The economist Charles Tiebout is famous for analogizing local government to perfectly competitive firms. His model inspired this question on my last public finance midterm:To which Fischel responds in the comments (#22):Who wants to take a stab at this? I'll post my preferred answer as a followup.
If the Tiebout model were correct, how would you expect local governments to raise revenue? Carefully explain your answer.
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.I'm actually preparing to speak at Beloit College on Fischel's Homevoter Hypothesis as a prelude to my current research, and I've already incorporated a slide that defends both Fischel from Caplan and Caplan from Fischel. In short, voter's at the municipal level are more likely to pay a price for irrational beliefs and respond by voting wisely with respect to their housing prices.