Local%20Public%20Finance

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Local Public Finance

• Chapter 16
• (All Economics is Local)

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Collective Choice

• Median voter model
• Majority rule median persons preferences win
• How to influence median voter?
• Decide who has standing in the decision
• Facilitate your side to vote.

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Evaluating Social Utility

• Pareto optimal improvement at least one person
  gains and nobody is harmed from a change in
  policy.
• Difficult to achieve in practice
• Potential Pareto improvement the winner is
  able to compensate the loser and still have
  surplus remaining.

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Valuation techniques

• Consumer surplus (Ch 6)
• Ignores existence value
• Willingness to pay
• How much are you willing to pay to see a project
  through to its completion?
• Implicitly assumes everyone has same income or at
  least same preferences (high-income people
  dictate social preferences)
• Willingness to accept
• How much will you need to be compensated be just
  as well off with the status quo?

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Arrows Voting Paradox

• Solution to philosophical quagmire
• Majority voting
• Everyone gets one vote independent of their
  income
• Not flawless Social choices of rational people
  may not be transitive, and may seem irrational.
• Three Projectsa, ß, and ?. a P ß, ß P ? a, and
  ? P a! (P means preferred to.)

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Table 161. Arrows Voting Paradox Table 161. Arrows Voting Paradox Table 161. Arrows Voting Paradox Table 161. Arrows Voting Paradox
Voters/projects Alpha Beta Gamma
Alan 1 2 3
Betty 3 1 2
Chris 2 3 1
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Local public goods

• Citizens can vote at ballot boxes or vote with
  their feet
• Congestionpublic goods are mostly club goods
• Neither government nor private sector is always
  best at provision
• Spillover effects
• Some pay but do not benefit
• Others benefit but do not pay

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Assumptions of Tiebout Hypothesis

• All residents can move costlessly
• Everyone has perfect knowledge about the
  qualities of each community
• Enough jurisdictions exist to provide a full
  range of public goods
• All communities, regardless of size, have the
  same cost functions for their services
• Public goods do not cause any positive or
  negative spillovers and
• There is no social discrimination by
  jurisdictions.

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Public Finance Viewpoints

• Traditional public finance theory
• Government is benevolent, omniscient.
• Government efficiently allocates resources to
  provide optimal quantities of public goods
• It redistributes income to create a more
  equitable and more just society and
• It is responsible for maintaining economic
  stability. Public officials select policies that
  maximize social welfare.

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Public Finance Viewpoints

• Public choice theory
• Civil servants maximize their personal utility
  functions
• They cannot maximize the common good because
  such a thing is neither definable nor measurable.
  
• Maximization of social welfare results in the
  maximization of benefits to the most zealous
  lobbyists, interest groups and rent-seekers
• Government will inevitably become excessively
  large, unaccountable and untrustworthy.

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Provision of club goods

• Market fails in efficiently providing club goods
  because of
• externalities,
• imperfect competition,
• free-riders,
• lack of precise information,
• excessive regulation,
• improper incentives to provide an adequate amount
  of the quasi-public good.

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Provision of club goods

• Government fails in efficiently providing club
  goods because of
• Unreliable signals of the electors preferences
• Arrows voting paradox
• Rational ignorance (electors bear high costs of
  being well-informed marginal benefittheir one
  vote)
• Inertia inherent in bureaucracies,
• Tendency to mandate quick fixes (and its
  associated law of unintended consequences),
• Distributional inequalities.

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Revenue Sources of Local Government

• Benefit principle Whoever benefits from a public
  program should pay
• Difficult to determine with spillovers
• Free-riders
• Marginal cost of provision ? 0
• Ability to pay
• Equity and equal sacrifice
• Results in progressive taxes

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Tax Incidence Partial Equilibrium Analysis

• Who bears the tax?
• Excise tax consumption tax paid when product is
  purchased.
• When imposed, an excise tax shifts supply inward
• Consumers see higher prices
• Producers see lower per-unit revenues
• Society worse-off by deadweight loss

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Tax Incidence Partial Equilibrium Analysis

• Whether consumers or producers bear the most part
  of the tax depends on the relative price
  elasticities of supply and demand

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Incidence of an excise tax
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Tax Incidence General Equilibrium Analysis

• Quantity sold falls, fewer workers are needed, so
  excise taxes increase unemployment in
• the taxed industry (direct effect),
• the industries that supply products that the tax
  industry needs (indirect effect), and
• the industries that provide goods and services
  that the affected workers would use (induced
  effect.)

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Laffer curve

• High tax rates decrease revenues
• Reduce incentives to work
• Encourage consumption of leisure activities
• Encourage participation in shadow (hidden)
  economy
• Barter
• Work for cash
• Tax avoidance mechanisms
• Encourage out-migration

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Laffer curve
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Optimal local tax policy

• Traditional public finance theory
• Government maximizes its tax revenue to allow
  provision of sufficient quantities of public
  goods.
• Public choice theorists
• Taxpayers exchange their money for an optimal
  amount of public goods.
• Politicians choose the tax rates and fees to
  minimize their political cost function.
• They respond to preferences of social income
  groups and interest groups.

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Property taxes

• Controversial tax
• Equitable Property values benefit from efficient
  provision of services and amenities.
• Critics
• Property taxes have nothing to do with either the
  ability to pay or the benefits received
• Homeowners on fixed incomes are hurt.
• Property tax supports services that have an
  inverse relation to property values.

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Incidence of property taxesThree schools of
thought

• Traditional view
• Property composed of land and buildings
• One jurisdiction raises its tax rate
• If supply of land fixed, portion of tax
  attributable to land falls on landowners
• Portion of tax on buildings acts like excise tax
• Households and firms flee to other jurisdictions
• Property tax regressive

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Incidence of property taxesThree schools of
thought

• New view (Mieszkowski)
• Extends traditional view
• What if all jurisdictions increase rates by the
  same amount?
• Similar to national property taxno migration

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Incidence of property taxesThree schools of
thought

• New view (continued)
• Taxes fall on all capital owners
• Property owners would sell, decreasing the value
  of real property everywhere.
• They would invest in assets not subject to
  property tax, like bonds.
• Increase demand for bonds, bond prices rise
• Inverse relation between bond prices and interest
  rates, so interest rates fall

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Incidence of property taxesThree schools of
thought

• Benefit view (Hamilton)
• Accounts for benefits and costs
• Property tax is user charge.
• Tiebout hypothesis
• Value of services and value of tax are
  capitalized into property values.
• If the amount of taxes equals the value of
  benefits, then the landowners both benefit from
  and pay for the local public goods.
• Property tax is distributionally neutral

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Municipal sales taxes

• Essentially excise taxes
• Some consumers purchase goods from outside the
  jurisdiction
• Regressive (the poor spend a higher proportion of
  their incomes)
• Exportable
• May cause retail firms to relocate just outside
  jurisdictional boundaries (cause spatial
  mismatch?)

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Local income taxes

• Decrease the incentive to work
• Increase propensity to migrate
• Taxes on corporate income
• Encourage firms to relocate
• Firms act on after-tax income rather than pre-tax
  income

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User Fees

• Prices for local services
• (Close to) Marginal cost pricing
• Efficient for financing club goods with few
  externalities
• Water provision
• Sewerage
• Garbage collection
• Chimney sweeps (according to Norwegian study)

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Tax Exporting

• Interspatial incidence
• Taxes in tourist areas borne by vacationers
• Works very well if area lacks nearby alternatives
  (hotel room tax in Hawaii)

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Appendix

• Indifference curve analysis combines willingness
  and ability to determine quantity of two goods
  consumed by one individual
• Edgeworth box
• Assumes fixed amount of output of two goods
• Analyzes optimal distribution of these two goods.
• If production possibilities curve shifts,
  Edgeworth boxes change

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Edgeworth box within production possibilities
curve
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Edgeworth box for Dick and Jane
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Edgeworth box

• Two goods, (grapes and carrots)
• Two protagonists (Dick and Jane)
• Original endowment
• Dick 15 carrots, 40 grapes
• Jane 60 carrots, 10 grapes

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Edgeworth box

• Pareto optimal redistribution makes at least
  one person better off without decreasing the
  satisfaction of the other.
• Contract curve
• The contract curve locus of points where the two
  sets of indifference curves are tangent.
• When a distribution ends up on the contract
  curve, no Pareto optimal redistribution exists

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Edgeworth box

• NOTE the optimal distribution does not have to
  be in the middle of the box.
• Preferences can also be corner solutions.
• To be equitable, a distribution may not be equal.
• Equity vs. equality
• If we take subsequent production incentives into
  account, an equal distribution may affect the
  placement of production possibility curve during
  the next time period.