Abstract: Paper No. 170
Sorting and Voting: A Review of the Literature on Urban Public Finance
Stephen Ross and John Yinger
This paper reviews the literature on the boundary between urban economics and local public finance. The focus is therefore on research that considers both a housing market and the market for local public services. The first part of the paper considers positive theories. This part presents the consensus framework for understanding the allocation of households to jurisdictions, which is built on bid-functions and household sorting, as well as alternative approaches to this issue. It also examines models about local tax and spending decisions, which exhibit no consensus, and reviews research in which both housing and local fiscal variables are endogenous. The second part of the paper considers empirical research for the United States and, when it exists, for other countries. In particular, this part explores research on tax and service capitalization, on household heterogeneity within jurisdictions, and on the impact of zoning on housing markets. The third part of the paper considers normative theories about a decentralized system of local governments. This part examines the extent to which such a system leads to an efficient allocation of households to communities or to an efficient selection of local public service levels, and it discusses the fairness of local public spending.
This review shows that the bidding/sorting framework is strongly supported by the evidence and has wide applicability in countries with decentralized governmental systems. In contrast, models of local public service selection depend on institutional detail and their connections with housing markets have been largely unexplored in empirical work. Ever since Tiebout, many scholars have argued that decentralized local governments have efficiency advantages over centralized forms. However, a more general treatment of this issue identifies four key sources of inefficiency in a decentralized system: misallocation of households to communities, the property tax, public service capitalization, and heterogeneity. Few policies to eliminate these sources of inefficiency have yet been identified. Finally, this review shows how several key features of a decentralized system, such as the sorting of high-income households into certain jurisdictions, have implications for the fairness of local public spending.
The revised version of this paper will be published in Handbook of Urban and Regional Economics, Volume 3, Applied Urban Economics, edited by P. Cheshire and E.S. Mills (North-Holland, forthcoming). Those interested in this work should see that publication.