In new research, Ramona Dagostino and Anya Nakhmurina discuss how political misalignment between state governors and city leadership can affect how cities access financing, particularly in municipal bond pricing and crisis prevention investment.
When Hurricane Harvey devastated Houston in 2017, the city confronted first a humanitarian crisis, then a political one. As the Democratic mayor of Texas’s largest city sought billions in recovery aid, Republican Governor Greg Abbott was loath to open the state’s purse, igniting weeks of tension about accessing the rainy day fund for Houston’s reconstruction. The state eventually did release some funds, but not at the scale or speed Houston requested. The disagreements were prolonged and ultimately delayed Houston’s reconstruction. A 2022 audit by the United States Department of Housing and Urban Development found that additional dispute between the city and the Texas General Land Office had put recovery grant funds at risk and introduced further delays in their distribution.
In Huntington Beach, California, the conservative-majority city council has enacted policies that frequently conflict with the state’s progressive policies. For example, the city refused to comply with Governor Gavin Newsom’s agenda to build more affordable housing. In September 2025, a California appeals court ruled that Huntington Beach must comply with state law planning its proportional share of residential development. The judge is considering imposing fines that could range from $10,000 to $100,000 per month, and—under certain conditions—be “multiplied by a factor of six,” potentially reaching $600,000 per month. This is in addition to a previous $3.5 million in legal fees that would ultimately be funded by taxpayers.
These examples illustrate a broader pattern: the partisan relationship between cities and their state governments can profoundly affect municipal finances. Governors may be more inclined to support cities led by co-partisans—channeling resources, offering regulatory flexibility, or shielding them from penalties—while allowing conflicts with opposition-led cities to escalate into costly legal battles and funding losses.
In our recent paper, Ramona Dagostino and I empirically examine this pattern. We provide causal evidence that political alignment between city leaders and state governors is reflected in municipal bond prices. Our identification strategy exploits gubernatorial elections that switch the party in power at the state level from 2005-2019. By focusing on more than 400 cities that did not change their own political affiliation, we can attribute changes in borrowing costs to shifts in state-level politics rather than local factors.
We show that when a city’s leadership shares the same political party as the state governor, that city pays approximately 9 basis points (0.09%) less to borrow in the municipal bond market—a meaningful difference given typical municipal bond yield spreads (an average in our sample is 34 basis points). This translates to borrowing cost savings exceeding 20% for politically aligned cities.
Why is the effect of political alignment so substantial? The U.S. Constitution grants states broad authority over their local governments, creating a unique dependency that shapes municipal finance. States can create, dissolve, and alter local governments, preempt local legislation, and, critically, choose whether to provide financial assistance during times of distress. This discretionary power creates a political channel for credit risk.
Bond investors, it turns out, aren’t just looking at a city’s finances—they’re also evaluating the political relationship between city hall and the state capitol. Credit rating agencies explicitly recognize this channel and embed it into their methodologies. For example, Moody’s incorporates expected cost-shifting and state support as a formal adjustment factor, noting that the likelihood of state support rises when political incentives favor particular municipalities.
Empirically, in states where governors have stronger formal powers, or where cities are fiscally dependent—needing state approval to raise taxes—the partisan gap between aligned and misaligned local governments is even larger. Moreover, lower-rated, higher-risk municipal bonds show larger alignment gaps, consistent with how much investors believe cities will receive state government help to pay back debts.
Aligned cities receive more state aid when they experience financial distress. Following credit downgrades, politically aligned cities receive approximately $75 more per capita in state transfers compared to misaligned cities. This finding validates investors’ expectations that partisan alignment affects the likelihood of state support during crises.
Perhaps more troubling, political alignment also relates to investors’ interpretation of financial information. When cities fail to provide timely financial disclosures or receive adverse audit findings—traditional red flags for investors—the penalties are significantly smaller for aligned cities. This suggests investors discount negative information about aligned cities, assuming state intervention is more likely.
The consequences extend to real investment decisions. We find that politically aligned cities invest substantially less in costly flood resilience projects, appearing to rely on potential state help rather than proactive hazard mitigation. This moral hazard problem has significant implications as climate-related disasters become more frequent and severe.
As political polarization intensifies and states increasingly use preemption to override local policies, these partisan dynamics in municipal finance may become more pronounced. Our findings suggest that beyond ideological battles over policy, the fundamental aspects of public finance—from the interest rates cities pay to the infrastructure investments they make—are shaped by partisan politics, affecting the provision of public goods and services at the most local level.
The implication for taxpayers is straightforward: when your mayor and governor are from opposing parties, you may be paying a premium every time your city borrows money.
Author Disclosure: The author reports no conflicts of interest. You can read our disclosure policy here.
Articles represent the opinions of their writers, not necessarily those of the University of Chicago, the Booth School of Business, or its faculty.
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