Department of Agricultural and Applied EconomicsUniversity of Wisconsin-Madison
Support for this work was provided in part by the University of Wisconsin-Madison AgriculturalExperiment Station, University of Wisconsin-Extension, and the Wisconsin League ofMunicipalities. The views and opinions expressed in this paper are those of the authors and notnecessarily those of the University or the League. All errors of omission and commission are theresponsibility of the authors.
2
Local Public Sector Performance:Are Wisconsin City and Village Taxes Too High?
Executive Summary
This applied research project examines questions concerning the economic efficiency ofmunicipal government spending and taxation levels in Wisconsin. Using economic notions oflocal government effectiveness and efficiency, a theoretical and empirical model is presented andestimated using data from Wisconsin cities and villages. Theory suggests that expenditure andtaxation levels are capitalized into local property values. In short, public goods and services andcorresponding taxes are viewed as a normal good in an economic sense: more is better, toomuch is bad. From a property valuation perceptive, higher levels of public goods and servicesshould increase property values. But, overprovision of the public good places downwardpressure on property values. This inverted-U relationship is easily estimated from an empiricalperspective. Two separate tests are estimated. The first examines capitalization rates of serviceprovision (i.e., expenditures) into property values. The second complementary test examinescapitalization rates of taxation levels (i.e., municipal taxes) into property values. Results forWisconsin cities and villages suggest that service and taxation levels are positively related toproperty values suggesting that neither services or local taxation is not systematically too high. Inother words, based on rigorous economic theory, spending and taxing in Wisconsin’s cities andvillages are not too high and may indeed be too low. It is important to note that this appliedresearch study focuses on city and village taxation and spending, attention is not paid to publicschools, counties, towns or other special districts that have taxing authority.
3
Local Public Sector Performance:Are Wisconsin City and Village Taxes Too High?
“ My first priority will be to do as much as I can to change the perception and the reality ofWisconsin being a high-tax state”.
Governor Scott McCallum (Wisconsin State Journal, February 12, 2001)
I- Introduction
Wisconsin has been historicallyregarded as a relative high tax state.Comparing Wisconsin’s state, county,municipal and other local governmentfinances on the basis of population and/orincome to other states typically serve as thefoundation for such conclusions. Using suchcomparisons Wisconsin’s state and localtaxes per capita ranked 8th 1997 but 9th in1992, a slight decline (Table 1). For themost current year for which the Census ofGovernments is available, Wisconsin totaltax collection per person was $3,020, whichis $273 above the US average (Figure 1).Taxes collected at the local level, however,Wisconsin ranked 13th in 1992 and actuallydropped to 17th in 1997. At $1,051 collectedper person at the local level, Wisconsin isbelow the national average by $21 (Figure2).
Table 1: Wisconsin State & Local Tax Rankings 1997 1992
Per CapitaState and Local Taxes 8 9Local Taxes 17 13
Per $1,000Income
State and Local Taxes 5 4Local Taxes 15 11Source: US Census of Governments
On the other hand, Wisconsin’sstate and local tax collection per $1,000 ofpersonal income ranked 5th in 1997 and 4th
in 1992. Wisconsin’s collection of taxes atthe state and local level was $128 per$1,000 of personal income, $17 higher thanthe national average (Figure 3). But isimportant to note that in 1992 state and localtaxes collected was $134 in 1992, implyingthat Wisconsin’s ability to pay (i.e., income)
grew faster than tax burdens. Indeed,between 1992 and 1997, the gap betweenWisconsin and the US average declinedfrom $18 to $17 pre $1,000 of personalincome.
Local tax collection, on a basis of$1,000 of personal income ranked as highas 11th in the nation in 1992, but dropped to15th five years latter in 1997. In 1992, forevery $1,000 of personal incomeWisconsin’s local governments collect $51,$4 higher than the national average. But by1997, local governments in Wisconsincollected only $45 per $1,000 of income, adecline of $6 while at the same time the gapbetween Wisconsin and the nationalaverage declined to $2 per $1,000 ofincome. This significant shift at the locallevel, and to some extent at the state levelas well, is due to the generous state aidprograms for municipalities and publicschools.
Yet, based on such rankings electedofficials, as well as organized members ofthe civil society, have been continuouslyadvocating lower taxes to decrease the sizeof the public sector throughout Wisconsin. Arecent pledge to cut taxes came from therecently inaugurated Governor ScottMcCallum:
“For too long Wisconsin hasranked near the top of everynational survey when itcomes to measuring overalltax burden. Wisconsintaxpayers have supportedthis level of taxation for toolong.” (Wisconsin StateJournal, February 4, 2001).
4
Figure 1: State and Local Taxes Per Capita (1997)
$1,500 $2,000 $2,500 $3,000 $3,500 $4,000 $4,500
NYMNWIRIILVTNEKSINVAFLNHUTTXOKARMS
Wisconsin
US Average
Figure 2: Local Taxes Per Capita (1997)
$0 $500 $1,000 $1,500 $2,000 $2,500
NYCTCOVTOHTXPAGAMNSDMOAZTNNCIDDENM
Wisconsin
US Average
Figure 4: Local Taxes Per $1,000 of Income (1997)
$15 $25 $35 $45 $55 $65 $75
NYVTRICOWYMDLAKSORIA
NDMNNVIDMIMSNM
Wisconsin
US Average
The purpose of this appliedresearch project is to reevaluate theperception of Wisconsin as an overly high-tax state. In our analysis, however, we willfollow a different path. Instead of focusingon the usual interstate comparisons of taxburden measurements, we will concentrateon intrastate comparisons on theperformance of local government’s inparticular Wisconsin cities and villages.
Local government is certainly themost visible face of government inWisconsin. They are responsible for theprovision of essential public services andgoods as well as for the collection of taxesand fees that amount of a considerable partof the Wisconsin tax burden. Therefore,opinions about the role of government, thelevel of taxes in particular, will most certainlydepend on how well local governments areperforming their assigned tax andexpenditure functions.
Two different criteria will be used toevaluate the performance of Wisconsin localgovernment and, ultimately, to evaluatewhether spending and taxes are too high.The first criteria is allocative efficiency,defined as the level of public output fromwhich any small increase or decrease is notunanimously preferred by all citizens living inthe community responsible for its provision.Any deviation from this level will always facesome objections. For the specific case of theprovision of local public goods, allocative
Figure 3: State and Local Taxes Per $1,000 of Income (1997)
$75 $100 $125 $150 $175
AKMNHIRINDKYKSMADEINLAORNCARTXFLAL
Wisconsin
US Average
5
efficiency is reached when the level of publicgood or service provided is such that itsmarginal cost of provision (includingproduction and distribution) equals the sumof what each local resident would be willingto pay individuallly for the good. Thiscondition is traditionally referred to as theSamuelson condition or Pareto optimality.
The second criterion is that oftechnical efficiency, being defined as theability of the government to provide goodsfor its citizens at the lowest possible cost.The cost of provision of any given publicgood can be minimized through theappropriate use of the techniques and inputsrequired for its production. It can also beminimized through the appropriate use ofthe tax instruments which local governmentshave available to draw resources from theircitizens in order to fund the production anddelivery of the goods and services. Ourfocus here will be on the second aspect ofthe technical efficiency criteria, which will bedefined simply as efficacy.
Using standard econometrictechniques and based on formal economicmodels, we look at a sample of Wisconsincities and villages. Based on the level ofpublic expenditures, taxes and propertyvalues along with housing andsocioeconomic characteristics observed atdifferent communities, we will be able toassess whether Wisconsin cities andvillages are spending too much. Since citiesand village’s public expenditures are mostlyfinanced by taxes either raised at the locallevel or raised at the state leveloverspending at the local level will beclosely related to over-taxation at the localand state level.1
Next section goes in more detailabout the public role of Wisconsin cities andvillages, its assigned functions and theresources they have available to performsuch functions. An intuitive way the theoryand statistical methodology behind ouranalysis of public sector efficiency isprovided and then we proceed to report our
1 Federal aids supplied as much as 10 percent of localrevenues in the 1970s, but they have since declined toless than 3 percent with the demise of federal revenuesharing and cutbacks in federal programs.
main findings. We repeat the discussion forour analysis of public sector efficacy. Ourbasic conclusions about public sectorefficiency and efficacy in Wisconsin arewrapped up in the conclusions. In atechnical appendix we review the theorymore formally for the interested reader.
II- Overview of Cities and Villages inWisconsin
In 1999, there were 190 cities and395 villages divided among 72 counties inWisconsin. Together they account for 70percent of the state’s population. Theremaining 30 percent reside in the state’s1265 towns. In spite of concentrating mostof the population within their territoriesWisconsin cities and specially their villagesare small. Only 30 cities have populationsover 20,000 and 69 percent have fewer than10,000 residents. Wisconsin’s largest city isMilwaukee with a population of 620,609 in1996; the smallest city is Bayfield with 678.Villages are usually smaller than cities butmore than half of Wisconsin’s villages islarger than Bayfield.
Most of Wisconsin’s cities adopt amayor-council form of government. A boardof trustees, on the other hand, usuallygoverns villages. Despite theseorganizational differences, for the most part,cities and villages exercise the samestatutory powers.
City and village governments alsoaccount for almost 50 percent of all propertytaxes raised and public expendituresexecuted at the local level and more than 40percent of all transfers received from thestate government (Table 2).
While towns and counties rely moreheavily on state aids as a revenue source,cities and villages sources are more diverse,relying on charges for services, utilityrevenues, interest income, and proceedsfrom long-term debt. The basic sources offunding available to Wisconsin localgovernments are summarized in Tables 3and 4. For the most part, however, propertytaxes are the major source of revenuesavailable to all types of local government inWisconsin.
6
Table 2: Local government relative participation
(1997) $ Millions % of total $ Millions % of total $ Millions % of total
While towns spent nearly half oftheir revenues on transportation andcounties spent more than 40 percent on theprovision of health and sanitation services in1997, Wisconsin cities and villages usually
provided a more diversified range ofservices to their citizens (Table 5). Overallall local government levels spent themajority of their available resources on fourbroad expenditure categories: public safety,health/human services/sanitation andservices that provide to overall life quality.The later includes all expenditures inrecreation (e.g., parks), conservation anddevelopment.
Given the size of their populations and theimportant role that their governments havein the provision of basic public services andin the collection of taxes, Wisconsin citiesand villages emerge as the natural locuswhere perceptions about the size andinfluence of government are formed. Nextsection presents the methodology used tocapture citizens’ perception about the sizeand efficiency of local governments.
Table 4: Local government relative participation
(1997) $ Millions % of total $ Millions % of total $ Millions % of total
Part of the difficulty with thediscussion that occurs in the publicdiscourse about Wisconsin’s taxing andspending levels is the lack of any rigorousway in which to frame and address thequestion. Here there is much that economictheory can provide as a foundation andframework. Here we build on the work ofOates, Brueckner and Laffer to a lessextent.
A- Theory
If individual and businesses basetheir location decisions not only on theoverall characteristics of a given communitybut also on the menu of public goods andservices available along with the taxliabilities imposed by local governments, theoverall value of property in a givencommunity can provide useful informationabout the performance of its localgovernment. That will happen becausewithin a group of communities with similargeographical and socioeconomiccharacteristics, individuals and firms wouldbe willing to pay more to live and operate,respectively, in the community, whichprovides the higher quality or volume ofpublic services at lower tax rates. In theshort-run given a fixed land and housingstock, this higher demand will be translated
into higher propertyvalues for existent realestate in thatcommunity.
To the extentthat resources for thepublic provision goodand services in acommunity were atleast partially raisedthrough the impositionof property taxes, anincrease in the level ofthose public goodswould not have a trivialeffect on property
values. While an increase in local publicservices will increase the menu of amenitiesavailable to property renters or owners,bidding up property values; on the other itwould require local governments to raiselocal taxes with exactly opposite effects onproperty values.
In a series of papers Bruecknerformalized the line of logic outline above in atheoretical model that combines the propertycapitalization of local taxes andexpenditures under a balanced budget.2Brueckner found that if government officialsbehave in a manner as to maximize totalproperty value, the resulting decision rulesthat local officials follow implies that theSamuelson condition for allocativeefficiency, as described in the introduction,is met.3
This theoretical result formalized thenon-linear effects of local publicexpenditures on aggregate property valueas an inverted U-shaped function with themaximum occurring at the level where theprovision of such public goods and servicesis efficient in an allocative sense. Bruecknerfurther explored this result in a test is basedon the effect of changes in the level of
2 Brueckner, Jan (1979). “Property Values, Local PublicExpenditure, and Economic Efficiency.” Journal ofPublic Economics 11, 223-2453 Appendix B summarizes Brueckner’s model.
The “Brueckner relationship” for theparticular case where only one type of publicgood is provided is illustrated in Figure 5. Iflocal governments are currently under-supplying the local public good (spendingtoo little), increases in expenditures, even iffollowed by an identical increase in taxes,should increase property values (point A). Atsome point, further increases in governmentexpenditures would require unattractive taxrates thus causing property values todecline. This would indicate an over-supplyof local public goods (too much is spent) –point C. At the efficient level, any smallincrease or decrease away from it will haveno effect on property values for thatcommunity (point B).
Figure 5: Property Value Hypersurface
TotalProperty
Value
Local GovernmentExpenditures
A
B
C� �
�
In order to implement Brueckner’s test oneneeds to collect a sample of differentcommunities observations on the aggregatevalue of all properties taxed in that communityalong with observations on the level of publicgoods and services it provides, with publicexpenditures being used as a proxy forquantities. Since property value is also affectedby other factors such as the quantity and qualityof housing in a particular community along withthe location, the wealth and the socioeconomiccharacteristics of the community, measures of allthese variables also need to be collected andfactored into the test.
4 Brueckner, Jan (1982). “A Test for Allocate Efficiencyin the Local Public Sector.” Journal of Public Economics,19, 311-331
The next step is to use multipleregression analysis to estimate the“Brueckner relationship” that an increase ina given category of local public expenditurewill have on a community’s total propertyvalue controlling for other factors. Astatistically positive regression coefficient onexpenditures indicates that all observationslie to the right of the peak of the inverted U-curve with the regression line being of thetype that passes through point A in Figure 5.This result indicates that all communitiesshare a common efficiency bias, which inthis case is negative, specifically, allcommunities are under-spending or at leastare not overspending.
Analogously, a statistically negativecoefficient indicates that all observations lieto the left of the peak of the inverted U-curvewith the regression line passing throughpoint C in Figure 5. All communities will beoverspending or at least not under-spending. All individuals may perceive adecrease in expenditure as desirable.
The test is less conclusive when theestimated regression coefficients are notstatistically significantly different from zero.Either communities do not present acommon efficiency bias with somecommunities under-spending and othersoverspending or all communities arespending at the efficient level with theregression line passing through point B inFigure 5.5 Brueckner prefers the latter andless strong interpretation of the results.
As it was mentioned above, local publicexpenditures are at least partially financedwith property taxes raised locally in thecommunity. Because of that, the Bruecknerrelationship can be reinterpreted in terms ofthe effects of taxes on local public sectorefficiency, specifically, under-spending canbe associated with under-taxation, over-spending with over-taxation. This broadinterpretation provides a link between thetwo tests provided in the applied researchproject.6
5 Another possibility is that local public expenditures aresimply not capitalized into property values.6 One potential criticism of the Brueckner test concernsthe functional form of the regression equation. WhileBrueckner’s model finds aggregate property values tobe a single peaked concave function of local
9
B- Statistical Analysis
Data for the estimation are drawn from asample of Wisconsin cities and villages. Outof a population of 585 cities and villages,twenty-nine villages and one city wereeliminated due to missing values leaving atotal of 554 observations. Data is drawnfrom the Census, Claritas, a private vendorof socio-economic data, and various issuesof the Wisconsin Department of Revenues”report “County and Municipal Revenues andExpenditures.”
The specification of the estimated modelis intended to mirror the specification of theBrueckner model. Four general expenditureareas are defined to measure public goodlevels: expenditure on transportation (e.g.street and highway maintenance, publictransit- (roads)); expenditure on publicsafety (e.g. law enforcement, fire fightingand prevention- (safety)); expenditure onhealth, human services and sanitation(sanitation); expenditure on life qualitygoods and services (e.g. conservation anddevelopment, parks and recreation-(lifequality)). As we saw in Section 2,although the responsibilities of Wisconsinlocal governments go beyond these areas, itwas determined that they represent usuallymore than 60 percent of all cities andvillages total local expenditures. Allmeasures of local public expenditurespresented above correspond to averages ofvalues observed between the fiscal years of1995 and 1997.
The dependent variable, aggregateproperty value, is measured by the total fullvalue of all taxable general property asdetermined by the Wisconsin Department ofRevenue excluding the full value ofimprovements to property within TaxIncrement Finance Districts (fvtif). The totalfull value is determined independently of thelocally assessed value and is meant toreflect the actual market value. The government expenditures, Brueckner’s test specifiesand estimates a linear function. A superior approachwould be to employ a non-linear procedure that iscapable of suggesting the “correct” functional form. Wehave chosen to employ a procedure, specifically theBox-Cox method, which allows the data to determine ifthe property value-public good expenditure relationshipis linear or non-linear.
apportionment of all taxes is measured byfvtif. It is also averaged between 1995 and1997.
The total number of housing unitsmeasures the absolute size of thecommunity’s housing stock in 1990(tothouse). The quality of the housing stockis measured by four different variables: thepercentage of houses built between 1970and 1990 as a measure of the newness ofthe housing stock (bw7090), the percentageof houses with three or more bedrooms as ameasure of the footage of each individualhouse (bed) as well as the percentage ofhouses with access to public water andsewage (pubwat and pubsew). All thesevariables were also from 1990.
Socioeconomic characteristics of thecommunity such as the median householdincome (mhincy), the proportion of residentswith at most a high school diploma (s3p573),the percentage of senior citzens, measuredby the percentage of the current populationover 65 years of age (tpacy65), thepercentage of children, measured by thepercentage of residents with less thaneighteen years (tpacy18) along with thecommunity location proxyed by its latitude(ycoord). A dummy variable, which equals 0for cities and 1 for villages, was also used asan explanatory variable to separate thedistinctions between cities and villages inWisconsin (city).
All housing characteristic regressioncoefficients (tothouse, bw7090, bed, pubwatand pubsew) are expected to be positive.Among the socioeconomic characteristics,mince, being a proxy of community wealth isexpected to have a positive coefficientestimate. On the other hand, there is noclear indication of whether tpacy 65 andtpacy 18 should be expected to have anunambiguous effect. One could speculatethat s3p573 could be just another form tocapture community wealth being a proxy ofhow low the community human capital levelshould be. For that reason s3p573 shoulddeliver a negative signal for its regressioncoefficient. Given the economic relevancy ofthe cities of Madison and Milwaukee and themore developed nature of southeasternWisconsin in general, ycoord is expected tohave a negative effect on property values.
10
Given its average population size, cities areexpected to have on average a largerproperty value, which would lead us toexpect a negative regression coefficient forcity. The value and signal of the remaininglocal public expenditure variables will be theobject of the regression analysis presentedbelow.
C- Empirical Results
The results of the regression analysisare presented in Table 6. Applying the Box-Cox procedure to the Wisconsin sample ofcities and villages produced estimatedlambdas indistinguishable from zero (bothdependent and independent variables weretransformed). This suggests that theappropriate functional form is logarithmic.The overall regression equation performsstrongly with an equation F-statistics of955.16 and an adjusted R2 of .96 which isconsidered high for the cross-sectionalnature of this study.
Among the housing characteristicsvariables the signs on total number ofhousing units (tothouse) and the spatiallocation of the municipality in Wisconsin(ycoord) and the age measure of thehousing stock (bw7090) are positive, asexpected, and statistically significant. Thenegative and statistically significant sign ofaccess to public water (pubwat) issomewhat unexpected. Less unexpectedwas the insignificance of average number ofbedrooms (bed) and access to publicsewers (pubwat). Among the socioeconomiccharacteristics median household income(mhincy) and the percent of the populationwith a high school diploma (s3p573) behaveas expected. The result for the dummyvariable separating cities and villagessuggest little difference between the twotypes of local organization.
The results of most interest to thisapplied research is the estimatedcoefficients on the four general expenditurecategories (safety, roads, sanitation, andlifequality). In each case, the estimatedcoefficient is positive and statisticallysignificantly different from zero at or abovethe 95 percent level of confidence. The
Table 6: Estimated Coefficients Variable Coefficient t safety 0.18 6.57roads 0.15 5.32sanitation 0.04 2.35lifequality 0.07 4.63tothouse 0.54 15.74bw7090 0.10 2.50bed -0.03 -0.30pubwat -0.11 -5.16pubsew -0.02 -0.78ycoord -1.24 -1.72city 0.05 0.73mhincy 0.98 14.51tpacy65 0.04 0.80tpacy18 -0.40 -4.12s3p573 -0.14 -2.11Intercept 2.49 0.85F-statAdj. R2Note: All variables are in logs Dependent variable is fvtif.
955.16 0.96
positive and significant coefficient presentsprima fascia evidence that Wisconsin citiesand villages are not systematically overproviding public services. By superimposingthe observed and the predictedcombinations of aggregate property valuefor the different levels of local governmentexpenditure observed in our sample in eachof the four different categories helpsillustrate this latter conclusion (AppendixFigures A1 to A4).
These results provide strong evidencethat cities and villages in Wisconsin are notsystematically over-spending and mayindeed be under-spending. We could usethis result to conclude that tax cuts, iffollowed by a correspondent decrease indisposable revenues at the local level and,thus, a decrease in expenditures, contrary togeneral perception, would not makeWisconsin citizens better off.
11
IV- Public Sector Efficacy
In the previous section we have foundsome preliminary evidence that Wisconsincities and villages have not been spendingtoo much in the provision of their publicservices. Our results also indicated that adecrease in expenditures would not result ina positive outcome for any Wisconsinresident. We used this result to concludethat tax cuts, if followed by a correspondentdecrease in disposable revenues at the locallevel and, thus, a decrease in expenditures,contrary to general perception, would notmake Wisconsin citizens better off.
A- Theory
An important assumption behind theBrueckner argument was that a decrease intax rates would necessarily decreaserevenues. A common argument against thislogic would be that state and localgovernments are not using their taxinstruments appropriately in order tomaximize revenue collection. By decreasingtax rates they would be generatingincentives for existent firms in the locale tohire more workers, increase theirinvestments. They could even go beyondthat by attracting new residents orbusinesses as a consequence of such taxcuts. In other words, taxes that are too highdrive economic activity out of the region.Behind this argument is the idea of publicsector efficacy where private resourcesshould be collected at the lowest cost forsociety.
This argument is better illustrated in thefamous Laffer curve, which expresses totalrevenues as an inverted-U function of stateor local tax rates. The curve, as presentedin Figure 6, is divided in two segments: theupward sloping portion of the curve is calledthe “normal” range and the downward-sloping segment is the “prohibitive” range.Right in the middle is the point where taxrevenues are maximized and where localgovernment activities are performed withefficacy. Tax cuts advocates would arguethat tax rates are beyond their maximumand thus in the prohibitive range. The logicis remarkably similar to the Bruecknerrelationship outlined above.
The total amount of revenues collectedfrom a given tax can be seen as the productof an average tax rate by the tax base. Foran income tax, the total tax base would bethe sum of wages and profits. Having thisconcept in mind, a change in a marginal taxrate would have two effects on the amountof tax revenues collected from that tax: adirect or first order effect, immediatelycaptured through the average tax rate, andan indirect or second order effect capturedby the tax base.7
Consider, for instance, a tax cutimplemented by a decrease in property taxrates. If the total tax base is unchanged, adecrease in marginal tax base will decreasethe total amount of revenues collectedsimply because each individual taxpayer willbe paying less in taxes. A tax cut will,however, increase after tax wages andreturn to capital. That could result in anincrease in investment by firms, more jobs,higher profits and a higher tax base.
Thus, the net effect of a tax cut willdepend on the balance between the positiveand second order effect. A negative neteffect implies that a tax cut will decrease taxrevenues. The direct effect dominates theindirect over the normal range where anincrease in taxes will increase revenues. Anincrease in taxes will decrease taxrevenues. This net positive effect decreasesas we move towards the tax rate whererevenues are maximized, becomingnegative after that. A negative effect reflectsthat the indirect effect now dominates thedirect effect. An increase in taxes under thisprohibitive range will now decrease taxrevenues. The rationale for each segment ofthe Laffer curve was based on this balance.
B- Statistical Analysis
As it is formally derived in the appendix,the elasticity of the property value withrespect to changes in the property tax rate(i.e., the shape and sensitivity of theinverted-U curve) assumes a central role inthe determination of the net effect. If theabsolute value of the property valueelasticity is greater than one a tax rate cut
7 This argument is formalized in the Appendix
12
will decrease revenues meaning that theeconomy would be in the normal range ofthe local Laffer curve (local revenue hill).Otherwise, a tax cut will increase revenues.In this case the local economy would be inthe prohibitive range of a possible localrevenue hill. Local public sector efficacy willbe achieved if the absolute value of theproperty value elasticity is one. Or as in thecase of the Brueckner test, there is nosystematic evidence of either over- or under-taxation. Simply estimating the elasticity ofproperty values with respect to the propertytax rate and testing this estimate against anull equal to negative one can implement atest of local public sector efficacy.
Using the same sample of Wisconsincities and villages, the elasticity of propertyvalue with respect to the property tax ratewas obtained by regressing the full value ofproperty in a given community (fvtif),described before as our proxy for the baseof the property tax, on different proxies oflocal tax rate, controlling for the same set ofhousing, and socioeconomic characteristicsused in the Brueckner test, as well as forintergovernmental transfers (transfers).8
Within a given municipality differentclasses of property receive different taxtreatments and rates. We have constructeda unique tax rate that tries to summarize theaverage burden imposed on a givencommunity by its property tax schedule. Twoproxies for a proportional and effective localproperty tax rate were obtained by dividingthe total amount of property tax revenuesraised in a given community by twoalternative bases: aggregate income earnedby community residents and aggregateproperty values. Behind the choice of eachbase is one assumption with respect to theincidence of the property tax. Aggregateincome would be the appropriate base ifproperty owners were able to shift the taxforward to renters with property values beingthe default if taxes were not shifted.
Having these in mind the computed“income tax rate” (taxraty) corresponds tothe proportional tax rate having aggregatecommunity income, measured in $1,000, as
8 See the Appendix for a fuller justification of thisspecification.
the tax base while taxratp is the tax rateusing aggregate property values as thebase.
C- Empirical Results
Given the intrinsic non-linearity inthe relationship between property valuesand tax revenues, a Box-Cox procedure wasused in order to suggest the most“appropriate” functional form. As in theBrueckner test of allocative efficiency,lambdas indistinguishable from zero weregenerated indicating that the appropriateform would be logarithmic.9 In a regressionin logs, elasticities between dependent andindependent variables are equivalent toregression coefficients. It suffices,therefore, to look at their estimates to makeinferences about overall local public sectorefficacy in Wisconsin.
Given two tax rate measures, two sets ofregression analysis are reported (Tables 7and 8). The results of regressing thecompute income tax rate (taxraty), plus therelevant control variables, on total propertyvalue (fvtif) are presented in Table 7, whilethe results using the aggregate property taxrate (taxraty) are presented in Table 8.Overall, both regression equations performwell given the cross-sectional nature of thedata with the equation F-statistics being1814.01 and 1439.64, respectively. Inaddition, the separate equations explainover 90 percent of the variation in propertyvalues (i.e., adjusted R2 equal to .96 and.95, respectively).
Control variables that seem to have thestrongest positive impact on aggregateproperty values include the age of thehousing stock, with newer constructionhaving a greater positive impact than olderconstruction, household income levels andthe size of the typical house as measured
9 Both dependent and independent variables weretransformed.
by number of bedrooms. A higherpercentage of the population that is youngseems to place downward pressure onvalues as does access to public water
supplies. This latter result, much like withthe Brueckner test above, is somewhatunexpected. The remainder of the resultson these control variables can be reviewedat the reader’s leisure.
The elasticity of property values withrespect to changes in both measures oflocal tax rates revealed themselves to bepositive and statistically different from zeroand thus also statistically different fromnegative one under a two-tailed test. In otherwords, tax rates broadly defined forWisconsin cities and villages are notsufficiently high to starve-off economicactivity. Figures 6 and 7 help illustrates thispoint by superimposing the observed andthe predicted combinations of aggregateproperty value – the size of the tax base inquestion – for the range of average taxesobserved in our sample of Wisconsin citiesand villages.
These results suggest thatWisconsin cities and villages are not over-taxing their citizens. A consequence of thatis that tax cuts in the property tax scheduleswould not improve the revenue-raisingcapacity of cities and villages.
V-Conclusion:
This applied research reportrepresented a rigorous theoretical andanalytical attempt to better evaluate theperformance of the local public sector inWisconsin. Instead of limiting our analysisto interstate comparisons of tax burden, wedecided to take a closer look at howWisconsin local governments, in particularits cities and villages have been using theirtax and expenditure functions.
For Wisconsin cities and villages,taxes are simply not a strain on the localeconomy and indeed, the services thatthese taxes support, such as police, roadsand parks, directly and indirectly benefitWisconsin residents. Based on theseresults as well as other applied studies, thedebate should not focus on absolute levelsof spending and taxation, but the mixbetween service and taxation rates.Wisconsin residents and businesses benefitfrom the services cities and villages provide
and the corresponding level of taxation hasnot counteracted those benefits.
Based on the Brueckner’s test forallocative efficiency in the local public sectorand on a sample of Wisconsin cities andvillages, we did not find evidence thatWisconsin city and village governmentswere over-spending. This result seems toindicate that a decrease in taxes leading to adecrease in local expenditures would notmake Wisconsin cities and village’sresidents better off and may indeed makethem worse off.
One could argue that, even toughthere seems to be no evidence of misuse ofpublic resources, the same level and qualityof public services and goods could beprovided at a lower cost for Wisconsinresidents. Based on the idea of the Laffercurve and on the concept of public sectorefficacy, we started touching this issue byasking whether the same level of propertytax revenues, the most important source offunding at the local level, could be raisedwith a lower property tax rate. Our resultsindicated that a decrease in the currentaverage property tax rates observed in eachcity or village in Wisconsin will necessarilyimply a decrease in the total amount of taxrevenues.
Our results bring a very differentpicture to the perspective of Wisconsinbeing a high tax state. While, there is someclear indication that their performance fallsshort from what should be expected ofefficient and effective governments, cuttingtaxes, at least local taxes, does not seem to
be the answer to fostering better localgovernments. Indeed, the results suggestthat Wisconsin cities and villages may beunder-providing key services.
In the end, Wisconsin residentsvalue the services that are being providedby cities and villages. It is a generalmisperception that taxes are too high andthat the local economy is suffering as aresult. These results suggest quite theopposite; cities and villages may bespending too little on key services. In theend people and businesses acknowledgethat there is no free lunch and that keyservices are of value and that taxes must belevied to pay for those services. If thecitizenry perceive that they are “not gettingwhat they pay for,” then potentially seriousproblems exist. The results of this appliedresearch effort suggest that Wisconsin citiesand villages are not to that point.
It is important to draw attention tothe limitations of this study. First andforemost, we focus on cities and villages, noattention is paid to other jurisdictions thathave taxing authority including the publicschool system, county and towngovernment, or overall state tax burdens.Clearly, the broader question “are overall taxburdens too high in Wisconsin” is notaddressed. The tiered system of localgovernment in Wisconsin, and indeedthroughout much of the Midwest, greatlycomplicates the ability to taxpayers toseparate out the individual affects ofseparate units of government. This affect,commonly referred to as “fiscal illusion” isthe subject of future analysis.
15
Figure A1: Property Value (fv) vs Lifequality (life)- Observed (x) and Predicted Values
Figure A2: Property Value (fv) vs Roads (roads)- Observed (x) and Predicted Values
fv
roads
fv Predicted fv
8.03647 18.4039
13.6715
23.5511
fv
life
fv Predicted fv
4.12326 18.2179
13.9256
23.5511
16
Figure A3 Property Value (fv) Vs Sanitation (sanit)- Observed (x) and Predicted Values
fv
sanit
fv Predicted fv
4.83797 18.0928
13.6715
23.5511
Figure A4: Property Value (fv) vs Public Safety (safety)- Observed (x) and Predicted Values
fv
safety
fv Predicted fv
6.81739 19.2938
13.6715
23.5511
17
Figure A5: Property value (fv) vs Local Tax $ paid for every $1,000 of income (taxraty)Observed (x) and Predicted Values
fv
taxraty.004219 4.79054
13.678
23.443
Figure A6: Property value (fv) vs (Local Taxes/full value)*1000-taxratp.Observed (x) and Predicted Values
fv
taxratp.029636 2.83975
13.678
23.6975
18
A. The Brueckner Model
This section of the appendixformalizes the arguments on the derivationof the Brueckner curve by summarizing themain steps for its derivation. (This Appendixdraws from Deller (1990), Regional Scienceand Urban Economics, 20:395-406)
The analysis begin by assuming thatpreferences are identical and rents vary in away that each consumer in a given incomegroup achieves the same level of utilityacross all governmental jurisdictions. Theutility function for the ith individual can bewritten
u = u (hi,g, xi) (A1)
where g is the level of a public good, hi is ameasure of housing services consumed andxi is a numeraire composite good consumedby the ith individual. Since the level of utilityachieved msut be the same for allindividuals with a given income, the utility ineq.(A1) must satisfy
u(hi, g, xi) = � (yi) (A2)
where yi is the income of the ith individualand utility is non-decreasing in income(�’�0).
Defining Ri as the rent of the ithindividual must pay for housing services hi,given public consumption g, the budgetconstraint of the ith consumer is xi + Ri = yi.Rearranging the budget constraint andsubstituting, eq.(A2) can be restated as
u (hi,g, yi-Ri) = � (yi) (A3)
Eq.(A3) implicitly defines the bid-rentfunction, which gives rent as a function ofhousing services, public good consumption,and income. For a given level of income andhence some fixed level of utility, the effect ofa change i the other arguments in eq.(A3)on rent can be determined.
Ri = R(hi, g, yi) (A4)
Totally differentiating eq.(4) yields eq.(A5)where the numerical subscripts denotepartial derivatives and i indicates that the
utility function is evaluated at i’sconsumption bundle.
u1i dhi + ui2 dg – ui3dRi = 0 (A5)
By holding housing services fixed,the effect of a change in the public goodlevel on rent can be determined byrearranging eq.(A5):
� Ri/�gi = ui12ui3 >0. (A6)
The implication of eq.(A6) is that a higherlevel of public good results in higher rent.Note that the ratio of partial derivatives ineq.(A6) is equal to the marginal rate ofsubstitution (MRS) between public good andthe composite good.
To complete the model it isnecessary to examine the value of property.In a perfect competitive market, the value ofthe property is equal to the net rent receiveddiscounted over time:
Vi = (Ri –Ti)/� (A7)
where Vi is the value of the ith property, Ti isthe property taxes paid on the ith propertyand � is the discount rate. Total propertyvalue is the sum of the values of allproperties:
V V R Tii
n
i ii
n
� � �
� �
� �1 1
( ) /� (A8)
With a balanced governmentbudget, the total amount of property tax paidequals the total cost of providing the publicgood. Since the total cost will be a functionof the public good level, c (g), eq. (A8) canbe written as
�/)(1
��
���
��� �
�
n
i
gcRV i (A9)
Differentiating eq.(A9) with respect to thepublic good yields
�
��
�
���
��
�Vg
Rg
c gg
i
i
n
1
( )(A10)
19
Suppose now that the public goodlevel is chosen to maximize total propertyvalue. Since it can be shown that V is astrictly concave function of g under standardassumptions, maximization requires that�V/�g = 0. But since the last term ineq.(A10) is marginal cost of producing anadditional unit of the public good and thesum of �Ri/�g is equal to the sum of themarginal rates of substitution acrossindividuals, �V/�g = 0 implies the Samuelsoncondition for allocative efficiency in publicgood provision.
Thus, if government officials behavein a manner as to maximize total propertyvalue, the resulting first-order conditionimplies that the Samuelson condition forPareto-Efficiency is met.
B. Test for Local Public Sector Efficacy
Let G = c (g) be the total cost required toprovide the level of g of the local publicgood. The local government budgetconstraint is given as
Gi = �i Vi + Z (B1)
The cost required to provide the local publicgood is financed with a tax revenues onproperty (Ti =�i Vi), whose total baseamounts to the sum of all property in thatparticular community as well as withintergovernmental transfers.10 Eq.(B1)implicitly determines g as a function of �i andZ. Recall from eq.(A7) that Vi is a function ofTi and Ri. Recall also from eq.(B4) that Ri isa function of hi, g and yi. Thus, Vi isultimately a function of the property tax rate(�i), the level of public services provided (g),as well as a function of housing andsocioeconomic characteristics of thecommunity.
Community i revenue frontier isdefined as the amount of disposablerevenues it has available being specified as:
� = �i Vi (�i, Z, hi, yi) + Z (B2) 10 Transfers are assumed to be determinedexogenously in this model. In reality given for instancerevenue sharing transfers they would be also be afunction of other variables in the model such as income,housing characteristics or even governmentexpenditures.
A small decrease in the property taxrate (��i), when matched with adjustments inlocal public goods as required in thecommunity budget constraint- eq.(B2),results in an equilibrium balanced budgetchange in community revenues of:
��= ��i Vi + �i � Vi. (B3)
The first term -��i Vi – measures the directrevenue effect of a small increase in theproperty tax rate. The second termmeasures the indirect effect of the rateincrease as local tax bases respond tochanges in local tax rates and to balancedbudget adjustment in G for given levels of hiand yi.
The second term can also be writtenas a function of the elasticity of the propertytax base with respect to small changes inthe property tax -� - defined as
� = �
�
V Vi i
i i
//� �
(B4)
In order to see that just isolate �Vi in (B4),substituting in the second-term in (B3). Theexpression for the indirect effect is now ���iVi and eq.(B3) is reduced to
��= (1+�) ��i Vi (B5)
Thus, the effect of a small decreasein property tax rates will depend on thesignal and magnitude of �. If �>-1, ��>0, atax rate cut will decrease revenues meaningthat the economy would be in the normalrange of the local Laffer curve (local revenuehill). Otherwise, �� <0, and a tax cut willincrease revenues. In this case the localeconomy would be in the prohibitive rangeof a possible local revenue hill. Local publicsector efficacy will be achieved if �=-1.
A test of local public sector efficacycan be implemented by simpling estimatingthe elasticity of property values with respectto the property tax rate. A statisticallysignificant elasticity (positive or negative)indicates the existence of a commoninefficacy bias among the local governmentunits in the sample.
