State and Local Public Finance Professor Yinger Spring 2019 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 The research on tax and expenditure limits (TELs) leads to five main conclusions. First, TELs come in many different forms. Some limit property tax rates; some limit property tax levy increases; some limit expenditure increases. Some include limits on assessment increases, which, over time, lower taxes for long-term residents. (More on this in a later class). For a thorough catalogue of the various types of limits, see Kioko, Public Budgeting and Finance, 2011.

Evidence about Tax Limits, 2 State and Local Public Finance Lecture 3: Voting Evidence about Tax Limits, 2 Second, TELS that focus on the property tax 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 has moderated since then. Some of the new revenue sources, especially fees, are very regressive, but others, such as income taxes in a few cases, are not.

Evidence about Tax Limits, 3 State and Local Public Finance Lecture 3: Voting Evidence about Tax Limits, 3 Third, TELs have not stopped the growth in state and local government spending. According to the Urban Institute: “Direct state and local spending on general government increased from approximately $1.1 billion in 1977 (in inflation- adjusted 2015 dollars) to $2.8 billion in 2015—a 170 percent increase over 38 years. Similarly, per capita expenditures increased from about $4,900 a person to $8,800 a person, an increase of 82 percent.” https://www.urban.org/policy-centers/cross-center-initiatives/state-local- finance-initiative/state-and-local-backgrounders

Evidence about Tax Limits, 4 State and Local Public Finance Lecture 3: Voting Evidence about Tax Limits, 4 Fourth, 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. For a review of this literature, see Downes and Figlio (Handbook on Education Finance and Policy, 2nd Edition 2015).

Evidence about Tax Limits, 5 State and Local Public Finance Lecture 3: Voting Evidence about Tax Limits, 5 Fifth, voter demand factors still matter even with a strong TEL. 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, 6 State and Local Public Finance Lecture 3: Voting Evidence about Tax Limits, 6 Sixth, TELs push governments to use special districts, which are generally not included in tax caps. For evidence on this point, see the article by P. Zhang, Economics of Governance, 2018. 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 technical exceptions. The cap exempts new construction (to preserve incentives for development and growth). The legislation allows jurisdictions to override the cap with a 60% vote, but few districts try to override (and fewer succeed).

State and Local Public Finance Lecture 3: Voting The New Tax Cap in NY, 2 In 2018, 662 districts proposed budgets within the cap and 98.6% passed. Also 14 districts proposed budgets that needed an override and only 50% passed. Nobody should expect this cap to make local governments more efficient. Without more state aid (unlikely) or many overrides (also not likely) this cap will cut local services. Source of data: http://www.nyssba.org/

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. Because poorer school districts receive more state aid, they have lower property tax levies. This fact implies that poorer 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.