Richard Florida and Joel Kotkin have just published an article calling for urban devolution. I agree with their argument and have previously suggested that the future might involve a return to the city-state model. In the ensuing conversation, Michael Hoexter suggested that talk of urban devolution was pointless because “[w]ithout federal subsidies the ambitions of urban and regional planners will be fiscally stifled.” Of course he’s right – but I want to argue back to a logically prior premise.

Federal subsidies are a way to reallocate the tax burden to favor or disfavor selected constituents, locations, or activities. Subsidies can be made as direct expenditures or (as in increasingly common) through tax deductions or credits. But the ability and willingness of the federal government to tax is always prior and superior to the subsidy; the federal government might give New York City some money for public transportation or bridges, but you can be sure that the subsidy to NYC is less than the prior extraction from NYC.

In short I believe that an essential prerequisite for urban devolution is urban fiscal autonomy. There is much more to be said, but to strike while the iron is hot I offer three quick points:

  1. Cities are net losers in the federal tax and benefit allocation. Cities subsidize the tax burden of the rest of the country, yet politically have very little say in how that tax burden is applied. I haven’t been able to find city-level tax transfer rates (i.e., how much tax benefit is received for each tax dollar paid), but I do know that “rural states, on average, received $1.40 in federal spending for every tax dollar paid; urban states, on average, received $1.10.” I am virtually certain that the major cities would be net less than $1.00 received for every $1.00 paid. The answer is not to force the federal government to give more back to cities through subsidies. Instead, the answer is move to a model where cities can raise and spend more money locally. An extreme and unworkable version of this, just to illustrate: Give a dollar-for-dollar credit (not a deduction, a credit) against federal income tax for every dollar paid in local taxes. If the total tax burden on business and individuals is the same, presumably the rational urban citizen would prefer more of that burden, relatively speaking, to stay in her city rather than going to the federal government.
  2. Cities cannot control their revenue mix. Basic economic theory establishes that there is optimally efficient mix of revenue sources for any unit of government. Given the established options for local revenue sources (property tax, income tax, sales tax, accommodations and hospitality tax, business license, real estate transfer tax, utility revenues, etc.) each city has a slightly different optimal revenue mix. In my home state of South Carolina, Myrtle Beach (a vacation economy) would prioritize accommodations and hospitality taxes, Hilton Head (a real estate economy) would prioritize real estate transfer taxes, Charleston (an active tourism and increasingly a knowledge economy) would prioritize sales taxes, and so on. The point is that the right revenue mix raises enough to fund local government within the context of the particular type of activity that makes the city work. But because of state and federal control, cities have very limited options in designing their revenue mix.
  3. Cities cannot use revenue policy to incentivize or disincentivize behavior. The federal governments uses tax policy for two purposes – to raise revenue and to direct behavior. The mortgage interest deduction encourages home ownership, tax credits for solar panels encourage energy efficiency projects, the charitable donation deduction encourages private charity. None of those policies are designed to raise revenue. Again because of federal and state control, however, cities have very limited options to use the revenue-raising apparatus for behavioral interventions. For example: a huge problem in my city is that greenfield development is much cheaper and easier than infill development. So like most cities, we have a derelict and failing transitional zone between the city center and the newest outer suburbs. The transitional zone includes abandoned big box retail, 25-50 year old housing units, empty professional spaces. There is a very obvious policy to address the problem: we could charge ten times more for building permits for greenfield construction than we do for infill or rehabilitation construction. Except we can’t do that – by state law, the amount we charge for building permits cannot exceed the cost of service. Oops.

Again there is much more to say. But the main point is that fiscal autonomy is essential for any possible urban devolution. As it is, city residents overpay federal tax and underpay local tax, relative to benefits received; cities are forced into sub-optimal revenue mixes; and cities lack the most efficient and effective tools to channel local behavior.

The odd thing is that we seem to take urban fiscal limitations for granted. For example, I have participated in dozens or hundred of conversations about encouraging infill development over the years. Those conversations are always about zoning and land use interventions. I love planning and zoning, but those regulatory solutions are inherently less efficient, more costly, and more subject to exploitation by special interests than would be a simple fiscal tool like tiered costs for building permits.

I’ll elaborate further in future notes. For now, just an overview.

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