HOW DID LOCAL GOVERNMENTS RECOVER THEIR FINANCIAL CONDITION? LESSONS FROM CITIZEN PARTICIPATION.

• Author: Park, Ji Hyung

1. Introduction

   This study offers lessons for overcoming future economic crises by examining whether democratic management helped local governments recover their financial condition following the Great Recession. We focus on the role of citizen participation in the budgetary process. Fiscal downturns occur regularly, and some are severe. In the post-Great Recession era, many scholars predict that another financial crisis is imminent (Larson, 2019; Ramey, 2019). Thus, the study of financial condition has taken on greater value ever since.

   During the Great Recession, local governments were forced to make painful decisions regarding increased taxes and user charges, and cuts in public services (Bozeman, 2010). Undoubtedly, political bodies make these decisions, but scholars argue that government decisions should be legitimated by the public (Schmidt, 2013). Despite that, most studies of the determinants of financial condition emphasize the role of public officials (Pandey,

   2010) rather than the public (Bozeman, 2010). Several case studies provide evidence that citizen participation allows localities to increase property taxes as well as cut public services (Saintamour and Huggler 2010; Hoppe, 2014; He and Ma, 2021). However, broader, systematic empirical research is lacking. Studying the relationship between citizen participation and financial condition can begin to fill this gap and offer a new theoretical perspective on financial management.

   The Great Recession has had a deeper economic impact than any other economic crisis since the Great Depression of the early 20th century (Martin, Levey and Cawley, 2012). Its causes were also different from previous recessions. Many scholars warn us of another economic crisis after COVID-19 (Banerjee, Kharroubi and Lewrick, 2020; Brenner, 2021), arguing that government intervention delayed bankruptcy filings during COVID-19. However, hyperinflation and high-interest rates can lead homeowners to file for bankruptcies (Heckney and Friesner, 2021). Local governments may face fiscal difficulty if a high foreclosure rate generates the collapse of property and sales tax levies post-COVID-19, leading to painful financial decisions again. Thus, the purpose of this study is to gain an understanding of how local governments can cope with possible financial difficulties by examining the relationship between citizen participation and fiscal recovery.

   The next section reviews the relevant literature related to the financial condition, citizen participation in the budget process, and the hypothesized relationship between citizen participation, financial condition, and fiscal recovery. The methodology section then outlines the statistical models and data, followed by the findings section. The final section draws conclusions and implications from the results of the study.

2. Determinants of financial condition

   Financial condition is defined as the financial ability to maintain current and future service obligations to creditors, employees, citizens, and suppliers (Berne and Schramm, 1986; Jacob and Hendrick, 2012; McDonald, 2018). It has four components: cash, budgetary, long-term, and service-level solvency (see Chapman and Gorina, 2012; Maher, Ebdon and Bartle, 2020; Wang, Dennis and Tu, 2007).

   While there is agreement on the components of financial condition, a wide variety of perspectives have been used to empirically measure it. Some studies use a single measure, others use multi-dimensional measures, and still others use an index to attempt to capture different aspects at once. A single measure only represents a slice of financial condition (Maher, 2013), whereas multi-dimensional measures provide more information, but there are several issues, such as whether financial condition is a relative or absolute concept (Kloha, Weissert and Kleine, 2005); what is the acceptable level of measures to be considered as being in good health (Raju, 2011); which of the components should receive primary attention (e.g., long-term solvency and/or budgetary solvency) (Rivenbark and Roenigk, 2011); and the extent to which financial condition measurement should focus largely on general funds, government funds, or all funds (Jacob and Hendrick, 2012; Maher, Hoang and Hindery, 2020). Some scholars have used an index to capture multiple dimensions of financial condition with a single measure, an approach that allows for clearer conclusions when testing its determinants. However, the issue remains of which dimensions should be included in the index, and the appropriate weighting for the various dimensions is not clear (Maher, 2013; McDonald, 2018).

   Three major groups of factors have been found to influence financial condition. Fiscal outputs and outcomes are determined by decision-makers' management choices, which reflect the institutional and financial, and political environments (Hendrick, 2011). First, efficiency-oriented structures and institutions and decentralized institutions may lead to good financial condition. This theory assumes that fiscal outputs and outcomes are constrained to the purposes of current institutions and structures (Nelson and Maher, 2014). Empirical findings show that financial condition is improved by home rule privilege (Hendrick, 2011), audit systems (Aikins, 2011), strategic planning (Shelton and Albee, 2000), and tax and expenditure limitations (TELs) (Nelson and Maher, 2014).

   Second, an economic boom may result in good financial condition. Fiscal outputs and outcomes vary depending on changes in the level of financial resources determined by the economic environment (Fox and Sullivan, 1978; Hendrick, 2011). Empirical findings suggest that spending needs and revenue base are factors influencing financial condition. Increased spending needs for public infrastructure are negatively related to financial condition (Fox and Sullivan, 1978). This negative connection extends to revenue bases, such as a high poverty level (Jargowsky, 2003), low per capita income (Ladd and Yinger, 1989), and low population (Hendrick, 2011).

   Third, fiscal outputs and outcomes rely on the extent to which decision-makers fully manage the current political environment (Garcia-Sanchez, Mordan and Prado-Lorenzo, 2012). Decision-makers may not concentrate on fiscal efficiency because of political conflict that generates wasteful costs and spillovers (Morgan and Pelissero, 1980). Thus, decision-makers' skills in managing political conflicts may be relevant to maintaining financial conditions (Levine, Rubin and Wolohojian, 1981). The empirical effects of political variables on financial condition are uncertain though; for example, Hendrick (2011) found that nonpartisan elections have a positive, but not statistically significant, association with financial condition.

   However, studies of the determinants of financial condition often downplay the role of the management choices that can affect fiscal outputs and outcomes. In the contingency theory framework, decision-makers anticipate different outputs and outcomes by adopting different management choices in response to their environment (Perrow, 1967). In terms of the Great Recession, variations in management choices generated different levels of fiscal recovery across local governments (Fudge, 2014). Recently, scholars have begun to emphasize the relationship between management strategies and financial condition (Jimenez, 2017; Kim and Ryu, 2017). Localities may adopt democratic management to provide citizens with participatory opportunities, expecting to legitimize their decisions and produce desired outputs and outcomes (Schmidt, 2013). However, little is known about how management choices to utilize citizen participation during the Great Recession affected financial condition.

3. The role of citizen participation

   Although some studies indicate that citizens allow localities to make painful decisions regarding tax increases and public service cuts (Saintamour and Huggler, 2010; He and Ma, 2021), there is limited research on the relationship between citizen participation and fiscal decisions related to responses to fiscal stress. Fiscal stress may encourage decision-makers to solicit citizen input for painful decisions regarding public service cuts and revenue-raising (Pandey, 2010; Berman, 1997; Zhang and Liao, 2011). Several individual case studies have shown that participatory decisions have contributed to governments being able to implement difficult policies addressing fiscal stress (Hoppe, 2014; Reed, 2014; Saintamour and Huggler, 2010). Overall, though, there is little empirical evidence regarding any effects of citizen participation on decision-making during periods of fiscal stress, and less evidence about the longer-term effects on fiscal recovery.

   There are two competing views of citizens that provide insight into the potential effects of citizen participation on fiscal recovery: the rational taxpayer and the free-rider.

   The rational taxpayer view is that citizen participation is a mechanism for legitimate government decisions, allowing the public to express their demands and support (Yang and Callahan, 2007; Handley and Howell-Moroney, 2010). For example, obtaining the support of taxpayers to accept increased tax rates can enable governments to improve their financial condition (Simonsen and Robbins, 2003). Citizens can express their willingness to pay additional taxes by understanding government financial difficulty through public hearings and meetings (Ahlbrandt and Sumka, 1983), while citizen participation has been used to legitimate fiscal decisions on new tax policies (Berman, 1997). Several empirical studies have found citizens who participate are willing to pay additional taxes (Welch, 1985; Beck et al., 1987; Beck, Rainey and Traut, 1990; Glaser and Hildreth, 1999).

   Moreover, budgetary goals linked to citizen input may improve fiscal accountability for public policies and programs (Cole, 1974). Governments may reduce...