Backyard Political Farmer: 02/28/13

This Is a Reblog: Original Author Peter Manda

Current Research Project: The Hierarchical Structure of Municipal Finance: A Comparative Law Contribution

Abstract

A municipality whose access to domestic and international markets becomes restricted through capital and financing constraints resembles a traditional Monopoly game in that the ability of its treasury to secure liquidity in the markets becomes limited to the revenue it can generate from the assets within its jurisdiction. When money and capital flows are constrained, tangible assets and real property become the commodities driving liquidity. As long as assets remain fungible, municipalities can continue to function regardless of externally imposed legal constraints on their ability to obtain financings through local, domestic, or international markets. The Research will seek to identify the factors that contribute to a municipality’s financial success or failure.

Research Proposal Overview

Public finance texts assume that the financing of municipalities is bounded by (a) legal restraints on legislative power, (b) types of debt, debt limitations, and techniques of debt avoidance / reorganization, (c) investor protection, and (d) state and national law requirements. Research and literature on public finance, however, is unclear on which financing approach is most successful for securing financial sustainability or generating municipal growth. Generally, there appear to be six perspectives through which the success (or failure) of a municipality is defined: (1) Political structure driven by socio-economic factors, (2) Location and the ability to attract labor and capital, (3) Tax base and the ability to generate revenue, (4) Dependency on centralized credit mechanisms, (5) Presence of a cross-linked banking system, or (6) Flexible system of administrative governance defined by law. To test these perspectives, the research will seek to analyze the laws governing the public finance system of nine or ten municipalities which can be aggregated into three distinct classes as described in the next section.

Case Study Classification

To simplify the research proposition, it helps to classify the case studies within the frame of a game of Monopoly.[1]

Assume that a Municipality (M) operates like a Monopoly game — it has a limited number of assets, public utilities and services, no (or limited) ability to generate revenue through taxation, and its treasury cannot issue securities nor print money. The Municipality’s ability to grow would be limited to a finite pool of money and assets. As in the Monopoly game, over time winners and losers in Municipality (M) would become members of defined castes of haves and have-nots. Those who own the key assets (sets of utilities and real estate generating higher rents) and income-generating resources (houses and hotels) would be able to divert an ever-increasing amount of money into their hands up to available financing limits. In essence Municipality (M)’s Monopoly game looks much like the City of Hampton Roads, Virginia or the City of Iron Mountain Lake, Missouri, where legislative decision-makers have chosen to implement laws of fiscal governance that isolate their jurisdictions from larger capital flows.[2]

To make a Monopoly game more interesting, players can be allowed to divide their holdings into tranches which they can trade with others before combining groups of real estate into sets. Say player /a/ in the Monopoly game representing Municipality (M’)[3] acquires two properties in a three property set and player /b/ holds the third property. Rather than agreeing to sell the third property outright to player /a/ (as required by the rules of the game in Municipality (M)), player /b/ could agree to transfer to player /a/ a certain interest (say 2/3) in the third property in return for a 1/3 interest in revenue streams generated from the other two properties when the set is completed (revenues from a completed set being higher than from a property held outside a set). In effect, the players would be creating an asset-backed security in the properties, thus allowing for greater liquidity in the property markets and a more equitable distribution of earnings. In addition, the outcome of the game would not be as caste-defining as game (M), because shrewd investors could use the system of quasi-security interests to generate revenue even if they end up holding no single set (a result that in Municipality (M) would rapidly lead to the non-realty/utility holding player’s bankruptcy).

There are several types of M’ class Municipalities. One type is much like the City of Newark, New Jersey where in order to encourage investment, the City council has implemented a series of tax abatement and exemption schemes that in the short-run attracted investment but in the long-run have left the city with ever-dwindling sources of tax revenue. The second M’ type Municipalities much like Shiraz, Iran. The Islamic Republic of Iran is a nation whose access to international financing streams has been increasingly constrained through economic sanctions. As a result of the sanctions, the national government, provinces, and municipalities have had to resort to innovations in finance that have included the creation of an asset-backed securities market, real estate investment trusts, assets poolings, and similar real-property based financing vehicles to secure continued market liquidity in otherwise trade-constrained domestic markets.

Municipalities like Shiraz have had to innovate their financing schemes – innovations that a web of administrative consulting mechanisms have made relatively easier when compared with other (more constrained) systems. In contrast, the third M’ type Municipality resembles the City of Richmond, Virginia. In addition to being restricted by law as to the nature and type of revenue the city can raise under home rule regulations promulgated by the Virginia state legislature, Richmond’s ability to raise revenue is limited because much of the property within its boundaries is exempt from taxation due to legal restrictions imposed by state and federal agencies attaching primarily to state-and federal controlled land and activity within Richmond’s jurisdictional boundaries.

While M-class municipalities are growth-constrained[4]either by choice or by increasingly limited access to revenue streams, the systems of growing municipalities are active and much like several Monopoly games playing simultaneously next to each other (say games (F), (J), and (O)) either synchronously or asynchronously. The Monopoly games of municipalities(F), (J), and (O)are more free-market oriented in their regulatory and administrative framework and favor foreign-direct investment and trade with other municipalities and entities (foreign or domestic). Indeed, each game is hypothetically allowed to develop her own set of market and asset-growth rules. She is also allowed to develop an independent taxing authority and a treasury that can raise revenue through bond and/or third-party (outside) financings according to policies promulgated by the governing city, state, and national authorities and interest groups.

Players in these latter municipality classes can insist on stronger voices in the rule-making process or can wield their financial power to influence the direction of municipal growth. Disputes are settled by mutual agreement or by resort to a neutral third party. Players are also allowed to agree on rules to generate and create new securities or asset-classes in order to maximize potential revenue streams. In contrast to the players in (M) and (M') class municipalities, (F), (J), and (O)municipalities are, as mentioned, able to acquire assets on the game-boards of the other games being played based upon rules that the players of each game would fashion among each other (treaty formation).

Opportunities for financial, operational, and strategic hedging could also arise. In essence, these games mimic the financial and governance systems of municipalities in post-world war II Western economies though they may develop in their own unique way based on player preferences. Indeed, rather than the Monopoly games ending in the caste- and quasi-caste-based systems of games (M) and (M’), the outcomes of failed (F), (J), and (O) type games would likely be municipal reorganization or bankruptcy due to market-collapses following asset bubbles and speculative streaks.[5]

As mentioned, there are some recognizable distinctions between non-(M)-type municipalities that determine their independent growth trajectories[6]. For example, (F)-class municipalities, such as municipalities in France outside the Ile-de-France, are traditionally dependent on banks and financing institutions (including the central government) located in the capital city. The reason for municipal dependence on the central institutions of the capital city appears historically rooted in the central authority’s aim to secure cohesive national boundaries and to ensure the allegiance of its distant provinces to the central government. In the case of France, the law has been flexible enough over time to allow for change while simultaneously guaranteeing national boundaries to remain relatively settled across the centuries. Nevertheless, during the 2007 financial crisis, the system left many municipalities temporarily without funding for project finance and operational/distributional needs compelling some to engage in innovative financing schemes in order to continue the delivery of desired services.[7]

In (J)-type municipalities, like those of Iwaki, Fukushima Prefecture, Japan, municipal finance is governed by a series of laws securing cross-linked arrangements with the national and prefectural governments, national and local banks, and local industrial and business leaders. This cross-linked system ensures that public works remain operating and that welfare requirements are met in coordination with prefectural and national political and economic objectives. At the same time, the cross-linked system discounts direct public and citizen input. While the crash of the bubble in the late 1980s challenged the system (especially where banking and enterprise interests had leveraged the system to speculate in real estate and similar ventures), deregulation implemented by the national government did not significantly affect the municipal finance system. Municipalities are still required to obtain prefectural and/or national authority before issuing bonds. In addition, the most powerful local enterprises continue to wield significant influence on the direction development projects take.As a result investment expenditures reflect only a small fraction of the municipal liability sheet in (J)-type municipalities.

Niagara Falls, Ontario, Canada, by contrast, is an (O)-type municipality. Niagara Falls has been attracting tourists for more than a century; but in the 1970s it began to face fiscal and administrative issues that negatively influenced the number of visitors to the falls and thus the city’s revenue stream. The city decided to create a perpetual redevelopment pool based on revenues collected from power generation at the falls and from completed tourism-related projects and investments. As projects were implemented and further developed, new tax sources were generated that each further contributed to the reinvestment pool, thus providing for an ever-growing source of funds to support continued and targeted infrastructure and tourism attraction development.

Niagara Falls, New York on the American side of the falls provides a stark contrast to this development in Ontario. The American sister pursues a revenue policy and allows for a structure of laws and regulations that typifies M’-class municipalities; thusleading to a fiscal outcome that is reflected in abandoned buildings, blighted land, and wide-spread unemployment and poverty. Agreeing with the premise that the ability to finance depends on the legal framework through which capital can be accessed, raised, and wound-up, analyzing the contrasting financing framework of these two cities (Niagara Falls, Canada vs. Niagara Falls, New York) willprovide a baseline for laying out the legal structures that the two cities operate under. This same baseline will serve as a comparable against which to analyze the effectiveness of the other municipal classes and types identified.

Research Methodology and Approach

The focus of the research will be to develop a hierarchical structure of municipal finance. The research will assess whether there are universal administrative governance structures bound by law and legal covenant that define a municipality’s ability to effectively finance its operations. The research will seek to answer the following questions: (a) what is the legal structure defining municipal financial systems; (b) do these systems exhibit a common baseline regardless of political, economic, or cultural frame; and (c) are observed differences in the laws governing selected case municipalities significant and how do those differences bear upon or modify the hypothetical baseline.

The research will consist of three groups of case studies. The cities of Niagara Falls, Ontario and Niagara Falls, New York will provide the baseline. These two cities will frame a hypothesis that the law effects a municipality’s financial capacity. The proximity of the cities and their access to the same resources and capital would lead to an assumption that their socio-economic systems should be very similar. Yet they have each experienced visibly different outcomes in growth, welfare distribution, and asset management that appear to be rooted in legislative decision-making, legal tradition, and regulatory framework.

From this baseline, the project will turn its attention to the American M’ set of cities identified in this proposal. The goal will be to determine (a) whether we can identify commonalities with the baseline cities and (b) whether the legal constraints under which these cities operate have an effect on their capacity to finance that differs from the baseline. Based on the observations gained from the second series of case studies, the research will then turn to the third group of case studies in order to (a) ascertain how legal approaches in different countries contribute to or detract from the ability of municipalities to sustain financial liquidity and (b) establish whether there exists a common set of laws and regulations governing municipal finance that are universal and are employed regardless of historical tradition, culture, or politics.

Conclusion

The research will seek to make a contribution by ascertaining whether there exists a baseline set of laws governing the financing of municipal operations that creates a uniform hierarchy of municipalities regardless of the cultural, political, or economic frame under which municipalities operate.

Selected Bibliography

Akerlof, George A., and Robert J. Schiller. 2009. Animal Spirits: How Human Psychology Drives the Economy, and Why it Matters for Global Capitalism. Princeton and Oxford: Princeton University Press.

Aronson, J. Richard, and Eli Schwartz. 2004. Management Policies in Local Government Finance. Washington, D.C.: ICMA Training Institute.

Axelrod, Robert. 1984. The Evolution of Cooperation. Cambridge MA: Basic Books.

Bardach, Eugene. 2005. A Practical Guide for Policy Analysis: The Eightfold Path to More Effective Problem Solving. 2d ed. Washington, D.C.: CQ Press.

Baron, Jane. 2004. "The 'No Property Problem': Understanding Poverty by Understanding Wealth." Michigan Law Review no. 110:1000.

Bivens, Josh. 2011. Failure by Design: The Story behind America's Broken Economy. Ithaca and London: ILR Press.

Boston, Thomas D., and Catherine L. Ross. 2002. The Inner City: Urban Poverty and Economic Development in the Next Century. New Brunswick and London: Transaction Publishers.

Brealey, Richard, Stewart Myers, and Franklin Allen. 2010. Principles of Corporate Finance. 10th ed: McGraw-Hill/Irwin.

Briffault, Richard. 1999. "A Government for Our Time? Business Improvement Districts and Urban Governance." Columbia Law Review no. 99 (2):365-477.

Callies, David L., Daniel J. Curtin Jr., and Julie A. Tappendorf. 2003. Bargaining for Development: A Handbook on Development Agreements, Annexation Agreements, Land Development Conditions, Vested Rights, and the Provision of Public Facilities. Washington, D.C.: Environmental Law Institute.

Caner, Asena, and Edward Wolff. 2004. "Asset Poverty in the United States, 1984-1999." Challenge no. 47 (1):5-52.