Local Government Finance and Entrepreneurial Activity in U.S. Metropolitan Areas

Recent empirical literature finds that greater economic freedom at the state level tends to have a positive effect on entrepreneurial activity and economic growth generally. However, state boundaries are relatively arbitrary, and the level of economic freedom in local economies can vary widely within individual states. While there is currently no economic freedom index for metropolitan areas, this paper uses data for government revenue and expenditure as a proxy. It provides the first examination of that relationship at the local level, using data on net new business formation for 288 U.S. metropolitan areas over the period 1990-2003. We found a statistically significant negative relationship between increases in all seven selected sources of revenue (used to fund an equal increase in spending on public welfare) and net new business formation. We also found that replacing welfare spending with higher spending for seven of eight selected spending categories was positively and significantly associated with net new business formation