The interesting case of special and extraordinary items: What are they and how do they influence municipal government finances?

Abstract

AbstractOne‐shot revenue shocks influence government budget decisions and service provision. However, how governments respond to transitory income remains a theoretical and empirical puzzle. The permanent income hypothesis posits that governments save windfalls to smooth expenditures, while other models predict spending increases. Empirical findings are inconclusive as the focus has been on revenues that are not truly transitory. The case of special and extraordinary gains allows us to investigate the effects of transitory resources. Taking advantage of the Governmental Accounting Standards Board's requirement that governments report such gains in their financial statements, this study examines the effects of gains on expenses for a sample of cities across 10 years. Using a staggered adoption event study design, we find that gains stimulate spending and that the size of gains matters before one observes the stimulatory effects. These results have substantial implications for budgetary transparency and fiscal sustainability in municipal governments.