Author:Park, Ji-Hyung

    Understanding how local governments respond to fiscal stress has been an important theoretical and empirical issue, especially since the mid-1970s. Fiscal choices are shaped by fiscal and political environments, and institutions in general (Hendrick, 2011). However, the extant cutback management literature has largely been relegated to fiscal and political environments: theoretical and empirical investigations of fiscal choices where resource scarcity influences cutback strategies (e.g., Levine, Rubin and Wolohojian, 1981a) and; investigations of fiscal choices where political environments affect cutback strategies (e.g., Wolman, 1980). The literature, in general, has not fully considered institutional effects on the implementation of cutback strategies during periods of fiscal distress. We propose to expand the theoretical understanding of cutback strategies by investigating the effects of institutional constraints on fiscal outcomes during the Great Recession of 2008-09.

    Tax and expenditure limitations, by their very definition, impose constraints on fiscal decision-making. More specifically, TELs, as fiscal institutions, are expected to shape or structure fiscal behavior and decisions of budgetary actors by providing certain incentives (von Hagen, 2002; Poterba and von Hagen, 2008) and by altering "the rules of politico-fiscal game" (Brennan and Buchanan, 1979, p.11). At the local level, the predominant TEL is on property tax rates and/or property tax levies but in other states such as Arizona and Colorado, these limitations extend to total operating revenues and expenditures. Conversely, local TELs are nonexistent in states such as Delaware, Vermont, Utah and Kansas. (1) Given this institutional variation, we hypothesize that the implementation of cutback strategies by municipal officials will be mitigated by the stringency of TELs.

    To test our research hypothesis, this study focuses on a cross-section of municipalities throughout the U.S. during and shortly after the 2008-09 recession. We build empirical models which examine the effects of TELs constraints on fiscal outcomes; observed differences in fiscal outcomes are interpreted in terms of the impact of the restrictiveness of local TELs on cutback strategy choices. The following section reviews literature on cutback management and local TELs. The next sections are devoted to explain the methodology and findings. The last section draws discussion and conclusions.


    At the heart of this study is the work by Levine (1980) who typically identified a set of fiscal retrenchment strategies on the expenditure side and proposed that adoption of the specific strategies was based on the level of fiscal stress, or resource scarcity. Levine et. al. (1981a) suggest that local governments generally implement cost saving strategies such as deferring maintenance, drawing down unreserved fund balances and debt financing under conditions of low fiscal stress. Moderate levels of fiscal stress require cost cutting strategies such as across-the-board cuts for public programs and facilities, as well as personnel cost cuts. More severe levels of fiscal stress require cuts in public services, service elimination and/or personnel cuts. Hendrick (2011) more recently added a fourth tier of response strategies that correspond with extreme resource scarcity; illegal actions, filing for bankruptcy and/or state takeover of financial matters. Thus, different fiscal responses correspond to different levels of resource scarcity in order to maximize fiscal retrenchment effectiveness (Plerhoples and Scorsone, 2013).

    The empirical evidence supports this relationship between resource scarcity and cutback strategies. In the case of the City of Oakland (Levine et al., 1981b), the choice of fiscal retrenchment strategies differed depending on the level of resource scarcity. The city implemented cost saving strategies such as deferring capital projects and freezing salaries and new hires under conditions of low fiscal stress. When fiscal stress elevated to the moderate and severe levels, the city's fiscal retrenchment strategies shifted to deep public service cuts for fire, police, street repairs, recreation, and library systems (Levine et al.,1981a). Lewis (1984) found that twelve major cities' revenue and expenditure patterns were incremental under good fiscal health, but these patterns were decremental under poor fiscal health. Thus, consistent with ordered decision-making, higher levels of perceived fiscal stress and budget deficits were positively associated with the implementation of across-the-board cuts (Lewis, 1984), and targeted cuts (Jimenez, 2014).

    Regarding the role of political environments on fiscal choices, scholars have typically focused on the revenue side of cutback strategies, arguing that cutback management relies on the extent to which fiscal decision makers manage current political conflicts with stakeholders, interest groups, and taxpayers. Wolman (1980) suggest that the implementation of fiscal retrenchment strategies is not simply about linking actions to levels of fiscal stress but that the response strategies by decision-makers must also consider managing conflicts with citizens, stakeholders, and interest groups. This rule assumes that citizens are reluctant to pay additional taxes for revenue raising strategies and that reluctance also extends to cutting public services (Morrison, 1980). Furthermore, fiscal decision makers need to manage opposition from stakeholders and interest groups, such as employee unions (Greenhalgh and McKersie, 1980; Wolman, 1980). Thus, under the condition of managing conflict, local governments are more inclined to pursue intergovernmental revenues (Walker, 1980) and raising user charges and fees (Mushkin and Vehorn, 1980). On the expenditure side, fiscal decision makers tend to prefer to implement cost saving strategies, such as deferring capital projects, that minimize conflicts of stakeholders (Bell, 1975).

    The role of politics and political conflict is pervasive in the cutback management literature. Not surprisingly, employees and employee unions tend to oppose reduced benefits and layoffs (Schachter, 1983; Jimenez, 2014; Kiefer, Hartley, Conway and Briner, 2014). For instance, during the 1975 fiscal crisis, the City of New York, NY could not utilize the options of the cost cutting strategy, such as layoffs, due to the strong opposition of employee unions (Schachter, 1983). In addition to public employees, other sources of conflict include those with citizens and other interest groups. Several studies have found that higher levels of taxpayer conflict are associated with higher levels of cost cutting and saving strategies than tax policy strategies (Greenhalgh and McKersie, 1980; Peters and Rose, 1980; Wolman, 1980; Jimenez, 2014). Jimenez (2014) also found that local governments with a higher level of ethnic fragmentation tend to implement cost-saving strategies such as reduced travel budget and professional development budget.

    Although few studies explore the impact of institutional constraints on cutback approaches, there is a substantial body of work on the role of fiscal institutions--the focus here is on tax and expenditure limitations--that is applicable to the cutback literature. Much of the early cutback management literature appears to assume that response strategies are universally available to decision-makers and that the selection criteria are merely a function of distress levels and/or political will. In reality, the empirical evidence has been consistent in finding that tax limits affect local tax structures, including reliance on property taxes, other tax sources (e.g., sales taxes) non-tax sources (including fees/changes and intergovernmental aids) and total revenues. Preston and Ichniowski (1991), in one of the first cross-section studies over time found that property tax rate limits in conjunction with assessment limits reduces property taxes. This work is supported by Fisher and Gade (1991), Shadbegian (1998), Cutler, Elmendorf and Zeckhauser (1999), Skidmore (1999), Johnston, Pagano and Russo (2000), Hoene (2004), Dye, McGuire and McMillen (2005) and Sun (2014). Shadbegian (1999) also found that the level of TEL stringency affected revenue structures--the stricter the TEL, the less the entity's reliance on own-source revenues.

    What is less clear is the effect of TELs on overall revenue structures. The evidence is mixed on the extent to which local governments under TELs compensate for levy reductions with other tax and non-tax revenue sources. According to Dye and McGuire (1997), Shadbegian (1998) and Chapman and Gorina (2012), local total revenues are lowered under TELs. Others find the opposite effect--TELs, while reducing property taxes, produce net revenue gains (Clair, 2012; Blom-Hansen, Baekgaard and Serritzlew, 2014; Sun, 2014). Local governments tend to compensate for property tax reductions through increases in intergovernmental aid (Mullins and Joyce, 1996; Skidmore, 1999; Johnston et al., 2000), and/or fees and charges (Johnston et al., 2000; Hoene, 2004; Sun, 2014).

    The research on local TELs has, perhaps not surprisingly, tended to focus on revenues but there is some empirical evidence that TELs also affect expenditures. Shadbegian (1998) found that local TELs decreased per capita expenditures. Chapman and Gorina (2012) find the opposite effect--TELs are associated with higher per capita expenditures. Blom-Hansen et. al. (2014), studied Danish municipalities under a central government-imposed TEL and found that per capita expenditures actually increased. Other research on TELs has found that institution structure matters. Maher, Deller and Amiel (2011) found that the form of county government under TELs affected fiscal outcomes. Following the TEL, Wisconsin counties under an Executive form of government had lower property tax burdens...

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