State and Local Public Finance Professor Yinger Spring 2017 Lecture 3 Voting

Class Outline The Median Voter Model State and Local Public Finance Lecture 3: Voting Class Outline The Median Voter Model How does it link voting and demand? Why it is useful? What are its limitations? Property Tax Limitations What are they? How do they shed light on voting?

State and Local Public Finance Lecture 3: Voting Voting and Demand In most cases, citizens cannot directly express their demand for local public services. So they express their demand through their voting, either for public officials or on referenda. In this class, we explore how an understanding of demand helps us understand the choices local governments make.

The Median Voter State and Local Public Finance Lecture 3: Voting The median voter always votes on the winning side. Line voters up by the strength of their preference for public services. Identify the voter in the middle—the median voter. A majority vote must include the median voter. -------------------------M----------------------------- weakest strongest preference preference

Identifying the Median Voter State and Local Public Finance Lecture 3: Voting Identifying the Median Voter But voters do not line up, so the median voter is not identified! The median voter model shows how to identify the median voter assuming preferences are driven by demand factors. The median voter has the median income and the median tax price. This model places certain restrictions on preferences. This model assumes political institutions are neutral.

State and Local Public Finance Lecture 3: Voting The Median Voter Model S = Local public service quality D = Median voter’s demand MB = Median voter’s marginal benefit from S TP = Median voter’s tax price MC = Marginal cost of S = Median voter’s tax share S* = Median voter’s preferred S TP = MC( ) D = MB S S* $

Using the Median Voter Model State and Local Public Finance Lecture 3: Voting Using the Median Voter Model The median voter model is widely used because: It explains community decisions based the demand function for a single voter—the median voter. It makes use of widely available data at the community level: spending (or performance), median income, median tax price (median divided by mean house value). It works!

Example: Eom, Nguyen-Hoang, Duncombe & Yinger, State and Local Public Finance Lecture 3: Voting Example: Eom, Nguyen-Hoang, Duncombe & Yinger, Education Finance and Policy, 2014 1991-2011 data for over 600 school districts in New York State. Service quality measured by high school exams and drop-out rates. Income elasticity = 0.17 (based on income per pupil). Price elasticity = -0.22 (based on median tax price). Significant preference variables include share of housing that is owner- occupied and share of population age 65 or older.

State and Local Public Finance Lecture 3: Voting Other Examples The median voter model works well for local governments, particularly school districts. Recent applications include: Massachusetts (Nguyen-Hoang and Yinger, Journal of Education Finance, Spring 2014). California (Duncombe and Yinger, International Tax and Public Finance, June 2011).

Preference Assumptions State and Local Public Finance Lecture 3: Voting Preference Assumptions Median voter models need “single-peaked” preferences. Consider two communities with a high demand for education, one (City A) with a good private school and the other (City B) without. In City A, the high demand for education may not show up as a high demand for public education. In this case, which is extreme, the median voter model breaks down.

The Role of Institutions State and Local Public Finance Lecture 3: Voting The Role of Institutions Scholars disagree about the importance of institutions. Some scholars believe institutions are fairly neutral in most cases, particularly outside large cities. Other scholars believe bureaucrats can have a large impact on spending and service quality—the leviathan view. In some cases, it is possible to control for institutions, such as whether a city as a mayor or a city manager.

State and Local Public Finance Lecture 3: Voting Tax Limits Tax limits challenge the median voter model: Why do voters need to limit taxes if they control spending anyway? Some scholars believe that most tax limits make a political point with little impact on spending. Others believe that tax limits reveal voters’ belief in leviathan—and their desire to reign in bureaucrats.

Evidence about Tax Limits State and Local Public Finance Lecture 3: Voting Evidence about Tax Limits Studies of tax limits in the U.S. lead to four main conclusions. First, property tax limits shift the tax burden away from property taxes to other revenue sources. This shift was very large right after Proposition 13 in CA and Proposition 2 ½ in MA. But the shift has moderated since then.

Evidence about Tax Limits, 2 State and Local Public Finance Lecture 3: Voting Evidence about Tax Limits, 2 Second, strong tax and expenditure limits (TELs) limit but do not stop the growth in state government revenue. A large share of this effect comes from a drop in state aid to local governments And hence involves a higher burden on local tax sources. The magnitude of these impacts depends on the design of the limit (see Kioko, Public Budgeting and Finance, 2011).

Evidence about Tax Limits, 3 State and Local Public Finance Lecture 3: Voting Evidence about Tax Limits, 3 Third, there is no compelling evidence that TELs have boosted the efficiency of state and local governments. States with strong TELs have experienced a decline in the quality of public services. The performance by California’s students on national tests has dropped significantly, for example, since Proposition 13.

Evidence about Tax Limits, 4 State and Local Public Finance Lecture 3: Voting Evidence about Tax Limits, 4 Fourth, voter demand factors still matter even with strong TELs. California has severe limits, for example. But Duncombe and Yinger (ITPF, 2011) find that voters with higher incomes or lower tax prices still pick higher school quality— Through active monitoring of school officials or the use of secondary revenue sources, such as parcel taxes or private foundations.

Evidence about Tax Limits, 5 State and Local Public Finance Lecture 3: Voting Evidence about Tax Limits, 5 Fifth, TELs push governments to use special districts, which are generally not included in tax caps. This is the conclusion of a recent PAIA Ph.D. graduate, Pengju Zhang, in his dissertation. This is an unintended consequence and its benefits and costs are not well understood.

State and Local Public Finance Lecture 3: Voting The New Tax Cap in NY A couple years ago Governor Cuomo proposed and the legislature passed a cap on tax levy increases for all local governments. The cap is the lesser of 2% and inflation, with exceptions. The cap exempts new construction (to preserve incentives for development and growth).

State and Local Public Finance Lecture 3: Voting The New Tax Cap in NY, 2 The legislation allows jurisdictions to override the cap with a 60% vote. But in a bizarre twist to the story, NY added a tax-freeze credit in 2014, which rebates any property tax increase below the cap. As of this year, the credit is provided only if a district not only meets the cap, but also implements an “efficiency plan.”

State and Local Public Finance Lecture 3: Voting The New Tax Cap in NY, 3 In 2016, 662 of 676 school budgets passed (98.5). Also 635 of 636 within the cap passed (99.7%). Budgets passed for 28 of the 36 districts (78%) that attempted an override. Both the number and share passing increased from 2015. These overrides occurred despite the addition of the “tax-freeze credit” in 2014. Source: http://www.nyssba.org/

State and Local Public Finance Lecture 3: Voting The New Tax Cap in NY, 4 Nobody should expect this cap to make local governments more efficient. Without more state aid (unlikely) or many overrides (more likely, at least in the long run) this cap will cut local services.

State and Local Public Finance Lecture 3: Voting The New Tax Cap in NY, 5 This cap is likely to increase disparities across jurisdictions in education and other public services. Richer school districts are more likely to override the cap. Poorer school districts need larger percentage increases in revenue just to keep up with richer districts.

State and Local Public Finance Lecture 3: Voting The New Tax Cap in NY, 6 Some wealthy school districts raise about $30,000 in property taxes per pupil; Buffalo, Rochester, and Syracuse (the Upstate Big 3) raise about $3,700. In 20 years, the allowable annual revenue will go up by $30,000×[(1.02)20 – 1] = $14,578 in these rich districts, But by only $3,700×[(1.02)20 – 1] = $1,798 in the Upstate Big 3.