Samuel B
Samuel B. Stone Doctoral Candidate in Public Affairs School of Public and Environmental Affairs Indiana University 1315 East 10th Street Bloomington, Indiana 47405-1701 [email protected] cell: (817) 454-0276
Association for Budgeting and Financial Management 22nd Annual Conference Omaha, NE October 7-9, 2010 Home Rule, Local Government Independence, and Fiscal Decentralization: Effects on State and Local Government Fiscal Condition ABSTRACT Fiscal decentralization, devolution, and local government autonomy are recurring issues in the study of public finance and management, especially as many state governments become burdened with local property tax relief. The study of fiscal federalism and the subject of which government should do what, when and how are well traveled areas of research in public administration and the fields of economics and political science. However, these fields typically address the questions of the efficient production of public goods and the proper size and scope of governments. What they tend not to address are more traditional public finance measures of fiscal health, condition, and outcomes. Using established measures of financial management and more novel measures of centralization, this study will address the following questions: What effect does the degree of fiscal centralization within a state vis-à-vis its local governments and degree of local government autonomy have on the fiscal condition of the state and its local governments? What effect does the degree of centralization or fragmentation amongst local governments have on their fiscal conditions?
1
Introduction The purpose of this paper is to outline a program of research to study the fiscal effects of decentralization on state and local governments. Fiscal decentralization, devolution, and local government autonomy are recurring issues in the study of public finance and management. The study of fiscal federalism and the subject of which government should do what, when and how are well traveled areas of research in public administration and the fields of economics and political science. However, these fields typically address the questions of the efficient production of public goods and the proper size and scope of governments. The local government management field has long advocated the norm of home rule and local government independence. What they tend not to address are more traditional public finance measures of fiscal health, condition, and outcomes. We know very little about whether a state that is highly centralized with limited municipal home rule is fiscally healthier than a state that is decentralized with more permissive home rule. Nor do we know how those same things affect the fiscal health of local governments. The research question, then, in its broadest sense is: What are the actual fiscal outcomes of decentralization? This research is important for at least two reasons. First, though home rule is considered one of the central issues affecting local governments, its actual outcomes are unknown. Fiscal independence and fiscal outcomes are key facets of this. Second, government efficiency and organization are some of the most studied topics within the field of public management, yet the fiscal impact of state/local government structure is unknown. Since the mid 1980s, spending at the state level has surpassed and grown faster than spending at the local level (Figure 1). So while it seems that states have become more fiscally
2
centralized, it is unknown whether this trend has produced positive results for their fiscal condition and for the fiscal condition of their local governments. Additionally, is seems that own source revenues have grown faster at the state level than at the local level (Figure 2).
Figure 1: Total Real Expenditures, State vs. Local (2006 Dollars) $2,000,000,000
$1,500,000,000 Real Local Total Expend iture
$1,000,000,000
Real State Total Expend iture
$500,000,000
$0 1986
1991
1996
2001
2006
Figure 2: General Own Source Revenues, State vs. Local (2006 Dollars) $1,500,000,000
$1,000,000,000
Real Gen Rev-‐ Own Sources Local
$500,000,000 Real Gen Rev-‐ Own Sources State
3
20 06
20 01
19 96
19 91
19 86
$0
Research Questions Using established measures of fiscal health and financial management (financial ratios, fiscal crises, bond rating, debt burden, etc.) and more novel measures of centralization (home rule by structure, function, and fiscal rules; relative shares of revenues and expenditures) this study will address the following questions: Question 1: What effect does the degree of centralization within a state vis-à-vis its local governments and degree of local government autonomy have on the fiscal condition of the state? Question 2: What effect does the degree of centralization within a state vis-à-vis its local governments and degree of local government autonomy have on the fiscal condition of local governments? Question 3: What effect does the degree of centralization within a state vis-à-vis its local governments and degree of local government autonomy have on the fiscal condition of municipal governments? Question 4: What effect does the character of local government autonomy (the different types of autonomy) have on eth fiscal condition of the state, local governments, and especially cities? Literature There is a wealth of literature on fiscal federalism and no need to address all of it here. What is missing from this literature, however, are empirical studies analyzing the effect of home rule, local autonomy, and local decentralization on the fiscal condition of state and local governments.
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According to Sohl et al (2009), there are few to no objective or accepted standards to measure a city’s financial condition or position. The authors contrast studies by Hendrick (2004; 2007) and Wang et al (2007). Hendrick does not use a composite financial condition index, whereas Wang et al construct an index based on their weighted ratios. Hendrick does not use an industry wide benchmark, but uses cohorts of similar cities. Sohl et al argue that by not comparing the cities to others outside of their cohorts, what is really being measured is financial position rather than financial condition. Using the ICMA’s Financial Trend Monitoring System (FTMS), Sohl et al create more carefully constructed cohorts, but note some underlying problems with measures of financial condition across cities (Table 1). The measures of financial condition do not account for differences in financial structure Honadle et al (2004) use the FTMS and a location quotient. In this system the case is the city and the denominator is the cohort. See appendix for a list of FTMS indicators. Brown (1993) creates a similar, but similar set of indicators intended for small cities (Table 2). Some of the data needed for Brown’s indicators cannot be found all in a single source and would require unit by unit data gathering. As this would be impractical, only the indicators that require data found in the census of governments and the Fiscal Survey of the States would be used in this study. Wang et al (2007) offer another set of indicators based on the GASB 34 statement (Table 4). Kloha et al (2005) produce their own ten point scale of fiscal distress based on combinations of measures from previous studies (Table 3). Honadle (2003) presents a conceptual framework for understanding researching the role that state governments play in monitoring and managing local government fiscal crises. The study surveys officials in all 50 states and categorizes states’ different approaches to averting or managing fiscal crises at the local level. The study does no
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attempt to make a connection between the approach to fiscal crises and home rule, but presents an alternative measure of state involvement in the fiscal affairs of local government. Hawkins et al (1982) find that the centralization of revenues to the state level reduces spending at the local level in the categories of education, highways, health, and police. Gold and Erickson (1989) found that as state governments assume responsibilities that were formerly local, aid to local government tends to slow. Also, the character of state aid to local governments is important. For instance a number of states pay property tax relief to local governments in exchange for state mandated exemptions or limits on rates. This is not the same as expanded resources. Reschovsky (2004) that state aid to local governments, especially education, declines most when states are hit with fiscal crises or recessions. Unlike what Gold and Erickson find, Reschovsky argues that these cuts in aid due to the economic cycle do fundamentally alter the total resources available to local governments. Home rule refers to the ability of city and county governments to exercise discretion with respect to government form, structure, functions, fiscal, and regulatory matters. States have the power to authorize whether local governments may exercise home rule and the breadth of their home rule powers. Home rule is an important measure of local government independence. There is a great deal of variation in home rule powers among states. Broad home rule authority allows a community to tailor its local government to meet local needs. It is recognition that not all local governments within a state are alike. Restrictive home rule policies make local governments more administratively and fiscally dependent on the state. This can place greater burdens on the state and affect the state’s own fiscal environment. At this time, however, little empirical research has been done on the fiscal effects or outcomes of home rule policies on either the state or local governments. Additionally, it is not
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clear which particular features (form, structure, functions, fiscal, regulatory, etc.) of home rule provide the most flexibility to address problems and provide services. Home rule policies have different implications for counties than for municipalities. Counties are subdivisions of state government and are obligated to provide basic public services; for example, law enforcement. County home rule represents a layer of local independence over an otherwise quasi state government entity. Municipalities, on the other hand, are generally established to provide a more extensive set or level of services. The geographic boundaries of municipalities may change over time, and the level and number of public services may vary based on state law and/or local ordinance. The particulars of home rule are so numerous and so important, that measuring and operationalizing them is not an easy task. The literature does, however, generally recognize some common facets of home rule. These include home rule with respect to government structure, function, fiscal, regulatory, and boundary powers (Krane et al 2001; Stone 2010). Carroll and Johnson (2010) find that home rule status contributes to revenue diversification of small town governments. Stephens (1974) creates an index of local government autonomy and centralization. This composite index is composed of indices for financial responsibility, service delivery, and personnel distribution. Financial responsibility is measured by the share of state spending (including federal intergovernmental revenue) relative to local spending. Service delivery is measured by the share of state spending across a set of expenditure categories. Personnel distribution is measured as a ratio of local to state full time employees per million dollars of expenditure for the respective level of government. Each index has arbitrary cut-points that demarcate decentralized, balanced, and centralized governments.
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The Advisory Commission on Intergovernmental Relations (ACIR) has produced a large number of studies and reports dealing with the relationship between state and local governments. Many of these are devoted to measuring local autonomy. In one of these reports (1993) the ACIR developed a group of indicators of local autonomy. These groups of indicators are form of government, altering boundaries and responsibilities, local elections, administrative operations and procedures, financial administration, personnel management. Camoes (2003) creates a single index out of these indicators that attempts to capture all aspects of local autonomy. Indices for the facets of home rule discussed above will be created. Dimensions of fiscal home rule are perhaps easier to measure and quantify. These would include fiscal institutions such as tax, expenditure, and debt limits as well as the relative share of fiscal activity (taxing, spending, and issuing debt) that occur at the state vs. the local level. Camoes (2003) finds a statistically significant relationship between local autonomy and local government spending. The Camoes study, though, is cross sectional and uses two measures of local autonomy: a single index of local autonomy constructed from dichotomous measures, and a dichotomous home rule variable. The cases are stratified sample of cities. Akai and Sakata (2002) examine the relationship between fiscal decentralization and economic growth. To do this, they create four indicators of fiscal decentralization. These include a revenue indicator that represents the ratio of local revenue to total state and local revenue, an expenditure indicator that represents the ratio of local spending to total state and local spending, an autonomy indicator that is a ratio of local own source revenue to total local revenue, and combined revenue and expenditure indicator that is the mean of the first two indicators. They find that fiscal decentralization results in economic growth. Data
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State and aggregated local fiscal data are currently available at a high level of detail for all fifty states from the 1970s to 2008 from the US Census Bureau’s Census of Governments (COG). Disaggregated local fiscal data are available to a lesser degree of detail from the same source. The data include revenue, expenditure, and cash and debt figures for separate sources and categories. The local government data are less complete than the state data. Local government data from 2001 and 2003 are unavailable. Municipal government data is censored by population so that only cities with a population greater than 25,000 are included. Table 6 provides a list of these data. The COG data are also not without error. The data are self reported and thus subject to some bias with respect to how each state classifies its revenue, expenditure, cash and debt data. It is my contention, however, that these are sources of random, rather than systematic error and that they do not fundamentally alter the larger fiscal picture. Carroll (2009) used the municipal portion of these data in a study on revenue diversification. Additional state level budget data is available from the National Association of State Budget Officers (NASBO) in their Fiscal Survey of the States and their State Expenditure Report. The Fiscal Survey of the States is available on a semi-annual basis from 1979 to the present while the State Expenditure Report is available on an annual basis from 1987 to 2009. Table 5 lists the data available in these publications. Moody’s, Standard & Poor’s, and Fitch rate state and local government issued debt. The ratings of general obligation debt provide an independent, third party evaluation of an issuer’s ability to repay that debt. Though the rating agencies’ formulas and methodology are proprietary, it is generally accepted that they take into account many of the measures listed in the various aforementioned financial ratios. On the other hand there is very little variation in bond
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ratings at the state level. This may be a variable that is more appropriately used on the local level. Economic and labor force data are available for the same periods from the BEA and BLS. The Census also has government employment and wages that match the state and local fiscal data. I have already collected data from this data from the Census, BEA, and BLS. Measures of decentralization and local government independence will have to be constructed. Qualitative measures of structural, functional and fiscal independence can be constructed from a combination of existing work and original research. Quantitative measures of fiscal decentralization can be constructed out of the fiscal data listed above. Geographic data may also be employed to construct measures of geographic centralization and fragmentation. Models and Methods Dependent variables would be measures of fiscal condition. There are two types of dependent variables. One type is the individual variable where each measure is a separate variable. The other type is an index that combines multiple measures. I will run separate models using individual measures as dependent variables and then construct indices that include the most salient measures. The individual measures are much more fine grained and will be easier to interpret, but will produce a surfeit of results. The indices can condense all of this information, but are potentially more difficult to interpret. Independent variables will consist of measures of decentralization and independence as well as control variables for economy, income, demographics, etc. Some of the measures of decentralization and independence will indices. The indices will be tested for consistency and robustness.
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The data would seem to lend themselves to time-series analysis. Though it may be premature to say, linear ordinary least squares regression should suffice for most of the models. Models using fixed effects for the 50 states are often used for this type of research. Hierarchical linear models (in which local governments are nested within states, for instance) may also be useful. Logit/probit models would be used where dependent variables are categorical, binary, or ordinal.
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REFERENCES Advisory Commission on Intergovernmental Relations. State Laws Governing Local Government Structure and Administration. 1993. Washington, DC: U.S. ACIR Nobuo Akai and Masayo Sakata. “Fiscal Decentralization Contributes to Economic Growth: Evidence from Stat-Level Cross-Section Data for the United States.” Journal of Urban Economics. 2002, 93-108. Kenneth W. Brown. “The Ten Point Test of Financial Condition: Toward an Easy-to-Use Assessment Tool for Smaller Cities.” Government Finance Review. 1993, 9(6). Pedro J. Camoes. “Evaluating the Policy Consequences of Local Government Autonomy: A Stratified Sampling-Cross Sectional Study.” NEAPP, Series IV, 2003, draft. Deborah A. Carroll. “Diversifying Municipal Government Revenue Structures: Fiscal Illusion or Instability?” Public Budgeting and Finance. Spring 2009, 27-48. Deborah A. Carroll and Terri Johnson. “Examining Small Town Revenues: To What Extent are They Diversified?” Public Administration Review. March-April 2010, 223-235. Steven D. Gold and Brenda M. Erickson. “State Aid to Local Governments in the 1980s.” State and Local Government Review. Winter 1989, 11-21. Brett W. Hawkins, Richard D. Bingham, and David M. Hedge. “A Note on the Local Effects of State Revenue Centralization.” State and Local Government Review. May 1982, 91-93. Rebecca Hendrick, “Assessing and Measuring the Fiscal Health of Local Governments: Focus on Chicago Suburban Municipalities,” Urban Affairs Review. 2004, 40(1): 78-114 Beth Walter Honadle. “The States’ Role in U.S. Local Government Fiscal Crises: A Theoretical Model and Results of a National Survey.” International Journal of Public Administration. 2003 26(13), 1431-1472. Beth Walter Honadle, James M. Costa, Beverly A. Cigler, Fiscal Health for Local Governments. 2004. Eslevier Academic Press, San Diego. Philip Kloha, Carol S. Weissert, and Robert Kleine. “Developing and Testing a Composite Model to Predict Local Fiscal Distress.” Public Administration Review. May-June 2005 65(3), 313-323. Robert S. Kravchuk and Samuel B. Stone. “How and When Do Structural Deficits Reveal Themselves? The Case of Indiana.” Journal of Public Budgeting, Accounting & Financial Management. 2010. (Forthcoming)
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Shannon Sohl, Michael T. Peddle, Kurt Thurmaier, Curtis Wood, and Gregory Kuhn. “Measuring the Financial Position of Municipalities: Numbers Do Not Speak for Themselves.” Public Budgeting and Finance. Fall 2009, 74-89. Andrew Reschovsky. The Impact of State Government Fiscal Crises on Local Governments and Schools. State and Local Government Review. 2004, 36(2), 86-102. Dale Krane, Platon N. Rigos, and Melvin Hill, Jr., M.B. (Eds.). Home rule in America: A Fifty state handbook. 2001. Washington, DC.: CQ Press. G. Ross Stephens. “State Centralization and the Erosion of Local Autonomy.” The Journal of Politics. 1974. 36(1). 44-76. Samuel B. Stone. “Home Rule in the Midwest.” Indiana University Public Policy Institute. 2010. Indianapolis, IN. Xiaohu Wang, Lynda Dennis, and Yuan Sen (Jeff) Tu, “Measuring Financial Condtion: A Study of U.S. States,” Public Budgeting and Finance. 2007, 27(2): 1-21.
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APPENDIX Table 1: ICMA Financial Trend Monitoring System (Honadle et al 2004) # 1 2 3 4 5 6 7 8
Indicator Revenues per Capita restricted revenues intergovernmental revenues elastic tax revenues one-time revenues property tax revenues uncollected property taxes user charge coverage
Formula Net Operating revenues/population restricted operating revenues/net operating revenues intergovernmental operating revenues/gross operating revenues elastic operating revenues/net operating revenues one time operating revenues/net operating revenues property tax revenues uncollected property taxes/net property tax levy revenues from fees and user charges/expenditures for related services
9 10 11 12 13
revenue shortfalls expenditures per capita employees per capita fixed costs fringe benefits/fringe benefit expenditures/salaries and wages operating deficits Enterpise losses fund balances liquidity Current liabilities long term debt debt service overapping debt unfunded pension liability pension assets accumulated employee leave
revenue shortfalls/net operating revenue net operating expenditures/population number of municipal employees/population fixed costs/net operating revenue
14 15 16 17 18 19 20 21 22 23 24
25 maintenance effort quantity of assets 26 capital outlay 27 depreciation expense 28 population 29 median age 30 personal income 31 poverty households or public assistance recipients 32 property value 33 residential development 34 vacancy rates 35 employment base 36 business activity
general fund operating deficits/net operating revenues enterprise profits or losses unreserved fund balances/net operating revenues cash and short term investments/current liabilities current liabilities/net operating revenue net direct bonded long term debt/assessed valuation net direct debt service/ne operating revenues long term overapping bonded debt/assessed valuation unfunded pension liability/assessed valuation pension plan assets/annual pension benefits paid total days of unused vacation and sick leave/number of municipal employees expenditures for repair and maintenance of general fixed assets/assessed valuation capital outlay from operating funds/net operating expenditures depreciation expense/cost of depreciabe fixed assets population median age of population personal income/population poverty households or public assitants recipients/ total households change in property value market value of new residential development/market value of total new development vacancy rates unemployment rate reatil sales, number of business units, business gross recepits, number of acres devoted to business, market or assessed value of business property
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Table 2: Ten-Point Test of Financial Condition (Brown 1993) # Factor 1 Revenues 2 Revenues
3 Revenues 4 Expenditures
5 Operating position 6 Operating position 7 Operating position
Ratio Total Revenues per capita
Formula Total revenues in general, special revenue, debt service, and capital projects funds/population Total general own source Total revenues less total intergovernmental revenue in general revenue/total general fund revenues fund/total revenue in general fund General fund sources from other funds/total general fund sources Operating expenditures/total expenditures
Total operating transfers into the general fund/total revenue in general fund plus transfers in Total expenditures in general, special revenue, debt service funds/total expenditures in general, special revenue, debt service, and capital projects funds Total revenues/total expenditures Total revenue in general, special revenue, debt service, and capital projects funds/total expenditures in general, special revenue, debt service, and capital projects funds Unreserved general fund Unreserved, designated and undesignated fund balance in balance/total general fund revenues general fund/total revenue in general fund
9 Debt structure
Total general fund cash and investments/total general und liabilities Total general fund liabilities/total general fund revenues Direct long term debt/population
10 Debt structure
Debt service/total revenues
8 Debt structure
Total cash and investments in general fund/total assets in general fund less reserved and unreserved fund balances Total assets in general fund less reserved and unreserved fund balances/total revenue in general fund GO Debt to be repaid from property tax revenue/population Total expenditures in debt service fun/total revenues in general, special revenue, debt service, and capital projects funds
Table 3: Indicators of Fiscal Distress (Kloha et al 2005) # Indicator 1 Population growth 2 Real taxable value growth Large real taxable value decrease 3 General fund expenditures as a 4 percentage of taxable value General fund operating deficit 5 Prior general fund operating deficit 6 Size of general fund balance 7 Fund deficits in current or previous 8 years General long term debt as a 9 percentage of taxable value
Description two year growth two year growth looks for large drop over a two year period current general fund expenses divide by current taxable value current general expenditures subtracted from current general fund revenues, divided by general fun revenues checks indicator 5 for two previous years general fund balance as a percentage of general fund revenues current or previous years deficit in major fund current general long term debt divided by current taxable value
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Table 4: Financial Ratios (Wang, Dennis, and Tu 2007) Indicator The cash ratio
Definition Cash+Cash Equivalents+Investments)/ Current liabilities
The quick ratio
Cash+Cash Cash solvency Equivalents+Investments+Receivables)/Curre nt liabilities
The current ratio
Current assets/Current liabilities
Cash solvency
The operating ratio
Total revenues/Total expenses
Budget solvency
Surplus deficit per capita
Total surpluses (deficits)/Population
Budget solvency
Net asset ratio
Restricted and Unrestricted net assets/Total assets
Long-run solvency
Long-term liability ratio Long-term (non-current) Liabilities/Total Assets
Dimension Cash solvency
Long-run solvency
Long-term liability per capita
Long-term (non-current) Liabilities/Population Long-run solvency
Tax per capita
Total taxes/Population
Service solvency
Revenue per capita
Total revenues/Population
Service solvency
Expenses per capita
Total expenses/Population
Service solvency
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Note Only the amount of "cash, cash equivalents, and investments" in current assets is included Only the amount of "cash, cash equivalents, investments, and receivables" in current assets is included Perhaps the most popular liquidity ratio Total revenues=Total program Revenues+Total general revenues Total Surpluses (deficits) represent the Change in Net Assets A higher ratio indicates a better position to pay off long-term obligations Long-term non-current) liabilities are the liabilities due in more than one year Long-term (non-current) liabilities are the liabilities due in more than one year Higher tax per capita indicates a higher tax burden for residents and a lower service-level solvency Higher revenue per capita indicates a higher revenue burden for a resident to pay and lower service-level solvency Higher expenses per capita indicate a more expensive government and lower servicelevel solvency to sustain that expense level
Table 5: National Association of State Budget Officers Data Fiscal Survey of the States (1979-Present) Budget Cuts made after the budget has been passed Program area cuts Annual percentage medicaid growth rate Percentage change in medicaid enrollment Total proposed fiscal actions to revenue and net increase or decrease General fund actual, estimated, and recommended Beginning balance Revenues Adjustments Total resources Expenditures Adjustments Ending balance Budget Stabilzation Fund General fund nominal expenditure change Strategies used to reduce or eliminate budget gaps Tax collections compared with projections Comparison of tax collections enacted Comparison of tax collections recommended Proposed revenue changes by type Proposed revenue measures Total balances and balances as a percentage of expenditures Total bsf and bsf as a percentage of expenditures State Expenditure Report (1987-2008) Total state expenditures-capital inclusive, actual Annual percentage change State spending by function as a percent of total Function by function Items excluded from revenue sources
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Table 6: US Census of Governments Data Government County
Table Names County_Govt_Finance
Data Detail Broad
Years 1957, 62, 67, 70-06
State
1_Revenues
All
42, 44, 46, 48, 50-06
State
2_ExpendituresA
All
42, 44, 46, 48, 50-06
State
3_ExpendituresB
All
42, 44, 46, 48, 50-06
State
4_Debt_and_Cash_&_Securities
All
42, 44, 46, 48, 50-06
City
City_Govt_Finances
Broad
51-06 (07, 08 forthcoming)
County
1_Revenues
All
57-02 (07 forthcoming)
County
2_ExpendituresA
All
57-02 (07 forthcoming)
County
3_ExpendituresB
All
57-02 (07 forthcoming)
County
4_Debt_and_Cash_&_Securities
All
57-02 (07 forthcoming)
State, Local
1_Revenues
Broad
State, Local
2_Expenditures
Broad
State, Local
3_Debt_and_Cash_&_Securities
Broad
State, Local State, Local State, Local State, Local State, Local State, Local State, Local State, Local
DAC1 DAC2 DAC3 REX1 REX2 REX3 REX4 REX5
All All All All All All All All
State 1902, 13, 22, 27, 32, 34, 36, 38, 40, 42, 44, 46, 48, 50, 52-06, Local category 67-92, local total, 93-00, 02, 04-06 State 1902, 13, 22, 27, 32, 34, 36, 38, 40, 42, 44, 46, 48, 50, 52-06, Local category 67-92, local total, 93-00, 02, 04-06 State 1902, 13, 22, 27, 32, 34, 36, 38, 40, 42, 44, 46, 48, 50, 52-06, Local category 67-92, local total, 93-00, 02, 04-06 State 1972-06, Local category 1972-92, Local Total 93-00, 02, 04-06 State 1972-06, Local category 1972-92, Local Total 93-00, 02, 04-06 State 1972-06, Local category 1972-92, Local Total 93-00, 02, 04-06 State 1972-06, Local category 1972-92, Local Total 93-00, 02, 04-06 State 1972-06, Local category 1972-92, Local Total 93-00, 02, 04-06 State 1972-06, Local category 1972-92, Local Total 93-00, 02, 04-06 State 1972-06, Local category 1972-92, Local Total 93-00, 02, 04-06 State 1972-06, Local category 1972-92, Local Total 93-00, 02, 04-06
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Association for Budgeting and Financial Management 22nd Annual Conference Omaha, NE October 7-9, 2010 Home Rule, Local Government Independence, and Fiscal Decentralization: Effects on State and Local Government Fiscal Condition ABSTRACT Fiscal decentralization, devolution, and local government autonomy are recurring issues in the study of public finance and management, especially as many state governments become burdened with local property tax relief. The study of fiscal federalism and the subject of which government should do what, when and how are well traveled areas of research in public administration and the fields of economics and political science. However, these fields typically address the questions of the efficient production of public goods and the proper size and scope of governments. What they tend not to address are more traditional public finance measures of fiscal health, condition, and outcomes. Using established measures of financial management and more novel measures of centralization, this study will address the following questions: What effect does the degree of fiscal centralization within a state vis-à-vis its local governments and degree of local government autonomy have on the fiscal condition of the state and its local governments? What effect does the degree of centralization or fragmentation amongst local governments have on their fiscal conditions?
1
Introduction The purpose of this paper is to outline a program of research to study the fiscal effects of decentralization on state and local governments. Fiscal decentralization, devolution, and local government autonomy are recurring issues in the study of public finance and management. The study of fiscal federalism and the subject of which government should do what, when and how are well traveled areas of research in public administration and the fields of economics and political science. However, these fields typically address the questions of the efficient production of public goods and the proper size and scope of governments. The local government management field has long advocated the norm of home rule and local government independence. What they tend not to address are more traditional public finance measures of fiscal health, condition, and outcomes. We know very little about whether a state that is highly centralized with limited municipal home rule is fiscally healthier than a state that is decentralized with more permissive home rule. Nor do we know how those same things affect the fiscal health of local governments. The research question, then, in its broadest sense is: What are the actual fiscal outcomes of decentralization? This research is important for at least two reasons. First, though home rule is considered one of the central issues affecting local governments, its actual outcomes are unknown. Fiscal independence and fiscal outcomes are key facets of this. Second, government efficiency and organization are some of the most studied topics within the field of public management, yet the fiscal impact of state/local government structure is unknown. Since the mid 1980s, spending at the state level has surpassed and grown faster than spending at the local level (Figure 1). So while it seems that states have become more fiscally
2
centralized, it is unknown whether this trend has produced positive results for their fiscal condition and for the fiscal condition of their local governments. Additionally, is seems that own source revenues have grown faster at the state level than at the local level (Figure 2).
Figure 1: Total Real Expenditures, State vs. Local (2006 Dollars) $2,000,000,000
$1,500,000,000 Real Local Total Expend iture
$1,000,000,000
Real State Total Expend iture
$500,000,000
$0 1986
1991
1996
2001
2006
Figure 2: General Own Source Revenues, State vs. Local (2006 Dollars) $1,500,000,000
$1,000,000,000
Real Gen Rev-‐ Own Sources Local
$500,000,000 Real Gen Rev-‐ Own Sources State
3
20 06
20 01
19 96
19 91
19 86
$0
Research Questions Using established measures of fiscal health and financial management (financial ratios, fiscal crises, bond rating, debt burden, etc.) and more novel measures of centralization (home rule by structure, function, and fiscal rules; relative shares of revenues and expenditures) this study will address the following questions: Question 1: What effect does the degree of centralization within a state vis-à-vis its local governments and degree of local government autonomy have on the fiscal condition of the state? Question 2: What effect does the degree of centralization within a state vis-à-vis its local governments and degree of local government autonomy have on the fiscal condition of local governments? Question 3: What effect does the degree of centralization within a state vis-à-vis its local governments and degree of local government autonomy have on the fiscal condition of municipal governments? Question 4: What effect does the character of local government autonomy (the different types of autonomy) have on eth fiscal condition of the state, local governments, and especially cities? Literature There is a wealth of literature on fiscal federalism and no need to address all of it here. What is missing from this literature, however, are empirical studies analyzing the effect of home rule, local autonomy, and local decentralization on the fiscal condition of state and local governments.
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According to Sohl et al (2009), there are few to no objective or accepted standards to measure a city’s financial condition or position. The authors contrast studies by Hendrick (2004; 2007) and Wang et al (2007). Hendrick does not use a composite financial condition index, whereas Wang et al construct an index based on their weighted ratios. Hendrick does not use an industry wide benchmark, but uses cohorts of similar cities. Sohl et al argue that by not comparing the cities to others outside of their cohorts, what is really being measured is financial position rather than financial condition. Using the ICMA’s Financial Trend Monitoring System (FTMS), Sohl et al create more carefully constructed cohorts, but note some underlying problems with measures of financial condition across cities (Table 1). The measures of financial condition do not account for differences in financial structure Honadle et al (2004) use the FTMS and a location quotient. In this system the case is the city and the denominator is the cohort. See appendix for a list of FTMS indicators. Brown (1993) creates a similar, but similar set of indicators intended for small cities (Table 2). Some of the data needed for Brown’s indicators cannot be found all in a single source and would require unit by unit data gathering. As this would be impractical, only the indicators that require data found in the census of governments and the Fiscal Survey of the States would be used in this study. Wang et al (2007) offer another set of indicators based on the GASB 34 statement (Table 4). Kloha et al (2005) produce their own ten point scale of fiscal distress based on combinations of measures from previous studies (Table 3). Honadle (2003) presents a conceptual framework for understanding researching the role that state governments play in monitoring and managing local government fiscal crises. The study surveys officials in all 50 states and categorizes states’ different approaches to averting or managing fiscal crises at the local level. The study does no
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attempt to make a connection between the approach to fiscal crises and home rule, but presents an alternative measure of state involvement in the fiscal affairs of local government. Hawkins et al (1982) find that the centralization of revenues to the state level reduces spending at the local level in the categories of education, highways, health, and police. Gold and Erickson (1989) found that as state governments assume responsibilities that were formerly local, aid to local government tends to slow. Also, the character of state aid to local governments is important. For instance a number of states pay property tax relief to local governments in exchange for state mandated exemptions or limits on rates. This is not the same as expanded resources. Reschovsky (2004) that state aid to local governments, especially education, declines most when states are hit with fiscal crises or recessions. Unlike what Gold and Erickson find, Reschovsky argues that these cuts in aid due to the economic cycle do fundamentally alter the total resources available to local governments. Home rule refers to the ability of city and county governments to exercise discretion with respect to government form, structure, functions, fiscal, and regulatory matters. States have the power to authorize whether local governments may exercise home rule and the breadth of their home rule powers. Home rule is an important measure of local government independence. There is a great deal of variation in home rule powers among states. Broad home rule authority allows a community to tailor its local government to meet local needs. It is recognition that not all local governments within a state are alike. Restrictive home rule policies make local governments more administratively and fiscally dependent on the state. This can place greater burdens on the state and affect the state’s own fiscal environment. At this time, however, little empirical research has been done on the fiscal effects or outcomes of home rule policies on either the state or local governments. Additionally, it is not
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clear which particular features (form, structure, functions, fiscal, regulatory, etc.) of home rule provide the most flexibility to address problems and provide services. Home rule policies have different implications for counties than for municipalities. Counties are subdivisions of state government and are obligated to provide basic public services; for example, law enforcement. County home rule represents a layer of local independence over an otherwise quasi state government entity. Municipalities, on the other hand, are generally established to provide a more extensive set or level of services. The geographic boundaries of municipalities may change over time, and the level and number of public services may vary based on state law and/or local ordinance. The particulars of home rule are so numerous and so important, that measuring and operationalizing them is not an easy task. The literature does, however, generally recognize some common facets of home rule. These include home rule with respect to government structure, function, fiscal, regulatory, and boundary powers (Krane et al 2001; Stone 2010). Carroll and Johnson (2010) find that home rule status contributes to revenue diversification of small town governments. Stephens (1974) creates an index of local government autonomy and centralization. This composite index is composed of indices for financial responsibility, service delivery, and personnel distribution. Financial responsibility is measured by the share of state spending (including federal intergovernmental revenue) relative to local spending. Service delivery is measured by the share of state spending across a set of expenditure categories. Personnel distribution is measured as a ratio of local to state full time employees per million dollars of expenditure for the respective level of government. Each index has arbitrary cut-points that demarcate decentralized, balanced, and centralized governments.
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The Advisory Commission on Intergovernmental Relations (ACIR) has produced a large number of studies and reports dealing with the relationship between state and local governments. Many of these are devoted to measuring local autonomy. In one of these reports (1993) the ACIR developed a group of indicators of local autonomy. These groups of indicators are form of government, altering boundaries and responsibilities, local elections, administrative operations and procedures, financial administration, personnel management. Camoes (2003) creates a single index out of these indicators that attempts to capture all aspects of local autonomy. Indices for the facets of home rule discussed above will be created. Dimensions of fiscal home rule are perhaps easier to measure and quantify. These would include fiscal institutions such as tax, expenditure, and debt limits as well as the relative share of fiscal activity (taxing, spending, and issuing debt) that occur at the state vs. the local level. Camoes (2003) finds a statistically significant relationship between local autonomy and local government spending. The Camoes study, though, is cross sectional and uses two measures of local autonomy: a single index of local autonomy constructed from dichotomous measures, and a dichotomous home rule variable. The cases are stratified sample of cities. Akai and Sakata (2002) examine the relationship between fiscal decentralization and economic growth. To do this, they create four indicators of fiscal decentralization. These include a revenue indicator that represents the ratio of local revenue to total state and local revenue, an expenditure indicator that represents the ratio of local spending to total state and local spending, an autonomy indicator that is a ratio of local own source revenue to total local revenue, and combined revenue and expenditure indicator that is the mean of the first two indicators. They find that fiscal decentralization results in economic growth. Data
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State and aggregated local fiscal data are currently available at a high level of detail for all fifty states from the 1970s to 2008 from the US Census Bureau’s Census of Governments (COG). Disaggregated local fiscal data are available to a lesser degree of detail from the same source. The data include revenue, expenditure, and cash and debt figures for separate sources and categories. The local government data are less complete than the state data. Local government data from 2001 and 2003 are unavailable. Municipal government data is censored by population so that only cities with a population greater than 25,000 are included. Table 6 provides a list of these data. The COG data are also not without error. The data are self reported and thus subject to some bias with respect to how each state classifies its revenue, expenditure, cash and debt data. It is my contention, however, that these are sources of random, rather than systematic error and that they do not fundamentally alter the larger fiscal picture. Carroll (2009) used the municipal portion of these data in a study on revenue diversification. Additional state level budget data is available from the National Association of State Budget Officers (NASBO) in their Fiscal Survey of the States and their State Expenditure Report. The Fiscal Survey of the States is available on a semi-annual basis from 1979 to the present while the State Expenditure Report is available on an annual basis from 1987 to 2009. Table 5 lists the data available in these publications. Moody’s, Standard & Poor’s, and Fitch rate state and local government issued debt. The ratings of general obligation debt provide an independent, third party evaluation of an issuer’s ability to repay that debt. Though the rating agencies’ formulas and methodology are proprietary, it is generally accepted that they take into account many of the measures listed in the various aforementioned financial ratios. On the other hand there is very little variation in bond
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ratings at the state level. This may be a variable that is more appropriately used on the local level. Economic and labor force data are available for the same periods from the BEA and BLS. The Census also has government employment and wages that match the state and local fiscal data. I have already collected data from this data from the Census, BEA, and BLS. Measures of decentralization and local government independence will have to be constructed. Qualitative measures of structural, functional and fiscal independence can be constructed from a combination of existing work and original research. Quantitative measures of fiscal decentralization can be constructed out of the fiscal data listed above. Geographic data may also be employed to construct measures of geographic centralization and fragmentation. Models and Methods Dependent variables would be measures of fiscal condition. There are two types of dependent variables. One type is the individual variable where each measure is a separate variable. The other type is an index that combines multiple measures. I will run separate models using individual measures as dependent variables and then construct indices that include the most salient measures. The individual measures are much more fine grained and will be easier to interpret, but will produce a surfeit of results. The indices can condense all of this information, but are potentially more difficult to interpret. Independent variables will consist of measures of decentralization and independence as well as control variables for economy, income, demographics, etc. Some of the measures of decentralization and independence will indices. The indices will be tested for consistency and robustness.
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The data would seem to lend themselves to time-series analysis. Though it may be premature to say, linear ordinary least squares regression should suffice for most of the models. Models using fixed effects for the 50 states are often used for this type of research. Hierarchical linear models (in which local governments are nested within states, for instance) may also be useful. Logit/probit models would be used where dependent variables are categorical, binary, or ordinal.
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REFERENCES Advisory Commission on Intergovernmental Relations. State Laws Governing Local Government Structure and Administration. 1993. Washington, DC: U.S. ACIR Nobuo Akai and Masayo Sakata. “Fiscal Decentralization Contributes to Economic Growth: Evidence from Stat-Level Cross-Section Data for the United States.” Journal of Urban Economics. 2002, 93-108. Kenneth W. Brown. “The Ten Point Test of Financial Condition: Toward an Easy-to-Use Assessment Tool for Smaller Cities.” Government Finance Review. 1993, 9(6). Pedro J. Camoes. “Evaluating the Policy Consequences of Local Government Autonomy: A Stratified Sampling-Cross Sectional Study.” NEAPP, Series IV, 2003, draft. Deborah A. Carroll. “Diversifying Municipal Government Revenue Structures: Fiscal Illusion or Instability?” Public Budgeting and Finance. Spring 2009, 27-48. Deborah A. Carroll and Terri Johnson. “Examining Small Town Revenues: To What Extent are They Diversified?” Public Administration Review. March-April 2010, 223-235. Steven D. Gold and Brenda M. Erickson. “State Aid to Local Governments in the 1980s.” State and Local Government Review. Winter 1989, 11-21. Brett W. Hawkins, Richard D. Bingham, and David M. Hedge. “A Note on the Local Effects of State Revenue Centralization.” State and Local Government Review. May 1982, 91-93. Rebecca Hendrick, “Assessing and Measuring the Fiscal Health of Local Governments: Focus on Chicago Suburban Municipalities,” Urban Affairs Review. 2004, 40(1): 78-114 Beth Walter Honadle. “The States’ Role in U.S. Local Government Fiscal Crises: A Theoretical Model and Results of a National Survey.” International Journal of Public Administration. 2003 26(13), 1431-1472. Beth Walter Honadle, James M. Costa, Beverly A. Cigler, Fiscal Health for Local Governments. 2004. Eslevier Academic Press, San Diego. Philip Kloha, Carol S. Weissert, and Robert Kleine. “Developing and Testing a Composite Model to Predict Local Fiscal Distress.” Public Administration Review. May-June 2005 65(3), 313-323. Robert S. Kravchuk and Samuel B. Stone. “How and When Do Structural Deficits Reveal Themselves? The Case of Indiana.” Journal of Public Budgeting, Accounting & Financial Management. 2010. (Forthcoming)
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Shannon Sohl, Michael T. Peddle, Kurt Thurmaier, Curtis Wood, and Gregory Kuhn. “Measuring the Financial Position of Municipalities: Numbers Do Not Speak for Themselves.” Public Budgeting and Finance. Fall 2009, 74-89. Andrew Reschovsky. The Impact of State Government Fiscal Crises on Local Governments and Schools. State and Local Government Review. 2004, 36(2), 86-102. Dale Krane, Platon N. Rigos, and Melvin Hill, Jr., M.B. (Eds.). Home rule in America: A Fifty state handbook. 2001. Washington, DC.: CQ Press. G. Ross Stephens. “State Centralization and the Erosion of Local Autonomy.” The Journal of Politics. 1974. 36(1). 44-76. Samuel B. Stone. “Home Rule in the Midwest.” Indiana University Public Policy Institute. 2010. Indianapolis, IN. Xiaohu Wang, Lynda Dennis, and Yuan Sen (Jeff) Tu, “Measuring Financial Condtion: A Study of U.S. States,” Public Budgeting and Finance. 2007, 27(2): 1-21.
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APPENDIX Table 1: ICMA Financial Trend Monitoring System (Honadle et al 2004) # 1 2 3 4 5 6 7 8
Indicator Revenues per Capita restricted revenues intergovernmental revenues elastic tax revenues one-time revenues property tax revenues uncollected property taxes user charge coverage
Formula Net Operating revenues/population restricted operating revenues/net operating revenues intergovernmental operating revenues/gross operating revenues elastic operating revenues/net operating revenues one time operating revenues/net operating revenues property tax revenues uncollected property taxes/net property tax levy revenues from fees and user charges/expenditures for related services
9 10 11 12 13
revenue shortfalls expenditures per capita employees per capita fixed costs fringe benefits/fringe benefit expenditures/salaries and wages operating deficits Enterpise losses fund balances liquidity Current liabilities long term debt debt service overapping debt unfunded pension liability pension assets accumulated employee leave
revenue shortfalls/net operating revenue net operating expenditures/population number of municipal employees/population fixed costs/net operating revenue
14 15 16 17 18 19 20 21 22 23 24
25 maintenance effort quantity of assets 26 capital outlay 27 depreciation expense 28 population 29 median age 30 personal income 31 poverty households or public assistance recipients 32 property value 33 residential development 34 vacancy rates 35 employment base 36 business activity
general fund operating deficits/net operating revenues enterprise profits or losses unreserved fund balances/net operating revenues cash and short term investments/current liabilities current liabilities/net operating revenue net direct bonded long term debt/assessed valuation net direct debt service/ne operating revenues long term overapping bonded debt/assessed valuation unfunded pension liability/assessed valuation pension plan assets/annual pension benefits paid total days of unused vacation and sick leave/number of municipal employees expenditures for repair and maintenance of general fixed assets/assessed valuation capital outlay from operating funds/net operating expenditures depreciation expense/cost of depreciabe fixed assets population median age of population personal income/population poverty households or public assitants recipients/ total households change in property value market value of new residential development/market value of total new development vacancy rates unemployment rate reatil sales, number of business units, business gross recepits, number of acres devoted to business, market or assessed value of business property
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Table 2: Ten-Point Test of Financial Condition (Brown 1993) # Factor 1 Revenues 2 Revenues
3 Revenues 4 Expenditures
5 Operating position 6 Operating position 7 Operating position
Ratio Total Revenues per capita
Formula Total revenues in general, special revenue, debt service, and capital projects funds/population Total general own source Total revenues less total intergovernmental revenue in general revenue/total general fund revenues fund/total revenue in general fund General fund sources from other funds/total general fund sources Operating expenditures/total expenditures
Total operating transfers into the general fund/total revenue in general fund plus transfers in Total expenditures in general, special revenue, debt service funds/total expenditures in general, special revenue, debt service, and capital projects funds Total revenues/total expenditures Total revenue in general, special revenue, debt service, and capital projects funds/total expenditures in general, special revenue, debt service, and capital projects funds Unreserved general fund Unreserved, designated and undesignated fund balance in balance/total general fund revenues general fund/total revenue in general fund
9 Debt structure
Total general fund cash and investments/total general und liabilities Total general fund liabilities/total general fund revenues Direct long term debt/population
10 Debt structure
Debt service/total revenues
8 Debt structure
Total cash and investments in general fund/total assets in general fund less reserved and unreserved fund balances Total assets in general fund less reserved and unreserved fund balances/total revenue in general fund GO Debt to be repaid from property tax revenue/population Total expenditures in debt service fun/total revenues in general, special revenue, debt service, and capital projects funds
Table 3: Indicators of Fiscal Distress (Kloha et al 2005) # Indicator 1 Population growth 2 Real taxable value growth Large real taxable value decrease 3 General fund expenditures as a 4 percentage of taxable value General fund operating deficit 5 Prior general fund operating deficit 6 Size of general fund balance 7 Fund deficits in current or previous 8 years General long term debt as a 9 percentage of taxable value
Description two year growth two year growth looks for large drop over a two year period current general fund expenses divide by current taxable value current general expenditures subtracted from current general fund revenues, divided by general fun revenues checks indicator 5 for two previous years general fund balance as a percentage of general fund revenues current or previous years deficit in major fund current general long term debt divided by current taxable value
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Table 4: Financial Ratios (Wang, Dennis, and Tu 2007) Indicator The cash ratio
Definition Cash+Cash Equivalents+Investments)/ Current liabilities
The quick ratio
Cash+Cash Cash solvency Equivalents+Investments+Receivables)/Curre nt liabilities
The current ratio
Current assets/Current liabilities
Cash solvency
The operating ratio
Total revenues/Total expenses
Budget solvency
Surplus deficit per capita
Total surpluses (deficits)/Population
Budget solvency
Net asset ratio
Restricted and Unrestricted net assets/Total assets
Long-run solvency
Long-term liability ratio Long-term (non-current) Liabilities/Total Assets
Dimension Cash solvency
Long-run solvency
Long-term liability per capita
Long-term (non-current) Liabilities/Population Long-run solvency
Tax per capita
Total taxes/Population
Service solvency
Revenue per capita
Total revenues/Population
Service solvency
Expenses per capita
Total expenses/Population
Service solvency
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Note Only the amount of "cash, cash equivalents, and investments" in current assets is included Only the amount of "cash, cash equivalents, investments, and receivables" in current assets is included Perhaps the most popular liquidity ratio Total revenues=Total program Revenues+Total general revenues Total Surpluses (deficits) represent the Change in Net Assets A higher ratio indicates a better position to pay off long-term obligations Long-term non-current) liabilities are the liabilities due in more than one year Long-term (non-current) liabilities are the liabilities due in more than one year Higher tax per capita indicates a higher tax burden for residents and a lower service-level solvency Higher revenue per capita indicates a higher revenue burden for a resident to pay and lower service-level solvency Higher expenses per capita indicate a more expensive government and lower servicelevel solvency to sustain that expense level
Table 5: National Association of State Budget Officers Data Fiscal Survey of the States (1979-Present) Budget Cuts made after the budget has been passed Program area cuts Annual percentage medicaid growth rate Percentage change in medicaid enrollment Total proposed fiscal actions to revenue and net increase or decrease General fund actual, estimated, and recommended Beginning balance Revenues Adjustments Total resources Expenditures Adjustments Ending balance Budget Stabilzation Fund General fund nominal expenditure change Strategies used to reduce or eliminate budget gaps Tax collections compared with projections Comparison of tax collections enacted Comparison of tax collections recommended Proposed revenue changes by type Proposed revenue measures Total balances and balances as a percentage of expenditures Total bsf and bsf as a percentage of expenditures State Expenditure Report (1987-2008) Total state expenditures-capital inclusive, actual Annual percentage change State spending by function as a percent of total Function by function Items excluded from revenue sources
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Table 6: US Census of Governments Data Government County
Table Names County_Govt_Finance
Data Detail Broad
Years 1957, 62, 67, 70-06
State
1_Revenues
All
42, 44, 46, 48, 50-06
State
2_ExpendituresA
All
42, 44, 46, 48, 50-06
State
3_ExpendituresB
All
42, 44, 46, 48, 50-06
State
4_Debt_and_Cash_&_Securities
All
42, 44, 46, 48, 50-06
City
City_Govt_Finances
Broad
51-06 (07, 08 forthcoming)
County
1_Revenues
All
57-02 (07 forthcoming)
County
2_ExpendituresA
All
57-02 (07 forthcoming)
County
3_ExpendituresB
All
57-02 (07 forthcoming)
County
4_Debt_and_Cash_&_Securities
All
57-02 (07 forthcoming)
State, Local
1_Revenues
Broad
State, Local
2_Expenditures
Broad
State, Local
3_Debt_and_Cash_&_Securities
Broad
State, Local State, Local State, Local State, Local State, Local State, Local State, Local State, Local
DAC1 DAC2 DAC3 REX1 REX2 REX3 REX4 REX5
All All All All All All All All
State 1902, 13, 22, 27, 32, 34, 36, 38, 40, 42, 44, 46, 48, 50, 52-06, Local category 67-92, local total, 93-00, 02, 04-06 State 1902, 13, 22, 27, 32, 34, 36, 38, 40, 42, 44, 46, 48, 50, 52-06, Local category 67-92, local total, 93-00, 02, 04-06 State 1902, 13, 22, 27, 32, 34, 36, 38, 40, 42, 44, 46, 48, 50, 52-06, Local category 67-92, local total, 93-00, 02, 04-06 State 1972-06, Local category 1972-92, Local Total 93-00, 02, 04-06 State 1972-06, Local category 1972-92, Local Total 93-00, 02, 04-06 State 1972-06, Local category 1972-92, Local Total 93-00, 02, 04-06 State 1972-06, Local category 1972-92, Local Total 93-00, 02, 04-06 State 1972-06, Local category 1972-92, Local Total 93-00, 02, 04-06 State 1972-06, Local category 1972-92, Local Total 93-00, 02, 04-06 State 1972-06, Local category 1972-92, Local Total 93-00, 02, 04-06 State 1972-06, Local category 1972-92, Local Total 93-00, 02, 04-06
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