1. PUBLIC FINANCE IN A FEDERAL SYSTEM
Chapter 22

2. Background Federal system Fiscal federalism Centralization
Centralization ratio = Central government expenditures Total government expenditures

3. Distribution of All U.S. Expenditures by Government Level
Source: Figures for 1900 through 1980 are from Pommerehne [1977]. Figures after 1980 are computed from various editions of the US Bureau of the Census, Statistical Abstracts of the United States , and from US Bureau of the Census [2012b].

4. Community Formation
Club – voluntary association of people who band together to finance and share some benefit
Optimal Club (or community)

5. The Tiebout Model Voting with your feet Tiebout’s assumptions
Government activities generate no externalities
Individuals are completely mobile
People have perfect information with respect to each community’s public services and taxes
There are enough different communities so that each individual can find one with public services meeting her demands
The cost per unit of public services is constant so that if the quantity of public services doubles, the total cost also doubles
Public services are financed by a proportional property tax
Communities can enact exclusionary zoning laws—statutes that prohibit certain uses of land

6. Tiebout and the Real World
Critique of Tiebout
Empirical tests

7. Optimal Federalism
What is the optimal allocation of economic responsibilities among levels of government?
Macroeconomic functions
Microeconomic functions

8. Disadvantages of a Decentralized System
Efficiency issues
Externalities
Local public good
Scale economies in provision of public goods
Inefficient tax systems
Scale economies in tax collection
Equity issues

9. Advantages of a Decentralized System
Tailoring outputs to local taxes
Fostering intergovernmental competition
Experimentation and information in locally provided goods and services

10. Implications
Purely decentralized systems cannot maximize social welfare
Dealing with community activities that create spillover effects that are not national in scope
Combine communities under a single regional government
Pigouvian taxes and subsidies
Division of responsibility in public good provision
Distributional goals and mobility

11. Public Education in a Federal System
Local control of schools
Financing education through property taxation
Federal role in education

12. Residential Property Tax Rates
(selected cities)
How the property tax works
Assessed value
Assessment ratio
City
Effective Tax Rate (%)
Indianapolis
2.75
Detroit
2.11
Jackson
1.70
New Orleans
1.40
Oklahoma City
1.25
Boston
1.06
Seattle
0.79
New York
0.62
22-12

13. Incidence and Efficiency Effects – The Traditional View – Tax on Land
Rent per acre of land SL
Price received by landowners falls by amount of the tax
PsL = P0L
P0L
PnL DL
DL’
Acres of land

14. Incidence and Efficiency Effects – The Traditional View – Tax on Land
Tax capitalized into price of land
Land not fixed in supply

15. Price paid by tenants increases by full amount of the tax
Incidence and Efficiency Effects – The Traditional View – Tax on Structures
Price per structure
Price paid by tenants increases by full amount of the tax
PgB
PnB = P0B
P0B SB
PnL DB
DB’
Number of structures per year B1 B0

16. Summary and Implications of the Traditional View
Progressivity
Land tax
Structures tax
Empirical evidence
Measuring income

17. The New View: Property Tax as a Capital Tax
Partial equilibrium versus general equilibrium
General Tax effect
Excise Tax effects
Long-run effects

18. Property Tax as a User Fee
The notion of the incidence of the property tax is meaningless
The property tax creates no excess burden
Federal income tax subsidizes consumption of local public services for individuals who itemize

19. Reconciling the Three Views
New view: Eliminating all property taxes and replacing them with a national sales tax
Traditional view: Lowering property tax rate and making up revenue from local sales tax
User fee view: Taxes and benefits jointly changed and people are sufficiently mobile

20. Why Do People Hate the Property Tax So Much?
Property tax levied on estimated value
Property tax highly visible
Property tax perceived as being regressive
Circuit breakers
Property tax easier to attack

21. Ideas for Improving the Property Tax
Improve assessment procedures
Personal net worth tax

22. Intergovernmental Grants
Total Grants
Grants as %
Billions of
Of Total Federal
of State & Local
Year
2010 $
Outlays
Spending
1970 88
9.6
17.1
1980
168
12.3
21.9
1990
171
8.8
15.2
2000
309
13.2
19.3
2010
532
14.4
25.4
Source: Computed from Economic Report of the President, 2012 [pp. 320, 415].
Possible explanation for growth: Mismatch Theory

23. Conditional (Categorical) Grants
Matching Grants
Consumption (c) per year A E2 c2 E1 c1 G1 G2 B R
Units of public good (G) per year

24. Conditional (Categorical) Grants
Matching Closed-Ended Grants
Consumption (c) per year A E3 c3 D E1 c1 G1 G3 B R
Units of public good (G) per year

25. Conditional (Categorical) Grants
Non-matching Grants
Consumption (c) per year J A H E4 c4 E1 c1 G1 G2 B R
Units of public good (G) per year

26. Unconditional Grants Revenue sharing Flypaper Effect
Whose indifference curves?
Median voter theorem
Flypaper effect

27. Chapter 22 Summary
In a federal system of government, different governments provide difference services, although advantages and disadvantages of centralized government exist
The club model of community formation indicates that community size and quantity of public goods depend on tastes
According to the Tiebout model, a Pareto efficient allocation of public goods is possible under certain conditions through “voting with your feet”
The property tax is an important revenue source for state and local governments
Various types of grants from the federal and state government are other sources of revenue for state and local governments