Fiscal Capacity and Public Spending: Historical Evidence from U.S. Cities

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This paper explores the importance of sources of revenue for local public spending. Using newly collected data on municipal finances for more than 300 U.S. cities over 1910-1936, I leverage information on revenue flow from 44 categories with a city's past reliance on each category to predict both tax and non-tax revenue (intergovernmental transfers, fees and charges). Additional tax revenue causes greater spending on service provision than same-sized non-tax revenue, with additional services concentrated on education, welfare and public safety. Second, tax revenues have more persistent effects on total revenue, spending, and service provision. Tax revenue increases total revenue by 81% 10 years after the initial increase, while similar non-tax revenue affects total revenue for only 3 years. Third, I find long-run effects of tax revenue. Combining municipal finance data for 1940-2000, I provide evidence that cities with more tax revenue per capita in 1910-1936 have greater revenue and expenditure per capita throughout the next 60 years, associated with a higher median household income, larger population and migration.