April 1, 2001 - From the April, 2001 issue

Brookings Institute Continues To Ask: How Do State Policies Affect The Fiscal Health Of CIties

One of the factors inherent in the passage of Prop. 13 was the public's lack of understanding of the true ramifications it would have on municipalities. The following report, entitled "Lost in the Balance: How State Policies Affect The Fiscal Health of Cities?" by Professors Howard Chernick and Andrew Reschovsky, tracks those ramifications--specifically the growing trend of disinvestment in the urban core--and proposes new policy and funding mechanisms to combat it, not merely in California, but across the few states that are faced with the current and continuing problem of struggling central cities.

By: Prof. Howard Chernick &

Prof. Andrew Reschovsky


Despite recent signs of economic and fiscal recovery, many U.S. central cities continue to struggle with declines or slow growth in population and employment, higher tax burdens, lower quality public services, and poorer performing schools compared to their suburban neighbors. This paper examines the factors that have led to fiscal distress in central cities, and fiscal disparities between cities and suburbs, in three states-California, New York and Wisconsin. Using data on intergovernmental aid, it also presents new evidence on how these state governments are responding to fiscal issues in their cities. Throughout most of the 1990s, both the population and the tax base of most of the central cities in these three states grew more slowly than the population and tax base in their suburbs. Rather than serving to compensate these cities for their slower rates of growth in fiscal capacity, however, state aid and state tax tended to favor suburban communities, making it relatively more difficult for cities to afford basic services for their residents. These trends suggest that the devolution of welfare programs to the state level may exacerbate cities' fiscal problems, especially during an economic downturn. Drawing from the evidence on state-city fiscal relationships in these three states, the papers offer recommendations for new policy directions at the federal, state and local levels that could serve to improve the fiscal health of central cities.

The Fiscal Health Of Cities

To understand the long-run fiscal problems faced by many central cities, it is important to recall that local governments are responsible for both the provision and financing of most government services used by the average citizen on a daily basis. Police and fire protection, sewage and sanitation, recreation, the lighting and maintenance of streets, the provision of water, elementary and secondary education, libraries, and public health are all local government functions. This reliance on local government finance has the advantage of allowing public decisions about the mix and the level of government services to closely reflect the preferences and tastes of the residents of each local community, and encourages innovation in producing public services.

The strength of a decentralized fiscal system must however be tempered by the realization that when urban areas are divided into a number of fiscally independent local governments, each local government has an incentive to exclude those individuals who require extra expenditures in excess of their marginal contributions to locally-raised revenues. As the poor tend to be concentrated in central cities and in older suburbs, there exists a strong incentive for the non-poor to escape fiscal responsibilities for the poor by moving to suburban communities where the poor are often effectively excluded through the use of zoning ordinances and the existence of housing market discrimination. The fiscal health of central cities can then be further weakened if the out-migration from the city of both businesses and moderate- and high-income families creates fiscal externalities. These occur if out-migration leads to a further weakening of the fiscal capacity of the central city and a raising of the average cost of providing public services.

The Effect Of State And Federal Policies On Cities

In principle, the structural fiscal problems that plague many central cities could be mitigated by explicit policies of state governments or the federal government. The most direct form of assistance would be the allocation of lump-sum grants to local governments in weak fiscal positions. Alternatively, higher level governments could take over either the provision or financing of some public services currently carried out by city governments or, as we shall discuss in more detail below, higher level governments could provide incentives for increased fiscal cooperation among central cities and their suburbs.

State Government Policies: Fiscal Relationships in Three States

State policies affect the fiscal condition of their cities in a number of ways. On the revenue side, these include the amount and distribution of state aid, the types of taxes cities are allowed to impose, and state rules for the geographic distribution of user fees and taxes collected by regional public authorities. On the expenditure side, state assumption of particular local services (e.g. public assistance, criminal justice) can reduce costs to large cities. On the other hand, many state mandates are likely to have a greater spending impact in cities than in suburbs.

Summary of Conclusions

A. Impact of State Aid

The fiscal condition of a local government with low fiscal capacity and/or high costs can be significantly affected by intergovernmental policies, particularly at the state level. We investigated state responses to central city fiscal conditions in the three states. Our results were striking. We found that in the 1990s, state policies, rather than serving to compensate central cities for slower rates of growth in fiscal capacity, have tended to favor suburban communities. On a per capita basis, state intergovernmental aid has in many cases increased more rapidly in faster growing and wealthier suburban areas than in central cities.

Our findings on state aid suggest that the federal government has an important role to play in providing systematic and timely information about the impact of state policies on central cities. Since the abolition of the Advisory Commission on Intergovernmental Relations (ACIR), there is no official body that regularly evaluates state policies toward its big cities.


The full Census of Governments is conducted only every five years, with several more years elapsing before data are available. The annual state aid data used in this report were collected from readily available state data sources. On the basis of our research in three states, we recommend that the federal government provide for the annual collection and compilation of data on state aid to cities and suburban areas in all 50 states.

B. Federal Devolution of Welfare

Welfare caseloads are becoming increasingly concentrated in urban counties. Even where the city is not directly responsible for welfare payments, this increasing concentration of welfare cases raises relative costs of public services in central cities. Among those who have left welfare, evidence suggests that many families have experienced quite limited increases in income. These low-income families remain heavily concentrated in central cities. Thus even though the welfare caseload in most cities has been falling rapidly, the costs of providing public services in cities will remain high relative to the suburbs and the competitive position of central cities relative to their suburbs will remain weak.

Policy Options For Improving The Fiscal Position Of Central Cities

Despite some recent indications of central city recovery, our analysis shows that the long-run fiscal health of most central cities is hardly guaranteed. To be able to compete with their suburbs, city governments must be able to provide adequate public services at reasonable tax rates, as compared with their suburban competitors. The ability of cities to do so depends both on their capacity to raise revenues and on the costs they face in providing public services. Fiscal capacity, however, remains low in most central cities relative to their suburbs, and primarily because of concentrations of poverty, costs tend to be substantially higher.

Finding solutions to the long-run fiscal problems of central cities will not be easy and will require a wide mix of local, state, and federal policies. In the following paragraphs, we highlight three broad policy initiatives that would contribute significantly to the long-term fiscal health of central cities.

1. Return responsibility for the poor to the federal government.

It has long been accepted that programs for the poor should be paid for mainly by the central government. Lower level jurisdictions which pursue pro-poor policies risk inducing the exit of high-income individuals. By shifting more responsibility for cash assistance for the poor to the states, and moving away from open-ended financing via matching grants, welfare reform has moved in the opposite direction from this centralization principle. The fiscal risk for cities comes from the fact that increasing state responsibility comes with political pressure to share those responsibilities with local governments, particularly when states are experiencing difficult economic conditions.

[A] second best strategy for the federal government to pursue is to increase targeted grants for particular types of social services, such as health care and job training services. Because need is more concentrated in central cities, such grants could help to compensate for the loss in automatic funding under the previous entitlement programs.

2. Account for cost differences in the distribution of state aid to local governments

As long as there are differences in the fiscal conditions of local governments within a metropolitan area, both businesses and individuals have an incentive to relocate to communities in stronger fiscal health. One policy response is to establish a system of state aid with grants being targeted to local governments in the weakest fiscal health. Most existing state aid programs rely on formulas that only account for differences across communities in property values per capita, ignoring differences in costs and service responsibilities. Evidence suggests that central cities tend to have both higher than average costs and broader than average public service responsibilities. Thus, by ignoring cost differences among local governments, existing state aid formulas tend to under-allocate financial resources to local governments with above-average costs. The fiscal position of central cities will be strengthened if aid formulas were better targeted to those jurisdictions in the weakest fiscal health, where fiscal health is measured on the basis of both differences in fiscal capacities and costs.

3. Enhance cooperation among metropolitan-area governments

Although most metropolitan areas in the U.S. are composed of a large number of independent governments, actions by individuals, businesses, or governmental units in one community often have impacts (both positive and negative) on the rest of the metropolitan area. Many of the problems of central cities have impacts on residents of the entire region, and cooperation among governments can strengthen both the fiscal condition of the central city and the economic and fiscal prosperity of the entire metropolitan area. One form of metropolitan cooperation would be metropolitan-wide provision of specific services. Ideal candidates for metropolitan provision are public services for which scale economies exist or public services that are characterized by metropolitan-wide externalities. Alternatively, cooperation can take the form of suburban government or resident contributions to the financing of central city public services, especially those that provide direct benefits to suburban residents or that respond to problems that are arguably metropolitan in scope, such as affordable housing.

It is clearly easier to articulate policies to improve the long-run fiscal health of central cities than to develop the broad-based political support necessary for the enactment of these policies. One starting point, however, is to convince people that the fiscal health of the nation's central cities will benefit all Americans. A prerequisite for support of these policies is a clear understanding of the causes of the fiscal problems of central cities and the realization that many of these problems are largely due to factors outside the control of city residents and political leaders.


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