Academic journal article The Journal of Government Financial Management

The Impact of State Authority on Local Finances under Periods of Cyclical Fluctuation

Academic journal article The Journal of Government Financial Management

The Impact of State Authority on Local Finances under Periods of Cyclical Fluctuation

Article excerpt


Local fiscal condition is more than just a local concern.1 A locality's poor financial condition could trigger statewide effects hurting state bond ratings and regional economies.2 In recent years, state governments have increased financial oversight on their localities as economic fluctuation and fiscal federalism have pushed local economies to their limits.3

According to the literature, most state governments respond to local fiscal problems after the crisis surges.4 A small number of state governments apply a proactive approach as they use "early warning systems" to predict fiscal threats before they escalate to a financial crisis.5 In particular, Florida uses the International City/ County Management Association's (ICMA) index; Ohio utilizes Brown's "10-point financial condition test," while Kentucky, Maryland, New Hampshire, New Jersey, New Mexico, North Carolina and Pennsylvania have developed their own warning systems.6

Depending on what type of action a state takes once local fiscal problems are diagnosed, the proactive states are categorized into strong or weak authority/ Strong-authority states such as North Carolina have written legislation enabling them to impose fiscal sanctions to correct financial problems of their local governments.8 The Local Government Commission (LGC), established by the 1931 Local Government Finance Act, oversees the financial oversight of all North Carolina local governments.9 LGC's mission regulates local government debt and financial reporting. The LGC ensures that localities create debt that is reasonable and manageable. Further, the LGC continuously monitors the financial health of local governments and provides assistance to localities when needed.10

Weak-authority states like Florida, are limited to recommending measures but not requiring fiscally troubled localities to "straighten their financial course" following their suggestions.11 In Florida, the Joint Legislative Committee (JLAC) with the help of the Auditor General's Office has held responsibility for monitoring local finances and auditing procedures since 1967. Fiscal emergency is defined by the criteria established by state statute under and the Auditor General's Office.12

Literature indicates that most studies have focused on examining and assessing "early warning systems," and the indexes to predict fiscal stress. Surprisingly, the impact of state intervention authority on local fiscal condition has not gained the attention of academicians. Are localities in strong-authority states more fiscally sound than localities in weakauthority states? We answer this question by studying a homogeneous sample of 56 small- to medium-sized municipalities (populations of 10,000 to 50,000) from North Carolina (strong-authority state), and Florida (weak-authority state).

To assess the finances of the selected local governments, we used Brown's "10-point test of financial condition." This test is performed during fiscal years 2006, 2008 and 2010, to capture the effects of the business cycle on local finances. Fiscal year 2006 represents the booming phase; 2008, the recession; and 2010, the recovery phase. We speculated that North Carolina's strong authority assists its municipalities to achieve a better financial condition than Florida municipalities, no matter the time period.


Using public finance literature, a variety of comparative studies of local governments' financial condition was uncovered. In comparative studies, data reliability and validity strongly depends on the characteristics of the sample. Therefore, building a homogeneous sample was essential.13 Although the literature provided minimal guidance on building homogeneous cohorts, we designed a three-stage process to produce a highly comparable sample.

In the first stage, we selected a strong and a weak-authority state, and grouped their local governments based on their population size. …

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