Government Competition, Leviathan and Benevolence: Suppose governments can spend taxpayer resources on both public goods that have social benefits and political “rents” that are private benefits for government officials. To the extent to which governments emphasize the latter over the former, we have called them “Leviathan” — and this exercise investigates to what extent competition between governments can restrain this Leviathan. To the extent to which governments emphasize the former, we will call them “benevolent”. In part B of the exercise, we consider competition between such benevolent governments.
A: Consider a collection N of local governments that can employ local property taxes to fund public goods and local political rents. Suppose that local governments are pure Leviathans—i.e. they seek only political rents. For simplicity, suppose also that all households are identical.
(a) Begin with a simple demand and supply (for housing) graph for one community. If a local Leviathan government is a political monopolist in the sense that it faces no competitive pressures from other communities, how would it go about setting the tax rate that maximizes its rents?
(b) Now consider the case where households are fully mobile across jurisdictional boundaries— and thus choose to live where their utility is highest. In equilibrium, how must utility in any jurisdiction i be related to utility in any other jurisdiction j?
(c) Suppose that the property tax is zero in all communities. Consider community i’s Leviathan mayor. If he raises ti above zero, and uses the revenues only for political rents, what will have to be true about housing prices in community i after the tax is imposed (relative to before it is imposed)? Can you demonstrate how this comes about? (Hint: Consider the competitive pressure from household mobility.)
(d) True or False: So long as housing supply is not perfectly elastic, the Leviathan mayor in part (c) will be able to raise property taxes to fund political rents.
(e) Now consider all local governments setting some tax rate t and using revenues for political rents. If t is very low, can a single community’s Leviathan’s mayor benefit from raising his tax rate? If t is very high, can a single Leviathan mayor benefit from lowering his tax rate?
(f) Use your answer to (e) to argue that there must exist some level of Leviathan taxation across competing communities that will be a Nash equilibrium.
(g) Evaluate the following statement: “Unless housing supply is perfectly elastic, government competition between Leviathan governments is not sufficient to eliminate political rents — but it restrains the ability of Leviathan government to amass such rents.”
(h) True or False: To the extent to which government behavior is characterized by rent-seeking, greater competition between governments enhances efficiency.
B: Next, consider the opposite type of government—i.e. one that is benevolent and raises taxes only to the extent to which it can find worthwhile public goods to finance. Suppose again that there are N such governments that use a local property tax to fund local public goods — and suppose that all public benefits from such public goods are contained within each government’s jurisdictional boundaries.
(a) Begin, as in A (a), by assuming that there is mobility of consumers across jurisdictions and thus no government faces any competitive pressures. Will they produce the efficient level of local public goods?
(b) Next, consider the competitive case. If the projects funded by local governments are truly local public goods, in what sense are taxes imposed by benevolent governments offset by benefits received?
(c) Suppose other governments are charging low tax rates that result in inefficiently low levels of public goods. If community i raises its tax rate and provide more public goods, will population increase or decrease in community i? Will housing prices go up or down?
(d) Consider an equilibrium with benevolent local governments providing efficient levels of local public goods. Can any government raise property values by raising or lowering taxes? True or False: Property values maximizing local governments behave like benevolent local governments.
(e) Suppose next that local property taxes are paid by both households and firms — but only households’ benefit from local public goods (like schools). If firms are mobile, in what sense does community i ’s decision to tax the property of firms give rise to a positive externality for other communities?
(f) What does your answer to (e) imply about the spending levels by benevolent local governments as competitive pressures increase in environments such as those described in (e)?