Transcript State and Local Public Finance Spring 2006, Professor Yinger

State and Local Public Finance
Spring 2015, Professor Yinger
Lecture 17
Introduction to
Intergovernmental
Relations
State and Local Public Finance
Lecture 17: Intergovernmental Relations
Class Outline

Key Features of the U.S. Federal
System

Principles for Allocating
Responsibilities in a Federal
System

Intergovernmental Grants

Fiscal Disparities
State and Local Public Finance
Lecture 17: Intergovernmental Relations
U.S. Constitutional Structure

The federal government and the
states have equal standing as
constitutional units, with
separate rights and
responsibilities.

Counties, townships, cities,
villages, school districts, and
special districts are creatures of
the states.
State and Local Public Finance
Lecture 17: Intergovernmental Relations
Rough Distribution of
Responsibilities

The federal government provides
national defense, social insurance,
and social welfare

The states provide higher education,
social services, and highways.

Local governments provide
elementary and secondary
education, police and fire protection.
State and Local Public Finance
Lecture 17: Intergovernmental Relations
The Role of
Intergovernmental Grants
Higher levels of government
provide extensive financial
assistance to lower levels of
government in the form of
intergovernmental aid.


The federal government gives
grants to states and to local
governments

State governments give grants to
local governments.
State and Local Public Finance
Lecture 17: Intergovernmental Relations
Federal Grants to State and
Local Governments

Federal grants peaked in 1978 at
over ¼ of state and local general
revenue.

Federal grants declined rapidly in
the Reagan years, but have usually
increased since, mainly due to
Medicaid—to about the 1978 level.

Federal grants now (2012) provide
22.5% of state and local general
revenue and 10.1% of local school
revenue (up from 8.1% in 2008).
State and Local Public Finance
Lecture 17: Intergovernmental Relations
State Grants to Local
Governments

States provide 32.2% of local
general revenue (2012).

This share rose slowly for a
long time but has now stalled.

The state share is higher for
education (45.5%, down from
48.3% in 2008).
State and Local Public Finance
Lecture 17: Intergovernmental Relations
Mandates and Rules

Higher levels of government
also affect lower levels of
government in other ways.

The federal government can
give financial incentives for
state or local governments to do
certain things (e.g. NCLB).

The federal government cannot
impose requirements on states,
however.
State and Local Public Finance
Lecture 17: Intergovernmental Relations
Mandates and Rules, 2

State governments can impose
unfunded spending mandates
on local governments.

State governments can alter the
assignment of spending
responsibilities or taxing rules.

E.g., some cities must provide
ports, airports, hospitals, or higher
education.

E.g., some cities have access to a
commuter tax.
State and Local Public Finance
Lecture 17: Intergovernmental Relations
Principles to Guide the
Assignment of
Responsibilities
A famous framework developed
by an economist named
Richard Musgrave, divides the
responsibilities of government
into three “branches”:




Stabilization
Allocation
Distribution
State and Local Public Finance
Lecture 17: Intergovernmental Relations
Stabilization

Everyone agrees that the main
responsibility for stabilization
policy (i.e. monetary and fiscal
policy) should fall on the
federal government.

Nevertheless, states can alter
the impact of economic
fluctuations on their citizens
through rainy day funds or
similar policies.
State and Local Public Finance
Lecture 17: Intergovernmental Relations
Allocation

All levels of government
address issues involving the
allocation of resources.

Allocation questions involve
both of the types of efficiency
discussed in this class:

Productive or technical efficiency.

Allocative efficiency.
State and Local Public Finance
Lecture 17: Intergovernmental Relations
Productive Efficiency, Economies of
Population Scale
The per-capita cost of a public
service may depend on the number
of people being served.


Economies of population scale, also
called publicness, arise when the percapita cost declines with population.

Diseconomies of population scale, also
called congestion, arise when the percapita cost increases with population.
State and Local Public Finance
Lecture 17: Intergovernmental Relations
Productive Efficiency, Economies of
Population Scale
Elementary and secondary education
has U-shaped cost functions.



The minimum-cost size is 3,000 pupils in
New York and 58,000 in California.

This difference reflects different measures
of school performance emphasized in
each state and perhaps other factors.
Defense is a pure public good; there
are diseconomies of scale for police.
State and Local Public Finance
Lecture 17: Intergovernmental Relations
Economies of Population
Scale in Public Education
Cost
Per
Pupil
(for
given
output)
New York
California
Consolidate
Split Up? (NY)
3,000
58,000
Number of Pupils in District
State and Local Public Finance
Lecture 17: Intergovernmental Relations
Productive Efficiency, Economies of
Population Scale, Cont.
All else equal, the responsibility for a
public service should be assigned to
the unit of government with the scale
closest to the minimum-cost scale.






Suburban school districts meet this test.
Rural districts are too small, and, on cost
grounds, at least, they should consolidate.
Urban districts are too large and, on cost
grounds, they should be split up.
Different public services have
different optimal scales—a reason for
layers of government.
Cost considerations may, of course,
be offset by other concerns.
State and Local Public Finance
Lecture 17: Intergovernmental Relations
Allocative Efficiency, 1

Recall the normative argument
by Tiebout: A federal system
is efficient if there are many
local governments and people
are able to choose their
preferred service-tax package.

This argument calls for
assigning service
responsibilities to small local
governments, all else equal.
State and Local Public Finance
Lecture 17: Intergovernmental Relations
Allocative Efficiency 2,
Spillovers
Spillovers from public services are an
externality.


Example: Benefits from a state highway
system to people in surrounding states.
One way to address spillovers is to
assign service responsibility to a level
of government high enough to
internalize the externality.


Example: An air- or water-pollution district
that encompasses an entire air- or watershed.
Another way to address spillovers is
with intergovernmental grants


Examples: Federal matching grants for
highways, state aid for education.
State and Local Public Finance
Lecture 17: Intergovernmental Relations
Distribution
Most analysts call for the
assignment of distribution to higher
levels of government:
Truly equal opportunity requires a
higher level of government.



E.g., national programs for social
insurance or civil rights.
Redistribution may involve spillovers:


People in State A who believe in equality
benefit from equality in State B.
Redistribution at lower levels of
government may be undermined by
mobility.




Wealthy individuals can escape
progressive state and local taxes
Needy individuals may move to generous
cities or states.
Evidence says these effects are small.
State and Local Public Finance
Lecture 17: Intergovernmental Relations
Behavioral Responses to Grants

Intergovernmental grants are
intended to influence the
choices made by lower levels of
government.

The impacts of grants on the
behavior of recipient
governments has been widely
studied.

Policy makers who design
grants should know about this
research!
State and Local Public Finance
Lecture 17: Intergovernmental Relations
Fisher’s Intergovernmental Grant Table
Conditions
on Use
Categorical Grants
Allocation
Method
Formula
Matching?
LumpSum
Project
LumpSum
Limits?
1
General
Grants
2
Formula
Matching
ClosedEnded
OpenEnded
3
4
LumpSum
Revenue
Sharing
(Matching)
5
6
State and Local Public Finance
Lecture 17: Intergovernmental Relations
Lump-Sum Grants as Income

In theory: In a median-voter model,
$1 of grants is equivalent to an
increase in voter income that equals
$1 after being multiplied by tax-price
(= what the voter saves).

In practice: Grants have consistently
been found to have a larger-thanpredicted impact on public spending.

This is called the flypaper effect.
State and Local Public Finance
Lecture 17: Intergovernmental Relations
The Flypaper Effect
Estimates of the flypaper effect vary
widely.



A typical estimate finds that $1 of aid has
the same impact as $3 of income.
Eom/Duncombe/Nguyen-Hoang/Yinger
estimate that $1 of school aid has the
same impact on demand as $50 of
income!
There is no consensus about the
cause of the flypaper effect.



Some scholars think it represents voter
illusion of mis-measurement.
My recent work with Nguyen-Hoang
provides evidence that it reflects the
salience of a voter’s tax price.
State and Local Public Finance
Lecture 17: Intergovernmental Relations
Impact of Grants on Efficiency
An issue at the frontier of
knowledge is whether grants
affect governmental efficiency.
This issue has 2 parts:






A grant to promote service A (math
and English scores) may also
boost service B (music education).
A grant may lead to bureaucratic
waste.
Duncombe and I find indirect
evidence of both effects.
So grants funds are transferred
in a leaky bucket!
State and Local Public Finance
Lecture 17: Intergovernmental Relations
Categorical vs. General Grants

The decision as to which type of
grant to use is analogous to that
of cash versus food stamps.

There is no evidence that the
flypaper effect (or the efficiency
impacts) are different for
general and categorical grants,
so the standard graph applies.

Making a grant “categorical”
often does not alter its impact.
State and Local Public Finance
Lecture 17: Intergovernmental Relations
Categorical Versus General Grant
Everything
Else
Budget line with general grant
Y+G
Y
I
I
3
2
I
City 1
1
I 2*
City 2
I 1*
Original
budget line
0
Budget line with
categorical grant
Subsidized Category
State and Local Public Finance
Lecture 17: Intergovernmental Relations
Matching vs. Lump-Sum Grants

In deciding which of these grants to
use, the standard figure for income
and price subsidies is often used.

This figure implies that a matching
grants has a larger impact on local
performance than does a lump-sum
grant with the same cost to the
granting government.

This effect reflects the fact that a
matching grant, unlike a lump-sum
grant, has both an income effect and
a price effect.
State and Local Public Finance
Lecture 17: Intergovernmental Relations
Matching Versus Lump-Sum Grant
Budget Line with
Lump-Sum Grant
Everything
Else
Tangency Point
with Lump-Sum Grant
Tangency Point
with Matching
Grant
I3
I2
Budget Line with
Matching Grant
I1
E1 E3
Cost of Both Programs
E2
Education
State and Local Public Finance
Lecture 17: Intergovernmental Relations
Matching vs. Lump-Sum Grants

But this theorem ignores (a) the
flypaper effect, which only applies to
lump-sum grants and (b) the impact
of grants on efficiency.

When these two factors are
considered, lump-sum grants might
be more stimultative in some cases,
particularly when given to
disadvantaged districts.

In addition, matching grants are
unpopular with elected officials
because their cost is not known at
budget time.
State and Local Public Finance
Lecture 17: Intergovernmental Relations
Fiscal Health

Fiscal health is the extent to which a
jurisdiction’s ability to provide
reasonable services at a reasonable
tax rate is constrained by factors
outside its control.

Fiscal health is relevant for policy:



It provides perspective on
spending/performance differences.
It helps in designing aid to local
governments, particularly schools.
The key philosophical issue here is
whether a state should accept some
responsibility for the fiscal disparities
its actions help to create.
State and Local Public Finance
Lecture 17: Intergovernmental Relations
Fiscal Health, 2

Fiscal health equals the
difference between a
jurisdiction’s expenditure need
and its revenue-raising
capacity, both based on factors
outside the jurisdiction’s control.

A deficit is a poor measure of
fiscal health because
forecasting methods and
assumptions are not outside a
jurisdiction’s control.
State and Local Public Finance
Lecture 17: Intergovernmental Relations
Expenditure Need

Expenditure need depends on
expected service quality
(constant across jurisdictions),
assigned responsibilities, and
public service costs.

In symbols:
EN j  ( E )( R j )(C j )
State and Local Public Finance
Lecture 17: Intergovernmental Relations
Revenue-Raising Capacity
RRC = the ability of a jurisdiction
to raise revenue based on factors
outside its control.
The Income-Plus-Exporting
approach holds tax burden
constant across jurisdictions.



How much could a jurisdiction raise if
it placed the same tax burden on its
residents as the average jurisdiction?
The Representative Tax System
approach holds tax rates constant.


How much could a jurisdiction raise if
it levied the same tax rates as the
average jurisdiction?
State and Local Public Finance
Lecture 17: Intergovernmental Relations
Income-Plus-Exporting Approach
Define for jurisdiction j and tax i:






b = tax burden
Y = income per capita
e = taxes raised from nonresidents
for every dollar raised from residents
= export ratio
s = expected revenue share for
given tax
Then

RRC j  bY j 1

i



sieij 


State and Local Public Finance
Lecture 17: Intergovernmental Relations
Representative Tax System
Approach
Define for jurisdiction j and tax i:




t = tax rate
B = tax base per capita
Then
RRC j   ti Bij
i
State and Local Public Finance
Lecture 17: Intergovernmental Relations
Fiscal Health, 3

In short:
FH j  RRC j  EN j

States influence fiscal health by
setting service responsibilities,
access to taxes, and tax rules.

Fiscal health is also influenced
by a city’s economy.

Fiscal health varies widely
across large cities and across
school districts.