4. (25 points) In the Persky-Haydar paper, the authors claim that even though the Federal government spends more on cities than on suburbs, the expenditures in the suburbs are more geared to increasing wealth.

1. In particular, how does the home mortgage interest deduction tend to build more wealth in the suburbs than in the cities?
2. How would the Federal highway system tend to build more wealth in the suburbs than in the cities?

DO FEDERAL FUNDS BETTER SUPPORT CITIES OR SUBURBS? A. SPATIAL ANALYSIS OF FEDERAL SPENDING IN THE CHICAGO METROPOLIS I. INTRODUCTION The distribution of federal funds between central cities and their suburbs has long been a major source of controversy. City advocates have claimed that federal programs heavily subsidize suburban development. Others have argued that, on the contraryI Washington has steadin channeled transfer dollars into central cities and ignored newer suburban needs. On the surface. these debates have focused on the question: Who gets how much? But the argument has repeatedly hinted at a deeper set of issues; it may not simply be about how much a jurisdiction gets from the federal government but what kind of dollars it gets. To what extent has federal spending in cities and suburbs subsidized the real accumulation of private and public wealth? Where, on the contrary, have federal dollars simply gone to support consumption? Where have they lowered the effective price of land and housing so as to encourage wealth building through residential investment? Where have they simply subsidized rents? Where have they constructed public capital, roads and other infrastructure. so as to produce a continuous ow of public services? In the 1950s, attention focused on the contribution of the Federal Housing Administration and its home _ guarantees. These guarantees made home ownership a possibility for a substantial segment of the country's lower-middle-class, urban population. These were mainly households that had experienced great difficulty borrowing from traditional credit sources before the Second World War. The FHA favored new housing construction thatI in many metropolitan areasI could only be undertaken in suburbs near the periphery where land was plentiful. undeveloped and cheap. It also took a conservative attitude toward risk and as a result, redlined many central-city neighborhoods, and this further concentrated poverty in the urban core. Most researchers have concluded that the FHA, serving populations eager to escape high urban densities, directly undermined older urban communities, discriminated against minority households, and facilitated considerable suburbanization (Gelfand, 1975). From a slightly different perspectiveI these policies worked primarily to build wealth in the suburbs. Highway constmction, a second major federal priority, has also strongly influenced metropolitan growth and development. Especially with the development of the interstate highway system in the Eisenhower administration, federal highway spending opened a considerable amount of rural and semi-mral land to housing development. The metropolitan expressways encouraged automobile travel by making it easier to commute to, and escape from, the center city. There can be little doubt that in this period massive federal funding of highways opened up new suburban opportunities and helped keep residential land prices relatively cheap (Urban Transportation Center, 1999 and Boarnet, 2000). These low land prices underwrote further private residential investments in the new suburbs. Table 5: Average Annual Per Capita Federal Expenditures: Spatially Related Programs Cost Reducing, 1989-1992 and 1993-1996 1999 1992 City Pre - 1950 1950 -1970 Post-1970 Satellites Highways and Related 22 50 60 92 44 Public Transit 73 37 26 20 16 Other Infrastructure 36 5 2 O 1 Income Tax Subsidy for Housing 125 536 554 538 275 Environment and Disaster 2 2 1 7 4 Crime 3 0 0 0 0 Total 267 631 642 656 340 1993 - 1996 City Pre - 1950 1950 -1970 Post-1970 Satellites Highways and Related 25 55 65 30 54 Public Transit 70 35 22 16 14 Other Infrastructure 1 1 2 0 D 0 Income Tax Subsidy for Housing 125 556 560 552 301 Environment and Disaster 6 1 1 2 4 Crime 21 0 0 D 1 Total 259 649 649 650 375 As the data suggest' the federal govemment's role in providing infrastructure (other than for transportation), environmental assistance and anti-crime expenditures accounts for relatively modest sums on a per capita basis. Even more surprising, is the relatively small contribution of highway and related programs to the overall total. Even in the new suburbs of the urban periphery we estimate that only about $85 per capita was spent annually on this subcategory, and in the city the gure falls to about $25 per capita. Two observations should be made in connection with these statistics: 0 First. we have tried hard to ascribe to households in each municipality their share of highway expenditures based on use ofthe highway expenditures made over this period. This means that a town's allocation of highway expenditures doesn't depend on how many highway dollars were actually spent within its borders, but rather on the joumey-to-wolk miles its commuters made over highways constructed, improved or maintained with federal funds in each county.3 0 Second. these estimates relate only to expenditures actually made in the eight-year period. The Chicago area has not had signicant highway construction since the eany 19703. Much of the expressway system originally planned for the area was never actually built. Still, there is a sense in which current commuters and other highway users are benefiting from previous capital expenditures. One could make a case for considering the ongoing flow of services 3 We use commuting miles because traditionally the capacity of a highway system is only seriously challenged during peak use. For more details on our modeling see the Appendix. 14 from earlier investments. However, the policies and programs that put the existing expressways in place are long gone. To give a clear picture of policy today we had little choice but to put aside these early expenditures and focus only on current dollar ows. By far the most signicant program area is the federal income tax subsidy of owner-occupied housing. While the return on almost all other investments must be declared as income and taxedI home owners are in effect allowed to underreport their non-eamed income.'1 In the suburbs. these housing related tax expenditures per capita are much larger than in the city. A suburban family of four receives about $2200 a year while a city family of four receives about $500. The difference comes about for three reasons: higher home ownership rates in the suburbs, higher incomes in the suburbs, and higher housing values in the suburbs. Between the three rings of suburban municipalities, we nd no signicant differences, although more detailed data by individual municipalities show considerable variation related to income levels (see Map 3). The richest third of municipalities have an average subsidy of almost $4000 per family of four. To measure the tax expenditure involved in leaving these imputed incomes untaxed, we need to estimate two critical parameters: the rate of return on housing capital and the applicable income tax rate. As to the rst we make the very conservative assumption that in all communities housing capital pays a real rate of return of 5 percent per year. We put aside here issues of capital gains and inflation and in effect treat housing as an asset held in perpetuity. This 5 percent rate is applied to owner-occupied housing as reported in the 1990 census. Marginal tax rates were computed separately for each housing value category in each community. It might be objected that the housing tax subsidy does not really affect locational costs. For any given household owning a unit of a specic value, the same housing tax subsidy applies throughout the urbanized area. However, such a conclusion fails to take into account supply differences at the periphery and the center. At the edge of the urbanized areaI land supply is bountiful and subsidies reduce real costs of acquisition. At the center of the city. subsidies are far more likely to be capitalized into housing prices, and hence new home buyers gain little real benet. 4 These estimates start from the longstanding tenet in public nance that various types of investment income should be treated similarly for tax purposes and. in particular, that implicit income from owner-occupied homes rightly should be taxed. From this point of view, _ deductions are perfectly appropriate as a cost of engaging in a \"home\" business, as long as the net income generated by that business is fully taxed (Musgrave and Musgrave, 1980. p. 359-381) Because of problems in implementation, taxation of imputed earnings from investments in owner-occupied dwelling has not been common among the countries of the world. However. both the Netherlands and Canada have actually implemented such taxation policies. We also note that the dollar gures we come up with using this method are quite similar to the federal tax subsidy implicit in deductibility of mortgage interest (Gyourko, 2001). Finally, we do not estimate the value of the property tax deduction on personal federal income taxes, since we are treating housing as a business investment. and such a deduction would be appropriate before taxing business income as prots. Through the Public Use Microdata Sample of the 1990 Census we estimate for each housing value category in a municipality the income distribution of owning households in that category. For more details see the Appendix. '15