Taxes
The most common choices are a lump sum head tax, a property tax, and
various kinds of income taxes, such as taxes on wage income or rents
(proWts). Not surprisingly, lump-sum taxes are often required for eYcient
outcomes.
The Knowledge Set
Nash or Other Behavior
The main distinction here is how savvy the individuals are within each
community. Do they take the policies of other communities as given as they
make their own decisions about public services and taxes? Or, do they assume
that people in other communities react to their decisions in a utility-
maximizing fashion? The distinction matters because decisions of any one
community generate externalities for all other communities as people move in
response to the decisions. As expected, federalism is more likely to achieve
eYcient outcomes if the mobility externalities are internalized. Note, also,
that assumptions about people's reactions to policies in other communities
are relevant only in the Wxed-community models.
JURISDICTION FORMATION IN ACCORDANCE WITH
THE THEORY OF CLUBS
The natural place to begin is with a model of mobility that generates a social
welfare optimum, in line with Tiebout's conjecture. The assumption of Xexible
communities is the one most compatible with Tiebout's thinking, a frontier
environment in which communities can form, break apart, and reform to
generate the public service levels that subsets of people most prefer. The
housing market is irrelevant in such a market, as are information assumptions.
Flexible-community models ask three interrelated questions:
1. Are there incentives for the formulation of local jurisdictions to
provide traditional public services such as Samuelsonian nonexclusive
public goods?
2. Will the resulting local public services be provided in accordance with
standard Wrst-best decision rules, such as
P
MRS MRT ?
3. Will jurisdictions form in such a manner that the public service is
provided at least cost?
If the answer to all these questions is ``yes'', then the outcome can be a social
welfare maximum with some additional assumptions.
The models used to analyze these questions draw heavily on Buchanan's
theory of clubs.
3
BrieXy, Buchanan argued that determining the optimal
3
J. Buchanan, ``An Economic Theory of Clubs,'' Economica, February, 1965.
30. OPTIMAL FEDERALISM: THE SORTING OF PEOPLE WITHIN THE FISCAL HIERARCHY 859
membership of any club has an externality element to it. Think of a swim
club. On the one hand, accepting new members reduces the direct out-
of-pocket costs to the current members by spreading the costs associated
with the swimming pool and clubhouse over more people. On the other
hand, the new members generate external diseconomies in the form of a
more crowded pool. Thus, the optimum-sized membership occurs when the
marginal costs of the external diseconomies just equal the marginal savings
from spreading total operating costs. A related issue is the optimal size of the
pool for a given membership.
The theory of optimal clubs can be adapted quite easily to explain the
optimal formation of local jurisdictions along with the provision of local
public services. It can also be used to justify the existence of local jurisdic-
tions. We will consider a simple model that Martin McGuire used to analyze
this problem.
4
To Wx ideas, begin with a baseline model of a nonexclusive good that is
consistent with the model in Chapter 6, a model that does not have club-like
features. Suppose a country consists of H identical people whose preferences
are deWned over two goods, X, and Y
h
, where:
X a Samuelsonian nonexclusive public good provided by a
government.
Y
h
the income of person h assumed Wxed (alternatively, an endowment
of a composite commodity with P
y
1).
Preferences are given by:
U
h
X, Y
h
all h 1, ..., H (30:1)
Rather than deWning a production function relating X and the Y
h
,
assume Wrst-best production eYciency and posit a cost function for X:
C C X; other arguments(30:2)
where C is measured in dollars, the same as the Y
h
. If we assume that
1. Income is optimally distributed,
2. C C (X), with no other arguments, and
3. The costs of X are shared equally by all people by means of head
taxes
then this representation of the Samuelsonian public good is equivalent to the
formulation in Chapter 6.
5
To see this, note that the utility of each person h
with equal cost sharing is
4
M. McGuire, ``Group Segregation and Optimal Jurisdictions,'' Journal of Political Econ-
omy, January/February, 1974.
5
The assumption of equal cost sharing is convenient but unnecessary, as long as the cost
sharing is lump sum.
860 JURISDICTION FORMATION IN ACCORDANCE WITH THE THEORY OF CLUBS
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