Local fiscal autonomy requires constraints: the case for fiscal menus.

• Author: Shanske, Darien

INTRODUCTION I. CITY DEBT AND THE BASIC CHALLENGE II. MODELS FOR STATE CONTROL PRACTICES III. SO WHAT WILL THESE REFORMS ACCOMPLISH AGAIN? IV. LARGER LESSONS V. ANYPLACE ELSE? YES, TAXES CONCLUSION INTRODUCTION

At the state level, the worst of the fiscal crisis seems to have subsided, (1) for now. (2) At the local level, there is some dispute as to whether the worst is still to come, (3) but in any event, localities have had a very bad recession. (4) One measure of this is the various records set in filings for municipal bankruptcy. (5) Indeed, municipal bankruptcy had previously been so rare that fundamental questions of law have not yet been determined. It is possible that the law established by the current municipal bankruptcies, and in particular as to pension obligations, might itself encourage more bankruptcies. (6) That is, if the courts--and possibly the Supreme Court--were to adopt a relatively lenient rule as to when pensions could be trimmed, then that might make filing for municipal bankruptcy considerably more appealing. (7)

Whatever is to come, this is a moment of relative repose and so an apt moment to consider whether and how the fiscal powers of local governments can be reformed. In this Article, I will focus upon cities, which as bottom-up general-purpose governments have, I believe, the strongest argument in their favor that they should be given very significant fiscal powers. By "bottom-up" entities, I mean that cities, at least at one moment in (perhaps mythological) time, were started by a community that affirmatively chose self-government through taking an external action, such as adopting a charter. (8) Both as a matter of history and theory, taking control over the use of one's tax dollars was and is central to the decision to incorporate a community as a city. Even now, when there are many cities already in existence, not everyone must live in a city, and new cities can be created (or old cities dissolved). Counties, by contrast, are administrative units of states that cover the entire state, and so have weaker democratic credentials to the extent one thinks that a citizen's affirmative choice to live in a distinctive community should influence how much citizens should have control over their community.

One might conclude from the recent fiscal crises that there is considerable consensus that, going forward, cities ought to have less fiscal autonomy. (9) However, that is not at all the consensus, at least among prominent scholars of local government law. These scholars have powerful, if somewhat surprising, arguments that cities should have greater fiscal powers. (10) First, they argue that cities had generally already been operating under all manner of state-level fiscal restrictions. (11) Indeed, there is a good argument that the contortions cities went through to evade these restrictions further weakened their fiscal position. Second, given the failure of these state-level rules to date, why believe that new ones would be any better? (12) Third, there is good reason to believe that even a moderately well-functioning system of interjurisdictional competition is likely to do at least as well at regulating local fiscal affairs as a set of rules imposed from above. (13) It is much easier to leave a mismanaged city than a mismanaged state. Fourth, credit markets, though imperfect, are better guardians of municipal fiscal probity than the crude rules that currently restrain cities. (14)

Fifth, greater state control undermines the functioning of local democracies either as schools for citizenship or as competitors in a jurisdictional market. By hamstringing the ability of cities to fund themselves, the states are essentially denying themselves much of the possible benefit of having a decentralized system to begin with, while retaining most of the costs. That is, it is expensive and in many ways inefficient to have many duplicative local governments--why go to the trouble if cities cannot engage in meaningful experimentation? (15) Further, since cities have been hamstrung for so long, why assume that they will fail if given a reasonable set of powers? (16)

And so it appears that reformers face a simple and unpleasant choice--they can cither advocate for more imperfect state regulation of the type already in place or they can try to advocate for more local fiscal autonomy, trusting in the current agglomeration of non-state rule constraints, such as the credit markets, to channel that autonomy. I will argue that this is a false choice, that there can be a set of new state-level rules that enhance the operations of local democracy.

Taking a fresh look at the problem, this possibility should not seem very counterintuitive. Consider the standard form of a state-level rule governing the issuance of debt: the rule requires a local supermajority vote before a locality can borrow. These crude rules were usually put in place in the nineteenth century and thus:

[A]rose in an era prior to the advent of sophisticated bond markets, accounting standards for government issuers, federal disclosure requirements, the development of bond counsel as a legal specialty to pass on the legality and validity of bonds, the birth of rating agencies to track the financial stability of issuers, and the creation of a thick secondary market for bonds that provides bondholders with additional incentives to monitor performance of issuers. (17) It should not seem counterintuitive that we could do better. In particular, states can prohibit localities from using only the types of debt demonstrated to be most likely to get them into trouble despite the aforementioned safeguards, such as the credit markets. (18)

A smart reform would swap out a supermajority requirement for issuing debt for a requirement that a local government use an approved (vanilla) financing structure. (19) Such a nuanced reform would increase substantive local autonomy while also protecting the city from itself.

Or the matter could be put another way. It could be argued that I am most autonomous if I can go into a restaurant and order whatever dish I want based on the ingredients in the kitchen. But that's an impoverished kind of autonomy. This is because, left to my own devices, I will waste time pondering all the options and will then likely proceed to ask for something familiar. My autonomy is enhanced, at least in many respects, if the restaurant uses its expertise to provide me with a list of the best options, a menu. With a menu I can be introduced to better dishes than I could have thought of and, better yet, can choose among them. And, even better still, because there is a fixed menu my meal can be prepared relatively quickly and inexpensively, leaving me time and money to make other choices--choices that are more important to me. Without doubt, the initial choice to accept the restraints of a menu does limit my options, but it also opens up many other options that would not otherwise be available to me at all. It could therefore be autonomy enhancing to limit my freedom in this way. (20)

Returning to debt instruments, our choice as institutional designers should thus not be seen as one between granting a city the freedom to choose whatever the city would like and a single choice imposed from above. A menu can enhance autonomy; certain simple financing structures should be on the menu while more exotic instruments should not be.

But is debt a special case? I do not think so. The deeper lesson here is that there are certain decisions that can be withdrawn from the toolbox of local governments to the net benefit of local government autonomy because these are decisions over which local structures provide no leverage. I will develop this point a bit more at the end of the Article, but I will foreshadow it briefly. It is generally understood that most local voters are not informed about even large issues in their communities. Those who believe that, nevertheless, having a multiplicity of local governments is economically desirable, point to a marginal "homevoter," (22) who like the marginal consumer in a regular marketplace, is the educated consumer who actually sets prices. When it comes to comparing school quality and tax rates, there is some evidence that this homevoter exists. (23)

Similarly, if one believes that a multiplicity of local governments is justified because they can make good decisions as democracies, then one must believe that voters are either informed themselves or are somehow acting as if they are informed. At this point, it is impossible to argue that the voters are informed. (24) It is more plausible to believe that local voters are able to gather enough cues from political parties, public figures, or other citizens in order to make sound decisions. Admittedly, the evidence for such cues working is decidedly mixed, (25) but in theory I am persuaded that local democracies could work this way, (26) especially if reformed. (27)

But note that, on either general theory, namely that local democracy can work well through a quasi-market or through signaling, it takes truly heroic assumptions to believe that either mechanism will produce good results as to the specifics of debt instruments. This general theory of competitive non-advantage should not come as a surprise--local governments have already been relieved of similar decisions in other technical domains. Consider, for instance, utilities regulation.

Are there then other fiscal powers that ought to be adjusted? The answer is yes. I will briefly consider the power to tax. This may seem counterintuitive. After all, if cities cannot fund themselves, then there is little point in having them, and so how can I argue that the power to tax should be constrained? Yet here again cities are already hamstrung by many limitations of different vintages. The most cogent concern about taxes, as with debt, is that the taxes will be designed poorly and this concern too can be...