Jurisdictional Spillovers and Decentralized Local Governments

1. Dr. Eunice Patron Gaithersburg, MD Judith I. Stallmann, Professor University of Missouri Community Development Extension Agricultural and Applied Economics Rural Sociology Public Affairs stallmannj@missouri.edu Jurisdictional Spillovers and Decentralized Local Governments  Third International Conference on Local GovernmentKhon Kaen University, Thailand. November 15-18, 2012

2. Decentralized local governments • A large literature focuses on relations between different levels of government. • My focus today is on relationships between local governments. • They are equals in terms of their powers and responsibilities. • But not necessarily equals in their endowments and resources.

3. Economic Argument for Decentralization • If the tax revenues come from other levels of government, citizens lack incentives to consider costs and will demand local services beyond the efficient level • Marginal costs are higher than marginal benefits • If citizens must tax themselves for the local services they receive, they will consume those services at a more efficient level • Marginal costs=marginal benefits

4. The competitive market • Basic economic theory suggests that under competitive market conditions, competition among firms will result in an efficient allocation of resources.

5. Inter-jurisdictional competition • Similarly competition among decentralized local governments can lead to more cost-effective local services, innovation in services, etc. • Tiebout (1956) suggests that the ability of citizens to choose among local jurisdictions will result in an efficient allocation of citizens among jurisdictions based on their preferences for public goods. • The governments are implicitly competing

6. Efficiency of competitive market • Series of strong assumptions for competitive market conditions to exist. • If the assumptions do not hold the market may not be competitive and therefore may not produce efficient results. • In addition there are economic outcomes beyond efficiency that society may want.

7. Roles of government in a market economy Public finance theory: when the market is not providing economic outcomes that the society desires there is a role for government. • Maintain competitive market conditions. • Ensure efficient provision of goods that the market does not provide at efficient levels. • Equity • Economic growth • Economic stability

8. Decentralizaiton • But it is possible that competition among local governments may not produce the results that public finance theory suggests for the role of government. • The cases I will focus on are equity and inter-jurisdictional spillovers. • In these cases competition among local governments can lead to undesirable outcomes. • This is an argument for flexible governance relations between local governments.

9. Equity • There may be differences in endowments across jurisdictions, such as natural resources or past investment in infrastructure. • I will not focus on this case • In addition citizens may move between jurisdictions (Tiebout 1956) • People’s demand for public services varies by income. • As a result jurisdictions may have wide differences in per capita income

10. Equity • Tiebout (1956) notes, in the case of equity expenditures those who are not receiving the benefits may chose other jurisdictions because they are paying for public services they do not receive. • It is also possible that those receiving equity assistance may migrate to jurisdictions offering higher levels of assistance.

11. Equity • To avoid the potential that lower income individuals may migrate in search of higher benefits, jurisdictions may cut equity expenditures; known as a “race to the bottom.” • Bruekner (2000) reviews 8 studies after the US changed its main income assistance program for low income families. • Finds evidence that states looked to neighbors when setting benefit levels to avoid recipients migrating into the state.

12. Policy Recommendation • Recommendation is to place responsibility for funding equity expenditures at higher levels. • Funding to provide equity between regions with different resource endowments is also recommended to be at a higher level of government.

13. Market inefficiency • T he market does not produce efficient outcomes if the actor does not receive the full benefit or pay the full costs of the action. That is actions by one actor affects others, positively or negatively: • External costs • External benefits • Public goods • Common pool resources

14. Inter-jurisdictional spillovers • As with market actors, the actions of one jurisdiction can provide benefits or costs for other jurisdictions. • These are called inter-jurisdictional spillovers and are caused by the same factors that lead to the market not being efficient. • Therefore, the jurisdictions may not allocate resources efficiently

15. External costs: example #1 • The actor does not have to take the full costs of the action into account and others bear part of the costs in the form of pollution. • Similarly, jurisdictions may cause costs– pollution--for other jurisdictions • by the direct actions of the jurisdiction, or • due to regulations (or lack of them) on their citizens or businesses • Example: US sulfur dioxide emissions drifted into Canada, causing acid rain, because there were no US regulations on emissions.

16. External Costs: example #2 • US rivers that cross state borders are more polluted at the borders than in the interior of the state (Sigman, 2002). • In the interior, the state bears the cost of pollution so it has an incentive to keep the river clean. • At its downstream border the pollution falls on another state. • At its upstream border the state is receiving pollution from another state.

17. External Costs: example #3 • Compared the water quality of interstate rivers of states in statas that have been given authority to set water quality guidelines with those that have not. Sigman (2005). • Those with state authority sent 4% more pollution downstream than those operating under federal rules. • States choose to minimize their costs at the expense of other states.

18. External costs and jurisdictions • These issues lead to adversarial relations. • Governance mechanism are needed that encourage collaboration • An independent facilitator or mediator that is perceived as unbiased by all parties may be needed in cases where jurisdictions do not collaborate.

19. Common pool resource • The good is rival: once one person or jurisdiction has it, it is not available to another or its value to another is reduced. • Also, it is difficult to exclude people or jurisdictions from access to the good. • The combination results in competition to get as much of the good as possible before others can get it. The competition results in degradation of the quality or depletion of the quantity of the good.

20. Common pool: Example #1 • An example of this is the damming of a river that flows through multiple jurisdictions. • The jurisdiction that builds the dam lessens the water flow downstream—that is the quantity of the resource is less • Or the use of a river for irrigation water lessens the water flow downstream • In the US the Missouri River is an example • There are similar issues on the Mekong River

21. Common pool: example #2 • Tax bases that are mobile are a common pool resource. Examples: • If local governments can charge a sales tax they may compete with other jurisdictions for shoppers. • Local government s may compete for firms to locate in their jurisdiction for the property taxes, business license revenues or other local business fees or taxes.

22. Common pool: example #2 • Rival: if one jurisdiction gets the shoppers or the firm (that is the tax base) the other does not. • Depletion: tax competition to get the tax base--through lowering tax rate or giving tax incentives to firms-- may result in lower tax revenues for the competing jurisdictions. • Called strategic interactions or tax competition and can take many forms

23. Common pool: example #2 • In the US, state and local governments spend $50 Billion in direct incentives to firms (Peters and Fisher 2004). • Where firms locate has almost no impact on national economic growth. • Local governments are trying to increase local economic growth and competing for the common pool tax bases. • Jurisdictions are competing for local economic growth; not concerned with national level.

24. Tax competition literature • West Virginia had a sales tax on food, 1979-1984. • The neighboring five states did not. • Divided counties into those on the state border where it is easy for shoppers to cross state lines and counties not on state borders so it is more difficult for shoppers to cross. • Shoppers did cross state lines and stopped doing so when the tax was removed. (Walsh and Jones, 1988)

25. The Missouri sales tax holiday • In Missouri the state has a sales tax and local governments—counties and cities—may have additional sales taxes. The total sales tax varies by jurisdiction. • In 2004 Missouri held a sales tax holiday—certain items were exempt from state sales taxes for 3-days. Said it was to help families buy school clothing and computers.

26. Tax competition in Missouri • Local governments in Missouri can choose any combination of property and sales taxes and set their own rates up to a cap imposed by the state. • Local governments could choose to opt-0ut—not lower their local sales tax rate--or opt-in • All local governments had a very short period in which to decide. • This is a natural experiment to test for tax competition

27. Missouri tax competition • Cities in counties on the state border were more likely to participate than interior cities. • Cities located in counties that participated in the holiday were more likely to participate. • Cities in counties with a higher number of cities were less likely to participate. • This may be a reflection of the concentration of a large number of smaller cities around the two largest cities—St. Louis and Kansas City.

28. Missouri tax competition • Cities with higher sales tax rates—that is they are more dependent on sales taxes for revenues—were less likely to participate • Some cities have only a sales tax and no property tax • Nearly 78% of the cities participated • Overall there is evidence of tax competition. • In another study we estimated the loss of revenue by local governments as $8 million

29. Common pool: Example #3 • Strategic interactions: when the competition between local governments involves expenditures or regulations. • Can lead to increased regulations—planning—or expenditures—better local services. • The common pool resource is mobile citizens that they want to attract or do not want to attract.

30. Strategic interactions • Case, Rosen and Hines (1993) find that US states follow their neighbors in spending. • They may be competing to attract citizens that want these services. • Higher spending by neighbors may give the state some room to increase spending and still be competitive with neighbors. • Bruekner (1998): California cities adopted growth control measures if their neighbors adopted them. • May be trying to not attract certain citizens

31. Policy implications • Government decentralization can lead to a more efficient allocation of local public services because those who receive the services also pay for them. • Competition among decentralized governments can lead to lower costs of public services, innovation, etc.

32. Policy implications • In some cases, competition among decentralized governments can lead to undesirable outcomes. • Citizens may search for the mix of public services that they desire. This can lead to large differences in income among communities. • To alleviate this sorting, equity expenditures may be funded by a higher level of government.

33. Policy implications • Because inter-jurisdictional spillovers may be positive or negative, may be short or long run, may involve varying numbers of jurisdictions, flexible governance mechanisms may be more useful than formal structures. • Laws which allow collaborations, such as sharing of tax bases, contracting between governments, voting by jurisdictions on joint issues.

34. Policy implications • Laws which allow collaborations, such as • sharing of tax bases, • voting by jurisdictions on joint issues, • contracting between governments, • agreements that are specific to the issue and not a general collaboration. • Unbiased facilitators and mediators may be need when a jurisdiction refuses to collaborate.

35. Third International Conference on Local GovernmentKhon Kaen University, Thailand. November 15-18, 2012 Thank you