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Do fiscal constraints prevent default? Historical evidence from U.S. municipalities

Abstract

Through the nineteenth century numerous U.S. states developed extensive municipal fiscal constitutions. These generally came in the wake of financial crises and large-scale default of public debts. Although the constraints were imposed in order to minimize the likelihood that such outcomes would occur in the future, little work has been undertaken to analyze whether they were successful in achieving that goal. Therefore, this current study attempts to do so by empirically investigating how procedural safeguards and outright prohibitions on debt accumulation, along with hard budget constraints, and tax limits impacted the likelihood of default. This is done by evaluating municipal defaults that centered on the Panic of 1893. Overall, the results suggest that outright prohibitions on debt accumulation and hard budget constraints actually reduced the likelihood of municipal default across states, while tax limits and procedural safeguards increased that likelihood.

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Fig. 1

Notes

  1. See Scott (1893), Ratchford (1941), McGrane (1935) for detailed discussions of both periods.

  2. Anecdotal evidence from contemporary sources will be discussed in greater detail in a later section.

  3. For recent literature reviews on these issues, especially as they relate to U.S. states see Rose (2010) and Krol (2007).

  4. For an overview of this issue see Kornai et al. (2003) and Rodden et al. (2003).

  5. For an overview of state public finance policy during this period see Grinath et al. (1997).

  6. The eight states were Arkansas, Illinois, Indiana, Louisiana, Maryland, Michigan, Mississippi, and Pennsylvania. The territory was Florida. Of these Arkansas, Florida, Louisiana, Michigan, and Mississippi repudiated at least a portion of those outstanding debts.

  7. See Summers (1984) for a full historical account of this period and the economic policies Southern states pursued.

  8. The bulk of these amendments were compiled from the NBER/University of Maryland State Constitution Project (Wallis 2015). When constitutions were not available, the remaining amendments were hand collected.

  9. For important historical analyses of the Panic of 1893 and the ensuing depression see Hoffman (1970), Steeples and Whitten (1998), and White (1982).

  10. Importantly, although municipal defaults are available to 1930, after 1905 states again went through an extended period of constitutional revision. Thus, extending the analysis beyond 1905 brings in endogeneity concerns that can otherwise be largely avoided over the sample period explored. Further, in order to alleviate any endogeneity problems that may exist, those constraints that were adopted by a state through the period under analysis are dropped. For example, Louisiana passed DebtGuard in 1894. Therefore, all Louisiana DebtGuard observations are excluded from the entire analysis 1890 to 1905.

  11. Per Hillhouse, “Any failure to meet an interest or principle payment on time was treated as a default” (1930, pg. iii).

  12. The U.S. Census Bureau groups states into specific geographic regions for statistical reporting purposes. In this paper I include the four major and broadest regions used by the Census Bureau, which are the Northeast, South, Midwest, and West regions.

  13. For a more thorough discussion of these issues see Cameron and Trivedi (2013).

  14. This model largely follows from Blundell et al. (1995), Allison and Waterman (2002), and Cameron and Trivedi (2013). For the sake of space it is presented in a much reduced form here.

  15. Due to the time invariant nature of most of the main independent variables involved, state fixed effects could not be incorporated into the model.

  16. This method is employed as including the lagged dependent variable would lead to coefficients that are inconsistent due to the time-invariance of the fiscal constraint variables. Therefore, including the current variable for repeat defaults should help avoid inconsistent estimates and should also help address any potential serial correlation.

  17. The historical and anecdotal evidence would suggest that many times these procedural safeguards were abrogated through technicalities in the language of the voting rule itself. Although beyond the scope of this current study, for a good overview of how these procedural rules were circumvented see Hillhouse (1936).

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Correspondence to John A. Dove.

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The author would like to thank two anonymous referees as well as participants at the 2015 Economic and Business History conference in La Crosse, Wisconsin for extremely helpful comments on earlier versions of this paper.

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Dove, J.A. Do fiscal constraints prevent default? Historical evidence from U.S. municipalities. Econ Gov 17, 185–209 (2016). https://doi.org/10.1007/s10101-015-0172-y

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Keywords

  • Default
  • Sovereign debt
  • Fiscal constraints
  • Panic of 1893
  • Credible commitments

JEL Classification

  • D78
  • H73
  • H74
  • N21
  • N41