Local jurisdictions differ in the per capita costs that they must incur to provide a standard quality and quantity of municipal services at average efficiency. These cost differences are attributable to local social and economic characteristics or circumstances that are outside the control of local government.Local finance - Massachusetts ; Property tax - Massachusetts ; Cities and towns - Massachusetts

Bo Zhao

Katharine Bradbury

English

Research Papers in Economics

Policy
Brief
07-6
New England Public Policy Center
at the Federal Reserve Bank of Boston                 July 2007
Municipalities in New England are facing 
long-term structural fiscal imbalances. Vari-
ous 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 lo-
cal 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 mu-
nicipal (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 Fed-
eral Reserve Bank of Boston working paper 
(NEPPC  WP  No.  06-3/Research  WP  No. 
06-19) develops a new measure of such fis-
cal 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 de-
mands for new municipal aid distributions.
Local  fiscal  imbalances  can  be  mea-
sured by comparing the costs of providing 
local public services with the ability of lo-
cal 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, mea-
sures of costs and revenue capacity should 
be based upon characteristics that local gov-
ernments cannot influence directly.
Non-school costs
Local jurisdictions differ in the per capita 
costs that they must incur to provide a stan-
dard quality and quantity of municipal ser-
vices at average efficiency. These cost dif-
ferences are attributable to local social and 
economic  characteristics  or  circumstances 
that are outside the control of local govern-
ment.  For  example,  a  community  with  a 
heavier concentration of jobs has to spend 
more  on  services  for  commuters  and  em-
ployers, such as traffic lights, snow plowing, 
road maintenance, and police protection. 
These  costs  are  different  from  the             
actual  spending  by  a  municipality.  While                     
local governments can to some extent choose 
how  much  to  spend,  they  cannot  choose 
their costs that depend upon uncontrollable 
local characteristics. In practice, most state 
aid formulas either completely ignore costs 
or use an extremely simple or ad hoc mea-
sure, often population alone (or, in the case 
of school aid, enrollment) to represent cost 
variations.
Following earlier studies of Massachu-
setts,  Nebraska,  and  Minnesota,  NEPPC 
WP  No.  06-3  used  a  statistical  approach 
to  measure  cost  differences  across  cities 
and  towns  in  Massachusetts. While  it  ex-
plored  an extensive list of uncontrollable 
local characteristics, only those characteris-
tics strongly related to per capita spending 
were retained in calculating costs. To insure             
New England Public 
Policy Center
Director
Robert Tannenwald
Staff
Heather Brome
Tom DeCoff
Joanna Helou
Adam Langley
Matthew Nagowski
Antoniya Owens
Darcy Rollins Saas
Alicia Sasser
Bo Zhao
The New England Public Policy 
Center is dedicated to enhancing 
access to high-quality analysis on 
economic and public policy issues 
that affect the region.
For more information about the 
New England Public Policy Center, 
please visit: www.bos.frb.org/ 
economic/neppc/
The views expressed are the 
authors’ and not necessarily those 
of the Federal Reserve Bank of 
Boston or the Federal Reserve 
System.
Measuring non-school fiscal imbalances  
of New England municipalities 
By Katharine Bradbury, Senior Economist, and Bo Zhao, Economist  
federal reserve 
bank of boston
TM
New England Public Policy Center
at the Federal Reserve Bank of Boston
Table 1: Per capita non-school costs of prototype Massachusetts communities   
 
Value of cost factors:
	 Population	density	(000s	per	square	mile)	 1.26	 8.00	 0.08	 1.50	 0.90	 0.24
	 Population	size	(in	logarithm)	 9.00	 11.50	 7.50	 10.20	 9.00	 8.60
	 Percent	of	population	in	poverty,	1999	 6.00	 18.90	 5.00	 3.70	 2.60	 6.50
	 Unemployment	rate	(percent)	 2.61	 4.30	 2.70	 1.80	 1.20	 2.60
	 Jobs	by	place	of	work	per	resident,	2000–02	 0.37	 0.35	 0.20	 1.00	 0.22	 0.53
Non-school cost  $799  $1,224  $682  $918  $657  $813
Source:	NEPPC	Working	Paper	06-3	/	Research	Department	Working	Paper	06-19,	2006.	See	the	working	paper	for	more	details	of	the	calculations.		
Note:	Data	year	is	2000	unless	otherwise	indicated.	
comparability across communities, the paper 
considered  spending  for  a  consistent  set  of 
non-school local services provided by all cities 
and towns. To isolate and identify only costs 
that local governments cannot control, it also 
took into account and removed other reasons 
for inter-local spending differences, such as 
different choices made by local officials and 
residents  about  service  quality,  and  institu-
tional differences, such as regional versus local 
school districts. The analysis indicated that 
Massachusetts communities with greater  den-
sities, larger populations, more jobs per capita, 
and higher poverty and unemployment rates 
incur higher costs per capita to provide a stan-
dard bundle of municipal services. Based on 
these estimated relationships, a cost measure 
was calculated to reflect the degree to which 
higher values of the cost factors raise the per 
capita cost of providing municipal services.  
Table 1 demonstrates how different lo-
cal characteristics translate into cost differ-
ences. It displays values of the cost factors 
and  measured  costs  for  five  example  cities 
and towns, which are labeled “prototype com-
munities”—large city, rural town, job-center 
suburb,  higher-income  residential  suburb, 
and resort town. These prototypes are con-
structed based on data for several actual cit-
ies and towns that exemplify each descriptive 
label. The large city, job-center suburb, and 
resort town prototypes face higher costs, with 
above-average values for several cost factors. 
By contrast, costs are considerably lower in 
the rural town and higher-income residential 
suburb prototypes, which feature lower den-
sity, less poverty, and fewer jobs/commuters. 
One can adapt this measurement approach 
to  other  states,  incorporating  knowledge  of 
specific state-local institutions into a similar 
statistical  investigation  of  the  relationships 
between municipal spending and a range of 
uncontrollable local characteristics. The criti-
cal element of the approach is identifying po-
tential cost factors, while taking into account 
and removing the influence of spending dif-
ferences across municipalities that are not due 
to uncontrollable characteristics (for example, 
differences due to quality choices and to vary-
ing service responsibilities between state and 
local governments and among localities). The 
key cost factors and estimated relationships 
are  likely  to  vary  across  states,  depending 
upon differing municipal responsibilities and 
other  institutional  arrangements,  as  well  as 
the physical and socio-economic environment 
in which local services are produced. 
Non-school local revenue capacity
Municipalities  differ  in  their  local  revenue     
capacity, that is, their ability to raise revenues 
from local resources. Revenue capacity is dif-
ferent  from  the  amount  of  actual  revenues 
raised by a municipality; while local govern-
ments can to some degree choose how much 
revenue they raise, they cannot choose their 
underlying revenue capacity.3 In the 1960s, the 
Advisory  Commission  on  Intergovernmental 
Relations developed an approach, commonly 
referred to as the “Representative Revenue 
System” (RRS), to estimate revenue capacity as 
the amount of revenue that would be raised 
from each tax base if it were to be taxed at 
a  standard  rate. Therefore,  this  measure  of 
revenue capacity depends only on the size of 
the tax base, not on the actual tax rate. It has 
been adopted in various aid formulas, includ-
ing the Massachusetts lottery aid formula and 
	 	 	 	 	 Higher-income
	 	 	 	 Job-center	 residential	
	 Average	 Large	city	 Rural	town	 suburb	 suburb	 Resort	town	
	 community	 prototype	 prototype	 prototype	 prototype	 prototype
Table 2: Per capita non-school local revenue capacity  
of prototype Massachusetts communities
Value of property tax capacity factors:           
Per	capita	residential	and		 $78,786	 $23,400	 $50,500	 $70,500	 $145,500	 $250,000		
		open	space	property	value
Per	capita	income,	1999	 $27,233	 $17,100	 $22,900	 $35,000	 $54,000	 $28,300
Per	capita	non-residential	
		property	value	 $17,211	 $6,400	 $8,100	 $30,000	 $6,000	 $26,500
Property tax capacity	 $1,212	 $460	 $794	 $1,403	 $1,915	 $2,493
Other local revenue capacity	 $115	 $55	 $96	 $140	 $140	 $225
Capacity dedicated to 
non-municipal purposes	 $650	 $250	 $525	 $915	 $1,100	 $825
Non-school local revenue capacity	 $677	 $265	 $365	 $628	 $955	 $1,893
Source:	NEPPC	Working	Paper	06-3	/	Research	Department	Working	Paper	06-19,	2006.	See	the	working	paper	for	more	details	of	the	calculations.	
Notes:		Data	year	is	2000	unless	otherwise	indicated.	 	
Other	local	revenue	capacity	includes	ability	to	raise	revenue	from	motor	vehicle	excise,	hotel-motel	excise,	urban	redevelopment	excise,	local	share	of	
racing	taxes,	and	state	government	payment	in	lieu	of	taxes	for	state-owned	land.	The	capacity	dedicated	to	non-municipal	purposes	include	the	net	
minimum	required	local	contribution	for	schools,	county	taxes,	charges	for	regional	transit	and	regional	planning	authorities,	and	state	assessments	
for	air	pollution	and	mosquito	control.
the Connecticut Supplemental Aid formula, 
both of which allocate per capita aid inversely 
to the size of the per capita property tax base.
However, the RRS approach ignores one 
significant revenue constraint now faced by 
municipalities in many states—local tax limi-
tations.  RRS  assumes  that  all  communities 
can tap their property tax bases to the same 
degree,  but  this  assumption  does  not  hold 
when  local  tax  limitations  effectively  con-
strain communities to varying degrees. Three 
of the six New England states (Maine, Mas-
sachusetts, and Rhode Island) have imposed 
some form of local property tax limit.
NEPPC WP No. 06-3 is the first attempt 
to account for the constraints of a local tax 
limitation  in  measuring  revenue  capacity. 
Analysis  of  Massachusetts  data  found  that 
local governments in higher-income commu-
nities have a greater ability to tap into their 
residential property tax base and are thus less 
constrained by the local property tax limita-
tion  (Proposition  2½).  Based  on  the  esti-
mated  Massachusetts  relationships,  a  mea-
sure of residential property tax capacity was 
calculated to reflect how a higher per capita 
residential property tax base and a higher per 
capita income together increase the ability of 
a local government to raise revenue from local 
residential property. 
In addition to residential property, mu-
nicipal governments can raise revenues from 
non-residential  property  and  limited  other 
(non-property-tax) local sources, such as the 
motor vehicle excise tax and the hotel-motel 
excise tax. The analysis in Massachusetts also 
indicated that the RRS approach is appropri-
ate for measuring non-residential property tax 
capacity and other local revenue capacity in 
proportion to those tax bases. Moreover, be-
cause not all local revenue capacity is available 
for general municipal purposes, the capacity 
that is dedicated to non-municipal purposes 
should be excluded in calculating non-school 
local revenue capacity. Two typical reductions 
are required contributions for public schools 
set by the state government and payments 
for services provided by other public organi-
zations (for example, regional transit). As for 
other elements of measured capacity, it is im-
portant that these capacity reductions reflect 
required—not locally chosen—amounts.
Per capita non-school local revenue capa-
city varies widely among Massachusetts cities 
and towns. As shown in Table 2, the large city 
and rural town prototypes have very limited 
revenue capacity, while the three other proto-
types have higher capacity, even considering 
	 	 	 	 	 Higher-income
	 	 	 	 Job-center	 residential	
	 Average	 Large	city	 Rural	town	 suburb	 suburb	 Resort	town	
	 community	 prototype	 prototype	 prototype	 prototype	 prototype  This policy brief is based on Measuring Disparities in Non-School Costs and Revenue Capacity among 
Massachusetts Cities and Towns, a New England Public Policy Center and Research Department 
working paper from the Federal Reserve Bank of Boston. The full paper is available at http://www.
bos.frb.org/economic/neppc/wp/2006/neppcwp0603.htm. To receive a copy of future policy briefs, 
please contact the Policy Center at neppc@bos.frb.org or 617-973-4257.
Table 3: Per capita non-school cost-capacity gap  
of prototype Massachusetts communities       
Non-school	cost	 $799	 $1,224	 $682	 $918	 $657	 $813
Non-school	capacity	 $677	 $265	 $365	 $628	 $955	 $1,893
Non-school	cost-capacity	gap	 $122	 $959	 $317	 $290	 -$298	 -$1,080
Source:	NEPPC	Working	Paper	06-3	/	Research	Department	Working	Paper	06-19,	2006.		See	the	working	paper	for	more	details	of	the	
calculations.
Note:	Data	year	is	2000	unless	otherwise	indicated.
their greater revenue responsibility for schools.
This approach to measuring local revenue 
capacity can be adapted to other states if some 
principles are followed. First, an appropriate 
capacity measure should reflect the resources 
that municipal governments can tap and the 
constraints  on  tapping  such  resources  (such 
as tax limitations), but not local government 
choices  or  behaviors.  Second,  the  measure 
should take into account state-specific situa-
tions and institutions, such as what tax bases 
localities are allowed to tax. Measures of lo-
cal revenue capacity are likely to differ across 
states because of institutional differences or 
different  relationships  among  the  capacity       
factors, even with similar institutions.
Non-school fiscal gaps and options  
for allocating aid 
To calculate the per capita gap for each com-
munity, per capita local revenue capacity is sub-
tracted from per capita costs. The relative size 
of a community’s gap represents the degree 
of mismatch between its costs for a standard 
bundle of municipal services and its ability to 
raise revenue from local sources for municipal 
purposes. Communities with larger gaps have a 
greater need for aid. 
As  Table  3  shows,  substantial  inter-local 
differences in the size of the per capita non-
school gap exist across Massachusetts cities  and 
towns. Its distribution ranges from large nega-
tive gaps—as shown for the resort town pro-
totype, which has very large capacity—to sub-
stantial positive gaps, as shown for the large city 
prototype, with high costs and low capacity.
There are several options for policy makers 
to allocate aid on the basis of the cost and capa- 
city measures described above. One option is 
to distribute aid to communities in proportion 
to their cost-capacity gaps. This approach tar-
gets the neediest cities and towns by channel-
ing more aid to communities with larger mis-
matches between their service costs and their 
ability  to  raise  local  revenue.  Other  options 
include allocating aid in proportion to costs, or 
inversely to local revenue capacity, or taking an 
average or the larger of the aid amounts from 
these two options. Policy makers should decide 
which approach is appropriate based on the cir-
cumstances of their individual state and their 
policy needs. 
Endnotes
1	
For	example,	see	Municipal	Finance	Task	Force,	Local 
Communities at Risk: Revisiting the Fiscal Partnership 
Between the Commonwealth and Cities and Towns, 2005;	
and	Barry	Bluestone,	Alan	Clayton-Matthews,	and	David	
Soule,	Revenue Sharing and the Future of Massachusetts	
Economy, 2006.	
2
Katharine	Bradbury	and	Bo	Zhao.	“Measuring	Disparities	
in	Non-School	Costs	and	Revenue	Capacity	among	
Massachusetts	Cities	and	Towns.”	Federal	Reserve	Bank	of	
Boston	NEPPC	WP	No.	06-3/Research	WP	No.	06-19,	2006.
3
In	the	long	run,	cities	and	towns	could	have	some	influence	
on	the	size	of	their	tax	bases	through	economic	development	
strategies.	But	many	big-city	mayors	and	small-town	
selectmen	would	probably	argue	that	quite	a	few	aspects	of	
local	revenue-raising	ability	remain	outside	their	control	even	
in	the	long	run,	and	most	do	in	the	short	run. 
	 	 	 	 	 Higher-income
	 	 	 	 Job-center	 residential	
	 Average	 Large	city	 Rural	town	 suburb	 suburb	 Resort	town	
	 community	 prototype	 prototype	 prototype	 prototype	 prototype

Measuring non-school fiscal imbalances of New England municipalities

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Measuring non-school fiscal imbalances of New England municipalities

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