MSU Extension

Executive Summary

One provocative pattern to emerge from the Great Recession is that instances of acute local fiscal distress have clustered in certain states and not others. As recently as last year in Michigan, a state appointed Emergency Manager was operating in each of 17 local governments and school districts. A recent California Policy Center report suggests that more than a dozen cities and counties in California – a state that has already experienced three recent, high-profile municipal bankruptcies and a nearbankruptcy in San Jose, the “capital of Silicon Valley” – are on the cusp of defaulting on general obligation bonds.

With the generous support of the C.S. Mott Foundation and Michigan State University, we have engaged in a multi-pronged, multi-method research program to assess the crucial but often overlooked role of state governments in shaping the ways in which cities respond to financial difficulties. This report, based on our analysis of a unique, nearly half-century-long dataset of state and local financial and policy information and correspondence with state officials, analysts and legal experts involved in state-local fiscal affairs, elaborates several key findings:

• Municipal fiscal distress is not simply a local problem. State laws and policies provide state governments with extraordinary influence over the ability of cities to balance revenue and expenditure flows. The common perception that critical taxing and spending decisions are largely within a city government’s control tends to conceal this fundamental detail about American statelocal fiscal relations.
• The ways in which state lawmakers act on this influence varies from state to state and over time. We refer to the complex mix of laws and policies that prescribe the powers, rights and capacities of local lawmakers to respond to their financial conditions as the state context for local fiscal distress. Section 1 of this report assesses key elements of this state context for the lower 48 states since 1970.
• Some states incubate local financial stress by simultaneously driving up spending pressures on their cities while curtailing their capacity to raise critical revenue. Since the 1970s, the proliferation of state-imposed tax revenue limitations, coupled with recurring cuts to state aid, has fostered a system that limits a city’s ability to fund critical services. Some state governments further undermine the fiscal capacity of their cities via state laws and policies that engender steep expenditure-side pressures (e.g., devolving program responsibilities or driving up labor costs). We classify these states as incubators of fiscal distress.
• Michigan incubates financial stress among its local governments. Michigan’s particular mix of stringent limitations on local revenue and its relatively low level of financial assistance to cities, coupled with spending pressures stemming from spiking local service burdens and increased labor costs, creates conditions that drive up the potential for local fiscal distress.
• Because state governments can foster dramatically different state contexts for local fiscal stress, there is no single model policy for state intervention in distressed cities or for prevention of local fiscal distress. A policy that does not address a state’s unique context is unlikely to help cities escape financial trouble over the long term. State lawmakers must decide which legal and political tradeoffs they are willing to make to support city fiscal health. Michigan lawmakers, for instance, must recognize that the state context contributes to the problem of local fiscal distress. An aggressive intervention policy does little to curtail the consequences of this state-imposed context. Section 2 of this report draws policy lessons from comparable states in an effort to illustrate alternative approaches to state involvement in local fiscal affairs.

This report’s practical recommendations are aimed at assisting the C.S. Mott Foundation, state and local officials, and Michigan residents in identifying a more effective policy and legal approach to local fiscal crises. These are not overly startling recommendations, yet they are easy to neglect because policymakers tend to focus more on shortterm political gain rather than the histories and unintended consequences of policies that, over time, become increasingly difficult to alter. Some key recommendations:

• Creating a state agency that coordinates services to local governments and offers technical support and fiscal monitoring.
• Raising awareness among citizens and state decision makers that the causes of fiscal distress are not solely at the local level. Though state governments are certainly part of the solution, they can be a big part of the problem as well.