8.4 Local Government Finance and State-Local Fiscal Relations
3 min read•july 22, 2024
Local government finance is a complex system of revenue sources and spending priorities. Property taxes, sales taxes, and form the backbone of local funding, enabling essential services like education and public safety.
shape local finances through aid programs, , and policy constraints. While these relationships can help equalize resources, they also create tensions between state control and in financial decision-making.
Local Government Finance
Revenue sources for local governments
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- Property taxes assess levies on real estate and personal property serving as a major revenue source for most local governments
- Sales taxes imposed on goods and services sold within the jurisdiction are often shared between state and local governments (clothing, electronics)
- Income taxes levied on individual and/or corporate income are less common at the local level than state level
- User fees and charges are collected for specific services like utilities, parking, and recreation to recover costs of providing these services (water bills, parking meters)
- Intergovernmental transfers from federal and state grants, aid, and revenue sharing support specific programs or general local government operations (Community Development )
Property taxes in local funding
- Primary funding source for essential services
- Enables provision of police and fire protection
- Supports public education (K-12 schools)
- Funds infrastructure maintenance for roads, bridges, and sewers
- Stability and predictability
- Property values tend to be less volatile than other tax bases providing a reliable revenue stream for long-term planning
- Allows for consistent budgeting and forecasting
- and accountability
- Rates set by local officials based on community needs and priorities giving residents a voice in taxation
- Taxpayers can hold officials accountable for spending decisions through elections and public meetings
- arise from the regressive nature of property taxes where the burden falls more heavily on lower-income households and disparities in property values across jurisdictions can lead to funding inequities (school districts in wealthy vs. poor neighborhoods)
State-Local Fiscal Relations
State-local fiscal relationships
- State aid to local governments includes
- for specific purposes like education and transportation
- Block grants with more flexibility in spending
- tied to factors like population, need, or
- involve states distributing a portion of state-collected taxes to local governments based on formulas or local government characteristics to help equalize resources across jurisdictions ( revenue sharing)
- are state policies designed to reduce disparities in local fiscal capacity by redistributing funds from wealthier to poorer jurisdictions (school finance formulas)
- Limitations and challenges arise when state lead to cuts in aid or revenue sharing, local governments become overly dependent on state funds, and tension emerges between state control and local autonomy in spending decisions
State policies vs local finances
- are state requirements for local governments to provide services without corresponding funding which can strain local budgets and limit flexibility in spending priorities (environmental regulations)
- (TELs) are state-imposed caps on local rates, revenue growth, or spending designed to limit growth of local government and provide taxpayer relief but may constrain local ability to respond to changing needs or emergencies ( in California)
- occurs through state laws that prohibit or limit local government action in certain policy areas affecting local revenue options like banning local income taxes and restricting local control over land use, environmental protection, or other issues (state bans on plastic bag fees)
- Implications for local autonomy and innovation arise as state policies can create a one-size-fits-all approach that ignores local context, mandates and limitations may discourage local experimentation and problem-solving, leading to a balancing act between statewide uniformity and local flexibility
Key Terms to Review (39)
Audit: An audit is a systematic examination and evaluation of financial records, operations, and compliance with regulations within an organization or government entity. This process ensures transparency, accountability, and proper use of resources, particularly in local governments where public funds are managed. Audits help identify inefficiencies and ensure that entities adhere to established standards and regulations, thereby fostering trust among stakeholders.
Balanced Budget Amendment: A balanced budget amendment is a constitutional rule requiring that a government not spend more than its income, thereby ensuring that budgets are balanced each fiscal year. This concept relates to fiscal discipline and aims to prevent excessive borrowing and debt accumulation, which can impact local government finance and state-local fiscal relations, as well as state budgeting processes and fiscal federalism.
Block Grants: Block grants are large sums of money provided by the federal government to state or local governments for broad purposes, allowing the recipients significant flexibility in how to spend the funds. This approach contrasts with categorical grants, which are restricted to specific programs or projects, and reflects a desire for more local control over spending decisions.
Budget constraints: Budget constraints refer to the limits imposed on the amount of money that can be spent by local governments and state entities, which shape their fiscal policies and decision-making processes. These constraints are influenced by various factors including revenue sources, expenditure needs, and legal or political requirements that dictate how funds can be allocated. Understanding budget constraints is essential for analyzing the financial health and operational capacity of local governments, as they determine what services can be provided and how effectively resources are managed.
Budget cycle: The budget cycle refers to the process through which governments plan, approve, execute, and evaluate their budgets over a specific period, typically annually. This cyclical process includes phases like preparation, approval, execution, and audit, which are essential for effective local government finance and the relationship between state and local fiscal operations. Understanding this cycle helps clarify how funds are allocated, managed, and reviewed at different levels of government.
Budget deficits: Budget deficits occur when a government's expenditures exceed its revenues, leading to a shortfall that must be financed through borrowing or other means. This situation can significantly impact local governments and state fiscal relations, as well as influence state spending priorities and overall fiscal health. Budget deficits often result in difficult decisions about resource allocation and can strain the relationship between different levels of government.
Budgetary transparency: Budgetary transparency refers to the openness and clarity in the preparation, approval, and implementation of government budgets, ensuring that citizens have access to budget documents and understand how public funds are allocated and spent. This concept is crucial for promoting accountability and trust between government entities and the public, particularly within local government finance and state-local fiscal relations.
Capital budgeting: Capital budgeting is the process through which local governments evaluate and prioritize long-term investments, such as infrastructure projects, equipment purchases, and other significant expenditures. This method helps ensure that limited financial resources are allocated efficiently to projects that offer the greatest benefits to the community. By utilizing this process, local governments can make informed decisions on how to finance and implement these projects while balancing fiscal responsibilities and community needs.
Categorical grants: Categorical grants are federal funds provided to state and local governments for specific programs or projects, with strict guidelines on how the money should be spent. These grants are designed to address particular needs or policy areas, influencing state and local governments' decisions and priorities through targeted financial support.
Economies of scale: Economies of scale refer to the cost advantages that organizations experience as they increase their level of production. These advantages arise because the cost per unit of output generally decreases with increasing scale as fixed costs are spread out over more units of output. This concept is crucial in understanding how local governments finance their operations and manage fiscal relations with state governments.
Efficiency in taxation: Efficiency in taxation refers to the ability of a tax system to raise revenue with minimal economic distortion and administrative costs. An efficient tax system aims to collect necessary funds for government operations while ensuring that it does not significantly interfere with individuals' and businesses' decisions, thus maintaining overall economic productivity.
Equity Concerns: Equity concerns refer to issues related to fairness and justice in the distribution of resources and opportunities within local government finance and state-local fiscal relations. These concerns often focus on how different communities are affected by taxation, funding for services, and overall economic policies, leading to discussions about whether resources are allocated in a way that promotes equal opportunity and addresses disparities among different populations.
Financial reporting: Financial reporting is the process of producing statements that disclose an organization's financial status to management, investors, and regulators. This process provides transparency and accountability in local government finance, allowing stakeholders to understand the financial health of municipalities and their relationships with state governments.
Fiscal Capacity: Fiscal capacity refers to the ability of a government, particularly at the state or local level, to generate revenue and effectively manage its financial resources to provide public services. This concept encompasses various factors including tax base, revenue sources, administrative efficiency, and economic conditions that influence how much revenue a government can raise and spend. Understanding fiscal capacity is essential for evaluating the financial relationships between different levels of government and how policies are implemented across various jurisdictions.
Fiscal equalization mechanisms: Fiscal equalization mechanisms are financial systems and policies designed to reduce disparities in revenue-raising capacity among different regions or local governments, ensuring that all jurisdictions can provide similar levels of public services. These mechanisms typically involve the redistribution of funds from wealthier areas to poorer ones, promoting equity and fairness in local government finance and enhancing overall state-local fiscal relations.
Formula-based aid: Formula-based aid refers to financial assistance provided by the government to local governments or agencies based on specific formulas, which typically take into account various factors such as population size, income levels, and local needs. This type of funding is designed to ensure that resources are distributed equitably among different jurisdictions, allowing for more predictable budgeting and planning for local entities. The use of formulas helps to standardize the allocation process and ensures that funding is directed toward areas with the greatest need.
Funding shortfalls: Funding shortfalls occur when a government or organization does not have enough financial resources to meet its budgetary needs. This situation often affects local governments, which rely heavily on state funding and revenue sources like property taxes, sales taxes, and grants. When funding shortfalls happen, essential services like education, public safety, and infrastructure maintenance may be compromised, leading to a broader impact on community well-being and state-local fiscal relations.
General obligation bonds: General obligation bonds are debt securities issued by local governments that are backed by the full faith and credit of the issuing authority, which means they are secured by the government's ability to levy taxes. These bonds are typically used to finance public projects such as schools, roads, and parks, making them essential for local government finance. Because they are considered low-risk investments, they often offer lower interest rates compared to revenue bonds, which are repaid from specific revenue sources.
Grants-in-aid: Grants-in-aid are funds provided by one level of government to another, typically from the federal government to state or local governments, to support specific projects or programs. These financial transfers play a critical role in shaping state-local fiscal relations, as they influence how resources are allocated for public services and infrastructure, and can impact policy outcomes across different jurisdictions.
Home Rule: Home rule refers to the power or authority granted to local governments to govern themselves with a significant degree of independence from state governments. This concept allows municipalities to enact laws, manage budgets, and oversee local affairs without needing extensive state approval, promoting localized decision-making. Home rule emphasizes the autonomy of local entities, balancing the power dynamics between state and local governance.
Intergovernmental transfers: Intergovernmental transfers are financial resources allocated by one level of government to another, often from state governments to local governments or between different state agencies. These transfers play a crucial role in shaping the fiscal landscape, as they impact local government financing, revenue distribution, and the overall budgeting process within states, influencing how resources are allocated for public services and infrastructure.
Line-item budgeting: Line-item budgeting is a financial management approach where budgets are prepared based on specific line items, detailing individual expenditures and revenues. This method emphasizes transparency and accountability by breaking down budget allocations into specific categories, allowing for easier tracking and analysis of spending. It is commonly used at various government levels to ensure that funds are spent according to legislative intent and to facilitate comparisons across different periods.
Local autonomy: Local autonomy refers to the degree of self-governance and independence that local governments have to make decisions without interference from higher levels of government. This concept is crucial for understanding how local authorities can implement policies that cater to the specific needs and preferences of their communities, particularly in relation to finance and fiscal relations with state governments.
Local control: Local control refers to the authority and power that local governments possess to make decisions and manage their own affairs without excessive interference from state or federal governments. This concept emphasizes the importance of local governance, allowing communities to tailor policies and services to meet their specific needs, which plays a critical role in local government finance and state-local fiscal relations.
Matching funds: Matching funds are financial contributions provided by governments or organizations that match the funds raised from private donations for political campaigns, projects, or programs. This system incentivizes fundraising efforts by ensuring that for every dollar raised from private sources, an equal amount is contributed by the government, which can significantly impact campaign financing and public funding initiatives.
Pension liabilities: Pension liabilities refer to the financial obligations that a government or organization has to pay future pension benefits to its employees. These liabilities represent the present value of the promised pension payments, which are often determined by actuarial calculations and can significantly impact local government finance and state-local fiscal relations due to their long-term nature and funding requirements.
Preemption of local authority: Preemption of local authority refers to the legal principle where higher levels of government, such as state or federal, can invalidate or limit the actions and regulations of local governments. This principle often comes into play in areas like local government finance and state-local fiscal relations, where states may impose restrictions on how cities or counties can raise revenue or manage their budgets.
Property tax: Property tax is a levy imposed by local governments on real estate properties, based on their assessed value. It serves as a crucial source of revenue for local services, such as education, public safety, and infrastructure maintenance. The way property taxes are assessed and collected can significantly impact local government finance, the relationship between state and local governments, and the prioritization of state spending.
Proposition 13: Proposition 13 is a landmark California ballot initiative passed in 1978 that drastically reduced property tax rates and changed the way property taxes were assessed in the state. It capped property tax rates at 1% of the property's assessed value and limited annual increases in assessed value to a maximum of 2%, fundamentally altering local government finance and state-local fiscal relations by reducing revenue for municipalities and shifting funding responsibilities.
Public Goods Theory: Public goods theory explains the characteristics and implications of goods that are non-excludable and non-rivalrous, meaning that individuals cannot be effectively excluded from use, and one person's use does not diminish availability to others. This theory plays a crucial role in understanding how local governments fund and provide services that benefit the community as a whole, ensuring equitable access and addressing market failures where private entities may underprovide essential services.
Revenue bonds: Revenue bonds are a type of municipal bond that funds specific projects and are repaid from the revenue generated by those projects, rather than from general tax revenues. These bonds are commonly used to finance public infrastructure like roads, bridges, and utilities, making them crucial for local government finance and state-local fiscal relations.
Revenue Sharing: Revenue sharing is the distribution of a portion of federal tax revenues to state and local governments, enabling them to fund public services and infrastructure projects. This approach helps balance the financial resources available to various levels of government, ensuring that local entities have the necessary funds to meet their needs. Revenue sharing can enhance collaboration between different government levels, fostering a more efficient allocation of resources and addressing regional disparities.
Revenue sharing programs: Revenue sharing programs are financial arrangements where the federal government allocates a portion of its tax revenues to state and local governments. This approach aims to enhance local government finance by providing additional funding for public services and infrastructure, helping bridge the fiscal gap between different levels of government. By redistributing federal funds, these programs empower local entities to better address community needs and promote fiscal stability.
Sales tax: Sales tax is a consumption tax imposed on the sale of goods and services, calculated as a percentage of the purchase price. This tax plays a crucial role in generating revenue for state and local governments, influencing local government finance and shaping state-local fiscal relations, as it directly affects how both entities fund their operations and public services.
State-local fiscal relationships: State-local fiscal relationships refer to the financial interactions and responsibilities between state governments and local governments regarding revenue generation, expenditures, and funding. These relationships shape how local governments manage their finances, which services they can provide, and how reliant they are on state funding for essential programs. Understanding these dynamics is crucial for analyzing the overall effectiveness of local governance and public service delivery.
Tax and expenditure limitations: Tax and expenditure limitations are policies implemented by state and local governments to control the growth of public spending and taxation. These limitations can take various forms, such as constitutional amendments or statutory caps that restrict how much revenue can be raised through taxes and how much can be spent. The main goal is to promote fiscal discipline and prevent excessive government spending, while also influencing the financial relationship between state and local governments.
Tax base erosion: Tax base erosion refers to the reduction in the taxable income or revenue that a government can collect due to various factors such as tax exemptions, deductions, and shifting of profits to lower-tax jurisdictions. This phenomenon significantly affects local governments and state-local fiscal relations as it limits the revenue that can be generated to fund public services. Tax base erosion impacts how effectively states can implement their tax policies, leading to potential inequalities in service delivery and financial health across different regions.
Tax Limitations: Tax limitations are legal restrictions placed on the ability of local governments to impose and increase taxes. These limitations are often enacted through state legislation or voter initiatives and can significantly impact local government finance, as they restrict the revenue that local entities can generate to fund essential services such as education, public safety, and infrastructure maintenance. Understanding tax limitations is crucial for grasping how state-local fiscal relations shape the financial landscape of local governments.
Unfunded Mandates: Unfunded mandates are regulations or statutes that require state or local governments to perform certain actions without providing federal funding to cover the costs. These mandates can significantly strain state and local budgets, forcing governments to allocate resources from other programs or raise taxes to comply.