Study Questions 3

3-1

Tiebout Hypothesis - Individuals choose the one community from among all communities
offering the package of public services and taxes that comes closest to satisfying their
preferences.

If the Tiebout Hypothesis is met there will as many communities as there are preferences. If no
one has the same preference each community will have only one person.

Fiscal Zoning - Fiscal zoning improves efficiency in the supply of public services by reducing
the potential for some residents of a community to free ride. Ex. If community A adopts a zoning
restriction that sets a minimum house value of $100,000, newcomers will be unable to “free ride”
by building a smaller, lower-valued and lower-taxed house. Fiscal zoning converts the non-
benefit property tax into a benefit tax that is consistent with Lindahl equilibrium. The Lindahl
equilibrium is now stable so that communities’ fiscal zoning can still satisfy the Tiebout
hypothesis even if they use non-benefit taxes.

Capitalization - Capitalization means that the discounted present value of all future tax payments
is included in the current price of housing. The price of a house is lower by an amount equal to
the discounted present value of all future taxes.

In this case, owners of large houses in a heterogeneous community pay higher taxes than owners
of similar houses in a homogeneous community. However, with capitalization, the difference in
taxes between the two communities is capitalized into the price of large houses in the
heterogeneous community. This means the price of a large house in the heterogeneous
community is lower than the price of the same house in a homogeneous community. The lower
price offsets the higher taxes.

3-2
1. Consumers are mobile and will move their residence to the community that best satisfies their
preferences.

This assumption is essential to the Tiebout Model because in order for Tiebout to be valid
individuals must be able to satisfy their individual preferences. People must be mobile in order
to move into a community of their preference.

2. Consumers are completely knowledgeable about the differences among communities in public
services and taxes.

In order to validate the Tiebout model, consumers must have the ability to move to a community
which meets their preferences. If consumers do not know which community will satisfy their
preferences because they do not have access to the information then the Tiebout model cannot be
met.

3. Consumers have many communities from which to choose.

Tiebout requires that there are as many communities as there are preferences. In order for each
person to be satisfied there must be many communities, unless every person shares the same
preference.

4. Employment opportunities do not restrict or limit the mobility of individuals among

communities.

If employment opportunities inhibit a person’s ability to move to the community of their choice
then the Tiebout Model cannot be validated.

5. There are no spillovers of public service benefits or taxes among communities (no inter-
jurisdictional externalities).

The Tiebout Model assumes that people will move into communities that meet their preferences
and where they pay their marginal benefit. It requires homogeneity of preferences, and perfect
benefit taxes. If there are spillovers of public service benefits or taxes people will move to
communities that meet their preferences and also where they can pay below their marginal
benefit. Spillovers create a free riding problem.

6. Each community attempts to attract a population that is exactly large enough to take full
advantage of any economies of scale in the supply of public services without being so large as to
encounter diseconomies of scale.

Your optimal jurisdiction in a Tiebout Model is where your average total cost is lowest and that
is where the population is maximized.

3-3
What is the efficient number of communities and what is the efficient size of each community?

a.) The efficient number of communities is that there are enough communities to cover each
person’s preferences. The size of the community must be at least one and is efficient if every
person in that community has their preferences satisfied.

b. does metropolitan consolidation, where two or more cities merge into one or where a county
and one or more cities merge into a single government unit, increase or decrease efficiency and
why?

b.) Consolidation decreases efficiency unless each member of the community pays the same
amount for the public goods provided. Metropolitan consolidation would decrease efficiency
unless proper Lindahl equilibrium can be found. This would create a heterogeneous population,
making the efficiency more difficult to obtain.
We also all stated that to be efficient, the entire community must have the same preferences to be
in that community. But remember it is possible to have non homogenous communities but still
have a Tiebout result.

c. do limits on the use of fiscal zoning and laws and policies that make communities more
heterogeneous increase or decrease efficiency and why?
c.) Limits on fiscal zoning cause heterogeneous communities to be less efficient. Putting limits
on fiscal zoning, laws, and policies make heterogeneous communities less efficient because there
will be an incentive to free ride on the people with higher MB than you. Fiscal zoning helps to
force people to pay for their benefit and excludes them if they cannot. Where as if you limit
zoning people could free ride on the spending of others.

3-4)
a. If the parkland fee in each community were replaced by a property tax equal to 1 percent of
house value, how would it change the incentives for residents in each community to relocate to
the other community? What happens to the Lindahl equilibrium? Explain.

Residents of Hueytown would have no incentive to move to Deweyburg. Residents of

Deweyburg would have an incentive to build a smaller house in Hueytown to gain 2 more acres
of parkland per household, but at the same tax rate that they would have been charged only
gaining one acre of land.

b. Would substitution of a property tax for the parkland fee affect the initial Lindahl equilibrium
if Hueytown enacted a zoning ordinance establishing a minimum house value of $150,000 before
it adopted the property tax? Explain.

No. The Lindahl equilibrium would remain constant because those in Hueytown already own
$150,000.00 or above homes while enjoying their preferred acres of parkland. Those in
Deweyburg would have no incentive to move to Hueytown because they prefer a smaller home
and fee for the parkland they receive and would have to pay a higher price to move to Hueytown.
If they wanted a bigger home, they would have already moved to Hueytown.

The Lindahl equilibrium would no longer exist since the tax changed to a 1% property tax,
consumers in Deweyburg would move to Hueytown, build small houses and still pay a
maintenance fee of only $500 while receiving 3 acres of parkland instead of 1 acre as in
Deweyburg manifesting the “Free-rider problem.” The parkland fee is no longer equal to every
citizen’s in Hueytown marginal benefit, meaning no Lindahl equilibrium. They collect less tax
revenue and the amount of parkland in Hueytown will now pay more taxes for less parkland and
the people from Deweyburg. Finally residents of Hueytown will now pay more taxes for less
parkland, and the people from Deweyburg that moved over will pay fewer taxesand receive more
parkland.

c. Louieville has a mix of big houses and small houses. Like Hueytown, Louieville provides a
large amount of parkland per household and pays the costs of parkland from a propertytax.
However, because of capitalization of fiscal differentials, residents of Deweyburg who own small
houses do not relocate to Louieville even though they would get more parkland with no increase
in their taxes. Similarly, residents of Louieville who own big houses do not relocate to Hueytown
even though they would pay less tax for the same amount of parkland. Explain what
“capitalization of fiscal differentials” means in this setting. How does capitalization eliminate the
incentive for Louieville’s residents to relocate to Hueytown or for Deweyburg’s residents to
relocate to Louieville?

In this case, owners of large houses in a heterogeneous community pay higher taxes than owners
of similar houses in a homogeneous community. However, with capitalization, the difference in
taxes between the two communities is capitalized into the price of large houses in the
heterogeneous community. This means the price of a large house in the heterogeneous
community is lower than the price of the same house in a homogeneous community. The lower
price offsets the higher taxes. Similarly, owners of small houses in a heterogeneous community
pay lower taxes than owners of similar houses in a homogeneous community. The tax differential
is capitalized into the price of small houses in the heterogeneous community so that the price of a
small house in the heterogeneous community is higher than the price of the same house in a
homogeneous community. The higher price offsets the lower taxes.

Initially, individuals who prefer small houses have an incentive to move to Community
Louieville where they can pay lower taxes but receive the same amount of parkland. However,
the increased demand bids up the price of small houses in Louieville, making the amount of taxes
paid the same. On the other hand, individuals do not move from Louieville to Hueytown because
when demand for homes in Hueytown rises the price of homes in Hueytown rises, thus the tax
while lower in Hueytown is the same as you would pay in Louieville.