The Effect of Fiscal Decentralization on the Financial Condition of Municipal Government

Abstract

This study examines the effect of fiscal decentralization between states and their local governments on the financial condition of municipal governments. There are strong theoretical arguments on both sides of the federalism debate about the benefits for and against decentralization. Most of the research in this area investigates economic and social welfare consequences of fiscal decentralization. There is limited research, however, on the effects of fiscal decentralization on the financial health of local governments. Using data from the nation’s 150 largest cities, this study finds that intrastate fiscal decentralization results in weaker financial condition for municipalities in those states.

Keywords:

• fiscal decentralization
• financial condition
• municipal government

Notes

¹ Creating a dataset of this size with financial data originally from CAFRs is quite labor intensive. For this reason, the data in this study were sourced by way of Bloomberg LP. Due to availability and inconsistencies in reporting methods in the original CAFR documents, the Bloomberg dataset still contains missing values. For the dependent variable missing the most data (the cash ratio), only 8% of the data are missing and there is no reason to suspect that it is systematic.