Economic Segregation, Fiscal Capacity, and Investment in Local Services

• In Event: Segregation, Corruption, and Hidden Wealth

Abstract

Municipalities within the United States have long had “separate and unequal” fiscal capacity (Hill 1974). Recent events, such as the contamination of drinking water in Flint, Michigan, have renewed interest in the role of fiscal capacity in local service provision. The Tiebout (1956) model attributes unequal fiscal capacity to residential choice based on preferences for different bundles of public goods and taxes. But residential choice also facilitates population sorting by economic class. Urban policies, such as zoning requirements and expenditure limits, have reinforced patterns of economic segregation (Dreier, Mollenkopf, and Swanstrom 2004; Trounstine 2018). This paper examines how economic segregation between municipalities affects service provision in the case of water service provision.

Public finance and public choice theories suggest economic segregation between municipalities should decrease investments in service provision. Since local governments fund services with own-source revenue from taxes and fees, public finance research links provision to fiscal capacity (Hill 1974; Schneider and Logan, 1982; Ladd and Yinger 1989; Lowery 2000). Economic segregation creates municipalities with limited capacity to invest in service provision. Public choice theory suggests inter-jurisdictional competition mediates this relationship. While local governments provide development services to attract high-income taxpayers (Peterson, 1981; Oates, 1972), Jimenez (2014) shows investment depends on the distribution of tax revenues between municipalities in metropolitan areas. In economically segregated metropolitan areas, poor municipalities spend less. However, some political economy theories suggest economic segregation should increase investments in service provision. Economic segregation makes the local population more homogenous, which tends to increase investment in public goods and services (Boustan et al. 2013, Trounstine, 2018). Greater need in low-income municipalities or willingness to pay in high-income municipalities may also induce demand for services (Oates 1985).

This paper examines how economic segregation between municipalities affects investment in water services in metropolitan areas of the United States. I use a pooled cross-sectional time-series model to explain variation in municipal investment both over-time and across metropolitan areas. The dependent variable is yearly per capita investment in water infrastructure. I measure investment as the dollar amount of municipal bond issues for water with data from Bloomberg Financial from 1980-2010 and check the robustness with data from the U.S. Census Bureau’s Annual Surveys of State and Local Government Finances. The main independent variable is economic segregation. I measure economic segregation using Schneider and Logan’s (1981) location quotient, a ratio of the number of low- and high-income families to the number that would be in each municipality if the income group was proportionally distributed. The 1980, 1990, and 2000 income data are from the decennial Census and the 2010 income data are from the 2008–12 American Community Survey estimate. I control for economic and demographic factors that may influence investment and segregation, including population, population density, population growth, and racial and ethnic diversity. I use also the percentage of the employed population in manufacturing as services as a proxy to control for the strength of business interests (Schneider 1989).

Author

• Kathleen Hansen, Duke