Local Fiscal Responses to Procyclical Changes in State Aid

Nguyen-Hoang, P.; Hou, Y.

Abstract

This article examines the asymmetry in local government responses to economic-cycle-based changes of state aid in a framework that distinguishes current outlay from noncurrent expenses and discretionary savings. Employing a panel dataset of Massachusetts municipalities for two economic cycles, we obtain three findings. First, we do not find evidence of property-tax relief during economic booms. Second, discretionary savings may be used to cover noncurrent outlays during booms and to offset spending cuts during recessions. Finally, we find a large (asymmetric) fiscal inducement that may emerge during recessions when state aid cuts coincide with property-tax shortfalls. While these context-specific results may not be easily generalizable, they necessitate further research into the role of local discretionary savings and cash reserves in intergovernmental fiscal relations.