Urban Fiscal Policy

Abstract

This article will focus on urban fiscal policy in the United States. The history of fiscal policy, including discussions of economic depression, contraction, expansion, and taxation, will be introduced as a foundation for an analysis of the issues surrounding budget deficits and fiscal crises in urban regions in the United States. In addition, this article will analyze how federal and local revenues are raised, how fiscal revenues are spent, and describe how the federal government affects the finances of local governments.

Overview

The economic goals of the United States government include maintaining high levels of employment, establishing stable prices for goods and services, and controlling the pace of economic activity. The United States government uses the tools of fiscal policy and monetary policy to achieve those goals. Fiscal policy refers to expenditures by federal, state, and local governments and to the taxes levied to finance these expenditures. Fiscal policy supports and funds the federal budget, aids the federal government's social policies, and promotes overall economic growth and stability. Federal spending includes contracts, grants, loans, and direct payments such as Social Security.

Federal fiscal policy is created annually in collaboration between the president and Congress. The president proposes a budget, otherwise known as a spending plan, to Congress in February, and Congress spends approximately six to eight months engaged in the following decision-making process:

• Congress decides the overall level of spending and taxes;
• Congress divides that overall budget amount into separate categories such as national defense, health and human services, and transportation; and
• Congress creates individual appropriations bills that detail how the funds in each category will be spent.

The federal government depends on taxes to cover almost half of the expenses included in the federal budget. The main income generating taxes are income tax, payroll tax, and tax on corporate profits. Common debates in American government and society about income tax include issues such as the appropriate overall level of taxation and the extent to which taxes should be used to promote social objectives. State and local governments collect the majority of their tax revenue from property taxes.

The federal government is fiscally responsible to all of the states and regions in the country. That said, states and regions do not receive equal grants and aid from the federal government. Economic research demonstrates that the allocation and distribution of federal funds does not create fiscal equalization across American cities. For example, “the intraregional distribution patterns of federal expenditures across Southern Californian cities (as reported in the Consolidated Federal Funds Reports data from fiscal years 1983 to 1996) suggest that while poorer cities receive more money from anti-poverty funds, they receive less from other fiscal funds intended for maintenance and improvement to physical infrastructure” (Joassart-Marcelli, 2001, abstract).

Cities and urban regions in the United States are a unique category and concern for fiscal policy makers. Urban fiscal policy, negotiated and carried out at the federal, state, and local levels, affects the ability of cities to meet the economic and social needs of diverse resident and business populations. Urban fiscal policy refers to a variety of tax, budget, financial, and similar public policy issues that influence the features of life and the economic success of people in cities. Areas of concern and influence for urban fiscal policy makers are comprised of the inducements and ramifications of urban fiscal catastrophe, the design of preferable tax and expenditure procedures for local governments, and the capital behind public foundations. The goal of urban fiscal policy is a strong urban economy and a thriving populous.

The history and theory of federal fiscal policy and regional fiscal policy, with a focus on urban concerns, will be discussed in the following sections. This discussion will provide an overview of the economic environment in the federal and state governments and serve as foundation for a later analysis of the issues surrounding budget deficits and fiscal crises in urban regions of the United States.

History of Federal Fiscal Policy. The history of the U.S. economy is full of economic expansion and economic contraction. Following the American Revolution, the individual economies of the states were faltering, paper money had little value, and there was conflict between borrowers and lenders. The original thirteen states came together to draft the U.S. Constitution in part to stabilize and strengthen the U.S. economy.

From the Civil War through the beginning of the Industrial Revolution, the U.S. economy was characterized by cycles of growing and contracting. Periods of economic expansion and economic contraction averaged approximately two years. By 1920, the U.S. had begun mass production of standardized goods in factories and the practice of commercial advertising on the radio. The development of commercial radio meant that companies could promote their products and services to a larger audience of potential consumers than ever before. Post-1920, periods of economic expansion lasted three to four years followed by shorter periods of economic contraction of approximately one year (Conte, 2001).

The Great Depression, the severe international economic recession of the 1930s, was caused in the United States by instability of the economy created, in part, by new mass manufacturing processes, uneven distribution of wealth and profits, and the government's investment in new industries rather than agriculture. The effects of the Depression were lessened after President Franklin D. Roosevelt took office in 1933. Roosevelt's New Deal campaign outlawed gold coins, set farm quotas, and established government work programs to generate confidence and money in the U.S. economy.

In the 1930s, the United States government began a program and approach of mixed fiscal and monetary policies in an effort to produce sustained economic growth and stable prices (for goods, services, and natural resources). The government, with a strong record in controlling cycles of expansion and contraction during the latter half of the twentieth century, has remained periodically challenged by inflation and the related problems of unemployment, including the Great Recession of 2007 to 2009, the worst economic downturn since the Great Depression.

The government, including budgets and regulatory agencies, has grown steadily since the 1930s. In 1930, the federal government accounted for about 3.3 percent of the nation's gross domestic product (GDP) while in 1999, federal government spending accounted for 21 percent of the nation's gross domestic product (Conte, 2001). As a result of the Great Recession, that number had risen to over 24 percent by 2009, before falling to approximately 20.5 percent of the national GDP in 2017, according to the Federal Reserve Bank of St. Louis.

History of State & Local Fiscal Policy. Congress established the modern system of grants-in-aid to support state and local governments in the early twentieth century. The Weeks Act of 1911 (authorizing the secretary of Agriculture to cooperate with any state, when requested to do so, to protect the forested watersheds of navigable streams from fire) and the Smith-Lever Act of 1914 (distributing millions of dollars in agricultural grants-in-aid to states) established a pattern of sustained and reliable Congressional fiscal support for state and local governments (Canada, 2003).

Grants-in-aid refer to the federal funds appropriated by Congress for distribution to state and local governments. Congress awards four kinds of fiscal grants:

• Categorical grants: Federal funds that can only be used by states for a pre-determined purpose.
• Block grants: Federal funds given automatically to state and communities to support community development and social services programs and needs.
• Project grants: Federal funds awarded on the basis of the merits and strengths of an application.
• Formula grants: Federal funds awarded based on a set legislative or regulatory formula.

The funds for state and local budgets come from federal grants, as described above, as well as indirect taxes and personal income taxes. Trends in government grants to state and local governments have followed social and public policy interests since the late twentieth century. State and local spending during the latter half of the twentieth century was characterized by the need to finance and support education and Medicaid. Federal grants supported the economic burden and social responsibilities of these two initiatives. Education and Medicaid expenditures accounted for almost 60 percent of the growth in the state and local share of gross domestic product from 1952 to 1975.

For example, between 1952 and 1976, grant increases were associated with education, preparation, occupation, and social services. The need to educate a growing population aided in creating a peak in federal education grants during the late 1970s. In the following years education grants equalized. Transportation grants rose in the late 1950s before moderating after the country’s highways system was completed. Health grants notably increased with the beginning of Medicaid in 1965 and then leveled off after 1976 (Penner, 1998, Composition of State & Local).

The federally financed program of Medicaid established a strong program and channel of grants to state and local governments. Medicaid characterized an era of big government. However, in the early twenty-first century the size of grants-in-aid to state and local governments declined (in areas such as education, training, transportation, and community development) as the federal government worked to avoid budget deficit. The decline in federal support has caused states and local governments to become more fiscally self-reliant in their efforts to finance the budget categories of education and income support, Social Security, and welfare. Exceptions to this decline since 2009 and the Great Recession have included the US Department of Education Race to the Top contest and national health insurance in the form of the Patient Protection and Affordable Care Act (commonly called “Obamacare”). Social program spending has also continued to rise (Blodget, 2012).

Economic Theory of Federal Fiscal Policy: Keynesian Economics. U.S. fiscal policy of the twentieth century was strongly influenced by the economic theories of John Keynes, author of The General Theory of Employment, Interest, and Money (1936). Keynes theorized that unemployment results from insufficient demand for goods and services in society-at-large. According to Keynesian economics, a vicious cycle begins when people do not have sufficient income to buy everything the economy can produce. As a result prices of goods and services fall, and companies lose money and go bankrupt. Without government intervention, according to Keynes, this vicious cycle would create wide-spread unemployment and bankrupt the economy. Keynes argues that government could stop economic decline, and promote economic growth, by increasing spending and by cutting taxes. Lastly, Keynesian economics accepts a government deficit as a necessary and acceptable consequence of strengthening the economy.

The U.S. government followed the Keynesian approach (with numerous tax cuts and increased spending to stimulate the economy) throughout the twentieth century and, as a result, strengthened the U.S. economy and created a huge national deficit. Beginning in the late 1980s, the federal government's main goal of fiscal policy became reducing the federal deficit.

The federal government's budget reached a balanced state in 1998 as a result of the economic growth created by foreign trade and technologies (such as the microprocessor, the laser, fiber-optics, and satellite). The federal government has since largely abandoned Keynesian economic goals. Since the late 1990s, policymakers have approached fiscal policy as a means to achieve narrow policy changes rather than broad economic goals (Conte, 2001).

Issues

American Cities & Budget Deficits. Ideally all American cities, often considered to be the drivers of the federal economy, would generate wealth, employment, and productivity growth. In reality, American cities, such as Washington, D.C., and Detroit, have suffered from the negative externalities created by urbanization such as unemployment or underemployment, economic and social inequalities, challenges to social cohesion, urban sprawl, and congestion, environmental problems, and housing shortages. Numerous American cities have suffered from urban decline and have not had the local or federal fiscal support to fix the situation. Urban decline is characterized by problems in urban regions such as unemployment or underemployment, under-investment in physical infrastructure, homelessness, decrease in local population, and decrease in private sector presence and investment (Freudenberg, 2006).

The fiscal health of American cities influences the physical infrastructures and services provided in a city. The fiscal issues facing local governments in the United States are complex. Local governments that serve urban areas in the United States receive funds from the federal government (in the form of grants) and the local populations (in the form of taxes). Local governments must use funds as specified by the grants given by the federal government and must meet the needs of the local population.

Numerous urban regions in the United States have faced large structural budget imbalances in which there has existed a persistent gap between the regional government's ability to raise revenues and the cost of providing basic services. Large budget expenditures include the high cost of living, public safety, and social service needs. One result of this fiscal imbalance is a long-term under-investment in city physical infrastructures. In the interest of a balanced budget, local governments are often forced to defer infrastructure maintenance and improvement. Federal contributions (to be used for repayment of bonds, school construction, information technology, and transportation costs) are necessary to address structural budget imbalances that cannot be addressed or remedied at the local level (Lazere, 2005).

Cities' revenue sources have been, in many instances, shrinking. Revenue sources, such as the income tax and corporate profit tax, have not grown in proportion with the needs of America's cities. Direct federal aid to local governments has also decreased or leveled off. For example, the Community Development Block Grant (CDBG) (a federal program that serves more than 1,200 communities and provides fiscal flexibility to local officials) was cut by 46% in the fiscal year 2003 federal budget compared to fiscal year 2002 (Sawicky, 2002).

The problem of budget deficits in state and local governments affects the economic health of the whole country. Numerous states have projected budget gaps for upcoming years. The nonprofit Center on Budget and Policy Priorities (CBPP) makes recommendations for how state policymakers can make substantial improvements to their state fiscal systems in upcoming legislative sessions. In 2007, proposed strategies for fixing state and local revenue problems, addressing budget gaps, and financing new initiatives included the following (Johnson, 2007):

• Review the corporate income tax flaws;
• Strengthen and modernize state sales taxes;
• Separate state tax codes from the federal tax code;
• Raise state cigarette taxes;
• Avert the Tax Payer Bill of Rights (TABOR); and
• Limit state tax cuts to the state estate tax, corporate income tax, or for senior citizens.

Ultimately, American cities may be understood as economic organizations similar to publicly owned corporations. While a corporation has shareholders, a board of directors, and a chief executive officer, a city has landowners, a city council, and a mayor. The main economic purpose of a city is to offer resources and services such as infrastructure, safety, and schools. Cities must provide the services that their residents need or the residents will leave, creating falling real estate prices and unemployment. Efficient cities attract investment and development. Inefficient cities go bankrupt. Unfortunately, some of America's cities have struggled and have approached bankruptcy. Between January 2010 and October 2013, there were a total of 38 municipal bankruptcy filings on record and 8 general purpose local government filings (“Bankrupt Cities,” October 7, 2013). These American cities have struggled to attract private sector investment. American cities in fiscal crisis need to rely on urban fiscal policy, drafted at the federal, state, and local levels, to provide resources for change and growth.

Conclusion

Looking to the Future. This article analyzes urban fiscal policy and the health of urban governments, examines how local and urban revenues are raised and how they are spent, describes how the federal government affects local and urban finances, and explores the major challenges, such as budget deficits, that urban governments face.

At the local level, urban fiscal policy is influenced by factors such as city planning, requests from the business sector, protests, riots, mayoral power, and reading proficiency scores. Urban fiscal policy, possibly more than any other government policy, has the potential to strengthen the experiences of health, education, physical infrastructure, and arts in American cities.

Looking to the future, state and local governments, which have been forced to be more fiscally self-sufficient due to recession and cuts in federal fiscal policy, have the task of creating and enacting fiscal policies that protect and strengthen their cities and urban regions. State government policymakers have an opportunity to make important policy advances in numerous areas such as aid to working families, budget transparency, and long-range budget planning (Johnson, 2007).

State fiscal policy can help to address the problems faced by urban working families with low and moderate incomes. States may consider offering earned income tax credits (EITC), increasing the minimum wage, reducing or eliminating income taxes on working-poor families, reducing or eliminating taxation of groceries, and other approaches to support working families such child care, health care, and workforce development strategies.

Policymakers, advocates, journalists, and the general public make better tax and budget decisions when information is made accessible. States may consider providing tax expenditure budgets to clarify the hard-to-track spending that takes the form of tax credits, deductions, etc. States may choose to promote accountability in tax codes by producing a document that provides an overview of how the tax burden and taxes are distributed among its citizens.

State governments, by law, are not required to engage in long-term budget planning and, as a result, most state governments budget for one year or two years at a time. State governments facing budget deficits may choose to analyze their future spending needs and create a long-term projected budget. Long-term projected budgets encourage the practice of banking funds for recession periods as well as for identifying underfinanced programs or other structural flaws in the budget.

Terms & Concepts

Appropriations bill: A legislative motion that authorizes the federal, state, and local governments to spend money on designated expenses.

Congress: The United State government's legislature granted the power to make laws.

Deficit: The amount of money that a government, company, or individual spends that exceeds its income.

Depression: A sustained economic recession.

Economic contraction: The descending phase of the corporate circuit in which the GDP falls and the unemployment rate rises gradually.

Economic expansion: The upward phase of the corporate cycle in which GDP rises and unemployment falls over time.

Federal government: A form of government in which a group of states recognizes the sovereignty and leadership of a central authority while retaining certain powers of government.

Fiscal policy: The expenditures by federal, state, and local governments and the taxes levied to finance these expenditures.

Gross domestic product (GDP): The market value of all goods and services that were created within a nation during a certain frame of time.

Inflation: The rate at which the common price for goods and services rises, and, afterward, the purchasing power falls.

Monetary policy: A tool used by the federal government to control the supply and availability of money in the economy.

Public policy: The basic policy or set of policies that serve as the foundation for public laws.

Recession: A significant decline in national economic activity lasting more than a few months.

Taxation: The practice of imposing a tax.

Urban fiscal policy: A wide variety of tax, budget, financial, and similar public policy issues that influence the features of life and the economic success of people in cities.

Bibliography

Bankrupt cities, municipalities list and map. (October 7, 2013). Governing.com, Accessed December 2, 2013 from http://www.governing.com/gov-data/municipal-cities-counties-bankruptcies-and-defaults.html

Blodget, H. (December 28, 2012). Sorry, folks, we don’t just have “a spending problem.” Business Insider. Accessed December 2, 2013 from http://www.businessinsider.com/government-spending-and-taxes-2012-12

Callahan, R. F. (2012). Moving beyond magical thinking: Finding leadership, strategy, and fiscal sustainability in local government. National Civic Review, 101 , 8–10. Retrieved November 27, 2013 from EBSCO online database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=74464198&site=ehost-live

Canada, B. (2003). Federal grants to state and local governments: A brief history. Report for Congress. Retrieved March 20, 2007, from the Library of Congress Congressional Research Service website. http://usinfo.state.gov/usa/infousa/politics/states/fedgrants.pdf

Conte, C., & Karr, A. (February 2001). An outline of the U.S. economy. Retrieved March 20, 2007, from U.S. Department of State Publications website: http://usinfo.state.gov/products/pubs/oecon

Federal net outlays as percent of gross domestic product. (2018, February 28). FRED/Federal Reserve Bank of St. Louis. Retrieved March 9, 2018, from https://fred.stlouisfed.org/series/FYONGDA188S

Freudenberg, N., Fahs, M., Galea, S., & Greenberg, A. (2006). The impact of New York City's 1975 fiscal crisis on the tuberculosis, HIV, and homicide syndemic. American Journal of Public Health, 96, 424–434. Retrieved March 21, 2007, from EBSCO online database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=19971710&site=ehost-live

Johnson, N. (2007, January). Improving state fiscal policies in the 2007 legislative sessions. Retrieved March 20, 2007, from the Center on Budget and Policy Priorities website: http://www.cbpp.org/12-6-06sfp.htm#fixing

Joassart-Marcelli, P., & Musso, J. (2001). The distributive impact of federal fiscal policy: Federal spending and southern California cities. Urban Affairs Review, 37, 163–183.

Lazere, E., & Garrison, D. (2005, November). A new federal contribution to the District of Columbia? The need, likely impact, and some options. Retrieved March 20, 2007, from the D.C. Fiscal Policy Institute website: http://www.dcfpi.org/?p=15

Penner, R. (1998). A brief history of state and local fiscal policy. Retrieved March 20, 2007, from the Urban Institute website: http://www.urban.org/url.cfm?ID=308018

Sawicky, M. (2002, June). U.S. cities face fiscal crunch: Federal and state policies exacerbate local governments' budget shortfalls. Economic Policy Institute Issue Brief, 181. Retrieved March 20, 2007, from the Economic Policy Institute website. http://www.epinet.org/content.cfm/issuebriefs%5fib181

Title I funding targets large urban districts. (2011). Electronic Education Report, 18 , 2–3. Retrieved November 27, 2013 from EBSCO online database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=60618486&site=ehost-live

Vlaicu, R., & Whalley, A. (2011). Do housing bubbles generate fiscal bubbles? Public Choice, 149 (1/2), 89–108. Retrieved November 27, 2013 from EBSCO online database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=65243725&site=ehost-live

Suggested Reading

Ansari, M. (1996). Monetary vs. fiscal policy: Some evidence from vector autoregression for India. Journal of Asian Economics, 7, 677. Retrieved March 20, 2007, from EBSCO online database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=9704141144&site=ehost-live

Arestis, P., & Sawyer, M. (2003). Reinventing fiscal policy. Journal of Post Keynesian Economics, 26, 3–25. Retrieved March 20, 2007, from EBSCO online database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=11381985&site=ehost-live

Auerbach, A. (2003). Fiscal policy, past and present. Brookings Papers on Economic Activity, Retrieved March 20, 2007, from EBSCO online database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=10787542&site=ehost-live

Fuchs, E. R. (2012). Governing the twenty-first-century city. Journal of International Affairs, 65 , 43–56. Retrieved November 27, 2013 from EBSCO online database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=74560605&site=ehost-live

Hinkley, S. (2017). Structurally adjusting: Narratives of fiscal crisis in four US cities. Urban Studies, 54(9), 2123-2138. doi:10.1177/0042098015618167. Retrieved March 9, 2018, from EBSCO online database Business Source Ultimate. http://search.ebscohost.com/login.aspx?direct=true&db=bsu&AN=123785098&site=ehost-live&scope=site

Kim, S., & Law, M. T. (2012). History, institutions, and cities: A view from the Americas. Journal of Regional Science, 52 , 10–39. Retrieved November 27, 2013 from EBSCO online database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=70857252&site=ehost-live

Okun, A. (1972). Fiscal-monetary activism: Some analytical issues. Brookings Papers on Economic Activity, Retrieved March 20, 2007, from EBSCO online database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=7075713&site=ehost-live

Wolozin, H. (1970). Is fiscal policy dead? Journal of Economic Issues, 4, 23. Retrieved March 20, 2007, from EBSCO online database Business Source Complete http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=4674342&site=ehost-live