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Title
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Causes of Fiscal Crises in State and Local Governments
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Author
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Kogan, Vladimir
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Research Area
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Social Institutions
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Topic
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Government Systems
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Abstract
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Financial insolvency is a rare occurrence in American state and local governments. However, when it does happen, as in the case of Detroit's historical bankruptcy filing in 2013, the consequences for vital city services, public employees, and taxpayers can be devastating. This essay reviews existing and emerging research on the causes of government fiscal crises, paying particular attention to how social, economic, and legal constraints interact with the electoral incentives faced by public officials to create financial distress. It concludes by identifying a number of open questions that should guide future research, to help identify potential institutional and political reforms that can help avert future problems before they occur.
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extracted text
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Causes of Fiscal Crises in State and
Local Governments
VLADIMIR KOGAN
Abstract
Financial insolvency is a rare occurrence in American state and local governments.
However, when it does happen, as in the case of Detroit’s historical bankruptcy filing in 2013, the consequences for vital city services, public employees, and taxpayers
can be devastating. This essay reviews existing and emerging research on the causes
of government fiscal crises, paying particular attention to how social, economic, and
legal constraints interact with the electoral incentives faced by public officials to create financial distress. It concludes by identifying a number of open questions that
should guide future research, to help identify potential institutional and political
reforms that can help avert future problems before they occur.
When the city of Detroit filed for bankruptcy protection in mid-July 2013,
it became the largest municipal bankruptcy in US history, with outstanding
debt of nearly $20 billion. Although Detroit was by far the biggest city to go
broke, it was far from alone. In the two years leading up to of its filing, two
other major cities—Stockton and San Bernardino, both in California—filed
for protection under the same section, Chapter 9, of the federal bankruptcy
code. A few years earlier, another California city, Vallejo, announced that it
could no longer pay its bills as they became due and sought protection of
its creditors. Although it had emerged from the bankruptcy process in 2011,
Vallejo again seemed poised on the precipice of a financial abyss at the time
of Detroit’s filing.
At first glance, the proximate causes of these high profile financial crises
appear to be quite varied. Detroit succumbed to insolvency after decades
of declining population, deindustrialization, and poor fiscal management.
Stockton had bet heavily on the “infrastructure of play” (Judd, 2002), taking out substantial debt to finance the construction of minor league sports
venues, revitalize its marina, refurbish its historic theater, and upgrade its
Emerging Trends in the Social and Behavioral Sciences. Edited by Robert Scott and Stephen Kosslyn.
© 2015 John Wiley & Sons, Inc. ISBN 978-1-118-90077-2.
1
2
EMERGING TRENDS IN THE SOCIAL AND BEHAVIORAL SCIENCES
City Hall. The bet did not pay off. San Bernardino suffered disproportionately from the housing market collapse that accompanied the 2008 financial crisis, while Vallejo faced mounting bills for generous benefits promised
to its city employees, a problem that caused another city, Central Falls in
Rhode Island, to declare bankruptcy in 2011. Yet, the experiences of these
cities share an underlying pattern: In each case, financial ruin came about as
an unintended result of city leaders working within rigid social and economic
constraints while trying to respond to the electoral pressures from their constituents and other political stakeholders.
This essay reviews the political economy of fiscal ruin, focusing on the
causes of solvency crises in state and local governments. As will become
clear, the research on the origins of public-sector financial stress is limited
by the fact that truly catastrophic fiscal failures occur quite infrequently.
Between 2008 and 2013, for example, lesser than 0.05% of municipalities
filed for bankruptcy protection in federal court (Maciag, 2013). Because the
traditional workhorses of empirical social science research—sophisticated
multivariate econometric models—do not perform well in predicting such
“rare events” (King & Zeng, 2001), much of the literature of government
fiscal crises takes the form of individual case studies. While this literature
has yielded important insights on the causes of these crises, which I review
in the following section, it has also left open a number of important questions
of interest to both scholars and policy practitioners, which I discuss at the
conclusion of this essay.
FOUNDATIONAL RESEARCH
WHAT WE KNOW ABOUT FISCAL CRISES
Although municipal bankruptcies and government fiscal crises are extraordinary events, substantial budget deficits and episodes of fiscal stress occur
with relative frequency at both the state and local levels and follow a
predictable pattern. As a general rule, public finances track the economic
business cycle, deteriorating during recessions and improving again as the
economy recovers. The trend has a clear institutional explanation: Unlike
the federal government, which can run large deficits during economic
downturns to stimulate private demand, nearly every state and most local
governments face a binding balanced-budget requirement (Poterba, 1995).
This presents state and local officials with serious policy challenges. On
the one hand, economic downturns generally increase demand for public
services these governments provide. As workers lose their job and see their
personal incomes decline, they become eligible for cash aid and Medicaid
services, which are funded partly out of state coffers. Similarly, high unemployment has historically coincided with rising crime rates, requiring cities
Causes of Fiscal Crises in State and Local Governments
3
to increase investment in law enforcement services during downturns. On
the other hand, state and, to a lesser extent, local government revenues
decline during recessions, as job losses translate to lower income and sales
tax receipts. This is especially true for states, such as California, that rely
on volatile capital gains taxes for a substantial share of their revenues.
With service demands and revenues moving in opposite directions, elected
officials must choose between cutting government programs and increasing
tax rates—both politically unpopular options—in order to balance their
budgets or find stealth ways to delay the day of fiscal reckoning, by using
short-term loans to paper over deficits, deferring capital maintenance, or
reducing payments into pension plans (Congressional Budget Office, 2010).
For these reasons, government fiscal crises often occur in waves, coinciding with broader economic shocks. The financial panics of the late 1830s,
for example, triggered a series of state government defaults, which led to
important state constitutional reforms in areas of government borrowing and
corporate regulations (Wallis, 2005). During the Great Depression, both state
and local governments were overwhelmed by public demand for welfare
services, historically provided by lower level governments, which in part
motivated the creation of the federal welfare state. Similarly, the period of
economic stagflation during the 1970s contributed to financial troubles in
some major cities, including Chicago and New York (Fuchs, 1992).
The close empirical relationship between the state of the economy and
government balance sheets also explain the recent financial struggles faced
by declining industrial cities, including Detroit. In the period since World
War II, many urban centers in the industrial Northeast and the Midwest have
experienced substantial population losses, as many upper- and middle-class
residents left the central city for the surrounding suburbs. These population
shifts had an undeniable racial dimension, with out-migration of wealthier
whites exacerbating housing segregation and resulting in large swathes
of concentrated poverty in many major cities (Beauregard, 2003). By the
1970s, some major employers began to follow their workers, moving their
offices from the central city to outlying suburbs. Globalization, which
disproportionately affected older industrial cities with a big manufacturing
presence, further exacerbated these big-city employment losses, marking
an era of deindustrialization and manufacturing decline that has continued
through the first decade of the twenty-first century.
The loss of their wealthiest taxpayers and some of the largest employers
dramatically reduced the tax base in many urban areas during this period
(Ladd & Yinger, 1989). Between 1950 and 2012, for example, the population of
the city of Detroit fell sharply from nearly 1.9 million people to about 700,000.
However, declining population has usually not been matched by a proportional reduction in service demands or local government costs. In part, this
4
EMERGING TRENDS IN THE SOCIAL AND BEHAVIORAL SCIENCES
is due to the geographically diffuse nature of out-migration. As residents
left the central city, but not any neighborhood in particular, the reduction
in population density has required city agencies to continue to cover the
same geographic footprint, reducing the efficiency of services. High rates of
concentrated poverty and crime in many major cities have also required substantial government investment to improve living and working conditions
of their residents and help avoid pushing even more city dwellers to safer,
wealthier suburbs that do not face similar social and economic challenges.
Balanced-budget requirements and how these institutions interact with the
broader economic and social context mean that elected officials often find
themselves at the whim forces beyond their direct control in the sphere of
public finance. Even the most fiscally prudent public servants cannot escape
the feast-and-famine cycle of driven by macroeconomic ups and downs,
although they might temper these impacts by setting aside generous budget
reserves during good times to prepare for future economic slowdowns.
Since the 1970s, moreover, government officials have faced even greater
constraints in their fiscal authority and flexibility owing to the passage
of tax and expenditure limitations (often referred as TELs), often through
mechanisms of direct democracy. This trend began with the passage of
Proposition 13 in California but quickly spread across the country (Martin,
2008).
Individual TELs vary substantially but most set limits on overall tax rates,
how much these rates can be increased over time, and how quickly property
may be reassessed to reflect current market rates for the purpose of taxation.
Some TELs also impose procedural requirements—such as voter approval or
super-majority vote thresholds—before taxes can be raised. Although most
TELs target local government taxing authority, others—such as Colorado’s
recently weakened Taxpayers Bill of Rights (TABOR)—also have tremendous
impact on state finances (Kousser, McCubbins, & Moule, 2008). California’s
Proposition 13 appeared to play a pivotal role in the bankruptcy of Orange
County (Baldassare, 1998), one of the largest local government default until
Detroit, and in the decade-long fiscal crisis faced by San Diego (Erie, Kogan,
& MacKenzie, 2011).
To say that external and exogenous forces constrain state and local policy
options does not, however, let policymakers in these levels of government off
the hook for allowing fiscal stress to turn into unmanageable crisis or default.
Public officials can and do respond to similar cyclical and demographic challenges in different ways, with political factors serving an important moderating role. States with unified partisan control of government, for example,
appear to react quicker to unanticipated economic shocks, adjusting policies
accordingly (Alt & Lowry, 1994; Klarner, Phillips, & Muckler, 2012; Poterba,
1994). Elections, on the other hand, limit necessary but politically unpopular
Causes of Fiscal Crises in State and Local Governments
5
adjustments, with incumbents fearful of upsetting voters in an election year
(Poterba, 1995).
At the local level, the diffusion of authority between political and legal
offices can raise the cost of coordination, resulting in undesirable policy
choices and slow responses in the face of worsening fiscal conditions, while
strong party organizations have been shown to lead to more responsible
policy (Berry, 2009; Fuchs, 1992; Shefter, 1985). Some scholars also point to
the role played by ordinary voters and the local “political culture” in laying
the groundwork for poor fiscal outcomes (Clark & Ferguson, 1983; Erie et al.,
2011). When voters do not understand—or perhaps are convinced by political entrepreneurs to ignore—the reality that popular government services
must be funded by unpopular taxes and instead demand “something for
nothing” (Sears & Citrin, 1982), elected officials face tremendous political
pressure to oblige, often resulting in unsustainable policy choices or obscure,
off-budget spending that solves short-term political problems but increase
the risk of long-term insolvency.
CUTTING-EDGE RESEARCH
EMERGING RESEARCH QUESTIONS AND AGENDAS
The research described in the previous section provides much important context and background for understanding the experience of fiscally stressed
state and local governments during the twentieth century. In the new millennium, however, the types of fiscal challenges facing policymakers and the
actors involved in responding to them appear to be changing, developments
that are prompting new lines of scholarly research.
Although public-sector employees have long been recognized as important
stakeholders and active participants in the public policy process, they have
attracted renewed critical attention from many political observers in recent
years. One reason is growing concern about the sustainability of public pensions and other post-employment benefits promised to government workers,
together accounting for some of the largest unfunded long-term liabilities
facing state and local governments (Kieweit & McCubbins, 2014). In recent
years, almost every state has passed some form of pension-reform legislation,
although financial experts project that these changes will do little to address
the long-term solvency of public pension funds (Novy-Marx & Rauh, 2009).
When viewed in historical context, the salience of present-day pension
woes are in many ways surprising: since the 1970s, public pension funds and
their government sponsors have faced increasing accounting and funding
rules, meaning that public pensions in the modern era are probably better
funded than they’ve ever been before (Kogan, 2014). Indeed, until the 1970s-
6
EMERGING TRENDS IN THE SOCIAL AND BEHAVIORAL SCIENCES
and 1980s-era reforms, most pensions were funded on a pay-as-you-go
basis, with no actuarial pre-funding, something even the worst-managed
pension funds today dare not do.
One reason for why pension shortfalls have attracted so much political
attention may be that the vast majority of pension assets today are invested
in the stock market, exacerbating cyclical fiscal stress faced by their government sponsors. During good economic times, strong pension investment
earnings reduce the amount state and local governments must contribute to
pre-fund employee retirement benefits. During recessions, however, disappointing earnings mean that fund sponsors must increase contributions at
exactly the moment they confront falling revenues and are forced to make
cuts to other popular government programs, making public employee pensions a political albatross around the neck of elected officials (Kogan, 2014).
In other words, public pension are as much a political problem as a policy
problem, with government sponsors paying the least when they can most
afford to and contributing the most when it is politically infeasible to do so
(Kogan & McCubbins, 2010).
Thanks to high rates of unionization among public employees, another
phenomenon that dates back only to the 1970s most states, government
workers are also better organized than most other diffuse interest groups to
fight off retrenchment in government spending (Anzia & Moe, 2013). Public
employees can exercise their influence through a variety of channels. Some
unionized workers, such as firefighters and police officers, can leverage their
high esteem among regular voters to make endorsements contingent on
candidate support for pro-labor policies. In many state and local contests,
public employees also represent an important source of campaign resources,
including monetary donations and volunteer man hours, which can help
labor-aligned candidates win office. At the local level, low turnout among
ordinary voters also means that the voices of government employees may
be heard disproportionately at the ballot box (Anzia, 2011; Moe, 2006).
Given what some perceive to be overweening influence of public employees over government actors, many political reformers and some scholars
have advocated reforms, such as the outsourcing the provision of public
services to private contractors, meant to weaken organized labor. Such
arguments suffer from two logical weaknesses, however. First, it is unclear
why public employees—even politically influential and well-organized
employees—have any reason to exacerbate financial challenges or precipitate fiscal crises for their employers. Since public employment opportunities
and membership dues at the end of the day depend on the financial health of
government employers, even self-interested unions have a clear interest in
looking out for the long-term solvency of the agencies at which their members work. Second, there are few reasons to expect that private contractors
Causes of Fiscal Crises in State and Local Governments
7
will be any less malevolent than their public-sector counterparts. Having
won a contract to provide public services, these firms should be expected
to fight just as hard, and make just as many campaign contributions, to
avert budget cuts that reduce their profits. These reasons may explain
why the empirical literature has generally found mixed evidence about the
cost-effectiveness of government outsourcing efforts (e.g., Australia Industry
Commission, 1996; International City-County Management Association,
2007).
Even as public employees have gained political influence, their traditional adversaries in the business community have taken on a lower
profile, particularly in local government. Scholars have attributed the
declining “corporate citizenship” and civic advocacy in political affairs to
the consolidation of major local business into bigger multinational firms
and their increasing global focus (Hanson, Wolman, Connolly, Pearson,
& McManmon, 2010; Poterba 1994). With low level executives no longer
expecting to spend most of their career in a single location and with business
profits less tied to the health of their local economy, corporate leaders have
become increasingly disengaged from local public affairs, weakening their
traditional role as government watchdogs and governing partners. In their
place, local political debates have come to be dominated by single-issue,
place-based businesses, such as land developers and local hotel owners,
who have few roots in the local community and whose long-term interests
are much less likely to coincide with those of local taxpayers (Erie et al.,
2011). Even as the magnitude of government financial challenges has grown,
the political capacity for addressing them has continued to shrink.
KEY ISSUES FOR FUTURE RESEARCH
Financial crises at the state and local level have a tremendous impact on
the lives of ordinary constituents and service users. As governments lay off
workers, reduce service levels, or increase taxes to regain their fiscal footing, public policies create hardships for many families. The collateral damage
from such crises, in other words, is substantial, so scholarly efforts to identify
their causes and examine potential institutional and political reforms to avert
problems before they occur have the promise to make important scholarly
and societal contributions.
To do so, however, researchers must move toward better research designs
that allow them to draw credible causal inferences. To date, much of the
empirical work on the origins and causes of fiscal crises, particularly at the
local level, remain confined to single-city case studies and cautionary tales.
While such case studies are certainly informative for building new theories
8
EMERGING TRENDS IN THE SOCIAL AND BEHAVIORAL SCIENCES
and deriving testable hypotheses and propositions, they rarely provide credible evidence about causal processes. Examining only cases of financial distress leads to the well-known problem of selection on the dependent variable,
without providing a clear basis for counterfactual comparison. The fact that
truly serious financial crises are incredibly rare, even though the factors cited
by scholars for their causes—voter apathy or misinformation, strong interest groups, economic business cycles—are far more prevalent, suggests that
something important is missing from pictures painted by the widely read
and closely studied cases. Although many factors identified in the literature
appear to be necessary conditions for financial calamities and government
bankruptcies, few of them are sufficient.
Aside from a few notable exceptions (e.g., Baldassare, 1998; Clark & Ferguson, 1983; Erie et al., 2011), much of the existing work on fiscal stress and
crisis generally focuses on elite actors in and outside of government, while
paying scant attention to the role played by ordinary voters. To the extent
that voters enter the picture, they are generally portrayed as victims of mismanagement, corruption, or malfeasance. Yet publicly officials are almost
always constrained by the preferences of their constituents and many of the
short-term decisions linked to long-term problems are rooted in the electoral
incentives faced by officeholders. In order to understand the political conditions that give rise to financial problems, scholars must place ordinary voters
and the decisions they make at the ballot box front and center.
Finally, financial problems rarely go away when deficits disappear or when
governments regain access to the public bond markets. Efforts to increase
taxes or make substantial service cuts that are necessary to balance the budget result in long-run consequences, both for the end-users of government
services and for the political actors responsible for making the tough decisions. Although the question of why crises occur has been well studies by
scholars, understanding how governments respond to such crises and the distributional consequences of financial reforms enacted in response requires
substantially greater attention from scholars. Although there may be few
winners during tough economic times, varying policy responses clearly produce different sets of losers.
REFERENCES
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deficits: Evidence from the states. American Political Science Review, 88(4), 811–828.
Anzia, S. F. (2011). Election timing and the electoral influence of interest groups. Journal of Politics, 73(2), 412–427.
Anzia, S. F., & Moe, T. M. (2013). Public sector unions and the costs of government.
Unpublished manuscript.
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Australia Industry Commission (1996). Competitive tendering and contracting by public
sector agencies. Report No. 48.
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CA: UC Press.
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York, NY: Routledge.
Berry, C. R. (2009). Imperfect union: Representation and taxation in multilevel governments. New York, NY: Cambridge University Press.
Clark, T. N., & Ferguson, L. C. (1983). City money: Political processes, fiscal strain, and
retrenchment. New York, NY: Columbia University Press.
Congressional Budget Office (2010). Fiscal stress faced by local governments. Economic
and Budget Issue Brief.
Erie, S. P., Kogan, V., & MacKenzie, S. A. (2011). Paradise plundered: Fiscal crisis and
governance failures in San Diego. Stanford, CA: Stanford University Press.
Fuchs, E. R. (1992). Mayors and money: Fiscal policy in New York and Chicago. Chicago,
IL: University of Chicago Press.
Hanson, R., Wolman, H., Connolly, D., Pearson, K., & McManmon, R. (2010). Corporate citizenship and urban problem solving: The changing civic role of business
leaders in American cities. Journal of Urban Affairs, 32(1), 1–23.
International City-County Management Association (2007). Profile of local government service delivery choices, 2007. http://icma.org/Documents/Document/
Document/100022.
Judd, D. R. (2002). Infrastructure of play: Building the tourist city. New York, NY: M.E.
Sharpe.
Kiewiet, D. R., & McCubbins, M. D. (2014). State and local government finance: The
new fiscal ice age. Annual Review of Political Science, 17, 3.1–3.17.
King, G., & Zeng, L. (2001). Logistic regression in rare event data. Political Analysis,
9(2), 137–163.
Klarner, C. E., Phillips, J. H., & Muckler, M. (2012). Overcoming fiscal gridlock: Institutions and budget bargaining. Journal of Politics, 74(4), 992–1009.
Kogan, V. (2014). Market-based policy diffusion and the origins of the public pension crisis.
Unpublished manuscript.
Kogan, V., & McCubbins, M. D. (2010). Changing tracks? The prospect for California
pension reform. California Journal of Politics and Policy, 2, 1–17.
Kousser, T., McCubbins, M. D., & Moule, E. (2008). For whom the TEL tolls: Can state
tax and expenditure limits effectively reduce spending? State Politics and Policy
Quarterly, 8(4), 331–361.
Ladd, H. F., & Yinger, J. (1989). Ailing cities: Fiscal health and the design of urban policy.
Baltimore, MD: Johns Hopkins University Press.
Maciag, M. (2013). How rare are municipal bankruptcies? Governing. http://www.
governing.com/blogs/by-the-numbers/municipal-bankruptcy-rate-and-statelaw-limitations.html.
Martin, I. W. (2008). The permanent tax revolt: How the property tax transformed American
politics. Stanford, CA: Stanford University Press.
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EMERGING TRENDS IN THE SOCIAL AND BEHAVIORAL SCIENCES
Moe, T. M. (2006). Political control and the power of the agent. Journal of Law, Economics, and Organization, 22(1), 1–29.
Novy-Marx, R., & Rauh, J. D. (2009). The liabilities and risks of state-sponsored pension plans. Journal of Economic Perspectives, 23(4), 191–210.
Poterba, J. M. (1994). State responses to fiscal crises: The effects of budgetary institutions and politics. Journal of Political Economy, 104(4), 799–821.
Poterba, J. M. (1995). Balanced budget rules and fiscal policy: Evidence from the
states. National Tax Journal, 48(3), 329–36.
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New York, NY: Basic Books.
Wallis, J. J. (2005). Constitutions, corporations, and corruption: American states
and constitutional change, 1842 to 1852. Journal of Economic History, 65(1), 211–256.
VLADIMIR KOGAN SHORT BIOGRAPHY
Vladimir Kogan is an Assistant Professor at The Ohio State University’s
Department of Political Science, where he studies state and local politics and
political reforms. He is the coauthor of Paradise Plundered: Fiscal Crisis and
Governance Failures in San Diego (Stanford University Press, 2011). His work
has been published in American Politics Research, Political Communication, Rutgers Law Journal, State Politics and Policy Quarterly, and Urban Affairs Review.
His research website can be accessed at: http://u.osu.edu/kogan.18/.
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Causes of Fiscal Crises in State and Local Governments
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-
Causes of Fiscal Crises in State and
Local Governments
VLADIMIR KOGAN
Abstract
Financial insolvency is a rare occurrence in American state and local governments.
However, when it does happen, as in the case of Detroit’s historical bankruptcy filing in 2013, the consequences for vital city services, public employees, and taxpayers
can be devastating. This essay reviews existing and emerging research on the causes
of government fiscal crises, paying particular attention to how social, economic, and
legal constraints interact with the electoral incentives faced by public officials to create financial distress. It concludes by identifying a number of open questions that
should guide future research, to help identify potential institutional and political
reforms that can help avert future problems before they occur.
When the city of Detroit filed for bankruptcy protection in mid-July 2013,
it became the largest municipal bankruptcy in US history, with outstanding
debt of nearly $20 billion. Although Detroit was by far the biggest city to go
broke, it was far from alone. In the two years leading up to of its filing, two
other major cities—Stockton and San Bernardino, both in California—filed
for protection under the same section, Chapter 9, of the federal bankruptcy
code. A few years earlier, another California city, Vallejo, announced that it
could no longer pay its bills as they became due and sought protection of
its creditors. Although it had emerged from the bankruptcy process in 2011,
Vallejo again seemed poised on the precipice of a financial abyss at the time
of Detroit’s filing.
At first glance, the proximate causes of these high profile financial crises
appear to be quite varied. Detroit succumbed to insolvency after decades
of declining population, deindustrialization, and poor fiscal management.
Stockton had bet heavily on the “infrastructure of play” (Judd, 2002), taking out substantial debt to finance the construction of minor league sports
venues, revitalize its marina, refurbish its historic theater, and upgrade its
Emerging Trends in the Social and Behavioral Sciences. Edited by Robert Scott and Stephen Kosslyn.
© 2015 John Wiley & Sons, Inc. ISBN 978-1-118-90077-2.
1
2
EMERGING TRENDS IN THE SOCIAL AND BEHAVIORAL SCIENCES
City Hall. The bet did not pay off. San Bernardino suffered disproportionately from the housing market collapse that accompanied the 2008 financial crisis, while Vallejo faced mounting bills for generous benefits promised
to its city employees, a problem that caused another city, Central Falls in
Rhode Island, to declare bankruptcy in 2011. Yet, the experiences of these
cities share an underlying pattern: In each case, financial ruin came about as
an unintended result of city leaders working within rigid social and economic
constraints while trying to respond to the electoral pressures from their constituents and other political stakeholders.
This essay reviews the political economy of fiscal ruin, focusing on the
causes of solvency crises in state and local governments. As will become
clear, the research on the origins of public-sector financial stress is limited
by the fact that truly catastrophic fiscal failures occur quite infrequently.
Between 2008 and 2013, for example, lesser than 0.05% of municipalities
filed for bankruptcy protection in federal court (Maciag, 2013). Because the
traditional workhorses of empirical social science research—sophisticated
multivariate econometric models—do not perform well in predicting such
“rare events” (King & Zeng, 2001), much of the literature of government
fiscal crises takes the form of individual case studies. While this literature
has yielded important insights on the causes of these crises, which I review
in the following section, it has also left open a number of important questions
of interest to both scholars and policy practitioners, which I discuss at the
conclusion of this essay.
FOUNDATIONAL RESEARCH
WHAT WE KNOW ABOUT FISCAL CRISES
Although municipal bankruptcies and government fiscal crises are extraordinary events, substantial budget deficits and episodes of fiscal stress occur
with relative frequency at both the state and local levels and follow a
predictable pattern. As a general rule, public finances track the economic
business cycle, deteriorating during recessions and improving again as the
economy recovers. The trend has a clear institutional explanation: Unlike
the federal government, which can run large deficits during economic
downturns to stimulate private demand, nearly every state and most local
governments face a binding balanced-budget requirement (Poterba, 1995).
This presents state and local officials with serious policy challenges. On
the one hand, economic downturns generally increase demand for public
services these governments provide. As workers lose their job and see their
personal incomes decline, they become eligible for cash aid and Medicaid
services, which are funded partly out of state coffers. Similarly, high unemployment has historically coincided with rising crime rates, requiring cities
Causes of Fiscal Crises in State and Local Governments
3
to increase investment in law enforcement services during downturns. On
the other hand, state and, to a lesser extent, local government revenues
decline during recessions, as job losses translate to lower income and sales
tax receipts. This is especially true for states, such as California, that rely
on volatile capital gains taxes for a substantial share of their revenues.
With service demands and revenues moving in opposite directions, elected
officials must choose between cutting government programs and increasing
tax rates—both politically unpopular options—in order to balance their
budgets or find stealth ways to delay the day of fiscal reckoning, by using
short-term loans to paper over deficits, deferring capital maintenance, or
reducing payments into pension plans (Congressional Budget Office, 2010).
For these reasons, government fiscal crises often occur in waves, coinciding with broader economic shocks. The financial panics of the late 1830s,
for example, triggered a series of state government defaults, which led to
important state constitutional reforms in areas of government borrowing and
corporate regulations (Wallis, 2005). During the Great Depression, both state
and local governments were overwhelmed by public demand for welfare
services, historically provided by lower level governments, which in part
motivated the creation of the federal welfare state. Similarly, the period of
economic stagflation during the 1970s contributed to financial troubles in
some major cities, including Chicago and New York (Fuchs, 1992).
The close empirical relationship between the state of the economy and
government balance sheets also explain the recent financial struggles faced
by declining industrial cities, including Detroit. In the period since World
War II, many urban centers in the industrial Northeast and the Midwest have
experienced substantial population losses, as many upper- and middle-class
residents left the central city for the surrounding suburbs. These population
shifts had an undeniable racial dimension, with out-migration of wealthier
whites exacerbating housing segregation and resulting in large swathes
of concentrated poverty in many major cities (Beauregard, 2003). By the
1970s, some major employers began to follow their workers, moving their
offices from the central city to outlying suburbs. Globalization, which
disproportionately affected older industrial cities with a big manufacturing
presence, further exacerbated these big-city employment losses, marking
an era of deindustrialization and manufacturing decline that has continued
through the first decade of the twenty-first century.
The loss of their wealthiest taxpayers and some of the largest employers
dramatically reduced the tax base in many urban areas during this period
(Ladd & Yinger, 1989). Between 1950 and 2012, for example, the population of
the city of Detroit fell sharply from nearly 1.9 million people to about 700,000.
However, declining population has usually not been matched by a proportional reduction in service demands or local government costs. In part, this
4
EMERGING TRENDS IN THE SOCIAL AND BEHAVIORAL SCIENCES
is due to the geographically diffuse nature of out-migration. As residents
left the central city, but not any neighborhood in particular, the reduction
in population density has required city agencies to continue to cover the
same geographic footprint, reducing the efficiency of services. High rates of
concentrated poverty and crime in many major cities have also required substantial government investment to improve living and working conditions
of their residents and help avoid pushing even more city dwellers to safer,
wealthier suburbs that do not face similar social and economic challenges.
Balanced-budget requirements and how these institutions interact with the
broader economic and social context mean that elected officials often find
themselves at the whim forces beyond their direct control in the sphere of
public finance. Even the most fiscally prudent public servants cannot escape
the feast-and-famine cycle of driven by macroeconomic ups and downs,
although they might temper these impacts by setting aside generous budget
reserves during good times to prepare for future economic slowdowns.
Since the 1970s, moreover, government officials have faced even greater
constraints in their fiscal authority and flexibility owing to the passage
of tax and expenditure limitations (often referred as TELs), often through
mechanisms of direct democracy. This trend began with the passage of
Proposition 13 in California but quickly spread across the country (Martin,
2008).
Individual TELs vary substantially but most set limits on overall tax rates,
how much these rates can be increased over time, and how quickly property
may be reassessed to reflect current market rates for the purpose of taxation.
Some TELs also impose procedural requirements—such as voter approval or
super-majority vote thresholds—before taxes can be raised. Although most
TELs target local government taxing authority, others—such as Colorado’s
recently weakened Taxpayers Bill of Rights (TABOR)—also have tremendous
impact on state finances (Kousser, McCubbins, & Moule, 2008). California’s
Proposition 13 appeared to play a pivotal role in the bankruptcy of Orange
County (Baldassare, 1998), one of the largest local government default until
Detroit, and in the decade-long fiscal crisis faced by San Diego (Erie, Kogan,
& MacKenzie, 2011).
To say that external and exogenous forces constrain state and local policy
options does not, however, let policymakers in these levels of government off
the hook for allowing fiscal stress to turn into unmanageable crisis or default.
Public officials can and do respond to similar cyclical and demographic challenges in different ways, with political factors serving an important moderating role. States with unified partisan control of government, for example,
appear to react quicker to unanticipated economic shocks, adjusting policies
accordingly (Alt & Lowry, 1994; Klarner, Phillips, & Muckler, 2012; Poterba,
1994). Elections, on the other hand, limit necessary but politically unpopular
Causes of Fiscal Crises in State and Local Governments
5
adjustments, with incumbents fearful of upsetting voters in an election year
(Poterba, 1995).
At the local level, the diffusion of authority between political and legal
offices can raise the cost of coordination, resulting in undesirable policy
choices and slow responses in the face of worsening fiscal conditions, while
strong party organizations have been shown to lead to more responsible
policy (Berry, 2009; Fuchs, 1992; Shefter, 1985). Some scholars also point to
the role played by ordinary voters and the local “political culture” in laying
the groundwork for poor fiscal outcomes (Clark & Ferguson, 1983; Erie et al.,
2011). When voters do not understand—or perhaps are convinced by political entrepreneurs to ignore—the reality that popular government services
must be funded by unpopular taxes and instead demand “something for
nothing” (Sears & Citrin, 1982), elected officials face tremendous political
pressure to oblige, often resulting in unsustainable policy choices or obscure,
off-budget spending that solves short-term political problems but increase
the risk of long-term insolvency.
CUTTING-EDGE RESEARCH
EMERGING RESEARCH QUESTIONS AND AGENDAS
The research described in the previous section provides much important context and background for understanding the experience of fiscally stressed
state and local governments during the twentieth century. In the new millennium, however, the types of fiscal challenges facing policymakers and the
actors involved in responding to them appear to be changing, developments
that are prompting new lines of scholarly research.
Although public-sector employees have long been recognized as important
stakeholders and active participants in the public policy process, they have
attracted renewed critical attention from many political observers in recent
years. One reason is growing concern about the sustainability of public pensions and other post-employment benefits promised to government workers,
together accounting for some of the largest unfunded long-term liabilities
facing state and local governments (Kieweit & McCubbins, 2014). In recent
years, almost every state has passed some form of pension-reform legislation,
although financial experts project that these changes will do little to address
the long-term solvency of public pension funds (Novy-Marx & Rauh, 2009).
When viewed in historical context, the salience of present-day pension
woes are in many ways surprising: since the 1970s, public pension funds and
their government sponsors have faced increasing accounting and funding
rules, meaning that public pensions in the modern era are probably better
funded than they’ve ever been before (Kogan, 2014). Indeed, until the 1970s-
6
EMERGING TRENDS IN THE SOCIAL AND BEHAVIORAL SCIENCES
and 1980s-era reforms, most pensions were funded on a pay-as-you-go
basis, with no actuarial pre-funding, something even the worst-managed
pension funds today dare not do.
One reason for why pension shortfalls have attracted so much political
attention may be that the vast majority of pension assets today are invested
in the stock market, exacerbating cyclical fiscal stress faced by their government sponsors. During good economic times, strong pension investment
earnings reduce the amount state and local governments must contribute to
pre-fund employee retirement benefits. During recessions, however, disappointing earnings mean that fund sponsors must increase contributions at
exactly the moment they confront falling revenues and are forced to make
cuts to other popular government programs, making public employee pensions a political albatross around the neck of elected officials (Kogan, 2014).
In other words, public pension are as much a political problem as a policy
problem, with government sponsors paying the least when they can most
afford to and contributing the most when it is politically infeasible to do so
(Kogan & McCubbins, 2010).
Thanks to high rates of unionization among public employees, another
phenomenon that dates back only to the 1970s most states, government
workers are also better organized than most other diffuse interest groups to
fight off retrenchment in government spending (Anzia & Moe, 2013). Public
employees can exercise their influence through a variety of channels. Some
unionized workers, such as firefighters and police officers, can leverage their
high esteem among regular voters to make endorsements contingent on
candidate support for pro-labor policies. In many state and local contests,
public employees also represent an important source of campaign resources,
including monetary donations and volunteer man hours, which can help
labor-aligned candidates win office. At the local level, low turnout among
ordinary voters also means that the voices of government employees may
be heard disproportionately at the ballot box (Anzia, 2011; Moe, 2006).
Given what some perceive to be overweening influence of public employees over government actors, many political reformers and some scholars
have advocated reforms, such as the outsourcing the provision of public
services to private contractors, meant to weaken organized labor. Such
arguments suffer from two logical weaknesses, however. First, it is unclear
why public employees—even politically influential and well-organized
employees—have any reason to exacerbate financial challenges or precipitate fiscal crises for their employers. Since public employment opportunities
and membership dues at the end of the day depend on the financial health of
government employers, even self-interested unions have a clear interest in
looking out for the long-term solvency of the agencies at which their members work. Second, there are few reasons to expect that private contractors
Causes of Fiscal Crises in State and Local Governments
7
will be any less malevolent than their public-sector counterparts. Having
won a contract to provide public services, these firms should be expected
to fight just as hard, and make just as many campaign contributions, to
avert budget cuts that reduce their profits. These reasons may explain
why the empirical literature has generally found mixed evidence about the
cost-effectiveness of government outsourcing efforts (e.g., Australia Industry
Commission, 1996; International City-County Management Association,
2007).
Even as public employees have gained political influence, their traditional adversaries in the business community have taken on a lower
profile, particularly in local government. Scholars have attributed the
declining “corporate citizenship” and civic advocacy in political affairs to
the consolidation of major local business into bigger multinational firms
and their increasing global focus (Hanson, Wolman, Connolly, Pearson,
& McManmon, 2010; Poterba 1994). With low level executives no longer
expecting to spend most of their career in a single location and with business
profits less tied to the health of their local economy, corporate leaders have
become increasingly disengaged from local public affairs, weakening their
traditional role as government watchdogs and governing partners. In their
place, local political debates have come to be dominated by single-issue,
place-based businesses, such as land developers and local hotel owners,
who have few roots in the local community and whose long-term interests
are much less likely to coincide with those of local taxpayers (Erie et al.,
2011). Even as the magnitude of government financial challenges has grown,
the political capacity for addressing them has continued to shrink.
KEY ISSUES FOR FUTURE RESEARCH
Financial crises at the state and local level have a tremendous impact on
the lives of ordinary constituents and service users. As governments lay off
workers, reduce service levels, or increase taxes to regain their fiscal footing, public policies create hardships for many families. The collateral damage
from such crises, in other words, is substantial, so scholarly efforts to identify
their causes and examine potential institutional and political reforms to avert
problems before they occur have the promise to make important scholarly
and societal contributions.
To do so, however, researchers must move toward better research designs
that allow them to draw credible causal inferences. To date, much of the
empirical work on the origins and causes of fiscal crises, particularly at the
local level, remain confined to single-city case studies and cautionary tales.
While such case studies are certainly informative for building new theories
8
EMERGING TRENDS IN THE SOCIAL AND BEHAVIORAL SCIENCES
and deriving testable hypotheses and propositions, they rarely provide credible evidence about causal processes. Examining only cases of financial distress leads to the well-known problem of selection on the dependent variable,
without providing a clear basis for counterfactual comparison. The fact that
truly serious financial crises are incredibly rare, even though the factors cited
by scholars for their causes—voter apathy or misinformation, strong interest groups, economic business cycles—are far more prevalent, suggests that
something important is missing from pictures painted by the widely read
and closely studied cases. Although many factors identified in the literature
appear to be necessary conditions for financial calamities and government
bankruptcies, few of them are sufficient.
Aside from a few notable exceptions (e.g., Baldassare, 1998; Clark & Ferguson, 1983; Erie et al., 2011), much of the existing work on fiscal stress and
crisis generally focuses on elite actors in and outside of government, while
paying scant attention to the role played by ordinary voters. To the extent
that voters enter the picture, they are generally portrayed as victims of mismanagement, corruption, or malfeasance. Yet publicly officials are almost
always constrained by the preferences of their constituents and many of the
short-term decisions linked to long-term problems are rooted in the electoral
incentives faced by officeholders. In order to understand the political conditions that give rise to financial problems, scholars must place ordinary voters
and the decisions they make at the ballot box front and center.
Finally, financial problems rarely go away when deficits disappear or when
governments regain access to the public bond markets. Efforts to increase
taxes or make substantial service cuts that are necessary to balance the budget result in long-run consequences, both for the end-users of government
services and for the political actors responsible for making the tough decisions. Although the question of why crises occur has been well studies by
scholars, understanding how governments respond to such crises and the distributional consequences of financial reforms enacted in response requires
substantially greater attention from scholars. Although there may be few
winners during tough economic times, varying policy responses clearly produce different sets of losers.
REFERENCES
Alt, J. E., & Lowry, R. C. (1994). Divided government, fiscal institutions, and budget
deficits: Evidence from the states. American Political Science Review, 88(4), 811–828.
Anzia, S. F. (2011). Election timing and the electoral influence of interest groups. Journal of Politics, 73(2), 412–427.
Anzia, S. F., & Moe, T. M. (2013). Public sector unions and the costs of government.
Unpublished manuscript.
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9
Australia Industry Commission (1996). Competitive tendering and contracting by public
sector agencies. Report No. 48.
Baldassare, M. (1998). When government fails: The orange county bankruptcy. Berkeley,
CA: UC Press.
Beauregard, R. A. (2003). Voices of decline: The postwar fate of U.S. cities (2nd ed.). New
York, NY: Routledge.
Berry, C. R. (2009). Imperfect union: Representation and taxation in multilevel governments. New York, NY: Cambridge University Press.
Clark, T. N., & Ferguson, L. C. (1983). City money: Political processes, fiscal strain, and
retrenchment. New York, NY: Columbia University Press.
Congressional Budget Office (2010). Fiscal stress faced by local governments. Economic
and Budget Issue Brief.
Erie, S. P., Kogan, V., & MacKenzie, S. A. (2011). Paradise plundered: Fiscal crisis and
governance failures in San Diego. Stanford, CA: Stanford University Press.
Fuchs, E. R. (1992). Mayors and money: Fiscal policy in New York and Chicago. Chicago,
IL: University of Chicago Press.
Hanson, R., Wolman, H., Connolly, D., Pearson, K., & McManmon, R. (2010). Corporate citizenship and urban problem solving: The changing civic role of business
leaders in American cities. Journal of Urban Affairs, 32(1), 1–23.
International City-County Management Association (2007). Profile of local government service delivery choices, 2007. http://icma.org/Documents/Document/
Document/100022.
Judd, D. R. (2002). Infrastructure of play: Building the tourist city. New York, NY: M.E.
Sharpe.
Kiewiet, D. R., & McCubbins, M. D. (2014). State and local government finance: The
new fiscal ice age. Annual Review of Political Science, 17, 3.1–3.17.
King, G., & Zeng, L. (2001). Logistic regression in rare event data. Political Analysis,
9(2), 137–163.
Klarner, C. E., Phillips, J. H., & Muckler, M. (2012). Overcoming fiscal gridlock: Institutions and budget bargaining. Journal of Politics, 74(4), 992–1009.
Kogan, V. (2014). Market-based policy diffusion and the origins of the public pension crisis.
Unpublished manuscript.
Kogan, V., & McCubbins, M. D. (2010). Changing tracks? The prospect for California
pension reform. California Journal of Politics and Policy, 2, 1–17.
Kousser, T., McCubbins, M. D., & Moule, E. (2008). For whom the TEL tolls: Can state
tax and expenditure limits effectively reduce spending? State Politics and Policy
Quarterly, 8(4), 331–361.
Ladd, H. F., & Yinger, J. (1989). Ailing cities: Fiscal health and the design of urban policy.
Baltimore, MD: Johns Hopkins University Press.
Maciag, M. (2013). How rare are municipal bankruptcies? Governing. http://www.
governing.com/blogs/by-the-numbers/municipal-bankruptcy-rate-and-statelaw-limitations.html.
Martin, I. W. (2008). The permanent tax revolt: How the property tax transformed American
politics. Stanford, CA: Stanford University Press.
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EMERGING TRENDS IN THE SOCIAL AND BEHAVIORAL SCIENCES
Moe, T. M. (2006). Political control and the power of the agent. Journal of Law, Economics, and Organization, 22(1), 1–29.
Novy-Marx, R., & Rauh, J. D. (2009). The liabilities and risks of state-sponsored pension plans. Journal of Economic Perspectives, 23(4), 191–210.
Poterba, J. M. (1994). State responses to fiscal crises: The effects of budgetary institutions and politics. Journal of Political Economy, 104(4), 799–821.
Poterba, J. M. (1995). Balanced budget rules and fiscal policy: Evidence from the
states. National Tax Journal, 48(3), 329–36.
Sears, D. O., & Citrin, J. (1982). Tax revolt: Something for nothing in California. Cambridge, MA: Harvard University Press.
Shefter, M. (1985). Political crisis/fiscal crisis: The collapse and revival of New York city.
New York, NY: Basic Books.
Wallis, J. J. (2005). Constitutions, corporations, and corruption: American states
and constitutional change, 1842 to 1852. Journal of Economic History, 65(1), 211–256.
VLADIMIR KOGAN SHORT BIOGRAPHY
Vladimir Kogan is an Assistant Professor at The Ohio State University’s
Department of Political Science, where he studies state and local politics and
political reforms. He is the coauthor of Paradise Plundered: Fiscal Crisis and
Governance Failures in San Diego (Stanford University Press, 2011). His work
has been published in American Politics Research, Political Communication, Rutgers Law Journal, State Politics and Policy Quarterly, and Urban Affairs Review.
His research website can be accessed at: http://u.osu.edu/kogan.18/.
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Causes of Fiscal Crises in State and
Local Governments
VLADIMIR KOGAN
Abstract
Financial insolvency is a rare occurrence in American state and local governments.
However, when it does happen, as in the case of Detroit’s historical bankruptcy filing in 2013, the consequences for vital city services, public employees, and taxpayers
can be devastating. This essay reviews existing and emerging research on the causes
of government fiscal crises, paying particular attention to how social, economic, and
legal constraints interact with the electoral incentives faced by public officials to create financial distress. It concludes by identifying a number of open questions that
should guide future research, to help identify potential institutional and political
reforms that can help avert future problems before they occur.
When the city of Detroit filed for bankruptcy protection in mid-July 2013,
it became the largest municipal bankruptcy in US history, with outstanding
debt of nearly $20 billion. Although Detroit was by far the biggest city to go
broke, it was far from alone. In the two years leading up to of its filing, two
other major cities—Stockton and San Bernardino, both in California—filed
for protection under the same section, Chapter 9, of the federal bankruptcy
code. A few years earlier, another California city, Vallejo, announced that it
could no longer pay its bills as they became due and sought protection of
its creditors. Although it had emerged from the bankruptcy process in 2011,
Vallejo again seemed poised on the precipice of a financial abyss at the time
of Detroit’s filing.
At first glance, the proximate causes of these high profile financial crises
appear to be quite varied. Detroit succumbed to insolvency after decades
of declining population, deindustrialization, and poor fiscal management.
Stockton had bet heavily on the “infrastructure of play” (Judd, 2002), taking out substantial debt to finance the construction of minor league sports
venues, revitalize its marina, refurbish its historic theater, and upgrade its
Emerging Trends in the Social and Behavioral Sciences. Edited by Robert Scott and Stephen Kosslyn.
© 2015 John Wiley & Sons, Inc. ISBN 978-1-118-90077-2.
1
2
EMERGING TRENDS IN THE SOCIAL AND BEHAVIORAL SCIENCES
City Hall. The bet did not pay off. San Bernardino suffered disproportionately from the housing market collapse that accompanied the 2008 financial crisis, while Vallejo faced mounting bills for generous benefits promised
to its city employees, a problem that caused another city, Central Falls in
Rhode Island, to declare bankruptcy in 2011. Yet, the experiences of these
cities share an underlying pattern: In each case, financial ruin came about as
an unintended result of city leaders working within rigid social and economic
constraints while trying to respond to the electoral pressures from their constituents and other political stakeholders.
This essay reviews the political economy of fiscal ruin, focusing on the
causes of solvency crises in state and local governments. As will become
clear, the research on the origins of public-sector financial stress is limited
by the fact that truly catastrophic fiscal failures occur quite infrequently.
Between 2008 and 2013, for example, lesser than 0.05% of municipalities
filed for bankruptcy protection in federal court (Maciag, 2013). Because the
traditional workhorses of empirical social science research—sophisticated
multivariate econometric models—do not perform well in predicting such
“rare events” (King & Zeng, 2001), much of the literature of government
fiscal crises takes the form of individual case studies. While this literature
has yielded important insights on the causes of these crises, which I review
in the following section, it has also left open a number of important questions
of interest to both scholars and policy practitioners, which I discuss at the
conclusion of this essay.
FOUNDATIONAL RESEARCH
WHAT WE KNOW ABOUT FISCAL CRISES
Although municipal bankruptcies and government fiscal crises are extraordinary events, substantial budget deficits and episodes of fiscal stress occur
with relative frequency at both the state and local levels and follow a
predictable pattern. As a general rule, public finances track the economic
business cycle, deteriorating during recessions and improving again as the
economy recovers. The trend has a clear institutional explanation: Unlike
the federal government, which can run large deficits during economic
downturns to stimulate private demand, nearly every state and most local
governments face a binding balanced-budget requirement (Poterba, 1995).
This presents state and local officials with serious policy challenges. On
the one hand, economic downturns generally increase demand for public
services these governments provide. As workers lose their job and see their
personal incomes decline, they become eligible for cash aid and Medicaid
services, which are funded partly out of state coffers. Similarly, high unemployment has historically coincided with rising crime rates, requiring cities
Causes of Fiscal Crises in State and Local Governments
3
to increase investment in law enforcement services during downturns. On
the other hand, state and, to a lesser extent, local government revenues
decline during recessions, as job losses translate to lower income and sales
tax receipts. This is especially true for states, such as California, that rely
on volatile capital gains taxes for a substantial share of their revenues.
With service demands and revenues moving in opposite directions, elected
officials must choose between cutting government programs and increasing
tax rates—both politically unpopular options—in order to balance their
budgets or find stealth ways to delay the day of fiscal reckoning, by using
short-term loans to paper over deficits, deferring capital maintenance, or
reducing payments into pension plans (Congressional Budget Office, 2010).
For these reasons, government fiscal crises often occur in waves, coinciding with broader economic shocks. The financial panics of the late 1830s,
for example, triggered a series of state government defaults, which led to
important state constitutional reforms in areas of government borrowing and
corporate regulations (Wallis, 2005). During the Great Depression, both state
and local governments were overwhelmed by public demand for welfare
services, historically provided by lower level governments, which in part
motivated the creation of the federal welfare state. Similarly, the period of
economic stagflation during the 1970s contributed to financial troubles in
some major cities, including Chicago and New York (Fuchs, 1992).
The close empirical relationship between the state of the economy and
government balance sheets also explain the recent financial struggles faced
by declining industrial cities, including Detroit. In the period since World
War II, many urban centers in the industrial Northeast and the Midwest have
experienced substantial population losses, as many upper- and middle-class
residents left the central city for the surrounding suburbs. These population
shifts had an undeniable racial dimension, with out-migration of wealthier
whites exacerbating housing segregation and resulting in large swathes
of concentrated poverty in many major cities (Beauregard, 2003). By the
1970s, some major employers began to follow their workers, moving their
offices from the central city to outlying suburbs. Globalization, which
disproportionately affected older industrial cities with a big manufacturing
presence, further exacerbated these big-city employment losses, marking
an era of deindustrialization and manufacturing decline that has continued
through the first decade of the twenty-first century.
The loss of their wealthiest taxpayers and some of the largest employers
dramatically reduced the tax base in many urban areas during this period
(Ladd & Yinger, 1989). Between 1950 and 2012, for example, the population of
the city of Detroit fell sharply from nearly 1.9 million people to about 700,000.
However, declining population has usually not been matched by a proportional reduction in service demands or local government costs. In part, this
4
EMERGING TRENDS IN THE SOCIAL AND BEHAVIORAL SCIENCES
is due to the geographically diffuse nature of out-migration. As residents
left the central city, but not any neighborhood in particular, the reduction
in population density has required city agencies to continue to cover the
same geographic footprint, reducing the efficiency of services. High rates of
concentrated poverty and crime in many major cities have also required substantial government investment to improve living and working conditions
of their residents and help avoid pushing even more city dwellers to safer,
wealthier suburbs that do not face similar social and economic challenges.
Balanced-budget requirements and how these institutions interact with the
broader economic and social context mean that elected officials often find
themselves at the whim forces beyond their direct control in the sphere of
public finance. Even the most fiscally prudent public servants cannot escape
the feast-and-famine cycle of driven by macroeconomic ups and downs,
although they might temper these impacts by setting aside generous budget
reserves during good times to prepare for future economic slowdowns.
Since the 1970s, moreover, government officials have faced even greater
constraints in their fiscal authority and flexibility owing to the passage
of tax and expenditure limitations (often referred as TELs), often through
mechanisms of direct democracy. This trend began with the passage of
Proposition 13 in California but quickly spread across the country (Martin,
2008).
Individual TELs vary substantially but most set limits on overall tax rates,
how much these rates can be increased over time, and how quickly property
may be reassessed to reflect current market rates for the purpose of taxation.
Some TELs also impose procedural requirements—such as voter approval or
super-majority vote thresholds—before taxes can be raised. Although most
TELs target local government taxing authority, others—such as Colorado’s
recently weakened Taxpayers Bill of Rights (TABOR)—also have tremendous
impact on state finances (Kousser, McCubbins, & Moule, 2008). California’s
Proposition 13 appeared to play a pivotal role in the bankruptcy of Orange
County (Baldassare, 1998), one of the largest local government default until
Detroit, and in the decade-long fiscal crisis faced by San Diego (Erie, Kogan,
& MacKenzie, 2011).
To say that external and exogenous forces constrain state and local policy
options does not, however, let policymakers in these levels of government off
the hook for allowing fiscal stress to turn into unmanageable crisis or default.
Public officials can and do respond to similar cyclical and demographic challenges in different ways, with political factors serving an important moderating role. States with unified partisan control of government, for example,
appear to react quicker to unanticipated economic shocks, adjusting policies
accordingly (Alt & Lowry, 1994; Klarner, Phillips, & Muckler, 2012; Poterba,
1994). Elections, on the other hand, limit necessary but politically unpopular
Causes of Fiscal Crises in State and Local Governments
5
adjustments, with incumbents fearful of upsetting voters in an election year
(Poterba, 1995).
At the local level, the diffusion of authority between political and legal
offices can raise the cost of coordination, resulting in undesirable policy
choices and slow responses in the face of worsening fiscal conditions, while
strong party organizations have been shown to lead to more responsible
policy (Berry, 2009; Fuchs, 1992; Shefter, 1985). Some scholars also point to
the role played by ordinary voters and the local “political culture” in laying
the groundwork for poor fiscal outcomes (Clark & Ferguson, 1983; Erie et al.,
2011). When voters do not understand—or perhaps are convinced by political entrepreneurs to ignore—the reality that popular government services
must be funded by unpopular taxes and instead demand “something for
nothing” (Sears & Citrin, 1982), elected officials face tremendous political
pressure to oblige, often resulting in unsustainable policy choices or obscure,
off-budget spending that solves short-term political problems but increase
the risk of long-term insolvency.
CUTTING-EDGE RESEARCH
EMERGING RESEARCH QUESTIONS AND AGENDAS
The research described in the previous section provides much important context and background for understanding the experience of fiscally stressed
state and local governments during the twentieth century. In the new millennium, however, the types of fiscal challenges facing policymakers and the
actors involved in responding to them appear to be changing, developments
that are prompting new lines of scholarly research.
Although public-sector employees have long been recognized as important
stakeholders and active participants in the public policy process, they have
attracted renewed critical attention from many political observers in recent
years. One reason is growing concern about the sustainability of public pensions and other post-employment benefits promised to government workers,
together accounting for some of the largest unfunded long-term liabilities
facing state and local governments (Kieweit & McCubbins, 2014). In recent
years, almost every state has passed some form of pension-reform legislation,
although financial experts project that these changes will do little to address
the long-term solvency of public pension funds (Novy-Marx & Rauh, 2009).
When viewed in historical context, the salience of present-day pension
woes are in many ways surprising: since the 1970s, public pension funds and
their government sponsors have faced increasing accounting and funding
rules, meaning that public pensions in the modern era are probably better
funded than they’ve ever been before (Kogan, 2014). Indeed, until the 1970s-
6
EMERGING TRENDS IN THE SOCIAL AND BEHAVIORAL SCIENCES
and 1980s-era reforms, most pensions were funded on a pay-as-you-go
basis, with no actuarial pre-funding, something even the worst-managed
pension funds today dare not do.
One reason for why pension shortfalls have attracted so much political
attention may be that the vast majority of pension assets today are invested
in the stock market, exacerbating cyclical fiscal stress faced by their government sponsors. During good economic times, strong pension investment
earnings reduce the amount state and local governments must contribute to
pre-fund employee retirement benefits. During recessions, however, disappointing earnings mean that fund sponsors must increase contributions at
exactly the moment they confront falling revenues and are forced to make
cuts to other popular government programs, making public employee pensions a political albatross around the neck of elected officials (Kogan, 2014).
In other words, public pension are as much a political problem as a policy
problem, with government sponsors paying the least when they can most
afford to and contributing the most when it is politically infeasible to do so
(Kogan & McCubbins, 2010).
Thanks to high rates of unionization among public employees, another
phenomenon that dates back only to the 1970s most states, government
workers are also better organized than most other diffuse interest groups to
fight off retrenchment in government spending (Anzia & Moe, 2013). Public
employees can exercise their influence through a variety of channels. Some
unionized workers, such as firefighters and police officers, can leverage their
high esteem among regular voters to make endorsements contingent on
candidate support for pro-labor policies. In many state and local contests,
public employees also represent an important source of campaign resources,
including monetary donations and volunteer man hours, which can help
labor-aligned candidates win office. At the local level, low turnout among
ordinary voters also means that the voices of government employees may
be heard disproportionately at the ballot box (Anzia, 2011; Moe, 2006).
Given what some perceive to be overweening influence of public employees over government actors, many political reformers and some scholars
have advocated reforms, such as the outsourcing the provision of public
services to private contractors, meant to weaken organized labor. Such
arguments suffer from two logical weaknesses, however. First, it is unclear
why public employees—even politically influential and well-organized
employees—have any reason to exacerbate financial challenges or precipitate fiscal crises for their employers. Since public employment opportunities
and membership dues at the end of the day depend on the financial health of
government employers, even self-interested unions have a clear interest in
looking out for the long-term solvency of the agencies at which their members work. Second, there are few reasons to expect that private contractors
Causes of Fiscal Crises in State and Local Governments
7
will be any less malevolent than their public-sector counterparts. Having
won a contract to provide public services, these firms should be expected
to fight just as hard, and make just as many campaign contributions, to
avert budget cuts that reduce their profits. These reasons may explain
why the empirical literature has generally found mixed evidence about the
cost-effectiveness of government outsourcing efforts (e.g., Australia Industry
Commission, 1996; International City-County Management Association,
2007).
Even as public employees have gained political influence, their traditional adversaries in the business community have taken on a lower
profile, particularly in local government. Scholars have attributed the
declining “corporate citizenship” and civic advocacy in political affairs to
the consolidation of major local business into bigger multinational firms
and their increasing global focus (Hanson, Wolman, Connolly, Pearson,
& McManmon, 2010; Poterba 1994). With low level executives no longer
expecting to spend most of their career in a single location and with business
profits less tied to the health of their local economy, corporate leaders have
become increasingly disengaged from local public affairs, weakening their
traditional role as government watchdogs and governing partners. In their
place, local political debates have come to be dominated by single-issue,
place-based businesses, such as land developers and local hotel owners,
who have few roots in the local community and whose long-term interests
are much less likely to coincide with those of local taxpayers (Erie et al.,
2011). Even as the magnitude of government financial challenges has grown,
the political capacity for addressing them has continued to shrink.
KEY ISSUES FOR FUTURE RESEARCH
Financial crises at the state and local level have a tremendous impact on
the lives of ordinary constituents and service users. As governments lay off
workers, reduce service levels, or increase taxes to regain their fiscal footing, public policies create hardships for many families. The collateral damage
from such crises, in other words, is substantial, so scholarly efforts to identify
their causes and examine potential institutional and political reforms to avert
problems before they occur have the promise to make important scholarly
and societal contributions.
To do so, however, researchers must move toward better research designs
that allow them to draw credible causal inferences. To date, much of the
empirical work on the origins and causes of fiscal crises, particularly at the
local level, remain confined to single-city case studies and cautionary tales.
While such case studies are certainly informative for building new theories
8
EMERGING TRENDS IN THE SOCIAL AND BEHAVIORAL SCIENCES
and deriving testable hypotheses and propositions, they rarely provide credible evidence about causal processes. Examining only cases of financial distress leads to the well-known problem of selection on the dependent variable,
without providing a clear basis for counterfactual comparison. The fact that
truly serious financial crises are incredibly rare, even though the factors cited
by scholars for their causes—voter apathy or misinformation, strong interest groups, economic business cycles—are far more prevalent, suggests that
something important is missing from pictures painted by the widely read
and closely studied cases. Although many factors identified in the literature
appear to be necessary conditions for financial calamities and government
bankruptcies, few of them are sufficient.
Aside from a few notable exceptions (e.g., Baldassare, 1998; Clark & Ferguson, 1983; Erie et al., 2011), much of the existing work on fiscal stress and
crisis generally focuses on elite actors in and outside of government, while
paying scant attention to the role played by ordinary voters. To the extent
that voters enter the picture, they are generally portrayed as victims of mismanagement, corruption, or malfeasance. Yet publicly officials are almost
always constrained by the preferences of their constituents and many of the
short-term decisions linked to long-term problems are rooted in the electoral
incentives faced by officeholders. In order to understand the political conditions that give rise to financial problems, scholars must place ordinary voters
and the decisions they make at the ballot box front and center.
Finally, financial problems rarely go away when deficits disappear or when
governments regain access to the public bond markets. Efforts to increase
taxes or make substantial service cuts that are necessary to balance the budget result in long-run consequences, both for the end-users of government
services and for the political actors responsible for making the tough decisions. Although the question of why crises occur has been well studies by
scholars, understanding how governments respond to such crises and the distributional consequences of financial reforms enacted in response requires
substantially greater attention from scholars. Although there may be few
winners during tough economic times, varying policy responses clearly produce different sets of losers.
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IL: University of Chicago Press.
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Moe, T. M. (2006). Political control and the power of the agent. Journal of Law, Economics, and Organization, 22(1), 1–29.
Novy-Marx, R., & Rauh, J. D. (2009). The liabilities and risks of state-sponsored pension plans. Journal of Economic Perspectives, 23(4), 191–210.
Poterba, J. M. (1994). State responses to fiscal crises: The effects of budgetary institutions and politics. Journal of Political Economy, 104(4), 799–821.
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VLADIMIR KOGAN SHORT BIOGRAPHY
Vladimir Kogan is an Assistant Professor at The Ohio State University’s
Department of Political Science, where he studies state and local politics and
political reforms. He is the coauthor of Paradise Plundered: Fiscal Crisis and
Governance Failures in San Diego (Stanford University Press, 2011). His work
has been published in American Politics Research, Political Communication, Rutgers Law Journal, State Politics and Policy Quarterly, and Urban Affairs Review.
His research website can be accessed at: http://u.osu.edu/kogan.18/.
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