing (August 2021), which may conflict with internationally recognized political/diplomatic territorial claims. d. Founded in the first millennium CE to be the Abbasid Caliphate’s capital. e. Another federal territory city, Putrajaya is the federal administrative center, a semi-capital, and is planned. f. In 2016, Mexico City became a state-like (Agren, 2016) non-state (Notimex, 2016) federating unit. g. Pakistan’s territorial composition is an ongoing controversy with India, with both claiming the Kashmir region. Pakistan’s four full provinces and capital territory are universally accepted. Pakistan is also the de facto power in its two Kashmiri autonomous territories, Gilgit-Baltistan (GB) and Azad Jammu and Kashmir (AJK). In late 2020 (Farooq, 2020), Pakistan began elevating GB to full province status, leaving GB as an interim province at the time of writing. h. This total includes the Crimean Republic and Federal City Sevastopol, reflecting Russian practical authority despite these regions being internationally considered illegally occupied Ukrainian territory. i. This total does not include the claimed state of Somaliland, which declared itself independent in 1991 and has since maintained a separate government, including de facto territorial control (Felter, 2018). j. Though South Sudan’s 2011 constitution is federal (Constitute Project, 2021b), the peace process for the recent civil war includes full constitutional re-drafting (Bayot, 2021), meaning the country may not remain federal. k. Sudan is engaged in a five-year transition to democracy; its 2019 draft constitution establishes the country as federal, but the full constitution may not (Constitute Project, 2021a; International Crisis Group [ICG], 2021; Zaidan, 2021).

Yes, capital district, with a Single-level, territorially special government structure complete

Washington,b District Yes, federal district with of Columbia fewer powers than a state

Venezuela 23 estados [states] + 1 dependencias fed- Santiago de León (Bolivarian erales [federal dependencies] + 1 distrito de Caracas, Distrito Republic of) capital [capital district] Capital [Caracas]

United States of America (the)

United Arab 7 imārāt [emirates] Emirates (the)

Abu Dhabib

Bern

26 Kantone [cantons]

Switzerland

Capital Al-Khurṭūm [Khartoum]

Federating Units (and Equiv.)

Sudan (the)k 18 states + Abyei condominium

Nation

Table 20.1  (continued)

Municipal finance in federalist systems  ­375

aspects may be differentially centralized. Belgium is a notable case of increasing decentralization since its initial federal formation (Brown, 2019). In contrast, Russia’s 21st-century activities embody a re-centralizing trend (Åslund & Kuchins, 2009) towards a government “federal in form, [but] unitary in function” (Russell, 2015). It only follows that these varying nation–state relationships influence subnational governments’ source(s) of authority, particularly municipal/local governments. The prototypical federal configuration is a central government plus a group of state governments (with which the central government shares sovereignty) and then a number of local governments, subordinate creations of state governments. Certainly, this is the American, Australian, and Canadian model. However, this is far from the universal, or even most common, system. In many federal countries, local governments instead derive their authority directly from the national constitution or other nationwide law and there may be strict limits on the extent to which any higher body may interfere with municipal competencies. At the opposite end of municipal autonomy, the dual-island Caribbean nation Saint Kitts and Nevis has no local governments, only administrative subdivisions.

MUNICIPALITY SYSTEMS IN FEDERAL COUNTRIES As Table 20.1 shows, the local government systems of federal countries can likewise take varied forms. The simplest, often found where local government has nationally defined competence, is the single-level territorially complete municipality system, consisting of a single local government level designed so that no national territory is outside a local government. Countries with this system include Austria, Brazil, Malaysia, Mexico, Micronesia, Nepal, Nigeria,3 South Sudan, the Sudan, and Venezuela.4 Australia has a single-level local government structure that is nearly complete but excludes some natural features and sparsely populated areas. The next sizable category has two or three levels of local government, at least one of which is territorially complete: Belgium (provinces and municipalities), Bosnia (cantons and municipalities), Germany (districts and municipalities),5 Iraq (districts

3   The country has such local governments in theory. In practice, elected local governments are dissolved by state governors at will and replaced by temporary administrative entities (Okeke, 2021). Where an elected local government exists, its functions are sharply limited by insurgent activity intense enough that experts report “huge parts of rural Nigeria have become completely ungovernable” (Parkinson & Akingbule, 2021, n.p.). 4   As with Nigeria, this local government structure is theoretical in Venezuela. In addition to an ongoing inflation crisis disrupting economic activity, at the time of writing Venezuela is experiencing a “protracted breakdown of the rule of law” (Kinosian & Sequera, 2021, n.p.) in which gangs, insurgents, and other groups “run large stretches of the nation’s territory” (Kurmanaev, 2021, n.p.), replacing normal local and higher government functions. 5   The German municipality system technically excludes a small number of sparsely or unpopulated natural features and military training areas.

376  Research handbook on city and municipal finance

and subdistricts),6 Russia (raions/equivalents and settlements), Somalia (regions and districts),7 and Switzerland (districts and municipalities).8 Next are municipality systems that are mostly complete but have important gaps. Canada has multiple local government levels but some sparsely populated regions lack any sub-province government. India’s urban municipalities and rural three-tier Panchayati Raj system of district, intermediate, and village councils cover almost all areas but not those of cantonments. Pakistan has a two- to three-tier local system somewhat comparable to Panchayati Raj but has never had local governments in the former Federally Administered Tribal Areas (FATA).9 The United States has a generally two-tier system of noncontiguous local (village, city, etc.) and contiguous township, county, or equivalent governments10 for the majority of its area but lacks counties in swathes of sparsely populated Alaska, one Hawai’ian island, and much of its territories. The remaining countries – Argentina, Ethiopia, and the United Arab Emirates (UAE) – have large areas with either no local government (Argentina and UAE) or local governments that are mostly administrative-only entities wielding devolved powers and lacking any own authority (Ethiopia).11 One factor that these widely varying municipal systems have in common, however, is their ultimately limited power: no federal country currently seats its residual power with municipalities. With their nations alternately fully assigning all power or, more commonly, leaving residual powers with either the state or federal government, municipalities in federal countries across the world share in the limitation of theoretically possessing only those powers explicitly permitted to them, by either the national or state government (depending on the terms of their national constitutions and laws).

 6   All governorate, district, and subdistrict councils outside Kurdistan were dissolved in 2019 (Shafaq, 2019) and had not been restored at the time of writing (Dri, 2021).  7   Somalia is experiencing a civil war at the time of writing, with both terrorism-linked violence (Omar, 2021) and political turmoil (Zeidan, 2021). In addition to local government activity and funding disruption (Harper, 2020), the country’s composition is in flux, with Somalia still claiming Somaliland as a state.  8   Like Germany, Switzerland’s municipality system excludes a small number of unpopulated natural features. Switzerland may fit better in the prior category of nearly complete single-level local governments, as only 17 of its 26 cantons have districts and six of those 17 have district governments.  9   There are currently no active local governments in Pakistan. Local governments’ terms were cancelled or allowed to expire in each province (Iqbal, 2021). In the territories, local governments either never existed (Bureau of Democracy, Human Rights, and Labor [BDHRL], 2021) or expired (Ali, 2020; Raza, 2021; The Nation, 2021). At the time of writing, despite multiple Supreme High Court cases (Iqbal, 2021), territorial High Court cases (Alvi, 2018; Dawn, 2021), and direct Prime Minister orders (Shabbir, 2021), no local government elections have been held since the expirations. 10   The states of Connecticut, Massachusetts, and Rhode Island historically had tripart local governments consisting of counties, townships, and localities (villages, etc.). While these states have largely or entirely dissolved their county governments, their township systems are territorially complete, allowing them to act as county equivalents for this purpose. A minority of other states still maintain partial or full tripart local governance systems. 11   This characterization of Ethiopia’s local government is largely theoretical. At the time of writing, the majority of regions are engaged in the Tigray (civil) war, disrupting local government (Endeshaw & Fick, 2021).

Municipal finance in federalist systems  ­377

MUNICIPAL FINANCE IN FEDERAL COUNTRIES Thus far, our analysis has been of structural decentralization in federal systems, such as the nature of local governments and their prevalence. Governments, however, may be more or less centralized on multiple metrics, as illustrated by Boex and Yilmaz’s (2015) LoGICA framework for measuring aspects of decentralization. This approach considers five dimensions of local control: appropriate assignment of functions (subsidiarity); meaningful candidate choice independent of national party politics (political freedom); elected officials being answerable to residents (accountability); capacity to make staffing and purchasing decisions (administrative authority); and fiscal autonomy. It is the latter we now explore. Municipal finance’s foundation – that some number of services must be provided and funds to provide those services must come from somewhere – is no different in unitary, quasi-federal, semi-federal, federal, or confederate nations. However, the particulars vary considerably in the realms of both expenditures and revenues when considering a federal nation’s municipal finances. In many newer or struggling federal countries, the practical power, activities, and finances of local governments are negligible. As Dickovick (2014, p. 554) puts it, in unstable countries, while “federalism may have some implications for identity and for resource division … federalism will matter little where institutions themselves have little import.” Accordingly, the following general discussion of municipal finance in federalist systems must exclude the federal countries of Ethiopia, Iraq, Nigeria, Pakistan, Somalia, South Sudan, the Sudan, and Venezuela.12 While these countries are important examples to study for insights into the successes and failures of federalism as a system, they have neither detailed nor up-to-date municipal information due to their operational disruptions. For the remaining federal countries (and also for many decentralized unitary states, which are not discussed here), some generalizations can be made. First, federal municipalities typically have more autonomy to make spending choices and more authority to raise revenues to satisfy their spending needs than their unitary peers, especially those that are not highly decentralized. This autonomy is a core feature of federal function, as “insofar as federal theory is rooted in the experiences of advanced, industrialized countries, it carries an assumption of non-trivial tax bases at the subnational level, as these underpin the prospects for differential decision-making by [subnational governments]” (Dickovick, 2014, p. 561). Second, this autonomy is not universally distributed. In more centralized federations, local governments may have considerable spending duties but minimal own-source revenue, leaving them reliant on transfers from higher strata of government and the overall system with large vertical fiscal imbalances – the difference between the expenditure needs of municipalities and their own tax revenues. Some transfers are unconditional, as in the case of most revenue-sharing schemes and equalization grants. Other transfers may be conditional (“earmarked”), discretionary (not mandated by law), or both, further limiting autonomy. Third, there is less e­ xpectation 12   See previous notes on these nations’ current local and general government difficulties. Additionally, South Sudan (Genocide Watch, 2020) and Nigeria (Genocide Watch, 2021a; Stanton, 2020) since 2020 and Ethiopia since 2021 (Genocide Watch, 2021b) are in genocide emergency status, while the Sudan continues to experience massacres despite peace efforts (Ross & Hill, 2021).

378  Research handbook on city and municipal finance

than in decentralized unitary systems of horizontal fiscal equity or uniform service provision to all residents. While a few federal countries pursue horizontal equity, in many others, uneven service provision is seen either as a neutral consequence of subnational government choices or as a positive indication of subnational autonomy – that lower service provision and accompanying lower charges is the preferred utility bundle of that government’s residents. As Table 20.2 shows, there is considerable variation in local government systems and finances even within this subset of federal countries. The average number of persons per local government ranges from fewer than 4,000 (Switzerland) to over 215,000 (Malaysia). While not perfectly aligned, expenditures and revenues are generally consonant. At one Table 20.2 Select federal countries’ local government counts (c. 2021) and finances (2016)

Argentina Australia Austria Belgium Bosnia Brazil Canada Germany India Malaysia Mexico Nepal Russia Switzerland United States

Statesa

Local Govsb

Avg. Pop. per Local Gov.

Local Gov. Exp., % of General

Local Gov. Rev., % of General

Grants, % of Local Gov. Rev.c

24 16 9 6 3 27 13 16 36 16 32 7 85 26 57

2,217 563 2,095 591 154 5,571 3,646 11,670 283,777 150 2,470 753 20,303 2,220 38,984

19,422 45,293 4,299 19,610 21,727 38,155 10,352 7,179 4,863 215,773 52,199 38,694 7,188 3,898 8,574

4.5 8.9 16.7 13.3 10.8 19.3 20.8 18.1 13.4 2.8 6.8 24.0 21.1 21.6 26.2

5.4 7.3 17.1 14.3 10.9 25.0 21.2 18.1 6.7 4.6 8.6 33.0 21.7 21.3 29.5

17.1 29.1 65.1 48.7 11.7 65.0 42.7 42.2 53.7 10.5 87.4 80.2 76.2 18.5 32.7

Notes: a. The States column includes all state-level entities, including those that do not constitute legally federating bodies. b. The Local Govs column reflects active municipal (city, town, county, etc.) governments but not specialpurposes entities (school boards, etc.). Local government counts are for 2021 or most recent prior update, taken from Instituto Nacional de Estadística y Censos de La República Argentina (INDEC) (2019); Australian Bureau of Statistics (ABS) (2016); Statistics Austria (2020); StatBel (2021); Agencija za statistiku Bosne i Hercegovine (ASBH) (2020); Instituto Brasileiro de Geografia e Estatística (IBGE) (2020); Statistics Canada (2016, 2020); DeStatis (2021); Ministry of Panchayati Raj (MPR) (2021); Jabatan Kerajaan Tempatan (JKT) (2021); Instituto Nacional de Estadística, Geografía e Informática (INEGI) (2020); Open Data Nepal (ODN) (2018) and Devkota (2021); RosStat (2021); Bundesamt für Statistik (BFS) (2021a); and US Census Bureau (2021). Population estimates are for 2020 from UNDESA (2019). c. The Grants column includes tax sharing, grants, subsidies, and similar transfers from higher government strata. Financial data is for 2016 and comes from OECD/UCLG (2021) except for India, Malaysia, Nepal, and the United States, which did not have complete local government information in the OECD file; accordingly, their figures are lower in reliability. India data are from Department of Economic Affairs (2018) and Ahluwalia et al. (2019); Malaysia from OECD/UCLG (2019b); Nepal from Devkota (2021); and United States from Urban Institute (2021) and OECD/UCLG (2021). Micronesia and the United Arab Emirates are excluded due to no publicly available financial data.

Municipal finance in federalist systems  ­379

extreme, municipalities intended to provide few services have little revenue (such as in Malaysia); at the other, local governments providing key services have a large share of expenditures (United States). More enlightening is the relationship of local government’s share of revenues to the fraction of a local government’s revenue that comes from transfers. When considering the function and nature of intergovernmental transfers in a system, trends become somewhat clearer. Though there are certainly exceptions for every case, lower shares of grants as a total of local government revenues are loosely associated with lower local government activity, as measured by the share of expenditures. Moderate granting is associated with moderately high expenditures, and high grants are associated with generally high expenditures. Most indicative of the actual fiscal autonomy and flexibility of a given local government system is the character of intergovernmental transfers – earmarked grants, unconditional but sometimes discretionary grants, by-law transfers, standardized revenue-sharing payments, and so on. Low-autonomy municipalities can act as passthrough service provision agents, making large expenditures that are primarily financed by earmarked grants requiring the municipality to execute the service per the granting government’s budget and priorities. While detailed data on the composition of grants to local governments is less evenly available than the total levels of those grants, insights are still possible.13 Argentina, for example, centralizes its subnational powers in the provinces, which are financially and politically powerful. Its local governments are provincial creations and highly centralized to provincial and national priorities, despite local government’s relatively modest share of grant revenue due to the grants’ conditional and discretionary nature. Such grants motivate “continuous bids for additional resources instead of focusing on developing managerial efforts or improving their own-source revenues” (Artana et al., 2013, p. 2) and reduce local government autonomy. Australia similarly invests most financial powers at the state level, leaving weak local governments with few expenditures funded by relatively few, mostly conditional grants. The United States too considers municipalities exclusively state creations. Unlike many other such countries, however, local governments retain relatively strong revenue and expenditure autonomy. They are also supported by a low level of conditional, discretionary federal grants and many mostly conditional (though occasionally general-purpose and even sometimes equalizing) state grants. Canada, like Argentina, Australia, and the United States, treats its municipalities as extensions of provincial will, with whatever structure and duties the province or territory sets them. Still, they are imbued with relatively high own-revenue authority and only moderate grant support in the form of both conditional and unconditional transfers, some of which may – uncommonly, for a federal country – pursue in-province horizontal equalization. While Germany constitutionally guarantees local governments’ status, their structures and duties are at the discretion of their Länder. These may, as in Canada, decide to offer fiscal equalization to their municipalities, but local finances are otherwise dominated by unconditional, by-law tax sharing and exclusively land (not federal) grants. Switzerland,

13   Information in the following paragraphs is from OECD/UCLG (2016) except where otherwise noted.

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too, constitutionally acknowledges municipalities but leaves their organization and duty assignments to their cantons; however, Switzerland stands out as one of the most fiscally decentralized countries, allowing meaningful direct taxation by municipalities and withincanton equalization granting (as with Canada and Germany), with nearly one-half of all transfers earmark-free. Fitting for a country where most municipalities predate both their region and the country in its current form (Belgian Federal Government [BFG], 2019), Belgium’s municipalities are similarly constitutionally acknowledged but regionally governed, retain many – if overlapping – responsibilities, and have moderately high ownsource revenues. They receive moderate, mostly compulsory, unconditional transfers, further supporting their autonomy. To an even greater extent than the foregoing trio, Brazil’s municipalities are politically independent, with recognition as independent federating entities that are, most unusually, not creations of their states and whose duties are specified in the national constitution. Though Brazilian municipalities have a high share of grant funding, the funds are, like Germany, Switzerland, and Belgium, compulsory and the most important are unearmarked, further enhancing municipal autonomy. In contrast, Austria acknowledges the role of both states and local governments in national legislation but leaves neither with much fiscal or practical autonomy, preferring to remain highly centralized at the national level. It does, however, preserve a measure of subnational autonomy via primarily compulsory and unconditional transfers. Similarly, though India’s central government has taken steps to attempt to increase local autonomy and its constitution has recently explicitly acknowledged local governments, states are still entirely in control of what, if any, duties are devolved to local entities. Own-source funds make up a very small proportion of local finances; their meagre expenditures are financed through grants (in states largely unconditional, in territories typically discretionary).14 Malaysia likewise remains a highly centralized federation, which acknowledges local governments and sets their duties nationally, appoints officials (rather than allowing local elections), and permits only minor expenditures financed by shared-down taxes (levied exclusively by federal law) that turn into a mix of conditional and unconditional funds. Mexico follows this model of constitutionally acknowledging municipalities but sharply restricting their own-source revenue capacity, leaving local governments reliant on an exceptionally high level of granting, much of which is conditional. Similarly, Nepal’s constitution recognizes local government as part of its federal structure and specifies exclusive and concurrent local duties, but revenue authority remains primarily federal and municipalities rely on tax sharing and a mix of conditional (~60 percent) and unconditional grants, including internationally rare national equalization grants (Devkota, 2021; Khatiwada, 2020). In the final cluster, Bosnia’s federal system is a notable example of asymmetric federalism, in which the federating entities are of unequal scales and differing powers. This asymmetry extends to its municipalities and their finances (Sahadžić, 2020). The federating unit of Brčko District has no subdivision governments. Republika Sprska has municipalities but no intermediate local governments. The Federation of Bosnia and Herzegovina is itself a federal entity composed of cantons, which then have

14   It is difficult to speak with confidence on India’s local governments due to their great number and weak reporting thus far (Ahluwalia et al., 2019).

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­municipalities. Unlike many other federal countries, the national government of Bosnia has minimal own funding, relying on the federating entities to allocate funds upward to the state and downward to their local governments, with the Federation further devolving authority over municipalities (and their finances) to their cantons (Jokay, 2001). Direct taxation is only permitted at the entity level, so local governments are funded primarily by shared-down tax revenues and discretionary transfers (Hunziker & Dejonghe, 2019; OECD, 2021). Russia is also a classic example of asymmetric federalism, with each type of federating entity having its own set of powers and rights. Before 2005, these entities’ local government was heterogenous, but with the 2003 promulgation of Federal Law No. 131-FZ, the national government imposed a regular local government system on each federating unit and, with it, consistent financing. Local governments receive the significant majority of their funding from vertical transfers and have little financial or other autonomy (Babun, 2020).

MUNICIPAL FINANCE AND DEVELOPING TRENDS Even in normal operations, the dynamics of municipal finance are not static. As conditions change, local governments and their finances change too. Key trends affecting municipal finances are aggregation and incorporation pressures, intra- and inter-strata competition, and climate mitigation. Aggregation and Incorporation Pressures In many federal countries, there are active pressures for “right-sizing” of local governments. Particularly in Europe, this tends to take the form of amalgamation – the association of municipalities to provide certain public services at more optimal scales – with policies that encourage smaller municipalities to fuse into a single entity (horizontal aggregation) or intermediate governments to devolve their powers and dissolve (vertical aggregation). This trend reflects pressures for increased efficiency in service provision via economies of scale. Agglomeration movements can be seen in Australia (869 Local Government Areas in 1980 to 580 by 2021), Austria, Belgium, Canada, Germany (municipality count decreased by one-third 1990 to 2016), Nepal (3,374 local bodies to 753 upon adopting federalism in 2015), and Switzerland (20 percent municipality decrease 1990 to 2012) (Devkota, 2021; Hachhethu et al., 2018; OECD/UCLG, 2016). Switzerland also demonstrates the dissolution mode, with both a reduction via agglomeration of total districts from 176 (1990) to 134 (2021) and conversion of 65 (of 134) districts from true governments to electoral-statistical entities in the same period (BFS, 2021b; Cools & Chirtoaca, 2017). In contrast, other federal countries are gaining new municipal entities (incorporation), primarily motivated by increased autonomy but also by transfer systems that provide equal amounts of funds to each local government regardless of size, such as in the case of equalization grants. Most growth is in countries that are newer to decentralization and/ or federalism. For example, India introduced four new states and three new union territories, as well as 46,000 local governments, between 2000 and 2021 (Ministry of Housing and Urban Affairs [MOHUA], 2021; Ministry of Panchayati Raj [MPR], 2021; Ministry

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of Statistics and Program Implementation [MOSPI], 2013), but some more-established federations are also seeing net growth (OECD/UCLF, 2019a; Statistics Canada, 2020; US Census Bureau, 2020). Incorporation may appear in the form of a new, more local government springing up to organize otherwise minimally governed areas. Alternately, the “suburban secession” or “cityhood” movement (Allums & Markely, 2020; Kasakove, 2019; Kruse, 2005) may inspire an existing urbanized population to exit a larger (e.g., county) government to set their own taxes and policies and receive a different service bundle on a more advantageous fiscal exchange basis (comparing the taxes paid and the services received). Though the southern United States is the most cited example of this trend, the same forces are found in a variety of federal countries (see Grossmann, 2019), whether or not they have yet prompted municipal change. Intra- and Inter-strata Competition Another significant municipal dynamic is intra- and inter-strata competition. In the case of the former, local governments may find themselves engaging in horizontal competition for resources, such as the classic example of attempting to attract a large employer via escalating incentive packages (Simon, 2017). While this horizontal competition continues to be common, an additional type of competition has emerged: that of local government with its next highest layer. This type of vertical competition takes different forms, involving, for example, the common-pool resource nature of tax bases or the underlying moral hazard problem of a revenue-sharing system where subnational governments rely on federal transfers. In municipal systems without clearly defined duties or guaranteed autonomy, the theory that local governments have only those powers specifically permitted by their higher governments (“Dillon’s Rule” in the United States) tends to apply (Public Health Law Center [PHLC], 2020). Though most American states operate with a mix of Dillon’s and home rule elements, recent years have witnessed “an unprecedented effort to roll back home rule and the policymaking role of local governments” (Briffault et al., 2019, p. 11) via preemption – state laws reversing or forbidding local ordinances on minority protections, higher minimum wages, ecological preservation, and so on (Riverstone-Newell, 2017). While the United States is certainly well-known for such conflicts, politically charged crises such as the COVID-19 pandemic have brought local–state (and state–nation) tensions to the fore in many federal countries with relatively strong municipalities (Mankoff et al., 2020; Moore, 2021; Naishadham, 2020; Peel, 2020; Povich, 2021; Stelzenmüller & Denney, 2020; Zilla, 2020). Given the likelihood of further disruptive crises in the future, such competition seems primed to escalate. Climate Mitigation As touched on in the previous trend, municipal finance must increasingly reckon with large-scale unforeseen events, such as pandemics, climate change mitigation, and management/recovery from disasters (Kochanov et al., 2020; Negreiros et al., 2021; Reiners et al., 2020). Municipal governments must tailor their infrastructure spending to climate resiliency, mitigation, and adaptation, increasing the likelihood that their polity will survive the crises to come (Martinez-Vazquez, 2021). Indeed, one of the UN’s 17 Sustainable Development Goals is improving cities’ climate resilience (United Nations [UN], 2015).

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When an entire town can disappear in less than an hour (Alsup & Colon, 2021), the timeliness of local response to disasters has never been clearer. These challenges mean municipal governments operate “in a context of radical uncertainty” (Allain-Dupré et al., 2020) that makes both wise investment and flexible operational funding essential to long-term municipal survival.

CONCLUSION This overview of typical municipal finance in federal systems shows several key characteristics for scholars and practitioners of public finance to consider. First, no two federal municipal systems are exactly alike. The forces that led to a polity’s adoption of a federal system of government continue to shape federal countries’ power balances and political realities – and their subnational governments – decades or centuries after establishment. Second, a municipal system is shaped by its source of authority. Municipalities acknowledged by national law may have a more solid claim to autonomy than those whose existence is at the pleasure of a subnational government. Third, the structure of local government matters. Entirely or mostly territorially complete systems allow municipalities broader public support (being a constant in all or nearly all residents’ lives) and invest them with relatively greater resources and responsibilities. A system with only one layer of local government allows for more independence in the sub-state space. Those with two or more layers must navigate power division and permissible revenue sources more carefully but may also find efficiencies in subnational vertical partnership. Fourth, municipal finance is extremely variable across countries, municipal systems, and political structures. Care must be taken when attempting to increase fiscal independence. Local governments may be bound by national, state, or local laws or regulations that restrict their ability to generate own-source revenues. At the same time, over-reliance on transfers for funding risks sapping both revenue collection effort and meaningful autonomy if the transfers are discretionary, conditional, or both. Finally, municipalities and their finances are not static. Depending on social and economic pressures, municipalities may aggregate to reduce costs or fragment to increase autonomy. Competition with other municipalities on their own and higher levels may drive localities to rethink their priorities and service delivery strategies. Changing conditions, such as climate mitigation efforts and public health emergencies, require strong communication between governments and with the public, flexible funding and operations, and a commitment to investing in the future. Only by holistically understanding these challenges and the historical-political dynamics of the municipal setting can local governments effectively manage and evolve their finances.

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21. Municipal finances in unitary systems: the effects of crises on financial autonomy in four European countries*

Ringa Raudla, Mark Callanan, Kurt Houlberg, and Filipe Teles

INTRODUCTION One of the key questions in municipal financial autonomy is whether there should be any restrictions on municipalities’ borrowing or whether they should be free to borrow as they see fit (and only be subject to financial market discipline) (Dollery et al., 2020; Ladner et al., 2021). The profound challenges experienced by European countries after the financial and fiscal crises since 2008, combined with the tightening of the EU-level fiscal rules in 2011–13 (which pertain to general government finances, encompassing the local government sector), are likely to have triggered changes in municipal financial autonomy (Kotia & Lledó, 2016; Wortmann & Geissler, 2021). Jochimsen and Raffer (2020, p. 2) observe that after the global financial crisis (GFC), local governments in Europe have become exposed to an increasingly “dense web of numerical fiscal rules”: not only have the local fiscal rules become more numerous, they have also increased in institutional strength. Different countries have responded to the crises unfolding since 2008 in different ways (e.g., Pollitt, 2010; Raudla et al., 2015, 2020). The scope and content of the austerity measures adopted in response to the fiscal crisis have varied considerably from country to country (Walter, 2016). Hence, we would expect that the austerity pressures have led to different developments in municipal financial autonomy (including local fiscal rules). At the same time, Jochimsen and Raffer (2020) note that compared to the national-level fiscal rules, the developments in local government fiscal rules have received only limited attention in scholarly discussions in the EU context. A decade after the fiscal crises experienced by many European countries, the continent was hit by a whole new crisis – triggered by the COVID-19 pandemic – which is also likely to have major repercussions for municipal finances. Such a trajectory of developments allows us to take stock of how municipal financial autonomy is affected by various crises and what kinds of changes in fiscal rules are triggered by different types of crises. The goal of this chapter is to explore how fiscal crises have affected municipal financial autonomy in the unitary systems of European countries over the past decade. In particular, we focus on the following set of questions: (1) Did the experience of a fiscal crisis (from 2008 onwards) lead to increased centralization and reduced municipal autonomy or rather to increased decentralization? (2) What kinds of changes in fiscal rules pertaining to municipalities’ ability to borrow and incur deficits were triggered by the fiscal   This work was supported by the Estonian Research Council grant PRG1125.

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crisis/period of austerity? (3) How have the fiscal rules been affected by the COVID-19 pandemic? We will examine these questions by looking at developments in four small unitary states: Denmark, Estonia, Portugal, and Ireland. These four countries experienced very different degrees of fiscal crisis in the aftermath of the GFC. Portugal and Ireland went through a dramatic crisis, which necessitated a bailout by the “Troika” (consisting of the International Monetary Fund [IMF], the European Commission [EC], and the European Central Bank [ECB]) (e.g., Hardiman et al., 2019). Estonia and Denmark experienced milder fiscal crisis but both countries did adopt sizable austerity measures (e.g., Mailand, 2014; Paulus et al., 2017; Raudla & Kattel, 2011). In addition, these four cases provide useful variation as they represent different administrative “traditions” of local government – namely, Nordic, Central and Eastern European, Napoleonic, and Anglo-Saxon (Bouckaert & Kuhlmann, 2016; Kuhlmann & Wollmann, 2019; Loughlin et al., 2011; Raffer & Ponce, 2021). In the Nordic tradition, local governments have strong powers, extensive autonomy, and the inter-governmental decision-making follows a consensual style. The local governments in the Anglo-Saxon tradition have limited powers, constrained autonomy and a more centralized approach to decision-making by national government on local government issues. In the Napoleonic tradition, local governments have stronger legal protections and constitutional guarantees of autonomy than in the Anglo-Saxon tradition but their scope of tasks and autonomy are more constrained than in the Nordic tradition. In the Central and Eastern European tradition, local governments were given considerable constitutional and legal guarantees of autonomy at the onset of the transition in the early 1990s, but in reality the local governments in this tradition tend to have limited tasks and weak capacities, and be characterized by strong dependence on the central government (Ladner et al., 2021). The chapter is structured as follows. The second section outlines theoretical considerations about the effects of crises and austerity on local fiscal rules and financial autonomy. The third section presents the developments in our four cases and the fourth section offers a concluding discussion.

THEORETICAL DISCUSSION: CRISES AND MUNICIPAL FINANCIAL AUTONOMY The existing literature exploring fiscal crises and governance often argues that the experience of a fiscal crisis is likely to lead to changes in governmental decision-making processes. In particular, we can expect that the increased need to secure fiscal discipline would give rise to increased centralization of decision-making in the public sector (e.g., Di Mascio et al., 2013; Peters et al., 2011; Raudla et al., 2015). Increased centralization of decision-making can, inter alia, take the form of additional financial controls imposed on subnational governments with regard to municipal finances (Foremny, 2014; Hallerberg et al., 2009; Raudla, 2010; Tang et al., 2014). In a situation where municipal borrowing can generate externalities for the national government, having a central actor that is able to monitor the behavior of others and impose sanctions (if necessary) can help achieve coordination on the budgetary commons (Foremny, 2014; Hallerberg et al., 2009; Raudla et al., 2015). In unitary countries, the central government is the most obvious coordinator

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and it can (re)exert its authority with regard to the local governments by reducing the decision-making discretion of the local authorities and imposing constraints on their budgetary decision-making via fiscal rules (e.g., expenditure limits, deficit ceilings, or borrowing restrictions) (Bolgherini, 2016; Overmans & Timm-Arnold, 2016). In the context of the EU countries, such increased centralization can be driven by three key mechanisms: (1) attempts to address common-pool problems inherent in budgeting; (2) motives to avoid moral hazard; (3) incentives to strengthen macro-control over total (including subnational) borrowing to avoid supra-national fines. First, in the context of austerity, common-pool problems of budgeting become amplified (Jochimsen & Raffer, 2020). Common-pool problem of budgeting means that decision-makers internalize the full benefits of expenditure but bear only a fraction of the cost because it is financed from common tax fund (Hallerberg et al., 2009). The commonpool problem is viewed as a major driver of deficit bias in local budgeting (Foremny, 2014; Jochimsen & Raffer, 2020; Kotia & Lledó, 2016; Ter-Minassian, 2007). In the case of cutback measures and contained municipal borrowing, the costs of such restraints can be concentrated within individual organizations, while the potential benefits (if any) of successful fiscal consolidation are diffused, leading to disincentives for local governments to impose constraints on themselves (Tang et al., 2014). Conversely, the costs of fiscal indiscipline by some local governments are likely to spill over to others (Ter-Minassian, 2007). Thus, to mitigate the common-pool problems of budgeting and to restore financial control, the central government is likely to impose fiscal rules on the local governments. Second, controlling local-level borrowing may be motivated by the desire of the supra-municipal government to avoid municipal bankruptcies and having to bail out municipalities (Foremny, 2014; Jochimsen & Raffer, 2020; Kotia & Lledó, 2016; TerMinassian, 2007). Where the central government is responsible for the outstanding debt of local governments, or cannot credibly commit to a no-bailout policy, it has incentives to impose controls on borrowing to avoid moral hazard (Dollery et al., 2020; Foremny, 2014; Ter-Minassian, 2007).1 Third, in European countries, the key EU fiscal rules pertain to general government, which, in addition to the central government and social insurance sector also includes local government finances (Raudla & Douglas, 2021). That means that in unitary states, the national government is the actor that is ultimately responsible for complying with the EU-level fiscal rules, even if it is the local government sector that contributes to additional deficit or debt. In response to the sovereign debt crisis in European countries, the EU fiscal rules have become increasingly stricter over time (Jochimsen & Raffer, 2020; Kotia & Lledó, 2016; Raudla et al., 2020; Schnellenbach, 2018; Wortmann & Geissler, 2021). For example, the Treaty on Stability, Coordination and Governance (also called the Fiscal Compact), which entered into force on 1 January 2013, required members of the Eurozone to establish a general government structural deficit rule in their domestic legislation (Raudla et al., 2020). The fiscal rule requires that the annual structural balance meets the country-specific medium-term objective and does not exceed a structural 1   Moral hazard is more likely in countries where local governments have low tax autonomy. In such contexts, it is more challenging for the central government to ask local governments to make adjustments in subnational taxes, and, as a result, local governments may develop bailout ­expectations (Foremny, 2014; Kotia & Lledó, 2016).

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deficit of 0.5 percent of gross domestic product (GDP). The Treaty stipulates that if the structural balance deviates significantly from its medium-term objective, an automatic correction mechanism will be triggered to correct these deviations (for a more detailed overview of the changes in EU fiscal rules, see, e.g., Raudla et al., 2020). As there are (potential) sanctions involved for violating EU fiscal rules, the national governments in unitary states are likely to have had incentives to adopt stricter fiscal rules for municipalities in response to supranational pressure from above (Jochimsen & Raffer, 2020; Turley et al., 2021; Wortmann & Geissler, 2021). In sum, in response to fiscal crises, we would expect the central governments to impose stricter fiscal rules on municipalities, essentially limiting their financial autonomy. Fiscal rules “impose long-lasting constraints on policy through numerical limits on budgetary aggregates” (Geissler et al., 2021, p. 10). The four main types of fiscal rules are deficit rules (e.g., balanced budget requirements or deficit limits), debt rules (e.g., debt ceilings), expenditure rules (e.g., ceilings on general public expenditure growth or on certain types of government spending), and tax revenue rules (e.g., limits on the increase in the overall tax burden). Furthermore, there can be ceilings on the proportion of the budget that can be spent on debt service (either as a percentage of revenues or current spending). Restriction may also take the form of the “golden rule,” which means that borrowing is only allowed for capital expenditures (Dollery et al., 2020; Geissler et al., 2021; Jochimsen & Raffer, 2020; Raudla, 2010; Turley et al., 2021). The extent to which the national governments can go ahead with imposing stricter fiscal rules on municipalities depends on various factors. In countries characterized by traditions of strong local governments and a high degree of municipal autonomy, the imposition of restrictive rules may be more challenging (Ter-Minassian, 2007; Wortmann & Geissler, 2021). The degree of severity of the crisis may also influence to what degree austerity would lead to reductions in municipal financial autonomy (Bolgherini, 2016; Cepiku et al., 2016; Kristinsson & Matthíasson, 2016). The more severe the crisis, the easier it is for the central government to justify the imposition of restrictive fiscal rules on local governments. The existing empirical evidence about European countries suggests that local fiscal rules, when properly designed and enforced, can facilitate fiscal discipline at the subnational level (for a recent overview of literature, see Turley et al., 2021). Foremny (2014) demonstrates that in EU15 countries, fiscal rules lead to lower deficits only in unitary countries, while in federal countries (where subnational governments have higher a­utonomy), fiscal rules are less effective in securing fiscal discipline. Kotia and Lledó (2016) show in their study of 26 European countries that the effect of subnational fiscal rules on deficit tends to be dampened by vertical fiscal imbalance (i.e., higher the dependence of subnational governments on fiscal transfers from the central government).2 Jochimsen and Raffer (2020) find in their study of 19 European countries that balanced budget rules contribute to fiscal discipline more than other types of fiscal rules but only if they are properly implemented (in terms of monitoring, enforcement, and visibility).

2   Vertical fiscal imbalances, in turn, are more likely to occur when devolution of revenue mandates is outpaced by devolved spending responsibilities (Kotia & Lledó, 2016).

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However, local fiscal rules may also become rigid straightjackets when major crises hit that necessitate additional expenditures. In other words, local fiscal rules may hamper the resilience or robustness of local governments in dealing with crises like the COVID-19 epidemic (Capano & Woo, 2018; Howlett et al., 2018).

EMPIRICAL STUDY: DENMARK, ESTONIA, PORTUGAL, IRELAND Denmark Denmark is among the most decentralized countries in Europe, both in terms of fiscal decentralization and local autonomy (Ivanyna & Shah, 2014; Ladner et al., 2016). The three-tier level of government encompasses two levels of subnational governments besides the state level: regions and municipalities. A major structural reform in 2007 reduced the number of municipalities from 271 to 98, replaced 14 counties with five regions, and reshuffled functions between the three tiers, mainly in the direction of more functions at municipal level. After the reform, the regions are mainly responsible for hospitals, while the municipalities are multi-purpose units responsible for a wide range of tasks spanning from day care, schools, elder care, social housing and services for children and adults with special needs to labor market activities (including income transfers), spatial planning, roads and culture (Blom-Hansen et al., 2016; Houlberg & Ejersbo, 2020). As of 2019, municipal expenditures constituted 27.7 percent of GDP. Based on budget figures for 2019, the most important revenue source is local income and land taxes, covering around 64 percent of total municipal revenues. In addition, 23 percent of the revenue comes from general and conditional grants from the central government and around 13 percent from fees and user charges (Houlberg & Ejersbo, 2020). Central government regulation of local fiscal autonomy is nested within the so-called “budget cooperation system” (Blom-Hansen & Heeager, 2011; Houlberg & Ejersbo, 2020). One pillar is the “budget guarantee,” which compensates the municipalities as a whole for changes in expenditures for labor market activities and income transfers that are sensitive to economic fluctuations. In times of economic downturn, the increasing municipal expenditures for the unemployed, recipients of social benefits, and early retirement pensions are automatically compensated by an increased general grant from the central government – and vice versa in times of economic upturn. The most important pillar in the budget cooperation system is the annual economic agreements between the central government and the association of local governments (Local Government Denmark, LGD). In contrast to the “budget guarantee,” the economic agreements are not regulated by law but have evolved as an institution since the first agreements in 1979. The core of the annual economic agreements is the tax level, the level of service expenditures, and the level of gross investments for the municipalities collectively (Blom-Hansen et al., 2012; Houlberg & Ejersbo, 2020). No frames are set for the individual municipality, and the agreement is not binding for the individual municipality. In principle, each municipality is still able to set its own rates and policies – as long as the collective limits for the municipalities at large are not violated. In response to the GFC, the central government tightened local fiscal rules. In 2011, the national parliament implemented a sanction regime on the municipalities, which was

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later integrated into the so-called “Budget Law” (Houlberg & Ejersbo, 2020; Suenson et al., 2016). The Budget Law ‒ which is still effective – stipulates a balanced budget requirement and sets annual spending ceilings for each of the three tiers of government. The regime implies that the annual economic agreements between the central government and LGD are backed by law-enforced sanctions if the municipalities are breaking the spending ceilings. General grants can be cut by DKK3 billion if the ceiling for service expenditure is not kept in the approved budgets and in the final accounts. The law also stipulates that if budgets are overrun, 60 percent of the sanctions are directed to the individual municipalities violating the rules and 40 percent collectively on all municipalities. So far, no actual sanctions have been activated; the threat of sanctions seems to have been successful – and the fiscal policies of the municipalities collectively have moved from a period (prior to 2011) typically characterized by budget overruns to a period of systematic budget underruns since 2011 (Houlberg & Ejersbo, 2020). Since the spending ceilings are annual, money not spent in one year cannot – for the municipalities at large  – be carried over to next year. Budget underruns in one year therefore in practice end up in the municipal reserves, and since 2011 the municipalities’ total liquid assets have more than doubled to DKK60 billion (Indenrigs- og Boligministeriet, 2022). Following significant municipal budget underruns in 2012 and 2013, the central government imposed significant decreases in the spending ceiling for service expenditures in 2014 and 2015 – and cut general grants accordingly. Municipalities in principle have a high level of taxation autonomy. However, a tax stop has been a national tax policy since 2001, and unchanged tax levels for municipalities at large have correspondingly been an integral part of the annual agreements between the central government and LGD. One municipality is therefore only allowed to raise taxes if other municipalities correspondingly reduce taxes, and in practice fewer municipalities are actually changing their tax rates (Blom-Hansen et al., 2012, p. 129; Houlberg & Ejersbo, 2020). This de facto reduction in taxation autonomy was, however, not induced by the financial crisis, but traces back to changes in national tax policies at the turn of the century. Two important fiscal instruments did not change in the wake of the financial crisis. First, the “budget guarantee” was active and remained unchanged. The municipalities at large were thus compensated for the increased expenditures on labor market activities and income transfers for unemployed and so on by an increased central government grant. Second, the “golden rule” restricting debt financing to (specific forms of) capital expenditures applied both pre and post the financial crisis. In short, as a response to the fiscal crisis, the central government limited local financial autonomy via deficit rules (balanced budget requirement) and expenditure rules in the form of legally mandated expenditure ceilings for the municipal sector at large. Debt rules and tax revenue rules, however, were not affected. In response to the COVID-19 crisis, the central government relied on three fiscal instruments. First, according to the “budget guarantee,” the municipalities at large were automatically compensated for increasing expenditures on labor market activities and income transfers for the unemployed and so on. Second, the expenditure ceiling for gross investments was cancelled in 2020 and the municipalities were encouraged to spend as much as possible on construction activities and maintenance of buildings (to support employment in the building and construction industry). Third, the central government

Municipal finances in unitary systems  ­397

made a supplementary agreement with LGD to compensate the municipalities at large for additional operating expenditures directly related to the COVID-19 crisis, lockdown, and national COVID-19 restrictions in both 2020 and 2021 (e.g., extra expenditures for cleaning, tests, protective equipment, and extra staffing). No further fiscal rules were enacted as a response to the COVID-19 crisis. On the contrary, the fiscal rules were loosened and the central government aimed at compensating the municipal sector at large for all additional costs. Estonia As of 2021, Estonia has 79 municipalities.3 The main tasks of the local level are related to education, social assistance and services, public transport, physical planning, local roads, and utilities (Mäeltsemees, 2016). Local government expenditures constitute around 9 percent of GDP (as of 2019) (Eurostat). The tax autonomy of Estonian municipalities is very low and the local governments depend highly on transfers from the national government (Kriz, 2008; Mäeltsemees, 2016; Raffer & Valesco, 2019). The biggest portion ‒ around 50 percent of the total local revenues ‒ comes from part of the personal income tax transferred by the national government (Mäeltsemees, 2016). The second main source of local government revenues is subsidies and grants from the central government (Kriz, 2008; Mäeltsemees, 2016). The share of local taxes in revenues has been negligible – less than 1 percent (Kriz, 2008; Mäeltsemees, 2016; Raffer & Valesco, 2019). In response to the GFC, the central government cut transfers to the local governments, reduced the local share of national tax receipts, and, at the same time, enacted stricter local fiscal rules pertaining to debt and deficit (Friedrich & Reiljan, 2015; Mäeltsemees, 2016; Raffer & Valesco, 2019; Raudla et al., 2017). The local debt ceiling of 60 percent of operational revenues (which had been enacted already in 2003)4 was kept in place but since 2009, local governments have been allowed to incur loans only after receiving consent from the central government’s finance ministry (Raudla et al., 2017).5 To implement the EU Fiscal Compact, the 2014 reform of the national framework law for budgeting foresaw a balanced budget rule for the general government, which also had implications for the local level. As a result, the revised Local Government Financial Management Act (LGMA) requires municipalities to balance their operating budgets, meaning that they have to follow the golden rule of incurring debts only for capital expenditure. The LGMA also stipulates that if a local government breaks the debt or deficit rules two years in a row, it has to adopt a plan with correction measures to restore fiscal discipline. This plan has to be approved by the finance ministry. Overall, due to the deficit and debt rules, the fiscal discipline of the Estonian local governments has been high (Mäeltsemees, 2016; Raffer & Valesco, 2019). For example, between 2000 and 2005, average local-level deficit was 0.6 percent of GDP, while in   The amalgamation reform of 2016 reduced the number of municipalities from 213 to 79.   Local governments with higher revenue capacity were allowed to have debt loads of up to 100 percent of revenues. 5   Between 2004 and 2011, local governments in Estonia had also been subjected to a debt service rule: debt payments could not exceed 20 percent of annual budget revenues (Kriz, 2008). In 2011, this rule was abolished. 3 4

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2012–16, the average was 0.1 percent of GDP (Raffer & Valesco, 2019). By 2007, local government debt as a share of the general government debt reached above 75 percent but by 2016 it had fallen to around 35 percent (ibid.). Since 2009, the share of local public debt in GDP has varied closely around 3 percent (ibid.). However, municipalities have struggled with unfunded mandates (Friedrich & Reiljan, 2015) and the provision of public services has tended to be uneven, which was one of the drivers of the amalgamation reform in 2016. In response to the COVID-19 crisis, the EU suspended the fiscal rules pertaining to deficit and debt. In contrast to the fiscal actions undertaken in response to the GFC, in 2020 and 2021, the Estonian central government increased transfers to local governments to help them cope with the crisis and compensate reduced personal income tax revenues (Raudla & Douglas, 2020). As a result of those transfers and some cutback measures by local authorities, the local government sector actually recorded a small surplus in 2020 (0.02 percent of GDP) and is expected to have 0 percent deficit in 2021. Although initially, in spring 2020, in response to the COVID-19 crisis, the debt rule of 60 percent was relaxed, it was tightened again in December 2020 and a 60 percent debt limit was foreseen for all local governments without exceptions (with a transition period until 2024). Overall, the existing fiscal rules, along with fiscal transfers from central government, allowed the local governments to cope with the COVID-19-induced crisis. Portugal Portugal is a unitary state with a two-tier local level, consisting of 308 municipalities and 3092 civil parishes. These local governments have a wide range of competencies, but have been traditionally weak in terms of capacity, particularly given their low share of national public revenue and spending. Current local budgets and the fiscal framework were strongly influenced by the period of the (financial and fiscal) crisis, where municipalities were challenged by an intense fiscal supervision, decline in transfers, loss of autonomy regarding taxation, and strict debt limits. Local government spending in Portugal constitutes 13.4 percent of general government expenditure (Eurostat), significantly lower than the EU average of 21.9 percent. As of 2019, local spending constituted 5.7 percent of GDP (Eurostat). Local governments in Portugal operate in a clearly centralized setting (Teles, 2021). The subnational governance architecture reinforces this centralized perspective and undermines the formal constitutional autonomy of municipalities (Silva, 2017). Contrary to certain political claims, Portuguese local-level government has faced important recentralization trends regarding central government control, structure, staffing, and fiscal autonomy. Historically, state transfers and local revenues and taxes have been broadly equivalent, but a major change in this respect occurred after 2012. The local share of general government revenue shrank significantly after the crisis. Nowadays, local taxes account for a larger share than grants. With a share of income tax and levying several of their own local taxes (e.g., property tax and surtax on corporate profit), municipalities have some degree of freedom within a centrally determined range. This limited room for maneuver constitutes, nevertheless, around 40 percent of total revenue share, while state transfers amount to some 27 percent. In addition, regarding investments, there is a high dependency on extraordinary transfers originating from competitive EU regional funds. Portugal saw 84.2 percent of its direct public investment financed by cohesion funds in the period 2015–20.

Municipal finances in unitary systems  ­399

The procedures to recover deteriorated local budgets, after the crisis, resulted in a complex framework of fiscal regulation, which involves the Court of Audit, the Ministry of the Interior, and the Treasury. Annual budget approval requires their sanction. Prior to 2007, debt limits had focused on annual capital and interest payments, but the Local Finance Law of 2007 introduced the debt ceiling of 125 percent (with short-term loans being limited to 10 percent). The new Local Finance Law of 2013, adopted under pressure from the Troika, added further layers of fiscal rules, including a balanced budget rule on current spending. Furthermore, debt rules were made stricter by including offbalance-sheet liabilities under the debt ceiling. All attempts at budget consolidation and, especially, the reorganization of the public sector in Portugal, had a particular impact at local government level. The list of initiatives and measures directly aimed at municipal activity included its reorganization, cuts in grants and salaries, freeze on staffing (the Memorandum of Understanding signed with the Troika established the need to reduce staff at the local level by 2 percent each year), and strengthening the fiscal framework and policy supervision (Silva, 2014). The agreement with the Troika also imposed reforms to optimize the revenues of local property taxes by abolishing temporary exemptions and by changing valuation methods. Other reforms undertaken during that period included a major civil parishes’ amalgamation strategy, under the principles of rationalization and simplification (Tavares & Teles, 2018). Despite these cuts, local governments acted as a shock absorber in social protection, and the pressure to deliver public services encouraged municipalities to seek other sources of revenues. In the face of the drastic reforms in employment protection and unemployment benefits, there was a significant increase of local expenditures in social protection and, to a smaller extent, in health. For example, expenditures on education in Portugal registered an increase of 3.3 percent. All other policy areas experienced substantial cutbacks, at a higher pace than the average scenario in the EU. These distinct features seem to depict the “Portuguese local public services as the biggest loser of the austerity narrative” (Silva & Teles, 2018, p. 74). The ever-increasing borrowing costs and the financial support from the ECB, the IMF, and the EU, meant the implementation of a wide range of fiscal consolidation measures to reduce public spending (Teles, 2014). These presented a test for a fragile system of local democratic government, with unprecedented budget reductions, and an acceptance of increased central supervision and control over municipal activities, as a condition for receiving loans from government (Silva & Teles, 2018). The remote position occupied by Portugal in all indices of decentralization has not fluctuated significantly over the last decades, although the list of competences and responsibilities of municipalities has grown.6 The recentralization trends as a result from the crisis may help in explaining such developments. The financial crisis resulted in a decline in state transfers, stricter debt limits, intensive fiscalization and loss of taxation 6   A recent enactment, from 2019, set in motion a new process of delegation of competences to local governments in a wide number of policy areas. These came into force in 2022 and are for the most part related to infrastructure, functioning and maintenance of public services buildings, schools, and primary healthcare. This process has been highly contested by local authorities given the absence of relevant compensatory financial transfers or of new sources of revenue.

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autonomy. Despite the temporary relaxation of such policies during the recent pandemic, where local authorities were asked to swiftly answer to immediate needs regarding the health crisis, the general framework has not changed. Ireland As of 2014, Ireland has 31 local authorities.7 The primary functional responsibilities of the local government level are social housing, spatial planning, environmental protection, roads and transportation, the fire service, economic development, public libraries, and a range of recreational services. Local government spending in Ireland constitutes 2.5 percent of GDP (as of 2019) (Eurostat). Based on budgeted figures, in 2021, on average, 38 percent of revenue for local government in Ireland came from central government grants (Department of Housing, Local Government and Heritage [DHLGH], 2021), although some local authorities are more reliant on national transfers than others. Local sources of revenue comprise a local property tax on residential properties (7 percent of income in 2021), commercial rates (a form of property tax on business and commercial properties [29 percent]), and user charges for local government services (26 percent). The GFC had severe economic and financial implications in Ireland, manifested in an economic recession, a property crash, and a banking crisis. The scale of public deficits required a loan program from the so-called Troika between 2010 and 2013. Local authorities in Ireland have long been required to adopt a balanced budget each year to cover current (operating) expenditure – that is, combined budgeted revenue sources must be sufficient to meet budgeted expenditure demands. A timetable for the adoption of annual budgets by local authorities is set by the central government each year, and following their adoption by local councils, budgets are sent to the central government. If the minister responsible for local government considers that a budget adopted by a local council is insufficient to meet a reasonable standard of service, they may require the council to amend or revoke the budget within a specified deadline. If the local authority fails to comply, the minister can remove the entire elected council from office – a rather dramatic power that has not been actually exercised since 1985, but is nevertheless still sometimes threatened on recalcitrant councils (Callanan, 2018). Local authorities may borrow but only for capital expenditure, and proposals for borrowing must be approved in advance by central government. Bank overdrafts must also be approved by central government for all years that a local authority has need of an overdraft facility. A borrowing ceiling is set for all local authorities and on the local government sector indebtedness each year. It is worth observing that these arrangements around requirements to balance budgets and restrictions on borrowing were already in place before the financial crisis. Given the fiscal retrenchment at national level, the response to the financial crisis involved significant reductions in central government grants to local government after 2008. In addition, due to the property crash, there was a collapse in income from development levies used to finance capital projects (Considine & Reidy, 2015).

7   In 2014, a reform of local government structures resulted in a reduction in the number of local authorities in Ireland from 114 to 31.

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However, a significant development was the introduction of a new local property tax (LPT) as a new revenue source for local government in 2013. Between 1978 and 2013, no annual tax had been applied to residential properties in Ireland. The LPT introduced in 2013 was part of a broader reform in taxation policy in Ireland in the post-financial crisis period to move away from an earlier reliance on one-off transactional taxes to a more stable tax base, and had been included in the Irish government’s Memorandum of Understanding with the Troika in 2010 (although it is also worth noting it had also featured in national government proposals earlier than this). The decision to introduce the LPT arose not so much from a conversion by government to the merits of greater local government financial autonomy, but rather the pressure (and political cover) provided by the Troika to introduce a politically sensitive new tax. Proponents of the move could also draw upon a long lineage of commissioned reports and studies that had set out the financial merits of a property tax for local government going back to the 1980s and earlier (e.g., Commission on Taxation, 2009; Indecon, 2005). The proportion of local government income raised by the new LPT remains relatively modest (7 percent in 2021). Nevertheless, it does have the potential to become more significant in financial terms in the future, and as a new income stream for local government could therefore be seen as a response to the crisis that increased fiscal autonomy (Turley et al., 2015). On the spending side, following the financial crisis, local authorities were required to undertake a series of significant cutback measures and savings in terms of their operating costs – most savings and cost reductions arose from reducing staffing levels and procurement reforms (Local Government Efficiency Review Group [LGER,] 2010; National Oversight and Audit Commission [NOAC], 2016). Local budgets were reduced by 12 percent between 2012 and 2015, and some local authorities had to reduce their overall spending by over 20 percent during this period (Turley & McNena, 2016). There were also even more significant reductions in capital expenditure. Spending in many service areas reduced, although the wider economic climate meant additional spending demands in some services such as social housing (Considine & Reidy, 2015). A new National Oversight and Audit Commission was also established in 2014 to review and evaluate the financial and non-financial performance of local authorities. A small number of local authorities ran significant deficits in the years following the crisis (Robbins et al., 2016). Most of these were related to loans taken out by local authorities for capital projects before the financial crisis. By 2019, the organization responsible for the external audit of local authorities was reporting an improved position and reduced deficits across the sector, with just four of the 31 local authorities having a deficit balance of over €4 million (Local Government Audit Service [LGAS], 2021). During the COVID-19 pandemic, central government announced a waiver on commercial rates for the large majority of businesses affected by COVID-19 restrictions, with local authorities recouped for the loss of this income through significant increases in central grant transfers. However, local authorities also suffered losses in income in other areas due to the severe contraction in economic activity during the pandemic, including user charges such as planning fees and parking charges. This period also saw increased pressure on expenditure, including in areas such as social housing and the delivery of a range of financial assistance schemes for businesses and community supports that were  introduced in response to the pandemic restrictions (Shannon & O’Leary, 2021). While the pandemic had major financial implications for local authorities, no changes to

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the budgetary rules for local government were introduced in the immediate aftermath of the COVID-19 crisis. Taken together, we can observe in the Irish case both centralizing and decentralizing effects, through new restrictions on and greater surveillance of local government finances, but also some moves towards greater financial autonomy in the form of the LPT.

CONCLUDING DISCUSSION As our cases demonstrate, the small unitary states in Europe exhibit considerable ­diversity with regard to municipal financial autonomy, ranging from extensive autonomy in Denmark to rather limited autonomy in Ireland, with Estonia and Portugal in between. We can observe that the GFC brought about reductions in municipal financial autonomy – including stricter fiscal rules – in Denmark, Estonia, and Portugal. In Ireland, however, which entered the GFC with limited municipal financial autonomy, the crisis triggered some increase in the municipal financial autonomy in the form of a new local tax. In Portugal, too, local governments have had to resort to increasing own-source revenues to absorb the impacts of austerity measures adopted at the national level, but this has taken place in the context of considerably increased centralization of control over local governments (including the approval of the local annual budgets by central government bodies). While in all four cases, municipalities were subject to debt rules already before the crisis (either in the form of the golden rule or debt ceiling), the crisis brought about additional layers of fiscal rules: budget balance rules in Estonia, Portugal, and Denmark, spending rules in Denmark, and stricter debt ceilings in Portugal. In addition to the introduction of additional fiscal rules, the monitoring and enforcement of these rules were strengthened and intensified in Estonia, Denmark, Portugal, and Ireland. These developments were further reinforced by the tightening of fiscal rules at the EU level: stricter fiscal governance at the supranational level was echoed in tougher fiscal rules at the local level. Table 21.1 gives an overview of local fiscal rules in place in the four countries. As can be seen from Table 21.1, all four countries have balanced budget and golden rules (allowing borrowing only for capital spending). Curiously, while Danish municipalities can be regarded as enjoying a higher level of autonomy than those in the other three countries, they are the only ones that have to follow expenditure rules (although Table 21.1  Overview of local fiscal rules in Denmark, Estonia, Portugal, and Ireland

Denmark Estonia Portugal Ireland

Budget Balance Rule

Debt Stock Rule

Golden Rule

Expenditure Rule

✓ ✓ ✓ ✓

✓ ✓ ✓ ✓

✓

✓ ✓ ✓

Source:  European Commission (2018); Turley et al. (2021); authors.

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Source: Eurostat.

Figure 21.1  Government deficit/surplus as a percentage of GDP in Denmark, Estonia, Ireland, and Portugal collectively rather than individually). This may be due to the fact that the municipal expenditure in Denmark constitutes a considerably higher proportion of GDP than in the other three countries. At the same time, municipalities in the other three countries are subject to more direct supervision and monitoring by the central government (e.g., in the form of approving annual budgets). In line with stricter local fiscal rules in all four countries, after the acute crisis was over, the local government sector in all four countries exhibited considerable fiscal discipline. As Figure 21.1 shows, between 2012 and 2019, the local government sectors in Denmark, Portugal, and Ireland recorded a balance or a surplus, while in Estonia we can observe a small budget deficit (not exceeding 0.5 percent of GDP) in half the years.8 In contrast to the actions taken by national governments with regard to the local governments after the GFC, in response to the COVID-19 crisis the local fiscal rules were loosened somewhat (or at least not made stricter) to allow local governments to better deal with the repercussions of the economic and health crisis. While some re-tightening of the rules can already be seen in Estonia (in the form of restoring a stricter debt limit), overall, the longer-term impacts of the COVID-19 crisis on municipal financial autonomy still remain to be seen. Further developments in local fiscal rules in European countries are likely to be strongly affected by what happens to the fiscal governance framework at the EU level. If the pre-COVID fiscal rules are restored, local governments are likely to face even stricter fiscal rules than heretofore, given that national governments have become more heavily indebted in the course of the COVID crisis. 8   The Eurostat data for local governments includes the regional level for Denmark. In the case of Ireland, there have been lengthy debates about whether GDP is the most appropriate measure as a reference point, due to its volatility (see, e.g., Raudla & Douglas, 2021).

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Our cases also indicate that the fiscal governance framework poses different challenges to countries from different administrative traditions with regard to municipal finances, and this can have implications for countries considering joining the EU in the future. The supranational fiscal rules at EU level imply considerable control by national governments over local governments, which can contravene the administrative traditions where local governments have strong powers and autonomy. At the same time, in countries where local governments already have limited financial autonomy, the EU rules imply more restricted leeway for local governments to raise their own revenues to handle fiscal crises and stress.

REFERENCES Blom-Hansen, J., & Heeager, A. (2011). Denmark: Between local democracy and implementing agency of the welfare state. In J. Loughlin, F. Hendriks, & A. Lidström (Eds.), The Oxford handbook of local and regional democracy in Europe (pp. 221–241). Oxford University Press. Blom-Hansen, J., Houlberg, K., Serritzlew, S., & Treisman, D. (2016). Jurisdiction size and local government policy expenditure: Assessing the effect of municipal amalgamation. American Political Science Review, 110(4), 812–831. Blom-Hansen, J., Ibsen, M., Juul, T., & Mouritzen, P. E. (2012). Fra sogn til velfærdsproducent: Kommunestyret gennem fire årtier. University Press of Southern Denmark. Bolgherini, S. (2016). Crisis-driven reforms and local discretion: An assessment of Italy and Spain. Italian Political Science Review, 46(1), 71–91. Bouckaert, G., & Kuhlmann, S. (2016). Introduction: Comparing local public sector reforms: Institutional policies in context. In S. Kuhlmann & G. Bouckaert (Eds.), Local public sector reforms in times of crisis: National trajectories and international comparisons (pp. 1–20). Palgrave Macmillan. Callanan, M. (2018). Local government in the Republic of Ireland. Institute of Public Administration. Capano, G., & Woo, J. J. (2018). Designing policy robustness: Outputs and processes. Policy and Society, 37(4), 422–440. Cepiku, D., Mussari, R., & Giordano, F. (2016). Local governments managing austerity: Approaches, determinants, and impact. Public Administration, 94(1), 223–243. Commission on Taxation. (2009). Commission on Taxation report 2009. Stationery Office. Considine, J., & Reidy, T. (2015). Baby steps: The expanding financial base of local government in Ireland. Administration, 63(2), 119–145. Department of Housing, Local Government and Heritage (DHLGH). (2021). Local authority budgets 2021. DHLGH. Di Mascio, F., Natalini, A., & Stolfi, F. (2013). The ghost of crises past: Analyzing reform sequences to understand Italy’s response to the global crisis. Public Administration, 91(1), 17–31. Dollery, B., Kitchen, H., McMillan, M., & Shah, A. (2020). Local public, fiscal and financial governance: An international perspective. Palgrave Macmillan. European Commission. (2018). Fiscal rules in EU member states. https://ec.europa.eu/info/businesseconomy-euro/indicators-statistics/economic-databases/fiscal-governance-eu-member-states/nu​ merical-fiscal-rules-eu-member-countries_en. Foremny, D. (2014). Sub-national deficits in European countries: The impact of fiscal rules and tax autonomy. European Journal of Political Economy, 34, 86–110. Friedrich, P., & Reiljan, J. (2015). The unfunded mandates in local governments financing: Crises experiences from Estonia. Estonian Discussions on Economic Policy, 23(1), 1–35. Geissler, R., Hammerschmid, G., & Raffer, C. (2021). Introduction: The relevance and conceptualisation of local finance regulatory regimes. In R. Geissler, G. Hammerschmid, & C. Raffer (Eds.), Local public finance: An international comparative regulatory perspective (pp. 1–19). Springer. Hallerberg, M., Strauch, R., & Von Hagen, J. (2009). Fiscal governance in Europe. Cambridge University Press.

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Hardiman, N., Spanou, C., Araújo, J. F., & MacCarthaigh, M. (2019). Tangling with the Troika: “Domestic ownership” as political and administrative engagement in Greece, Ireland, and Portugal. Public Management Review, 21(9), 1265–1286. Houlberg, K., & Ejersbo, N. (2020). Municipalities and regions: Approaching the limit of decentralization? In P. M. Christiansen, J. Elklit, & P. Nedergaard (Eds.), Oxford handbook of Danish politics (pp. 141–159). Oxford University Press. Howlett, M., Capano, G., & Ramesh, M. (2018). Designing for robustness: Surprise, agility and improvisation in policy design. Policy and Society, 37(4), 405–421. Indecon. (2005). Indecon review of local government financing. Department of the Environment, Heritage and Local Government. Indenrigs- og Boligministeriet (2022). Indenrigs- og Boligministeriets kommunal nøgletal. https:// www.noegletal.dk. Ivanyna, M., & Shah, A. (2014). How close is your government to its people? Worldwide indicators on localization and decentralization. Economics, 8(3), 1–61. Jochimsen, B., & Raffer, C. (2020). Local government fiscal regulation in the EU: The impact of balanced budget rules [Conference paper]. In Beiträge zur Jahrestagung des Vereins für Socialpolitik 2020: Gender Economics. ZBW – Leibniz Information Centre for Economics. Kotia, A., & Lledó, V. D. (2016). Do subnational fiscal rules foster fiscal discipline? New empirical evidence from Europe (Working Paper No. 2016/084). International Monetary Fund. Kristinsson, G. H., & Matthíasson, P. B. (2016). Managing the financial crisis. In C. Greve, P. Lægreid & L. H. Rykkja (Eds.), Nordic administrative reforms: Lessons from public management (pp. 169–188). Springer. Kriz, K. (2008). Local government finance in Estonia. In Z. Sevic (Ed.), Local public finance in Central and Eastern Europe (pp. 161–182). Edward Elgar Publishing. Kuhlmann, S., & Wollmann, H. (2019). Introduction to comparative public administration. Edward Elgar Publishing. Ladner, A., Keuffer, N., & Baldersheim, H. (2016). Measuring local autonomy in 39 countries (1990–2014). Regional & Federal Studies, 26(3), 321–357. Ladner, A., Keuffer, N., & Bastianen, A. (2021). Local autonomy index in the EU, Council of Europe and OECD countries (1990–2020). Release 2.0. European Commission. Local Government Audit Service (LGAS). (2021). Overview of the work of the Local Government Audit Service, year ended 31 December 2019. Department of Housing, Local Government and Heritage. Local Government Efficiency Review Group (LGER). (2010). Report of the Local Government Efficiency Review Group. Stationery Office. Loughlin, J., Hendriks, F., & Lidström, A. (2011). Introduction – subnational democracy in Europe: Changing backgrounds and theoretical models. In J. Loughlin, F. Hendriks, & A. Lidström (Eds.), The Oxford handbook of local and regional democracy in Europe (pp. 1–23). Oxford University Press. Mäeltsemees, S. (2016). Local self-government in Estonia. Halduskultuur, 17(2), 79–109. Mailand, M. (2014). Austerity measures and municipalities: The case of Denmark. Transfer: European Review of Labour and Research, 20(3), 417–430. National Oversight and Audit Commission (NOAC). (2016). Local government efficiency review reforms (NOAC Report No. 5). Overmans, T., & Timm-Arnold, K-P. (2016). Managing austerity: Comparing municipal austerity plans in the Netherlands and North Rhine-Westphalia. Public Management Review, 18(7), 1043–1062. Paulus, A., Figari, F., & Sutherland, H. (2017). The design of fiscal consolidation measures in the European Union: Distributional effects and implications for macro-economic recovery. Oxford Economic Papers, 69(3), 632–654. Peters, B. G., Pierre, P., & Randma-Liiv, T. (2011). Global financial crisis, public administration and governance: Do new problems require new solutions? Public Organization Review, 11(1), 13–27. Pollitt, C. (2010). Cuts and reforms: Public services as we move into a new era. Society and Economy, 32(1), 17–31.

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Raffer, C., & Ponce, A. (2021). European patterns of local government fiscal regulation. In R. Geissler, G. Hammerschmid, & C. Raffer (Eds.), Local public finance: An international comparative regulatory perspective (pp. 73–90). Springer. Raffer, C., & Valesco, N. (2019). Estonia. In R. Geissler, G. Hammerschmid, & C. Raffer (Eds.), Local public finance in Europe: Country reports (pp. 70–81). Springer. Raudla, R. (2010). Constitution, public finance and transition. Peter Lang. Raudla, R., Bur, S., & Keel, K. (2020). The effects of crises and European fiscal governance reforms on the budgetary processes of member states. JCMS: Journal of Common Market Studies, 58(3), 740–756. Raudla, R., & Douglas, J. W. (2020). This time was different: The budgetary responses to the pandemic-induced crisis in Estonia. Journal of Public Budgeting, Accounting & Financial ­ Management, 32(5), 847–854. Raudla, R., & Douglas, J. W. (2021). Structural budget balance as a fiscal rule in the European Union – good, bad, or ugly? Public Budgeting & Finance, 41(1), 121–141. Raudla, R., Douglas, J. W., Randma-Liiv, T., & Savi, R. (2015). The impact of fiscal crisis on ­decision-making processes in European governments: Dynamics of a centralization cascade. Public Administration Review, 75(6), 842–852. Raudla, R., & Kattel, R. (2011). Why did Estonia choose fiscal retrenchment after the 2008 crisis? Journal of Public Policy, 31(2), 163–186. Raudla, R., Randma-Liiv, T., & Savi, R. (2017). Budgeting and financial management reforms in Estonia during the crisis of 2008–10 and beyond. In E. M. Ghin, H. F. Hansen, & M. B. Kristiansen (Eds.), Public management in times of austerity (pp. 222–238). Routledge. Robbins, G., Turley, G., & McNena, S. (2016). Benchmarking the financial performance of local councils in Ireland. Administration, 64(1), 1–27. Schnellenbach, J. (2018). Fiscal sovereignty in a globalized world: The pressure of European economic governance on domestic public finance. In A. Valdesalici & F. Palermo (Eds.), Comparing fiscal federalism (pp. 328–346). Brill Nijhoff. Shannon, L., & O’Leary, F. (2021). Leading the local response to Covid-19: The role of local government (Local Government Research Series No. 20). Institute of Public Administration. Silva, C. N. (2014). The economic adjustment program impact on local government reform in Portugal. In C. N. Silva & J. Bucwek (Eds.), Fiscal austerity and innovation in local governance in Europe (pp. 31–48). Routledge. Silva, C. N. (2017). Political and administrative decentralisation in Portugal: Four decades of democratic local government. In C. N. Silva & J. Bucwek (Eds.), Local government and urban governance in Europe (pp. 9–32). Springer. Silva, P., & Teles, F. (2018). The biggest loser? Local public services under austerity measures in Portugal. In A. Lippi & T. Tsekos (Eds.), Local public services in times of austerity across Mediterranean Europe (pp. 73–94). Palgrave Macmillan. Suenson, E. L., Nedergaard, P., & Christiansen, P. M. (2016). Why lash yourself to the mast? The case of the Danish “Budget Law.” Public Budgeting & Finance, 36(1), 3–21. Tang, S.-Y., Callahan, R. F., & Pisano, M. (2014). Using common-pool resources principles to design local government fiscal sustainability. Public Administration Review, 74(6), 791–803. Tavares, A., & Teles, F. (2018). Deeply rooted but still striving for a role: The Portuguese freguesias under reform. In N. Hlepas, N. Kersting, S. Kuhlman, P. Swianiewicz, & F. Teles (Eds.), Submunicipal governance in Europe: Decentralization beyond the municipal tier (pp. 193–209). Palgrave Macmillan. Teles, F. (2014). Local government and the bailout: Reform singularities in Portugal. European Urban and Regional Studies, 23(3), 455–467. Teles, F. (2021). Descentralização e podel local em Portugal. Fundação Francisco Manuel dos Santos. Ter-Minassian, T. (2007). Fiscal rules for subnational governments: Can they promote fiscal discipline? OECD Journal on Budgeting, 6(3), 1–11. Turley, G., & McNena, S. (2016). An analysis of local public finances and the 2014 local government reforms. The Economic and Social Review, 47(2), 299–326. Turley, G., Raffer, C., & McNena, S. (2021). Budget institutions for subnational fiscal discipline:  Local fiscal rules in post-crisis EU countries. In R. Geissler, G. Hammerschmid, &

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22. Government financial resilience – a European perspective

Carmela Barbera, Bernard Kofi Dom, Céline du Boys, Sanja Korac, Iris Saliterer, and Ileana Steccolini

INTRODUCTION Governments across the world are continuously faced by the adverse impacts of crises and incidents. Over the last two decades, for example, they have coped with the emergencies caused by migration, and particularly refugee movements (Wadsworth et al., 2016), the global financial crisis and the ensuing climate of austerity affecting many countries (Hastings et al., 2015; Kickert, 2012; Steccolini et al., 2017), and the recent coronavirus (COVID-19) pandemic waves (Ahrens & Ferry, 2020, 2021; Anessi-Pessina et al., 2020; Leoni et al., 2021). Such crises have important financial reverberations, in that they generally affect public finances negatively, while requiring financial interventions and responses. In light of these phenomena, an emerging body of research in public sector financial management has highlighted the ways in which governments and public sector organizations respond to crises, shocks, and austerity. Extensive knowledge has been accumulated on the types of responses adopted by governments in the face of the global financial crisis (see Baker, 2011; Dougherty et al., 2009; Kickert, 2012; Kickert et al., 2013; Overmans & Noordegraaf, 2014; Scorsone & Plerhoples, 2010; Steccolini et al., 2015), and of the COVID-19 pandemic (for syntheses, see Grossi et al., 2020; Leoni et al., 2021, 2022). The studies focusing on governmental responses to crises created an important accumulation of contextual knowledge on the ways in which governments responded to specific crises. Yet, while the occurrence of crises appears to have become a constant feature of the context within which governments operate, and their central role in economies coping with crises is barely questioned (Steccolini, 2019), governmental preparedness for future crises remains uncertain. For example, at the time of writing in 2022, climate change and environmentally unsustainable choices, future pandemics, rising inequalities, and unrest of our societies are often highlighted as possible ‘wicked issues’, making future crises and shocks more likely (Blondin et al., 2020; Boin, 2019; Pollitt, 2015; Thomasson et al., 2020). This suggests a need not only to understand specific responses and strategies adopted in the face of crises, but also to identify the underlying (and sometimes latent) capacities and dimensions that explain such responses, and make them possible (e.g., Ansell et al., 2021; Carayannopoulos & McConnell, 2018; Daviter, 2017). Resilience has often been proposed as a useful concept with which to understand how governments ‘keep operating even in adverse, “worst case” conditions and adapt rapidly in a crisis’ (Hood, 1991, p. 14). Interestingly, it refers both to the capacity to react to crises efficiently and to absorb shocks, returning to levels of activity and performance that were in place before the crisis (bouncing back) (Boin et al., 2010; Linnenluecke, 2017; Meyer, 1982; Sutcliffe & Vogus, 2003; Wildavsky & Caiden, 1988), and to the capacity to learn 408

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and transform, leveraging the crisis as a critical juncture to ‘bounce forward’ (Meyer, 1982; Somers, 2009). In the aftermath of austerity and the global financial crisis, Steccolini et al. (2015) and Barbera et al. (2017) introduced the concept of governmental financial resilience to the public administration literature, capturing governments’ capacity to anticipate and cope with shocks and difficulties that have an impact on governmental finances. The authors’ framework highlighted the role of four interrelated dimensions in shaping financial resilience – namely, financial shocks, perceived vulnerabilities, coping, and anticipatory capacities. This chapter presents the financial resilience framework, and the operationalization of the underlying dimensions, to suggest future potential uses in academia and in practice. First, the framework can provide the basis for the identification of relevant relationships to be empirically tested among resilience capacities and between them and their possible consequences (e.g., financial and non-financial performance, responses to crises). Second, the framework can be translated into a self-assessment tool to keep track of not only perceived vulnerabilities, but also resilience capacities in local governments in order to support both policymakers and managers in building and nurturing the latter. Along these lines, the chapter provides insights into the financial resilience dimensions in the local governments of the four largest European countries (France, Germany, Italy, and the UK), and illustrates how the framework can be translated into a self-assessment tool. Following the aim of the present chapter, in a first step, the overall governmental financial resilience framework is presented with details on the definitions and the operationalization of the financial resilience dimensions. The specific country context of France, Germany, Italy, and the UK, where data at the municipalities level have been collected, is then presented. Based on the findings from qualitative and quantitative (survey) studies, the chapter then provides an illustration of the resilience dimensions’ development, and finally, a discussion of the possibility of using these results for the development of a toolkit for practitioners and policymakers, before concluding reflections are drawn.

GOVERNMENTAL FINANCIAL RESILIENCE: THE FRAMEWORK The framework for governmental financial resilience presented in this chapter builds on the empirical evidence accumulated over the years and across different countries by a plurality of scholars. The first model of governmental financial resilience (Barbera et al., 2017) was developed based on a series of studies of English (Steccolini et al., 2015), Italian (Barbera et al., 2016), and Austrian municipalities, further validated through the analysis of 45 cases across 11 countries (Australia, Austria, England, France, Germany, Greece, Italy, the Netherlands, Sweden, US, Brazil), which have been collected in a book edited by Steccolini et al. (2017). Following a multiple case study design including interviews and extensive analyses of archival data, these studies have contributed to further defining and better understanding the dimensions of governmental financial resilience – namely, financial shocks, vulnerabilities, anticipatory capacities, and coping capacities, as illustrated in the financial resilience framework (see Barbera et al., 2017). The dimensions identified in the multiple country case studies were further operationalized into sub-dimensions of anticipatory and coping capacities, and sources and levels of financial vulnerabilities.

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Dimensions of Resilience

Consequences

Anticipatory Capacities

Crises & Shocks

Responses to Crises & Shocks

Perceived Vulnerability

Non-financial Performance Financial Performance

Coping Capacities

Figure 22.1  Financial resilience framework dimensions Figure 22.1 illustrates the resilience dimensions highlighted by Steccolini et al. (2017) and Barbera et al. (2017). These dimensions are described below. The model in Figure 22.1 identifies relevant relationships that have been already tested empirically (see below), or may be the subject of empirical test in future research. Crises and Shocks Crises and shocks are defined as events that take place in the institutional, economic, and social environment in which municipalities operate and which can impact on public sector organizations, affecting their finances. Two major aspects of crises and shocks seem to be particularly significant and have been included in past studies investigating public sector organizations’ resilience: severity and surprise. Under the framework presented here, severity represents the extent to which unexpected events financially affect an organization, thus the extent to which the financial situation of the organization (or of an individual sub-unit within it) is negatively affected by a crisis or shock. The level of surprise represents the extent to which the crisis was unexpected (see Billings et al., 1980; Boin et al., 2005), and thus may constitute a shock. In principle, the more such an event hits unexpectedly, the more its financial impact can be disruptive. At the same time, the level of surprise should be interpreted also considering the organizational capacity to be aware of external events (see the section on anticipatory capacities below). Crises can be seen as single one-shot events that negatively affect organizations, or as processes with potentially negative consequences occurring over time. Under the ‘crisisas-event’ perspective, one cannot completely plan for a such event, which has led to the traditional conception of effective crisis management where the goal is to bring a system back into alignment (Williams et al., 2017, p. 735). By contrast, in a ‘crisis-as-process’ perspective, crises occur in phases over time, and there is an inability to attend to weak signs of danger built up over time until they trigger a crisis event. In that perspective, the

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importance of pre-event, during-event, and post-event crisis management is highlighted (ibid., p. 736). It requires considering the antecedents of crises (e.g., organizational weaknesses, vulnerabilities) and the subsequent adjustments and adaptations (i.e., coping strategies). Financial Resilience Dimensions Vulnerabilities Vulnerability represents the extent to which an organization is exposed to shocks (Barbera et al., 2017; Hendrick, 2011; McManus et al., 2007), and thus the extent to which it can be negatively affected if shocks and crises occur. Internal or external sources of vulnerability can be identified (Table 22.1) such as organizational, financial, social, demographic, economic, or weather-related conditions. Moreover, vulnerability can be measured through financial or physical indicators, or through perceptions. Perceived vulnerability has been proved to be central to understanding patterns of financial resilience (Barbera, 2017; Jimenez, 2014; Maher & Deller, 2007, 2011; in more general, see also Boin et al., 2010; Lengnick-Hall & Beck, 2005; Linnenluecke & Griffiths, 2013; McManus et al., 2007; Somers, 2009). Barbera et al. (2017, p. 680) suggest that ‘the “endogenization” of vulnerability (i.e., the sense of being able to influence its sources) or its “exogenization” (i.e., the sense of being unable to control its sources) [affect] the way in which the financial crisis and the resulting impacts [are] interpreted and [receive] attention’. Anticipatory capacities Anticipatory capacities are defined as the tools and capabilities that enable organizations to better identify, manage, and control their vulnerabilities, and to anticipate potential financial shocks before they arise (Barbera et al., 2017, 2021; Steccolini et al., 2015, 2017). Table 22.1  Vulnerability: operationalization and examples Dimension

Categories

Definition and Examples

Vulnerability

Internal vulnerabilities

Perceived vulnerabilities related to the internal conditions (e.g., organizational or financial factors) Internal financial vulnerabilities may capture different aspects (e.g., Maher & Deller, 2011, 2013): ●  robustness: diversity and stability of own revenue sources, level of reserves ●  autonomy: level of own revenues sources, freedom to raise taxes ●  flexibility: debt level, access to loans, rigidity of expenditures

External vulnerabilities (see also Groves & Valente, 1994)

Perceived vulnerabilities related to the external environment such as socio-demographic, socioeconomic, or economic vulnerabilities, as well as local/organizational extreme weather-related vulnerabilities, and regulation-related vulnerabilities

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McManus et al. (2007, p. 1) identify ‘situation awareness’ as a component of organizational resilience and as a ‘measure of an organization’s understanding and perception of its entire operating environment’. The awareness of potential shocks affecting public local finances relies on the organizational planning capacity (Erol et al., 2010; Whitman et al., 2013) and its proactivity (Bhamra et al., 2011; Erol et al., 2010; Starr et al., 2003), as both contribute to decreasing the level of organizational vulnerability. Preparedness, intended as the ability to manage crises through anticipation and planning practices, is thus a key aspect of resilience (Fleming, 2012; Linnenluecke & Griffiths, 2013; McManus et al., 2007; Whitman et al., 2013). However, anticipation is a multifaceted concept and it therefore needs to be analysed in light of its underlying key processes and tools, especially those that are accounting based – that is, internal control systems (Ferry et al., 2018), auditing (Bracci et al., 2015), financial management (Anessi-Pessina et al., 2016), and the design of risk assessment strategies/plans to mitigate and minimize the impacts of such shocks (Linnenluecke & Griffiths, 2013). In Table 22.2, we list and define the behavioural and cognitive capacities, and provide examples of how these capacities are operationalized in financial and accounting tools. Coping capacities Coping capacities allow organizations to manage their vulnerabilities (Barbera et al., 2018b, 2021). These capacities ‘lie dormant in times of order and become visible in times of disruption through coping actions (Linnenluecke, 2017)’ (Barbera et al., 2017, p. 675). The following major drivers and approaches to respond to crises have been identified in past research: rapidity of action, adaptability, and networking (see Table 22.3 for more details on the four specific forms of coping considered in the municipalities’ surveys conducted in 2017 and 2021 – namely, adaptation of people, rapidity of action, internal collaboration, and external collaboration). However, not all coping capacities are already pre-existing. Indeed, and to provide an example, based on past research on governmental financial resilience, we have identified three main typologies of coping capacities (e.g., Béné et al., 2012; Darnhofer, 2014; Davoudi et al., 2013): Buffering capacities – the ability to absorb the impact of crises and shocks maintaining the status quo in terms of organizational structures and functions. These capacities seem to be adequate in the short term, when the organization hit by shocks needs to be robust and resist. ● Adaptive capacities – the ability to cope with shocks through incremental changes to extant structures and function (see, e.g., Mallak, 1998; McManus et al., 2007; Whitman et al., 2013). Adaptive capacities seem to rely on the idea of flexibility, where organizational resilience is the result of an ability to change after external and/or internal shocks (see Ates & Bititci, 2011; Demmer et al., 2011; de Oliveira Texeira & Werther, 2013; Pal et al., 2014; Skertich et al., 2013; Välikangas & Romme, 2012; Wildavsky & Caiden, 1988). Behind this interpretation is the belief that flexibility is an essential and distinctive feature of resilient organizations (e.g., Sheffi & Rice, 2005). ● Transformative capacities – the ability to cope with shocks by means of radical and  innovative changes of extant structure and functions, which also imply a change in organizational values and goals. Here, flexibility is particularly ­emphasized. ●

413

The conscious process of scanning the internal organization and external environments for possible threats and opportunities, including vulnerability assessment tools and practices, which allows warning signs of shocks to be spotted, thereby informing effective mediumand long-term decisions (reflecting, adapting, restrategizing)

The extent to which an organization liaises and collaborates with other organizations to inform their approach in dealing with potential shocks

External information exchange Ahrens & Ferry (2021); Anessi-Pessina et al. (2016); Boin & Van Eeten (2013); Linnenluecke & Griffiths (2013); Saliterer et al. (2017, 2021)

Monitoring Ahrens & Ferry (2021); Barbera et al. (2021); Boin & Van Eeten (2013); Linnenluecke & Griffiths (2010, 2013); Saliterer et al. (2021)

The ability of members to share valuable information and ideas with colleagues within the organization

Internal information sharing Barbera et al. (2017, 2021); Hood (1991); McManus et al. (2007); Skertich et al. (2013)

Anticipatory capacities

Definition

Categories

Dimension

Table 22.2  Anticipatory capacities: operationalization and examples

to forecast future revenues and expenditure ● Facilitating early budgetary approval ● Providing continuous monitoring of revenues collected, expenditure, and quantity and quality of services provided ● Internal control systems ● Auditing ● Financial management ● Design of risk assessment strategies/plans

● Simulations

Financial/Accounting Operationalization of Anticipatory Capacities

414

Critical thinkinga Baumard & Starbuck (2005); Boin & t’ Hart (2003); Carmeli (2007); Carmeli & Gittell (2009); Chance (1986); Collins & Peerbolte (2012); McGrath (2001); Reagans et al. (2005); Stern (2009); Vogel (2012)

Categories

The capacity to analyse events, justify decisions, and make comparisons, and draw inferences to make informed decisions to sustain and recover from the impacts of future events. Municipalities can engage in critical thinking internally (with their employees), and externally (with peer institutions and stakeholders such as citizens)

Definition

Financial/Accounting Operationalization of Anticipatory Capacities

Sources:  Adaptation from Barbera et al. (2017, 2021); Barbera and Steccolini (in press); Steccolini et al. (2017).

Note:  a. Critical thinking is borrowed as a critical dimension from disciplines spanning from crisis management (Boin & t’ Hart, 2003) to emergency management (Collins & Peerbolte, 2012; Kiltz, 2009; Peerbolte & Collins, 2013) to leadership (Boin & t’ Hart, 2003; Stern, 2009). It implies and fosters an organizational ‘learning behaviour’ (e.g., Carmeli, 2007; McGrath, 2001).

Dimension

Table 22.2 (continued)

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Different organizations may display different types and mix of these capacities, and this affects the resources and abilities that are used to cope with shocks. Table 22.3 gives a view on the specific accounting and financial processes and tools characterizing these abilities. Consequences of Resilience Capacities and Shocks Barbera et al. (2016, 2017) and Steccolini et al. (2015, 2017), through a plurality of case studies, have shown that there are different ways in which municipalities can be financially resilient, giving rise to a plurality of more or less financially resilient behaviours, including self-regulatory/proactive adaptation, reactive adaptation, constrained adaptation, contentedness, and powerlessness. These patterns (or resilience configurations) result from Table 22.3  Coping capacities: operationalization and examples Dimension of the Toolkit

Categories of Coping Capacities/Primary

Definition

Coping capacity

Rapidity of action and bricolage Bhamra et al. (2011); Bruneau et al. (2003); Kendra & Wachtendorf (2003); Sutcliffe & Vogus (2003); Whitman et al. (2013); Wicker et al. (2013)

The capacity to take prompt decisions and to quickly reconfigure internal resources to cope with unforeseen events, also by combining existing, but untapped, resources

Internal collaboration Andrews (2010, 2011); Lee et al. (2013); McManus (2008); Paliokaitė & Pačėsa (2015)

The extent to which employees collaborate to cope with shocks, also across different departments, which also tend to imply high levels of trust between organizational leaders and employeesa

Financial/Accounting Operationalization of Coping Capacities Buffering

● Cancellation

of doubtful liabilities ● Centralization of purchasing ● Cost cuts ● Deferring investments ● Financial reserves ● Increase in debt (loans) ● Increasing fees and charges ● Moratorium on debt repayment ● Over-programming (for flexibility) ● Prioritization of the expenditure ● Selling assets ● Virement

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Table 22.3 (continued) Dimension of the Toolkit

Categories of Coping Capacities/Primary

Definition

Financial/Accounting Operationalization of Coping Capacities

Employees’ adaptability, skills and knowledge Lengnick-Hall et al. (2011); Mallak (1998); McManus (2008)

Adapting The presence, within the organization, of resilient ● Brake on debt individuals with adaptive ● Collegiate planning behaviours, bricolage skills, ● Invest to save team-working, and sharing ● Performance of the decision-making management power. This implies the ● Re-balancing the capacity of employees to budget adapt to unforeseen events ● Risk management by assimilating and using new knowledge to manage their work and to keep updated to changes

External collaboration Andrews (2011)

The capacity to Transforming collaborate with external ● Autonomy partners regardless of ● Financial selforganizational boundaries, sufficiency (alternative to have strong relationships income sources) with external actors in order to better cope with unexpected events (e.g., as they allow mutual support of each other by integrating internal resources and capacities to provide services)b

Notes: a. Recently, Kober and Thambar (2021) showed that internal planning meetings to cope with the consequences of the COVID-19 crisis affecting charities’ funding were fundamental, thereby confirming Hall’s (2010) argumentation that accounting talk helps organizations develop financial resilience. b. External networking and collaboration, as community and organizational social capital, have been shown to have positive implications on organizational performance (Andrews, 2011). Evidence shows that working in a networked environment enables better mobilization and sharing of resources, learning, and better response to emergencies (e.g., Andrews et al., 2016). Sources:  Adapted from Barbera et al. (2018a) and Barbera and Steccolini (in press).

the dynamic combination of the different dimensions of the financial resilience framework (for details, see Barbera et al., 2017; Steccolini et al., 2017). In this chapter we will specifically focus on two types of consequences of resilience capacities – the types of responses to crises, and financial and non-financial performance.

Government financial resilience – a European perspective  ­417

Responses to crises and shocks In responding to a crisis, an organization may absorb the relevant shocks and return to its original state, ‘bouncing back’ to the performance and ways of doing things that characterized the time before the crisis (Barbera et al., 2021; Boin et al., 2010; Linnenluecke, 2017; Meyer, 1982). In contrast, an organization will ‘bounce forward’ by learning, adapting to the unexpected adversities and thus arriving at a new state, improved performance, and/or new ways of doing things (Meyer, 1982; Somers, 2009). Resilience capacities have been found to shape responses to crises. More specifically, in their study of Italian, German, and UK municipalities, Barbera et al. (2017) found that, while all types of shocks were associated both with bouncing-back and bouncing-forward strategies, a higher level of financial vulnerability encouraged bouncing-back strategies while discouraging bouncing-forward strategies. Moreover, while anticipatory capacities, and in particular information exchange, were found to facilitate the adoption of bouncing-forward strategies, they have no association with bouncing-back strategies. This suggested the importance of resilience capacities in taking a proactive approach in dealing with crises (Barbera et al., 2020). Financial and non-financial performance Looking at the relationship of vulnerabilities and capacities with the performance of municipalities, and more specifically differentiating between financial and non-financial (or service) performance, Barbera et al. (2021) found a strong association between financial vulnerability and financial performance. However, only some anticipatory and coping capacities affected this performance dimension – namely, monitoring, internal information sharing, and rapidity of action. Focusing on service performance, the results showed a comparatively lower impact of financial vulnerability, while the whole range of anticipatory and coping capacities showed a strong association with this dimension (Barbera et al., 2018b).

THE CONTEXT AND METHOD: EXPLORING LOCAL GOVERNMENT FINANCIAL RESILIENCE IN FRANCE, GERMANY, ITALY, AND THE UK The chapter offers a state of play of municipal financial resilience dimensions through the presentation of the results of two surveys conducted, among municipalities, in four European countries, France, Germany, Italy, and the UK, in 2017 and 2021. It provides descriptive statistics with which to compare the shocks that municipalities had to face in the different countries, their level of vulnerabilities, and the development of their capacities. This section presents the specific country contexts of France, Germany, Italy, and the UK, and the surveys conducted among top managers of municipalities. All four countries are large economies, and at the time of the studies were members of the European Union, with the UK having embarked on the path towards Brexit starting with the June 2016 referendum, and the exit from EU having taken place at the end of January 2021. While the politico-administrative system differs across the country contexts, with the UK and France being centralized states, Italy a centralized state with strong regionalization, and Germany a federal state, their municipalities have comparable functions and fiscal arrangements.

418  Research handbook on city and municipal finance

The countries also represent different administrative traditions (see Pollitt & Bouckaert, 2017). This enables us to account for a possible effect of different administrative contexts, and related properties of rules and regulations for the local level, on municipalities’ financial resilience. France and Italy represent the Continental European Napoleonic administrative tradition, with the former being an example of a Central European and the latter of the Southern European state. Germany has a Continental European federal state tradition, and the UK is a typical example of the Anglo-Saxon administrative tradition (Meyer & Hammerschmid, 2010; Pollitt & Bouckaert, 2017). The size of municipalities in terms of population differs across the four countries. While in France, Germany, and Italy, the average size of municipalities is smaller, and therefore the number of municipalities is relatively high (France: 34,965; Germany: 11,116; Italy: 7,904 municipalities), municipalities in the UK are fewer (408) but therefore substantially larger (average size: 150,000) than their continental counterparts (see also Table 22.4). Table 22.4  Characteristics of the selected studied contexts

Population in millions (2020)

France

Germany

Italy

UK

67,320,216

83,166,711

59,641,488

67,025,542

GDP in US$ billion 2019

3,419.58

4,782.66

2,756.95

3,334.00

GDP per capita in 2019 (US$)

50,693.52

57,557.86

45,691.04

49,912.48

Administrative tradition

Continental European Napoleonic

Continental European federal

Continental European Napoleonic/ Southern

Anglo-Saxon

Level of decentralization

Unitary

Federal

Unitary (‘quasi’)

Unitary

General debt level in % of GDP (2019)

123.1

67.5

154.2

118.5

Financial vulnerability 2006/2012 (Lodge & Hood, 2012)

Medium/high

Medium/medium

High/medium

Low/high

Local debt level in % of GDP (2019)

10.3

5.3

10.10

5.7

Local debt level in % of total public debt 2019)

8.3

7.8

6.5

4.9

34,965

11,116

7,904

408

Pop. under 5,000

32,775

8,236

5,681

Pop. above 15,000

505

798

750

2

Pop. above 50,001

129

182

147

406

No. of municipalities

Note: GDP = gross domestic product. Sources:  OECD database for 2019 and Eurostat for 2020.

Government financial resilience – a European perspective  ­419

To provide the insights into the financial resilience dimensions of local governments in Europe presented in the next section, we use the results of two surveys conducted in 2017 and 2021. The operationalization of resilience dimensions presented in the section above provided the basis for a survey instrument that has been addressed to chief executive officers, chief financial officers, and service managers of municipalities over 15,000 inhabitants. In 2017, it was administered to Italian, German and UK, municipalities, gathering ca. 500 responses (Barbera et al., 2018b). In 2021, the nature and timing of the COVID-19 pandemic provided an opportunity to use this crisis as a magnifying glass (Saliterer et al., 2021) for capturing and further increasing the understanding of financial resilience. Responses from more than 600 municipalities in France, Germany, Italy, and the UK were collected.

EUROPEAN MUNICIPALITIES: STATE OF THEIR FINANCIAL RESILIENCE CAPACITIES From the Global Financial Crises to COVID-19: A Decade of Shocks for European Countries Europe in the second decade of the 21st century provides a relevant context for observing resilience capacities that are in place for municipalities in Europe. A few years after the introduction of the euro in some European countries, Europe was faced first with the global financial crisis of 2008, and then with the subsequent austerity measures adopted by many countries to cope with rising public debt and deficits (Bracci et al., 2015). These were followed by the refugee and migration crises and the Brexit referendum, which ignited the process culminating in the exit of the UK from the European Union in January 2021. The decade closed with the outbreak of the COVID-19 pandemic in 2020. Municipalities analysed in our 2017 and 2021 surveys perceived the relative importance of the shocks quite differently in the various countries. As highlighted in Figure 22.2, in 2017 (changing) regulations were the central preoccupation in most countries, and especially in Italy (Barbera et al., 2017). The global financial crisis followed as the second most important source of shocks (in total), though with different concrete impacts in the observed countries: grant reduction in Italy, France (du Boys, 2017), and the UK, tightening of fiscal targets in Italy (Barbera, 2017), reduced commercial tax in Germany (Papenfuß et al., 2017), and business rates in the UK (Jones, 2017), and increased demand for services in Italy and the UK. The refugee crisis, affecting Europe in 2015 and 2016, mainly impacted German municipalities (see also Barbera et al., 2018b), with municipalities playing a crucial role in organizing accommodation and care facilities (see Papenfuß et al., 2017). Brexit was recognized in the UK as a moderate shock, while it did not seem to affect municipalities elsewhere in Europe (see Barbera et al., 2018b). The 2021 survey captured the impact of the COVID-19 crisis on finances and services across French, German, Italian, and UK municipalities (Figure 22.3). The European municipalities responding to the survey identified a severe negative impact of the pandemic on their financial situation, associated with a severe impact on internally generated income (i.e., local taxes, property taxes, sales, fees and charges). At the same time, external transfers were relatively preserved. The latter result may also be a consequence of support packages coming from the central government and the EU. With regard to the impact of

420  Research handbook on city and municipal finance SHOCK / CRISIS

3.05

3.89

3.83

3.75 3.29

3.25

2.7

2.61 2.16

2.61

2.07

1.34

1.43

1.2

Germany

Italy

Global Financial Crisis

3.48

3.22

Refugee Influx

UK

Total

Regulations (e.g., changes in tax base, task devolvement)

Brexit

Note: 1 = not at all; 5 = to a large extent. Source:  Adapted from Barbera et al. (2018b).

Figure 22.2  Results from the 2017 survey: shocks/crises affecting municipalities’ finances (country mean) IMPACT OF COVID-19 ON… 6.09

4.45

4.95

4.98 3.94

3.37

3.19 2.34

2.68

2.59

Financial Situation

External Funding Support France

2.9 2.3

Italy

3.98 2.72

2.12

Internally Generated Income Level

Germany

3.57

Service Level Capacity

UK

Note: 1–3 = negative impact; 4–6 = neutral; 7–9 = positive impact.

Figure 22.3  COVID-19 affecting municipalities’ finances and service-level capacity (country mean) COVID-19 on service-level capacity, a quite varied picture occurs, with the UK ­municipalities experiencing the most severe perceived impact. Financial Vulnerabilities of European Municipalities Perceptions of vulnerabilities evolve across crises, time, and countries. In the 2017 survey (Barbera et al., 2018b), municipalities in Germany perceived themselves, on average, as

Government financial resilience – a European perspective  ­421 3.18

3.01 2.97 2.83

Level of Debt

3.12

2.97 2.9

2.91 2.57

Financial Reserves

3.15 3.13 2.82

3.08 2.76 2.43

Diversity of Own Revenues France

3.13 3.17 3.18 2.62

Public Infrastructure

Germany

Italy

2.91

2.98

2.44

2.71 2.39

Service Capacity Long Term

Stability of Own Revenues

UK

Note: 1 = much worse; 3 = similar; 5 = much better; higher agreement with the statements equals lower perceived vulnerability.

Figure 22.4  Municipalities’ financial vulnerabilities (country mean) in 2021 more financially vulnerable than in Italy or the UK. In particular, they perceived themselves as less financially autonomous than their counterparts and more vulnerable regarding the volatility of their own revenue sources and the (in)sufficiency of financial reserves. Italian municipalities perceived themselves as slightly less vulnerable in terms of indebtedness than their counterparts. In all other aspects, UK municipalities appeared comparatively to feel less vulnerable, which is probably due to their power to retain a proportion of the business rates, increase council tax up to certain caps, and flexibility in their commercial activities (see Barbera et al., 2018b). In 2021, the situation appears to be different (Figure 22.4)1 as UK municipalities perceived their financial vulnerabilities to be higher than their European counterparts in France, Italy, and Germany for all the aspects investigated. These drastic results could be linked to the cumulated impact of external events such as Brexit and a decade of austerity. The greater perceived vulnerability of UK municipalities in 2021 also appeared with regard to context-related vulnerabilities of municipalities (Figure 22.5). Anticipatory Capacities in European Municipalities in the Face of Global Crises and Pandemics The four types of anticipatory capacities (Table 22.2) were assessed in the survey of municipalities across Germany, Italy, and the UK in 2017 (and subsequently in 2021, adding France). In 2017, monitoring seemed to be more widely applied and institutionalized across the three countries than internal information sharing, external information 1   While country comparisons offer an interesting starting point for discussions, the focus of the governmental resilience framework is on the organizational level. Therefore, we changed the assessment of financial vulnerability in the 2021 survey, and asked respondents to rate their vulnerability sources compared to peer governments (i.e., similar in size and task profile). This approach follows that taken to assess the performance of organizations, as it has proven to be a valid form of self-assessment. A direct comparison of the country results between 2017 and 2021 is therefore not feasible.

422  Research handbook on city and municipal finance 3.42 3.01

2.87

3.1

3.47

3.39

3.09

3.03

2.89

2.85

2.63

2.49

2.4

2.29

2.65

2.65

2.77

2.75 2.82

1.97

Socio-economic Vulnerabilities

Socio-demographic Vulnerabilities

Extreme Weather Vulnerabilities

Economic Vulnerabilities

France

Italy

Germany

Regulation-related Vulnerabilities

UK

Note: 1 = none; 2 = minor; 3 = average; 4 = considerable; 5 = major.

Figure 22.5  Municipalities’ external vulnerabilities (country mean) in 2021 exchange, and critical thinking (Barbera et al., 2018b). In 2021, the differences across countries appear to have narrowed. However, UK municipalities still seem to foster more critical thinking, followed by German and French municipalities, with their Italian counterparts seemingly downplaying this aspect of anticipatory capacities. Overall, both in 2017 and in 2021, UK municipalities seemed to have more developed anticipatory capacities than their continental counterparts (see Figure 22.6). In the aftermath of the COVID-19 crisis, municipalities across all four countries seemed to recognize the relevance of exchanging information with external service providers. However, especially UK municipalities seemed more likely to exchange information with their peers constantly. The latter is also the case with regular vulnerability assessment, where UK municipalities score notably higher. As suggested by earlier findings from case studies

3.33

3.67

3.56

UK 2021

3.75

3.58

3.86

3.88

UK 2017 AC Information Sharing

3.89

3.69

3.85

3.71

Italy 2021

AC Monitoring

3.84

3.25

3.37

3.43

2.93

Italy 2017

AC Information Exchange

3.43

3.39

3.09

Germany 2021

3.2

3.48

3.57

3.62

3.66

3.07

3.15

3.35

3.56

Germany 2017

France 2021

AC Critical Thinking

Note: 1 = strongly disagree; 5 = strongly agree; AC = anticipatory capacity. Source:  2017 adapted from Barbera et al. (2018b).

Figure 22.6  Municipalities’ anticipatory capacities (country mean 2017 and 2021)

Government financial resilience – a European perspective  ­423

(Barbera et al., 2016), this is to some extent due to regulations from the UK central government, which – compared with the other countries – put a stronger emphasis on mediumterm financial planning, risk assessment, and other environmental monitoring tools. In contrast, in Germany, municipalities’ anticipatory capacities comprised long-term investment plans and risk reports, but tools such as scenario analyses or contingency plans in some cases were deemed unsuitable for shocks such as the global financial crisis. The latter was considered too uncommon to be anticipated (Saliterer et al., 2017). However, other cases in Germany had implemented contingency plans seemingly due to more developed anticipatory capacities following experiences with prior (mainly natural disasterrelated) shocks and crises (ibid.). Hence, in both surveys, 2017 and 2021, German municipalities’ assessment of anticipatory capacities ranks in the middle, as they score lower on vulnerability assessment but higher when it comes to monitoring. In both 2017 and 2021, the level of development of anticipatory capacities seemed relatively lower in Italy. In particular, they scored lower when it comes to monitoring their environment. Case studies revealed that Italian municipalities’ planning and monitoring processes were often weak and awareness of political and administrative actors was low. In those cases where anticipatory capacities seemed to be more developed, the capacities surfaced mainly as good strategic and financial planning, internal monitoring processes, risk management, and simulation (Barbera, 2017; Barbera et al., 2017). According to survey results, critical thinking was also lower for Italian municipalities. In 2021, the level of development of anticipatory capacities in French municipalities tends to be higher than in their counterparts in Italy and Germany. In 2015, case studies of French municipalities underlined a more nuanced situation. On the one hand, a predominant lack of management control or monitoring was observed. On the other hand, after the impact of the financial crisis, municipalities had invested in developing management control processes, and monitoring and planning tools (du Boys, 2017). Coping Capacities in European Municipalities in the Face of Global Crises and Pandemics Steccolini et al. (2017), through case studies, offer several illustrations of the mix of coping capacities deployed by European municipalities in the face of austerity. Facing the financial crisis, municipalities in all countries seemed to rely significantly on buffering capacities, and on adapting ones to a much lesser extent. For example, in Italy, they were partly developed only some time after the initial impact of the shock and crisis had materialized. They were mainly visible through the actions of building internal competencies, increasing networking with external stakeholders, adjusting organizational activities, rationalizations, reorganization and restructuring of services, and retargeting service users while maintaining the general modus operandi of the municipalities (Barbera, 2017). In France, adapting capacities were mainly visible through a proactive stance in attracting businesses and a restructuring of their internal organization (du Boys, 2017). Compared to the other countries, municipalities in England seemed to build on more developed adapting capacities such as systematic task reviews or reviews of service _provision to reduce or redesign services, performance reporting, and changes to (­outcome-based) budget planning and budget execution that allowed policy prioritization, strengthening risk management and benchmarking, and fostering multi-agency collaboration as well as partnerships. At last, we observed limited actions that would

424  Research handbook on city and municipal finance

signal strong transforming capacities. The English cases included in the qualitative studies were those with more developed transforming capacities, as shown by measures to develop autonomy and self-regulation of the local context to achieve self-sufficiency of the local government, as well as by measures of repositioning or rethinking the modus operandi of the local government through increased co-production with other public partners (see Barbera et al., 2017). The surveys in 2017 and 2021 (Figure 22.7) show that similar to findings related to anticipatory capacities, municipalities in the UK have built stronger coping capacities than those in Germany, Italy, or France. Again, German municipalities lay in the middle, while their Italian counterparts appear to have relatively lower coping capacities. Comparing the four specific coping capacities, it turned out that external collaboration received the lowest scores in both years, and in all countries. In Germany, internal collaboration was relatively more developed than the other coping capacities. Conversely, in the UK, rapidity of action and adaptation of people (in 2017) scored slightly higher than internal collaboration. In France and in Italy, it is the rapidity of action and internal collaboration that received the highest scores. Between 2017 and 2021, Italian and German municipalities appeared to have developed their anticipating capacities (except for internal collaboration in Germany), while the development is more ambiguous in the UK, where only rapidity of action improved. In summary, the findings provided an indication that municipalities in the four European nations showed different levels of perceived vulnerability, and that the type of crisis faced would also shape the feeling of vulnerability. Indeed, UK municipalities felt less vulnerable in 2017, as opposed to their counterparts in France, Germany, and Italy. However, this situation changed in 2021, probably as a consequence of Brexit and COVID-19 bringing about changes to the international scene. Interestingly, UK municipalities appeared to rely on stronger anticipatory and coping capacities, especially those based on managerial tools, probably as a result of the UK having been at the forefront of new public management reforms. Differently, their EU, continental counterparts remain rooted in a neo-Weberian system, where the building of risk management systems or other systems for planning and monitoring may have attracted less attention. At the same time, however, France, Germany, and Italy appeared to have an institutional and fiscal context where municipalities are in better control of their own income and resources. Conversely, UK municipalities seem to be highly dependent on the central government funding decisions. Over time, this may have also contributed to explaining an increased sense of vulnerability and lack of control in the UK context as opposed to the EU one. These findings suggest the need to further investigate how differences in financial resilience dimensions explain different financial and non-financial outcomes, and how different resilience ­patterns emerge across different administrative traditions.

IMPLICATIONS FOR PRACTICE AND POLICY: FROM THE FRAMEWORK TO NEW EXPLORATIONS AND SELFASSESSMENT So far, this chapter has presented the governmental financial resilience model, discussed its operationalization, and illustrated it through data collected from municipalities across

Government financial resilience – a European perspective  ­425

3.13

3.47

UK 2021

3.42

UK 2017 CC Rapidity of Actions

3.81

3.68

3.73

3.7

3.93

3.77

3.84

3.9

3.1

Italy 2021

CC Internal Collaboration

3.89

3.47

3.29

Italy 2017

3.39

2.91

3.28

3.22

Germany 2021

CC Adaptation of People

3.32

3.29

3.53

3.38

3.09

3.42

3.61

3.18

3.35

Germany 2017

France 2021

CC External Collaboration

Note: 1 = strongly disagree; 5 = strongly agree; CC = coping capacity. Source:  2017 adapted from Barbera et al. (2018b).

Figure 22.7  Municipalities’ coping capacities (country mean 2017 and 2021) four European countries. From a practice and policy perspective, the framework can also be translated into a ‘toolkit’ that helps governmental organizations to assess their configuration of (financial) resilience dimensions. In practice, organizations can assess their anticipatory capacities, coping capacities, and perceived vulnerabilities to identify possible critical areas or strengths. Based on the results, municipalities can derive actions and strategies to sustain and strengthen extant capacities or build new ones (for a full version of a proposed toolkit, see Barbera et al., 2018b). The toolkit contains key questions for each governmental financial resilience dimension and sub-dimension. Table 22.5 shows an example of how a potential respondent of one governmental organization might respond to a self-assessment question concerning the monitoring dimension, the latter being part of the anticipatory capacity of its organization. All the other dimensions and related categories can be assessed in the same way. The self-assessment toolkit can help local decision-makers to conduct organizational analyses. By integrating answers from respondents of the same or different departments, the results can be used as a starting point for internal discussion and as a way to share interpretations, perceptions, and possible solutions, thus informing future decisions. From this perspective, the self-assessment toolkit can allow both financial managers and service managers to share ideas and reflections on how different capacities and sources of vulnerability affect their financial resilience. As such, the toolkit and the underlying governmental financial resilience model may be seen as a framework that not only enables the assessment of capacities and vulnerabilities, but also the sharing of a common language and way to frame crises and their impact – that is, as a tool that provides the basis for discussion on what are the determinants of organizational financial resilience. Additionally, municipalities may find it interesting to compare their own financial resilience positioning with the average positioning of local governments in the same country, or with the average positioning of municipalities across different countries. Moreover, the toolkit can be used by policymakers, auditors, and regulators to conduct analyses from an external perspective, or at an aggregate level (i.e., central governments’

426  Research handbook on city and municipal finance

Table 22.5  Example of a self-assessment question concerning the monitoring capacity Is my Organization Able to Anticipate Unexpected Events?

Anticipatory Capacities: Monitoring External Activities

Does the local government have a clear understanding of the environment?

Socio-economic environment: 3

Being aware of the external environment is essential in order to anticipate potential shocks and to identify and manage key local government vulnerabilities

Technology environment: 4

Citizen needs and demand: 4 Regulatory environment: 5

In my organization (1 = not at all; 5 = to a great we constantly extent) monitor changes 1 2 3 4 5 in socio-economic environment Source:  Adapted from Barbera et al. (2018b).

financial resilience). In sum, both the concept of financial resilience and the self-assessment toolkit can inform organizational strategies and public policies.

CONCLUSIONS In a context where crises and shocks are becoming more frequent, governments increasingly need to be aware of their financial resilience and its underlying dimensions. They need to be aware of the ways in which they make sense of shocks and their sources of vulnerability, to build and maintain the capacities that allow them to absorb and react to shocks that affect their financial conditions, and ultimately their ability to ensure continuity in the provision of services. This chapter has proposed a framework for understanding and studying, but also assessing, the financial resilience of municipalities, which results from the dynamic combination of types of crises or shocks, financial vulnerabilities, anticipatory capacities, and coping capacities. The chapter also highlights the main features of these dimensions in municipalities in the largest European countries (France, Germany, Italy, and the UK). Finally, it also shows how this research can inform practice and policy through the development of a governmental financial resilience toolkit. From a research perspective, the framework has proven robust and adaptable to different institutional contexts, including developing countries (e.g., de Aquino & Cardoso, 2017; Upadhaya et al., 2020) and crises of a different nature (financial crisis, migration, pandemics). It would be interesting to see further applications and studies concerning different levels of government, exploring further the connections among financial, organizational, and individual resilience, as well as the relevance of the dimensions in facing current slow-burning crises related to poverty, rising inequalities, and climate change. In addition, the financial resilience model was born as a result of European studies conducted in contexts experiencing economic and financial shocks and/or shocks with severe

Government financial resilience – a European perspective  ­427

economic and financial consequences, followed or accompanied by austerity, where resource constraints were a major issue. However, other crises may not show the same characteristics, and the COVID-19 pandemic provides an interesting example from this perspective. The COVID-19 crisis has placed further emphasis on governmental (financial) resilience to the point that this term is now commonly used in many international and central governments’ strategic agendas. As the pandemic has encouraged stimulus packages and expansion of spending in Europe, the coming years will witness the consequences of these policies, both on the capacities governments will be able to build and use, and on their finances. More generally, the current financial resilience framework identifies a plurality of relationships between types of crises and shocks, types and sources of vulnerabilities, types of anticipatory and coping capacities, and their possible consequences (in terms of responses, and financial and non-financial performance), which appear to be worthy of future investigation. It also points to the possibility of adopting configurational approaches to look into the consequences of different combinations of dimensions of resilience.

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23. Measuring urban financial resilience: a resource flow perspective Christine R. Martell and Temirlan T. Moldogaziev

INTRODUCTION Urban governments are responsible for their performance in providing goods and services to citizens (Jacob & Henrick, 2013; McDonald, 2015). Yet, any number of external shocks, or transboundary crises – such as recessions, wildfires or floods, or pandemics – can disrupt a city’s ability to perform and sustain services, as such events simultaneously decrease revenue and increase demand for goods and services (Kiewiet & McCubbins, 2014; Padovani et al., 2022; Scorsone et al., 2013). Urban financial resilience (UFR), the ability of a city to maintain government services in times of shock, is salient given the myriad of potential sharp interruptions to public service delivery. The concept is close to, but distinct from, traditional constructs of financial condition, fiscal health, and fiscal distress as it focuses on the immediate ability of a city to meet service, debt, and capital obligations during a crisis. This study applies accounting and financial tools to measure the extent to which resource flows signal UFR. It explores how accounting and financial management data can provide a means to discern which communities are more or less likely to withstand a shock and quickly return to service provision, debt service, and capital expenditure. The results of this study inform how cities can better prepare their financial resilience to maintain services, meet immediate obligations to creditors, and maintain capital expenditure in the face of shock. The study is informed by previous research in the areas of urban resilience, UFR, accounting and financial management, performance management, and policy learning. The starting point is to situate UFR at the nexus of urban resilience and financial condition. UFR is a subset of the large body of literature on resilience. This literature frames the resilience cycle and provides a focus for UFR on anticipatory and coping capacity. Similarly, UFR is a subset of the robust body of literature on financial condition, fiscal health, and fiscal distress. The two bodies of literature come together as they link accounting practices, strategic management, performance, and policy learning over the resilience cycle. This work emphasizes the contributions of city financial choices to urban resilience. The chapter proceeds with a literature review that discusses UFR as a subset of urban resilience, the rationale for using financial ratios as a means of informing resilience and attaining strategic goals, and prevalent methods and critiques for measuring financial performance. We argue that, in the short-term horizon, cities facing a shock must find a way to continue three streams of payments with minimal interruption: to cover operating costs, to cover debt service, and to maintain capital assets. Following a review of the literature, we identify measures of these three immediate needs and use them to construct a composite measure of UFR. Then we apply the measures to an unbalanced panel of data for 46 cities from 433

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1998 to 2019, which covers periods of economic stability before and after the turmoil of the Great Recession (2007–09). A discussion section of the measures’ qualities and limitations follows, and a concluding section that addresses future research ends the chapter.

LITERATURE REVIEW What is Urban Financial Resilience? Urban financial resilience (UFR) is best understood as a subset of urban resilience. While there is no consensus on the definition of urban resilience, Meerow et al. (2015, p. 45) build off the scholarship to define it as “the ability of an urban system – and all its constituent socio-ecological and socio-technical networks across temporal and spatial scales – to maintain or rapidly return to desired functions in the face of a disturbance, to adapt to change, and to quickly transform systems that limit current or future adaptive capacity” (emphasis added). The working definition of urban resilience makes no claims about the range of origins of disturbances, or shocks; highlights the importance of returning to a desired level of function; and puts forward the cyclical nature of resilience and policy actions over time. Meerow et al. (2015) conceptualize the urban system as a series of interrelated layers of governance networks, networked material and energy flows, urban infrastructure and form, and socio-economic dynamics. Their conceptualization does not address the financial management practices as an explicit component of governance; rather, they are implicit, underlying the urban system. Resilience scholars identify four stages of the resilience cycle (Barbera et al., 2017; Organisation for Economic Co-operation and Development [OECD] and World Bank, 2019), each of which apply to UFR. The first is anticipatory, also called awareness and preparation, which refers to the capacity of cities to anticipate, through risk assessment, and plan for disturbances by having good budget and financial health. The remaining three characteristics pertain to coping, or responding, which is the capacity of cities to respond to a disturbance and move beyond it. Buffering (or basic coping) refers to the capacity of the system to withstand shocks and maintain essential functions. In financial resilience terms, buffering refers to the ability of the city to use resources to resume or maintain operations and make debt obligations. Adapting refers to behavioral and institutional changes that occur based on learning from experience. With respect to financial resilience, adapting refers to the ability of the city to alter budget and investment priorities, revenues, expenditures, and/or processes based on learning. Transforming refers to actions where policies and investment unlock suppressed economic and social potential. From a financial resilience perspective, transforming means aligning operating and capital budgets with strategic goals that unlock economic and social potential, some of which may result from the shock, for medium- and long-term strategic goal attainment and to improve anticipatory capacity. These stages are cyclical, and they parallel a financial management policy process whereby socio-economic condition influences financial condition, which influences the financial capabilities of government, which further influence the resulting socio-economic condition (Wang et al., 2007). While a complete understanding of UFR must consider the sum of financial resilience as it applies to all stages of the resilience cycle, consistent with previous research this

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chapter focuses on the first parts of the resilience cycle (Padovani et al., 2021). In this sense, UFR is explicit about budgeting and financial management practices that allow the local government to (1) maintain and return to normal functioning; and (2) adapt and transform practices over a longer term to reduce the potential impact of shocks. Specifically, we conceptualize UFR as the capability of the urban government to manage its budget and financial resources in such a way that the jurisdiction can respond to shocks in a timely manner to maintain operating services, to meet creditor obligations, and to maintain capital expenses. Ultimately, the city is successful if it can restore financial health for the benefit of attaining medium- and long-term strategic objectives that bring the city closer to addressing other key components of the resilience cycle. Financial Performance, Strategic Goal Attainment, and Accounting Measures The capacity of a state or local government to manage its budgetary and financial resources is linked to organizational performance and the attainment of strategic goals. In particular, stability of budgetary and financial resource management improves performance ­outcomes (Anderson & Mortensen, 2009; Liang & Fiorino, 2013; Park et al., 2021). This work raises the important issue of countercyclical spending. Demand on cities is highest and resources lowest at the time of a shock. Policies and practices that allow for temporal smoothing help cities manage crises. Budgetary stability, achieved through countercyclical fiscal capacities such as reserve funds, contributes to reliable service provision and allows for smoothing during lean years when demands on cities are highest and investment in economic activities is needed to bolster future revenues (Hou & Moynihan, 2008). The relationship between financial management and performance may be recursive, with organizational capacity affecting financial management, and financial capacity affecting organizational capacity to perform (Kioko et al., 2011; Snow et al., 2015; Wang et al., 2007). This matters because of the presumed, though inconsistent, relationship between financial data and performance management (Ho, 2011; Hou et al., 2011; Kim et al., 2018). As such, there is an active role for accounting and financial management data, from products such as internal audits and financial reports, for decision-making and for strategy attainment, as a key component of governance for purposes of accountability, management, service provision, and policy development. Previous research into financial condition, fiscal health, and fiscal distress informs UFR. These terms are often used interchangeably, though there are conceptual nuances. For example, the temporal component may differ by construct. While the Governmental Accounting Standards Board (GASB, 1987, 2012) considers financial condition to be the jurisdiction’s ability to provide services and meet obligations as they come due, Maher and Nollenberger (2009, p. 62) characterize it as “an organization’s ability to maintain existing service levels, withstand economic disruptions, and meet the demands of growth and decline.” Fiscal health and fiscal distress are polar opposite ends of the financial condition continuum. A critical issue in organizational management is whether financial health or distress can be anticipated, and if so how to measure it. Efforts to pinpoint the most useful and precise measure are ongoing. Although there is little agreement (Clark, 2015; Honadle et al., 2003; Jacob & Hendrick, 2013; McDonald, 2019; McDonald & Maher, 2020; Stone et al., 2015; Trussel & Patrick, 2013; Wang et al., 2007), measures generally reflect four

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dimensions of solvency – cash, budgetary, long run, and service level (Groves & Valente, 1986, 1994; Maher & Nollenberger, 2009; Nollenberger et al., 2003; Wang et al., 2007). Financial performance measures rely on financial ratios. Brown’s (1993) “10-point test” of financial condition puts forward a number of ratios for assessment of city financial condition, a method for jurisdictions to evaluate their financial condition, and a means for comparative analysis. Extensions of the work by Maher and Nollenberger (2009) update Brown’s work to incorporate more valid indicators of financial condition. Among them are indicators of operating position, including the operating surplus or deficit as percentage of operating revenues. This measure of general fund results is important to credit quality, as credit rating agencies become concerned when “there are two consecutive years of deficits, a deficit in the current year that is larger than the deficit in the past year, a deficit in two or more of the past five years, or an abnormally large deficit – more than 5 to 10 percent” (Maher & Nollenberger, 2009, p. 63). Wang et al. (2007) develop a measure of financial condition and test it using US state government-wide financial data. Financial condition refers to the ability of government to “adequately provide services to meet current as well as future obligations” (Wang et al., 2007, p. 3). Their approach leverages data prepared, according to GASB Statement No. 34, with accrual accounting and with an emphasis on economic resource management to get a better measure of the long-term outlook of government entities. They identify 11 indicators of cash, budgetary, long-run, and service-level solvency. Their work highlights the dependence of long-term financial condition on short-term solvency, such that “consistently poor financial performance should lead to deteriorating financial condition” (ibid., p. 4). By applying the measures to government-wide financial data, the approach provides an opportunity to report on the assets and liabilities, including pension obligations, of all government funds, not just the general fund (Mead, 2013). Despite attempts to assess financial condition, common aggregate measures of financial condition, such as Brown’s (1993) 10-point test and Wang et al.’s (2007) Financial Condition Index (FCI) do not fully predict fiscally distressed jurisdictions (McDonald & Maher, 2020) and suffer issues of validity (Clark, 2015). Moreover, reliance on ratio analysis can be misleading because ratios alone may obscure local knowledge of financial condition. Yet, empirical studies of common indicators (Brown, 1993; Wang et al., 2007) find that some component measures predict fiscal distress, as observed by service reductions, municipal bankruptcy, or state takeover of financial operations (McDonald & Maher 2020; Trussel & Patrick, 2013). A consequence of fiscal distress is the reduction in public services. Trussel and Patrick (2013) use financial indicators to predict reductions and eliminations of services and find that increased reliance on intergovernmental revenue, less investment in capital relative to total liabilities and bond proceeds, and greater per capita debt and debt issuance, increase the likelihood of service reductions. McDonald and Maher (2020) use event history analysis to predict fiscal distress. Consistent with previous research (Gorina et al., 2018; Stone et al., 2015), they find that measures of fiscal reserves and long-term liabilities are more effective predictors of extreme fiscal stress. Conceptually, the work of Gorina et al. (2018) on fiscal distress comes closest to our understanding of UFR. In a study of 300 US city and county governments from 2007 to 2012, the authors followed the leanings of Trussel and Patrick (2013) to emphasize the consequences of fiscal distress. They measured fiscal distress through the analysis of governmental actions by counting episodes of fiscal distress based on a review of annual

Measuring urban financial resilience: a resource flow perspective  ­437

comprehensive financial reports, budgets, and media reports. Episodes of fiscal distress include personnel and salary cuts, deferred capital investment, deferred payments, service cuts, lower pension contributions, reliance on inter-fund transfers, nondebt-related tax or fee increases, declaration of emergency, default on debt, bankruptcy, auditor concerns, and takeover by the state. They find that a lower general fund balance as a percentage of total expenditure, higher total debt as a percentage of total revenue, and lower property tax revenues as a percentage of own-source revenues, are predictors of local fiscal distress. Local governments need to be prepared to use budgetary and financial resources to handle shocks, regardless of whether their origin is physical, economic, political, or social. Connecting the financial management to financial resilience, scholars use the concept of financial vulnerability, either objective or perceived (Barbera et al., 2017, 2020; Cabaleiro et al., 2013; Padovani et al., 2021; Zafra-Gómez et al., 2009). Barbera et al. (2017) conceptualize local government financial resilience as the inverse of financial vulnerability, which they measure by two financial indicators: fund balance (or operating budget position) and revenue volatility. Implicit in their work is the assumption that a local government with less financial vulnerability will have better potential to maintain or return to services in the event of a shock. The strength of financial resilience depends on reducing financial vulnerabilities. To put it another way, financial resilience is stronger when budgeting and financial health are better. Building on previous scholars (Barbera et al., 2017; Cabaleiro et al., 2013; Saliterer et al., 2017), Padovani et al. (2021) identify that financial vulnerability relates to three dimensions: external institutional design of municipal administrative structure and fiscal rules; internal issues of financial condition; and perception of capacity to cope with a crisis. They offer a framework of 21 internal and external perceived sources of financial vulnerability, based on institutional rules and permissible actions of the jurisdiction, to assess urban financial vulnerability before and in the immediate aftermath of a shock. Applying their 2021 framework to the national governments’ response to local governments and to the response of local governments during the COVID-19 pandemic, they find that governments relaxed many fiscal constraints, allowing local governments to manage the pandemic but at the possible expense of long-term financial sustainability (Padovani et al., 2021, 2022). Supporting the cyclical nature of the resilience cycle, Crow et al. (2018) approach UFR from the perspective of post-disaster financial policy change in local government, focusing on how cities learn from their experiences of managing a disaster and applying lessons to achieve longer-term performance goals of community resilience, fiscal stability, and disaster preparedness. Echoing the voice of Barbera et al. (2017), this work recognizes that cities operate within the environment of federal and state policy constraints, within which cities must manage financial resources in response to a shock. They show that those cities with better anticipatory capacity fared better in their coping capacity. In demonstration of policy learning, city officials leveraged the shock to address the weaknesses in their financial resilience and to take post-disaster steps to improve their financial resilience measures. They find that, while minor to moderate, or adaptive, policy changes are most common among the cases studied, the potential exists for cities to make more significant, or transformative, policy changes. Rich as it is, the emphasis of the literature on urban resilience, financial condition, fiscal health, and fiscal distress leaves space for focused attention on financial

438  Research handbook on city and municipal finance

­vulnerability and UFR – the ability of the government to respond quickly in the immediate aftermath of a shock. This study builds on previous work by defining a very narrow concept of financial resilience as one that reflects the organization’s ability to respond rapidly in the face of a shock to maintain services, meet current debt service obligations, and continue capital expenses. While financial condition literature highlights fiscal health in the long term, UFR highlights the immediate ability of the city to respond to a shock. While measures of financial condition include a broad array of indicators, our approach focuses on parsimony by identifying the most salient, immediate post-shock threats. And, while studies within a single country dominate the literature, our research addresses the call for comparative studies (McDonald & Maher, 2020) and tests constructs of UFR on a sample of cities from diverse contexts.

OPERATIONALIZING URBAN FINANCIAL RESILIENCE This study conceptualizes UFR as the city’s ability to meet the current service needs of the citizens, to make current payments to creditors in full, and to continue capital expenses. Previous work on financial resilience (Barbera et al., 2017) operationalized resilience as financial vulnerability, measured by the local government’s operating budget position (revenues minus expenditures, alternatively called fund balance) and its volatility. This measure captures an important facet of financial resilience, that of whether the city has resources to handle a shock. We argue, however, that financial resilience should capture a broader array of post-­ crisis obligations that the city government bears. When a shock occurs, city administrators must choose how to allocate strained resources among competing demands of operating expenditures, debt service, and ongoing capital expenses. Furthermore, there is a sensitive trade-off among the three. For example, newer capital, requiring less operation and maintenance demands on the operating budget, often requires debt financing and increases to debt service; in cases of an older capital stock, the maintenance of capital assets increases demands on the operating budget. Thus, measures of UFR should capture three budget aspects the city must simultaneously manage to effectively maintain services, to service debt obligations, and to pay for the (continued) maintenance of capital infrastructure. Building on previous work on financial resilience and accounting performance, this study specifically measures UFR at the interface of the anticipatory and buffering stages of the resilience cycle, where cities must be able to respond to a shock with cash flows by (1) meeting obligated operating expenditures; (2) paying debt service in full and on time; and (3) maintaining capital expenditures. Components of Urban Financial Resilience The components of financial resilience are useful both individually and collectively. The common-size constructs allow intra- and inter-jurisdictional comparisons, as well as longitudinal assessments. The three component parts of resource flows, presented as common-size ratios, measure the jurisdiction’s ability to meet operating expenditures, to meet debt service, and to maintain capital. The first component of UFR measures the jurisdiction’s ability to meet its operating expenditures. Measures of operating solvency are prevalent in the literature as measures

Measuring urban financial resilience: a resource flow perspective  ­439

of fiscal health (Brown, 1993; Gorina et al., 2018; Maher & Nollenberger 2009; Stone et al., 2015; Wang et al., 2007). This study adopts the measure of primary balance ratio (PBR), which is the difference between operating revenues (ORs) and operating expenditures (OEs) as a share of OEs. Fund balance, especially unreserved fund balance, is an expenditure stabilization tool to be used for countercyclical management and to manage revenue volatility (Hendrick & Crawford, 2014; Marlowe, 2005). This operationalization is consistent with the literature, which uses fund balance, the difference between ORs and OEs, as a measure of government capacity and of financial resilience (Barber et al., 2017; Hou & Moynihan, 2008; Marlowe, 2005; Maher & Nollenberger, 2009; Stone et al., 2015; Gorina et al., 2018). A PBR < 0 indicates the city has less revenue than expenditures; a PBR = 0 indicates the city has no surplus revenue; and a PBR > 0 indicates the city has surplus revenue. Equation 23.1 shows the estimation of PBR for city i in year t:

O​Rit​  ​​ − O​Eit​  ​​ ​PB​Rit​  ​​  = ​ ___________  ​ × 100​     (23.1) O​Eit​  ​​

The second component of UFR measures the jurisdiction’s ability to meet its debt service. As an indicator of debt service viability, this study operationalizes it as a debt service burden (DSB) ratio, focusing on the portion of principal (P) and interest (I) due in the current year as a share of OEs (Brown, 1993; Gorina et al., 2018; Wang et al., 2007). Additional, alternative constructs of debt service viability may include the direct debt as a share of expenditures and the tax-supported outstanding debt as a share of OEs. As these constructs capture the noncurrent portion and the tax-supported noncurrent portion of the outstanding debt burden viability, respectively, their role is important for a broader view but supplementary to the assessment of current financial capacity to address the most salient immediate post-shock threats. The indicator of debt service viability is an important complement to PBR because it indicates the jurisdiction’s ability to manage, leverage, and service debt (Brown, 1993; Gorina et al., 2018; Park et al., 2021; Tahey et al., 2010; Wang et al., 2007). A DSB = 0 indicates that the city has no current debt service; and a DSB < 0 indicates the city carries debt service, with bigger negative values representing a greater burden. Equation 23.2 shows the estimation of DSB for city i in year t:

​− ​(​​Pit​  ​​ + ​Iit​  ​​​)​​ ​DS​Bit​  ​​  = ​ _  ​     × 100​ (23.2) O​Eit​  ​​

The last component of UFR addresses the jurisdiction’s ability to maintain its capital assets and is measured by the capital balance ratio (CBR). The CBR is the difference between capital revenue (CR) and capital expenditure (CE), as a share of OEs. It captures the current portion of CRs and CEs. Capital investment is an important component of urban services provision. It complements OEs and allows for the provision, maintenance, and operation of capital infrastructure and equipment. Gorina et al. (2018) indicate lack of capital project investment as an episode of fiscal distress. Hendrick (2006) connects an entity’s discretionary spending on CEs to organizational slack, a concept positively associated with fiscal health. Trussel and Patrick (2013) leverage CE as a proxy for physical infrastructure in their predictive model of fiscal distress, and find jurisdictions that spend less on capital are more likely to reduce public services. In short, timely capital asset management, maintenance, and

440  Research handbook on city and municipal finance

utilization matter. A CBR < 0 indicates the city derives less from its capital in revenue than it spends on it; a CBR = 0 indicates the city capital generates enough revenue to cover its costs; and a CBR > 0 indicates the city’s capital generates more revenue than the city spends on capital. Equation 23.3 shows the estimation of CBR for city i in year t:

​CR​ it​​ − ​CE​ it​​ ​CB​Rit​  ​​  = ​ ___________  ​     × 100​ (23.3) O​Eit​  ​​

Building an Urban Financial Resilience Measure A UFR measure captures the immediate ability of a city to meet service, debt, and capital obligations during a crisis into a common-size measure that allows for standardization, evaluation, and comparison across jurisdictions. The combination of measures into a construct of UFR provides a standardized means to evaluate and compare jurisdictional financial resilience of current resource flows. We approach this task carefully and with full cognizance of the critiques that multicomponent constructs can obscure important unique information about financial resilience (Clark, 2015; McDonald & Maher, 2020; Stone et al., 2015). Clark (2015) critiques the validity of weighing components in an index measure. Stone et al. (2015) found that disaggregated indicators performed better than a scale indicator for predicting fiscal distress. McDonald and Maher (2020, p. 289) caution against the use of a summative index as it may obscure unique information about financial condition: “Measurement systems that are reliant upon a series of unique measures to describe the financial condition of government have a more meaningful influence than systems reliant upon some form of a summative index.” They qualify their caveat, however, by suggesting that the issue of measurement and selection of indicators and/or indexes begins with a conceptual understanding of fiscal health factors. We build the UFR measure based on weighed measures of operating capacity, debt burden, and capital provision. The PBR is considered the most important, as it pertains to the ongoing functions of government. Debt service is of next importance, as its timely payment affects the jurisdiction’s credit quality and ability to leverage debt (Park et al., 2021). Finally, capital management and maintenance have implications for the immediate ability to operate capital infrastructure and equipment. Equation 23.4 shows the computation of the UFR measure for city i in year t, where w represents weight:

​​UF​Rit​  ​​  = ​(PB​Rit​  ​​  × ​w​ PBR​​)​  + ​(D​SB​ it​​  × ​w​ DSB​​)​  + ​(​​CB​Rit​  ​​  × ​w​ CBR​​​)​​​​ (23.4)

We constructed each of the component measures to follow a similar scale, where negative, zero, and positive values respectively represent a worse, neutral, and better UFR position. As such, the composite measure shows, on average, to what extent the city is financially resilient. The component measures are valuable for understanding the strengths and weaknesses of UFR and the composite construct is useful for understanding how the city fares over time or relative to peer cities once the trade-offs of funding core operations, debt service, and capital are considered.

Measuring urban financial resilience: a resource flow perspective  ­441

A GLOBAL LOOK AT URBAN FINANCIAL RESILIENCE Sample of International Cities We leverage data from 46 cities to construct and illustrate the measures of UFR. First, key financial measures for cities in the unbalanced sample are collected from Standard & Poor’s city reports and observed for 1998–2019. Second, the sample is not representative of countries where Standard & Poor’s does not collect data on cities or their financial factors. Third, the filtering process focused only on the largest three cities from the countries in the sample. The final sample includes the cities for which there are available data. Data on national economic variables are obtained from the World Bank. Table 23.1 presents the descriptive statistics of the sample cities’ financial data, economic information, and context. Results for UFR Construct and the Component Measures In our interpretations of results, we discuss PBR, DSB, CBR, and the composite UFR measure. We report results for the UFR measure where the weights for PBR, DSB, and CBR are 50, 30, and 20 percent, respectively. To address concerns, of both conceptual and practical points, and for robustness purposes, we evaluate the UFR measure with various alternative weights. Doing so does not alter either the main conclusions in the chapter or the need for testing the measures in future empirical research. Figure 23.1 shows the distribution of individual components of UFR, as well as the composite UFR measure. In terms of PBR, Panel A, most cities in the sample range above zero, with the mean at about 20 percent. This means that most cities have more revenues than expenditures in their operating budget cycles. The highest number of cities below zero is observed in 2007. Overall, two types of cities are observed at or below zero, indicating operating budget distress and, ultimately, lower financial resilience. The first are cities with structural balance issues, such as Auckland or Melbourne. The other are cities from relatively more volatile economic contexts, such as Novosibirsk, Plovdiv, and cities from Central and Eastern Europe before their countries, such as Bulgaria or Romania, joined the European Union. In terms of DSB, Panel B, most cities range within −20 percent of their OEs, with a mean at about −10 percent. The value represents the share of a city’s operating budget that would be needed to service current debt. Those cities with a DSB = 0 carry no debt Table 23.1  Descriptive statistics and cities Variable Urban financial resilience Primary balance ratio Debt service burden Capital balance ratio GDP change, national GDP per capita change, national % of cities from emerging economies

Mean

Std. Dev.

Min.

Max.

2.10 19.81 −10.37 −23.49 2.45 2.16 34%

8.47 24.95 10.06 29.15 3.65 3.80

−30.67 −23.21 −69.15 −198.47 −14.84 −14.38

50.53 185.96 0.00 24.72 12.11 13.02

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Table 23.1 (continued) Cities from emerging contexts

Buenos Aires (Argentina), Córdoba (Argentina), Plovdiv (Bulgaria, pre-2007), Sofia (Bulgaria, pre-2007), Varna (Bulgaria, pre-2007), Rio de Janeiro (Brazil), Bogotá (Colombia), Zagreb (Croatia, pre-2013), Budapest (Hungary, pre2004), Vilnius (Lithuania, pre-2004), Riga (Latvia, pre-2004), Skopje (North Macedonia), Monterrey (Mexico), Kraków (Poland, pre2004), Bucharest (Romania, pre-2007), Moscow (Russia), Novosibirsk (Russia), St. Petersburg (Russia), Istanbul (Turkey), Kyiv (Ukraine), Lviv (Ukraine), Odessa (Ukraine)

Cities from developed contexts (EU members)

Plovdiv (Bulgaria, post-2007), Sofia (Bulgaria, post-2007), Varna (Bulgaria, post-2007), Zagreb (Croatia, post-2013), Brno (Czechia), Prague (Czechia), Lyon (France), Marseille (France), Paris (France), Budapest (Hungary, post-2004), Milan (Italy), Rome (Italy), Vilnius (Lithuania, post-2004), Riga (Latvia, post-2004), Kraków (Poland, post-2004), Bucharest (Romania, post-2007), Barcelona (Spain), Madrid (Spain), Göteborg (Sweden), London (UK)

Cities from developed contexts (non-EU members)

Melbourne (Australia), Sidney (Australia), Calgary (Canada), Montreal (Canada), Toronto (Canada), Basel (Switzerland), Osaka (Japan), Tokyo (Japan), Yokohama (Japan), Seoul (South Korea), Auckland (New Zealand), Christchurch (New Zealand), Wellington (New Zealand)

Sources:  Standard & Poor’s and the World Bank.

service, thus the DSB does not threaten financial resilience. Conversely, if a city has a DSB = −20 percent, meaning 20 percent of OEs need to go to debt service, then the OEs available to handle a shock’s impact on other expenditures become limited. Several cities have DSB levels that are greater than the mean. Cities such as Yokohama, Osaka, and those from emerging contexts, such as Istanbul or Kyiv, are notable. For CBR, Panel C, the mean is at about −20 percent of OEs, indicative of low revenues from capital provision, which is generally consistent with the public goods nature of urban infrastructure. Few cities raise more revenue from capital than they spend on it, suggesting that ongoing capital maintenance may threaten financial resilience in most cities. More worrisome, many cities have tremendous capital costs relative to OEs, limiting resources available for operating costs and debt service. These cities either have a lot of old stock that requires maintenance, or need new stock and capital investments to catch up with urban growth, or both. The list of cities below −50 percent appears to be exclusively from emerging economic contexts, such as Bogotá or Istanbul, consistent

Measuring urban financial resilience: a resource flow perspective  ­443

Sources:  Standard & Poor’s and the World Bank.

Figure 23.1  Urban financial resilience and the component measures with the high demand pressures for capital infrastructure in rapidly growing urban contexts. The UFR measure, Panel D, shows the distribution where negative, zero, and positive UFR values indicate less, neutral, and more financial resilience. The cities have a distribution centered around zero, with a significant number of observations ranging between −20 and 20. Thus, while the modal city is neutral with respect to financial resilience, many cities demonstrate weaker or stronger likelihood of being resilient during a shock. Relatively speaking, Novosibirsk and Bucharest (the latter before joining the EU) are on the low end of the spectrum and express the least financial resilience, while Bogotá and Istanbul are on the upper end of the spectrum and express the most financial resilience.

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Sources:  Standard & Poor’s and the World Bank.

Figure 23.2  Urban financial resilience in longitudinal and GDP growth perspectives Deeper trends in city resilience are most easily seen in Figure 23.2, Panels A and B. Istanbul was most resilient before 2010, while Bogotá has been in post-2010 years. Similarly, Novosibirsk and Bucharest both appear to have shored up their finances by 2010. About two-thirds of the cities in the sample remain consistently in the −10 to 10 range along the financial resilience measure. The trend shows a dip in financial resilience in the years during the Great Recession, and right before the COVID-19 pandemic. The mean financial resilience measure is at or about zero during these two time periods. Figure 23.2, Panel C contains a binary distribution between a country’s gross domestic product (GDP) growth rate and the measure of UFR. This relationship is important because it signals how a city’s UFR measure will respond to an economic shock. Using GDP growth rate, a continuous variable, as a proxy for the degree of economic stability, a negative percentage change in GDP reflects a period of economic shock, and a positive percentage change in GDP reflects a period of recovery or growth. One can generally observe a positive covariation between these two measures. When a shock hits, the rate of GDP growth falls and the UFR measure also decreases. Conversely, post-shock, when the economy recovers, the UFR measure increases. This suggests that shocks weaken levels of financial resilience and higher rates of GDP growth strengthen levels of financial resilience. A look at the components of the UFR measure informs where the potentially weakest spots in UFR are for each city. Figure 23.3 provides the bivariate distribution between GDP growth rates in the country and each of the component factors. The component parts are useful for understanding the structural weaknesses of a city’s financial resilience. For example, even in contexts with high GDP growth rates, structural balance issues – like those faced by city councils in New Zealand – or debt burdens, whether held directly by a city or indirectly through enterprises (transportation, utilities, public facilities) – like those faced by Bucharest or Novosibirsk – have a negative pull on UFR. One can observe in this figure, Panel A, that growth in GDP has a positive association with PBR. This is sensible as with better fortunes in the economy, all else equal, pressures on spending will decrease as revenue collections will increase. There is a group of cities in the sample, however, that appear to have fiscal balances that are much greater than

Measuring urban financial resilience: a resource flow perspective  ­445

Sources:  Standard & Poor’s and the World Bank.

Figure 23.3  GDP growth and component factors of urban financial resilience the fit line would suggest. Further research is necessary to explain what makes these cities – Istanbul, Moscow, or Bogotá – stand out from the rest of the cities in the sample. A binary distribution between GDP growth and debt service burden is presented in Figure 23.3, Panel B. When all cities in the sample are included, no discernable pattern emerges. Debt service is less sensitive to shock, owing to the fact that debt service is contractually obligated, regardless of a shock. Large DSBs appear to exist in several cities irrespective of national GDP growth. The most severe cases in this respect appear to be from Russia and Turkey, but also include cities such as Madrid or Basel. Understanding this phenomenon is critical to urban management. Are cities choosing to borrow during economic shock to backfill for operating losses, but then unable to work their way out of debt during recovery? If so, addressing the root of this debt burden issue, and offering mechanisms to create sustainable debt levels, is likely to play a positive role in shoring up the overall levels of financial resilience for these cities. Without doing so, the likelihood of a financial default becomes a real threat, especially in times of a shock when a city’s ability to continue servicing its debt may become untenable. Figure 23.3, Panel C, contains the binary distribution between GDP growth and CBR. Similar to other panels in Figure 23.3, there is a wide dispersion in the data for periods of economic growth. Many cities exhibit low levels of change in their CBR as GDP growth rates improve. However, several cities show a negative CBR across the range of GDP growth rates. This figure, like Figure 23.3, Panel B, is likely showing the depth of involvement by several cities in the provision of capital infrastructure. The pattern shows that cities like Moscow, Istanbul, and Bucharest spend much more on capital in good economic times than they gain in CRs. This reflects the contingent liabilities and maintenance responsibilities that these outlier cities have in operating public enterprises such as the metro transportation systems, housing stock, and utilities (water and heat, especially in centrally planned cities of Central and Eastern Europe). Finally, consider what happens to a city’s UFR measure over the course of a shock. Using the period of the Great Recession, we explore the values of the UFR measure for periods before, during, and after the Great Recession. Table 23.2 shows how three strata of cities, relatively ranked as high, medium, or low along the UFR measure, fared in 2007–08, in 2009–10, and post-Great Recession, in 2011–12. The impact of the reces-

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Table 23.2  Average performance of UFR measure, by level of financial resilience, before, during, and after the Great Recession Observations by Level of Financial Resilience High UFR > 5 Medium UFR Low UFR < −5

Mean (and Median) UFR Measure 2007–08

2009–10

2011–12

22 obs. UFR = 11 (10) 34 obs. UFR = 0 (0) 7 obs. UFR = −9 (−9)

7 obs. UFR = 15 (8) 53 obs. UFR = 0 (−1) 8 obs. UFR = −9 (−9)

11 obs. UFR = 16 (13) 57 obs. UFR = 1 (1) 7 obs. UFR = −9 (−7)

sion appears to be most pronounced in the 2009–10 period, with many cities dropping from the high UFR strata to the medium UFR strata. Specifically, the number of high performers fell during the Great Recession. Those that remained in the high-performance strata did very well and even improved, with the mean UFR of cities remaining as high performers increasing, especially post-recession. A few cities generate the high mean, while the median score of high performers drops during the Great Recession then bounces back to exceed the pre-recession level. The number of countries in the medium strata swelled during the Great Recession, most likely picking up countries that fell from the high UFR strata. Of those high performers that fell to medium during the recession, only a minority were able to quickly recover to a higher UFR post-recession. The number of countries with low UFR performance was relatively static. Those that started with a low UFR stayed low, with very little change in mean value.

DISCUSSION AND LIMITATIONS This discussion sets out some observations of the results, identifies limitations, and presents recommendations for future research. Both the UFR measure and the component parts inform understanding of a city’s immediate ability to withstand a shock. The city is most financially resilient when it has a positive and high PBR, a low DSB, and a positive and high CBR. While the composite UFR provides a measure of overall resilience, the component parts inform the areas of strengths and weaknesses of a city’s financial resilience. By policy design and practical necessity, PBR is by far the most critical measure relative to other components. The results, especially of the outlier cities, provide some insight into what makes a city particularly vulnerable or resilient. At the same time, data show that a city can have a weakness in one area and still have a positive overall UFR. For example, both Moscow and Istanbul score low on the debt service and capital investment measures but score high on the composite UFR measure due to their high primary balances. Upon disaggregation to component parts, the results show that the PBR is positive for nearly every observation. This is likely not only a matter of fiscal health, but also a legal requirement. When we do find negative values, we can attribute them primarily to economic cycles. For the DSB component, while the average is 10 percent, some cities are paying little to no debt service, while others are paying a debt service as high as or more than 20 percent of their OEs. These higher values of debt service in highly indebted cities may put a drain on current resources, hampering those cities’ efforts to meet OEs and invest in capital, thus reducing their financial resilience.

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Further, in most cities, the CBR is negative. The average capital balance is about half the operating balance. This means that the jurisdictions are spending quite a bit on capital on a pay-as-you-go basis. It makes sense that cities do not have a positive resource flow on capital given the public goods nature of local public investment, perhaps even reflecting the role that some cities play in providing (and subsidizing) enterprise-type services – transportation, utilities, and housing. Such obligations, including asset stock deterioration, can unduly burden the local budgets. Deeper understanding of the role of capital and the maintenance of the capital stock in diverse contexts is warranted. Overall, there is a positive correlation between debt service and the CBR, suggesting that cities use pay-as-you-go (CE) and pay-as-you-use (debt service to finance debt) as complementary, nonmutually exclusive strategies. Comparing the bivariate distribution of the UFR measure and percentage of national GDP growth reveals some structural issues. Generally, there is a positive link, with positive GDP growth facilitating more UFR. The relationship, however, does not hold for some cities. For those cities, strong economic growth does not appear to comport with higher UFR, suggesting there are structural impediments that keep these cities from developing their financial resilience. Why the UFR and GDP growth have different relationships in different cities is a policy concern, and future research should uncover what drives this structural divergence. We further speculate that high UFR cities may be benefiting from national, or supranational, policy in addition to economic growth; and that, on the other extreme, low UFR cities may be hampered by national policy, perhaps due to their economic (ir)relevance in the country. Further research is needed into why the financial resilience of some cities is significantly above or below the expected fit line. Padovani et al.’s (2021, 2022) work suggests that degree of financial autonomy, such as that measured by share of own-source revenue or modifiable revenues, and the extent to which fiscal institutions are enforced or relaxed during a crisis, bear upon the outcomes for both short-term management and long-term sustainability. We recommend exploration of whether type of industry (i.e., manufacturing vs high-skill services such as medical and financial) or being a political center may impact urban resilience. Another example of a city benefiting from supranational structure is Bucharest, which began to operate under the added governance umbrella of the European Union when Romania joined in 2007. Under the EU supranational structure, key capital infrastructure mechanisms became available to modernize and connect Bucharest to the EU market. Several other cities from Eastern and Central Europe that joined the EU under similar circumstances also appear to have benefitted from this broader context with greater UFR. The results beg consideration of the inherent trade-offs among the resource flow components of the UFR measure. What is the right balance of operating, debt service, and capital spending with respect to OEs? We gave greater weight to the PBR, less to debt service, and even less to CBR to reflect our judgement of what would matter most in a crisis. The key results are insensitive to minor variations of weight. Nevertheless, component weights may need to reflect the context of the cities, and the type and severity of a shock. Thus, some cities that are vulnerable to infrastructure shocks such as coastal cities and those in earthquake zones may have to pay more attention to capital balance. The data also appear to show that structural issues pertain to asset (assigned responsibilities, quality, and age) management. We know little about the nature of cities’ capital

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stock and why it requires higher expenditure relative to the revenue it generates. We do not know whether stock is old, requiring operation and maintenance, or new; the quality of assets; the use of assets (housing, utilities, transit, flood control, drainage, sanitation); or the ownership of assets. This aspect of the study needs deeper analysis in future research. Moving from the UFR measure to policy, what is the right amount of capital investment, both as it pertains to the expected vulnerably of a city and to financial resilience? Capital investment could decrease risk of harm due to a shock, but also may either decrease OEs or increase debt service, which, in turn, may adversely impact financial resilience. More research on the trade-offs among the types of risk (i.e., stronger infrastructure but greater debt; better protection of financial crisis, but more operating costs, etc.) is warranted. The UFR measure provides some, but incomplete, insight into how cities’ UFR responds to a shock. Overall, UFR is sensitive to the shock of the Great Recession as expected, with levels falling during the Great Recession and rising afterwards. However, the response is not universal. The data from the period of the Great Recession show that a high-level UFR is useful for attaining recovery, but unknowns remain about why or how a jurisdiction maintains or regains a high UFR post-shock. It seems that, in particular, the combination of primary balance and capital balance affect the recovery of UFR. Thus, research in this chapter falls short in several important ways. First, it does not fully explain which cities will sustain a shock. The data suggest that most cities’ UFR will drop during a shock and return to the pre-shock level post-shock, but the UFR of some high-performing cities will rise post-shock. To know how cities can manage future shocks, research should explore the segmentation of high UFR performers between those that remained high, and even improved, and those that fell to mid-UFR performance. What accounts for the divergence? More research should uncover the institutional and structural supports or impediments to financial recovery, as well as the relationship among primary balance, debt, and capital balance to recovery. The UFR measure, when applied to the sample, shows the resilience of cities over time and relative to one another, but does not specify what level of UFR is adequate to weather a shock. The unanswered empirical questions are “How does this scale comport with the city’s ability to weather a shock, and does the type and severity of the shock matter?” By design, the UFR measure is constructed such that a value of zero represents a “break-even” point; a value less than zero indicates a lack of resources to be resilient; and a value greater than zero indicates slack. We would like to know what value cities need to have to be able to survive a shock. We would like to know whether the UFR of zero is enough, or whether it needs to be a positive, much larger value. We also submit to future research how the measures perform by type of shock, severity of a shock, by context, and by other city characteristics. This research does not address all stages of the resilience cycle. The UFR measure focusing on the immediate resource flow management concerns is an incomplete signal of financial resilience, and we recognize its limitations. A full model of UFR will do three things. It will recognize the impact of a broad array of threats on perceived vulnerability and on financial management. It will internalize as many threats as possible. And, it will account for the interactive and iterative effect among fiscal and financial choices, perceived vulnerability, and financial resilience. In this chapter we argue that UFR measures of resource flow can signal a city’s ability to respond to a shock and resume the

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short-term provisions of public goods and services. Whether it is the case at the city level in practice is an empirical question. The measure, for instance, fails to represent the full resilience cycle in two important ways. First, it does not provide any information on how the city recognizes, assesses, and internalizes risk. A full assessment of UFR should consider the context of the risk of the shocks to which the city is vulnerable, the risk of internal and external constraints, and the city’s response and policy changes made to internalize those risks (Padovani et al., 2021). In this regard, Barbera et al. (2017) refer to risk as “perceived vulnerabilities” that result from external and internal constraints. Their distinction can be taken to mean the constraints that originate outside the jurisdiction versus those that are a matter of internal administrative limitations, like Hendrick’s (2011) distinction between exogeneity and endogeneity of constraints. Second, the quantitative measures of resource flow presented here are useful but fail to signal the adaptive and transformative stages. These stages in the resilience cycle pertain to efforts to improve UFR in the long term. While resource flow measures may inform a jurisdiction’s immediate response to a shock, quantitative indicators of debt burden viability and asset management, alongside qualitative information about risk assessment, investment strategies, and policy changes are needed to better measure UFR at latter stages in the resilience cycle. As Wang et al. (2007, p. 20) note: “The financial health of an organization is similar to that of the human body in the sense that the condition of one human body system is associated with that of others… Therefore, it is necessary for public officials to examine all financial dimensions to understand the state of its financial condition. The continual deterioration of cash or budget solvencies may result in or from long-term financial difficulties. Likewise, the ability of a government to finance the services required of its citizens may be hindered if long-term solvency deteriorates.” While the field is accustomed to measures of credit quality, economy, revenue and expenditure levels, and revenue diversification, it is less practiced at using measures of investment in climate, political stability, and governance matters that reflect democratic principles and public positions on social issues (percentage unhoused, percentage disenfranchised, wealth gap between haves and have nots, service delivery equity, etc.). These latter measures signal a community’s level of internalization of jurisdiction-specific risks and ultimately lead to more robust indication of its financial resilience (Barbera et al., 2016). A broader array of measures, alongside qualitative understanding, is necessary to fully capture the financial resilience offered by policy environments that impact risk mitigation. Thus, the proposed UFR measure focuses on resource availability for immediate post-shock operating needs through common-size analysis of resource flows. This view is appropriate for examining whether cities can adjust to shocks that require trade-offs in the allocation of resources. However, it is limited to signaling financial resilience at the coping stage of the resilience cycle. Ultimately, UFR must account for assets and liabilities (including the assigned responsibilities, value, and quality of infrastructure). A different picture, supplementary to ours and the focus of future research, is about asset and infrastructure resilience. Finally, the full extent of the usefulness of the UFR measure remains uncovered. Not only do we care about the immediate financial resilience of a jurisdiction facing a shock,

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but we also care about its long-term resilience (and sustainability). We seek to learn more about the relationship between financial resilience and credit quality, and the jurisdiction’s ability to use the information provided by the UFR measure to improve its credit quality. We seek to understand what the UFR measure means for long-term capital investment or policy change. We seek to know more about the interaction of the UFR measure and fiscal rules. We seek to assess whether there are variations in UFR levels by wealth, by geography, and over time. To what extent does the UFR measure relate to measures of environment, society, and governance (ESG)? We seek to better understand why some jurisdictions weathered shocks while others did not. We commend these areas to future research.

CONCLUSION In conclusion, in this chapter we offer a construct of UFR. By connecting the literature on urban resilience and financial management, we identify the immediate needs of a city during a shock. While existing literature emphasizes the importance of the PBR, we add that both DSB and capital maintenance spending draw on the city’s resource base and should be included in a measure of financial resilience. It is not enough to attend only to operating needs. Cities also need to service debt and operate capital stock. As such, our research expands on existing understanding of financial vulnerability. The UFR measures a city’s ability to maintain OEs, continue debt service, and maintain capital investment in the event of a shock. The construct allows a city to know its strengths and weaknesses of financial resilience, which informs future policy adaptations. This study adds to our understanding of UFR but directs at least three clear mandates for future research. First, the UFR measure needs to be further tested and calibrated against shocks, both in terms of the types and severity of shocks. Second, there needs to be more contextual analysis about what risks threaten a city and how the city can shore up against them. Third, there needs to be extension of the concept of UFR to the postcrisis period to learn more about policy changes that affect UFR over other parts of the resilience cycle.

REFERENCES Andersen, S. C., & Mortensen. P. B. (2009). Policy stability and organizational performance: Is there a relationship? Journal of Public Administration Research and Theory, 20(1), 1–22. Barbera, C., Guarini, E., & Steccolini, I. (2016). Italian municipalities and the fiscal crisis: Four strategies for muddling through. Financial Accountability & Management, 32(3), 335–361. Barbera, C., Guarini, E., & Steccolini, I. (2020). How do governments cope with austerity? The roles of accounting in shaping governmental financial resilience. Accounting, Auditing & Accountability Journal, 33(3), 529–558. Barbera, C., Jones, M., Korac, S., Saliterer, I., & Steccolini, I. (2017). Governmental financial resilience under austerity in Austria, England and Italy: How do local governments cope with financial shocks? Public Administration, 95(3), 670–697. Brown, K. W. (1993). The 10-point test of financial condition: Toward an easy-to-use assessment tool for smaller cities. Government Finance Review, 9(6), 21–26. Cabaleiro, R., Buch, E., & Vaamonde, A. (2013). Developing a method to assessing the municipal financial health. The American Review of Public Administration, 43(6), 729–751.

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Clark, B. Y. (2015). Evaluating the validity and reliability of the financial condition index for local governments. Public Budgeting & Finance, 35(2), 66–88. Crow, D. A., Albright, E. A., Ely, T., Koebele, E., & Lawhon, L. (2018). Do disasters lead to learning? Financial policy change in local government. Review of Policy Research, 35(4), 564–589. Gorina, E., Maher, C., & Joffe, M. (2018). Local fiscal distress: Measurement and prediction. Public Budgeting & Finance, 38(1), 72–94. Government Accounting Standards Board (GASB). (1987). Statement of Financial Accounting Concepts No. 1: Objectives of financial reporting by business enterprises. GASB. Government Accounting Standards Board (GASB). (2012). Basic facts about GASB’s project on economic condition reporting: Fiscal sustainability. GASB. Groves, S. M., & Valente, M. G. (1986). Evaluating financial condition: A handbook for local government. International City/County Management Association. Groves, S. M., & Valente, M. G. (1994). Evaluating financial condition: A handbook for local government (3rd ed.). International City/County Management Association. Hendrick, R. (2006). The role of slack in local government finances. Public Budgeting & Finance, 26(1), 14–46. Hendrick, R. (2011). Managing the fiscal metropolis: The financial policies, practices, and health of suburban municipalities. Georgetown University Press. Hendrick, R., & Crawford, J. (2014). Municipal fiscal policy space and fiscal structure: Tools for managing spending volatility. Public Budgeting & Finance, 34(3), 24–50. Ho, A. T. K. (2011). PBB in American local governments. Public Administration Review, 71(3), 391–401. Honadle, B. W., Cigler, B., & Costa, J. M. (2003). Fiscal health for local governments. Elsevier. Hou, Y., & Moynihan, D. P. (2008). The case for countercyclical fiscal capacity. Journal of Public Administration Research and Theory, 18(1), 139–159. Hou, Y., Lunsford, R. S., Sides, K. C., & Jonea, K. A. (2011). State performance-based budgeting in boom and bust years. Public Administration Review, 71(3), 370–388. Jacob, B., & Hendrick, R. (2013). Assessing the financial condition of local governments: What is financial condition and how is it measured? In H. Levine, J. B. Justice, & E. A. Scorsone (Eds.), Handbook of local government fiscal health (pp. 11–42). Jones & Bartlett Publishers. Kiewiet, D. R., & McCubbins, M. D. (2014). State and local government finance: The new fiscal ice age. Annual Review of Political Science, 17, 105–122. Kim, J., Maher, C. S., & Lee, J. (2018). Performance information use and severe cutback decisions during a period of fiscal crisis. Public Money & Management, 38(4), 289–296. Kioko, S. N., Marlowe, J., Matkin, D. S., Moody, M., Smith, D. L., & Zhao, Z. J. (2011). Why public financial management matters. Journal of Public Administration Research and Theory, 21(suppl_1), i113–i124. Liang, J., & Fiorino, D. J. (2013). The implications of policy stability for renewable energy innovation in the United States, 1974–2009. Policy Studies Journal, 41(1), 97–118. Maher, C. S., & Nollenberger, K. (2009). Revisiting Kenneth Brown’s 10-point test. Government Finance Review, 25(5), 61–66. Marlowe, J. (2005). Fiscal slack and counter-cyclical expenditure stabilization: A first look at the local level. Public Budgeting & Finance, 25(3), 48–72. McDonald, B. D. (2015). Does the charter form improve the fiscal health of counties? Public Administration Review, 75(4), 609–618. McDonald, B. D. (2019). The challenges and implications of fiscal health. South Carolina Journal of International Law and Business, 15(20), 78–99. McDonald, B. D., & Maher, C. S. (2020). Do we really need another municipal fiscal health analysis? Assessing the effectiveness of fiscal health systems. Public Finance and Management, 19(4), 270–296. Mead, D. M. (2013). Postemployment benefits and fiscal analysis. In H. Levine, J. B. Justice, & E. A. Scorsone (Eds.), Handbook of local government fiscal health. Jones & Bartlett Publishers. Meerow, S., Newell, J. P., & Stults, M. (2015). Defining urban resilience: A review. Landscape and Urban Planning, 147, 38–49. Nollenberger, K., Groves, S. M., & Valente, M. G. (2003). Evaluating financial condition: A handbook for local government (4th ed.). International City/County Management Association.

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Organisation for Economic Co-operation and Development (OECD) and World Bank. (2019). Fiscal resilience to natural disasters: Lessons from country experiences. OECD Publishing. Padovani, E., Iacuzzi, S., Jorge, S., & Pimentel, L. (2021). Municipal financial vulnerability in pandemic crises: A framework for analysis. Journal of Public Budgeting, Accounting & Financial Management, 33(4), 387–408. Padovani, E., Scorsone, E. Iacuzzi, S., & Valle de Souza, S. (2022). Local governments’ financial vulnerability: Analysing the impact of the COVID-19 pandemic. Routledge. Park, J., Lee, H., Butler, J. S., & Denison, D. (2021). The effects of high-quality financial reporting on municipal bond ratings: Evidence from US local governments. Local Government Studies, 47(5), 836–858. Saliterer, I., Jones, M., & Steccolini, I. (2017). Introduction. In I. Steccolini, M. Jones, & I. Saliterer (Eds.), Governmental financial resilience, public policy and governance (pp. 1–16). Emerald. Scorsone, E. A., Levine, H., & Justice, J. B. (2013) Introduction. In H. Levine, J. B. Justice, & E. A. Scorsone (Eds.), Handbook of local government fiscal health. Jones & Bartlett Publishers. Snow, D., Gianarkis, G., & Haughton, J. (2015). The politics of local government stabilization funds. Public Administration Review, 75(2), 304–314. Stone, S. B., Singla, A., Comeaux, J., & Kirschner, C. (2015). A comparison of financial indicators: The case of Detroit. Public Budgeting & Finance, 35(4), 90–111. Tahey, P., Salluzzo, R., Prager, F., Mezzina, L., & Cowen, C. (2010). Strategic financial analysis for higher education: Identifying, measuring & reporting financial risks (7th ed.), Prager, Sealy & Co., LLC, KPMG, LLP, and Attain, LLC. Trussel, J. M., & Patrick, P. A. (2013). The symptoms and consequences of fiscal distress in municipalities: An investigation of reductions in public services. Accounting and the Public Interest, 13(1), 151–171. Wang, X., Dennis, L., & Tu, Y. S. (2007). Measuring financial condition: A study of US states. Public Budgeting & Finance, 27(2), 1–21. Zafra-Gómez, J. L., López-Hernández, A. M., & Hernández-Bastida, A. (2009). Developing an alert system for local governments in financial crisis. Public Money & Management, 29(3), ­175–181.

24. Managing crises and public financial management in Singapore Chang Yee Kwan and Hui Li

INTRODUCTION Adverse shocks like the Great Recession and the COVID-19 pandemic necessitate additional mustering and mobilization of fiscal resources outside the regular budget cycle to manage/mitigate their wide-ranging effects. However, extended fiscal deficits and higher levels of public debt following a crisis potentially foreshadow lower economic growth as argued by Reinhart and Rogoff (2010).1 In contrast, there is little sign of extended fiscal deficits, or higher levels of public debt, after each crisis for Singapore. This chapter discusses Singapore’s public financial management and highlights several features that have served to enable the country to mobilize fiscal resources in response to a crisis without incurring substantial (and potentially destabilizing) fiscal deficits and/or levels of public debt in the longer term. An examination of the budgetary responses to the COVID-19 pandemic serves to illustrate and substantiate the discussion. It also discusses the wider applicability of these features and practices to other fiscal bodies. A regular feature is the recurring presence of fiscal surpluses in Singapore’s public financial management. Asher et al. (2015) report that between 2003 and 2014, budget surpluses averaged 7 percent of gross domestic product (GDP) a year. Over the same period, the public sector incurred no long-term external liabilities (debt). This is unusual, as major events over the period in Singapore include the outbreak of the severe acute respiratory syndrome (SARS) in 2003 and the Great Recession of 2008–09. Both led to greater spending by the public sector in order to manage their socioeconomic effects. Following the SARS epidemic outbreak, two fiscal stimulus packages of SGD230 million and SGD11.3 billion, respectively, were introduced in May and September 2003, leading to a reported fiscal deficit of SGD1.89 billion for financial year (FY) 2003. No fiscal stimulus was tabled following the bankruptcy of Lehman Brothers in September 2008, although the FY2009 budget made provisions of SGD20.5 billion for a “Resilience Package” in anticipation of worsening global economic conditions. The package contributed to a reported deficit of SGD0.82 billion for FY2009. The trend of increased fiscal commitments during crises has continued in the ­COVID-19 pandemic. Besides the main annual budget, this saw the introduction of four 1   Reinhart and Rogoff (2010) report a correspondence between increasing trends in public sector debt as a share of gross domestic product (GDP) and lower subsequent economic growth rates. However, Amann and Middleditch (2020) argue that debt build-ups may arise because crises lead to a reduction in economic activity and thus to higher debt-to-GDP ratios. It is clear that higher debt raises the current costs of debt servicing, but the direction of causality between ­debt-to-GDP ratios and GDP growth remains ambiguous.

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supplementary budgets in FY2020.2 The latter were primarily aimed at mitigating the wide-ranging socioeconomic effects of the pandemic while also ensuring that Singapore’s longer-term socioeconomic objectives and directives were not compromised (Chow & Ho, 2022). Fiscal provisions in direct response to the pandemic’s effects totaled SGD100.9 billion, resulting in an estimated budget deficit of SGD74.2 billion. Revised estimates have since put the deficit at SGD64.9 billion, or about 13.8 percent of GDP, because of marginally higher operating revenues and lower expenditures and discretionary transfers.3 Notably, no external debt was incurred to finance the deficit. Instead, the government made several requests to the Parliament and the President of Singapore to withdraw up to SGD52 billion from Singapore’s national reserves for deficit financing. Blöndal (2006) and Asher et al. (2015) review and discuss the major characteristics and historical trends of Singapore’s public financial management. Asher et al. (2015) argue that regular fiscal surpluses are integral to Singapore’s growth strategy as they serve to manage global investor confidence and expectations of macroeconomic stability. Complementing this, Kwan et al. (2016) report evidence of a consistent practice of underestimating revenues and over-estimating expenditures in the budget that lead to estimates of a poorer fiscal position, but enable a continuing record of fiscal surpluses (or a smaller deficit) at the budget outturn. Blöndal (2006, Section 2.1.6) reports that underspending of budgetary allocations has been small in public sector agencies – typically at less than 5 percent of allocations – as expenditure rules limit the share of allocations that may be carried forward to the next fiscal year to 5 percent. It follows that the successful mobilization of additional fiscal resources, while avoiding the accumulation of long-term fiscal deficits and/or public debt, in response to a crisis is more attributable to the prevailing features/practices in Singapore’s public financial management. This chapter argues that two features in Singapore’s public financial management serve to facilitate the mobilization of additional fiscal resources while avoiding long-term fiscal deficits and public debt following a crisis. These are: (1) design features in its fiscal rules;  and (2) a discerning identification and utilization of broad-based taxes and nonconventional – that is, nontax – sources for revenues that exhibit a lower level of volatility. The chapter thus complements the literature with its focus on the aspects that serve to facilitate additional mobilization and muster of fiscal resources in response to a crisis while constraining an increase in external public sector debt. The chapter also draws some parallels and extensions of Singapore’s public financial management practices with other ­governments. The rest of the chapter is organized as follows. The next section provides a brief review of the main features, fiscal rules, and nuances of the Singapore budget. The third section discusses the features that enable an effective mobilization of fiscal resources following a 2   The annual budget and subsequent three supplementary budgets were titled the “Unity Budget,” “Resilience Budget,” “Solidarity Budget,” and “Fortitude Budget.” The fourth supplementary budget was a reallocation of resources with no new fiscal injections. 3   Note that as government receipts are on a cash basis – that is, in nominal terms – GDP in current prices and not real GDP is the appropriate denominator when calculating the various ­balances and allocation as a share of output.

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crisis without incurring an increase in public debt, and the relevance to subnational governments. The final section concludes the chapter with a brief discussion of the wider implementation prospects, and avenues for further research.

THE SINGAPORE BUDGET Public sector mobilization and acquisition of resources in Singapore is historically focused towards supporting the country’s economic growth and development. Blöndal (2006, p. 51) highlights six main features in Singapore’s public financial management as follows: ● ●

● ● ● ●

fiscal rules that are contained in the Constitution of the Republic of Singapore; spending ceilings (or “blocks”) for ministries that are multi-year, linked with developments in GDP, and fully fungible between all categories of spending; across-the-board budget extractions (spending cuts) to fund reallocations across ministries; endowment funds where budget surpluses are placed, which in turn fund various good causes from their annual investment income; central workforce controls (head counts) and a system of imposing surcharges (financial penalties) if these are exceeded; and continual underspending of appropriations.

The focus of public spending includes providing education and healthcare services, transport, utilities, and other physical infrastructure. It also requires keeping government spending as a share of GDP (relatively) low. The International Monetary Fund (IMF, 2021b, Table A6) reports that average government spending as a share of GDP in highincome economies was 38.6 percent in 2019, and 46.7 percent in 2020. For Singapore, government spending as a share of GDP was 14.1 percent and 26.5 percent, respectively. Despite Singapore’s increasingly aging population, the budget had placed comparatively less emphasis on social protection and old-age financing (Asher et al., 2015, Section  3.3.1). However, recent initiatives like the Pioneer Generation Package, the Merdeka Generation Package and the Silver Support Scheme suggest a tacit acknowledgement of the need for a greater role of the public sector in social protection and in facilitating old-age financing adequacy and security.4 Increased emphasis and focus in 4   The Pioneer Generation Package was established with a one-off allocation of SGD8 billion from the budget in 2014. The principal sum and income generated from it is used to support various healthcare and social support schemes for citizens who were born before 1950 and had obtained citizenship before 1987. These include added supplementary subsidies for healthcare and to the premiums of the compulsory basic national catastrophic health insurance, MediShield Life, and top-ups to the medical savings account, MediSave. The Merdeka Generation Package provides for a near-similar set of benefits, albeit at lower levels, to citizens born between 1950 and 1959 and who obtained citizenship by 1996 from a principal budgetary allocation of SGD6.1 billion in 2019, and the income generated from it. The Silver Support Scheme is a quarterly income supplement introduced in 2015. This is targeted at retirees in the lowest three income deciles who were less able to accumulate sufficient savings for post-retirement needs over their working life.

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both areas are likely required in future budgets following the wide-ranging socioeconomic effects of the COVID-19 pandemic, including a possibility for longer-term after-effects (“long COVID”) that may affect an individual’s subsequent working ability following recovery from COVID-19.5 The budget’s directives on revenue acquisition and expenditure are undertaken in the incoming financial year, unless it is otherwise specified. The financial year begins on April 1 of the calendar year when the budget is read and ends on March 31 of the following calendar year. Accrual accounting has been used for the deliberation and formulation phases since 1999 but reporting of the budget to Parliament remains on a cash basis (Blöndal, 2006, p. 75). All revenues received by the government are managed and disbursed from the Consolidated Fund. This consists of the Consolidated Revenue Account that manages all receipts except for loans. The latter is managed by the Consolidated Loans Account in the Fund. Tax administration is primarily undertaken by the Inland Revenue Authority of Singapore (IRAS), a statutory board under the auspices of the Ministry of Finance.6 However, other departments may assist in some tasks – for example, Singapore Customs assists in refunds of the Goods and Services Tax (GST) to tourists. Other statutory boards may undertake the collection of various user fees and charges. For instance, the Land Transport Authority (LTA) manages the collection of road usage charges and vehicle quota premiums. Other statutory accounts of major focus include the Development Fund, Sinking Fund, and Skills Development Fund. These receive allocations from the Consolidated Fund for national development projects, investment in public and commercial assets and extended skills training and development of the labor force, respectively. Allocations to various state organizations are decided top-down with defined expenditure limits for five-year periods, or “blocks.” Allocation increases are capped at a proportion of GDP growth to encourage efficient use of funds and individual organizations and entities have considerable flexibility and discretion in using their budgetary allocations. Blöndal (2006, p. 60) states that this practice is peculiar to Singapore where “spending ceilings – multi-year, explicitly and directly linked to smoothened GDP, and fully fungible between operating, transfer and capital expenditure – are a unique form of the top-down concept which is not found in OECD countries.” This suggests that, besides the need to adhere to expenditure limits over the five years, there seem to be few official specific directions or determinants as to how individual agencies ought to utilize their funds in the public interest. Operating surpluses from statutory boards are returned as contributions to the budget (but on a negotiated basis) and reported as a consolidated sum for all statutory boards. There is minimal information on the source(s) of operating surpluses. This is despite, as mentioned, the fact that some statutory boards levy user fees and charges. They may also undertake commercial investment activities with relevant ministerial approvals. Allocations to statutory boards are reported as aggregate transfers from their respective parent ­ministries. Details of allocations are only available for selected agencies. 5   The World Health Organization (WHO) has defined “long COVID” as including symptoms of fatigue, shortness of breath, among others, which affect daily activity. See WHO (2021). 6   See Bird and Oldman (2000) on tax administration in Singapore. This is a topic that has received little attention in the recent literature.

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In addition, public debt in Singapore is domestically denominated in the form of Singapore Government Securities (SGS), a substantial portion of which are non-tradable and issued to the Central Provident Fund (CPF) Board to meet its investment requirements. SGS servicing costs are administratively benchmarked and managed to instruments of similar duration and risk (Chow & Ho, 2022). These are netted off against the investment returns of the government and not reported in the budget (Blöndal, 2006, pp. 48–49). Other debt servicing payments are not categorized as a part of the government’s current expenditures. The composition and reporting of the costs of debt servicing have changed marginally in FY2021 with the issue of SGD2.6 billion of bonds issued under the Significant Infrastructure Government Loan Act (SINGA) to retail investors on September 28, 2021.7 Of this, SGD0.6 billion was capitalized for spending on measures to mitigate the effects of a partial re-imposition of restrictions to socioeconomic activity. The latter was due to an increase in COVID-19 cases in Singapore. The capitalized amount was included in the interim budget estimates announced on July 5 and 26, 2021. Nonetheless, government debt for FY2019 stood at SGD641 billion, while there was SGD734 billion in the Government Securities Fund for debt repayment. The risk of default on public sector debt is, thus, nominal. Finally, the reporting of the budget’s financial accounts is in two main documents – the Analysis of Revenue and Expenditure and the Revenue and Expenditure Estimates. The former puts forward the key expenditure priorities and emphases of the government for the coming financial year, and forms much of the basis for the subsequent budgetary debates in Parliament. The Revenue and Expenditure Estimates document details the allocations to various ministries and civil organizations – for example, the President’s Office, and Parliament – on broad categories like workforce and development costs. It also includes capital receipts and expenditures. The government’s assets comprise the two main items of cash and total investments. The latter lists the following: Government Stocks; Other Investments – Quoted; Other Investments – Unquoted; and Deposits with Investment Agents. Asher et al. (2015) highlight a curio that the sum of the public sector’s assets includes a considerable amount of cash holdings. This was SGD123.4 billion, or about 32.1 percent of GDP, for FY2013. For FY2019, cash holdings are SGD49.5 billion, about 9.7 percent of GDP. The rationale for the size of cash balances in the government’s assets is unclear. Fiscal Rules and Political Economy Asher et al. (2015) argue that the design of fiscal rules in Singapore is intended to sustain global investor confidence in the public sector’s economic and financial management as part of the country’s growth strategy. This includes demonstrating a commitment to fiscal sustainability and resilience. Following Blöndal (2006, Section 2.1), fiscal rules in Singapore’s public financial management are briefly as follows.

7   Subhani, O. (2021, September 28).“Singa bonds’ interest rate set at 1.875%; investors applied for 1.58 times the $2.6b sold.” Straits Times. https://www.straitstimes.com/business/economy/ singa-bonds-interest-rate-set-at-1875-sale-raises-26b-to-finance-spore

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First, each sitting government is required by the Constitution to manage its finances within its period of appointment without drawing on past accumulated fiscal surpluses. Each term of government is limited to a maximum of five years, after which a general election must be called. Surpluses and deficits may be incurred and offset between years over its term, but they cannot be brought forward to become part of the financial assets/ liabilities of the next government. Each government is to ensure at least a balanced budget at the end of its term.8 Second, net surpluses over the sitting government’s term are added to the Singapore’s national reserves. In the event of a net (or anticipated) deficit over the sitting government’s term, the Finance Minister may table a resolution to Parliament for approval and request assent from the President of Singapore to draw upon past reserves for deficit financing.9 The first such request and withdrawal was made in 2009 following the collapse of Lehman Brothers in 2008, which marked the beginning of a global economic downturn. Requests for withdrawals were made again in 2020 and 2021 in response to the COVID-19 pandemic. Borrowing by the public sector for deficit financing is constitutionally not permitted, particularly if it is anticipated to require drawing on past reserves to service and repay the debt in future. Third, up to half of the expected long-term real returns from the investments using past accumulated reserves under the Net Investment Returns (NIR) framework may be used towards budgetary purposes as “Net Investment Returns Contribution” in the budget.10 Previously, the investments consisted of assets managed by GIC Private Limited and the Monetary Authority of Singapore (MAS). In 2016, the framework was amended to include investment returns from another government-owned company, Temasek Holdings Private Limited. A complementary political economy environment serves to facilitate effective implementation of the fiscal rules. Singapore is a city state with a single fiscal authority – the Ministry of Finance. Budgetary planning and the management of public finances is a single-tiered process, and all allocation and expenditure decisions are with the Ministry of Finance (Blöndal, 2006, pp. 56–59). Unlike geographically larger economies where some delegation of authority is necessary, no other civil or public sector agency has autonomy to procure funds for expenditure purposes without external approval. Thus, there are no strategic or political economy considerations to accommodate differing ­interests among intra-national agencies in Singapore’s budgeting and public financial ­management.11

  To date, no government has reported a net fiscal deficit at the conclusion of its term.   See Lee (2007, Section II) for a review of the fiscal responsibilities of the Parliament and President of Singapore. 10   Investment returns derived from the reserves of the current government are not subject to the 50 percent acquisition limit or included in the Net Investment Returns Contribution (Lee, 2007, Section IIIA(2)). 11   There are town councils in Singapore that are engaged in the day-to-day running and maintenance of public housing and spaces in constituencies. These have no fiscal powers and were introduced partly with the objective of providing elected members of Parliament with some experience in managing public funds (Peh, 2018, pp. 175–178). Also see Dollery et al. (2008) for an extended discussion of the functions and governance issues of town councils.  8  9

Managing crises and public financial management in Singapore  ­459

Reporting Nuances There is long-standing recognition that public sector accounts typically exhibit various reporting nuances. Anthony (1985) discusses some practices in relation to different accounting standards and the rationales for engaging in such. Similarly, idiosyncrasies in Singapore’s budgetary reporting render it necessary to exercise caution when drawing inference from the budget for policy discussions and formulation. Accounting caveats previously raised in the literature (e.g., Kwan et al., 2016, pp. 4­ 14–416), include the lack of reporting of debt servicing that understates the public sector’s current expenditures and the budget balance, and the lack of disaggregation in the contributions and allocations of statutory boards in the budget. These were also mentioned previously. In particular, the lack of disaggregation of the contributions and allocations to statutory boards indicates a lack of means to assess the expenditure management and performance of these bodies unless their financial statements are independently examined during budget debates. Quah (2010) highlights that statutory boards are expected to manage expenditures from their revenues but they can apply for low-interest loans from the government to meet the current year deficits. However, the ambiguity on the size, and purpose, of allocations can be of concern as some statutory boards hold mandates to undertake projects in the public interest. For instance, the Housing and Development Board (HDB) is responsible for the provision of public housing. As housing projects are longer-term undertakings, intuition suggests that the revenues and expenditures of the HDB are likely to follow the dynamics of housing market cycles. Potentially, this renders the need for sizable loans (and repayments) in various years over the housing market cycle. However, these are currently not observable in the budget’s reporting. The lack of disaggregation also limits inference of the government’s relative emphasis on these statutory boards with regard to those performing other functions – for example, the Building and Construction Authority that regulates the safety requirements and protocols of construction in Singapore. Subsequently, a broader examination of the public sector’s activities, including statutory boards as well as public and quasi-public organizations, suggests that the public sector’s involvement in the Singapore economy is larger than what may be inferred from the reported budgetary transactions. Estimates of the budget’s impact on the economy – the fiscal impulse – that are based on the budgetary aggregates as is will be overstated. Other substantial reporting caveats previously highlighted in the literature include the classification of land rents as proceeds from land sales (“Sales of Land”), omission of the acquisitioned investment income (“Net Investment Returns Contribution”) as a part of revenue, and classifying transfers from the budget to endowment and trust funds as a determinant of the overall balance in the budget documents. Discretionary transfers, or those not allocated to endowment and trust funds (“Special Transfers Excluding Top-Ups to Endowment and Trust Funds”), are considered in the determination of the “basic balance.” The basic balance is interpreted as the annual impact of the government’s revenue and expenditures on the economy but it has no international equivalent.12 12   Definitions of the terms used in the budget are available from https://data.gov.sg/dataset/ government-fiscal-position-annual.

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“Sales of Land” is a misnomer, as land parcels in Singapore are primarily leased for usage for periods of 99 years. There is no transfer of legal ownership. Such transactions are reflected as “the transformation of non-financial assets into financial assets and do not constitute a change in total government net worth” (IMF, 2021a, p. 7). As such, the revenues from the usage rights of land parcels are land rents that should be included on an accrual basis with the government’s operating revenues. For FY2020, revised estimates of the proceeds from the sale of land usage rights were SGD7.1 billion, or about 1.5 percent of GDP. As investment income is used to facilitate current government expenditures, the acquisition from the “Net Investment Returns Contribution” is more appropriately classified as a part of operating revenues and a determinant of the primary budget balance as per the IMF’s Government Finance Statistics Manual (GFSM) that Singapore subscribes to. Transfers to endowment and trust funds are more appropriately classified as a part of national savings under the GFSM. In 2020, this included a SGD16 billion allocation to the Government Contingencies Fund. However, such funds may not be discretionarily used until the relevant Supply Bill has been passed by Parliament and the President has given assent (Kwan, 2021). In addition, disbursements from these funds are reported in the Analysis of Revenue and Expenditure but not as part of the budget’s expenditures. Discretionary transfers to households and firms are more appropriately classified together with current expenditures and included in the determination of the primary balance. As shown previously in adjustments to the budget (Kwan, 2021; Kwan et al., 2016), the composition of Singapore’s primary and overall balances is identical.

BUDGETING IN CRISES The COVID-19 Budgets As mentioned earlier, five budgets were tabled in 2020 in response to the wide-ranging epidemiological and socioeconomic effects of COVID-19 per se, with fiscal commitments totaling SGD100.9 billion. Table 24.1 presents the consolidated budget estimates and revisions for FY2020. It is clear that the substantial increase in the overall budget deficit stems from higher expenditures and discretionary transfers (“Special Transfers Excluding Top-Ups to Endowment and Trust Funds”) and lower revenues with regard to the initial estimates. Expenditures increased by 12.6 percent, while, notably, discretionary transfers were 7.7  times the initial allocation. The increased expenditures and discretionary transfers were for a range of household transfers and financial assistance schemes, wage subsidies, job creation and skills upgrading programs, and managing the epidemiological effects of COVID-19 more generally. Revenues fell by 15 percent relative to initial estimates. This was due to income and property tax rebates, various levy and user charge rebates and exemptions, and marginally lower investment returns. The outcome is a (revised) overall deficit of SGD64.9 billion.13 13

  See Kwan (2021, Section 2.1) for details of the introduced budgetary measures.

Managing crises and public financial management in Singapore  ­461

Table 24.1  Revenue and expenditure (in SGD billion), FY2020a

Operating revenue Less: Total expenditure Primary surplus/(deficit) Less: Special transfers Excluding top-ups to endowment and trust funds Basic surplus/(deficit) Top-ups to endowment and trust funds Add: Net investment returns contribution Overall budget surplus/ (deficit)

Ministerial Revised Statement FY2020 (Oct. 5 2020)b

Budget 2020 (Unity Budget)

Budget Suppl. 1 (Resilience Budget)

Budget Suppl. 2 (Solidarity Budget)

Budget Suppl. 3 (Fortitude Budget)

76.0

70.8

70.4

68.8

63.7

64.6

83.6 (7.6)

89.1 (18.3)

89.8 (19.4)

110.5 (41.7)

102.1 (38.3)

94.1 (29.5)

22.0 4.7

39.6 22.3

43.6 26.3

51.2 33.9

54.5 37.1

53.6 36.3

(12.3)

(40.5)

(45.6)

(75.6)

(75.5)

(65.7)

17.3

17.3

17.3

17.3

17.3

17.3

18.6

18.6

18.6

18.6

18.6

18.1

(10.9)

(39.2)

(44.3)

(74.3)

(74.2)

(64.9)

Notes: a. Figures may not add up due to rounding. b. A prior ministerial statement was issued on August 17, 2020, but the interim estimates are identical to the ones accompanying the ministerial statement on October 5, 2020. As such, only the latter estimates are reproduced here. Sources:  Kwan (2021) and Ministry of Finance (2021).

Besides the COVID-19 response, the FY2020 budget cycle was also the last year of the sitting government’s term. The latter was formed following the opening of the 13th Parliament of Singapore on January 15, 2016 and served until June 23, 2020 when Parliament was dissolved. Thus, budget deficits accumulated between FY2016 and FY2020 must be met by the closure of the FY2020 financial accounts.14 From Table 24.1, the estimates in the “Fortitude Budget” suggest a deficit of SGD74.3 billion for FY2020. However, recall that the sitting government is allowed to use past surpluses accumulated over its term to offset subsequent deficits. In 2020, these were

14   The Constitution of the Republic of Singapore requires that the Finance Minister submit updated estimates of the accounts for the current financial year, estimates for the incoming financial year, and the budget outturn of the last completed financial year to the President and Parliament before the conclusion of the current financial year. As such, the FY2020 budget outturn will be reported in the FY2022 budget documents.

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estimated to be SGD22.3 billion (Kwan, 2021, p. 177). The government thus tabled requests to withdraw up to SGD52 billion from the national reserves to meet the budget deficit.15 Limiting Debt Increase That no external debt was incurred despite the substantial budget deficit as a result of the fiscal response to the COVID-19 pandemic is partially due to the national reserves that Singapore is able to draw on for deficit financing. There are also roles played by the design of its fiscal rules, and the contribution of broad-based taxes and nonconventional sources of revenue, both of which serve to limit the incurrence of external debt. Design of fiscal rules We previously reviewed the major fiscal rules that govern the conduct of Singapore’s public financial management. More generally, fiscal rules require governments to manage public finances in line with some set of objectives and/or numerical targets and in forms like tax and expenditure limits, restrictions to debt increases, and so on. Despite this, the wider literature has underlined that policymakers are often likely to circumvent these rules in various ways. And this happens at both national and subnational levels for a wide range of reasons. The issue of reporting caveats in Anthony (1985) is one example of how this occurs. In this case, it remains that no debt has been incurred despite the inherent reporting caveats of the budget and the fiscal response to the COVID-19 pandemic.16 The following aspects of Singapore’s fiscal rules that facilitated this outcome stand out in particular. First, budgetary management is a middle-term process with considerable flexibility. This is observed from the requirement that each government is to balance its budgets over its term, and surpluses and deficits can be offset between years. The absence of a hard target differentiates this from other medium-term rules where governments may be required to adhere to a specific fiscal target regardless of circumstances, such as the fiscal rules in the EU’s Stability and Growth Pact (Blanchard et al., 2021, Section 2). The inherent flexibility thus renders it less likely for kneejerk responses to exogenous events – for example, excessive spending in a year with a fiscal windfall; or substantial expenditure cuts during a recession/crisis. Second, there is an absence of discretionary powers for the sitting government to utilize surpluses from previous governments for current needs. Drawing on past reserves requires the Finance Minister to seek the agreement of Parliament and the assent of the President. The former may be argued to be of less significance if a sitting government has a supermajority in Parliament. However, the President, and the Council of Presidential Advisors whom the President has to consult on fiscal matters, is an apolitical office where the holder 15   The revised estimates now indicate a deficit of SGD64.9 billion, which is less than the sum of the amount approved for withdrawal and past surpluses. However, note that the approved withdrawal need not be fully utilized if the deficit at the budget outturn is smaller than forecasted. This was the case with the first drawdown of national reserves in 2009 where SGD4.9 billion was requested and approved but only SGD4 billion was withdrawn (Chew, 2017). 16   See Kwan et al. (2016) and Kwan (2021) for revisions to the budget balances.

Managing crises and public financial management in Singapore  ­463

may not be a member of any political party. This also implies that the President is not beholden to the agenda of any political party. Thus, while withholding of assent has yet to occur, it remains a distinct possibility. Also see the discussion by Lee (2007). It follows that the division of powers puts added onus on the sitting government to justify use of past reserves. To a limited extent, it may be argued that this also serves to reduce the prospect that a government actively engages in political budget cycles since it is accountable to two parties on the use of public funds – the voter and the President.17 Broad-based taxes and nonconventional sources of revenue The second feature is a discerning identification and utilization of broad-based taxes and nonconventional sources for fiscal revenues. The latter involves using regulatory powers to generate income such as levies on foreign domestic helpers and foreign workers; extensive application of road-user charges with varying rates depending on the time of the day; and revenues from the rights to car ownership (for a period of ten years) under the Certificate of Entitlement (COE) scheme.18 It also includes allocating usage rights in public spaces – for example, auctioning retail space in public transport hubs – and treasury and investment management of past reserves to generate revenue. Table 24.2 presents the consolidated amounts of five major revenue categories in the budget from the financial accounts in the Analysis of Revenue and Expenditure document of the FY2021 budget and their respective share of total revenue for the budget outturn of FY2019 and estimates for FY2020 and FY2021. These are: (1) income taxes; (2) asset and other taxes; (3) broad-based taxes; (4) other revenues; and (5) net investment returns contribution. The full set of accounts is reproduced in the Appendix. Several observations are evident. The first is that “Income taxes” are the largest individual share of revenues but they only comprise approximately one-third of total revenues. However, revenues from “Broad-based taxes,” “Other revenues” and “Net investment returns contributions” consistently make up about half the total revenue. This was the case even with the onset of the COVID-19 pandemic in FY2020. Second, revenues from income taxes and the GST in Singapore are about 45.5 percent of total revenues in estimates for FY2020 and FY2021 and the budget outturn for FY2019. Gordon et al. (2020) highlight that revenues from state sales and personal income taxes constitute more than 60 percent of local revenues for local governments in the US. However, they estimate that the COVID-19 pandemic may reduce these by up to half. Also, the contribution from other “Broad-based taxes” – that is, those besides GST – is consistently about 9 percent of total revenue. With nontax revenues (“Other revenues” and “Net investment returns contribution”), the combined share to total revenue is about 39 percent. 17   It may also partially explain an observation by Blöndal (2006) of a culture of aversion towards annual budget deficits among civil sector bodies. This is despite a considerable autonomy over how each department manages its budgets. This includes deficit spending in any year subject to the five-year budgetary cap. 18   Asher et al. (2015) highlight that while it is inappropriate to classify some of these instruments as taxes, they can still elicit tax-like effects as they serve to influence usage. See Walters (1969) for an early discussion.

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Table 24.2  Revenues by category (in SGD billion), FY2019–FY2021a

Total revenueb (as a share of) Income taxesc Asset and other taxesd Broad-based taxese Goods and Services Tax (GST) Other revenuesf Net investment returns contribution

Actual FY2019

Estimated FY2020

Revised FY2020

Estimated FY2021

91.31 (100.0) 30.74 (33.7) 15.64 (17.1) 19.47 (21.3) 11.16 (12.2) 8.43 (9.2) 17.04 (18.7)

94.64 (100.0) 31.31 (33.1) 15.61 (16.5) 19.77 (20.9) 11.27 (11.9) 9.33 (9.9) 18.63 (19.7)

82.75 (100.0) 28.05 (33.9) 10.53 (12.7) 17.47 (21.1) 9.90 (12.0) 8.57 (10.4) 18.14 (21.9)

96.20 (100.0) 31.99 (33.3) 15.42 (16.0) 20.04 (20.8) 11.34 (11.8) 9.19 (9.6) 19.56 (20.3)

Notes: a. Figures may not add up due to rounding. b. This is obtained as (Operating revenue) + (Net investment return contribution). c. Income taxes: corporate income tax, personal income tax, withholding tax. d. Asset and other taxes: assets taxes, stamp duty, other taxes. e. Broad-based taxes: customs, excise and carbon taxes, Goods and Services Tax (GST), motor vehicle taxes, betting taxes. f. Other revenues: statutory boards’ contributions, vehicle quota premiums, other fees and charges, others. Source:  Compiled from Ministry of Finance (2021).

The emphasis here is that revenues from broad-based taxes and nonconventional sources exhibit lower volatility in both absolute amounts and as a share of total revenue. This remained the case for FY2020 where varying degrees of lockdowns were imposed because of the pandemic. This provides some measure of certainty, and stability, for budgetary planning and fiscal management and is likely more important for subnational governments that typically have smaller tax bases and fewer revenue instruments for use.

PROSPECTS AND FURTHER RESEARCH This chapter has reviewed Singapore’s public financial management practices and discussed major features that have enabled the city state to respond to crises, such as the fiscal responses to the COVID-19 pandemic, without incurring longer-term fiscal deficits and external public debt. The chapter argues that this is attributable, in large part, to the design of fiscal rules that require each government to ensure a balanced budget at the end of its term, and prohibit sitting governments from discretionary use of accumulated surpluses from past governments for current expenditures without Parliamentary approval and assent by the President of Singapore. It is, however, facilitated by flexibility in

Managing crises and public financial management in Singapore  ­465

medium-term planning, notably by allowing budget surpluses and deficits to be offset between years of the sitting government’s term. A second feature is an astute identification and use of broad-based taxes and nonconventional sources, which contribute nearly half of total budgetary revenues, even in a crisis. The lower volatility of these revenues serves to provide some certainty, and stability, for medium-term budgetary planning and fiscal management. However, wholesale implementation of these aspects is unlikely as Singapore is a global minority in its budgetary position with a persistent record of fiscal surpluses and the absence of external public debt. Also, the viability of these features is complemented by a political economy environment in which the Ministry of Finance is the sole decisionmaking authority on the allocation of fiscal resources. But it remains that further research on how some of these aspects may be usefully adapted, particularly by subnational governments with smaller tax bases and lesser avenues to raise revenues locally. These include, among others, the duration for balanced budget rules and potential nonconventional avenues for fiscal revenues. Besides facilitating better fiscal management, there are also potential welfare effects. For instance, Costello et al. (2017) find that local governments in the US often also undertake the sale of public assets alongside tax increases and expenditure cuts. Adolph et al. (2020) report evidence that local governments often finance spending in their (politically) preferred areas with cuts in those that are less favored. Broadly, there may be detrimental effects on welfare from such policy actions. Also see Portes and Wren-Lewis (2015) for an analytical exposition and discussion. In addition, Portes and Wren-Lewis (2015) discuss the inherent complexity in the design of fiscal rules and argue that because of varying differences between countries, there may be no uniform fiscal rule that may be derived. Similarly, Howlett (2018) emphasizes the need to understand and align the policy context with the type of instrument used. As such, while adoption of the features raised in this chapter may not be feasible, research into identifying where/how some of them may be adapted will clearly be of relevance to facilitate further policy discourse.19

REFERENCES Adolph, C., Breunig, C., & Koski, C. (2020). The political economy of budget trade-offs. Journal of Public Policy, 40(1), 25–50. Amann, J., & Middleditch, P. (2020). Revisiting Reinhart and Rogoff after the crisis: A time series perspective. Cambridge Journal of Economics, 44(2), 343–370. Anthony, R. N. (1985). Games government accountants play. Harvard Business Review, 63(5), 161–170. Asher, M. G., Bali, A. S., & Kwan, C. Y. (2015). Public financial management in Singapore: Key characteristics and prospects. Singapore Economic Review, 60(3), Article 1550032.

19   One may also note the issue of fiscal councils to facilitate budgetary planning and management raised in Portes and Wren-Lewis (2015) and Blanchard et al. (2021). However, such institutions also require knowledge of the specific legislation(s) and regulations that each fiscal authority is subject to and are beyond the scope of this chapter. But this is also a relevant avenue for further exploration and research.

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Bird, R. M., & Oldman, O. (2000). Improving taxpayer service and facilitating compliance in Singapore (PREM Notes No. 48). Poverty Reduction and Economic Management, World Bank. https://openknowledge.worldbank.org/handle/10986/11406. Blanchard, O., Leandro, A., & Zettelmeyer, J. (2021). Redesigning EU fiscal rules: From rules to standards. Economic Policy, 36(106), 195–236. Blöndal, J. R. (2006). Budgeting in Singapore. OECD Journal on Budgeting, 6(1), 45–85. Chew, V. (2017). First drawdown of national reserves. Singapore Infopedia, National Library Board, Government of Singapore. https://eresources.nlb.gov.sg/infopedia/articles/SIP_1489_2009-0320.html. Chow, H. K., & Ho, K. W. (2022). The case of Singapore. In B. Andreosso-O’Callaghan, W. Moon & W. Sohn (eds.), Economic policy and the Covid-19 crisis: The macroeconomic response in the US, Europe and East Asia (pp. 204–226). Routledge. Costello, A. M., Petacchi, R., & Weber, J. P. (2017). The impact of balanced budgets on states’ fiscal actions. The Accounting Review, 92(1), 51–71. Dollery, B., Leong, W. H., & Crase, L. (2008). Virtual local government in practice: The case of town councils in Singapore. Canadian Journal of Regional Science, 31(2), 289–304. Gordon, T., Dadayan, L., & Rueben, K. (2020). State and local government finances in the ­COVID-19 era. National Tax Journal, 73(3), 733–758. Howlett, M. (2018). The criteria for effective policy design: Character and context in policy instrument choice. Journal of Asian Public Policy, 11(3), 245–266. International Monetary Fund (IMF). (2021a, July). Singapore: Staff report for the 2021 Article IV consultation. (IMF Country Report No. 21/156). International Monetary Fund (IMF, October). (2021b). Fiscal monitor: Strengthening the credibility of public finances. IMF. Kwan, C. Y. (2021). Design, reporting, and broader impact: COVID-19 budgeting in Singapore. Policy Design and Practice, 4(1), 169–183. Kwan, C. Y., Bali, A. S., & Asher, M. G. (2016). Organization and reporting of public financial accounts: Insights and policy implications from the Singapore budget. Australian Journal of Public Administration, 75(4), 409–423. Lee, Y. C. L. (2007). Under lock and key: The evolving role of the elected president as a fiscal guardian. Singapore Journal of Legal Studies, 2007(December), 290–322. Ministry of Finance (2021), Singapore budget 2021. Government of Singapore. https://www.mof. gov.sg/singapore-budget/budget-2021. Peh, S. H. (2018). Tall order: The Goh Chok Tong story, volume 1. World Scientific. Portes, J., & Wren-Lewis, S. (2015). Issues in the design of fiscal policy rules. The Manchester School, 83(S3), 56–86. Quah, J. S. T. (2010). Statutory boards. In J .S. T. Quah (Ed.), Public administration Singapore-style (Research in public policy analysis and management: volume 19) (pp. 41–69). Emerald. Reinhart, C. M., & Rogoff, K. S. (2010). Growth in a time of debt. American Economic Review: Papers and Proceedings, 100(2), 573–578. Walters, A. A. (1969). The cost of using roads. Finance & Development, 6(1), 16–22. World Health Organization (WHO) (2021). A clinical case definition of post COVID-19 condition by a Delphi consensus. https://www.who.int/publications/i/item/WHO-2019-nCoV-Post_COVID-19​ _condition-Clinical_case_definition-2021.1.

Managing crises and public financial management in Singapore  ­467

APPENDIX The financial positions for FY2019 to FY2021 from the Analysis of Revenue and Expenditure document are reproduced in Table 24A.1. Only supplementary notes listing the components of aggregate accounts are included. For the full set of supplementary notes, see Ministry of Finance (2021). Table 24A.1  Revenue and expenditure (in SGD billion)a

Operating revenue Corporate income tax Personal income tax Withholding tax Statutory boards’ contributions Assets taxes Customs, excise and carbon taxes Goods and Services Tax (GST) Motor vehicle taxes Vehicle quota premiums Betting taxes Stamp duty Other taxesb Other fees and charges Others Less: Total expenditure Operating expenditure Development expenditure Primary surplus/deficit Less: Special transfers Special transfers excluding top-ups to endowment and trust funds Jobs support scheme Other transfersc Basic surplus/deficit Top-ups to endowment and trust funds GST voucher fund Coastal and flood protection fund National research fund Skills development fund Special employment credit fund Top-ups to endowment and other fundsd Other fundse Add: Net investment returns contribution

Actual FY2019

Estimated FY2020

Revised FY2020

Estimated FY2021

74.27 16.73 12.37 1.64 1.80 4.76 3.26 11.16 2.42 2.87 2.62 4.20 6.68 3.41 0.35

76.01 17.10 12.51 1.70 2.59 4.65 3.60 11.27 2.27 2.64 2.63 4.29 6.67 3.62 0.48

64.61 13.74 12.77 1.54 2.52 3.09 3.51 9.90 2.21 2.28 1.85 3.66 3.78 3.32 0.45

76.64 17.97 12.37 1.65 2.51 4.74 3.77 11.34 2.52 2.28 2.41 4.25 6.43 3.91 0.49

75.34 58.67 16.67

83.61 64.60 19.01

94.06 77.64 16.41

102.34 82.46 19.87

(1.06)

(7.60)

(29.45)

(25.70)

15.13 1.56

21.98 4.66

53.59 36.27

4.86 4.86

– 1.56 (2.62) 13.57 – – – – 0.37 – 13.20

1.33 3.33 (12.26) 17.32 6.00 5.00 2.00 2.00 0.70 1.45 0.37

26.88 9.39 (65.72) 17.32 6.00 5.00 2.00 2.00 0.70 1.45 0.17

2.89 1.97 (30.57) – – – – – – – –

17.04

18.63

18.14

19.56

468  Research handbook on city and municipal finance

Table 24A.1 (continued)

Overall budget surplus/deficit

Actual FY2019

Estimated FY2020

Revised FY2020

Estimated FY2021

0.84

(10.95)

(64.90)

(11.01)

Notes: a. Figures may not add up due to rounding. b. For FY2019 and FY2020, “Other taxes” include the foreign worker levy, water conservation tax, development charge, and annual tonnage tax. From FY2021 onwards, “Other taxes” include the foreign worker levy, water conservation tax, land betterment charge, and annual tonnage tax. c. Includes Wage Credit Scheme, Workfare Special Bonus, Productivity and Innovation Credit, Service and Conservancy Charges Rebates, Top-ups to Child Development Accounts, Top-up to Self-Help Groups, CPF Medisave Top-up scheme, CPF Top-up Scheme, Top-ups to Edusave Accounts and Post-Secondary Education Accounts, SME Cash Grant, Productivity and Innovation Credit Bonus, Rebate for School Buses, SG Bonus, Merdeka Generation Package, Care and Support Package – Cash payout, PAssion Card Top-up, Grocery Vouchers, GST Voucher Special Payment, CPF Transition Offset, Self-Employed Person Income Relief Scheme, Cash Grant to Mitigate Rental Costs, and Solidarity Utilities Credit. d. Consists of ElderCare Fund, Community Care Endowment Fund, and MediFund. e. Consists of Rail Infrastructure Fund, Merdeka Generation Fund, Long-Term Care Support Fund, Public Transport Fund, and Community Capability Trust. Source: 

Ministry of Finance (2021).

Conclusion: themes and directions for future research

Craig L. Johnson, Temirlan T. Moldogaziev, and Justin M. Ross

We began the introduction by describing the running theme of the book as one of city and municipal strength and resilience. In conclusion, we believe all four parts of the book have delivered on that theme and demonstrate the strength and resilience of city and municipal finances through financial crises, pandemics, and other shocks. This final chapter summarizes the themes and selected findings of each chapter and discusses areas for future research.

PART I: THE FUTURE OF RAISING REVENUES AND SPENDING FUNDS While taking significant hits during crisis periods, the structure of city and municipal revenue is strong and adaptive to a changing environment. In Chapter 1, Ross and Peng outline the importance of selecting data sources and how different the financial picture of a unit can appear across these data sources on even the simplest questions. To look at national trends, they employ the US Census Annual Survey of State and Local Government Finances and demonstrate that municipalities in the top 1 percent and those below the median by population demonstrate some surprising patterns. First, the largest 1 percent of local governments stand out in terms of per capita levels while the rest are mostly the same, except since the Great Recession when the lower half of the distribution has started to make rapid gains. That is, the lower half has nearly equalized with the largest cities on a per capita basis through rapid growth, while the rest have essentially remained at similar trends since the 1970s. A natural question is whether all data sources would present the same picture, and whether this is somehow an artifact of the Census data. If it is a real phenomenon and not a data artifact, what is going on? Is it a rise of large city adjacent suburbs resulting from sprawl or difficult development restrictions? Or is it simple churn where cities better suited for the 21st-century economy are rising to replace the cities that were primed for the 20th? In Chapter 2, Youngman illustrated the importance of the property tax to local governments, particularly for the political independence it affords these jurisdictions. Some of the remaining challenges in these systems are familiar from recent decades of policy efforts, such as maintaining systems for property registration and keeping valuations current. Yet, she also highlights the many important challenges that await a society with a dynamic economy and evolving views on equity and priorities, particularly when it comes to estimating property values. How should we reconcile market-based valuation systems with shifting priorities on use of the property? Should the law allow primary residences, as opposed to secondary/vacation homes, to be valued on a different basis? Should shortterm and long-term rental units receive different valuation strategies? Can the use of 469

470  Research handbook on city and municipal finance

artificial intelligence and machine learning improve the equity of the assessment systems where politically oriented human assessors might fail? Afonso’s Chapter 3 explores the recent innovations in taxation that exist under the label “local option taxes.” Some, like the local option income taxes, are old hat in terms of their presented trade-offs of local expansion in a federalist system where competition, complexity, volatility, and adequacy are concerns. Others reflect changing policy priorities (e.g., marijuana and soda taxes) and economic dynamism (e.g., refitting occupancy taxes for the rise of Airbnb). As Afonso points out, COVID-19 has added fuel to the fire on the location of economic activity and what constitutes a taxable presence. In particular, the long-term shift towards remote workers and the recent expansion of the nexus to include e-commerce is likely to have many legal and economic implications for local governments taking the option to expand beyond the property tax. In Chapter 4, Su overviews the less traditional revenue sources that are not derived from taxing powers. These sources include charges, fees, fines, penalties, and so on, which in some cases are intended to align the cost-of-service provision with the persons experiencing benefits, and in others are seeking to actively discourage some type of behavior. Just as localities have turned to special districts, Su highlights the role of growing state restrictions on local taxation as a driver of the increased reliance on these sources. Yet, Su also provides evidence that this has made local governments more exposed to the volatility of the economic business cycle. It should be further identified that such reliance is likely to have other general equilibrium effects on the shape and nature of local governments. How will the development incentives differ for local governments when there is more money in opportunities for service charges than there is in tax base growth? Furthermore, concerns over equity – in particular, racial equity – have arisen as these governments have increasingly sought to become reliant on criminal justice fees. A WalMart with a need for daily protection from shoplifters and vagrants could represent a substantial demand on local policing, yet the fines and fees established for those purposes could disproportionately harm people in over-policed areas as well. Kass and colleagues cover in Chapter 5 what could potentially be the most radical change of the fiscal landscape in the wake of the COVID-19 pandemic – the relationship between municipalities and their encompassing state and federal government. As they document, for decades and regardless of the business cycle, local governments have received relatively nominal federal grants while raising local revenues within constraints put on them by the state. During COVID-19, federal grants became widely available to support cities managing the accompanying economic crisis, with some cities being able to apply directly to the federal government while others needed to use the state as a passthrough entity. Simultaneously, motivated by differing preferences over restrictions on mobility and the power to regulate commerce, many states altered the economic powers of local governments to “shut down” the local economy. The nature of the new status quo in federalism post-COVID-19 is currently anyone’s guess and an important area of future study. City and municipal expenditure structures have responded to new and growing spending demands. Historically, the federal government has dominated the attention of researchers when considering the role of the public sector in healthcare. Yet, the pandemic helped to shed light on the importance of local public health departments for this responsibility as well, as Kim explains in Chapter 6. Kim argues that a very

Conclusion: themes and directions for future research  ­471

plausible consequence of the pandemic is the centralization of these local functions to the state and federal level. This is a reasonable expectation given the perceived benefits of improved coordination across geographic areas that could have better mitigated the spread. On the other hand, across the ocean, China seems to be experiencing prolonged vulnerability as a consequence of its ability to contain the early spread. Furthermore, local experimentation as a policy laboratory seems to have reaped some real benefits on topics like the merits of school closure, where the earlier opening school districts demonstrated the relative safety of the practice. Whether these competing forces will result in more centralized or more diffuse powers in the area of public health will be a theme to watch for in the coming years. As measured by physical infrastructure investment, Wu makes the case that at least the 25 largest cities have not demonstrated a history of maintaining long-term investments in Chapter 7. Beyond the implications for physical infrastructure, this is a poor harbinger of things to come for similar concerns like those investments needed for climate change adaptation or preparations for the next pandemic. Wu argues that the prospects look poorer in the wake of COVID-19 for fiscal reasons, but the problems may run deeper still depending on how these cities fare with the rise of remote work. Much depends on the demand for living in and commuting to downtown cities for employment. Whether this relieves congestion pressures and reduces the rate of depreciation or simply hollows out the tax base as employers look for cheaper non-downtown office space is something only time will tell. Wu’s insights on the difficulty that cities seem to have in confronting long-term investments may extend to cybersecurity, the subject of Carr’s Chapter 8. Unfortunately, local governments appear to be a relatively profitable and easy mark for cyberattacks, which require continuous and evolving investment in cybersecurity. As Carr points out, many local governments may simply lack the resources for the required IT capacity, and it is unclear whether they will always be under that constraint.

PART II: THE FUTURE OF FISCAL ORGANIZATION STRUCTURE, BUDGETING, AND FINANCIAL CONDITION Organization structure, state oversight, budgeting, and financial condition analysis, are all essential parts of local public financial management. Part II provides the latest scholarly research and practical guidance on how to manage city and municipal finances well. In Chapter 9, Goodman lays out the stylized facts of special districts within the landscape of local governments. While general-purpose local governments are essentially stable over time, there is considerable churn in the landscape of special-district governments with new unit formation and the dissolution of existing governments. Goodman summarizes the research to highlight how this has in part been a historical response to state laws that vary the opportunities and constraints of their general-purpose sponsors, which is perhaps why they tend to be expensive governments as measured by per capita expenditures. Of course, states are likely to continue to alter the landscape of federalism by varying the powers available to local governments, but a broader point that can be taken from Goodman’s work is that the special districts are purposeful in that they solve problems. Whether the challenges of the future are in solving climate change problems or calibrating pandemic

472  Research handbook on city and municipal finance

responses, it is likely that special districts will be a part of the picture of how municipalities will rise or fall in meeting the challenge. In Chapter 10, Moldogaziev, Joffe, and Wheeler develop a financial risk model and apply that model to special districts. They use district-level data for fiscal years 2019 and 2020, allowing them to analyze the impact of the first wave of the COVID-19 pandemic on the financial health of community college districts (CCDs) and healthcare districts (HCDs), special districts organized to deliver specific services to the people of the state of California. They find asset management and performance to be the most important aspects of financial risk for weaker special districts. The authors suggest that future research analyze the impact of exogenous shocks and pandemic waves on special-district missions, tasks, and financial health. For example, plummeting CCD enrollments and acute healthcare service delivery pressures on HCDs may have significantly impacted CCD and HCD financial resources and their ability to deliver the types of services needed, to the point that they may have to make major adjustments in their missions and tasks. In addition, the financing structure of special districts may have changed over the pandemic, as well as their role in providing municipal-level services in relation to general governments. In Chapter 11, Kravchuk expands our typical understanding of municipal liquidity to include a Hicks-based classification scheme of balance sheet assets into running, reserve, earning, and investment asset categories. Kravchuk shows how such a classification enables government officials to better understand their ability to respond to acute fiscal stress, such as a natural disaster, as well as provide researchers with a new analytical approach to understanding government balance sheets that takes the understanding of liquidity beyond the typical flow of resources found in operating statements. In Chapter 12, McDonald and Abbott take an innovative approach to understanding municipal financial condition by analyzing fiscally healthy municipalities, rather than those in fiscal distress. Their results from an empirical analysis of the 150 largest cities in the US indicate that fiscal health is directly related to a city’s ability to manage its operating budget by either increasing revenues or decreasing expenditures, rather than managing cash or debt. They also find that municipal fiscal health is directly tied to strong demographic and geographic drivers. The authors encourage government officials and researchers to consider whether our current conception of fiscal health as the capacity to pay liabilities should be expanded to account for the possibility of a fiscal health spectrum. In Chapter 13, Yang shows the important role state governments play in helping local governments manage their finances. Yang provides a general framework within which to understand state government responses to municipal fiscal distress and state approaches to intervention laws. Yang finds that state-level early warning monitoring systems are associated with improved local financial management practices and outcomes. In Chapter 14, Johnson, Navarro, and Yushkov use US Census data to analyze the structure of county revenues and expenditures, and the financial condition of counties from 2002 to immediately prior to the COVID-19 pandemic. While the sector entered the Great Recession with a positive operating balance, post-Great Recession, the county government sector operating position has been negative. Expenditure growth significantly outpaced revenue growth from 2007 to 2012, indicating that the Great Recession resulted in a structural imbalance in county government revenues and expenditures.

Conclusion: themes and directions for future research  ­473

Indeed, revenue losses had not fully recovered by 2017, eight years after the recession officially ended. They find that entering fiscal year 2018, counties had less intergovernmental support and were more reliant on own-source tax revenues than in 2002. By most fiscal indicators, 2017 looks a lot like 2007, indicating a lost decade of county government finances and the high opportunity costs of the financial crisis and Great Recession. For future research they suggest analyzing the countercyclical spending behavior of county governments for potential relationships between changes in government spending and several economic and employment variables. Also, there should be interest in analyzing county fiscal structure across socio-demographic, economic, and population variables to determine whether there is evidence of significant differential impacts across race, ethnicity, region, and so on from the Great Recession and COVID-19 pandemic.

PART III: THE FUTURE OF DEBT AND PENSIONS Part III highlights two sides of the longer-term fiscal autonomy of cities and m ­ unicipalities – the ability to raise their own capital, as well as their responsibility for managing their own pensions. Chapters 15 and 16 cover the municipal securities market in depth. Chapter 15 by Hildreth and Jose expounds on recent municipal market developments and research findings on repayment security, alternative debt structures, and the regulatory environment, among other topics. They argue that the muni market has adapted to changing internal and external demands to fulfill its essential role in producing the nation’s built public physical infrastructure, despite the market’s historical and contemporary shortcomings. Chapter 16 by Luby and Terkel focuses on the process of financial intermediation in bringing debt issues to market. The chapter highlights the role that underwriters, bond insurers, municipal advisors, and credit rating agencies play in raising capital in the municipal securities market, alongside changes in the market and research advancements since the financial crisis and the passage of the Dodd-Frank Act in 2010. Luby and Terkel draw several conclusions on the impact of financial intermediaries on public financial management. There is increasing evidence for the borrowing cost advantage for underwriting by competitive bond sale over negotiating directly with underwriters, and private placements may also offer cost advantages. While municipal advisors, and especially highquality advisors, provide borrowing cost benefits, the repeated use of the same underwriter and advisor can negatively impact costs, so the authors suggest a healthy rotation of advisors and underwriters. Finally, the authors note that pension funding levels are a driving factor in credit rating actions and levels. In Chapter 17, Johnson, Yushkov, and Navarro analyze the county debt segment of the municipal securities market from 2002 to 2020, which finances the provision of the physical infrastructure for county government essential services provided in the US. They find that the county debt market has demonstrated much greater resiliency to the pandemic shock of 2020 than it did to the financial crisis and Great Recession. In Chapter 18, Park, Maher, and Deller analyze the impact of state-imposed fiscal rules on local government credit ratings, borrowing costs, and debt levels. They find that certain tax and expenditure limitations affect credit ratings and debt levels. In addition, for certain types of debt, state-imposed bond referendum and balanced budget requirements may lower borrowing costs and debt levels. Going forward, one question is whether state-imposed fiscal rules

474  Research handbook on city and municipal finance

will help or hinder municipal governments in financing their capital needs in a postCOVID-19 financial world. As stated by Chen in Chapter 19, pensions are important to municipal government finance because annual pension costs account for a significant share of their budgets. Increasing contributions to make pensions more solvent can crowd out spending on other government priorities, while insufficient contributions can lead to insolvency and credit rating downgrades. The chapter summarizes the impact of municipal pensions on municipal budgets, fiscal and credit risks, and government employees. Chen encourages municipal officials making pension policy and management decisions in a post-COVID-19 era to take a long-term perspective, factor in and balance the interests of all stakeholders, and understand the equity implications of past and future decisions at the individual level and across generations and racial and gender groups.

PART IV: THE FUTURE OF CITY AND MUNICIPAL FINANCE ACROSS THE GLOBE Several questions arise in the chapters on city and municipal finance from the international and comparative perspectives that future scholars will find of interest. Chapter 20 offers a broad review of municipal systems in 26 federal countries from around the globe and evaluates the relationships between types of governments, intergovernmental transfers, and municipal autonomy. This review by Thayer, Hathaway, and Martinez-Vazquez shows that federal countries differ in the degree of territorial completeness and subnational fragmentation. The authors offer three prominent trends influencing municipalities and their finances for future research, which are the aggregation and incorporation pressures in many contexts, intra- and inter-local competition, and the growing need for climate change mitigation and adaptation. Thayer et al. conclude that only by holistically understanding these rising challenges and the historical dynamics in each country can municipalities effectively manage their finances. In Chapter 21, Raudla and colleagues offer lessons from the smaller European Union countries’ experiences during the times of crises and subsequent austerity. Specifically, they evaluate whether fiscal crises have affected municipal financial autonomy, looking at a time frame between the financial crisis of 2008 and the COVID-19 pandemic. Overall, the countries represented by the four cases still differ significantly in the levels of local fiscal autonomy and their approach to mitigating the effects of the crises. While Denmark, Estonia, and Portugal appear to have relied on stricter fiscal rules, Ireland has offered new tax sources to its local governments. What is clear, however, is that the national governments selected to strengthen spending and debt balance rules after the financial crisis of 2008, which was further reinforced by the fiscal control and monitoring rules applied from the supranational level, the European Union. The COVID-19 shock, however, as the authors write, resulted in a loosening of the fiscal rules that brought fiscal discipline at the local level in the aftermath of the 2008 financial crisis. Though, arguably, the loosening was necessary, both national and local governments accumulated debt under COVID-19’s impact. An open empirical question is whether, as the countries begin to settle in a post-COVID-19 world, a return to fiscal rules will bring back the fiscal discipline that national and supranational levels desire and require. This will likely be

Conclusion: themes and directions for future research  ­475

further tempered by concerns of a post-COVID-19 recession in Europe and the economic fallout of the war in Ukraine. Chapters 22 and 23 consider the concept of local financial resilience in a global context. Chapter 22 by Barbera and colleagues draws on a European perspective of government financial resilience. They write that though there is an important accumulation of contextual knowledge on the ways in which governments around the world dealt with the 2008 financial crisis, whether local governments are prepared to deal with future crises remains uncertain. They ask future scholars whether financial capacities relate to financial vs non-financial outcomes, as well as the approaches that policymakers select to deal with external shocks. They further offer a self-assessment tool for resilience capacities and perceived vulnerabilities in local governments, as well as the application of the tool in the four largest European Union countries. Empirically, however, the authors caution that future scholars must continue to evaluate the connections among financial, organizational, and individual resilience. The critical contexts to keep in mind when doing so, as the authors direct, are the slow-burning crises related to poverty, inequalities, climate change, and certainly, the COVID-19 pandemic. Chapter 23, also focusing on financial resilience, by Martell and Moldogaziev, assesses the concept of city financial resilience from a resource flow perspective. Using a sample of 46 cities around the world, they measure city financial resilience as the city’s ability to meet its service demands, continue debt service payments, and operate capital stock throughout the duration of an external shock. They argue that their measurement approach can help city-level policymakers to adopt a baseline benchmarking approach to guide policy choices and appropriate urban management practices. The authors find a number of anomalies that require future in-depth analysis and also recommend that future research test their measure of urban financial resilience against crisis types and crisis severity. They conclude that future research may expand the concept of urban financial resilience to the full cycle of resilience, beyond the resource flow perspective, and consider a variety of institutional, geographic, and economic contexts. Chapter 24 offers a lesson from Asia, specifically the experience of Singapore in choosing different fiscal and management policies in times of crises from almost all other countries in the region. As Kwan and Li write, Singapore uses policy instruments that target both the spending and revenue sides of fiscal policy. The authors attribute the success of the city state in weathering the initial wave of the COVID-19 pandemic to its rigidity, with longer-term fiscal and financial limits but medium-term flexibility for the utilization of budget surpluses and deficits. Another feature of Singapore, according to the authors, is the use of broad-based taxes and nonconventional sources of revenues for more than half its budgets, even in times of crisis. Future policymakers and scholars, however, must carefully evaluate the benefits of adopting Singapore’s approach in other contexts, particularly those with decentralized and, certainly, weaker revenue bases. Nevertheless, the usefulness of the city state’s approach to facing shocks would be beneficial to other global cities, and research comparing Singapore to other key urban centers around the globe is undoubtedly welcomed.

Index Abbas, Y. 314 Abbott, M. E. 220 acceptable use policies 163 accountability transparency and 33 accounting accrual basis of 139 accounting procedures 17 accrual basis 18 acquisition price 37 acute fiscal crisis 205 acute fiscal shocks 204 adaptive capacities 412, 423 Adelson, M. 308, 309 administration of taxes 47 policy importance of 38 administrative autonomy 19 administrative independence 174 administrative traditions 418 Adolph, C. 465 Advisory Commission on Intergovernmental Relations (ACIR) 207, 220, 338 Affordable Care Act 107, 108, 188 Medicaid expansion 108 affordable housing subject 34 Afonso, W. 42 Afonso, W. B. 152 agglomeration movements 381 aging population 455 Agrawal, D. R. 53 agricultural land preferential valuation of 30 Airbnb rentals 49 air transportation revenue from 68 Akerlof, G. 305 Alfonso, Y. 106 allocative efficiency 64 Altman, E. I. 221 amalgamation reform 398 American municipal securities market 4 American Recovery and Reinvestment Act (ARRA) 119, 147 American Rescue Plan Act (ARPA) 83, 88, 99, 101, 118 federal aid from 98 American Road & Transportation Builders Association (ARTBA) 147

American Society of Civil Engineers (ASCE) infrastructure assessment, 144 amortization change 363 amortization period 361 Analysis of Revenue and Expenditure 457 Ang, A. 282, 284 annual budgets adoption of 400 Annual Comprehensive Financial Reports (ACFRs) 17, 19, 20, 139, 190 and Census data 21 auditing of 19 Census data and 20 financial information in 190 primary government columns 18 production of 18 annual county debt issuance 321 annual economic agreements 395 Annual Survey of State and Local Government Finances 19, 258 Anthony, R. N. 459, 462 anticipatory sub-dimensions of 409 anticipatory capacities 411, 413, 424, 425 assessment of 423 in European municipalities 421 in French municipalities 423 types of 421 Anzia, S. F. 355 appraisal definitions 32 arbitrage yield (AY) 308 Argentina subnational powers 379 Asher, M. G. 453, 454, 457 assessment limitations of 36, 37 asset liquidity 18 assets allocating 215 in the short run 206 structures 208 assets ratio 192 asset taxes 33, 38 Association for Budgeting and Financial Management (ABFM) 292 Atkinson, A. 26 Aubry, J.-P. 357, 359 476

Index  ­477

audited financial statements 22 auditing 412 austerity 393 aftermath of 409 measures 391, 392, 402 austerity policies 242 Austria states and local governments 380 Austrian municipalities 409 autonomy 42, 370, 377, 395, 458 common restriction on 46 constitutional and legal guarantees of 392 loss of 398 protections and constitutional guarantees of 392 taxation 400 average capital balance 447 Baicker, K. 76 Bailey, S. J. 151 balance budgets 247 arrangements around requirements to 400 balanced budget 458, 464, 465 balanced budget requirements (BBRs) 236, 277, 335, 338 and debt limitations 340, 341 on municipal debt financing 347 on municipal governments 335 significant effects of 347 state imposed 347 balance sheets virtues of 215 bank overdrafts 400 bankruptcies 189 bankruptcy 230 bankruptcy authorization 3, 239, 250 Barbera, C. 409, 410, 411, 415, 417, 437, 449 Bartle, J. 152 Bates 110, 113 Bauroth, N. G. 181 Bekemeier, B. 117 Belgium municipalities 380 benefit generosity 359 benefit-neutral reforms 362 benefit pension plans 354 benefit risk 359, 360 Benson, E. D. 339, 340, 346 Benston, G. J. 305 Bergstresser, D. 309, 311, 312, 313 Berne, R. 207 Berry, C. 181, 183

Biden, J. 99 “big box” 32 Billings, S. B. 181 bivariate distribution 444 black, indigenous, and people of color (BIPOC) 100 black market 52 Blakely, E. J. 216 Blavin 108 Blöndal, J. R. 454, 455, 456, 457 Boex, J. 377 Bollens, J. C. 175, 177 Bollinger, B. 51 Bonbright, J. 32 bond buying 303 bond deals 303 bondholder protection 272 bond insurance 279, 280, 303, 306 demise of 285 loss of 287 value of 272 bond insurance market 332 bond insurers 301, 302, 308 bond investors 272 bond market investors 252 bond referendum requirements 338 bonds 271 issued by tax type 283 yield differences 277 Booth, J. R. 305 borrowing 153 cost 282 costs 276, 277, 280, 281 impact on 278 borrowing cost 473 borrowing costs 306, 311, 335, 336, 339, 340, 341, 343, 346, 347, 348 Bosnia federal system 380 national government of 381 bouncing-forward strategies 417 Brainard, K. 356 Brazil municipalities 380 Brexit referendum 419 “brick-and-mortar” sales tax revenues, 97 broad-based taxes 6, 463 identification and use of 465 Brookings Institution 154 Brown, A. 356 Brown, E. 155 Brown, K. W. 223, 224, 436 Brueckner 112 Brunner, M. 169 Bruno, C. 275

478  Research handbook on city and municipal finance

budget 10 directives 456 flexibility 283 requirements 16, 96 revenue categories in 463 seasons for fiscal year 96 sources of revenues and funds 20 budgetary allocations 454, 456 budgetary decisions 251 budgetary insolvency 237 budgetary planning 464 budgetary stability 435 budget/budgeting common-pool problems of 393 consolidation 399 cooperation system 395 guarantee 395, 396 national framework law for 397 budget cuts 107 budget gaps 81 budgeting 3, 435 budgeting process 69 Budget Law 396 budget solvency 229 buffering 434 buffering capacities 412 Build America Bond (BAB) 321, 323 Build America Bond (BAB) program 281, 282, 320 “Build Back Better” campaign 99 buildings tax on 34 Bumgarner, M. 152 Bunch, B. S. 181 Bureau of Economic Analysis 246 Burns, N. 177, 184 Burns’s theory 177 business improvement districts (BIDs) 74 business travel 56 Butcher, G. H. 308, 309 buy and hold market 271 by-law tax sharing 379 Cahill, A. G. 242 California local government salaries in 355 market value assessment 30 Callanan, M. 391 Canada local government levels 376 Cannabis Equity Reinvestment Fund 52 capital assets 139, 439 government investment in 150 capital balance ratio (CBR) 439, 441, 442, 445, 447

capital budgeting formal and professional approach to 151 interfere with rational response 150 political influence on 151 process 150, 151 capital expenditure (CE) 400, 439, 456 significant reductions in 401 capital expenditures 152, 264 capital facilities replacement and reinvestment in 192 capital gains 25 capital improvements 3 Capital in the Twenty-First Century (Piketty) 25 capital investments 442, 448 capital maintenance 442 capital management 440 capital markets 235 in public pensions 365 capital outlays 144, 145, 146, 264, 325 cumulation of 139 trends of 145 capital planning 281 capital project investment 439 capital projects financing of 147 capital-related debt 192 capital revenue (CR) 439 capital spending 145, 147 institutional constraints restrict 151 in US 144 level of 151 municipal 152 of subnational governments 152 per capita 264 capital value 29 Carr, Douglas A. 159 Carr, J. B. 181 Carroll, D. A. 181 cash balances 457 cash/budget solvencies 449 cash insolvency 237 cash-strapped cities 81 Census Bureau fines and forfeits 75 revenue categories 66 Census revenues 21 Center for Retirement Research 356 central grant transfers 401 Central Provident Fund (CPF) Board 457 Certificate of Entitlement (COE) scheme 463 changeability 68 chargeability 71

Index  ­479

charges 260 for services 261 Cheek, C. M. 251 Chen, C. 152 Chen, G. 352 Chernick, H. 81 chief financial officers (CFOs) 81 Chief Information Officer (CIO) 164 Chief Information Security Officer (CISO) 164 circuit breakers 35 cities ability to perform and sustain services 433 administrators 438 capital stock 448 demand on 435 descriptive statistics and 441 estimation of capital balance ratio (CBR) for 440 financial condition 436 financial resilience of 447 functional home rule 182 immediate ability of 440 infrastructure condition in 138 officials 437 property tax revenue limits on 181 resilience 444 urban financial resilience (UFR) of 446 city 474 COVID-19 128 financial resilience 475 funding 121 funding, availability of 124 grant program 127 tax levy fund 123 tax revenue 122 city and municipal finances federalist system 1 global and comparative perspective on 5 strength and resilience of 1 city finance 1 city fiscal health 3 city general fund portfolios 90 cityhood movement 382 city revenue 469 civic well-being 28 civil asset forfeiture 75 civil organizations 457 civil rights law 33 Clark, B. Y. 205, 440 Clark, T. N. 206 climate change 408 climate mitigation 382 cloud-based software 166

coercive payments 8 collect revenue 10 Collins, B. K. 314 Colorado voters 92 commercial banks 205, 221 commercial rates waiver on 401 common tax fund 393 community college districts (CCDs) 3, 188, 190, 193, 194, 472 Composite Financial Index for 191, 193, 195 community colleges 188 Community Development Block Grant (CDBG) program 89, 149 community health 263, 264 expenditures 263 community hospitals 109 comparative analysis 436 Composite Financial Index (CFI) 189, 193 component of 192 measurement results 193 vs alternative specifications 195 compulsory levies 67 conflicts of interests 302, 303, 304 congestion pricing 70, 71 Congressional Budget Office 150, 154 Connolly, S. 151 conservation land 34 Consolidated Fund 456 Consolidated Loans Account 456 constitutional debt limits 153 consumer economy market transactions in 67 consumer expenditures 57 consumer receives 67 contiguous township 376 Continental European Napoleonic administrative tradition 418 contingent obligations 272 contribution costs and unfunded liabilities 361 contribution plans 353, 361, 365 contribution risk 357 Cope, G. H. 341, 346 coping capacities 412, 424, 425 in European municipalities 423 operationalization and examples 415 subdimensions of 409 typologies of 412 coping capacity 437 Cornaggia, K. R. 309 Coronavirus Aid, Relief, and Economic Security (CARES) Act 83, 99, 101, 118

480  Research handbook on city and municipal finance

Coronavirus Preparedness and Response Supplemental Appropriations Act 118 Coronavirus Relief Fund (CRF) 99, 100, 118 Coronavirus State and Local Fiscal Recovery Funds (CSLFRF) 99, 100, 101, 118 corporate finance industry 303 corporate finance literature 306 Cossman, J. 113 Costello, A. M. 465 cost of issuance 312 cost-of-living adjustments (COLAs) 356 reductions 362 cost sharing 353 plans 353 systems 353 Coughlin 112 county fiscal structure 258 revenues and expenditures 472 county debts 319 basic characteristics of 320 in municipal securities market 319 issuance 323 and capital outlays 325, 326 by general uses of proceeds 327 by insurance 332 by maturity 331 by specific use of proceeds 328 by state 323, 325 by tax status 322, 324 by type of sale 330 by type of security 329 by uses of proceeds 326 from 2002 to 2020 320 market 319, 321, 332 structure and issuance of 319 structure of 324 county governments 105, 145, 258 average operating position of 265 description of 257 expenditure composition 264 expenditures 263 finances 265 financial position 264 fiscal structure of 258 in sample by year 259 operating position by year 265 per capita capital outlays by year 264 revenue by year 261, 262 revenue on average 261 revenues, dominant source of 261 structure and nature of 257 tax revenue 262

county health spending 126 county intergovernmental revenue 261 county revenues and expenditures 4, 257 COVID-19 88, 152, 160, 188, 193, 197, 235, 261, 274, 280, 335, 340, 382, 396, 398, 401, 422, 453, 461, 470, 471, 474 affecting municipalities’ finances and service level capacity 420 budgetary impact of 147 citywide priorities following 126 crisis on finances and services 419 deaths 120 federal aid programs 100 federal declaration of 322 fiscal effects of 96 fiscal responses to 462, 464 fiscal shock of 2020 258 global financial crises to 419 health spending during 121 City and County Government of San Francisco 124 city government of New York 121 NYC DOHMH detailed budget 122 NYC Health + Hospitals Corporation expenditure 124 hospital spending 119 impact on public pension management 364 mitigation strategy 95 mortality 101 outbreak of 97, 159 recession 82, 98, 110 Response and Economic Loss contingency reserve 127 restrictions 397 revenue losses due to 357 socioeconomic effects of 456 spread of 105 trends in municipal and local health expenditure 105 COVID-19 pandemic 1, 2, 24 city governments in response to 3 federal support 2 on CCDs and HCDs 3 uncertainty attendant on 34 COVID crisis 94, 96 on property, sales, and income tax revenues 98 pernicious aspects of 95 revenue from 95 credit backing 242 credit enhancement 302, 308 business model for 308 credit markets 339 credit monitoring 160

Index  ­481

credit quality 273, 274, 291 measures of 449 fees 316 credit rating agencies (CRAs) 161, 301, 303, 304, 305, 313, 314 rating assignment 313 reputational capital of 304 credit ratings 5, 92, 277, 290, 316, 335, 336, 339, 340, 341, 342, 343, 344, 346, 347, 352, 363 assignment of 303 of municipal governments 358 credit resolution 160 credit risk 272, 290 collection of 274 indicator of 273 of issuers 292 Crifo, P. 276 crimes financial penalties for 75 criminal asset forfeiture 75 criminal investigation functions 77 criminal justice fees 10, 470 criminal justice reforms 52 criminal justice system 8, 75, 77 crisis 401 adverse impacts of 408 and municipal financial autonomy 392 antecedents of 411 definition of 410 financial 411 management 410 occurrence of 408 responses to 417 through anticipation and planning practices 412 “crisis-as-process perspective” 410 critical health care services 3 cross-state differences 17 Crow, D. A. 437 CRSP Mutual Funds Portfolio database 309 cultural amenity expenditures 49 cyber-attacks 169 cyber awareness 164 cyber insurance 168 cybersecurity 169, 276, 471 anatomy of incidents 159 attacks 159 breach 159, 160, 166, 167 competence 166 comprehensive approach to 164 consequences of 168 demand 170 fiscal impact of 161 fiscal implications of 159

fiscal risk of 169 guidance 169 human resource capacity 164 issues of 159, 170 losses 276 monitor 169 needs 163 policies 163, 164, 165 practices 166 risk assessment 166 risk mitigation strategies 163 risks 163, 169 social domain of 163 threats 159, 160, 162, 166 training 164 cybersecurity incident 159, 163, 167, 168, 169 Cybersecurity & Infrastructure Security Agency (CISA) 164 Cyber Third-Party Risk Management (C-TPRM) 166 Cyert, R. M. 207 Daniels, K. 311 data advantages of using 258 data backups 168 data management 166 data restoration 168 data theft 160 debt 473 instruments 272, 286, 287, 290 issuance and management 291 transaction 287 debt affordability 280 establishment and use of 281 debt and pensions 4 debt burden quantitative indicators of 449 debt burdens 338 debt ceiling 337, 397, 399 debt financing 153 control municipal excessive use of 347 debt insurers 305 debt issuance 323, 436 nuances of 272 debt issuers search 285 debt limitations 335 impact of 341 debt limits 175, 178, 181, 184 negative relationship between 182 debt management practices 303 debt markets 339 debt obligation 153 debt ratios 251 debt restrictions 337

482  Research handbook on city and municipal finance

debt rules 394 debt security bond insurance 279 description of 272 developments in 292 ESG risks 274 fiscal architecture 273 state leadership 276 threats to 272 debt service 440, 445, 446 positive correlation between 447 debt service burden (DSB) 441, 445, 446, 450 debt service burden ratio (DSB) 439, 441, 442, 446 estimation of 439 debt service payments 5 debt service ratios 230 debt services exemption for 336 debt service viability 439 alternative constructs of 439 debt servicing lack of reporting of 459 debt structure 291 alternative structures 285 borrowing instrument 280 debt affordability 280 refunding bonds 282 tax treatment 281 debt transactions 280 decentralized unitary systems 378 decision-making increased centralization of 392 Decker, J. W. 222 deferral programs 38 deficit financing 236, 247, 458 deficit spending 249 degree of freedom 398 delinquent fines 78 Deller, S. C. 335 demographic changes 275 demographic groups 222 Denmark 395 Deryugina 119 Detroit bankruptcy of 235 devolution 78, 79 and TELs 80 revolution 89 Diamond, D. 305 Dickovick, J. 377 digital access for employees 162 digital assets physical security of 163

digital forensics 161 digital orthophotos 27 digital security of systems 163 digital transformation 160 Dillon’s Rule 226, 229 direct disaster aid 119 disaster recovery procedures 167, 168 discretionary authority 44 discretionary powers 462 discretionary transfers 454, 459, 460 Disease Prevention and Control Branch (DPC) 126 Disproportionate Share Hospital fund 124 distressed municipalities 246 district financing 189 district functions 189 diverse countries 371 diversity 57 divided legal interests 31 disputes over 32 Dodd-Frank Act (DFA) 287, 302, 303, 304, 310, 311, 315, 473 Dodd-Frank Financial Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) 301 DOHMH 121, 123 budget 121 Dom, B. K. 408 Donaldson, G. 204, 206 donor/diplomacy organization 371 Doss, C. B. 151 double taxation 54 Dropbox 165 Du Boys, C. 408 due process protections 75 DuPuis, N. 151 Dzigbede, K. 284 early warning program 253 early warning systems 242 economic crisis 470 economic cycles 96, 446 economic downturn 96 economic efficiency 43 economic growth 455 economic inequality 24 economic nexus laws 56 economic rationale 291 economic recession 81, 82, 152, 153 economic refinancing 283 economic resource management 436 economic sanctions 75 economic shift 245 economic stability 434 economic theory 46

Index  ­483

educational institutions 188 efficiency in public sector 69 Eide, S. D. 355 elastic general tax revenue 96 elastic revenue sources 54, 95 Ely, T. L. 315 emission reduction credits 27 EMMA 289 empirical analysis 249 empirical evidence 178, 360 employee contribution rates 363 employee cybersecurity training 164 employees contributions from 360 impact of pension changes on 360 motivations and decisions of 365 employee training 165 employers contributions from 360 encryption 165 entity’s balance sheet 206 environmental risks 275 environment, society, and governance (ESG) 450 equalization transfers 236 equalized assessed value (EAV) 33 equitable sharing payments 78 equity 10, 43, 48, 70, 378 Erwin 117 ESG credit drivers 276 essential services 262 estimated liquidity 19 ethnic fractionalization 275 Europe 381, 419 European Central Bank (ECB) 399 European municipalities 419 anticipatory capacities in 421 coping capacities in 423 financial vulnerabilities of 420 state of the financial resilience capacities 419 European Union (EU) 399 fiscal rules 391, 393, 394 general principles 370 regional funds 398 transfer tax collections 25 Eurozone 393 event history analysis (EHA) 223 results of estimating 227, 228 event history analysis (EHA) methodology 3 excise tax 48, 52 common and emerging 48 executive agencies 19 exemptions 44

exogenous events kneejerk responses to 462 expendable net assets 191 expenditure 20, 248 conventional occurrence of 20 data 16 expenditure limits 456 expenditure rules 394 expenditures 262 autonomy 379 future of 469 percentage of 93 share of 379 transportation and infrastructure 263 extensive knowledge 408 external audit 21 external public debt 465 Farmer, J. L. 181, 182 farmland programs 36 federal aid 78 transfers in 90 federal aids for financing COVID-related activities 129 Federal Audit Clearinghouse 252 federal bankruptcy government access to 239 Federal Bankruptcy Code, 1934 238 federal countries 371, 372 local governments 378 local government systems of 375 municipal finance in 377 Federal Emergency Management Agency (FEMA) aid 124 Federal Equitable Sharing Program 78 federal fiscal expansion 78 federal fiscal intervention 98 federal funding 120, 252 contribution of 124 federal funds infusion of 101 federal grants 118, 122, 124, 153, 236, 470 in financing 147 programs 128, 149, 252 federal intergovernmental transfers 89 federalism conceptual frameworks and implementations of 371 “holding-together” 371 “putting-together” 371 status quo in 470 successes and failures of 377 federalism models 5 Federally Administered Tribal Areas (FATA) 376

484  Research handbook on city and municipal finance

Federal Medical Assistance Percentage formula 119 federal miscellaneous revenues 72 federal municipalities 377 Federal Reserve Economic Data (FRED) 259 federal stimulus funds 356 federal support to cities 2 federal system 88 of government 370 federal systems structural decentralization in 377 federal tax 281 federal transfers to municipal governments 90 federating units 371, 372 fees 66, 67 advantages of 69 common categories of 68 definition of 67 limitations of 71 regressiveness of 71 Ferguson, L. C. 206 finance operations 257 financial actions state regulations on 18 financial advisors 305 financial analysis 3 financial assets 458 non-financial assets into 460 financial assistance schemes 401 financial autonomy 392, 396, 402, 447 financial capacity 204 financial condition 3, 436 changes in 208 Financial Condition Index (FCI) 205, 225, 436 aggregated measure of 229 and individual dimensions 229 financial crisis 221, 309, 314, 321, 322, 332, 356, 357, 419, 473 and Great Recession 320, 323, 329 bonds’ value during 309 impact of 308 financial default 445 financial distress 187 Composite Financial Index 190 special-purpose districts and 188 financial education 361 financial guarantee firms 287 financial health of Australian universities 189 financial instruments 237 financial intermediaries 303, 315 benefits of 302 existence of 305

recent research on municipal market 306 theoretical background on 305 financial intermediary 305 financial intermediation 301, 473 process of 301 theories of 305 financial liabilities 458 financial management 235, 239, 242, 253, 412, 448 administrative improvements in 251 and performance 435 dimensions of 252 outcomes 251 policy process 434 financial management decisions 364 financial management practices 435 financial managers 425 financial mobility 204 financial performance 417, 436 methods and critiques for measuring 433 financial ratios 221 financial recovery impediments to 448 financial reporting inefficiency in 252 financial resilience 409, 419, 433, 434, 437, 443, 444, 446 analytical models of 5 anticipatory capacities 411 concept of 426, 438 consequences of resilience capacities and shocks 415 coping capacities 412 crises and shocks 410 description of 408 dimensions 409, 411, 424 financial vulnerabilities of European municipalities 420 framework 409, 410, 416 global financial crises to COVID-19 419 implications for practice and policy 424 information about 440 in France, Germany, Italy, and UK 417 levels of 444 measures 437, 439 patterns of 411 perspectives 434 respect to 443 robust indication of 449 vulnerabilities 411 financial risk 188, 190, 192 composite metric of 191 variables 187 financial security 359 financial shocks 221

Index  ­485

financial stigma 238 financial vulnerability 417, 421, 437, 438 focused attention on 438 sources of 437 financing, cost of 306 financing expenditure alternative means of 209 financing technique 154 fines 2, 64, 75 aggressive use of 77 as revenue source 77 for revenue purposes 76 growth of 76 firms discretionary transfers to 460 fiscal actions 398 fiscal architecture 273, 274 fiscal autonomy 19, 64, 235, 379, 380, 401 central government regulation of 395 of subnational governments 236 fiscal behavior 220 fiscal burden 162, 359 fiscal consolidation 399 fiscal crisis 205, 207, 208, 235, 237, 391, 392, 396 degrees of 392 fiscal decentralization 27, 235, 236, 395 literature on 236 fiscal decision-making 235, 237 fiscal defaults 189 fiscal deficits 6, 453, 454 fiscal discipline 394 fiscal disparities 49, 57 jurisdictions and 54 fiscal distress 189, 207, 208, 216, 238, 239, 277, 433, 435, 436, 437 consequences of 436 description of 235 designation of 242 episodes of 437 fiscal decentralization and 236 groups 242 intervention 240 local government 3 model 189 operationalization of 189 scale indicator for predicting 440 state responses to 238 fiscal emergency 339 fiscal emergency preparedness 205 fiscal equalization 10 fiscal federalism 88 American system of 319 in United States 78 fiscal flexibility 340 political and economic costs of 216

fiscal food chain 64 fiscal framework local budgets and 398 fiscal gap 236 fiscal governance 235, 245 fiscal health 207, 222, 223, 230, 276, 433, 435, 437, 439, 440 description of 220 economic conditions of government 222 impact on 230 literature of 221 measurement of 220, 227, 228 measures of 439 model, data, and methods 223 notion of 220, 221 of government 208, 221 of local governments 221 of municipality 223 of pension plan 364 results 227 score of 224 spectrum of 231 understanding of 221, 222 fiscal illusion 44 fiscal imbalance horizontal 236 fiscal imbalances 377 fiscal impacts 100 fiscal impulse 459 fiscal independence 173 fiscal institutions 237, 336 and special districts 178 brief overview of literature on 278 fiscal intergovernmental arrangements 257 fiscalization 399 fiscal landscape radical change of 470 fiscal liquidity 205 Fiscally Standardized Cities (FiSC) database 223, 224 fiscal management 5, 464 fiscal management practice 92 fiscal monitoring of local borrowing 277 fiscal monitoring systems 205 fiscal organization structure, budgeting, and financial condition 471 fiscal organization structure 3 fiscal outcomes 249, 251 fiscal policies 339 fiscal policy 475 further influences on 182 of municipalities 396 fiscal policy space (FPS) 90, 102

486  Research handbook on city and municipal finance

fiscal provisions in direct response 454 fiscal regulation framework of 399 fiscal relations 89 fiscal relationship 2 fiscal reliance revenue structures and 90 fiscal relief 123 fiscal resilience 457 fiscal resources 453, 454 mobilization of 454 fiscal restrictions 79 fiscal revenues nonconventional avenues for 465 nonconventional sources for 463 fiscal risk 160, 163, 167 description of 159 fiscal risks 5, 363 for governments 357 pensions 358 fiscal rules 341, 391, 392, 393, 395, 398 and limits 277 and local debt financing analysis results 344 and debt levels 341 credit ratings and borrowing cost 339 empirical modeling 342 budgetary decision-making via 393 description of 335 effects on credit ratings 336 empirical evidence on 341 impact of 4 literature on 336 on local governments state-imposed balanced budget requirements 338 state-imposed debt limitations 337 tax and expenditure limitations (TELs) 336 on municipalities 394 fiscal shock 319, 322 fiscal solvency 18 fiscal stance towards 2020 265 fiscal strain 147 fiscal stress 76, 207, 220, 229, 243, 253, 258, 436 among local governments 221 patterned response to 207 prediction of 228 to local governments 352 fiscal structure county 258 of US county governments 258 fiscal surpluses 453, 454

fiscal sustainability 457 fiscal transfers 88 fiscal uncertainty 100 fiscal year revenues 19 Fischer, M. 19 Fixing America’s Surface Transportation Act (FAST Act) 149 Flint water crisis 138, 235 food tax base of 48 food tax 55 Forbes, R. W. 305 foreign investors demand by 282 forfeits 2, 75 aggressive use of 77 as revenue source 77 for revenue purposes 76 growth of 76 forfeiture 64 gains 75 seized 78 Forrester, J. P. 150 Fortitude Budget 461 foster equity 70 Foster, K. A. 177, 178, 181, 182 Frant, H. 182 fraudulent website 160 “free rider” problem, 70 fund accounting 18 distinctions 18 “distributions” and “receipts” 20 fundamental economic change 245 fund balance 338, 437 fund expenditures 363 fund improvements 25 fund ratios credit ratings on 315 FY2019 government debt for 457 FY2020 state and local governments finance for 118 FY2021 executive budget 122 total operating budget in 123 vaccine administration in 124 Garrett, D. G. 288, 313 GDP growth and debt service 445 public debt in 398 gender gap in financial literacy 365 general capital outlays 147

Index  ­487

general fund 436 general fund revenue and expenditures 91 sources of 97 general grants 396 general health spending growth rate in 107 general obligation bonds (GOs) 153, 309 general obligation (GO) 329 general-purpose bonds 326 general revenues 79, 80 municipal charges and fees in 69 municipal miscellaneous sources in 72 General Revenue Sharing (GRS) program 89 general revenue sources percentage share of 65 general taxes 71 geographic information systems (GIS) 27 George, H. 29 German municipalities 420, 424 Germany local governments’ status 379 Gianakis, G. 206 GIC Private Limited 458 global financial crisis (GFC) 391, 395, 397, 400, 402, 403, 408, 409, 419, 423 Goldsmith-Pinkham, P. S. 275 Goodman, C. B. 173, 178, 181, 182, 222 Goods and Services Tax (GST) 456 Google Drive 165 Gordon, T. 119, 463 Gorina, E. 222, 360, 362, 436, 439 governance explicit components of 434 federal model of 5 specialized organizational forms of 187 governance networks 434 government ability and willingness to repay debt 303 academic literature and 67 analysis of 19 avoidance of transparency 18 credit ratings 358 debt issuers 305 entity 17, 302 finances 19 financial capacity of 365 financial stress 359 layers of 66, 68 manager-council forms of 356 mid- and small-sized 19 principals of 18 public services 18 revenue by types of 64 services, beneficiaries of 9

sponsor 18 subcategories across 18 Government Accountability Office (GAO) 68, 95 Governmental Accounting Standards Board (GASB) 17, 139, 238, 355, 358, 435, 436 implementation of 247 standards 249 governmental activities infrastructure condition ratio 140, 141, 142, 143 governmental finances 409 governmental financial resilience 409, 412 government budget insolvency 245 government capacity measure of 439 government capital spending 144 Government Contingencies Fund 460 government expenditures 460 Government Finance Officers Association (GFOA) 68, 92, 276 Government Finance Statistics Manual (GFSM) 460 government fiscal decision-making 151 government revenue 398 Government Securities Fund for debt repayment 457 GO vs revenue bonds 273 grant anticipation bonds 153 grant funding share of 380 Great Depression 238 Great Recession 2, 14, 66, 82, 96, 98, 110, 235, 237, 238, 263, 265, 315, 331, 361, 434, 445, 448, 453, 469, 472, 473 budget cutbacks during 106 environment 307 financial crisis and 319, 320, 321, 323, 329 impact of 260 pension costs and liabilities due to 356 pension reforms after 364 state aid in 81 total revenue losses from 259 Greer, R. A. 313 gross domestic product (GDP) geography of 12 growth rates 444 Grubb, W. N. 341, 346 Gruber, J. 108 gullible taxpayers 33 Guzman, T. 306 Haccius, L. 370 Hamersma 117 Hathaway, A. 370 Headlee Amendment of 1978 336

488  Research handbook on city and municipal finance

health assessment 123 healthcare districts (HCDs) 3, 190, 193, 194, 472 Composite Financial Index for 193, 195 healthcare financing 326 healthcare organizations 188 healthcare providers 108 healthcare sector organizations 190 healthcare services 105 narrow market for 108 health departments 2 operational expenditure of 105 health immunization clinics 121 health policy 113 health spending 106 healthy cities 223, 230 determinants of 220 fiscal behavior of 230 Hendrick, R. 73, 74, 439, 449 Hendrick, R. M. 206, 207, 208 Henisz, W. J. 275 HHS Provider Relief Fund 124 Hicks, J. R. 205, 206, 208, 209, 215, 216 hidden taxes 25 higher education financial resiliency of institutions of 191 public and private institutions of 189 high-income economies 455 Highway Trust Fund (HTF) 149 Hildreth, B. 310 Hildreth, W. B. 271 hiring process 163 Hoang. T. 360, 362 Hodrick-Prescott (HP) filter 322 home rule 178, 181, 182 homevoter category of 35 horizontal equity principle 70 hospital charges 113 expenditure 106, 111 ownership 108 spending 105, 106, 113 hostage situation 160 Hotelling–Downs model of political competition 130 hotel occupancy taxes (HOTs) 50 Houlberg, K. 391 household services 46 size of 43 households discretionary transfers to 460 house prices 26

Housing and Development Board (HDB) 459 Housing in the Twenty-First Century (DeVore) 26 housing markets cycles 459 Hou, Y. 119 Howlett, M. 465 Hoyt, W. H. 53 Huang, Q. 120 human services spending 263, 264 Hungary “tax suspension” 37 hybrid pension plans 356 identical property long-time owners of 36 identifiable beneficiaries 68 identity restoration services 160 Illinois balanced budget rules in 338 immediate payment demands for 209 immovable property 24, 27 value of 25 incentive packages 382 incident response plan 167 income tax 9, 10, 20, 26, 64, 90, 97, 98, 262 basis for 9 revenues 20, 98, 463 subnational government 53 independent registered municipal advisor (IRMA) 304 independent revenue 2, 38 India central government 380 urban municipalities 376 Indiana local income taxes in 53 individual beneficiaries 67 individual malfeasance 17 individual municipality 395, 396 individual pension accounts 361 industrial hubs intervention law and decline of 245 inflation 10, 37 inflation adjustment 259 inflation rate 337 information asymmetry 305 information disclosures 19 information gathering agencies (IGAs) 305 information systems 166 informed trades 290 infrastructure 3 aging and deteriorating 138 assets 143, 150 business-type condition 143

Index  ­489

city governments’ spending on 147 condition 139, 144 development 326 governmental condition 143 investment 151 COVID-19 pandemic and potential solutions to 152 investment deficiencies 3 private sector investment in 153 projects 149, 151, 155 services 147, 149 systems 150 Inland Revenue Authority of Singapore (IRAS) 456 insolvencies types of 237 institution financial strength of 191 institutional innovations 314 insurance payments 10 insurance policies 161, 168 insured debt share of 332 intangible assets value of 28 intangible property 27 integrated delivery system 126 intensive care units 123 intercensal surveys 19 interest-bearing deposits 72 interest earnings 72 interest rate environment 285 interest rates 20 interest reset instruments 285 inter-fund transfers 437 intergenerational equity 271, 360 intergovernmental aids 119, 129, 152 fiscal implications of 119 intergovernmental expenditure 17 intergovernmental fiscal relationship 236 intergovernmental fiscal system 257 intergovernmental grants 113, 129 for health and hospitals 114 intergovernmental relations 108, 113, 119, 379 intergovernmental revenue 64, 259, 261 reliance on 436 intergovernmental revenues 2, 260 intergovernmental revenue system beyond fiscal impacts 100 COVID context 94 description of 88 federal fiscal intervention 98 fiscal effects of COVID-19 96 historical context 88

intergovernmental transfers 79, 379, 474 interjurisdictional competition 42, 44, 51 inter-jurisdictional differences 49 interlocal transfers 10 internal administrative limitations 449 internal computer systems 163 internal control systems 412 International Growth Centre 34 International Monetary Fund (IMF) 399 Internet of Things (IoT) 170 intervention importance of 3 intervention policies 245 intervention programs 245, 247 investment managers 354 investment returns 352, 354, 361, 363 Ireland economic and financial implications in 400 local authorities in 400 issuance cost (IC) 308 Italian municipalities 423, 424 Ivonchyk, M. Y. 307, 311 Jacobson, M. 76 Jerch, R. 119 Jochimsen, B. 391, 394 Joffe, M. D. 187 Johnson, C. L. 1, 257, 277, 306, 319, 332, 340, 469 Jose, J. 271 jurisdictional eligibility 44, 57 jurisdictions and fiscal disparities 42, 54 in Montana 44 taxing 47 justification 56 K-14 education in California 188 Kalotay, A. 285 Kass, A. 88 Kaufman, B. G. 108 Kelly, J. M. 347 Keynes, J. M. 205, 208, 209 Kim, Y. 105 Kioko, S. N. 341, 342, 346 Knight, F. 204 Korac, S. 408 Kornai, J. 209 Kovandzic, T. V. 77 Kravchuk, R. S. 204 Kriz, K. A. 277, 340 Kwan, C. Y. 453 labor market activities 395, 396

490  Research handbook on city and municipal finance

Ladd, H. F. 206 land capital gains from 29 public ownership of 29 taxation in Bulgaria 30 tax on 34 use regulation and taxation 34 value taxation 28 land and property tax (LPT) 32 landlord’s interest 31 Land Transport Authority (LTA) 456 law enforcement 75, 76, 77, 78 profit-seeking practice in 78 revenue incentives 77 Layfield, F. 29 “leapfrog” development, 30 Lee, H. 340 Lee, Y. C. L. 463 Lehman Brothers 453, 458 Leigland, J. 174 Leland, H. E. 305 Leland, S. M. 178, 181, 182 less traditional revenue sources 470 Levine, C. H. 207, 208 levy limits 37 Lewis, C. W. 338, 347 license tax 262 Li, H. 453 Lindrooth, R. C. 108 Linh, N. T. P. 189 liquefiable assets 205 liquid assets 206, 208, 215 liquidity 209 degrees of 209 dimension 208 litigation 32 Liu, P. 339 local autonomy 242, 380 local budgets 245, 338 local-centric approach to intervention 243 local control dimensions of 377 local debt financing 337 analysis results 344 and debt levels 341 credit ratings and borrowing cost 339 empirical modeling 342 local financial management 252 local financial resilience 475 local fiscal distress “hands-off ” approach to 239 local fiscal outcomes 249 local general revenues 337 local governance 235 state intervention in 242

Local Government Denmark (LGD) supplementary agreement with 397 Local Government Financial Management Act (LGMA) 397 local government fiscal distress 3 local governments 88, 89, 90, 92, 94, 95, 96, 97, 139, 152, 173, 176, 189, 220, 238, 245, 250, 251, 253, 258, 271, 276, 279, 375, 376, 381, 382, 409, 417, 470 actual intervention in 242 administrative “traditions” of 392 advantages and disadvantages of 365 autonomy 379 borrowing costs of 281 budget 352, 364 budgetary outcomes 242 budgets and financial decisions of 238 category 89 composition of grants to 379 creditworthiness and borrowing costs of 340 debt 398 deficit 249 economic development opportunities 339 economic powers of 470 emergency manager to design and implement recovery plans. 235 employment in 355 factors in creating 177 finance 105, 106, 108, 112, 113, 118, 119, 277, 377 financial reporting 254 financial resilience dimensions of 409, 419 financial weaknesses of 237 fiscal distress 239, 240 fiscal responses 119 fiscal rules 391, 393 flexibility 96 form of 175 functional responsibilities of 400 functioning of 339 functions 174 general purpose 175, 177, 178, 182 impact of COVID-19 pandemic on 357 importance of municipal pensions for 352 importance of property tax to 469 infrastructure in United States 325 legal and economic implications for 470 levels of 375 nationwide survey of 162 nature of 377 non-entitlement units of 118 obligations of 153 operation 251 requirements on 340

Index  ­491

responses 355 response to state intervention 242 revenue and spending 92 revenues 259 revenue source for 98 “right-sizing” 381 robustness of 395 self-identified issues by 238 share of revenues 379 state-imposed balanced budget requirements 338 state-imposed debt limitations 337 tax autonomy 44 tax and expenditure limitations (TELs) 336 traditions of 394 local health departments 105, 106, 110, 118, 130 local income tax 53 administration of 54 local infrastructure systematic assessment of 139 local insolvency 245 local option excise taxes 48 local option income taxes 53 local option sales taxes 44 local option taxes (LOTs) 2, 470 available by state 45 constraints of 57 description of 42 diversity of 42 dramatic declines in 56 effectiveness of 58 evaluation of 42 additional criteria 44 standard criteria 42 in Massachusetts and Connecticut 57 jurisdictional eligibility and discretionary authority of 42 local governments to levy 57 pandemic, impact of 54 reliance on 42 selection of 44 tax criteria 43 types of 42 local pension plans 353 funded ratio for 357 local property tax (LPT) 401 local public finance scholars of 342 local public health 110 local sales tax distribution of 55 rate 58 LoGICA Framework 377

long-term debt description of 335 long-term external liabilities 453 long-term insolvency 237 long-term investments 24 Los Angeles Annual Survey of State and Local Government Finances for 21 low-income consumer 71 low-value properties 36 assessment of 35 Luby, M. J. 282, 288, 301, 307, 310, 311, 312, 313 Maciag, M. 76 MacManus, S. A. 178 Maher, C. S. 205, 222, 226, 228, 229, 230, 231, 335, 356, 435, 436, 440 Maine Public Employees Retirement System 362 maintenance of capital assets 438 Malaysia highly centralized federation 380 malware 167 management choices 207 mandatory budget reductions 129 March, J. G. 207 marijuana tax 52, 53 evaluation of 52 market description of 286 investors 290 liquidity and volatility 291 market-based valuation systems 469 “market-based” policy tool, 76 market complexity 290 market demand 36 market distortions 25, 44 market dynamics understanding of 272 market economy 237 market liquidity indicator of 272 market share 333 volume and 332 market value 29, 33 estimating 31 Marks, B. R. 339, 358 Marlowe, J. 340, 344 Martell, C. R. 315, 358, 433 Martinez-Vazquez, J. 370 Maser, S. M. 222 Massey, S. J. 347 Mays, G. P. 117 McBride, J. 155

492  Research handbook on city and municipal finance

McCabe, B. 178, 181 McCubbins, M. D. 73, 74 McCue, C. P. 206 McDonald, B. D. 205, 220, 222, 228, 229, 230, 231, 436, 440 McFarland, C. 88 McFarland, C. K. 151 McKinnon, R. I. 209 McManus, S. T. 412 meals tax 48 advantages of 48 median voter model 130 Medicaid 107, 108, 117, 130, 236 generosity of 110 mental health services 128 policy interventions 117 programs 124 spending 112, 120 state governments’ adoptions of 108 supplemental payments 120 Medicaid program 188 Medicare 68, 130 programs 124 reimbursement 108 Meerow, S. 434 Merdeka Generation Package 455 Mergent Municipal Bond Securities database 309 metropolitan cities 115 metropolitan statistical areas (MSAs) 246, 247 migration 408 Mikesell, J. 68, 71 Millon, M. H. 305 Minnesota bridge in 2007 138 Mirrlees, J. 26 miscellaneous revenues 66, 72, 81, 260, 261, 262 subcategories of 72 mitigation strategies 168 mobile labor 235 mobile revenue sources 24 moderate granting 379 Mohanlingam, S. 189 Moldogaziev, T. T. 1, 187, 288, 306, 307, 308, 309, 312, 340, 433, 469 Monetary Authority of Singapore (MAS) 458 monitoring capacity concerning 426 Moss, J. 155 Mughan, S. 77 multi-factor authentication (MFA) 165 multi-function municipality 183 multi-level governance 371 Multi-State Information Sharing and Analysis Center (MS-ISAC) 169

municipal advisors 287, 301, 302, 304, 310, 312 and underwriters 312 benefit of using 315 definition of 310 employees 312 firms 312 industry, descriptive and empirical analysis of 311 landscape 310 market 311 prestige 313 quality 310 registrants 310 responsibilities for 288 role 312 use of 316 municipal advisory firms 304 municipal autonomy 5, 375, 474 municipal balance sheets 205 municipal bankruptcy 230 authorization 242 system 237 municipal bond insurance demand for 279 municipal bond investors 17 municipal bond issuance 284 municipal bond market 273, 276, 291, 292, 325 municipal bond ratings 359 municipal bonds 153 investors in 313 offering documents 290 municipal borrowers implication for 288 municipal budget officials 118 municipal budgets 5 constraint 209 municipal business 164 municipal credit ratings 347 municipal cybersecurity 162 risk assessment 163 municipal data storage 166 municipal debt management 338 municipal decision-makers 338 municipal distress 187 municipal economic system 68 municipal entities solicitation of 311 municipal expenditures 395 municipal finance 159, 474 and developing trends aggregation and incorporation pressures 381 climate mitigation 382 intra- and inter-strata competition 382 federal countries and components 371

Index  ­493

federal motivations 370 foundation 377 general discussion of 377 in federal countries 377 initial phase of 15 literature on 205 municipality systems in federal countries 375 research 18 municipal finances 1 in unitary systems 5 repercussions for 391 municipal financial autonomy 394 crises and 392 Denmark 395 description of 391 developments in 391 Estonia 397 Ireland 400 Portugal 398 municipal financial condition 472 relevancy of 206 municipal financial health 187 municipal financial intermediaries 302, 303 roles and responsibilities of 302 municipal financial resilience 417 municipal fiscal distress 472 municipal fiscal health 207, 472 municipal fiscal indicators 204 municipal general fund 72 municipal general revenue revenue components in 66 municipal golf courses 71 municipal government 139, 145, 150, 151, 152 in capital and infrastructure investment 145 municipal government finance 474 municipal governments 73, 117, 178, 208, 209 charges 113 demand and fiscal pressure on 118 intergovernmental transfers to 119 public health spending for 110 rating decisions for 359 municipal healthcare delivery system 123 municipal health departments 110 municipal income tax 56 municipal infrastructure investment 150 municipalities 105, 110, 115, 129, 161, 167, 169 anticipatory capacities 422, 423 chief financial officers and service managers of 419 choice of training methods 164 competences and responsibilities of 399 coping capacities 425 cybersecurity 164, 166

Cyber Third-Party Risk Management (C-TPRM) 166 digital systems 163 discretionary authority for 46 effective practices for 169 external vulnerabilities 422 financial vulnerabilities 421 funds for 4 health spending 108 heterogeneity among 10 in Germany 420 in Massachusetts 110 in principle 396 performance of 417 resource constraints 162 revenue source shares for 11 risk assessment 162 size of 418 survey shocks/crises affecting 420 types and sizes of 169 municipality governments roles of 128 municipality spending on health and hospitals 107 on public welfare and public health 107 municipality systems 372 municipal leaders 43 municipal liquidity 3 municipal market 288 efficiency and functioning of 301 financial intermediaries 315 liquidity 311 Municipal Market Analytics 280 municipal nontax revenue overview of 78 sources of 66, 78, 82 municipal nontax-to-tax ratio 81 municipal officials 204, 216 municipal own-source nontax revenues common categories of municipal user charges and fees 68 relation to benefits received 68 sources of 66 user charges and fees 66 municipal pension management 365 municipal pension plans 356, 363 affect employees’ decisions 360 and governments’ credit ratings 358 benefit risk for employees 359 contributions and local budgets 354 equity issues in 360 Great Recession impact on 356 impact of COVID-19 pandemic on 356 in United States 353 reforms and impacts 361

494  Research handbook on city and municipal finance

short-term and long-term fiscal risks 357 sustainable reform options for 365 municipal pensions 5, 365 financial issues in 363 impact of COVID-19 pandemic on 356 impact on local governments 353 impact on local governments’ budgets 363 literature on 364 studies on 363 municipal policies and procedures 207 municipal public health budgets changes in public health expenditures 117 fiscal impacts 119 grants and other sources of revenue 118 municipal public health spending on health outcomes 115 municipal revenue 66, 469 collections from tax and nontax sources 80 sources 65 structure 81 municipal revenues Annual Comprehensive Financial Reports (ACFRs) 17, 139 annual survey of state and local government finances 19 contrasts of sources 20 description of 8 shares by source 11 sources of 8 state-specific data sources 16 trends in revenue sources 10 municipal securities 291 municipal securities gain 281 municipal securities market 4, 272, 287, 304, 306, 319, 325, 473 financial intermediation in 4 municipal securities offerings 302 Municipal Securities Rulemaking Board (MSRB) 286 municipal services 67, 68 in relation to benefits received 68 redistribution effect 71 special assessments for 74 municipal taxation critical for 43 municipal work 165 Munnell, A. H. 360 Murphy, A. 138 Musgrave, R. 101 Nakhmurina, A. 251 National Association of Counties (NACo) categorization 259 National Association of Independent Public Finance Advisors (NAIPFA) 310

National Association of State Retirement Administrators (NASRA) report, 355 National Bureau of Economic Research 82 national capitals 372 national development projects 456 national health expenditures 120 National League of Cities (NLC) 81, 83, 90 general fund revenue data 90 National Oversight and Audit Commission 401 national tax receipts 397 natural disasters 119 Navarro, L. 257, 319 Nechyba, T. J. 53 negative relationship 181 negotiated sales 307 Nelson, M. A. 178, 181, 182 neo-Weberian system 424 Nepal local governments 380 Net Investment Returns Contribution 458, 460 Net Investment Returns (NIR) framework 458 New Deal programs 88 New Mexico tobacco taxes 50 New York Bureau of Municipal Research 221 New York City Department of Health and Mental Hygiene (DOHMH) 121 DOHMH detailed budget 122 Health + Hospitals Corporation expenditure 124 public health and hospitals 121 public health facilities in 119 spending on health, hospital and social service 125 New York City Employees’ Retirement System (NYCERS) 353 New York City Health + Hospitals (NYCH+H) 123 spending 124 New York State and Local Retirement System (NYSLRS) 361 Nguyen-Hoang, P. 119 no-bailout policy 393 Nollenberger, K. 237, 435 non-agricultural zoning 28 nonconventional revenue 6, 462, 463, 465 non-financial performance 417 non-Medicaid costs 123 nonpayers use of service to 67 nonproperty tax 337 non-rational process 150 nontax revenues 2, 463

Index  ­495

nontax revenue sources 81, 326 advantages of user charges and fees 69 description of 64 devolution and growth of 78 fines and forfeits 75 growth and significance of 78 in economic recessions 81 limitations of user charges and fees 71 miscellaneous revenues 72 revenue components in municipal general revenue 66 special assessments 73 tax limits and growth of 79 variation of municipal dependence on 80 nontraditional investors 281 Nordlinger, S. 36 Norris, D. F. 162 North Carolina local sales taxes 55 notoriously inelastic housing supply 34 Nunn, S. 150, 151 occupancy tax 49, 55 revenue generated by 50 OLS regression models 315 Omeyr, F. 88 online payment system 162 operating budget cycles 441 operating budget distress 441 operating expenditures (OEs) 439, 442 operating revenues (ORs) 439 operational expenditures 152 operational funding 383 operationalized resilience 438 ordinary least squares (OLS) regression 250 Organisation for Economic Co-operation and Development (OECD) 26 organization cybersecurity 160 organizational contexts governance and institutional factors in 187 organizational performance 435 organizational planning capacity 412 organizational resilience 412 component of 412 organizational solvency 189 organizational vulnerability 412 organization structure 471 other post-employment benefits (OPEBs) 190 CFI vs CFI with 194 inclusion of 193 outstanding debt 335

owner-occupied housing favorable treatment of 35 own-revenue authority 379 own-source funds 380 own-source revenue 2, 20, 88, 90, 92, 380 diversification 92 Padovani, E. 437, 447 Pagano, M. A. 88, 90, 151, 152 Painter, M. 275 Pakistan local governments 376 Palumbo, G. 340, 344 Park, H. 181, 184 Park, H. J. 181, 184 parking revenues 10 Park, S. 335, 341, 343 party affiliation 226 passwords 165 Patrick, P. A. 189, 436, 439 pay-for-play schemes 303 payments for services 10 Peng, L. 8 Pennsylvania local cigarette tax 50 pension annual contributions per employee 355 benefits and eligibility rules 364 management 364 reforms 364 pension costs crowd-out effect 355 pension funding 316 impact on municipal credit ratings 358 pension funds 352, 355 pension liabilities 193, 194 pension management 352, 364 complexity of 352 pension obligation bonds (POBs) 274, 362, 363 high risk with 363 pension plans benefits from 359 contributions to 355 financial health 358 funded ratio 358 mismanagement of 364 resources for 356 unfunded liabilities in 358 pension policies independence of 353 pension reforms 362 pension risks 362 pensions 473 costs and benefits of 361 costs and liabilities for the governments 364

496  Research handbook on city and municipal finance

pension system financial status 357 per capita debt 436 per capita local expenditure 247 per capita municipal government revenue 248 per capita property tax revenue trends in 12, 13 per capita revenues 10, 54 per capita spending 115, 116 Perez, V. 109 performance management financial data and 435 Perry, D. 90 personal accounts 165 personal data storage accounts 165 personal devices 165 security policies on 165 personal property 27 taxes 27 personnel budget 355 Pew report 356 phishing 160, 163, 164 physical infrastructure 138 actual condition of 138 condition in America’s major cities 138 declining federal infrastructure funding 147 deteriorating 144 municipal infrastructure investment 150 spending on 138, 144 physical infrastructure investment 471 physical risks 275 Pierson K. 258, 259, 325 Pigouvian soda tax 51 Pigouvian tax 58 Piketty, T. 25, 26 Pioneer Generation Package 455 plastic bag fees 70 policing budgetary allocation to 76 revenue-motivated 77 policy actions 434 policy autonomy 235 policy change 450 policy design 71 policy learning demonstration of 437 policymakers 77 political budget cycles 463 political economy environment 458 political ecosystem 315 political independence basis of 19 political party agenda of 463

political stigma 238 political viability 70 politico-administrative system 417 poll tax 30 population measures for 229 population growth 337 populations 115 density 108, 113 Portes, J. 465 Portugal 398 remote position occupied by 399 positive environmental outcomes 285 postal service fees 68 post-disaster financial policy change 437 potential endogeneity 249 potential investors search and identification of 302 potential risks 154 potential security measures 162 potential shocks 412 potential vendors capability of 166 Poterba, J. M. 277 powers division of 463 Prachyl, C. L. 19 practical autonomy 380 predatory governments 77 predatory policing 77 pre-retirement income 359 preventive healthcare 108 price mechanism 70 primary and secondary markets 292, 293 primary balance ratio (PBR) 439, 440, 441, 444, 446, 448 estimation of 439 primary reserve ratio 191 principal–agent relationships 302 principle tax growth 14 private activity bonds (PABs) 153 private insurers 120 private sector employees 359 proactive oversight systems 279 Program to Eliminate the Gap (PEG) 121 progressive global tax 25 progressive tax rates 71 property levy 25 property owners 75 property registration 469 property registration systems 38 property subject market value of 34 valuation of 31

Index  ­497

property tax 8, 10, 13, 37, 57, 64, 73, 74, 79, 80, 90, 97, 98, 262, 336, 341 administrative issues 32 fractional assessment 32 reassessment policy and practice 33 and land policy 34 and land-related taxes 24 and wealth taxes 25 area base for 30 argument for 25 bases 47 burden 35 cause of 33 collection rates 9 collections 25, 90, 98 decline in 14 deferment to rental assistance 96 definition of 25 dependent cities 92 description of 24 disguised 25 experience of 38 feature of 36 for local government 401 growth in 37 importance of 18 in United States 26, 29 levies 16, 79, 98 limitation measures 36 pandemic’s impact on 95 political debate over 24 primary residence allowances 35 rate limits 181 rates 8, 24 rates for counties 336 recession recovery of 54 relative importance of 90 reliance 13, 92 revenue limits 181 revenues 24, 37 sensitive object of 26 size and growth of 337 special treatment of specific uses 34 systems 25 to finance municipal services 70 valuation 35 varieties of local taxation and tax administration 27 well-functioning 25 property taxation administrative history of 2 property taxes 2 property tax revenues 437 property transfers taxes on 25

property valuation 24 property value 25 property value assessment 79 proportional tax 43 Proposition 13 (“Prop. 13”) tax revolt in California 92 public advertisements 37 public auction building rights at 25 public behaviors influencing 70 public debt 454 in GDP 398 levels of 453 management practices 308 public discourse 90 public education service delivery 188 public emergency municipality response to 129 public employees benefits for 245 pension plans 362 public employee turnover 360 public finance 222 public finance literature centers 112 public finance portfolios 310 public finances management of 458 public financial management implications 315 public financial management in Singapore budget 455 broad-based taxes and nonconventional sources of revenue 463 COVID-19 460 design of fiscal rules 462 fiscal rules and political economy 457 limiting debt increase 462 reporting nuances 459 description of 453 prospects and further research 464 public goods 67, 260 and services 69, 70 efficient provision of 110 provision of 110 public health and environment 138 categories, state government spending on 106 crises 105 departments 115 domain of 113 emergencies 105, 119 preserving and protecting 124

498  Research handbook on city and municipal finance

responsibility 123 state and local government spending on 106 public health crisis 274 public health emergency 319 public health services 2, 4, 129 demand for 108, 113 large-scale budget cuts in 112 provision, local health departments and regionalizing 110 total general expenditure on 115 public health spending 106, 112, 117 disparities in 113 public hospitals 109 revenue and spending for 114 revenue from 68 service 109 public housing provision of 459 public improvements 73 projects 73 special assessments and benefits of 74 public infrastructure 150 projects 4, 151 public institutions private values into 177 public interest funds in 456 public investment 25 objective of 115 public pension benefits 359 public pension liabilities 289 public pension plans 355, 360, 362 solvency issues in 357 Public Plans Data (PPD) 352, 358 public–private partnerships (PPPs) 154, 286 concession agreement 154 public programs 74 costs of 69 public protection 71 public referendum 42 public revenue source of 28 public safety law enforcement and 76 providers 77 public sector accounts 459 activities 459 demand information to 69 public sector financial management 408 public sector in healthcare 470 public sector organizations resilience 410 public service 236, 246 funding 71

public service delivery inequality in 74 public services 18, 43, 67, 73, 152, 168, 177, 221 public spending 130 focus of 455 purchasing bond insurance 316 Pyle, D. H. 305 Quah, J. S. T. 459 quantile regressions 250 Quinby, L. D. 360 Raffer, C. 391, 394 Raineri, L. 307 Raman, K. K. 358 ransomware attacks 159, 160, 161, 167, 168 ransom demands in 161 rating agencies 339, 358 methodology 358 ratio analysis reliance on 436 rational budgeting components of 150 rational reaction model 150 Raudla, R. 391 Reagan, R. 89 realizability 209 real property 27 value of 27 real property taxation 26 reasonable weighting plan 191 rebus sic stantibus 29 British valuation at 30 recessions government budgets during 355 investment losses in 354 redistributive policies 26 refugee crisis 419 refunding bonds 282 new capital vs 284 regional development strategies 187 regionalization 112 regional retail centers 47 regional similarities 80 regional special districts 105 regulated entities obligation of 290 Reinhart, C. M. 453 related-party transactions 288 relief packages 98 religious fractionalization 275 remote work 56 rental vacancy rates 34 rental value 29 Reschovsky, A. 81

Index  ­499

researchers trade-offs and challenges for 20 research questions state-specific data on 17 residential homesteads 36 residential property 33, 34 residual powers 376 resilience 408 aspect of 412 cycle, stages of 434 cyclical nature of 434 scholars 434 resilience capacities 409 consequences of 416 importance of 417 resilience cycle 437 anticipatory and buffering stages of 438 stages 448, 449 resilience dimensions 425 operationalization of 419 Resilience Package 453 resilient behaviours 415 resilient organizations essential and distinctive feature of 412 resource flow quantitative measures of 449 resource flows 438 retail investors 291 retail sales tax on 90 retirement employees’ financial security in 354 retirement income 353 for local government employees 352 retirement savings 30 revenue 17, 20 city and municipal sources of 2 complexity 47 contemporary levels of 10 conventional occurrence of 20 data 16 diversification literature 57 for municipal governments 42 for popular programs 43 instruments 20 portfolios 47 production and stability 43 sources of 10, 17, 121, 400 structure in American cities 2 Revenue and Expenditure Estimates 457 revenue bonds 153, 273 total annual issuance of 329 revenue capacity 152 revenue collections 8 revenue decline 94

revenue fall nontax sources of 66 revenue indicators 266 revenue-motivated policing 77 revenue-raising authority 64 revenues 259 for county governments 260 from income taxes 463 future of 469 general sources of 260 individual share of 463 sources of 192, 259 specific sources of 262 revenue sharing schemes 377 revenue-sharing system 382 Rhodes 109 risk assessment 161, 162, 163, 166 risk management 364 risk mitigation 162, 167 cyber insurance 168 disaster recovery procedures 167 human resource capacity 164 incident response planning 167 municipal response 169 prevention 163 risk assessment 162 vendor management 166 risk-sharing options 362 risk-sharing policies 362 Rivenbark, W. C. 139 Rogoff, K. S. 453 Ross, J. M. 1, 8, 469 Rothenberg, J. 341, 346 Rueben, K. S. 277 Rundle, J. 340, 341, 347 rural black residents 113 rural health facilities 120 rural hospitals 108 profit margins among 108 rural mortality 131 rural public health infrastructure 115 Russia asymmetric federalism 381 Sacks, S. 174 safety patrol 77 sales tax 9, 10, 64, 88, 97, 262 bases 47 economic inefficiencies of 47 for municipalities 46 local governments to adopt 44 rates 9, 47 receipts 97 revenue 55 selective 9

500  Research handbook on city and municipal finance

Saliterer, I. 408 Sances, M. W. 77 San Francisco budget 126 Department of Health (DPH) 126 Department of Public Health operating expenditure 127, 128 Santerre 110, 113 “Save Our Homes” assessment limits, 36 São Paulo practice in 25 Scandinavian tradition 392 Schick, A. 205, 207 school districts 145, 337, 471 Schramm, R. 207 Scorsone, E. 238, 245 second-generation fiscal federalism 237 “second-generation” transactions, 32 second-order devolution 78 Securities and Exchange Commission (SEC) 286 security 162 breach 164 practices 166 seized assets 75 selected studied contexts 418 selective taxes 9 self-assessment questions 426 self-assessment toolkit 425 self-sufficiency 77 Seligman, E. R. A. 26, 30 Seljan, E. C. 73, 74 separability 71 service delivery 12 service delivery decisions 177 service-level insolvency 237 service managers 425 service provision decisions 178 services charges for 261, 262 service solvency dimension 229 severe acute respiratory syndrome (SARS) 453 Sexton, S. 51 shared-down taxes 380 share investment 362 sheriff ’s departments 77 Shi, Y. 181, 182 shocks definition of 410 potential 412 relative importance of 419 types of 417 Siahpush, M. 113 Significant Infrastructure Government Loan Act (SINGA) 457

Silver Support Scheme 455 Simon, H. A. 207 Singapore 475 budgetary reporting 459 fiscal rules in 457 GST in 463 land parcels in 460 public financial management 454 revenue and expenditure 461 revenues by category 464 Singapore Government Securities (SGS) 457 Singh, G. K. 113 single aggregate group 18 single-function governments 183 single tax 29 situation awareness 412 Small Rural Hospital Improvement Program (SHIP) 120 Smith, C. W. 305 Smith, R. L. 305 Smith, S. A. 117 Smoke, P. 341, 346 social distancing 130 social engineering attacks 160, 161, 163 scams 160 threats 162 social issues 275 social protection 399 social security benefits 359 Social Security numbers 161 soda tax 51 regressivity of 51 software management 166 solvency dimensions of 436 solvency issues 205 solvency risk 358 solvency test 225 Sommers, B. D. 108 sound finance principles of 216 special assessments 73 advocates of 75 popularity of 74 primary uses of 73 use of 74 special districts 3, 178 creation of 177, 179, 181 datasets to analyze 174 debt limits 181 definition of 173, 174 description of 175 features of 173, 175, 177, 178 financing structure of 472

Index  ­501

forms of local government 175 functional home rule and 182 functions 173 growth of 175 independent and dependent 174 influence of 182 in metropolitan regions 178 institutions influence on 177 measurement of 183 overlapping nature of 183 prevalence of 173 proliferation 3 property tax revenue limits on 181 share of 183 spending of 182 territorial flexibility of 174 unique features of 174 special health districts 105 types of 3 special-purpose districts (SPDs) and financial distress 188 description of 187 financial health 189, 196 financial information for 194 financial outcomes for 187 financial risk 190, 193 service environments and institutions of 191 types of 3, 187 special-purpose governments in California 190 special service areas (SSAs) 73 special tax bonds 153 specialty valuation 31 sports local subsidies for 50 Spreen, T. L. 251 stakeholders in municipal debt financing 310 “standardized” city, 206 Standard & Poor’s rating methodology 358 state-administered pension funds 315 state-administered pension systems 352 state-appointed emergency manager 245 state budget shortfalls 119 state data products 16 state debt 337 state-federal programs 130 state fiscal restrictions 3 state grants availability of 123 state intervention adoption of 247 criteria for 251 laws 250 legislation 249

programs 238, 239 state-of-the-art cybersecurity technology 276 state policymakers 335 state response framework of 239 statutory boards allocations to 456 contributions and allocations to 459 operating surpluses from 456 Steccolini, I. 408, 409, 410, 415, 416, 423 Stevens, Justice 36 Stiglitz, J. 26 stock market 357 Stone, S. B. 222, 440 structural budget deficits 126 structural divergence 447 study variables simple statistics for 227 Suarez, V. 190 subnational autonomy 380 subnational governance architecture 398 subnational governments 154, 209, 237, 271, 274, 293, 455 bonds issued by 271 federal transfers to 236 financing of 272 fiscal autonomy of 236 levels of 395 subordinate agencies 174 subsidiarity principal 370 substantial budget deficit 462 substantial federal programs 274 substantial fiscal independence 174 suburban secession 382 Su, M. 64, 76 surcharges 75 survey response quality of 19 sustainable contribution policy 365 Sustainable Development Goals 382 Switzerland agglomeration of total districts 381 municipalities 380 Tanzi, V. 204, 205 targeted borrowing 209 tax adequacy of 43 administration 27 adoption and administration of 43 bases 18 burdens 43 collection agencies 54 federal property 28 jurisdictions 9

502  Research handbook on city and municipal finance

limitations 37 obligations 38 officials 32 provisions 36 structure 58 taxable properties proportion of 27 taxable value 37 tax administration 456 tax and expenditure limitations (TELs) 42, 44, 58, 73, 76, 79, 90, 92, 96, 102, 151, 178, 182, 226, 277, 335, 340 and debt issuance 341 fiscal flexibility 340 implementation of 341 level of restrictiveness of 337 on local governments 337 on municipal borrowing costs 340 on municipal credit ratings 340 on municipal revenues 341 restrictive components of 340 state adoption of 341 state imposed 336, 337 taxation academic literature on 9 current use 34 review of 26 taxation autonomy 396, 400 tax base definition of 27 land, buildings, and improved real property 28 real property 27 tax-based policies 25 tax collection 96 expenses and declines in 242 tax credit bonds 153 advantage of 153 tax credits 71, 154 tax criteria 43, 53 application of 44 Tax Cuts and Jobs Act (TCJA) 153, 321, 323 taxes type and structure of 260 tax-exempt bonds 281 tax-exempt institutions 70 tax exemption benefits from 282 refunding 285 value of 281 tax incidence renewed assessment of 102 tax-induced migration 53 tax intangibles 26

tax law 31 tax liability 25, 33 taxpayer behaviors 43 personal importance 24 taxpayers 29 fiscal illusion 74 Taxpayer’s Bill of Rights (TABOR) 92, 335, 336 tax portfolio 42 differences in 44 tax rates 36 tax revenue rules 394 tax revenues 9, 12, 14, 32, 55, 56, 260, 275 collections 13 growth 13 sources of 9 “tax revolt” movement 79 tax revolts 90 tax savings 30, 37 tax status 319, 320, 322, 323, 324 tax subsidy 31 tax treatment 281 technical threats 162 Teles, F. 391 TEL index 229 TELs positive relationship between 181 tender option bond (TOB) programs 309 Terkel, J. E. 301 territorial flexibility 174, 175 Test and Trace Corps (T2) 123 Thakor, A. V. 305, 339 Thayer, C. 370 THC retail sales of products with 52 the Netherlands area-based taxes 30 The Pew Charitable Trusts 242, 280 timing 204 long run 205 short run 205 ultra-short run 205 tobacco products 50 tobacco tax 50 Tolstoy, L. 220 total annual issuance 320 total budgetary revenues 465 total county issuance 320, 322 component of 322 total county revenue 261, 262 total direct general expenditure 105 total municipal revenue 92 total revenues 262 growth 259 share of 260, 261

Index  ­503

tourism promotion 49 township governments 65 trade-offs 15 and challenges for researchers 20 traffic fines 76, 77 transformative capacities 412 transforming capacities 424 transportation and water infrastructure 144 debt market 328 financing 326 issuance 333 operating and maintaining 147 public spending on 147 spending on 147 Troika 400, 401 agreement with 399 true interest cost (TIC) 306 negative impact on 311 Trump, D. 94 Trussel, J. M. 189, 436, 439 truth-in-taxation 37 UK municipalities 420, 421, 422 ultra-short run 204 unauthorized fractional assessment 33 uncertainty of generated revenues 153 underwriters 301, 302, 304, 306, 312, 315 in negotiated sales 308 intrinsic aspects of 306 purchasing 287 reputation 306 securities to 286 underwriting activities 307 fee 287 unfunded liabilities 355, 363, 364 UN-Habitat 32 unitary systems of European countries 391 United Kingdom 26 United States county governments in 319 federalist system 44 fiscal federalism in 78 Joint Committee on Taxation 43 land taxes 29 local governments in 44, 363 local tax in 27 market value in 30 municipal pensions in 353 property tax in 29 “urban agriculture” 30

urban areas 56 composite measure of 433 urban financial resilience model 5 urban financial resilience (UFR) 433, 475 accounting measures 435 and component measures 443 assessment of 449 bivariate distribution of 447 components of 438, 439, 445 computation of 440 construct and component measures 441 definition of 434 description of 433 descriptive statistics and cities 441 discussion and limitations 446 financial performance 435 focus on anticipatory and coping capacity 433 individual components of 441 in longitudinal and GDP growth perspectives 444 measures of 440, 441, 446 operationalizing 438 sample of international cities 441 strategic goal attainment 435 strengths and weaknesses of 440 urban governments 433 urban infrastructure public goods nature of 442 Urban Institute report 362 urban management 445 urban management practices 475 urban municipalities 114 urban public policymakers 5 urban resilience 434 literature on 437 US life expectancy at birth 356 US Census Bureau Annual Surveys of State and Local Government Finances 79 US cities COVID-19 spread across 95 decision-making authority of 90 federal government 96 financial condition 225 financially unhealthy 220 fiscally healthy 220 fiscally unhealthy 220 fiscal policy 102 likelihood of 228 population 226 revenue and expenditure trends 90 revenue trends during recent recessions 94

504  Research handbook on city and municipal finance

user access 165 control 163 user charges 10, 66, 67 advantages of 69 common categories of 68 definition of 67 financing grants 70 from liquor stores and utility services 67 implementation of 71 limitations of 71 regressiveness of 71 user fees charges consist of 8 uses of proceeds 326, 327, 332, 333 utilities financing 328 utility fees 10 vacant properties punitive taxation of 34 valuation artificial intelligence and machine learning in 38 “big-box” 32 capital value, rental value, and area 29 challenges 27 cost-based approach to 31 current use and highest and best use 30 issues in 29 of agricultural land 30 of agricultural property 38 of drug store 32 of property subject 31 policy importance of 38 procedures 36 property see property valuation property subject to divided legal interests 31 specialty 31 valuation process 36 valuation strategies 469 value-based tax 37 value capture 25 value increments 25 Vancouver basic tax rate was 34 vacant homes tax 34 vehicles capital expenditures on 17 vendor contracts 164, 166 cybersecurity assessment 166 management 163, 166 performance 167 vertical competition 42, 44 vertical equity 43 vertical equity principle 71

Vickrey, W. 209 Virginia retail cannabis sales in 52 voluntary exchange 67 VPN (virtual private network) 165 vulnerability 411 and capacities 417 and financial performance 417 capacities and sources of 425 “endogenization” of 411 of municipalities 421 operationalization and examples 411 organizational 412 perception of 420 sources of 411 Wall, A. 221 Wandrei, K. 357 Wang, W. 151 Wang, X. 225, 229, 436, 449 Ward, M. 169 warning system strategies 4 water infrastructure 144, 147 operating and maintaining 149 spending on 147 watertight finances 209 Wayfair decision 97 Wayfair ruling 49 wealth tax 26 Weingast, B. R. 209 welfare services provisioning of 89 Wheeler, A. 187 Willard, R. 118 window tax 28 World Bank 441 Worrall, J. L. 77 Wren-Lewis, S. 465 Wu, Y. 138, 151 Yale Hospital Financial Score 190 Yang, L. 235, 250, 314 Yilmaz, S. 377 Yinger, J. M. 206 You, H. Y. 77 Youngman, J. 24, 469 Yushkov, A. 257, 319 Zaporowski, M. P. 340, 344 Zhang, P. 109, 341, 342, 346 Zhu, L. 109 Zinoviev, R. 190 Zipf’s Law 204 zoning regulations 28