State and Local Public Finance Professor Yinger Spring 2019

1. State and Local Public FinanceProfessor YingerSpring 2019 Lecture 3 Voting

2. State and Local Public FinanceLecture 3: Voting Class Outline • The Median Voter Model • How does it link voting and demand? • Why it is useful? • What are its limitations? • Property Tax Limitations • What are they? • How do they shed light on voting?

3. State and Local Public FinanceLecture 3: Voting • Voting and Demand • In most cases, citizens cannot directly express their demand for local public services. • So they express their demand through their voting, either for public officials or on referenda. • In this class, we explore how an understanding of demand helps us understand the choices local governments make.

4. State and Local Public FinanceLecture 3: Voting • The Median Voter • The median voter always votes on the winning side. • Line voters up by the strength of their preference for public services. • Identify the voter in the middle—the median voter. • A majority vote must include the median voter. -------------------------M----------------------------- weakest strongest preference preference

5. State and Local Public FinanceLecture 3: Voting • Identifying the Median Voter • But voters do not line up, so the median voter is not identified! • The median voter model shows how to identify the median voter assuming preferences are driven by demand factors. • The median voter has the median income and the median tax price. • This model places certain restrictions on preferences. • This model assumes political institutions are neutral.

6. $ TP = MC( ) D = MB S* S State and Local Public FinanceLecture 3: Voting • The Median Voter Model S = Local public service quality D = Median voter’s demand MB = Median voter’s marginal benefit from S TP = Median voter’s tax price MC = Marginal cost of S = Median voter’s tax share S* = Median voter’s preferred S

7. State and Local Public FinanceLecture 3: Voting • Using the Median Voter Model • The median voter model is widely used because: • It explains community decisions based the demand function for a single voter—the median voter. • It makes use of widely available data at the community level: spending (or performance), median income, median tax price (median divided by mean house value). • It works!

8. State and Local Public FinanceLecture 3: Voting • Example: Eom, Nguyen-Hoang, Duncombe & Yinger, • Education Finance and Policy, 2014 • 1991-2011 data for over 600 school districts in New York State. • Service quality measured by high school exams and drop-out rates. • Income elasticity = 0.17 (based on income per pupil). • Price elasticity = -0.22 (based on median tax price). • Significant preference variables include share of housing that is owner-occupied and share of population age 65 or older.

9. State and Local Public FinanceLecture 3: Voting • Other Examples • The median voter model works well for local governments, particularly school districts. • Recent applications include: • Massachusetts (Nguyen-Hoang and Yinger, Journal of Education Finance, Spring 2014). • California (Duncombe and Yinger, International Tax and Public Finance, June 2011).

10. State and Local Public FinanceLecture 3: Voting • Preference Assumptions • Median voter models need “single-peaked” preferences. • Consider two communities with a high demand for education, one (City A) with a good private school and the other (City B) without. • In City A, the high demand for education may not show up as a high demand for public education. • In this case, which is extreme, the median voter model breaks down.

11. State and Local Public FinanceLecture 3: Voting • The Role of Institutions • Scholars disagree about the importance of institutions. • Some scholars believe institutions are fairly neutral in most cases, particularly outside large cities. • Other scholars believe bureaucrats can have a large impact on spending and service quality—the leviathan view. • In some cases, it is possible to control for institutions, such as whether a city as a mayor or a city manager.

12. State and Local Public FinanceLecture 3: Voting • Tax Limits • Tax limits challenge the median voter model: Why do voters need to limit taxes if they control spending anyway? • Some scholars believe that most tax limits make a political point with little impact on spending. • Others believe that tax limits reveal voters’ belief in leviathan—and their desire to reign in bureaucrats.

13. State and Local Public FinanceLecture 3: Voting • Evidence about Tax Limits • The research on tax and expenditure limits (TELs) leads to five main conclusions. • First, TELs come in many different forms. • Some limit property tax rates; some limit property tax levy increases; some limit expenditure increases. • Some include limits on assessment increases, which, over time, lower taxes for long-term residents. (More on this in a later class). • For a thorough catalogue of the various types of limits, see Kioko, Public Budgeting and Finance, 2011.

14. State and Local Public FinanceLecture 3: Voting • Evidence about Tax Limits, 2 • Second, TELS that focus on the property tax shift the tax burden away from property taxes to other revenue sources. • This shift was very large right after Proposition 13 in CA and Proposition 2 ½ in MA but has moderated since then. • Some of the new revenue sources, especially fees, are very regressive, but others, such as income taxes in a few cases, are not.

15. State and Local Public FinanceLecture 3: Voting • Evidence about Tax Limits, 3 • Third, TELs have not stopped the growth in state and local government spending. • According to the Urban Institute: • “Direct state and local spending on general government increased from approximately $1.1 billion in 1977 (in inflation-adjusted 2015 dollars) to $2.8 billion in 2015—a 170 percent increase over 38 years. Similarly, per capita expenditures increased from about $4,900 a person to $8,800 a person, an increase of 82 percent.” • https://www.urban.org/policy-centers/cross-center-initiatives/state-local-finance-initiative/state-and-local-backgrounders

16. State and Local Public FinanceLecture 3: Voting • Evidence about Tax Limits, 4 • Fourth, there is no compelling evidence that TELs have boosted the efficiency of state and local governments. • States with strong TELs have experienced a decline in the quality of public services. • The performance by California’s students on national tests has dropped significantly, for example, since Proposition 13. • See, for example, Downes and Figlio (NTJ 1999).

17. State and Local Public FinanceLecture 3: Voting • Evidence about Tax Limits, 5 • Fifth, voter demand factors still matter even with a strong TEL. • California has severe limits, for example. • But Duncombe and Yinger (ITPF, 2011) find that voters with higher incomes or lower tax prices still pick higher school quality— • Through active monitoring of school officials or the use of secondary revenue sources, such as parcel taxes or private foundations.

18. State and Local Public FinanceLecture 3: Voting • Evidence about Tax Limits, 6 • Sixth, TELs push governments to use special districts, which are generally not included in tax caps. • For evidence on this point, see the article by P. Zhang, Economics of Governance, 2018. • This is an unintended consequence and its benefits and costs are not well understood.

19. State and Local Public FinanceLecture 3: Voting • The New Tax Cap in NY • A couple years ago Governor Cuomo proposed and the legislature passed a cap on tax levy increases for all local governments. • The cap is the lesser of 2% and inflation, with technical exceptions. • The cap exempts new construction (to preserve incentives for development and growth). • The legislation allows jurisdictions to override the cap with a 60% vote, but few districts try to override (and fewer succeed).

20. State and Local Public FinanceLecture 3: Voting • The New Tax Cap in NY, 2 • In 2018, 662 districts proposed budgets within the cap and 98.6% passed. • Also 14 districts proposed budgets that needed an override and only 50% passed. • Nobody should expect this cap to make local governments more efficient. • Without more state aid (unlikely) or many overrides (also not likely) this cap will cut local services. • Source of data: http://www.nyssba.org/

21. State and Local Public FinanceLecture 3: Voting • The New Tax Cap in NY, 5 • This cap is likely to increase disparities across jurisdictions in education and other public services. • Richer school districts are more likely to override the cap. • Because poorer school districts receive more state aid, they have lower property tax levies. • This fact implies that poorer districts need larger percentage increases in revenue just to keep up with richer districts.

22. State and Local Public FinanceLecture 3: Voting • The New Tax Cap in NY, 6 • Some wealthy school districts raise about $30,000 in property taxes per pupil; Buffalo, Rochester, and Syracuse (the Upstate Big 3) raise about $3,700. • In 20 years, the allowable annual revenue will go up by $30,000×[(1.02)20 – 1] = $14,578in these rich districts, • But by only $3,700×[(1.02)20 – 1] =$1,798in the Upstate Big 3.