1. IntroductionLocal governments play an important role in day-to-day life of Americans. They provide education, garbage collection, police protection, and many other fundamental services that population cannot do without. This is especially true for United States, whose population is largely urbanized. A large literature in tradition of Tiebout (1956) has developed, which explores possibility that competition between jurisdictions may induce efficient provision of these goods and services. Much less attention has been devoted to question of how localities choose to allocate goods internally. In an important early paper that considered this issue, Inman and Rubinfeld (1979) observed that typical shows potentially significant inequalities in provision of municipal services across neighborhoods. There are a few neighborhoods with low crime rates, green parks, good schools, and clean streets, but most have occasional crime, decent streets, and schools financed at an adequate level. Of course, there are always some parts of a with high crime rates, dirty and potholed streets, and poor schools. Putting this in quantitative terms, Inman and Rubinfeld (1979) determined that families with $10,000 yearly incomes received on average 25% more in services than families with $5000 incomes, whereas a family with a $20,000 yearly income received an additional 25% more than $10,000 income family.This inequality is a bit mysterious if cities are ruled democratically. Intuitively, one might expect that lower income groups would not willingly tolerate an unfair allocation such as this. Of course, one could explain this by telling a political-economy story of how political donations, low voter turnout among poor, or ignorance and apathy effectively disenfranchise poor. The main point of this paper is to provide an explanation for this phenomenon that does not rely on this type of argument. We will show that, in fact, poor often have an interest in supporting this type of inequality and are better off as a result. As a secondary point, we will also explore how parameters of economy affect relative treatment of rich and poor by local governments.We consider a model with a private good, a public good, and a public service (a publicly provided private good). There are two types of agents, rich and poor, who differ in income but have identical tastes. We assume poor live in a jurisdiction called the city and form majority of population. The rich can choose to live in as well, but may instead choose to live in the suburbs apart from poor. We assume that because of zoning, commuting costs, or some other unmodeled factor, poor are unable to move to suburbs. The public good and service are funded by a proportional income tax, and public good is purely nonrival. The proportionality of this income tax (which may roughly proxy for sales taxes or property taxes) is a key modeling assumption. It precludes from using tax system to discriminate either in favor of or against rich.As we suggest above, there may be circumstances in which it is in interest of poor to treat rich better than they treat themselves with respect to municipal services. Intuitively, what drives this is that poor would prefer that rich live in city, as this allows them to capture their income as part of tax base. The rich also potentially benefit from living in city, since larger population (the rich plus poor) allows higher public good production at lower per capita cost. If there were nothing standing in their way, poor would choose to impose very high income taxes on everyone and redistribute resulting revenue in form of high levels of public service targeted specifically at poor. The rich, however, have option of moving to suburbs. To prevent this, poor must make rich at least as well off in as they would be on their own. …