ABSTRACT Title of Document: ENDOGENOUS INSTITUTIONAL CHANGE: THE TRANSFORMATION OF THE STATE- LOCAL RELATIONSHIP IN THE UNITED STATES Jessica Lynne Hennessey, Ph.D., 2009 Directed By: Professor John Wallis, Department of Economics This thesis focuses on the changing relationship between state and local governments. I explore state-level constitutional changes in the 19 th and early 20 th century with respect to the governance and organization of municipalities. The rich heterogeneity across state constitutions gives us an opportunity to understand the underlying political and economic forces at work, using a fiscal federalism and political economy framework. There are parallels between state-level constitutional changes regarding private corporations and the less well understood changes instituted for public corporations such as municipalities. The adoption of municipal general legislation stemmed from similar problems of special interests and political maneuvering under special legislation. In some states, general legislation protected municipalities from unwanted abuse by state-level politics, and provided a uniform structure under which all local governments could operate and easily gain access to the corporate form. However, as in the case of private corporations, the one-size-fits- all rubric of general legislation was often not amenable to all municipalities. Some states implemented a Pareto-improving solution, which is to have general legislation available for those well served by it, and to give municipalities the flexibility to self- select and independently charter themselves. The resolution to grant home rule to municipalities retained the political security afforded by general legislation and provided the freedom of organization to those who needed it most. The thesis is organized as follows. Chapter 2 documents the history of the relationship between states and their municipalities. The chapter also discusses the various problems states had in maintaining the original setup of passing special laws for municipalities. Chapter 3 evaluates the changing economic and political conditions which may influence a state’s choice of how to structure the state- municipal relationship. Chapter 4 looks at one institutional change, the adoption of home rule. By using a unique municipal-level dataset, I empirically investigate why certain states may have adopted this institution. Chapter 5 considers another form of local government, the school district. The patterns seen in the state-municipal relationship are mirrored in the state-school district relationship. ENDOGENOUS INSTITUTIONAL CHANGE: THE TRANSFORMATION OF THE STATE-LOCAL RELATIONSHIP IN THE UNITED STATES By Jessica Lynne Hennessey Dissertation submitted to the Faculty of the Graduate School of the University of Maryland, College Park, in partial fulfillment of the requirements for the degree of Doctor of Philosophy 2009 Advisory Committee: Professor John Wallis, Chair Professor Mark Duggan Professor Tracy Gordon Professor Irwin Morris Professor Wallace Oates © Copyright by Jessica Lynne Hennessey 2009 Dedication To my parents, Peter and Brenda. Thank you for your love and support. ii Acknowledgements I am indebted to John Wallis for his continual support and encouragement. He has been instrumental in helping me shape this research project. More importantly, he has helped me develop a passion for research which extends far beyond this work. I am grateful to Wally Oates and Mark Duggan for their guidance and advice on this project and throughout my graduate studies. I thank Tracy Gordon, John Shea, John Ham, and seminar participants at the University of Maryland, the NBER Development of the American Economy Summer Institute, and the History of Capitalism conference at Harvard University for their comments and suggestions. I also thank Matthew Kozora, Tamara Hayford, and Giulia Cangiano for their support during this process. All errors are my own. iii Table of Contents Dedication ..................................................................................................................... ii Acknowledgements ...................................................................................................... iii Table of Contents ......................................................................................................... iv List of Tables ............................................................................................................... vi List of Figures ............................................................................................................. vii 1 Introduction ........................................................................................................... 1 1.1 The Creation of Local Governments......................................................... 3 1.2 Local Governments in State Constitutions ............................................... 5 1.3 Categorizing Constitutions: Dillon’s Rule versus the Cooley Doctrine .. 6 1.4 Fiscal Federalism and Political Economy ................................................. 8 2 The State-Municipal Relationship ...................................................................... 12 2.1 Tradition of Incorporation and Special Legislation ................................ 12 2.2 Prohibition of Special Legislation .......................................................... 15 2.3 General Legislation ................................................................................. 18 2.4 A Mix of General and Special Legislation ............................................. 21 2.5 Home Rule .............................................................................................. 23 2.6 Difficulty in Maintaining Special Legislation ........................................ 26 3 Endogenous Institutional Change: The State-Municipal Relationship .............. 41 3.1 Prohibition of Special Legislation for Specific Purposes ....................... 42 3.2 General Legislation with Special Legislation ......................................... 45 3.3 Strict General Legislation ....................................................................... 48 3.4 General Legislation with Home Rule ..................................................... 51 3.5 Are Outcomes Socially Optimal? ........................................................... 52 3.6 Regional Differentiation ......................................................................... 53 3.7 Constitutional Changes within Region: A Case Study of the Midwest .. 75 3.8 Conclusion .............................................................................................. 79 4 Home Rule .......................................................................................................... 81 4.1 Introduction ............................................................................................. 81 4.2 Background ............................................................................................. 84 4.3 Endogenous Policy Determination ......................................................... 90 4.4 Approach ................................................................................................. 92 4.5 The Data .................................................................................................. 96 4.6 Descriptive Statistics ............................................................................... 98 4.7 Econometric Method ............................................................................. 100 4.8 Probit and Linear Probability Estimates ............................................... 104 4.9 Duration Estimates ................................................................................ 106 4.10 Comparing Municipalities in Home Rule and Non-Home Rule States 110 4.11 Application to Laboratory Federalism .................................................. 112 4.12 Conclusion ............................................................................................ 114 5 School Districts ................................................................................................. 116 5.1 The School District as a Corporate Body ............................................. 116 5.2 Schools Districts as Local Governments .............................................. 118 iv 5.3 The Creation of School Districts: Historical Factors ............................ 120 5.4 Laws for Creation of Independent School Districts .............................. 123 5.5 The State Organization of School Districts .......................................... 127 5.6 Future Empirical Approach ................................................................... 135 6 Conclusion ........................................................................................................ 138 Tables ........................................................................................................................ 140 Figures....................................................................................................................... 150 References ................................................................................................................. 158 v List of Tables Table 1: Apportionment Provisions in State Constitutions Table 2: Options for State-Municipal Relationship Table 3: Classification of Ohio Cities, 1894 Table 4: Adoption of Constitutional Changes by Region Table 5: Major Changes in Apportionment in Midwest State Constitutions Table 6: Variance in 1902