Association for Public Policy Analysis & Management

Annexation is defined as a legal process by which certain territory is taken from an unincorporated local unit (usually a county) to an incorporated local unit (usually a municipality). The fiscal implications of annexation are usually controversial. Studies have suggested that a positive relationship exists between annexation and a local government's financial condition (e.g. Steinbauer et al., 2002), which basically refers to a government's ability to adequately provide services to meet current as well as future obligations. However, other scholars suggest that annexation can constrain cities' finance because of the particular local circumstances (e.g. Edwards, 1999). Among the multidimensional issues influencing the fiscal implications of annexation, the local fiscal structure is particularly important and remains unaddressed in the literature. The local fiscal structure refers to the general combination of local revenues and expenditures. For instance, some cities are property tax dependent, while others are sales or income tax dependent; in some states the intergovernmental aid formulas are designed to offset changes in population and tax base capacity. These structural differences are assumed to influence annexation's impacts on local government finance (Pagano, 2003).

This research investigates if local government fiscal structure makes differences in annexation's fiscal implication. The analysis uses multi-city regression analysis with a sample of about 11,000 general purpose municipalities across the states with various revenue structures. The annexation and financial condition data are from the Census of Governments, and Census Bureau's Boundary and Annexation Survey (BAS) to present the changes between 1990 and 2000. Cities are categorized as property tax dependent and sales or income tax dependent according to the proportions of property tax and sales or income tax in their own source revenues. Also included is a measure of intergovernmental aid formula, which is whether the state intergovernmental aids formula is based on population changes of the municipality. With other demographic, socio-economic, and governmental variables controlled, municipal annexations' impacts on local government revenue and spending are investigated. The results show that municipalities with diversified taxing authority and/or with a balance of “inelastic” and “elastic” revenue sources are more likely to improve their financial conditions through annexation.