Year of Publication



Martin School of Public Policy and Administration

Date Available


Executive Summary

Budget stabilization fund (BSF) is a general term for rainy day funds, contingency funds, and reserves. Historically, researchers have studies BSFs at the state level. However, after the Great Recession municipalities have increasingly adopted BSFs. So far, there are several unknowns surrounding municipal BSFs. The intent of this paper is to start addressing some of these unknowns. The paper seeks to answer the question, did municipal BSFs smooth expenditures over the Great Recession? This study uses data from Lexington-Fayette Urban County Government and eleven comparable municipalities.

The municipality BSF literature is in its infancy. Previous research has focused on state BSFs. The optimal size for state BSFs is inconclusive, and the literature agrees that there should not be a one size fits all BSF fund size for states. The literature also agrees that states should consider revenue volatility when establishing a BSF policy. Municipal BSF research is limited and only examines cities within the same state. This study will add to the literature by looking at cities across state lines.

Analysis for this capstone adopts a model that Justin Marlowe (2005) and Yilin Hou (2003) used to study if municipal BSFs smooth expenditures over the Great Recession. I created a unique trend line for each city using data from 1997 to 2001 to predict future spending. A positive expenditure gap is the result of a city spending more than predicted. A negative expenditure gap is created if the city spends less than predicted. Using a fixed effect model, I regressed the expenditure gap on four categories of explanatory variables: fund characteristics, financial measures, institutional factors, and demographic/ economic factors.

Results show that cities divide themselves into two groups: always positive expenditure gap cities, or always negative expenditure gap cities. Positive expenditure gap cities had BSFs that were 14 percent of total revenues, and negative expenditure gap cities BSFs were 6 percent of total revenues, on average.

Regression results indicate the size of a BSF is only statistically significant for negative expenditure gap cities, and as the BSF gets larger, the negative gap becomes more negative. The only variable that was statically significant for both positive and negative expenditure gap cities was income per capita. However, income per capital worked in opposite directions for the positive and negative expenditure gaps.

The small sample size limited the scope of the study, and future research should have a large sample of cities across several states. With a larger sample size, it will be possible to look at expenditure gaps before, during, and after the recession. Additionally, this study created one expenditure trend line using data from 1997 to 2001, which was a period of high growth. It is possible expenditures during this time was not a good predictor for future expenditures and should be explored further.

Over the course of this study, the number of cities with BSF policies increased from six to eleven. As more cities adopt BSF, the need for a better understanding of BSF and polices used to create and regulate becomes more pressing. There will not be a policy suitable for all cities, and when creating a policy, cities should consider the volatility associated with its top revenue sources, income per capita, and vulnerability to unemployment. While a withdrawal policy will be beneficial to limit excessive use of the fund, it should not be so restrictive that money cannot be accessed when needed. Along similar lines, establishing a minimum amount to be in a BSF will ensure there is money available during an economic downturn. However, the minimum needs to be flexible to allow the funds to be used during a recession. The minimum policy could include a plan to replenish the funds if they are drawn down.



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