Conference on Fiscal Federalism

March 26-27, 2010
Julie Berry Cullen and Roger Gordon, Organizers

Katherine Baicker and Monica Singhal, Harvard University and NBER, and Jeffrey Clemens, Harvard University
Fiscal Federalism in the United States

The classic Tiebout model, first proposed over 50 years ago, remains the benchmark framework for thinking about the provision of local public goods. Although the model is not explicitly a model of optimal fiscal federalism, it does have natural implications for the allocation of responsibilities across levels of government. Despite continued widespread use of the Tiebout model, the empirical evidence to support its main predictions is mixed. Baicker, Clemens, and Singhal review empirical patterns over time in fiscal federalism and consider whether these patterns can be reconciled with the benchmark Tiebout framework. They then discuss the theory and evidence on four assumptions in the original Tiebout model (perfect mobility, "enough" jurisdictions, absence of spillovers and intergovernmental interactions, and perfect information) along with other fiscal constraints. They argue that while some of the patterns and trends over time are consistent with the predictions of the benchmark model, especially when interpreted in light of the effect of constraints placed on lower levels of government by those above, there are still some facts that do not appear to be consistent with the benchmark framework and are not easily explained by patterns of violations in the underlying assumptions.

David N. Figlio, Northwestern University and NBER, and Deborah Fletcher, Miami University
Suburbanization, Demographic Change and the Consequences for School Finance

David Figlio and Deborah Fletcher use a sample of school districts from twenty Northeastern and Midwestern cities to document the development of the suburbs in postwar America and to provide evidence that young suburban families have aged in place to a large degree. They find that development dates of the suburbs affect modern age distributions, which in turn influence the level of school spending: earlier-developing suburbs cut back faster on school spending between 1970 and 1990 than later-developing suburbs. These results are robust to a number of differences in specification and instruments used. They also find that differences in age distribution have the smallest effect in districts with the least voter control over local revenues and spending levels, but have the largest effect in districts where older and younger residents are more racially and ethnically mismatched.

Roberton C. Williams III, University of Texas at Austin and NBER
Growing State-Federal Conflicts of Interest in Environmental Policy: The Role of Market-Based Regulation

Early in the history of U.S. environmental regulation by the federal government, cases in which state governments chose to override federal regulation with tighter regulations of their own on the same pollutant were quite rare. In recent years, however, these cases have become more common, even for pollutants that have substantial spillovers across states (and thus for which one would expect the federal government to regulate more aggressively). Moreover, when California attempted in the mid-to-late 2000s to impose its own car and truck fuel economy regulations, the federal government acted to block those rules. Why have these conflicts of interest in environmental regulation become more common? Williams argues that this change arose at least in part because of a shift in the type of regulation used at the federal level, from command-and-control regulation toward more incentive-based regulation. These two types of regulation at the federal level provide substantially different incentives for state regulation. Under federal command-and-control, a state that imposes a tighter standard than the federal government will bear the full cost of that tighter standard. In contrast, under an incentive-based federal regulation, a state imposing a tighter regulation will bear only part of the additional cost, because of an offsetting reduction in emissions taxes paid or emissions permits bought within the state. Consequently, under incentive-based federal regulation, states will be much more inclined to impose their own tighter policies than under federal command-and-control.

Hilary W. Hoynes, University of California at Davis and NBER, and Erzo F.P. Luttmer, Harvard University and NBER
Insurance Benefits from Progressive Taxes and Transfers

Hoynes and Luttmer estimate the total value that individuals derive from their state's tax-and- transfer program, and show how this value varies by income percentile. They decompose the total value into two components: redistributive value, which is derived from expected taxes and transfers, and insurance value, which occurs when taxes and transfers compensate for unexpected income shocks. Their calculations use the Panel Study of Income Dynamics and allow for analysis of the determinants of changes in the insurance and redistributive value of state net benefits over a more than 30-year period.

Therese J. McGuire, Northwestern University, and Nathan B. Anderson, University of Illinois at Chicago
Do States Practice Benefit Taxation? School Finance Reform and the Distribution of State Taxes

One of the implications of Tiebout competition is that jurisdictions will attempt to align taxes with the benefits of government expenditures. McGuire and Anderson take an exogenous change in the distribution of state expenditures and examine how the distribution of state taxes changes. Others have found that court-ordered school finance reform results in a redistribution of state aid to schools from richer districts to poorer districts. These researchers explore the implications for state revenue structures of this shock to state expenditures. They find that, relative to states without court-ordered school finance reform, state income tax systems became more progressive in states with court-ordered school finance reform.

Julie Berry Cullen and Roger Gordon,both of the University of California at San Diego and NBER
Income Redistribution in a Federal System of Governments

The literature on fiscal federalism, dating back to work by Musgrave and Oates, argued that the Federal government should have primary responsibility for income distribution: states and localities have a comparative disadvantage when undertaking redistribution because they face the threat of exit of net payers and in-migration of net recipients. However, we see states and localities in the United States actively engaged in redistribution, with over 40 percent over overall state and local revenue coming from income and sales taxes. In their paper, Julie Berry Cullen and Roger H. Gordon develop a positive model of the respective roles of Federal and state governments in income distribution. In general, redistribution by states creates positive fiscal externalities to other states because of migration, but negative fiscal externalities to the national government through changes in reported taxable income. If the Federal government chooses its policies to assure that the net externalities are zero, then Berry and Gordon forecast that 1) it will play no role in redistribution if there is no migration, and 2) with migration it will choose redistribution policies so as to fully offset any fiscal externalities across states. They then use of the characterization of equilibrium state and Federal policies to back out the extent of distributional concerns and migration responses that would lead to the tax schedules observed in practice. The resulting welfare weights on different income groups and inferred migration elasticities seem plausible, suggesting that such a positive model can successfully explain the observed division of responsibilities for redistribution between state and Federal governments seen in the United States.

Rajashri Chakrabarti, Federal Reserve Bank of New York, and Joydeep Roy, Economic Policy Institute
Effect of Constraints on Tiebout Competition: Evidence from School Finance Reforms in the U.S.

Local financing of U.S. public schools leads to a bundling of two distinct choices – residential choice and school choice - and often results in a Tiebout-type economic and demographic segregation across school districts. School finance reforms, which seek to equalize per pupil spending and thus weaken this link, have become increasing prevalent over the last four decades. One important aspect of many of these school reforms is that they either severely limit or end altogether local discretion over school spending. This diminished local control over schooling has significant implications for the provision of public education, because a typical Tiebout framework suggests that centralization of public services at higher levels may reduce efficiencies associated with providing these services at the local level, possibly undermining the conformity between citizen preferences and the services provided. Chakrabarti and Roy examine the effects of these constraints in the context of school finance reforms in three states that varied markedly in their designs and hence likely affected incentives and responses differently: California, Michigan, and Vermont. They find that the school finance reforms in California and Michigan were instrumental in significantly increasing the growth rates of spending in the lowest spending districts. However, the reforms also constrained the highest-spending districts in each state. The researchers provide suggestive evidence that the restrictions on spending imposed on the highest-spending districts have affected their subsequent educational outcomes. Interestingly, however, highest-spending districts in Michigan seem to have done worse than their counterparts in California in terms of student performance, even though they were not as constrained in their school spending as the latter.

Patrick Bayer, Duke University and NBER, and Robert McMillan, University of Toronto and NBER
Tiebout Sorting and Neighborhood Stratification

Tiebout’s classic 1956 paper has strong implications regarding stratification across and within jurisdictions, predicting (in the simplest instance) a hierarchy of internally homogeneous communities, ordered by household income. In practice, urban areas tend to exhibit varying degrees of within-neighborhood mixing, likely attributable to departures from several standard Tiebout assumptions – the fact that households are influenced by more than public goods packages when deciding where to live, the heterogeneous nature of the housing stock, and the role of employment geography, given commuting costs are non-zero. To shed light on the way these factors influence observed residential mixing, Bayer and McMillan quantify the separate contributions of employment geography and housing preferences in reducing neighborhood stratification. They use an equilibrium sorting model, estimated with rich Census microdata. Simulations based on the model using credibly-identified demand estimates show that counterfactual reductions in commuting costs lead to marked increases in education segregation and, to a lesser degree, increases in income segregation, as households now find it easier to locate in neighborhoods with similar households. In contrast, turning off preferences for housing characteristics actually reduces income segregation, indicating that the nonuniform distribution of housing serves to stratify households based on ability-to-pay. Related, they show that differences in housing also help accentuate differences in the consumption of local amenities.

Robin Boadway, Queen's University, and Jean-Francois Tremblay, University of Ottawa, Canada
Reassessment of the Tiebout Model

The Tiebout model has been the staple reference point for the classical approach to fiscal federalism. Its emphasis on mobility, benefit taxation, and the advantages of fiscal competition have informed fiscal federalism since the seminal contributions of Musgrave and Oates. Boadway and Tremblay review the influence that the Tiebout model has had on fiscal federalism, and argue that although some of its insights remain relevant, it is far from compelling as a positive description or a normative prescription for the design of a federal system. Some aspects of alternative approaches are presented, which lead to quite different perspectives than Tiebout-inspired ones.

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