Empirical Tiebout

© Allen C. Goodman, 2008

Read TieboutRead Oates

What should we look for?

We showed last time that if we have an asset (let’s say a bond), that pays $y per year, its value V is approximately:

V = y/r; We wrote D = 1/r, so V = Dy.

Suppose we now tax that bond at rate t.

What will happen to its value?

Value of a taxed asset

V = Dy – D(tV) Why?

Then:

V (1 + Dt) = Dy, and

V = Dy/(1 + Dt)

What does this mean?

As t, V

Oates’s Thought

• If Tiebout was right, and people shopped around:– Higher property tax rates, without

accompanying higher services are likely to lower house values in the places with higher taxes.

– If the tax rates better services, then these better services will higher values.

– Kind of a classic article!

Data for 53 New Jersey suburbs

• 1960 Census data.

• Suburbs, because they are likely to be similar, as opposed to central cities like Newark and Jersey City.

New Jersey Suburbs

ManhattanSuburbs

Oates Regressions

Dependent Variable: Median Home Value in 1,000 (1960)

Expected Sign (1) (2)

Constant ? -21.0 -29.02.4 2.3

% Tax Rate (log) Negative -3.6 -3.64.1 3.1

Expend/student (log) Positive 3.2 4.92.1 2.1

Miles to NYC (log) Negative -1.4 -1.34.8 4.0

Rooms Per House Positive 1.7 1.64.1 3.6

% Built Since 1950 Positive 0.1 0.13.9 3.9

Median Family Income Positive 1.5 1.58.9 7.7

% Incomes < 3000 Positive 0.3 0.33.6 3.1

R2 0.93 0.93

N 53 53

Coeffient in bold; t statistic in roman

OLS 2SLS

How do we interpret?

• Equations say that an increase in local property tax rates from 2% to 3% reduced market value of house of about $1,500.

• What would theory tell us?– If interest rate is 5%– If life of house is 40 years– If mean house value is $20,000– We expect reduction of value of $2,260

So, 1500/2260 = 0.66,About 2/3 of the taxes are

“capitalized into lower property values.

What about expenditures

• He uses expenditures as his measure of educational output (inherently problematic – why?).

• He determines that a 1% point increase in property tax on $20,000 house 200, and argues that about ½ goes to education.

• From regression, a $100 increase in expenditures drives up value of home by about $1,200.

So?

• Roughly speaking, the benefits from the taxation, offset the tax costs.

• One can argue, roughly, that what the tax increase pays for (regarding higher education), is a wash in terms of property value.

• Concludes:– “Consumers thus appear to some extent to ‘shop’ for

public services. If one community can provide a given program of public services more ‘cheaply’ (that is with lower tax rates) than another, at least some individuals appear willing to pay more to live there.”

Plethora of Studies

• If you do a citation search, you will find that this article was like Helen of Troy, the face that launched 1000 ships.

• All kinds of follow-ups. – Was this really what Tiebout

meant?– Was the econometrics right?– Did this work at the individual house

level, as opposed to the community level?

Goodman – 1983 (Land Economics)

• Took the model that Hamilton developed (the one presented in the previous lecture).

• Look at an equation as developed previously.

1i i

ii

Dy Dt BP

t D

then,

Derived from above

• First term – If all communities are “homogeneous” that is Bi = Pi, there would be no tax capitalization. Why?

( )

(1 ) (1 )i i i

i i ii i

B P D t DdP dt dB

t D t D

• Second term – Differences in tax bases can make migration attractive?

Equation to estimate

1 – Impact of random tax difference

0 1 2 3

1( )ni

j jn ni i i i

Pz t t t B

2 – Impact of tax differences among areas.

3 – Impacts of differing tax bases.

If λ= 1 linearIf λ = 0 logarithmic

Results

• Random differences are capitalized at just about 100%.

• Combination of community tax rates and tax bases are capitalized at about 60%. Kind of similar to Oates’s findings.

Sample was 1835 houses in theNew Haven Connecticut metro

Area from 1967-1969

Why not 100%

• We’ve only talked about housing demanders. What about suppliers.

• If the demanders are willing to pay 100% capitalization, suppliers may be able, for a while, to get excess profits by providing housing. This increased production will lower prices and “undo” some of the capitalization.

Arrière pensées

• Tiebout model has some “legs” for the suburbs. There was a 50th anniversary conference regarding the original article recently, with a volume to come out.

• Problems– Doesn’t tell us much about central cities.– Assumes everything is paid for from within.– No outside grants, federal or state monies.

Instability

Instability

• Tax financing generates inherent instability.

• Need not be solely property tax. Happens with any tax other than a pure benefit tax or a head (per/person) tax.

• Incentive for one family to move to take advantage of fiscal surplus will lead other (or all) families to move.

How to Make Things Stable

• Fiscal Zoning – Keep people from building cheaper housing.

• One way – Prohibit construction of housing that is smaller than the original houses. This could constitute a “taking” of the land, and is unconstitutional.

• Another way – a different set of rules that is not defined to be exclusionary … but is.

What’s a taking? What’s wrong with it?

What’s a taking? What’s wrong with it?

Fiscal Zoning

• Often these specify lot size. If you specify a minimum lot size, you have a limited number of (big) parcels.

• With big parcels you typically want to build big (expensive) houses.

• Developers may choose to build a large development of similarly valued houses. This will also lead to (relatively) homogeneous communities.

Impact of Lot Size Restrictions

• Land could be used either for little houses or big houses. In eq’m, rent/acre is same for both.

$

Acres

$

Acres

Little Houses Big Houses

Re

DL DB SBSL

Impact of Lot Size Restrictions

• With restrictions, SL falls, SB rises. Zoning keeps the land prices from equalizing. Preserves homogeneity, prevents subsidization.

$

Acres

$

Acres

Little Houses Big Houses

Re

DL DB SBSL

RL

RB

Is Zoning Used this Way?

• If it is, then the property tax serves roughly as a user charge with each household paying the full cost of the services. This is called the “benefit” view.

• Mieszkowski/Zodrow feel that it isn’t. They feel that the zoning regulations that are seen are not stringent enough to meet the “benefit” criterion.

Fischel

• Fischel notes that there are a lot of restrictions, including:– Required street frontage– Yard setbacks– Off-street parking– Minimum house floor area– Height restrictions

• Says “The family of eight that wants to rent part of a lot in Scarsdale and park two house trailers on it and send their kids to Scarsdale’s fine schools is apt to find a few regulations in the way.”

Capitalization!

• What IS capitalization?

• Answer: Capitalization is the change in the price of an asset due to a shift in demand for the asset.

• For complete capitalization, the price of a small house in a BIG community must increase (decrease) by the present value of the fiscal surplus (deficit).

Several Implications

1. You don’t need a bunch of homogeneous communities to achieve an efficient equilibrium.

2. You can have a lot of different kinds of housing in a single community.

3. Complete capitalization property tax as a benefits tax. Lower taxes, but higher cost of housing!

Does Capitalization Occur and Can It Be Maintained?

• Capitalization results from competition for limited amount of land and housing. If there is unlimited land, there cannot be capitalization. Why?

• So, anything that limits competition, will limit capitalization.

In the Long Run

• If the value of houses in Ferndock Township (Macomb County) – Might have more housing constructed, or– Might develop a clone of Ferndock Township.

• If this happens we will have reduced the scarcity of what makes Ferndock Township valuable, and capitalization will not be complete.

• May not be a perfect substitute if Ferndock II is, for example, further away from desirable places.

Valuation of Surplus

• Capitalization may not occur if residents in one community do not value the additional services offered elsewhere, even if tax rates of housing prices are lower.

• Supposing you could get a fiscal surplus of $5,000/year of spending for $4,400.

• If you don’t value it even at $4,400, you won’t move, and difference won’t be capitalized.

Evidence and Reality

• Not likely to get perfect Tiebout equilibrium because it is expensive to move.

• Moving entails, search costs, time costs, “adventure in moving”, closing costs of buying a house!

• You also have spillovers, and income matters.• Fisher and Wassmer (1998) find that where there are

greater differences in desired gov’t spending, you will see more communities. This is consistent with Tiebout.

• Most importantly, Tiebout idea emphasizes idea of decentralized governmental structure.