State-Imposed Local Fiscal Rules and the Fiscal Health of City Governments in the US

This award is funded in whole or in part under the American Rescue Plan Act of 2021 (Public Law 117-2).

City governments across the United States provide public services that people rely on in their everyday lives. The ability of a city governments to provide a consistent level of services to their residents depend on the budget choices of the officials in state governments. In order to mitigate detrimental budget decisions such as patronage hiring, risky investments, incurring massive debt, and under-funding of pension and other post-employment benefits, state governments impose fiscal rules on their city governments.

These fiscal rules are aimed to improve local fiscal discipline by preventing the unsustainable growth of local spending, revenues, and debt, as well as ensuring that local budgets are balanced. State-imposed local fiscal rules include balanced budget requirements (BBR), debt limits (DL), and tax and expenditure limits (TEL). This project will identify different provisions of these fiscal rules and examine if such rules actually shape the fiscal health of city governments.

Fiscal health refers to the ability of governments to meet their service responsibilities and other financial obligations. To achieve this goal, the project will collect data on state-imposed fiscal rules using a combination of legal research and surveys of state and city government officials.

The literature on political economy suggests that one mechanism to improve government fiscal discipline is constitutional constraints. The prohibitive costs of gathering information about budget policies to monitor official’s budget choices, and agency problems in setting budget agendas lead to the notion that it may be more effective to bind the actions of government officials through fiscal rules.

BBRs, DLs, and TELs function as ex-ante constitutional constraints that limit government’s budgetary choices. BBRs require governments to match their expenditures with revenues. TELs control the extent to which governments can increase revenues, spending, or both.

DLs control the type and amount of debt that a government is authorized to incur. Even though there are these fiscal rules, there is inadequate knowledge on whether these rules work as intended. While there are rich data on state-level fiscal rules, data on state-imposed local DLs, BBRs, and TELs are outdated or limited.

The majority of research focuses on state governments as the unit of analysis, and the evidence on the effectiveness of fiscal rules is mixed. This research will take advantage of the diversity of fiscal institutional arrangements across the fifty states to examine the design of local fiscal rules. The project will use multi-year detailed data from comprehensive annual financial reports collected from cities to measure the different dimensions of fiscal health.

The econometric analyses will involve different approaches to address a critical issue in the study of institutions, which is the potential endogeneity of fiscal rules.

This award reflects NSF's statutory mission and has been deemed worthy of support through evaluation using the Foundation's intellectual merit and broader impacts review criteria.