Financial management conservatism under constraints: tax and expenditure limits and local deficit financing during the Great Recession

Abstract

ABSTRACTThis paper investigates the relationship between tax and expenditure limits (TELs) and local government deficit financing decisions following the recent recession. Cities under the resource constraints are hypothesised to practise conservatism in financial management decisions and thus less likely to deficit finance during difficult times. Using data from 2005 to 2012 Comprehensive Annual Financial Reports of the 50 largest US cities, this paper finds that cities subject to a binding TEL are more likely to control expenditure growth from pre-crisis years to years following the recession; these cities are also less likely to increase deficit financing following the recession, as indicated by a relative increase in their net assets. Although continuous deficit erodes fiscal sustainability and is an undesirable management practice, deficit financing during recessions may be needed for smoothing expenditure and sustaining service provision. The management conservatism associated with the fiscal rules may contribute to the cyclicality of local spending.