Measuring and Modeling Determinants of Fiscal Stress in US Municipalities

The recession of 2008 negatively affected many cities and counties across the United States, causing them to resort to extreme fiscal practices in order to respond to new budget pressures. Many localities were forced to declare fiscal emergencies, default on debt, and sometimes even lay off or furlough workers. Extreme cases of fiscal stress took place at the local level in California, Michigan, and Pennsylvania. Researchers can learn from these states’ responses about what causes fiscal stress and how policymakers can better respond in order to meet financial obligations.

This study highlights the importance of local fiscal policy that builds and uses adequate reserves to weather fiscal shocks. Increasing revenues, managing debt, and moving toward a reliance on property taxes can decrease the likelihood of experiencing fiscal stress. This latter policy is even more salient today than in previous decades because of the state-level initiatives to limit local taxing authority.

There are tradeoffs to weigh when choosing how to structure tax systems, but when diversification is paired with sound fiscal management of reserves, local officials can improve their government’s fiscal condition. This can help prevent worst-case scenarios, and policymakers will not have to make such difficult choices in times of fiscal stress.

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