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II. ASSESSING FRAGMENTED GOVERNANCE: COST, COMPETITION, VARIETY AND EXCLUSION

Is it desirable to reduce the degree of fragmentation in metropolitan governance by implementing compacts among municipalities, and how should the efficiency of such governance mechanisms be judged?

Mills and Hamilton (1994) have observed that most large U.S. metropolitan areas are composed of a multitude of local governments, which include municipalities and special purpose bodies such as school districts, water districts and regional transportation authorities:

    "...an integrated economic area, such as an MSA [Metropolitan Statistical Area] may contain an extraordinarily large number of local governments. The Chicago MSA has more than 1,100 local governments, and the New York City, Philadelphia and Pittsburgh MSAs have more than 500 local governments each." (Mills and Hamilton, p.316).

Is it desirable to implement a new set of State level regulations and laws which would induce such a multitude of jurisdictions in metropolitan areas to act as a compact? I interpret a compact to imply that jurisdictions belonging to it would act with much less autonomy and more coordination in many areas, than they do currently. It also means that members of the compact would accept constraints and regulations imposed at the state or federal levels and would engage in various forms of revenue sharing whether such revenue sharing is voluntary or imposed by state or county governments.

Here are some examples of how a metropolitan compact could affect the workings of local governments in the compact:

1) Services of a particular type could be consolidated across local governments. These could be public education, public health and welfare delivery, public housing, police and fire protection, public transportation, water supply, sanitation and wastewater collection and treatment.

2) The compact could institute tax rates and zoning regulations in a coordinated manner in order to achieve some common objective deemed beneficial in the aggregate. Or, equivalently, individual jurisdictions may be allowed to set their own taxes while redistribution within compacts is achieved by various revenue sharing formulas.

3) Infrastructure planning and supply decisions could be deferred to higher level governments (e.g. county or state) or decided jointly by the jurisdictions within the compact.

The efficiency implications of such a compact are as follows. The compact should be implemented only if the economic benefits generated by it exceed the added economic costs that will occur when it is implemented.

Efficiency will depend on four factors: cost savings on the one hand and reduced benefits from the loss of competition, reduced variety in the provision of local services and loss of the localized power to include/exclude undesirable land uses from a community.

Cost savings: Cost savings are possible when there are economies of scale in the provision of public services by local governments. Economies of scale exist when the public service can be provided more cheaply on a per-capita basis when it is provided to a larger number of people than when it is provided to a smaller number of people.

Public transportation services are subject to relatively strong scale economies. It is not possible to provide public transportation -- especially fixed-rail public transit -- to a small number of people at a reasonable cost and quality. But such services are already regionalized in almost all metropolitan areas. The various local governments which share public transportation services have seen the wisdom of creating regional transportation authorities.

It is doubtful that other services such as schools, wastewater treatment, police and fire protection etc. are subject to a high degree of scale economies. That is why these services are not regionalized to the same degree as is public transportation. But to the extent that several municipalities can get together and save costs in supplying their citizens with public education or with mosquito abatement, they do that. There are school districts, sanitation districts etc. which act as special governmental entities. Nothing prevents adjoining municipalities from striking voluntary agreements to share services and save costs.

If there are any significant unrealized cost savings from the consolidation of public service provision, these are most probably in the area of administrative costs. Regionalizing a service could result in lower per-capita administrative costs. But even that is not certain. There is reason to believe that the larger the government agency, the less efficiently it will be run. If this is true, there would be added costs not cost savings from consolidation.

Competition: While the proponents of the new regionalism have emphasized cost savings from consolidation and the coordination of local government services, they have -- to my knowledge -- ignored the benefits from the increased competition among a large number of local governments in the same metropolitan area.

In 1956, the economist Charles Tiebout emphasized precisely that principle, and his original insights have since been made more precise and extended by many scholars. Tiebout noted that businesses and households choose local governments according to the quantity, quality and cost of the service-bundle which they provide. To choose a local government and to locate there means to get the public services provided by that local government and to agree to pay the cost (net of any subsidies) in the form of local taxes and fees. The public services provided by a local government contain the usual menu of education, parks, police and fire protection, garbage collection etc.

Local governments also provide a number of other benefits to the consumers who locate there. The most important of these is the character of the community insured by a set of zoning and other ordinances. Local governments also provide a particular style of financial management and a fiscal reputation. For example, some local governments are business-friendly and seek to attract businesses, while others are resident-friendly and seek to exclude businesses. Some local governments are pro-growth while others are growth-control oriented. Finally, local governments provide a profile of existing resident businesses and households.

Households and businesses choose local governments not only for the particular bundle of services which they provide, but also because of the bundle of zoning and other ordinances, their financial management and fiscal styles, their orientation toward growth or business and the profile of existing businesses and residents. In a metropolitan area with a multitude of local governments, these local governments compete with one another. For example, they compete in setting a structure of taxes and fees and in insuring a particular character by means of zoning ordinances and by pursuing growth or not.

Tiebout observed that if a particular government were run badly, failing to provide a bundle of services which appealed to its residents or because it charged too much for the bundle of services which it provided, then the residents and businesses could "vote with their feet" and move to another local government in the same metropolitan area where they could elect local politicians more responsive to their needs.

In this Tiebout framework of the "metropolitan marketplace" the presence of many other local governments means that each local government would be more responsive to the needs of its residents. The presence of many other local governments means that the disciplining force of competition insures that each local government does not get excessively out of line. Also, competition generates peer pressure: if one local government comes up with an innovation, others are motivated to emulate it.

The benefits of competition among local governments is lost when the entire metropolitan area has only one government or if it consists of many local governments tied to each other through a regional compact which reduces competition among local governments.

Consider the following example of how having a single government agency can hurt an entire region. Suppose that XYZ Corporation must set up a new plant and it is considering leaving the community where its current plant is located because of high state taxes. The officials of the local Industrial Development Authority (IDA) fail to provide it with the necessary incentives to offset the high state taxes. XYZ Corp. negotiates with another IDA in the same metropolitan area which provides the needed incentives and it sets up its new factory in the jurisdiction of the second IDA. XYZ Corp. is lost to the community where it was initially located but it is not lost to the region. Competition between the two IDAs increases the overall competitiveness of the region. XYZ's employees continue to hold on to their jobs but now commute to XYZ's new location within the same metropolitan area. For a parochially motivated region, seeking to keep as much employment within its boundaries, the presence of several IDAs competing with one another is an advantage that should not be easily given up. Others may observe that this may lead to excessive competition, causing a "race to the bottom" with the region paying too much to keep the employer. But there is little evidence that competition, in this context, will be excessive or wasteful.

What would happen if there was only one IDA in the metropolitan area? That metropolitan IDA would face competition from the IDAs of other metropolitan areas but it would not face any competition from within the metropolitan area. But that is less, not more competition for the IDA and fewer not more choices for XYZ Corp. Furthermore, a single IDA facing no local competition could easily become a lethargic bureaucracy unable to respond effectively. If that happened, the likes of XYZ Corp. would leave in droves. That is in part what has caused many of our central cities, which are large jurisdictions, to remain behind the curve. They have, for the most part, failed to effectively change their culture or to institute innovative business-friendly policies. They have had less pressure to compete, partly because they have received a higher level of state and federal subsidies and partly because they have had relative monopoly power because of their size.

What would residents do if they observed that their regional compact is instituting region-wide policies with which they disagreed or for which they did not wish to pay? They would have two choices. One would be to move out of the boundary of the regional-compact and into the rural towns where they can again exercise locally meaningful voting power. Such a move, being within commuting distances, would entail a change of residence without a change of job. A second and more costly choice would be to move to another metropolitan area or another state where regional compacts did not exist or where regional compacts operated more efficiently. Such a move is more costly as, in most cases, it would entail a change of job as well as a change of residence. To the extent that moving costs prevented residents from responding to failures in regional governance, their welfare would be reduced.

To be sure, the competition which occurs among local governments is not like the perfect competition or monopolistic competition which exists in many forms of industry. One well-known failure of local government competition is the fact that some services provided by one local government spill over to the residents and businesses of adjoining local governments. This was certainly true with the example of the region's efforts to retain XYZ Corp. If one IDA succeeds in doing that, the entire region benefits. Another example is that if a central city provides better public facilities for its residents, suburban residents can also use those facilities without having paid for their provision. If a suburb provides a new shopping mall with free and adequate parking, that benefits city residents as well. Countless other examples can be given. They all amount to one conclusion: that many residents and businesses benefit from the public services of other local governments for which they do not pay.

Spillover effects mean that competitive local governments can free-ride on one another. If the adjacent municipality built a new park that my community's residents can also use, then that makes it less necessary for my community to also build a park. But the presence of free-riders causes under-provision of public services. If my community cannot charge the residents of adjacent communities for the services provided in my community, then my community is not as willing to provide those services because it does not take into account the spillover of benefits. Conversely, if my community provides services or facilities which are costly to neighboring communities (for example, a new shopping mall which creates spill-over traffic congestion), then my community will over-provide such facilities and services because it does not take into account the costs it would impose on the neighboring communities.

A major benefit of a regional compact of local governments, if accompanied by appropriate regional planning, would be that these spill-over effects could in principle be calculated by a single regional planning agency. Then, the over-provision and under-provision effects could be reduced by compensating transfers which would be possible within a regional revenue sharing arrangement. But although that sounds attractive in principle, no one knows how to reliably calculate the spill-over effects and the kind of regional planning which is required would be impossible to do in practice. Therefore, even with the spill-over effects present, it would be wrong to conclude that competition among a multitude of local governments does not improve efficiency in the provision of public services.

Variety: Another aspect of Tiebout's observation was on the variety of services and characteristics provided through the multitude of local governments. He observed that having a multitude of local governments in a metropolitan area, with each government providing a different variety of services, consumers tastes for local services are better matched.

Consider an elderly couple with the children out of high school or a single childless unmarried individual. What these two households have in common is that they do not wish to pay (or pay too much) for public education. In a metropolitan area with a variety of educational services provided by local governments, these households will reduce their share of property taxes which support education, by choosing a community where the education portion of the property tax rate is low. In a regionally managed governance structure where the same tax rate would apply to each municipality, there would be no opportunity for a similar choice to be made. Countless other examples can be given.

The benefits of a rich variety in public service provision are surely as important as the benefits of competition. It would be a mistake to embrace alternative forms of metropolitan governance without giving due consideration to how variety in public service provision would be sacrificed. One of the most important characteristics of U.S. metropolitan areas, as compared to European metropolitan areas, is that a richer variety of local service bundles are offered in the U.S. As a result of competition among them, local governments strive to differentiate their services and because of this differentiation, consumer choice is improved.

Exclusion/Inclusion: One of the most controversial benefits of local governance is the ability of residents to exclude or include certain land uses from their community. This observation is also a part of the Tiebout perspective. There are various forms of exclusion/inclusion.

Fiscal inclusion occurs when the local government zones land use in favor of uses such as commercial or multifamily residential which may be paying higher taxes on a per acre basis. To the extent that land is so zoned, additional single family development is excluded. This has the benefit that the majority of residents (e.g homeowners in single family homes) lower their tax bill in exchange for accepting a higher proportion of an otherwise undesirable land use. They may experience more traffic congestion locally and a loss of residential character but they are compensated by the lower taxes.

Economic exclusion occurs as an offset to the free-rider problem. The free-rider problem refers to the fact that a lower income resident who lives in a higher density and cheaper housing unit pays less for the same bundle of local public services than does a higher income resident who lives in a lower density and more expensive housing unit. Consider the following, now classical, example. In a suburb all of the housing is large lot residential single family, costing about $ 100,000. Public services such as schools and police protection are paid out of property taxes on single family housing of about 2% of housing value, making the annual bill $ 2,000. Now suppose that the same community also allows the construction of some multiple family apartments (or condominiums) each worth about $ 50,000. The residents of these units are poorer but also pay 2% of property value in annual taxes or $ 1,000 per year. The result is that both groups of residents receive the same bundle of public services but one pays twice as much as the other. The lower income residents are said to be free-riders because they are underpaying for the public services.

As a result of free-riding by lower income residents, the higher income residents are motivated to exclude the lower income residents (by zoning) and to cause the same land to become developed in the single family use. Notice that doing this could result in a reduction in the tax rate from 2% as long as the value per acre is higher in the single family use than it is in the multifamily use. Also, if residents prefer living in an all-single -family environment, the exclusion would cause their housing values to appreciate and an even lower tax rate would be required.

Of course, there are other responses to the free-rider problem. Instead of excluding the use, some communities would charge the free-riding use a higher tax rate. That, in turn, serves to induce partial exclusion by means of taxation, instead of total exclusion by means of zoning. The multiplicity of local governments in a metropolitan area allows several solutions to the free-rider problem to be tried out in different communities. Residents can then sort themselves out among the communities according to their preferred solution.

Prejudicial exclusion, although morally repugnant, is also prevalent. In this case, residents with similar prejudicial tastes live in communities which exclude lower income residents or minorities. A good example of such exclusion is a low-density suburban community which fights in the courts the introduction of multiple family housing even if it can be shown that it is financially beneficial. The residents believe in preserving the racial or income profile of their school district, or they believe that the introduction of such housing will reduce their property values since others are prejudiced and will flee the community. Residents of such a community are often willing to pay higher income or property taxes to maintain a high degree of racial or income homogeneity in their own communities as long as those taxes are used to subsidize the cities and other localities where the "undesirable" groups are largely confined. In other words, they believe in paying to insure "not in my community" or "not in my school district." It cannot be denied that the multiplicity of local governments benefits those who are inclined to isolate themselves by forming a community which excludes groups they consider undesirable.

To conclude, the presence of economies of scale in the provision of public services means that regional compacts can save cost in selected areas. At the same time the loss of competition and of variety in the provision of public services together with the loss of the power to selectively include/exclude means that the loss of benefits from instituting regional compacts could be sizable. I am, therefore, unconvinced that the new forms of regional governance which are advocated are desirable. I am prepared to concede, however, that there may be specific areas of public service provision where regionalization may be desirable. I leave it to others to provide the examples.

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