Jurisdictional Spillovers and Decentralized Local Governments

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Jurisdictional Spillovers and Decentralized Local
Governments 
Judith I. Stallmann, Professor University of
Missouri Community Development
Extension Agricultural and Applied
Economics Rural Sociology Public
Affairs stallmannj_at_missouri.edu

• Dr. Eunice Patron
• Gaithersburg, MD

Third International Conference on Local
GovernmentKhon Kaen University, Thailand.
November 15-18, 2012
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Decentralized local governments

• A large literature focuses on relations between
  different levels of government.
• My focus today is on relationships between local
  governments.
• They are equals in terms of their powers and
  responsibilities.
• But not necessarily equals in their endowments
  and resources.

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Economic Argument for Decentralization

• If the tax revenues come from other levels of
  government, citizens lack incentives to consider
  costs and will demand local services beyond the
  efficient level
• Marginal costs are higher than marginal benefits
• If citizens must tax themselves for the local
  services they receive, they will consume those
  services at a more efficient level
• Marginal costsmarginal benefits

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The competitive market

• Basic economic theory suggests that under
  competitive market conditions, competition among
  firms will result in an efficient allocation of
  resources.

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Inter-jurisdictional competition

• Similarly competition among decentralized local
  governments can lead to more cost-effective local
  services, innovation in services, etc.
• Tiebout (1956) suggests that the ability of
  citizens to choose among local jurisdictions will
  result in an efficient allocation of citizens
  among jurisdictions based on their preferences
  for public goods.
• The governments are implicitly competing

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Efficiency of competitive market

• Series of strong assumptions for competitive
  market conditions to exist.
• If the assumptions do not hold the market may not
  be competitive and therefore may not produce
  efficient results.
• In addition there are economic outcomes beyond
  efficiency that society may want.

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Roles of government in a market economy

• Public finance theory when the market is not
  providing economic outcomes that the society
  desires there is a role for government.
• Maintain competitive market conditions.
• Ensure efficient provision of goods that the
  market does not provide at efficient levels.
• Equity
• Economic growth
• Economic stability

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Decentralizaiton

• But it is possible that competition among local
  governments may not produce the results that
  public finance theory suggests for the role of
  government.
• The cases I will focus on are equity and
  inter-jurisdictional spillovers.
• In these cases competition among local
  governments can lead to undesirable outcomes.
• This is an argument for flexible governance
  relations between local governments.

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Equity

• There may be differences in endowments across
  jurisdictions, such as natural resources or past
  investment in infrastructure.
• I will not focus on this case
• In addition citizens may move between
  jurisdictions (Tiebout 1956)
• Peoples demand for public services varies by
  income.
• As a result jurisdictions may have wide
  differences in per capita income

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Equity

• Tiebout (1956) notes, in the case of equity
  expenditures those who are not receiving the
  benefits may chose other jurisdictions because
  they are paying for public services they do not
  receive.
• It is also possible that those receiving equity
  assistance may migrate to jurisdictions offering
  higher levels of assistance.

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Equity

• To avoid the potential that lower income
  individuals may migrate in search of higher
  benefits, jurisdictions may cut equity
  expenditures known as a race to the bottom.
• Bruekner (2000) reviews 8 studies after the US
  changed its main income assistance program for
  low income families.
• Finds evidence that states looked to neighbors
  when setting benefit levels to avoid recipients
  migrating into the state.

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Policy Recommendation

• Recommendation is to place responsibility for
  funding equity expenditures at higher levels.
• Funding to provide equity between regions with
  different resource endowments is also recommended
  to be at a higher level of government.

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Market inefficiency

• T he market does not produce efficient outcomes
  if the actor does not receive the full benefit or
  pay the full costs of the action. That is
  actions by one actor affects others, positively
  or negatively
• External costs
• External benefits
• Public goods
• Common pool resources

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Inter-jurisdictional spillovers

• As with market actors, the actions of one
  jurisdiction can provide benefits or costs for
  other jurisdictions.
• These are called inter-jurisdictional spillovers
  and are caused by the same factors that lead to
  the market not being efficient.
• Therefore, the jurisdictions may not allocate
  resources efficiently

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External costs example 1

• The actor does not have to take the full costs of
  the action into account and others bear part of
  the costs in the form of pollution.
• Similarly, jurisdictions may cause costs
  pollution--for other jurisdictions
• by the direct actions of the jurisdiction, or
• due to regulations (or lack of them) on their
  citizens or businesses
• Example US sulfur dioxide emissions drifted into
  Canada, causing acid rain, because there were no
  US regulations on emissions.

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External Costs example 2

• US rivers that cross state borders are more
  polluted at the borders than in the interior of
  the state (Sigman, 2002).
• In the interior, the state bears the cost of
  pollution so it has an incentive to keep the
  river clean.
• At its downstream border the pollution falls on
  another state.
• At its upstream border the state is receiving
  pollution from another state.

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External Costs example 3

• Compared the water quality of interstate rivers
  of states in statas that have been given
  authority to set water quality guidelines with
  those that have not. Sigman (2005).
• Those with state authority sent 4 more pollution
  downstream than those operating under federal
  rules.
• States choose to minimize their costs at the
  expense of other states.

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External costs and jurisdictions

• These issues lead to adversarial relations.
• Governance mechanism are needed that encourage
  collaboration
• An independent facilitator or mediator that is
  perceived as unbiased by all parties may be
  needed in cases where jurisdictions do not
  collaborate.

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Common pool resource

• The good is rival once one person or
  jurisdiction has it, it is not available to
  another or its value to another is reduced.
• Also, it is difficult to exclude people or
  jurisdictions from access to the good.
• The combination results in competition to get as
  much of the good as possible before others can
  get it. The competition results in degradation
  of the quality or depletion of the quantity of
  the good.

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Common pool Example 1

• An example of this is the damming of a river that
  flows through multiple jurisdictions.
• The jurisdiction that builds the dam lessens the
  water flow downstreamthat is the quantity of the
  resource is less
• Or the use of a river for irrigation water
  lessens the water flow downstream
• In the US the Missouri River is an example
• There are similar issues on the Mekong River

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Common pool example 2

• Tax bases that are mobile are a common pool
  resource. Examples
• If local governments can charge a sales tax they
  may compete with other jurisdictions for
  shoppers.
• Local government s may compete for firms to
  locate in their jurisdiction for the property
  taxes, business license revenues or other local
  business fees or taxes.

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Common pool example 2

• Rival if one jurisdiction gets the shoppers or
  the firm (that is the tax base) the other does
  not.
• Depletion tax competition to get the tax
  base--through lowering tax rate or giving tax
  incentives to firms-- may result in lower tax
  revenues for the competing jurisdictions.
• Called strategic interactions or tax competition
  and can take many forms

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Common pool example 2

• In the US, state and local governments spend 50
  Billion in direct incentives to firms (Peters and
  Fisher 2004).
• Where firms locate has almost no impact on
  national economic growth.
• Local governments are trying to increase local
  economic growth and competing for the common pool
  tax bases.
• Jurisdictions are competing for local economic
  growth not concerned with national level.

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Tax competition literature

• West Virginia had a sales tax on food, 1979-1984.
  
• The neighboring five states did not.
• Divided counties into those on the state border
  where it is easy for shoppers to cross state
  lines and counties not on state borders so it is
  more difficult for shoppers to cross.
• Shoppers did cross state lines and stopped doing
  so when the tax was removed. (Walsh and Jones,
  1988)

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The Missouri sales tax holiday

• In Missouri the state has a sales tax and local
  governmentscounties and citiesmay have
  additional sales taxes. The total sales tax
  varies by jurisdiction.
• In 2004 Missouri held a sales tax holidaycertain
  items were exempt from state sales taxes for
  3-days. Said it was to help families buy school
  clothing and computers.

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Tax competition in Missouri

• Local governments in Missouri can choose any
  combination of property and sales taxes and set
  their own rates up to a cap imposed by the state.
  
• Local governments could choose to opt-0utnot
  lower their local sales tax rate--or opt-in
• All local governments had a very short period in
  which to decide.
• This is a natural experiment to test for tax
  competition

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Missouri tax competition

• Cities in counties on the state border were more
  likely to participate than interior cities.
• Cities located in counties that participated in
  the holiday were more likely to participate.
• Cities in counties with a higher number of cities
  were less likely to participate.
• This may be a reflection of the concentration of
  a large number of smaller cities around the two
  largest citiesSt. Louis and Kansas City.

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Missouri tax competition

• Cities with higher sales tax ratesthat is they
  are more dependent on sales taxes for
  revenueswere less likely to participate
• Some cities have only a sales tax and no property
  tax
• Nearly 78 of the cities participated
• Overall there is evidence of tax competition.
• In another study we estimated the loss of revenue
  by local governments as 8 million

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Common pool Example 3

• Strategic interactions when the competition
  between local governments involves expenditures
  or regulations.
• Can lead to increased regulationsplanningor
  expendituresbetter local services.
• The common pool resource is mobile citizens that
  they want to attract or do not want to attract.

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Strategic interactions

• Case, Rosen and Hines (1993) find that US states
  follow their neighbors in spending.
• They may be competing to attract citizens that
  want these services.
• Higher spending by neighbors may give the state
  some room to increase spending and still be
  competitive with neighbors.
• Bruekner (1998) California cities adopted growth
  control measures if their neighbors adopted them.
  
• May be trying to not attract certain citizens

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Policy implications

• Government decentralization can lead to a more
  efficient allocation of local public services
  because those who receive the services also pay
  for them.
• Competition among decentralized governments can
  lead to lower costs of public services,
  innovation, etc.

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Policy implications

• In some cases, competition among decentralized
  governments can lead to undesirable outcomes.
• Citizens may search for the mix of public
  services that they desire. This can lead to
  large differences in income among communities.
• To alleviate this sorting, equity expenditures
  may be funded by a higher level of government.

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Policy implications

• Because inter-jurisdictional spillovers may be
  positive or negative, may be short or long run,
  may involve varying numbers of jurisdictions,
  flexible governance mechanisms may be more useful
  than formal structures.
• Laws which allow collaborations, such as sharing
  of tax bases, contracting between governments,
  voting by jurisdictions on joint issues.

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Policy implications

• Laws which allow collaborations, such as
• sharing of tax bases,
• voting by jurisdictions on joint issues,
• contracting between governments,
• agreements that are specific to the issue and not
  a general collaboration.
• Unbiased facilitators and mediators may be need
  when a jurisdiction refuses to collaborate.

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Thank you

• Third International Conference on Local
  GovernmentKhon Kaen University, Thailand.
  November 15-18, 2012