Importance of the Size of Local Government in Avoiding the Fiscal Distress – Empirical Evidence on Communes in Poland

Abstract

Theoretical background: In the literature on finance there are findings which examine reasons for the fiscal distress of units of the public sector, including local governments. However, this distress might be differently defined. Therefore, it determines both the approach to identify this phenomenon and the types of explanatory variables. Nevertheless, in the field of the business sector in the econometric models concerning the financial distress the size of the unit is considered. In this case there are also some possibilities to apply the correct proxy variable. This results from the fact that the size of local government might determine its fiscal capability as well as the level and structure of expenditures, which affect fiscal distress. Purpose of the article: The aim of this paper is to examine the influence of the size of the local government on the probability of the decrease of the exposure to the fiscal distress. Research methods: The author reviewed the literature in the field of the fiscal distress and introduced a multi-criteria decision analysis as well as a logistic regression modelling to examine this. The research procedure also required the use of the linear ordering to construct the dependent variable of the fiscal distress in order to analyse the “size effect” on the fiscal distress. Main findings: Fiscal distress of local governments is a core issue, which should be constantly analysed. It depends on the financial, economic, social and even political aspects. To identify exposure to this distress the TOPSIS method can be used. However, the fiscal distress can be affected by the size of the unit, which influences lots of budgetary categories. Due to the specificity of dependent and independent variables in the econometric models the “size effect” might be represented through the level of the population or the assets. Using the ordinal logistic regression in the research, the authors should consider that this effect can differ between the units with the disparate exposure. So, the partial proportional odds models can be required. Thus, the growth of the size of the unit, measured by the population, increases the odds of reaching very low exposure to fiscal distress. Simultaneously, there are some other important issues which should be included in this type of research.