Inefficiencies from Metropolitan Political and Fiscal Decentralization: Failures of Tiebout Competition

S M Calabrese,R E Romano,D N Epple

doi:10.1093/restud/rdr048

Abstract

We examine the welfare effects of provision of local public goods in an empirically relevant setting using a multi-community model with mobile and heterogeneous households and with flexible housing supplies. We characterize the first-best allocation and show efficiency can be implemented with decentralization using head taxes. We calibrate the model and compare welfare in property-tax equilibria, both decentralized and centralized, to the efficient allocation. Inefficiencies with decentralization and property taxation are large, dissipating most if not all the potential welfare gains that efficient decentralization could achieve. In property-tax equilibrium, centralization is frequently more efficient! An externality in community choice underlies the failure to achieve efficiency with decentralization and property taxes: poorer households crowd richer communities and free ride by consuming relatively little housing thereby avoiding taxes.

Highlights

“Tiebout (1956) competition” among jurisdictions in providing local public goods is central to the economic study of local public finance
While standard models frequently fail to meet the conditions for efficiency, economic intuition suggests that some Tiebout competition is better overall than none: The alternative of centralized provision will do nothing to match heterogeneous preferences to provision of local public goods
We show that increasing the housing supply elasticity results in a higher welfare loss from Tiebout sorting under property taxation than in our baseline calculation

Summary

Introduction

The analogy between competition among firms in providing private goods and “Tiebout (1956) competition” among jurisdictions in providing local public goods is central to the economic study of local public finance. While standard models frequently fail to meet the conditions for efficiency, economic intuition suggests that some Tiebout competition is better overall than none: The alternative of centralized provision will do nothing to match heterogeneous preferences to provision of local public goods. With local head taxes chosen efficiently and equilibrium household choices of jurisdictions, the modified Tiebout allocation would generate substantial welfare gains. Let fj(y,α) denote the density of household types living in jurisdiction j, tj the property tax rate, and hj(y,α) housing consumption of household (y,α), all of which are given in the third stage. The gross housing price (pj), local public good level (gj), and household numeraire consumption are determined in the third stage, satisfying respectively:.

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