Local governance

What Is Local Governance?

Local governance refers to the system by which local jurisdictions, such as cities, counties, towns, and special districts, manage their public affairs and deliver services to their residents. Within the realm of public finance, local governance primarily focuses on how these subnational entities generate revenue, allocate resources, and manage their finances to support public services like education, public safety, infrastructure, and sanitation. The effectiveness of local governance directly impacts a community's economic well-being and quality of life, as it dictates the provision and funding of essential local services. Understanding local governance involves examining its revenue sources, expenditure patterns, and the legal frameworks that define its financial autonomy.

History and Origin

The concept of local governance in the United States traces its roots back to colonial times, where local units like towns and counties were crucial for managing community affairs and collecting taxes. Initially, the financing of local services was primarily through local taxes, particularly property taxes. As the nation grew, the responsibilities of local governments expanded significantly. By the early 1900s, local government was often the largest component of the U.S. federal system in terms of revenues and expenditures.¹⁸

A major shift in municipal finance occurred in the early 20th century as infrastructure needs evolved, leading cities to invest more in public health initiatives like sanitation and clean water. This period saw local taxes, such as property taxes, becoming the primary funding source for urban infrastructure. Over time, reliance on municipal bonds increased, making them an essential capital source for infrastructure projects.¹⁷ During significant economic downturns, such as the Great Depression, local finances experienced substantial turbulence, often necessitating federal assistance, which marked a period of "cooperative federalism."¹⁶ More recently, during the COVID-19 pandemic, the Federal Reserve intervened in the municipal bond market by establishing the Municipal Liquidity Facility (MLF) to help state and local governments manage cash flow pressures and continue providing services, an unprecedented step given the Fed's non-intervention during the Great Recession.¹⁵,¹⁴

Key Takeaways

• Local governance involves the financial management and service delivery functions of subnational government entities like cities and counties.
• Primary revenue sources for local governance include property taxes, sales taxes, user fees, and intergovernmental transfers.
• Local governments are responsible for essential services such as education, public safety, infrastructure, and sanitation.
• Effective local governance is crucial for a community's economic well-being and quality of life.
• Local government finances can be significantly impacted by economic cycles and broader fiscal policy decisions made at state and federal levels.

Formula and Calculation

While there isn't a single universal formula for "local governance," the financial health and operational capacity of local governments are often assessed through various metrics. These metrics involve calculating revenue per capita, expenditure per capita, debt-to-revenue ratios, and the percentage of revenue derived from different sources. For instance, understanding the reliance on a specific tax type can involve:

Where:

• Revenue from Specific Tax Source represents the total funds collected from a particular tax, such as sales taxes or property taxes.
• Total Own-Source Revenue includes all revenues generated directly by the local government, excluding intergovernmental transfers.

This calculation helps evaluate the diversification of a local government's revenue base and its vulnerability to fluctuations in specific economic sectors.

Interpreting Local Governance

Interpreting local governance involves assessing its financial sustainability, operational efficiency, and responsiveness to community needs. A strong local governance structure typically exhibits a balanced and diverse revenue portfolio, reducing over-reliance on any single income stream. For example, local governments that heavily depend on commercial property taxes might face significant challenges if commercial property values decline, as seen in some major cities.¹³ Diversified revenue streams, incorporating residential property taxes, sales taxes, and user fees, indicate greater fiscal resilience.

Additionally, effective local governance is characterized by sound financial management practices, transparent budgetary processes, and a clear alignment of expenditures with community priorities. Interpreting the health of local governance also requires considering demographic trends, economic conditions, and state-imposed limitations on taxation and spending, which can significantly influence a local government's financial flexibility.¹²

Hypothetical Example

Consider the hypothetical city of "Harmonyville." Its local governance relies heavily on property taxes, which historically have been stable. However, a major manufacturing plant, a significant commercial property taxpayer, announces its closure.

Harmonyville's local governance must now react. They review their budget and identify potential revenue shortfalls. The city council, through its existing budgetary process, analyzes options:

1. Adjusting property tax rates for remaining properties: This is often unpopular and can strain residents.
2. Exploring new revenue sources: Could they introduce or increase local sales taxes if permitted by state law? Are there services for which they can implement or increase user fees?
3. Seeking state or federal grants: Are there opportunities for intergovernmental transfers for economic development or infrastructure projects?
4. Cutting expenditures: Where can the city reduce spending without significantly impacting essential services?

Through this process, Harmonyville's local governance team might decide to diversify its tax base over time, perhaps by attracting new businesses to promote economic development and by seeking grants for new infrastructure that could draw residents and commercial activity.

Practical Applications

Local governance principles are applied across various aspects of public life and finance. In investment, analysts assess the fiscal health of local governments when evaluating municipal bonds, as the creditworthiness of these bonds depends on the issuer's ability to generate sufficient revenue and manage its debt burden. A local government with robust governance and sound fiscal practices is generally seen as a lower credit risk.

In urban planning, local governance dictates zoning laws, land use policies, and public investment in infrastructure like roads, utilities, and public transport. These decisions directly influence property values, commercial activity, and residential growth. For example, the Lincoln Institute of Land Policy conducts extensive research on how sound urban planning and land-based taxation can promote the fiscal health of municipal governments.¹¹ Local governance also plays a crucial role in regulating local economies through business licensing, building codes, and public-private partnerships for large-scale projects. The National Conference of State Legislatures (NCSL) regularly addresses issues related to state-local fiscal relations, including unfunded mandates and tax systems, which directly impact the practical application of local governance.¹⁰

Limitations and Criticisms

Despite its importance, local governance faces several limitations and criticisms. One significant challenge is the reliance on a limited range of revenue sources, primarily property taxes and, in some cases, sales or income taxes. This can lead to revenue shortfalls during economic downturns, particularly when property values stagnate or decline. Many states also impose tax and expenditure limits (TELs) on local governments, restricting their ability to raise taxes or spend funds, which can severely limit financial flexibility.⁹

Another criticism revolves around potential inefficiencies or lack of expertise in financial management at the local level compared to national governments. Critics also point to issues of equity, where wealthier localities may provide better services due to a stronger tax base, while less affluent areas struggle. Furthermore, fragmented local governance structures, with numerous overlapping jurisdictions, can lead to coordination challenges and inefficiencies in service delivery. While fiscal decentralization is often championed for bringing government closer to the people and enhancing accountability, it can also lead to a weakening of overall fiscal discipline if subnational governments struggle to adhere to broader fiscal targets.⁸

Local Governance vs. Fiscal Decentralization

While closely related, local governance and fiscal decentralization represent distinct but interconnected concepts within public finance.

Local Governance broadly refers to the administrative and operational framework of subnational entities—cities, counties, towns—in managing their local affairs and providing public services. It encompasses the entire spectrum of decision-making, service delivery, revenue generation, and expenditure management at the local level. It's about how local entities govern themselves.

Fiscal Decentralization, on the other hand, is a specific aspect of this broader framework, focusing on the transfer of financial responsibilities, including the authority to impose and collect taxes and determine expenditure priorities, from central governments to regional and local levels. It ⁷is a mechanism of fiscal federalism that quantifies the degree to which subnational governments control their own revenues and expenditures. The International Monetary Fund (IMF) and World Bank maintain datasets to measure this concept across countries., Fi⁶s⁵cal decentralization is a policy choice that shapes the financial landscape within which local governance operates.

In essence, fiscal decentralization defines the financial resources and autonomy available to local governments, while local governance describes how these governments utilize that autonomy and those resources to function effectively.

FAQs

What are the primary sources of revenue for local governance?

The primary revenue sources for local governance typically include property taxes, sales taxes, user fees for specific services (like water or trash collection), and intergovernmental transfers from state and federal governments.

##⁴# What services do local governments typically provide?
Local governments are responsible for providing a wide array of essential services that directly impact daily life. These commonly include public education, police and fire protection, road maintenance and infrastructure, water and sewer systems, waste management, parks and recreation, and public health services.

##³# How do local governments finance major projects?
Major projects, often involving significant capital expenditures, are typically financed through a combination of methods. These include issuing municipal bonds, obtaining state or federal grants, utilizing dedicated user fees, and sometimes through public-private partnerships.

##²# Why is financial management important for local governance?
Sound financial management is critical for local governance to ensure the sustainable provision of public services. It involves effective budgeting, managing debt responsibly, transparent reporting, and strategic planning to navigate economic fluctuations and ensure long-term fiscal stability. Poor financial management can lead to service cuts, increased taxes, or even financial distress for a locality.¹