76 comparison across years and among the American states. This will improve scholars’
ability to conduct time series and panel analysis of the state experience of fiscal stress and their responses to fiscal stress as well as policy makers’ ability to make judgments
about policies affecting the financial condition of their specific government.
4.2 Financial Indicators and Index Construction
The financial indicators used in this analysis were chosen based on their past use to measure state financial condition as well as because of the availability of data. Wang et
al 2007 operationalized the cash, budget, long-run and service-level solvency definitions introduced by Groves et al 1981. The authors use eleven financial
indicators
5
to construct four separate indices of financial condition: cash ratio, quick ratio, current ratio, operating ratio, surplus deficit per capita, net assets ratio, long-term
liability ratio, long-term liability per capita, tax per capita, revenue per capita, and expenses per capita. Table 4.1 lists each financial indicator, its definition, the
interpretation of its value, and the fiscal stress index to which it contributes. The data used to create these financial indicators are available in the government-wide financial
statements in state Comprehensive Annual Financial Reports CAFRs. As mentioned above and detailed in table 4.1, four indices of fiscal stress are
created in this chapter: cash, budget, long-run, and service-level. These indices capture
5
Other financial ratios are proposed in the literature and are available using state government-wide financial statements in CAFRs. Kamnikar et al 2006 proposes three measures to assess state financial
condition: cash quick ratio cash+cash equivalents+investmentscurrent liabilities, debt to asset ratio total liabilitiestotal assets, and continuing services ratio unrestricted net assetsexpenses. Chaney et al
2002b list six financial ratios to measure local government financial condition including cash ratio, operating ratio, and long-term debttotal assets. In sum, multiple financial ratios exist and all measure some
component of a government’s financial condition. The value of using those proposed by Wang et al 2007 is that these financial ratios are linked to each of the four dimensions of solvency. And, as explained later in
this chapter, these financial ratios are internally and externally consistent measures of each dimension of financial condition examined here.
77 both the financial condition of a state as well as its level of fiscal stress. The methodology
for creating these indices draws from Wang et al 2007.
Table 4.1: Financial Indicators Used to Measure Fiscal Stress
ID Financial
Indicator Definition
Meaning Dimension
1 Cash Ratio
Cash+Cash Equivalents+ InvestmentsCurrent Liabilities
a
Higher ratio indicates greater cash solvency
Cash 2
Quick Ratio Cash+Cash Equivalents+
Investments +Receivables Current Liabilities
Higher ratio indicates greater cash solvency
Cash 3
Current Ratio Current Assets
b
Current Liabilities
Higher ratio indicates greater cash solvency
Cash 4
Operating Ratio
Total RevenuesTotal Expenses 1 or above indicates
budget solvency Budget
5 Surplus
deficit per capita
Total Surpluses DeficitsPopulation
Positive indicates budget solvency
Budget 6
Net Asset Ratio
Restricted and Unrestricted Net AssetsTotal Assets
Higher ratio indicates stronger long-run
solvency Long-run
7 Long-term
Liability Ratio
Long-term non-current Liabilities Total Assets
Lower ratio indicates stronger long-run
solvency Long-run
8 Long-term
Liability per capita
Long-term non-current Liabilities Population
Lower value indicates greater long-run
solvency Long-run
9 Tax per
capita Total TaxesPopulation
Higher value indicates lower service-level
solvency Service-level
10 Revenue per
capita Total RevenuesPopulation
Higher value indicates lower service-level
solvency Service-level
11 Expenses per
capita Total ExpensesPopulation
Higher value indicates lower service-level
solvency Service-level
Source: Wang et al 2007, 8-9
a
Current liabilities were classified for twenty-four states. Twenty-six states did not classify liabilities as current or noncurrent for all eight years. Using the same method as Wang et al 2007 liabilities are
assumed to be listed in order of maturity. Current liabilities as measured in this analysis do not include any liability items listed as or after noncurrent liabilities or long-term liabilities. Since states list
different items as liabilities, the composition of current liabilities across states is not identical.
b
Current assets were classified for twenty-four states. Twenty-six states did not classify assets as current or noncurrent for all eight years. Using the same method as Wang et al 2007 assets are
assumed to be listed in order of liquidity. In this analysis, current assets include assets listed before restricted or capital assets. Receivables include all items listed as receivable that are listed before
restricted assets. Since states list different items as assets, the composition of current assets across states is not identical.
78 Five of the financial indicators Surplus per capita, Long-term liability per capita, Tax per
capita, Revenues per capita, and Expenses per capita are not presented as ratios and therefore, require adjustment due to yearly fluctuations in inflation. These financial
indicators are deflated using the GDP price index. To ensure that the financial indicators are interpreted correctly when added together, five are transformed so that higher values
denote higher solvency. This was done by taking the inverse of the original variable.
6
All the financial indicators were standardized and converted to z scores. Each index was
created as follows; the standardized financial indicators underlying each solvency index were added together and then averaged. The resulting score is the value for each index.
All states for which data is available are included in the analysis.
4.3 Data
