THE DYNAMICS OF MUNICIPAL FISCAL ADJUSTMENT

by

Thiess Buettner
ifo
and
Munich University
Poschingerstrasse 5
D-81679 Munich
GERMANY

and

David E. Wildasin
Martin School of Public Policy
and
Department of Economics
University of Kentucky
Lexington, KY 40506-0027
USA

Abstract

The dynamic fiscal policy adjustment of local jurisdictions is investigated empirically using a panel of more than 1000 U.S. municipalities over a quarter of a century. Distinguishing own-source revenue, grants, expenditures, and debt service, the analysis is carried out using a vector error-correction model which takes account of the intertemporal budget constraint. The results indicate that a large part of the adjustment in response to fiscal imbalances takes place by offsetting changes in future expenditures. In addition, the results show that fiscal imbalances are financed to a significant extent by subsequent changes in grants. Decomposition of the sample according to average city population reveals that the basic pattern of fiscal adjustment is robust, although intergovernmental grants play a much more pronounced role in maintaining budget balance for large cities.

David Wildasin / dew@davidwildasin.us

Last updated: September 19, 2005.