Measuring non-school fiscal imbalances of New England municipalities

Municipalities in New England are facing long-term structural fiscal imbalances. Various reports have documented that cities and towns have had a hard time raising sufficient local revenue to meet increasing demands for spending, and some communities are experiencing greater distress than others. To address such issues, states often use local aid—a mechanism by which funds are collected statewide and distributed among cities and towns. Several Massachusetts reports suggest that because state aid has been reduced, fiscal imbalances have particularly hurt municipal (non-school) services.1 These reports recommend increasing municipal aid and distributing the additional funds through a new formula that would address the local non-school fiscal imbalances. A recent Federal Reserve Bank of Boston working paper (NEPPC WP No. 06-3/Research WP No. 06-19) develops a new measure of such fiscal imbalances for Massachusetts cities and towns.2 This measure, which aims to more accurately reflect the current realities and constraints of local governments, creates a yardstick for appropriate comparisons across communities. This methodology may also be applicable to other states that are facing demands for new municipal aid distributions. Local fiscal imbalances can be measured by comparing the costs of providing local public services with the ability of local governments to raise revenue from local resources, which is known as local revenue capacity. The difference between costs and revenue capacity—the fiscal “gap”—can provide the basis for a new formula that channels more aid to communities with larger gaps. To avoid creating incentives for distorted responses to aid allocations, measures of costs and revenue capacity should be based upon characteristics that local governments cannot influence directly.