MUNICIPAL FRAGMENTATION AND LOCAL FINANCIAL CONDITION.
Local governments decide which and how much services to produce with different tax authorities, and citizens shop for packages of taxes and services from one jurisdiction to another. Numerous governments satisfy citizens' heterogeneous service demands more effectively than a few, as a larger number of such local authorities provide distinctive tax and service packages for the citizens (Schneider, 1989; Tiebout, 1956). As the citizen's migration indicates relocation of wealth and potential for economic development, the fragmented local landscape, composed of numerous municipalities, is often described as the rivalry among local governments (Boyne, 1992; Eberts and Gronberg, 1988; Ostrom and Ostrom, 1965). Citizens may compare the tax and service packages across jurisdictions, signaling governments to provide popularly appealing packages--more services and lower tax rates. Sufficient public service benefit and zero tax are infeasible, but local governments may want to attract citizens beyond their capacity to provide unique packages, intensifying competitive interlocal relationships further. Competition pressures local governments to manage the allocation of limited public resources, to lower the service production cost, and reduce the size of their organizations, thereby achieving greater efficiency to survive on the competitive market of public goods and services (Brennan and Buchanan, 1980).
Though municipal fragmentation is associated with efficiency gains, the actual number of municipalities demonstrates the opposite story, since their number should have increased if greater fragmentation is equivalent to greater gains. The number of cities and townships in the U.S. has marginally changed, with a few cases of incorporation and dissolution, as the Bureau of Census reports 35,508 subcounty general-purpose governments in 1972 and 35,599 in 2017. The trends indicate that the benefits of municipal fragmentation may be offset by some negative factors. Such gap between theories and reality is understood differently depending on the subject of interest, which varies across government financial outcomes, urban sprawl, unequal service provision, and income segregation (Carruthers and Ulfarsson, 2002; Hill, 1974; Lyons, Lowery and DeHoog, 1992; McGuire, 1991).
This study utilizes a factor score of municipal financial condition to incorporate diverse fiscal outcomes into a single broad concept. The financial condition is defined as the ability, willingness, and amount of resources of a municipality to meet its financial and service obligations (Berne, 1992; Hendrick, 2004, 2011; GASB, 2009; Groves, Nollenberger and Valente, 2003; Ladd and Yinger, 1989). The financial condition is a complex and multifaceted concept understood with several measures, such as solvency types across different time spans, the difference between expenditure needs and the revenue-raising capacity, and demographic and environmental factors associated with government performance (Chernick and Reschovsky, 2001; Hendrick, 2004; Justice and Scorsone, 2013; Ladd and Yinger, 1989). In order to encompass various financial indicators that define different aspects of the fiscal outcomes, this study utilizes factor analysis to measure the concept of the financial condition comprehensively.
The estimation result of pooled cross-sectional time series regression with panel-corrected standard error using U.S metropolitan statistical area (MSA) data from 1972 to 2017 shows that fragmentation declines the financial condition of municipalities. Findings of this study contribute to the literature of intergovernmental relationships at the regional level and fiscal outcomes fragmentation. By using the concept of financial condition, this study tests different fiscal outcomes that are not directly comparable, and diagnoses whether municipal fragmentation is beneficial beyond separate fiscal outcomes.
In the following section, the theoretical foundation of municipal government fragmentation and empirical studies of determinants of the local financial condition are introduced. The next section suggests theoretical bases about how municipal fragmentation affects the financial condition of cities and townships negatively. Finally, the findings and implications of this study are discussed.
2.1. Fiscal outcomes of government fragmentation
Scholars speculate the opposite effects of government fragmentation on two types of efficiency: allocative efficiency, that stands for responsiveness to citizen preference, and technical efficiency, that represents the production of services with lower inputs (Boyne, 1996; Dowding and Mergoupis, 2003; Goodman, 2019). First, it is proposed that fragmentation increases both efficiencies. Citizens vote with their feet for a preferred set of services at an affordable tax rate if there is no restriction in relocation, and the citizens have full information on service provision in all jurisdictions. An increase in allocative efficiency reflects several competing governments providing assorted services from which citizens can choose what they want and can pay. A decrease in the level of government spending reflects that public resources are optimally utilized, and wasted resources are minimal (Brennan and Buchanan, 1980; Schneider, 1989).
Brennan and Buchanan (1980) suggest that government size without competition tends to grow, due to the absence of a benchmark of performance. Bureaucrats benefit from the larger budget as it preserves their political power. The bureaucrats' budget-maximizing effort derives from asymmetric information of the actual cost of service production (Niskanen, 1971; Schneider, 1989). The cost information is roughly available when citizens can compare tax amounts of a certain quality of services from other governments. Thus, the fragmentation enables taxpayers to approximate the cost and pressure their governments to lower tax rates by comparing neighboring jurisdictions' performance (Besley and Case, 1995; Breton, 1991).
Oppositely, some studies posit that the municipal fragmentation impedes both the technical efficiency and allocative efficiency of governments as an intensive competition raises transaction costs across governments (ACIR, 1974; Carruthers and Ulfarsson, 2002). Since the types of government services are finite and political authorities tend to favor the popular interest, governments tend to provide some duplicated services, thereby limiting public choice. Also, it is less costly for a single government to specialize in the production of some services than when several governments produce the same services separately; thus, some inputs can be saved when producing different services that require similar inputs (Boyne, 1992; Panzar and Willig, 1981). The lesser competition derived from the defragmented governments allows governments to run more efficiently by reducing the number of governments that could provide services separately.
Second, some scholars focus on fiscal equity of service distribution to citizens. Oates (1972) argues that some services are provided at suboptimal level because some services with high spillover effects may benefit competing governments unless enforced to pay for the benefit. The presence of spillover in public services makes a local government levy on less stable revenue sources rather than on property taxes (Wildasin, 1989).
Also, as local governments vary by the capacity for public service provision, municipal fragmentation often leads to unequal access to public services (Boyne, 1992; McGuire, 1991; Oakerson, 1999). McGuire (1991) suggests that the threat of migration makes the government's levy taxes on the affluent lower than an optimal rate for sustainable service provision when all local governments attract wealthy households with tax cuts. Thus, the budget deficit derived from revenue-expenditure imbalance reduces types and levels of existing services or burdens other taxpayers. Hoyt (1991) proposes that a government's response to tax rate changes in a neighboring jurisdiction results in changes in service levels that may not correspond to the actual demand of citizens.
Third, the fragmentation also facilitates racial and income segregation. Segregation may result from a governments' exercise of power to exclude and to particularize services through zoning and land use control (Hill, 1974; Lyons, Lowery and DeHoog, 1992). However, the affluent are more likely capable of relocating when segregation causes these issues. This implies that the poor residents have no other choice but to remain in a jurisdiction, while the affluent households migrate to jurisdictions with better services at the higher tax rates with exclusive benefits of public goods and services (Lowey, 2000).
Last, it is argued that fragmentation makes urban sprawl hard to control. Divided land-use authority across several jurisdictions allows local governments to exercise zoning within a jurisdictional boundary. The uncooperative development reaches to areas with a small population, resulting in operating deficits for service provision (Carruthers and Ulfarsson, 2002).
2.2. Determinants of local financial condition
Several studies investigate the factors that determine local governments' ability to meet diverse service needs. First, local demographic composition matters. Jacob and Hendrick (2013) provide examples of spending needs, such as crime levels for police protection service, age of infrastructure for fire service, capital spending, building inspection, the income level of citizens, employment status, and cost of public health and welfare services. Also, they propose that population growth and economic development increase government spending in general. Groves, Nollenberger and Valente (2003) suggest that some demographic factors directly or indirectly affect local financial condition, such as population density, personal income per capita...
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