Taxation Under Tiebout

Interesting question. I assume the point is that you don’t necessarily expect them to tax in the most efficient manner – i.e. with the least dead weight loss to society as a whole.

Given that my initial response was that you would expect them to raise revenue entirely from non-residents in some manner. So some type of tax that they might impose entirely on outsiders doing business in the jurisdiction. But any such tax would ultimately be borne by residents.

So my second shot is that you would expect local governments to raise revenues entirely through user fees. That would seem to be in equilibrium, because if any other jurisdiction tried some other scheme where taxes were imposed on those who didn’t use the services, they would move to another jurisdiction where they got their money’s worth of the services.

Provide services which prospective residents find valuable, thus increasing demand for living in the town. This can increase revenue either by allowing the town to charge a higher price (raise taxes) or by expanding the tax base at current rates.

Or adjust tax rates towards the revenue-maximizing tax rate, which should be just enough less than the market price to overcome switching costs. And in a perfectly competetive market, switching costs are assumed to be zero. So cut your taxes to once cent lower than the next-cheapest town.

I’m not an expert on this, but here’s my take.

My first guess is why people won’t be charged for the services they use, just like businesses. Thinking further, if local governments are perfectly competitive that means that the price they are charging for their services are at marginal cost. If people choose to move places and are sorted into communities based on preferences for services, why can’t they also sort themselves into places where they are taxed differently. It is possible that some communities might tax income and some might tax just based on services received. Or within each one there might be a combination of them. I don’t know enough about the theory to be able to say, straight up, that one type of taxation would/could emerge.

Given that my initial response was that you would expect them to raise revenue entirely from non-residents in some manner. So some type of tax that they might impose entirely on outsiders doing business in the jurisdiction. But any such tax would ultimately be borne by residents.

Well, you do see such “taxes” as aggressive ticketing for speeding of people driving out-of-state plates (or out-of-county, when the license plates indicate that, as in Florida) in some areas with popular roads and lots of non-resident traffic passing through. In some cases the advantage of the route passing through the jurisdiction may be high enough that the “highway robbery” rents can be extracted without ultimately placing too much of a burden on the residents.

User fees won’t cut it for everything. Tieboutville is just the right size to contain the benefits from the public goods it provides. People want their local government to provide certain public goods. Tieboutville gives people what they want, ergo Tieboutville provides public goods. Public goods are non-excludable, so they can’t be funded by user fees.

Consider that even though the residents are equally charitable, that doesn’t make them 100% charitable. They are equally uncharitable as well. so you can’t rule out free riders just because everybody wants the same services and is equally willing to pay for them.

All of the residents are the same, so they get the same benefit from city services and they are willing to pay the same price. Ergo: head tax. It’s your presence or absence in Tieboutville that determines if you get the public services, therefore you have to pay to be present.

It’s possible that the residents of Tieboutville also have a taste for government provided private goods. These services, unlike the other services which the town is best suited to provide, could be funded by user fees.

The Tiebout model sheds light on municipal annexation. To my knowledge, townships commonly can annex nearby unincorporated land with some ease. I don’t know of any circumstance where it is easy for a part of a local government to spin off into a smaller unit. And so, most townships are too big. Some townships form for the sole reason of resisting external annexation, since even small local governments better able to protect themselves from annexation compared to unincorporated areas. Here, you would expect the townships to be too small.

My guess would be to specialize, or cater to a specific audience.

Say there is a community in Florida that sees benefits from retired persons living in their town. They should offer services that the retired persons would see as most beneficial to them, and therefore be willing to pay for through tax dollars.

Or perhaps there is a supply of young families with children in a certain area. It might be good to focus on parks, little league sports (hopefully ones where they keep score), and active involvement in the local schools in order to justify a certain tax rate (or user fee) that can raise revenues.

Otherwise, I know my hometown has seen some revenues come in from community festivals, but I don’t know how much, or how effective they have been.

I don’t think it would matter what the tax structure would be, because you would reach some sort of equilibrium among communities once a community found a way of collecting taxes. Once a community found a way of taxing, other communities would emulate them (that being easier than coming up with other ideas), and little real choice would then be involved for people.

Local communities, I would think, would look for taxes that would be “hidden,” such as a sales or property tax. The taxes we pay are included in our mortgage payments, so we don’t think too much about them, and renters have that tax further hidden from them. I personally don’t like property taxes, because it amounts to rent being paid to the government, meaning they are the ones who actually own the land, and can take it away from you (evict you) if you don’t pay the rent. So long as the government pretends you have property rights and ownership, you do — but when they decide to stop pretending, you won’t.

Another hidden tax is the sales tax. Most people don’t really pay attention to how much they pay in sales taxes, even though it’s on our receipts. So it’s not literally hidden, though for as much attention as anyone pays to it, it is virtually hidden. Local governments could have different kinds of sales taxes, which would affect locations of shopping more than anything, I would think.

A lottery might work, but as my brother once observed, the lottery is more of a poor tax. Still, that might raise money from people not only in the community, but from people outside it as well.

In any case, if his theory is right, it will actually end up in the creation of the same tax structures across communities, as they reach an equilibrium that keeps people in with services and does not drive them off with taxes. And isn’t that essentially what we see across the U.S.?

Does Tiebout have the ability to keep people out? If they give everyone in town free health care, do all the sick people in the world get to move there?

Every year the Tax Foudnation or someone publishes highest and lowest lists of municipalities with respect to taxes. The highest taxes are where everyone lives (e.g. NY, LA, DC) and the lowest (e.g., Bismark). So to be competitive with those hughly desireable locales, wouldn’t you implement high personal, property and sales taxes? Or would you admit that taxes are so low in importance that you shouldn’t let that tail wag the dog?

(And please don’t bring up Texas, it has high property taxes, etc so it can keep pimping the “No Income Taxes” brand)

I suggest issuing municipal bonds like there’s no tomorrow.

After all, the people on the city council don’t hold any equity in the city. Unlike the people sitting on a corporate board, they don’t have to worry about losing capital and future dividends. Sure, this strategy will eventually bankrupt the city, causing living conditions go down. But, as Tiebout assumes, there are many other cities to move to, and no costs associated with moving. Assuming that our council members have the foresight to rent rather than own property, there’s no downside.

Bond buyers and landlords will eventually wise up to this strategy. In the short-run, however, there’s some great opportunity for legal, risk-free fraud here.

Politically, the scheme is most viable in cities with many renters and few property owners. Conversely, this fraud can be prevented by weighting each person’s vote in proportion to the value of the real estate they own with city limits. (In analogy with the “one share, one vote” arrangement typical to jointly owned businesses.)

A student pointed this question out to me, so let me give it a try. There is some literature on this that suggests that a land tax is the ideal method. It is incentive compatible (you don’t want to trash your neighbor because it would lower taxable values) and it has no deadweight loss. Henry George had a point. I have argued that a system of local zoning with ordinary property taxation (land and buildings) is actually a pretty good approximation of a land tax in a Tiebout model. The citation is (please excuse my pedantic aside) Fischel, William A. 1998. “The Ethics of Land Value Taxation Revisited: Has the Millennium Arrived Without Anyone Noticing?” In Land Value Taxation: Can It and Will It Work Today? ed. Dick Netzer. Cambridge, Mass.: Lincoln Institute of Land Policy. The reason zoning is essential is that it keeps supply of capital inelastic (in fixed proportion to land), so the tax on both is like a tax on land. A related argument is Glaeser, 1996. “The Incentive Effects of Property Taxes on Local Governments.” Public Choice 89 (October): 93-111. I was a little surprised to learn that Bryan had asked this question, since I gather that he does not think too highly of voters’ ability to make rational decisions, one of which would be choice of tax base. I would demur on that on the basis of median voter evidence and Condorcet’s jury theorem, but now I’ve really veered from the topic.

Fees and charges evades the question, which is really how to finance local public goods for which charging prices is prohibitively costly. A tax on site value as AK suggests is part of the answer. If the towns in question are as built up as the voters prefer, a tax on structures on top of site value works too.

People forget that in Tieboutville, people sort by preferences, not just to run away from taxes. Some communities like Takomaparkville could decide to have income taxes for redistributive purposes and control in-migration with zoning. Others could choose the libertarian ideal of private affluence and public squalor.

I would probably not be one of BC’s favorite students.