TaxProf Blog

Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Friday, May 19, 2017

Weekly SSRN Tax Article Review And Roundup

This week, Erin Scharff (Arizona State) reviews an article by Darien Shanske (Davis), The (Now Urgent) Case for State-Level Monitoring of Local Government Finances (or, One Way to Protect Localities from Trump's 'Potemkin Villages of Nothing'), forthcoming in the NYU Journal of Legislation and Public Policy: 

Scharff (2017)Darien Shanske’s forthcoming article on local government financing suggests reforms that might protect local governments from their own bad decisions.   The fiscal challenges facing local governments are enormous, and Shanske persuasively argues localities are ill equipped to deal with these problems on their own.  And his proposal responds to the variety of fiscal problems facing cities. There are problems both with the ways cities spend their revenue and also their revenue streams.  Too often, we foucs on only one side of this problem.

At the time Shanske wrote the paper, he was particularly worried about the possibility of a federal infrastructure plan that would flood local governments with public-private partnership opportunities that would fail to deliver promised benefits.  As Shanske’s title alludes to, Larry Summers denounced such infrastructure spending as a “Potemkin Village [] of nothing.”

Of course, in light of recent events, it seems unlikely that Congress will be rushing to pass pretty much anything soon, let alone a complicated infrastructure plan likely to be greeted with bipartisan suspicion. (But I also never thought the House would pass the AHCA, so what do I know?)

Shanske’s piece, however, deserves our attention, even if the federal infrastructure bill stalled.  As he demonstrates, there are other compelling reasons for states to consider cleaning up local government finances.  For one thing, unmet pensions obligations continue to pose significant challenges for balancing local government check books.  . Roderick Kieiet and Mathew McCubbins have suggested that “we are experiencing . . . the onset of a New Fiscal Ice Age, a period in which a given level of state and local tax revenue purchases a considerably lower level of current services,” given the amount of revenue needed to fund existing pension obligations.

Further, as Shanske summarizes, studies across a range of dimensions suggest local governments may lack the expertise to be savvy borrowers.  For example, there is widespread consensus that local governments pay lower interest rates when they issue bonds through competitive sales, rather than negotiation with a single bank.  Yet Shanske suggests that local governments still routinely issue debt through negotiation.  And of course, local governments have been sold a range of complicated financial products over the years, with frequently disastrous results.  Jefferson County’s problems did not begin with interest-rate swaps, but the swaps didn’t help matters.  And in the wake of the Great Recession, many local governments avoided insolvency, but still squandered revenue on such deals.

In addition to this empirical evidence that local governments are making poor decisions, Shanske also mounts a theoretical defense of state-level regulation of local government financing decisions, pointing to both limitations and critiques of the classic model of jurisdictional competition.

After making his case for state-level regulation, Shanske offers a proposal for a potential state regulator, a Local Government Finance Commission.  This regulator is roughly modeled on successful models in North Carolina and California. To ensure democratic legitimacy, the Commission’s members include a combination of elected officials (like State Treasurers) and appointees of elected officials.  However, Shanske insists that its staff be composed of public finance experts.  He is particularly keen on including senior local government officials.  Shanske argues that such former officials are both likely to have relevant expertise and developed judgment and also to command the respect of the local governments whom they advise. 

Shanske proposes giving such a Commission far-ranging oversight over local fiscal affairs.  Not only would the Commission have authority over local government borrowing, it would also advise on pension obligations (which he characterizes as a special  case of government borrowing), contracts for long-range public-private infrastructure partnerships, appropriate revenue instruments, and local development subsidies.  Ideally, the Commission would enforce rules enacted by the legislature, and local governments could request exceptions to these rules from the Commission.  Such a regulatory model would replace the states’ current approach to the regulation of local fiscal policy, the widely-condemned tax, spending and borrowing limits.  Evidence suggests such policies have largely been ineffective at countering many of the problems facing local governments, and, in fact, may discourage good fiscal policies.    

I am very sympathetic to the need for Shanske’s proposal, and its potential.    Perhaps I’m too much a cynic, or maybe I’ve just never lived in a “good government state,” but I worry about state-level regulators, too.  States suffer from many of the same fiscal illusions and fiscal myopia as local governments.  States, too, have their pension problems, their poorly designed public-private contracting, and their flawed mix of revenue options.  And state law often makes it harder for local governments to restructure existing pension agreements.  Of course, the success of North Carolina’s Local Government Commission suggests such challenges can be overcome. 

And squabbles only underscore the importance of the problem Shanske addresses. Shanke’s commission is a policy option worth serious considering for a problem to which all of us should be paying more attention.

Here’s the rest of this week’s SSRN Tax Roundup:

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