Standing Tiebout on his head: Tax capitalization and the monopoly power of local governments *

Abstract

Much of the public finance literature argues that localgovernments behave competitively due to residents' ease of exitand entry. The model presented here challenges this widespreadconclusion. Though it is costless to relocate to anotherlocality, the presence of tax capitalization makes it impossiblefor land-owners to avoid monopolistic pricing of public servicesby moving; land-owners can only choose between paying the taxdirectly, or paying it indirectly in the form of a lower sale valuefor their housing if they exit. In consequence, the only realcheck on local governments comes through imperfectly functioningelectoral channels.