Professor: Keren Mertens Horn Office: Wheatley 5-78B Office Hours: TR 2:30-4:00 pm ECONOMICS OF THE METROPOLITAN AREA 212G, SPRING 2013

© 2012 The McGraw-Hill Companies. All Rights Reserved 2  Thursday – Draft of Final Paper Due (everyone must hand in INDIVIDUAL assignments)  I will be accepting another revision of Assignment 2 or Assignment 1 up until May 9 th  Discussion Section Thursday Business Improvement Districts – Erik Benson, Roudy Bernadin, Andrew Cho  Discussion Questions:  Are BIDs democratic? - Roudy  Are BIDs accountable? - Andrew  Do you think it was a good idea to form a BID here in Boston? - Erik  Final Debates:  Gun Control – May 7 th  Stop and Frisk – May 9 th  Schools – May 14 th  Everyone is required to attend all 3 debates, or will lose a full grade on their final CLASS UPDATES

© 2012 The McGraw-Hill Companies. All Rights Reserved 3  Why do cities exist?  How do we get around in cities? What are the costs/benefits of these alternative modes?  What determines the value of land in cities?  How is land used in cities?  How is land governed in cities?  Why are urban schools failing? How are we addressing these challenges?  Why are our cities racially segregated? Should we care about this problem?  How do we make our cities safer? What factors have led to the long term decline in crime?  Is there a role for the government in the housing market?  TODAY – What are local governments and do we need them? BRINGING IT ALL TOGETHER

© 2012 The McGraw-Hill Companies. All Rights Reserved 4 LOCAL GOVERNMENTS 13-4

© 2012 The McGraw-Hill Companies. All Rights Reserved 5  There are lots of local governments!  Most Metropolitan Areas have very fragmented governments  Typical MSA looks like this:  114 Local Governments (2 Counties, 42 Municipalities, 21 School Districts, 49 Special Districts)  Local governments derive their power from state governments, and there is large variation in amount of power that state governments turn over to local governments.  In developing countries we see fewer local governments.  On average local government share of total government spending is around 32 percent in industrialized countries vs. 15 percent in the developing world.  In recent years there has been more of a push towards fiscal decentralization (pushing spending down towards local governments) in developing countries. LOCAL GOVERNMENTS

© 2012 The McGraw-Hill Companies. All Rights Reserved 6 LOCAL GOVERNMENTS

© 2012 The McGraw-Hill Companies. All Rights Reserved 7 BOSTON’S REVENUES

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© 2012 The McGraw-Hill Companies. All Rights Reserved 9 Boston Expenditures, Projected Budget 2014 Total Dollars Share of Total Spending Education1,127,345, % Administration and Finance374,738, % Police Department289,433, % Fire Department194,301,9507.5% Public Works163,488,9186.3% Public Property132,917,5875.1% Public Health110,930,7184.3% Housing and Neighborhood Development76,130,8842.9% Human Services53,475,7102.1% Transportation46,552,6231.8% Environment and Energy20,590,1680.8% Economic Development4,465,0000.2% Advocacy and Strategic Investment2,963,6520.1% Total Expenditures2,597,335, % BOSTON’S BUDGET

© 2012 The McGraw-Hill Companies. All Rights Reserved 10 ROLE OF LOCAL GOVERNMENTS  Not involved in macroeconomic policy  Do not set interest rates or issue currency  Not involved in too much income redistribution  Largest income redistribution programs are funded at the federal level, but often administered at the local level  Are involved in resource allocation  Local governments provide a wide range of services, either through direct provision or funding (or subsidizing) a non governmental supplier.  Examples:  Education  Police  Fire Protection  Parks

© 2012 The McGraw-Hill Companies. All Rights Reserved 11  Local Governments are generally defended through efficiency arguments.  Three main sources of market failure are used to support a role for local government in the allocation of particular resources:  Natural Monopoly  Ex/Case of Mass Transportation  Externalities  Ex/Pollution and Congestion  Local public goods WHY SHOULD LOCAL GOVERNMENT DO THESE JOBS?

© 2012 The McGraw-Hill Companies. All Rights Reserved 12  Public Goods:  Non-rival in consumption  Non-excludable: impractical to exclude those who do not pay  Local Public Goods:  Benefits confined to small geographical area  Ex/Street Lights LOCAL PUBLIC GOODS

© 2012 The McGraw-Hill Companies. All Rights Reserved 13  What is the socially optimal price of a public good?  Remember marginal cost of one additional consumer is zero (in the case of a non-rival public good)  Optimal price = 0  Only a government, that has the ability to cover costs through mechanisms not related to use of the public good, can provide the right amount.  How does a government determine the right amount of a local public good?  Cost/Benefit Analysis  Benefits = sum of marginal benefits for all individuals (vertical sum of individual marginal benefit curves)  Costs = costs of provision, including opportunity costs LOCAL PUBLIC GOODS

© 2012 The McGraw-Hill Companies. All Rights Reserved 14 LOCAL PUBLIC GOODS

© 2012 The McGraw-Hill Companies. All Rights Reserved 15 LOCAL PUBLIC GOODS

© 2012 The McGraw-Hill Companies. All Rights Reserved 16 LOCAL PUBLIC GOODS

© 2012 The McGraw-Hill Companies. All Rights Reserved 17  Voting – hold an election and let voters decide  Median Voter result: if spending level for public good is determined by majority vote, then the winning budget will be the preferred budget of the median voter.  Ex/Impose a $20 dollar tax and hold a series of elections  This may not be the efficient outcome (part of the problem is that voting does not take into account intensity of preferences)  Outcomes from elections can be highly inefficient when preferences are heterogeneous (diverse) HOW DO LOCAL GOVERNMENTS DECIDE HOW MUCH TO PROVIDE?

© 2012 The McGraw-Hill Companies. All Rights Reserved 18  “Voting with your Feet” – Tiebout Model  In the U.S. we have many local governments  When citizens disagree about how much of a local good to provide, they can “vote with their feet” and move to a jurisdiction with like minded people  This type of “voting” can prevent the inefficiencies associated with the median voter result  Empirical support – Fisher and Wassmer show that the greater the variation across households in the underlying demand for local public goods in a metropolitan area, the larger the number of municipalities and school districts in the metropolitan area.  Though increasing the number of local governments could increase efficiency when there is diversity in preferences, it can also lead to inequities (ex/Education) OTHER OPTIONS TO DETERMINING AMOUNT OF LOCAL PUBLIC GOOD

© 2012 The McGraw-Hill Companies. All Rights Reserved 19  Rather than eliminate diversity in a district an alternative approach is to match the diversity in demand with diversity in tax liabilities.  Lindahl approach – taxes are proportional to the willingness to pay for local public goods. BENEFITS TAXATION

© 2012 The McGraw-Hill Companies. All Rights Reserved 20 BENEFITS TAXATION

© 2012 The McGraw-Hill Companies. All Rights Reserved 21  Rather than eliminate diversity in a district an alternative approach is to match the diversity in demand with diversity in tax liabilities.  Lindahl approach – taxes are proportional to the willingness to pay for local public goods.  If there was any way for the government to accurately determine a voter’s willingness to pay, then this approach may work, but in reality the government would not be able to get voters to reveal their true willingness to pay if their tax liability rested on it.  In some cases, such as fire protection, benefits may be roughly proportional to your property value, and in this way a property tax could serve as a rough benefit tax. BENEFITS TAXATION

© 2012 The McGraw-Hill Companies. All Rights Reserved 22  Maybe certain populations that demand additional services will pay for additional services?  In the case of Business Improvement Districts (BIDs), businesses vote to pay additional taxes which will pay for private provision of these local public goods (Public/Private Partnership)  BIDs – privately directed, publicly sanctioned organizations that supplement public services within geographically defined boundaries by generating multiyear revenue through a compulsory assessment on local property owners and/or businesses.  Thursday we will discuss BIDs and the debates about their formation. HOW ELSE COULD WE DEAL WITH DIVERSITY IN DEMAND?

© 2012 The McGraw-Hill Companies. All Rights Reserved 23  Local Governments are generally defended through efficiency arguments.  Three main sources of market failure are used to support a role for local government in the allocation of particular resources:  Natural Monopoly  Externalities  Local public goods  Arguments against local governments are made both on the grounds of efficiency and equity.  Efficiency  Economies of scale may arise from provision of a good at the state or national level  A larger level of government may better internalize an externality  Equity  Can lead to an inequitable distribution of resources if rich live in suburbs and poor in central city  Can lead to greater segregation (by race or income) WHY SHOULD LOCAL GOVERNMENT DO THESE JOBS?