Topic 3 Study Questions

Study Questions 3 3-1 Tiebout Hypothesis - Individuals choose the one community from among all communities offering the package of public services and taxes that comes closest to satisfying their preferences. If the Tiebout Hypothesis is met there will as many communities as there are preferences. If no one has the same preference each community will have only one person. Fiscal Zoning - Fiscal zoning improves efficiency in the supply of public services by reducing the potential for some residents of a community to free ride. Ex. If community A adopts a zoning restriction that sets a minimum house value of $100,000, newcomers will be unable to “free ride” by building a smaller, lower-valued and lower-taxed house. Fiscal zoning converts the nonbenefit property tax into a benefit tax that is consistent with Lindahl equilibrium. The Lindahl equilibrium is now stable so that communities’ fiscal zoning can still satisfy the Tiebout hypothesis even if they use non-benefit taxes. Capitalization - Capitalization means that the discounted present value of all future tax payments is included in the current price of housing. The price of a house is lower by an amount equal to the discounted present value of all future taxes. In this case, owners of large houses in a heterogeneous community pay higher taxes than owners of similar houses in a homogeneous community. However, with capitalization, the difference in taxes between the two communities is capitalized into the price of large houses in the heterogeneous community. This means the price of a large house in the heterogeneous community is lower than the price of the same house in a homogeneous community. The lower price offsets the higher taxes. 3-2 1. Consumers are mobile and will move their residence to the community that best satisfies their preferences. This assumption is essential to the Tiebout Model because in order for Tiebout to be valid individuals must be able to satisfy their individual preferences. People must be mobile in order to move into a community of their preference. 2. Consumers are completely knowledgeable about the differences among communities in public services and taxes. In order to validate the Tiebout model, consumers must have the ability to move to a community which meets their preferences. If consumers do not know which community will satisfy their preferences because they do not have access to the information then the Tiebout model cannot be met. 3. Consumers have many communities from which to choose.

Tiebout requires that there are as many communities as there are preferences. In order for each person to be satisfied there must be many communities, unless every person shares the same preference. 4. Employment opportunities do not restrict or limit the mobility of individuals among communities. If employment opportunities inhibit a person’s ability to move to the community of their choice then the Tiebout Model cannot be validated. 5. There are no spillovers of public service benefits or taxes among communities (no interjurisdictional externalities). The Tiebout Model assumes that people will move into communities that meet their preferences and where they pay their marginal benefit. It requires homogeneity of preferences, and perfect benefit taxes. If there are spillovers of public service benefits or taxes people will move to communities that meet their preferences and also where they can pay below their marginal benefit. Spillovers create a free riding problem. 6. Each community attempts to attract a population that is exactly large enough to take full advantage of any economies of scale in the supply of public services without being so large as to encounter diseconomies of scale. Your optimal jurisdiction in a Tiebout Model is where your average total cost is lowest and that is where the population is maximized. 3-3 What is the efficient number of communities and what is the efficient size of each community? a.) The efficient number of communities is that there are enough communities to cover each person’s preferences. The size of the community must be at least one and is efficient if every person in that community has their preferences satisfied. b. does metropolitan consolidation, where two or more cities merge into one or where a county and one or more cities merge into a single government unit, increase or decrease efficiency and why? b.) Consolidation decreases efficiency unless each member of the community pays the same amount for the public goods provided. Metropolitan consolidation would decrease efficiency unless proper Lindahl equilibrium can be found. This would create a heterogeneous population, making the efficiency more difficult to obtain. We also all stated that to be efficient, the entire community must have the same preferences to be in that community. But remember it is possible to have non homogenous communities but still have a Tiebout result. c. do limits on the use of fiscal zoning and laws and policies that make communities more heterogeneous increase or decrease efficiency and why?

c.) Limits on fiscal zoning cause heterogeneous communities to be less efficient. Putting limits on fiscal zoning, laws, and policies make heterogeneous communities less efficient because there will be an incentive to free ride on the people with higher MB than you. Fiscal zoning helps to force people to pay for their benefit and excludes them if they cannot. Where as if you limit zoning people could free ride on the spending of others. 3-4) a. If the parkland fee in each community were replaced by a property tax equal to 1 percent of house value, how would it change the incentives for residents in each community to relocate to the other community? What happens to the Lindahl equilibrium? Explain. Residents of Hueytown would have no incentive to move to Deweyburg. Residents of Deweyburg would have an incentive to build a smaller house in Hueytown to gain 2 more acres of parkland per household, but at the same tax rate that they would have been charged only gaining one acre of land. b. Would substitution of a property tax for the parkland fee affect the initial Lindahl equilibrium if Hueytown enacted a zoning ordinance establishing a minimum house value of $150,000 before it adopted the property tax? Explain. No. The Lindahl equilibrium would remain constant because those in Hueytown already own $150,000.00 or above homes while enjoying their preferred acres of parkland. Those in Deweyburg would have no incentive to move to Hueytown because they prefer a smaller home and fee for the parkland they receive and would have to pay a higher price to move to Hueytown. If they wanted a bigger home, they would have already moved to Hueytown. The Lindahl equilibrium would no longer exist since the tax changed to a 1% property tax, consumers in Deweyburg would move to Hueytown, build small houses and still pay a maintenance fee of only $500 while receiving 3 acres of parkland instead of 1 acre as in Deweyburg manifesting the “Free-rider problem.” The parkland fee is no longer equal to every citizen’s in Hueytown marginal benefit, meaning no Lindahl equilibrium. They collect less tax revenue and the amount of parkland in Hueytown will now pay more taxes for less parkland and the people from Deweyburg. Finally residents of Hueytown will now pay more taxes for less parkland, and the people from Deweyburg that moved over will pay fewer taxesand receive more parkland. c. Louieville has a mix of big houses and small houses. Like Hueytown, Louieville provides a large amount of parkland per household and pays the costs of parkland from a propertytax. However, because of capitalization of fiscal differentials, residents of Deweyburg who own small houses do not relocate to Louieville even though they would get more parkland with no increase in their taxes. Similarly, residents of Louieville who own big houses do not relocate to Hueytown even though they would pay less tax for the same amount of parkland. Explain what “capitalization of fiscal differentials” means in this setting. How does capitalization eliminate the incentive for Louieville’s residents to relocate to Hueytown or for Deweyburg’s residents to relocate to Louieville? In this case, owners of large houses in a heterogeneous community pay higher taxes than owners of similar houses in a homogeneous community. However, with capitalization, the difference in

taxes between the two communities is capitalized into the price of large houses in the heterogeneous community. This means the price of a large house in the heterogeneous community is lower than the price of the same house in a homogeneous community. The lower price offsets the higher taxes. Similarly, owners of small houses in a heterogeneous community pay lower taxes than owners of similar houses in a homogeneous community. The tax differential is capitalized into the price of small houses in the heterogeneous community so that the price of a small house in the heterogeneous community is higher than the price of the same house in a homogeneous community. The higher price offsets the lower taxes. Initially, individuals who prefer small houses have an incentive to move to Community Louieville where they can pay lower taxes but receive the same amount of parkland. However, the increased demand bids up the price of small houses in Louieville, making the amount of taxes paid the same. On the other hand, individuals do not move from Louieville to Hueytown because when demand for homes in Hueytown rises the price of homes in Hueytown rises, thus the tax while lower in Hueytown is the same as you would pay in Louieville.