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

• Published in: Public budgeting & finance 2024, Vol.44 (2), p.69-89
• Main Authors: Ke, Laiyang, Jimenez, Benedict S.
• Format: Article
• Language: English
• Subjects: Expenditures; Financial statements; Governmental accounting; Local government; Municipal government; Public finance; Transparency
• ISSN: 0275-1100; 1540-5850
• DOI: 10.1111/pbaf.12357

One‐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. Key Takeaways Municipal governments experience one‐time gains by selling assets that they own, such as parks and buildings, or receiving assets from discontinued programs and agencies. Such windfalls can be used by governments to expand existing services, potentially creating budget difficulties in the future without the infusion of additional funds. Alternatively, the gains can be saved for use during “rainy days.” We examine how special and extraordinary gains affect municipal spending and saving behavior. We find that gains initially reduce expenses but increase them in subsequent years. Gains have no systematic effect on savings. The infrequent nature of gains and high fluctuation mean that voters are likely to have minimal knowledge about their availability, magnitude, and allocation. Our findings highlight the importance of increasing transparency regarding the sources, nature, and use of special and extraordinary gains as well as their impact on municipal fiscal sustainability.