Cities and Balanced Budget Rules

• In Event: Fiscal Rules, Capital Finance, and Infrastructure Delivery

Abstract

City governments are required to balance their budgets, we are often told. Yet, an examination of audited financial reports from cities reveals that budget deficits – sometimes across several years – regularly occur. How can this happen? This study presents the results of a National Science Foundation-supported project that 1) documented balanced budget rules (BBRs) imposed by state governments on their cities, 2) collected and analyzed decades-worth of city audited financial reports to develop measures of budgetary solvency, and 3) applied rigorous econometric approaches to assess the effects of BBRs on municipal budgetary solvency.

Several studies have examined the effects of BBRs on different fiscal outcomes, but almost all have focused on states as the unit of analysis. A critical issue that has hampered attempts to study the impact of budget rules on municipalities across the country is data availability. The federal agency tasked to document local budget rules – the US Advisory Commission on Intergovernmental Relations – was abolished 25 years ago. In addition, audited financial data at the municipal level across the fifty states are not readily available.

Using least squares dummy variable regression, correlated random effects models, and instrumental variable regression to address potential endogeneity caused by time-variant and invariant unobserved variables, we find that highly stringent BBRs – those that require balanced budgets at the end of the fiscal year – are effective in controlling deficits. This type of BBR, however, is very rare and operates only in a handful of states. Most cities are only required to propose and enact balanced budgets.

Author

• Benedict Jimenez, Georgia State University