Fiscal Implications of Managing Natural Disasters for National and Subnational Governments

Abstract

Natural disasters cause massive social disruptions and can lead to tremendous economic and human losses. Given their uncertain and destructive nature, disasters invariably induce significant governmental responses and typically pose severe financial challenges for jurisdictions across all levels of government. From a public finance perspective, disasters cause governments to incur additional spending on various emergency management activities, and by disrupting normal business activities they also affect tax base robustness and cause revenue losses. The question is: How significant are these fiscal effects and how do they affect hazards governance more generally? Understanding the fiscal implications of natural disasters is essential to evaluating the size of the economic costs of disasters as well as forecasting governments’ financial exposure to future shocks. Furthermore, how disaster costs are shared among different levels of government is another important question concerning the intergovernmental dynamics of disaster management. In the US federal system, the direct fiscal costs of natural disasters (i.e., increased government expenditures due to disaster shocks) are largely borne by the federal government. It is estimated that Hurricane Katrina cost the federal government approximately $120 billion while Hurricane Sandy cost $60 billion. Even in the years without large-scale disaster events, federal disaster spending is between $2 billion and $6 billion annually. Under the Stafford Act, the federal government plays a critical role in funding disaster-related programs (e.g., direct relief, mitigation grants, and subsidized insurance programs) and redistributing the actual costs of natural hazards, meaning that a considerable portion of the local disaster burden is shifted to all US taxpayers. This raises a set of issues concerning the equity and efficiency of the US disaster policy framework. Managing disasters involves multiphased activities to mitigate, prepare for, respond to, and recover from disaster shocks. There is a common belief that the federal government inappropriately spends far more on ex post disaster response, relief, and recovery than what it spends on ex ante mitigation and preparedness, often driven by political motivations (e.g., meeting voters’ preferences for postdisaster aid) and the current budget rules. As pointed out by many others, federal disaster relief and assistance distort the subnational incentive to invest in local disaster prevention and mitigation efforts. Furthermore, given the mounting evidence on the cost-effectiveness of disaster mitigation programs in reducing future disaster damages, the current practice of focusing resources on postdisaster assistance means substantial public welfare losses. In recent years there has been a call for the federal government to shift its disaster policy emphasis toward mitigation and preparedness and also to facilitate local efforts on mitigation. To achieve the goal requires a comprehensive reform in government budgeting for emergency management.