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3.2.3 A Good Measure of Fiscal Stress
What is a good measure of fiscal stress? To a certain extent the answer depends on the unit of analysis and the availability of data. The literature on financial condition
and fiscal stress measurement points to several issues that should be considered in constructing a measure of fiscal stress. Four considerations – using a composite or
multiple measures, the time frame of different indicators, the operationalization of public demand, and the criteria by which to declare fiscal stress – are discussed in several
articles focusing on measurement Hendrick 2004; Ross and Greenfield 1980; Jimenez 2009; Brown 1993; Kloha et al 2005. These issues can help guide the construction of a
good fiscal stress measure for this analysis. A fundamental concern for researchers creating measures of financial condition
and by extension fiscal stress is whether a composite measure combining indicators of different underlying conditions should be used or instead each dimension of financial
condition should be defined and then indicators used to measure them separately. Both methodologies have been used. Hendrick 2004 notes that since governments may differ
in their levels of solvency on different measures, combining different dimensions of financial condition would be misleading. The author proposes constructing the
dimensions separately and then assessing how governments perform on each. Wang et al 2007 uses both a set of indices measuring budget, cash, long-run and service-level
solvency and a single index that combines the underlying financial indicators to create a composite measure of financial condition. Brown 1993 and Kloha et al 2005, in their
models to predict local government fiscal stress, use multiple measures to arrive at a single score with which to assess a local government’s condition. Despite the persistence
of researchers using a single measure, many have noted the difficulty of measuring a multidimensional concept such as fiscal stress with a single measure or a composite
measure Jimenez 2009; Ross and Greenfield 1980. Another concern with creating a composite measure is how to set the correct weights on different indicators Hendrick
60 2004. These philosophical and technical concerns point to the usefulness of multiple
measures along different dimensions of financial condition and fiscal stress rather than a single measure.
A consideration that flows directly from the discussion of multiple versus single measures is how to account for measures or dimensions of fiscal stress that have different
time frames. Hendrick 2004 provides an example of how this problem would arise. Some indicators of fiscal stress such as a government’s ability to pay its bills on time are
short-term. They deal with liquidity in how the government currently operates. Whether a government is able to meet its obligations over an entire budget year or whether it is able
to generate enough revenue in a budget year to pay for planned expenditures within the budget year are mid-term measures of fiscal stress. A government’s ability to meet debt
obligations is a long-term measure. Since financial indicators and other types of fiscal stress measures may differ in terms of their time horizon, the usefulness of a measure that
combines these measures is questionable. A continuing difficulty in the measurement of financial condition or fiscal stress,
as touched on in the previous section – is how or whether to attempt to measure public demand for government goods and services. To deal with this, many researchers use per
capita income as a proxy for public demand Hendrick 2004; Ladd and Yinger 1989. Ross and Greenfield 1980, 102 suggested that other measures, such as financial
indicators do not assess whether a local government provides its citizens with the appropriate level of services. Financial indicators are not designed to measure public
demand or to assess whether a government is meeting its service obligations; however, Chaney et al 2002a proposes that it may be better to assess a government’s ability to
pay for services. By focusing on the ability to meet service obligations, we assume that the other factors that lead to choices about the level of goods and services occur. That
way we do not end up penalizing a government for not providing ‘enough’ services when in fact citizens in that area may not want many or a certain level of government services.
61 However, we are still able to discern governments in stress based on their ability to
provide these goods and services. Wang et al 2007 proposes three indicators to measure a government’s ability to provide goods and services: tax per capita, revenues per capita,
and expenses per capita. The higher any of these measures are, the less ability a government has to increase the provision of goods and services.
Finally, setting a criterion or standard for fiscal stress is highly subjective Bahl 1982. Researchers disagree on whether to use an absolute or relative measure of fiscal
stress. With relative measures, cities or states values on different indicators are compared to one another. One method uses a location quotient to compare one unit’s indicators
against the median or mean value for the entire cohort Berne and Schramm 1986; Chaney et al 2002a; Miller 2001. Brown 1993 assigns scores based on a city’s
performance on ten indicators relative to cities of roughly the same population. A score is given for each indicator depending on the quartile a city falls into. Then the scores are
assigned meaning – a city that performs in either the third or fourth quartile for all 10 indicators receives a rating of “among the best” 24. Falling in the lowest quartile will
earn a city a rating of “among the worst”. Since the cities used for comparison purposes were not randomly selected, Brown 1993 notes that a city with a low score may not be
in poor financial condition – just in poorer financial condition than the cities in the Government Finance Officers Association GFOA Financial Indicators database. Ross
and Greenfield 1980 hold that the concept of fiscal stress urban distress in their parlance is relative and therefore can only have meaning when comparing localities.
Kloha et al 2005a also use financial and socioeconomic indicators to measure cities’ financial conditions; however, they devise absolute criteria for poor financial condition.
To do this, the authors note they have to assign values to variables that may seem subjective. Based on these values, cities can compare their point values to the authors’
scale – 0 to 4 points and no action needed; 5 points and recommend fiscal watch, 6 to 7 points and recommend fiscal warning, and 8 to 10 points and the city is in fiscal
62 emergency. In state fiscal measures, the use of unreserved budget balance as a percent of
total expenditures has invited much discussion of the point of fiscal stress Joyce 2001. An often-cited threshold of good financial condition is a balance of 5 percent or greater
Rubin and Willoughby 2009; however, the appropriate value is far from settled. The purpose of this discussion is to illustrate that regardless of whether an absolute or relative
measure is used; assigning value is subjective – whether the values are relative to other governments or relative to fixed criteria. Especially in the absence of agreed upon
external criteria, comparing governments to one another and viewing their level of fiscal stress relative to other states makes sense.
3.2.4 Typology of State Fiscal Stress Measures
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