Association for Public Policy Analysis & Management

Natural disasters pose severe shocks to public finances by incurring considerable costs of relief and reconstruction as well as disrupting regional/local economies. Given the growing scientific consensus that climate change is occurring now and could be worsening certain disasters (e.g., floods, droughts, and tropical cyclones), it also has significant fiscal implications for governments at all levels. Therefore, quantifying the fiscal costs of disasters is an important task for both policy makers and researchers in order to better maintain financial stability and sustainability.

Although there is a vast literature on the short- and long-run macroeconomic impacts of natural disasters, only a few studies have examined the fiscal impact of natural disasters, most of which are based on cross-country comparisons (e.g., Melecky and Raddatz, 2011; Lis and Nickel, 2009; Noy and Nualsri, 2011). Little is known about the disaster-induced fiscal burden for subnational governments and in particular, the intergovernmental dynamics in responding to disasters. Our paper focuses on the U.S. context and empirically examines the fiscal consequences of natural disasters at the state level. Specifically, we ask how natural disasters, particularly climatic shocks, affect state government spending (including current expenditure and capital expenditure), revenues (including tax revenues and intergovernmental transfers such as federal disaster relief), and the use of debts. By studying state fiscal responses to disaster shocks, this paper aims to provide a better understanding of the different mechanisms through which natural disasters affect subnational public finance outcomes. Our empirical analysis will integrate government finance data with disaster damage data and meteorological data (state annual temperature and precipitation anomalies). We will employ a panel vector autoregressive model and also take into account state-level economic variables including gross state product, personal income and employment. Our study sample includes 50 states for an extended period.

This paper will contribute to the existing literature in several ways. First, it will add to the evidence base on evaluating the fiscal costs of natural disasters and in particular, actual disaster cost sharing between federal and subnational governments. Such estimation will be helpful for projecting the future climate change impacts on state government finance, since this study is the first to use objective weather data to examine the fiscal impacts of weather shocks. Additionally, this research can inform subnational governments on preparation for rainy day funds, as well as inform the cost-benefit evaluation of disaster mitigation programs. It will also provide important policy implications on potential risk-management tools that can lessen the adverse impacts of disasters. Overall, this paper will present important lessons for state and local governments that are on the frontline of coping with natural disasters and climate change in a federalist system.