Association for Public Policy Analysis & Management

Natural disasters are environmental events that may have catastrophic consequences. Historically, they have resulted in significant economic and human losses across the United States. According to the statistics of the Federal Emergency Management Agency (FEMA), the total economic loss during the period of 1960 to 2015 is over $850 billion, with an estimate of annual cost of over $15 billion. How to effectively prepare for and mitigate the risks of natural hazards has become an increasingly important question concerning both policy makers and academic scholars.

Natural disasters can pose severe shocks to the public purse. On the revenue side, they can disrupt business activities and reduce government revenues. On the expenditure side, they can destroy government-owned buildings, facilities, and infrastructure and incur considerable costs in disaster responses, relief, and recovery. All these fiscal consequences will affect the short-term and long-term fiscal prospects of governments. Given the alarming trend of rising disaster risks, a better understanding the fiscal condition consequence of natural hazards is critical. Although there is an extensive literature documenting the macroeconomic effects of natural disasters, little research has been devoted to examining the relationship between natural disasters and fiscal condition. To fill this gap, this study explores the following two research questions: Whether and how do natural disasters affect the fiscal health of state governments? Which dimensions of fiscal health among state governments are more vulnerable to disaster risks? Drawing on the theories of fiscal health, we empirically test the predictions on the effects of natural disasters on state government fiscal condition. We employ a set of fiscal indicators to measure the four dimensions of fiscal health including cash solvency, budget solvency, long-run solvency, and service solvency. We also construct a composite fiscal health index to gauge the overall fiscal condition of state governments. To measure the severity of natural disasters, we use the total economic losses (combining direct crop and property damage) from major types of natural disasters (e.g., hurricanes, floods, earthquakes, tornados) at the state level. Our panel data consist of 50 states from 2002 to 2014, which are taken from a variety of sources including the State Comprehensive Annual Financial Statements (CAFRs), the Spatial Hazard Events and Losses Database for the United States (SHELDUS), US Census Bureau State Government Finances, US Bureau of Economic Analysis, and US Councils of State Governments. To account for the potential endogeneity issue of natural hazards and fiscal health, both panel instrumental variables estimation and dynamic panel model estimation are utilized.

This research represents one of the first few studies evaluating the fiscal health consequence of natural disasters. It contributes to the extant literature of public finance and natural disasters in several important ways. First, this study identifies and assesses the relevance of disaster risk for public finance. Second, it explores how natural hazards influence the short-term and long-term fiscal prospects of state governments and improves our understanding of the determinants of fiscal health. Third, it provides policy suggestions on strengthening fiscal resilience to promote state government fiscal health.