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A Partisan Mismatch with State Government Means Higher Borrowing Costs for Cities‌‌

Are red cities marooned in blue states—and blue cities in red states—at a financial disadvantage because of partisan politics? A new study co-authored by Yale SOM’s Anya Nakhmurina finds that cities whose leaders are from the opposite political party as their state governors are penalized in the bond market.‌

In her PhD dissertation, Yale SOM’s Anya Nakhmurina explored the effects of state fiscal monitoring policies on the financial health of cities, finding that oversight improved municipal finances and even reduced corruption. When she presented the resulting paper, she was often asked by audience members how politics might influence such monitoring. For instance, would state auditors reporting to a governor of one political party more aggressively police the finances of cities led by the opposite party?‌

Now she and Ramona Dagostino of the University of Virginia, who met Nakhmurina during one of those presentations, have teamed up to explore a related question: how city-state politics affect cities’ ability to finance projects and provide public goods. Their new paper reveals that there are consequences for cities whose leaders do not share the same political party as their state’s governor. Specifically, cities that Nakhmurina and Dagostino call “misaligned” pay significantly more in interest to borrow money in the bond market.‌

Given that local governments often finance not just day-to-day operations but also special and long-term projects through bonds, things are much more expensive for misaligned cities, who, according to the paper, pay on average about eight basis points higher interest rates than aligned cities do.‌

Prior papers have compared spending by Republican and Democratic cities and found little differences at the local level, but Nakhmurina and Dagostino’s paper is unique in that they take a novel approach by examining aligned versus misaligned cities—that is, cities whose political party matches or differs from their state government. Nakhmurina and Dagostino argue that the U.S. institutional setup, where cities derive their existence from the state, creates an environment where partisan disagreements between elected officials can manifest in substantial differences in the outcomes for the aligned and misaligned cities.‌

Moreover, the paper uses an objective, outside measure—the cost of capital as determined by investors—to assess differences in politically aligned and misaligned cities. Recognizing that misaligned cities are less likely to be assisted or bailed out by state governments, investors penalize such cities by demaninding higher interest payments.‌

The paper finds that differences in borrowing costs also depend on the balance of power between a state and its local governments. For instance, the gap in interest rates is greater in states where governors have more power to assist cities in distress—if they choose to—and rates are higher for misaligned cities that are financially dependent on the state (as opposed to so-called “home rule” cities that have more power over their own finances).‌

“It’s not enough to compare Republican and Democratic cities—you need to understand the political context in which cities operate,” she says. “This relationship between states and cities is crucial for whatever cities are able or not able to do.”‌

The authors drew from Nakhmurina’s previous paper, “Financial Constraints and short-term planning are linked to flood risk adaptation gaps in US cities,” to show how the dynamics she and Dagostino identify affect a specific area of public infrastructure projects: flood-risk adaptation.‌

No politician or state government in their right mind is going to say, ‘We withheld this money for partisan reasons.’ So we need a large sample to see what’s really going on.”

“We were thinking, ‘Where might [political alignment] matter most?’” she explains. “What areas are top of mind for people in local governance and would really affect the lives of constituents?”‌

Given that aligned cities can borrow money more cheaply, one might assume that they would proactively invest in adaptation efforts. But actually the opposite is true: cities whose leaders are politically aligned with governors underinvest in flood-adaptation measures compared to misaligned cities. Nakhmurina speculates that city leaders have probably recognized what investors have: the state is more likely to bail them out if they ever get in trouble.‌

“The underinvestment we observed is potentially concerning,” she says. “Natural disasters don’t wait for political alignment to change.”‌

As an example of a misaligned city that did not get adequate support from the state, the paper points to Jackson, Mississippi. In February 2021, tens of thousands of residents lost power in a winter storm there, losing access to clean water for more than a month. The Democratic mayor requested $47 million in aid; the Republican-led state government provided $4.6 million. ‌

“We don’t know exactly how they arrived at their decision,” Nakhmurina says. “But we saw that Jackson asked for more, and that the state deliberated and gave them 10 times less than they asked for.” ‌

In any one interaction between city and state governments, it is impossible to know what exactly is going on behind the scenes, she notes. But in aggregate, patterns are easier to grasp.‌

“No politician or state government in their right mind is going to say, “We withheld this money for partisan reasons,’” she explains. “So we need a large sample to see what’s really going on.”‌

Department: Research