Is Fiscal Illusion a factor Central Falls’ bankruptcy?

Central Falls, Rhode Island has been at the brink before. In 1991, the state took over its schools. John Hill writing at Providence Journal reports this move may have set up a fiscal dynamic responsible for the current municipal pension crisis. Central Falls was given a chance to avoid property tax increases for 10 years by relying on state funding for schools. The result is that Central Falls got used to not raising property taxes and not putting money into its pension plan.

In 1991, state aid accounted for 19 percent of Central Falls’ revenues. By 2008, state aid was 31 percent of revenues. When aid was reduced after the recession started, Central Falls finances experienced a shock. Over the same period, other Rhode Island towns increased their property tax levy by 133 percent, Central Falls only increased its levy by 23 percent. As Projo.com reports, if Central Falls instead raised property taxes by 2 percent a year over the period and contributed $200,000 a year to the pension system,  it could have avoided the 50 percent cut in benefits proposed by State Appointed Receiver, Robert Flanders.

What this 20 year policy of growing dependency on state aid and decreased reliance on property taxes points to is the fiscal illusion that operated in Central Falls’ finances. That is, when the source of taxation and of spending are not fully observed (or obviously linked) spending may be perceived as less costly than it actually is.

Another public choice lesson in the article is the incentive of politicians to obscure the real cost of spending:

“Though they say Schaefer’s numbers and reasoning on tax increases are right, two members of the 1991 commission said it was unrealistic to expect politicians up for reelection every two years to raise taxes when state aid increases were covering increases in annual operating costs. “Unfortunately, the reality is that in the political structure of any town, there just isn’t anyone who has the discipline to do that,” said Francis Dietz, president of Memorial Hospital and a 1991 commission member. “I think Frank is right in that assumption,” Varin said. “That’s not just a hard sell; it’s a practical impossibility.”