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What Is the Optimal Level of Local Government Fund Balances?

Kriz, Kenneth A.

State guidelines in Minnesota recommend a 5% fund balance for local governments. Given the diversity in revenue mix among Minnesota municipalities, however, this figure seems somewhat arbitrary. The largest municipalities in the state tend to rely more on aid and less on property tax revenues than do small cities. Some cities have adopted local option sales taxes to support specific projects. Property tax bases in the state also vary greatly in size and mix of uses. Any of these might cause the need for fund balances higher or lower than the 5% level suggested by the state. This article attempts to determine the optimal level of fund balance for local governments, as well as the factors that might change the recommendation for fund balance levels from one municipality to another. Using a Monte Carlo simulation model of local government revenue and expenditures, the author concludes that a standard 5% rule for local government fund balances is far too oversimplified and is likely to be inadequate to maintain, with much confidence, even moderately high growth rates in government expenditures for extended periods. In addition, the author concludes that the 5% recommendation is strongly dependent on a particular jurisdiction's revenue history and revenue mix, the jurisdiction's desire for future expenditure growth, and the success of the jurisdiction in producing interest earnings on its fund balances. The implications of these findings are that jurisdictions need to thoroughly analyze their revenue histories to develop working policies for appropriate reserve fund levels to weather economic hard times.

CURA Reporter
Publication date: 
Minneapolis: Center for Urban and Regional Affairs, University of Minnesota.
Supported through a New Initiatives grant from CURA.
34 (1): 8-12.
Online availability
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CURA call number: 
Reporter 34 (1)

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