Financial difficulties of the US cities have recently become a major issue of concern. However, there is little agreement on why certain cities experience crises while others do not. Two arguments are put forward: Cities suffer from: (1) structural problems like high immigration, congestion, etc.; and (2) non-structural political problems like the weakness of the mayor, union-power, etc. Starting from a common pool model of municipal goods we estimate demand equations for spending and debt with structural variables. The estimation is based on 900 US cities in 1985, 1991 and 1999. Structural factors predicted by the model explain most of the variation of spending and debt levels. Furthermore coefficients are stable over time.

However, excessively high debt burdens as indicators of potential crisis and high spending levels are outliers and not explained by structural factors. Fiscal distress and crises have become issues of considerable concern for the US cities. Mayors ask for state aid to compensate for revenue short falls (The Economist, May 22, 2003; and Herbert, 2003). Some argue that New York City now faces the worst fiscal crisis since the mid-1970 (Cooper, 2003). In Oregon, school districts consider shortening the school year to avoid large deficits.

Even states are affected by the fiscal distress and lay off employees. While the media coverage of fiscal distress and crises is substantial, a systematic evidence on the determinants of crises and, at an earlier stage, distress is quite scarce. The present paper investigates the determinants of fiscal distress in 900 US cities in the mid 1980s, early 1990s and the late 1990s. Since no systematic data set on the occurrence of fiscal crises in US cities exists, cities in fiscal crises are identified by cluster analysis. The cluster of cities with a high debt-per-capita level is in a state of distress, while the low debt-per-capita levels are a sign of fiscal health. We argue that fiscal distress is a situation from which fiscal crisis is likely to result. Potential.

Financial difficulties, US cities, major issue, arguments,structural problems, high immigration, congestion, n-structural political problems, weakness of the mayor, union-power, common pool model,municipal goods, demand equations.