University of Turin Department of Economics MODELLING HOUSEHOLD CHOICES OF DWELLING AND LOCAL PUBLIC SERVICES: A Behavioural Simulation of the Effects of Fiscal Decentralization. Ugo Colombino Marilena Locatelli

University of Turin Department of Economics 2  To estimate a micro-econometric model of residential choice and simulate the effects of alternative systems of fiscal decentralisation upon public finance and household behaviour and welfare. Purpose

University of Turin Department of Economics 3 The Model  Derived from the discrete choice approach proposed by McFadden (1978).  Applied to a sample of Italian chief towns of district.  The choice is assumed to depend on personal characteristics, income, structural and environmental characteristics of the dwelling and of the town, local taxes and local expenditure on services and public goods.

University of Turin Department of Economics 4 The model (cont.)  We assume that the consumer faces a residential location decision among the alternatives belonging to the opportunity set  For consumer h, the alternative produces a utility flow  The consumer h chooses the alternative j if

University of Turin Department of Economics 5 The model (cont.)  Under the assumption that the are i.i.d. type III Extreme Value, it is well-known that the probability that household h chooses alternative turns out to have the multinomial logit form.

University of Turin Department of Economics 6 The model (cont.)  We estimate (and simulate) the model under two different specification of the price function that differ as to the assumptions on returns to scale.  If we assume constant returns to scale:  If we assume decreasing return to scale:

University of Turin Department of Economics 7 The model (cont.) DADA DBDB Supply function with constant return of scale

University of Turin Department of Economics 8 The model (cont.) DADA DBDB Supply function with decreasing return of scale

University of Turin Department of Economics 9 A Behavioural Simulation of Fiscal Decentralization  The total expenditure for local services is kept constant, but it is re-distributed among the different locations, i.e. towns, in such a way that the local expenditures of each town represent the same proportion of the (national) income taxes paid by the households living in that town (the way each town distributes expenditures for local services is not changed).

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University of Turin Department of Economics 14 A Behavioural Simulation of Fiscal Decentralization  For each household we compute the expected maximum utility before and after the reform:

University of Turin Department of Economics 15 Equivalent variation (EV)  The equivalent variation, is a measure of the amount of money necessary to maintain the same level of households’ utility facing under two different fiscal decentralization regimes, which is implicitly defined as:

University of Turin Department of Economics 16 Efficiency and Equality Effects of the Reform  We compute the iso-elastic social welfare function

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University of Turin Department of Economics 28 Conclusions  Results support the hypothesis that dwelling quality, location and local public services affect residential choice decisions, giving a quantitative measure of their relevance.  Since residential choice decisions of individual households are affected by the actions of local government, in a decentralised system, the local government, through its expenditure and tax decisions, can influence the socio-economic composition of its population and consequently the size of its tax base.

University of Turin Department of Economics 29 Conclusions (cont.)  the reform is efficient, since the overall mean value of EV is positive but it produces different disequalizing effect depending on the chosen specification.  In specification A, the reform is disequalizing only for the highest value of the inequality aversion parameter, whereas in B it is always strongly disequalizing.