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Tiebout's Theory/Model on Local Public Goods

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Tiebout’s Theory/Model on
Local Public Goods
(Urban Studies - Term Paper of Part B Coursework)

Submitted to:
Dr Kala Sridhar
Professor
Centre for Research in Urban Affairs

Submitted by:
Ramakrishna Nallathiga
PhD (Part Time) Student

March 2017

Institute for Social and Economic Change, Bangalore

 Tiebout’s Theory/Model on Local Public Goods

Table of Contents

Section No. Title Pages

1 Introduction 3
2 Tiebout’s Theory/Model 5
3 Critique of Tiebout’s Model 9
4 Empirical examination of Tiebout’s Theory 12
5 Conclusions 14
References 15

“Les gens qui ne soient pas une voix dans la decisions administratif et fiscale
peut voter (choisser les jurisdictions) avec les pieds”

- C M Tiebout (1956)

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1. INTRODUCTION

Based on the nature of production and consumption, economic goods/ services can
be broadly divided into: (a) Private goods (b) Public goods. Much of the eeconomic
theory is concerned with resource allocation for the production and consumption of
private goods and services. The principles of economics concern with the pricing of
these goods and services that are bought and sold in market place; therefore,
markets serve as a platform for the exchange of goods between producers and
consumers. The concept of market based solution to the exchange of goods is
commonly adopted in the case of ‘private goods and services’, after it was formally
developed by Adam Smith. Private goods/services have also the notion of ownership
i.e., they are privately owned. However, market based solutions and principles are
not widely applicable, especially in the case of public goods and services.

Public goods and services are the economic goods that are different from private
goods and services. Most of them are provided by the public agencies/authorities
(through budgetary process of spending) for wider public consumption and they are
owned by the public at large. In terms of consumption, they exhibit the common
characteristics of: (i) non-rivalry (ii) non-excludibility. Further, from the resource point
of view, as noted by Samuelson, public goods have the problems of: (i) free ridership
(ii) charging for consumption. Given the different nature and characteristics of the
public goods and services, they are seldom provided by private suppliers; they are
largely provided by the governments at different levels. Governments perform this
role, as they are elected by the citizens (in democratic societies) so as to get served
themselves through the provision of public goods/ services.

Local public goods are a set of the public goods that are largely provided by local
governments/ authorities, which are at the lower tiers of government, for the
consumption of local population. In several countries, they are recognized by their
constitution as self-government institutions. Local Authorities/Governments have the
following advantages in the provision of local public goods and services (LGF 2008):

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  Local knowledge required in their provision (especially, local preferences)

 Local accrual of benefits and costs

 Appropriate incentives at local level

Local governments across the world provide a variety of local public goods e.g.,

(i) water supply and waste water management

(ii) street lights and pavements
(iii) waste management
(iv) parks and recreation spaces
(v) roads and traffic management
(vi) museums and galleries
(vii) libraries and swimming pools
(viii) education and healthcare
(ix) social housing

The above listed public goods have further differentiating factors – based on which
they can be categorized into either pure public goods or quasi/semi public goods or
public goods that are/can be provided by private agencies. Table 1 shows one such
distinction criteria of public goods based on the characteristics of public goods and
services provided by local governments.

Table 1 Characteristics of Local public goods and services

Rivalry in consumption

Low Medium High

Excludibility of
consumption

Low Street lights, Streets, pavements

parks and
recreation

Medium Flood protection Sports grounds, Arterial roads,

public conveniences economic
development

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 High Museums and Libraries, swimming Public transport,
galleries pools, recreation waste water, waste
spaces disposal, parking
Source: LGF (2008)

The provision of public goods and services by public agencies was considered to be
based on the costs of services rather than demand based, as in the case of private
goods/services. The consumer/citizen demand could not have been captured in the
process. Public choice theory proponents argued that the citizen consumer demand
could be elicited through democratic political process. For example, in a direct
democracy, the citizens could explicitly vote for/against the set quantum of public
goods/services in a public referendum to express their choice/preference; here, the
preference of median voter choice matters in identifying the demand, therefore, also
termed as ‘median voter choice/preference’ representing citizen consumer demand.

However, it is difficult/ costly to get the ‘median voter choice’ for every set of public
good/service provided by the urban local governments. Moreover, representative
democracy is prevalent in several nations (including India) and, in representative
democracy, elected politicians choose the quantum of public good/service service
provision. The politicians may or may not reflect citizen/public preferences I.e., they
may or may not reflect the public interest in decision making. Although local
governments have been providing local public goods and services for a long time,
their choice is largely reflective of the control of political and bureaucratic system.

Clearly, there was a lack of explanation of ‘citizen consumer’ choice of local public
goods/services in traditional public economics. Tiebout attempted to offer the same.

2. TIEBOUT THEORY/MODEL

Tiebout believed that citizen consumer’s preference/choice of public goods can be

captured through a competitive metropolitan market of local governments. Tiebout

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attempted to find a ‘market type’ solution to determine the level of expenditure on
local public goods by taking forward Musgrave-Samuelson analysis. The major
problem Musgrave and Samuelson have with public goods is the lack of mechanism
by which consumer voter preferences for them can be measured (as rational
consumer may understate preferences to enjoy goods while paying low tax).
Tiebout’s concern was about getting this consumer preferences revealed so that
they can be satisfied like that of private good and also tax him accordingly

2.1 Assumptions

Any theory/model is based on a set of assumptions and they have to be explicitly

stated in the model/theory building itself. Tiebout’s theory/model has five major
assumptions and two other assumptions to support it (Tiebout 1956).

2.1.1 Major Assumptions

The following are the major assumptions made by Tiebout:

 Consumer-voters are fully mobile and will move to that community where their
preference patterns, which are set, are best satisfied

 Consumer-voters assumed to have full knowledge of differences among

revenue and expenditures patterns and to react to these differences

 There are large number of communities in which the consumer-voters may

choose to live

 The population is considered to be living on dividend income (thereby

avoiding employment restrictions)

 The public goods/services supplied do not exhibit any external economies or

diseconomies

2.1.2 Other Assumptions

In addition, Tiebout also held the following assumptions:

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  For every pattern community services set by, say a city manager, who follows
the preferences of older residents of community, there is an optimal size (in
terms of cost)

 Communities below the optimum size seek to attract new residents to lower
average costs, those above the optimum size do the opposite, and those at
the optimum try to keep their population constant

2.2 Tiebout’s Equilibrium

Under the above assumptions, the movement of consumer-voter takes place (from
greater than optimal size community to less than optimal size community), which
satisfies his preference pattern. In the process, the jurisdictions will operate at the
lower average costs (or, cost efficient) in the provision of public goods/services. The
act of moving or failing to move replaces the usual market test of willingness-to-buy
a good and reveals the consumer-voter’s demand for the public good or a set of
public goods (and associated individual tax). Thus, each locality has a revenue and
expenditure pattern that reflects the desire of its residents.

Tiebout further states that this equilibrium is close that found in the case of private
goods of maximizing consumer welfare within the framework of available resources.
If production function shows Constant Returns to Scale (CRS) with diminishing
marginal returns and if indifference curves are regularly convex, then optimal
solution is possible. On the production side, it is assumed that the communities are
forced to keep the production costs at a minimum i.e., minimum of long-run average
costs, either through the efficiency of the city managers or through competition from
other communities providing such goods. On the consumption-side, the citizen
chooses the locality which offers the set public goods (and the tax) he/she prefers.

Given the above, Tiebout notes that:

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 “each individual in seeking as a competitive buyer to get to the highest level
of indifference subject to given prices and tax, would be led as if by an
„invisible hand‟ to the grand solution of the social maximum position”.

This is analogous to the consumer walking into a private market place to buy his
goods, the prices of which are already set; we place him in the position of walking to
a community where the prices of community services are already set. Spatial
mobility provides the local public-goods counterpart to the private market’s shopping
trip. In tiebout’s model terms, the preference/choice of a locality by moving signals
the consumption choice of public good/service, much a like the consumer’s choice of
a shopping mall signals his/her consumption choice of private good/service.

Tiebout’s theory/models holds well to the Western countries, where the cities tend to
have large number of local governments within themselves and each of them work
on providing the public goods/services of their own choice, and in the process may
even specialize in the provision of some of them. For example, Paris metropolitan
area has more than 1,000 local governments, which is not only large but they also
concentrate on their own focus public goods/services. In tiebout’s model, the larger
number of local governments also gives rise to more competition among them to
attract individuals/firms by providing public goods cost efficiently (and tax effectively).
Therefore, there could be welfare gains from the resource utilization efficiencies.

2.3 Policy Implications

Three implications are offered by Tiebout himself (Tiebout 1956):

 Municipal integration is justifiable only or more of any service is forthcoming at

the same total cost and without any reduction of any other services. In other
words, metropolitan consolidation should be considered only if it leads to the
provision of more quantum of public services (at same tax cost).

 Policies that promote residential mobility and increase the knowledge of

consumer-voter will improve the allocation government expenditures in the

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 same sense that mobility among the jobs and knowledge relevant to the
location of industry and labour improve the allocation of private resource.

 The policy of fixed revenue-expenditure pattern is not possible in large,

dynamic metropolis but only in small rural and suburban localities. This
happens because of the nature of local public goods (discussed in Section 1)
and also smaller localities spending efficiently in line with citizen preferences.

One of the main policy implications that was not proposed by Tiebout but interpreted
by others subsequently is - decentralisation would serve as a better model for the
governance of metropolitan areas rather than centralisation model. Although the
argument for decentralisation comes from ‘the theory of fiscal federalism’ 1, tiebout’s
theory had laid down support to decentralisation as a better means of not only
serving the public but also providing public goods/services of their choice. Tiebout’s
theory/model therefore supported (political and fiscal) decentralisation theory that
came from public finance, policy and administration.

3. Critique of Tiebout Model

The critique of tiebout model/theory comes from the various perspectives and it is on
the various aspects of it.

□ One of the main criticisms is that agglomeration and scale economies play an
important role in large metropolitan areas, therefore, a single authority can
perform better than competitive multiple local governments by leveraging the
above advantages (as recent evidence shows)
□ Another criticism is the ignoring of the equity dimension. Sorting of people
according to preferences may give rise to some undesirable (or, even ugly)
outcomes e.g., racial segregation, segregation of people by income.

1
According to fiscal federalism theory, local governments are better equipped to govern local areas
when compared to national or provincial governments. It is also conceptually linked to ‘subsidiarity
principle’ of OECD, which states that there is no reason why an upper tier of government should
provide goods/services when there is lower tier government to perform the same function.

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 □ Multiple jurisdictions under tiebout model may lead to fragmentation and
proliferation leading to urban (suburban) sprawl and complicated metropolitan
urban governance i.e., coordination and accountability issues.
□ Last, some of the unorthodox economic theory groups that do not believe in
the concept of local public goods, deny the usefulness of taxation as an
instrument of signaling for the movement/ location of individuals/firms.

Ahrend, Lemboke and Schumann (2016) argue that the metropolitan areas have
agglomeration benefits (which were estimated at about 2-5% higher productivity in
OECD countries), which can be harnessed better under a metropolitan authority.
Based on a survey of metropolitan authorities in OECD countries, they find that the
metropolitan authorities play an important role in regional development, urban
planning, transportation and infrastructure development. They also find that regional
governance by metropolitan authorities has led to agglomeration benefits, control of
sprawl and lesser air pollution.

Gordon (2016) also argues the need for a metropolitan authority for the development
and management of transportation and regional infrastructure in Australia. He notes
that decentralised governance structure established under tie bout model has some
drawbacks as it leads to fragmented local governments with large spillover benefits
and externalities. The mechanism of grants proposed under fiscal federalism does
not lead to the creation/supply of regional infrastructure per se. Therefore, he argues
the need for creating a metropolitan authority with clear mandate and financial
structure to overcome the problem

Lowery (2001) attempted to put the centralization and decentralization debate about
the metropolitan urban governance in the context of the USA and elsewhere. He
states that the earliest approach took the form of progressive reform movement that
argued for consolidated metropolitan governance. Subsequently, the public choice
theorists led by Tiebout argued for decentralized metropolitan governance as having
the advantages of competitive pressures and efficiency. However, as metropolitan
areas began to grow rapidly, there was more and more fragmentation – political,

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spatial and services/functions. Therefore, the centralized model got revived again
under the neo-progressive perspective. This is argued on two counts:

 Full information to citizens on government functions was assumed under

Tiebout model; however, in practice citizens do not have full information about
services and politicians take full advantage of it to act on their own interests.
 Citizens may engage in a dialogue or develop pressure on local government
with regard to provision of services rather than voting with their feet, as they
have some psychological attachment to the community they live in

Based on the study of DeHoog, Lyons and Lowery (1990), the author also notes that
the citizen satisfaction does not vary much with the type of governance structure.
Citizens are more satisfied when more public goods/services are provided, which
happens under consolidated government. Based on few other studies, Lowery
(2001) also argues that the variation in citizen satisfaction is higher in fragmented
governments rather than under consolidated government. He concludes that the
fragmentation effects are stronger under multiple local governments.

Fedako (2006) criticizes tiebout model for its unrealistic nature in comparison to the
real world. He cites the Austrian school’s (an unorthodox group) rejection of the
concept of local public goods. Unlike the assumption of improved public service
performance e.g., student performance in schools, and improved property taxes
under tiebout equilibrium, he criticizes that the property values are rather depressed
by tax rises; also, there is a lot of non-substitutability between the public services in
one location and another. In effect, tiebout effects do not exist in the real world.

Sadler and Highsmith (2016) argue that the water crisis in Flint city of Michigan State
is attributable to Tiebout phenomenon of ‘voting with feet’ that happened gradually
over time. It began with the flight of affluent white to the suburbia and forming the
suburban local governments that were planning better services and taxes. Flint city
not lost the affluent (white) population but also got erosion of taxes due to property
value decline. Consequently, the central city was with poor (black) population with
poor infrastructure and the suburban areas with rich (white) population and good
infrastructure. This result was tiebout sorting that led to fight between the city and

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suburbs for resources and infrastructure, and, in the absence of a regional authority,
it led to an iniquitous outcome and environmental injustice to the central city.

4. EMPIRICAL EXAMINATION OF TIEBOUT MODEL

Tiebout’s theory/model has generated a lot of interest and stimulated debate among
the academicians and practitioners. Several researchers have attempted to examine
the evidence of tiebout effects through their own studies in the context of the USA.
The following are some of the studies that examined tiebout’s model/theory in their
framework. This sample may appear small but may serve the purpose here, as it is
difficult to represent the wider range of studies (given a large number of them) that
examine it in terms of both theory as well as empirical evidence. Further, the
empirical evidence is mixed, as some of them confirm the propositions laid down
under tiebout model, whereas some of them refute it.

Oates (1969) is one of the foremost studies that examined the presence of evidence
for tiebout effects. Oates lays down that the consumer-voter’s choice of the
community, based on the property tax and public service bundle, can be observed
through the capitlisation effect of them i.e., property values accommodate and reflect
the mix of tax and local public goods of the community. Through a cross-sectional
study of 53 (suburban) municipalities in New York Metropolitan Region, he arrives at
the conclusion that property tax (measured as weighted tax rate) tends to have
depressed effect on property values, but local public goods positively affect them.
The net effect will depend upon the strength/ composition of the two, but it tends to
be positive, as the public goods benefits tend to outweigh tax costs.

Schneider (1989) performs the testing of tiebout’s hypothesis that competition

among alternate service providers (governments) will give rise to efficiency in terms
of check on tax price as well as restraint on budgetary spending (or, government
size). The author notes that the quasi-public goods nature of local goods/services

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and the limited number of service providers gives rise to imperfect competition
among them, which offers strong incentives to bureaucrats to maximize budget. He
uses cross-sectional data of 839 suburban municipalities in 39 metropolitan regions
of the USA to find the relationship between total expenditure per capita as a function
of local demand and competition while controlling for regional location. The results
vindicate ‘tiebout effects’ by showing that tax competition among local governments
limits budgets (or, government size) and also the presence of local governments –
both as neighbours and elsewhere in a metropolitan area – does limit budget.

Ashworth et al (2016) attempt to examine one of the propositions that political

competition leads to better local government performance by examining 308 local
governments of Flanders (Belgium). Efficiency, measured as outputs (local public
goods) to inputs (total expenditure) of local governments, is a function of: (i) Control
Variables (Demand, Budgetary context and Political Control) and (ii) Competition
variables (Electoral and Political competition). They find that Competition measured
in both variables affects efficiency but weaker in latter. They also note that the
fragmentation of governments works against competition.

Cost and Fernandes (2009) attempt to test ‘voting with feet’ model by examining
Porte metropolitan area of Portugal. They construct homogeneity index for the public
goods provided by local governments for 1981, 1991 and 2001. They examine the
trends and patterns of differentiation (opposite of homogeneity) in major provinces in
terms of (i) services provided (ii) socio-economic characteristics. They do not find
any trend or pattern of differentiation on local government services but only in terms
of socio-economic characteristics. The results do not point to reliable conclusions

Corcoran (2014) states that Tiebout sorting works in large metropolitan cities that
have a large number of jurisdictions to choose. He criticizes tie bout model for its
unrealistic assumptions of no constraints on residential choice and perfect
information about the quality and cost of public goods. He also points of another
study by Caroline Hoxby, whose results imply the predictions of ‘tie bout’ model i.e.,
test outcomes of students are high where tie bout type sorting conditions are high.

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Hassett et al (2012) revisit tiebout model/theory in the context of ‘competitiveness’
and argue that it can also be extended to sub-national and national governments.
Tiebout’s concept of voting with feet and competition also apply to them, as the firms
are foot loose now and consider competitive nations/states in the location choice.
The authors make a good survey of major empirical literature concerning tiebout
effects till date and analyze the empirical studies under the broad categories of:

(a) the tiebout competition and the efficiency of services

(b) the tiebout model and the housing market

(c) the tiebout model and the firm

(d) Is tiebout competition zero sum?

They also further classify the empirical studies in terms of the implications of tiebout
model such as housing, migration, efficiency of services and firm location decision.

5. CONCLUSIONS

Tiebout theory/model is perhaps the foremost proposal to explain the existence of

competitive market for provision of local public goods. This is akin to Adam Smith’s
model for private goods but also different from it. In tiebout model, consumer voter
signals his preference for the mix of local public goods (and tax) through ‘voting with
feet’ that invokes competition among local governments to provide those public
goods/services optimally using their costs and specialization. Although tiebout
theory/ model appears to be good theory, the real world is rather complex and some
of its assumptions are unrealistic. Tiebout himself cautioned about these limitations.
The critiques of tiebout model/theory point to the presence of scale economies and
agglomeration, cost advantages of regional production, information asymmetry to
citizen-voters and tax capitalization. Empirical evidence from the cities of Western
countries points to the presence (and lack of it) of tiebout effects. Certainly, tiebout
theory made strides in local public goods, especially by supporting decentralization.

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 REFERENCES

Ahrend R., A Lemboke and A Schumann (2016), ‘Why metropolitan governance matters a
lot more than you think’, Vox CEPR Policy Portal, January 2016 (Retrieved from
http://voxeu.org/article/why-metropolitan-governance-matters )
Ashworth, J., B, Greys, B Heyndels and F Wille (2006), ‘Political Competition and Local
Government Performance: Evidence from Flemish Municipalities’, Working Paper,
Berlin Social Science Centre, Berlin (Retrieved on March 3, 2016 at
https://www.wzb.eu/sites/default/files/personen/geys.benny.328/political_competition_
and_efficiency.pdf
Corcoran (2014), ‘Tiebout Sorting’, In, Encyclopedia of Education Economics and Finance,
Sage Publications, Inc (pp 787-788)
Costa, J D and R. Fernandes (2009), ‘The Tiebout Hypothesis and Local Governments
Specialization: The Case of Greater Porto’, Conference Paper, Cabo Verde Resdes e
Desenvolvimento Regional, June 9-11, 2009 (Retried from
www.apdr.pt/congresso/2009/pdf/Sessão%2019/14A.pdf )
Gordon, C (2013), ‘An economic theory perspective on optimal design of government of
regional infrastructure in Australia: the national transport’, Conference Paper,
Australian Conference of Economics 2013, Perth (Retrieved from
https://www.murdoch.edu.au/School-of-Business-and-
Governance/_document/Australian-Conference-of-Economists/An-economic-theory-
perspective-on-optimal-design-of-government.pdf )
Hassett, K A, Hubbard R G., and M H Jensen (2012), ‘Chapter 1: Tiebout and
Competitiveness’, in K A Hassett (Ed), Rethinking Competitiveness, The American
Enterprise Institute Press, Washington DC (pp 1-31)
Fedako, Jim (2006), ‘Voting with Our Feet? Local Government Services and the Supposed
Tiebout Effect’, Mises Institute, (Published on https://mises.org accessed on March 4,
2017)
LGF (2008), Local Government and the Provision of Public Goods, Local Government
Forum (LGF), New Zealand
Lowery, D (2001), ‘Metropolitan Governance Structures from a Neoprogressive Perspective’,
Swiss Political Science Review 7: 130-36
Sadler, R C and A R Highsmith (2016), Rethinking Tiebout: The Contribution of Political
Fragmentation and Racial/Economic Segregation to the Flint Water Crisis’,
Environmental Justice, Volume 9, Number 5, pp 143-151
Schneider, M (1989(, ‘Intermunicipal Competition, Budget-maximizing Bureaucrats and the
Level of Suburban Competition’, American Journal of Political Science, 33(3): 612-28
Oates, W. E. (1969), ‘The Effects of Property Taxes and Local Public Spending on Property
Values: An Empirical Study of Tax Capitalization and the Tiebout Hypothesis’, Journal
of Political Economy, Volume 77, No. 6, pp 957-971
Tiebout, C. M. (1956), ‘A Pure Theory of Local Expenditures’, The Journal of Political
Economy, Volume 64, No 5, pp 416-424

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