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By Root 450 0

at the national, state (or provincial), and local level have their own tax collections and separate provision of public goods. The system may include collection of revenue at one level of government and its transfer to another, such as when the federal government collects revenues and then returns them to the states as block grants to administer various programs. The question then arises as to the appropriate levels for collecting revenues and providing public goods and services. Why not, for example, simply leave the decisions to the most local level and thereby allow maximum freedom of choice? There are three reasons.

First, certain public goods are best provided at a higher level of government. National defense, clearly, should depend on the federal government, not the fifty states. Some are clearly the responsibility of governments at all levels, such as planning and implementing the national highway system or a national power grid. In these cases, indeed, the situation is even more complex because the goods and services involve the private sector alongside multiple levels of government.

Second, there is a collective action problem that makes tax collection more convenient at the higher level of government, that is, at the federal level rather than the state and local level. The fifty states are in competition with one another for businesses and wealthy citizens. By keeping its tax rates just a bit lower than the others’, each state can attract business and revenues. Yet the result is a race to the bottom, as described for the global economy in tax competition between nations. Each of the fifty states shaves the tax rate to entice business to come over the state border, until all of the states together are starved for cash. The race to the bottom among the states can be obviated in part by a unified federal tax collection that is then returned to the states so that they can implement programs that are tailored to each state’s needs.

Third, the differential provision of public goods in different jurisdictions leads to mobility of households as they sort themselves in response to the changing tax and spending conditions of the state and local governments. In part this is exactly what is desired. Economists have long studied a conceptual model in which sorting allows each household to choose just the spot where it would like to live: the place that delivers just the right combination of parks, good schools, public concerts, and other amenities, balanced by high or low tax collections as needed to supply that level of public goods. The result is a “Tiebout equilibrium,” named after the economist Charles Tiebout, who first proposed it.22

In some cases this sorting can work well, but there are obvious reasons why it can create enormous trouble. If one jurisdiction decides to provide more generous help for the poor, it ends up being flooded by low-income residents in just the same way that businesses and wealthy individuals flee from high-tax jurisdictions. Once again, there is a race to the bottom when it comes to supporting the poor, which is a public function that should be shared across the society, not a small part of it. Similarly, the sorting will tend to lead to segregation by income, as rich households move to affluent jurisdictions in search of good schools and other public amenities. Land prices and property taxes increase, squeezing poorer families out of the more affluent communities. The society divides between rich communities and poor communities, with reduced spillovers and contacts between the various parts of society. This can leave the poor trapped in poverty, resulting in a massive loss of well-being not only for the poor but also for the rich, who end up absorbing the indirect costs of poverty (in terms of lower worker productivity, higher crime rates, larger transfer programs, more political instability, and so forth). The point is that when there are spillovers in human capital, the sorting of the population across local jurisdictions can be disadvantageous for the entire society, rich and poor alike.