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Capitalization, decentralization, and intergenerational spillovers in a Tiebout economy with a durable public good

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Abstract

We consider an overlapping generations model with a durable local public good (DLPG). We establish a Tiebout theorem (equilibrium exists and is first best) as well as an equal treatment Second Welfare Theorem in this dynamic DLPG economy. We establish conditions, including the Small Jurisdiction assumption, under which local provision of durable public goods results in the full internalization of the intergenerational spillovers that durability entails. In contrast, when durable public goods are provided by the national government, internalization does not take place and underprovision of public goods results. This sets up an institutional trade-off between national and local provision of public goods that balances the relative strength of intergenerational and interjurisdictional spillovers. Our main conclusion is that while capitalization is an effective mechanism to cause agents to internalize intergenerational spillovers, the effectiveness of this mechanism is limited by the degree to which there are more general spillovers across jurisdictions.

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Notes

  1. It is also worth calling the reader’s attention to the literature of dynamic Tiebout models without DLPG or capitalization. See especially Kotlikoff and Raffelhueschen (1991), Glomm and Lagunoff (1999), Benabou (1996), and Brueckner (1997), and more recently Chen et al. (2009) and Epple et al. (2012). Schultz and Sjöström (2001) treat a two-period, two-jurisdiction model with public debt and Free Mobility. They find that the equilibrium is generally inefficient, but their model does not allow either DLPG or debt to be capitalized into housing prices (also see Schultz and Sjöström 2004).

  2. Wildasin and Wilson (1996) consider an overlapping generations economy with imperfectly mobile agents, but with local public goods that are nondurable. They discover that the capitalization mechanism may not induce efficient provision of local public goods. Similarly, Sprunger and Wilson (1998) consider how the desire of governments to exploit imperfectly mobile households may be expressed when public goods choices are made a period before the goods are consumed. These goods fully depreciate the period they are produced, however, so may have more of a flavor of a standard intergenerational good than of a DLPG.

  3. In Hatfield (2014), efficient provision with a finite number of jurisdictions can be attained only in the head tax regime. We will return to the issue of efficient provision in Sect. 5 below after establishing the First Welfare Theorem.

  4. This approach to indivisible land follows Fujita (1985), Dunz (1985), and Nechyba (1996). See also McCallum (1983), Wang (1987), Glomm (1992), and Geanakoplos (2008) for work that introduces land into OLG models.

  5. We shall return to both the transfer from infinity and forward-looking Pareto optimality issues in Sect. 7. We will also discuss the difficulty associated with infinite horizon OLG structure and the generality of some of our key results.

  6. This is not essential. See Sect. 7 for a generalization.

  7. We assume that only the young have the franchise. This is because the young realize both the costs of investing in period t and the consequences on housing prices in period \(t+1\). In contrast, the old are not responsible for sharing the cost of DLPG investment in period t and leave the economy before period \(t+1\) arrives. Thus, the old are completely indifferent over all political outcomes in period t and so would have no reason to vote even if they had the franchise.

  8. Stage 2 is equivalent to a notion defined later at a more formal level that we call Political Equilibrium.

  9. We show that the set of social optima defined in this way is equivalent to the set of Pareto optimal allocations. Of course, one could introduce inequality aversion to the social welfare function, but given the quasilinearity of utility, this formulation of the planner’s problem would yield similar necessary conditions for social optimality.

  10. The assumption that the social planner discounts at the same rate as the agents is standard in the literature, particularly when the focus is on a benevolent government.

  11. We refer to this part of the solution to the planner’s problem as the optimal steady state, and to the DLPG levels and the per-period contributions by each jurisdiction needed to maintain this DLPG level as the optimal steady-state DLPG and investment levels, respectively.

  12. We thank anonymous referees for suggesting this direction, which considerably simplifies and streamlines the paper.

  13. Clearly, we could construct similar nonoptimal price systems even if the nonnegativity constraint bound.

  14. Note that the results in this section would also hold if we had agents in many jurisdictions voting collectively for the national level of a pure public good like defense or research and development. To make direct comparisons to the previous sections clear, however, we set this up as a kind of national vote over grants-in-aid to local governments to build a common specified level of DLPG such as city streets or school buildings in each.

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Acknowledgements

We would like to thank Marcus Berliant, Hideo Konishi, Tom Nechyba, Antonio Rangel, Robert Rosenthal, Steve Tadelis, anonymous referees, an associate editor, and an editor. We are also grateful to participants of the Public Economic Theory Meetings, the Midwest Economic Theory Meetings, and the National Tax Conferences for useful discussions. Needless to say, the usual disclaimer applies.

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  1. Department of Economics, Vanderbilt University, Nashville, TN, 37235, USA

    John P. Conley & Robert Driskill

  2. Washington University in St. Louis, St. Louis, MO, USA

    Ping Wang

  3. NBER, Cambridge, MA, USA

    Ping Wang

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Correspondence to John P. Conley.

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Conley, J.P., Driskill, R. & Wang, P. Capitalization, decentralization, and intergenerational spillovers in a Tiebout economy with a durable public good. Econ Theory 67, 1–27 (2019). https://doi.org/10.1007/s00199-017-1094-4

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