American cities in turbulent economic times: An exploration of financial slack in municipal finance

Abstract

This dissertation is a comprehensive study of financial slack’s roles in municipal finance. Drawing theories and hypotheses in various fields of disciplines, the dissertation explores both the causes and impacts of financial slack accumulation in municipal government. Based on organization theory’s risk-slack hypothesis, I first examine whether tax revenue volatility along with other risk factors in a city’s fiscal structure increase municipal financial slack accumulation. The findings support organization theory’s hypothesis that volatile tax revenues and other risk factors increase a city’s financial slack level. I then examine financial slack’s impact on municipal expenditure stabilization. Using the first-differenced equation model to analyze the same dataset used in the previous chapter, I find that the change of a city’s accumulated financial slack always counteracts the change of its expenditures, suggesting that financial slack stabilizes municipal expenditures when revenues fluctuate—it provides fungible financial resources when a city faces a revenue shortfall and it absorbs additional revenues when a city experiences a revenue surplus. Lastly, I examine financial slack’s role in managing municipal cash flows. Municipal governments often use internal financial resources (i.e. accumulated financial slack) and external financial resources (i.e. short-term debt) to manage cash flow fluctuations. The pecking order theory posits that firms have a preference order over financial resources: internal funds come first, followed by debt, and then equity. I find that financial slack reduces both the probability and the amount of municipal short-term debt, providing evidence to support the pecking order theory.