The Functions of Government (Musgrave)

1. Stabilization (Function of Federal Government)

2. Distribution (Tax-transfer system)

3. Allocation (Resources for public or collective goods and quasi-public goods)

System of State and Local Governments

1. State and local governments provide most of the government services that have a direct and immediate effect on peoples lives. (Public education, public health and welfare programs, police and fire protection, public transportation, and water supply and refuse collection.

2. Local governments have limited power to levy taxes and spend revenues collected. The jurisdiction of local government entities frequently overlap. (School districts, water districts, public transit authorities, municipal governments)

3. Many residents are within the jurisdiction and taxing power of several local governments. Some critics of the system point to the duplication , but nearly all of the reduction of jurisdictions has come from school district consolidations.

Finance

1. Overall government expenditure has been a growth industry both in dollar spending and as a percent of GDP. In 1929 government spending accounted for 9.9 percent of GNP. In 1990 it amounted to 34.9 percent of GNP. (Table 14.1)

2. Property taxes, sales taxes, and user charges (water bills, tuition to community colleges, parking fees, transit fares, license fees, etc.) make up most of the revenue to local governments, although income taxes are important in some states. (Table 14.2)

3. Education, welfare, transportation, health and public safety, and administration costs make up most of the expenditure (Table 14.3)

4. In large cities, more revenue is generated in central cities than in suburbs, even though income is larger in suburbs. In most cities the central city receives more in intergovernmental transfers (grants from the federal government).

5. There are three reasons why central cities tax themselves more heavily than suburbs:

a. Central cities are relatively well endowed with nonresidential properties.

b. Many of the grants to local governments have matching provisions. c. Central cities have more demands on public services to the poor.

Reasons for Central-City Fiscal Problems

1. Rising taxes, taxpayer revolts, bankruptcies, and general perceptions of declining city services led to cries of a fiscal crisis during the 70s and 80s. There are five reasons cited for crisis.

2. Already noted is that central cities are increasingly the home of low-income households that place a greater demand on public services.

3. A second reason is the declining relative economic importance of central cities as the transport system has flattened the rent gradient. Firms cannot be taxed too heavily or they will leave the central city. Recently nonresidential activity has decentralized more rapidly than has residential activity.

4. A third reason is central-city population decline, especially in northeastern cities. Costs to a declining population do not fall proportionally in the short-run. Fewer people results in higher per capita cost for fixed capital investment, such as a water or sewer system. Even police and fire protection and school cost do not fall proportionally in the short-run.

5. Declining cities find it more difficult to cut back on employment than on capital expenditures. Public employees are heavily unionized in larger cities and they represent a large part of local election turnouts.

6. Being small is not the problem, but moving from big to smaller is the problem. While the role of federal aid should help, it has had the opposite effect of making the adjustment more painful by encouraging the growth of local government spending at precisely the time that local governments should be moving to lower public expenditure levels.

5. Another financial problem resulted from the shift toward revenue sharing and subsequent decline in federal aid to cities and states (after adjustment for inflation). Federal mandates shifted the responsibility to the states without increasing the funding necessary to meet increased requirements.

6. A final financial problem resulted from sensitivity to economic cycles increasing spending and lowering revenues without the ability to run current account deficits during recessions.

Goods and Services

1. The demand for public goods and services has increased while the technology for producing these goods and services has not increases materially over the past few decades. The "productivity lag" has contributed to rising costs.

2. Local public goods are not pure public goods in the sense of national defense. Rather, they are produced under constant returns to scale and are frequently subject to the "exclusion principle." The decision to provide them publicly varies from case to case.

a. Public road network is not easily excludable, even though toll roads may be used for selected purposes.

b. Police protection involves coercion that, if not enforced by terror, must be granted by the public sector.

c. Water, sewer, and fire protection are a natural spatial monopoly that are provided by the public sector to avoid duplication at higher costs. Could use

publicly regulated private industries.

d. Education is the most important and difficult case, since it is not a natural monopoly nor does it involve the police power of coercion. The rationale seems to be more philosophical and constitutional than economic. If left to the private sector (without public supported vouchers), then differences in parents' tastes and preferences for spending income would surely result in inequality of

education

Tiebout Hypothesis

1. The Tiebout hypothesis argues that "shopping" for a jurisdiction and its attendant offerings of education and other services is much like shopping for other goods, except that people "vote with their feet" rather than their dollars.

2. The multiple jurisdictions in metropolitan areas allows households to vote the bundle of local governmental services and property taxes to pay for them that best meets their needs and tastes. Multiple school districts (the most expensive local government service) especially attracts people with similar demands for local government services.

3. Higher real estate taxes to suburban dwellers to provide local public goods eliminates the "free rider" effect of low income households that receive more benefits than they pay for based upon the value of their property.

4. Land use controls that are justified as protecting residents from noise, pollution, and congestion are used to exclude free riders and "to protect the character of the community."

5. Both high and low income residents receive a larger net fiscal benefit from locating in the wealthier area. Suppose two towns exist that are adjacent. The value of residential property is used to define the wealth of the town. Residents in both towns pay a tax of 2% of property value and receive equal benefits from a balanced budget. The net gain is the difference between benefits and tax payments. Both towns redistribute income from the rich to the poor, but the net redistributive effects favor both the rich and the poor by locating in the wealthier area. Example is table below:

	Value of residential property	Tax payments at 2% of property value	Benefits received	Net gain to household
Wealthy Town
Citizen W1	$100,000	$2,000	$1,400	-$600
W2	100,000	2,000	1,400	- 600
P1	__10,000	___200	_1,400	+1,200
Total	$210,000	$4,200	$4,200	0
Poor Town
Citizen P2	$10,000	$200	$800	+$600
P3	10,000	200	800	+ 600
W3	_100,000	_2,000	__800	-1,200
Total	$120,000	$2,400	$2,400	0

6. Payment in proportion to benefit is the theoretically preferred method of financing allocative functions. Without some type of exclusion principle, however, there will be some redistributive effects between the amount paid in taxes and benefits received.

7. As a practical matter local budgets are likely to remain redistributive from the rich to the poor, but the redistribution is less in wealthier towns than in poorer towns. Hence, the property tax system promotes wealthier citizens locating in wealthier neighborhoods to the exclusion of lower income housing.

8. The housing value premium based upon net fiscal gain may be capitalized into its present value. Once capitalized, the higher relative price of suburban housing in wealthier areas eliminates any utility differences that exist between the city and the suburb. Then, if a poor family wishes to become a beneficiary of income redistribution by moving to a wealthier neighborhood, it must purchase this right at a higher fair market price. (What the tax-expenditure bundle gives, the housing market takes away.)

9. Zoning is used by wealthy suburbs to keep the poor from outbidding the wealthy for available land. 10 poor families could outbid 1 wealthy family for suburban land unless the land were zoned for low density, single unit housing. Zoning offsets the net benefit of property taxes versus spending to the poor by redistributing benefits to the wealthy.

Realism of the Tiebout Hypothesis

1. There is considerable evidence that people get roughly what they pay for among local jurisdictions.

2. There is evidence that homogeneity of neighborhoods and capitalization of net fiscal gains. (Woodway houses in the Waco ISD sell for less per square foot that Woodway houses in the Midway ISD, even though the houses are comparable in size and amenities.)

3. Peoples preferences depend on many other things than local taxes and government services provided, but neighborhoods do not have to be perfectly homogeneous for the Tiebout hypothesis to work.

Welfare Economics and the Tiebout Hypothesis

1. Choices based upon "voting with their feet" simulates the competitive model in that taxes are more similar to benefits received. Resource use more nearly matches household demands. Competition from nearby communities encourages greater efficiency in allocating resources according to their marginal social benefit.

2. Limits to this welfare efficiency of allocation are several. (a) There may not be a large enough number of alternative jurisdictions in the area. (b) Local governments may not be free to choose their bundle of services or tax rates. (Federal mandates, and state and federal grants may be tied to specific purposes.) (c) Some local government services, such as water or transportation, cannot be provided by fragmented local governments because of economies of scale or logistical reasons. (d) Competition among jurisdictions is unlikely to offer the same technological discipline as private sector competition, since the method of shopping for local public services is so indirect and delayed by lack of mobility. (e) The practice of exclusion of free riders through land use controls is imperfect in most jurisdictions. The real estate market, through capitalization, partially corrects for this through relative housing values for similar units. But, it may not correct for a change in land use from low density to high density housing that is not homogeneous

3. The redistributive effects of taxes versus benefits is a result of less than perfectly homogenous jurisdictions. If redistribution of income is a goal of public policy, then it could be met more directly through income transfers or vouchers administered by state and federal government rather than by local governments.

Special Problems of Education

1. Education could be provided in a purely private market that would be competitive rather than monopolistic. People apparently would not like the private market outcome for philosophical reasons.

2. With a private system parents with a strong demand for education would purchase high quality education for their children, and vice versa for parents with a lower demand for education. The Tiebout mechanism has given us an elaborate and cumbersome mimic of this outcome, and it has given rise to similar displeasure.

3. Proposals to reform education are based upon displeasure with the Tiebout outcome. Vouchers and increased centralization are the primary proposals.

4. Education is not like other production functions that depend strictly upon textbooks material in and education out. Rather the determinants of quality education are complex.

5. Test scores show a decline for those born from 1962-64 but the trough was temporary. Beginning in 1985 verbal (but not math) standardized test scores declined, but this decline was due to a rise in the fraction of high school graduates taking the GRE.

6. Two other observations: blacks showed smaller declines than whites; their scores stopped declining earlier; and the upturn in black scores was sharper than that of whites. This occurred for both integrated and heavily segregated schools.

7. The drop out rate has declined significantly for blacks, as shown by adult persons who are high school graduates. (Table 14.9) Drop out rate data is not very reliable, and many students who drop out eventually return to graduate (or complete GED).

What Determines Quality Education?

1. How is quality measured? Generally, by standardized test scores. More recently by subsequent earnings.

2. Test scores depend crucially on the characteristics of parents and peers, rather than variance in educational expenditures. If income is used as a proxy for socioeconomic characteristics, the quality of education may be estimates in the following regression equation:

Estimates of the parameters in this equation show that b1 is not significantly different from zero. However, the equation suffers from the identification problem in that Q and E are intersections of both the production function above and a demand function. Another reason might be that good school districts can get good teachers with lower salaries (better working conditions).

3. Estimates that have used subsequent earnings as a measure of educational quality show that lower pupil to teacher ratios and higher pay have a positive effect, as well as the number of school years attained.

Education and the Tiebout Mechanism

1. If education is produced by a combination of purchased inputs, parents, and peers, the Tiebout model of education predicts that the application of various exclusionary practices, such as zoning, is valuable to residents of wealthy districts.

2. Not only are wealth saved from having to subside the poor, but they are saved from low achievement - lower socioeconomic pupils.

3. This has a sinister effect from the perspective of the poor who are denied the perceived achievement gain.

Proposals for Reform

1. Centralization is one proposal, but its success assumes that wealthier school districts affect achievement through expenditure. If parents and peer socioeconomic characteristics are the primary causal factor for educational achievement, then giving compensatory spending aid to poorer school districts will not solve the problem.

2. As long as private schools are a viable option, the centralization of public schools would probably increase upper income attendance at private schools. This is already the case for many households who have not fled the central city ISD for the suburbs (the Tiebout solution).

3. Vouchers could be given for redemption at any accredited school with no distinction between public and private schools. Schools would have to compete for students, and this competition would discipline their performance. This would not necessarily lead to more racial and socioeconomic integration unless vouchers were designated for specific socioeconomic groups. (As recently proposed in the Texas legislature.)

4. Privatization of public schools is often proposed as a way of improving educational quality. However, because private schools can exclude students and tuition is charged to parents that indicates their support, the fact that private schools show higher achievement than public schools is not a basis for concluding that an all private school system would be superior. In practice, local government hire private vendors to run their schools.

5. The return to education (investment in human capital) increased significantly in the 1980s, perhaps as a result of opening our economic to international trade and foreign competition. The United States has been an exporter of higher tech products that require more education and training, placing a premium on educational attainment.

Police Protection and Crime

1. Crime rates are significantly lower in wealthier, low density suburban neighborhoods than in poor, high-density areas.

2. The crime rate has been relative constant over the past decade, but the prison population has doubled. Drug related crime has receive considerable attention although there is evidence of a reduction in drug use between 1985 and 1990.

3. Open air drug markets developed during the 1980s. To be effective they must have four characteristics: (a) dealers do not like clean well lighted neighborhoods, (b) dealers need a legitimate cover on the street, such as a bar, convenience store, or a housing project, (c) dealers are attracted to neighborhoods with poorly supervised children that act as salesmen and lookouts, and (d) markets require a steady stream of customers and a ready means of escape.

4. Closing down open air markets is successful when there is: (a) enforcement of loitering laws, (b) attention to street lighting, (c) encouragement of neighborhood associations, and (d) boarding up and demolition of abandoned structures. Restriction to entry and photographic identification for entry into housing projects are effective.

Regulation

1. Local government have two kinds of regulation: (a) regulation of natural spatial monopolies, and (b) regulation of the use of land for any purpose through zoning ordinances and building codes.

2. Regulated natural monopolies (local cable company rates or power company rates, for example) are to protect the consumer against monopoly prices. In some cases, competition could provide better service (local taxi cab service, for example)

3. Building codes specify materials, structural integrity, etc. They are not performance standards but require the use of specific materials and methods.

4. Zoning is justified as a way of dealing with externalities. But exclusionary zoning is used to protect against the redistribution of income and to restrict supply in order to achieve a monopoly gain. (Close the door behind you.)

5. Local land use regulation are a police power that do not require compensation rather than the power of eminent domain use to seize property for public use.

6. Zoning ordinances do not require officials to weigh the costs and benefits of a parcel of land, but rather has if any costs will be imposed on current residents if the parcel of land is developed. If they had to compensate the land owner they would have to consider to benefit versus cost of the transaction.