Tuesday, 14 October 2014

Charles Tiebout at 90

It escaped my notice that the man behind the Tiebout Model (short for "feet voting"), Charles M. Tiebout, would have turned 90 on Sunday last week had he had as long a life as his insights deserved. Alas, he died suddenly, in his 40's, in 1968, but I belatedly celebrate his memory with a blog post on the Tiebout Model, his most famous brain-child.

The Tiebout model says that perfect competition between local political jurisdictions ensures an efficient supply of public goods. Perfect competition here means that there are no costs of migration, so that if Town A has better street lights but a higher sales tax than Town B, those who do not mind paying more for their purchases while having more ample light on the streets move to Town A and the rest move to Town B.

Obviously perfect competition is unlikely to hold, but the essence of the Tiebout Model is hard to escape when looking around oneself. If a local community decides to tax high-income earners at a higher rate than low-income earners, it will quickly lose most of the former. This is not necessarily so if this is done at the country level where movement costs are greater (compare moving abroad to moving to the neighbouring municipality). This implication of the Tiebout Model is evident in the fact that the world looks pretty much like what Tiebout predicted. Local governments have little to offer high-income persons by way of services, so cannot really tax them as much as can nations.

Chances are that most readers of this blog post, if they have ever moved house, have based some part of their decision on the tax-services bundles available in their destinations under consideration. If so, they act according to the Tiebout Model, works in several other ways, too, including if local governments engage in the production of private goods, such as schooling: In a celebrated paper (gated) from the year 2000, Stanford Economist Caroline Hoxby shows that competition among public schools benefit school quality as judged by available measures and Professor Hoxby's ingenuity. This adds a great deal of relevance to the Tiebout Model since pure public goods are few and far between.

There are ways of attacking the Tiebout Model, of course. For instance, one could belabour its assumption of perfect mobility, which does not hold for land and buildings. However, this critique is only partially successful, because the value of such stationary objects depends on the quality of human genius that tries to make something out of it. If land is taxed a lot by one local government, it is apt not to be as well developed as the land in the neighbouring jurisdiction in which it is lightly taxed.

EconLog blogger and GMU Economics Professor Bryan Caplan, whose judgement I respect immensely, has challenged the Tiebout Model on the grounds that it really deals with non-profit competition, which fails to provide the necessary incentives for the Tiebout Model to hold:
"If a business owner figures out how to produce the same good at a lower cost, he pockets all of the savings.  If the CEO of a publicly-held corporation figures out how to produce the same good at a lower cost, he pockets a lot of the savings.  But if the mayor of a city figures out how to deliver the same government services for lower taxes, he pockets none of the savings.  That's how non-profits "work.""
I find his critique unconvincing. Armen Alchian pointed out in his classic paper 'Uncertainty, Evolution, and Economic Theory', that whatever an actor does will result in an enhancement or a reduction in his capacity to survive. Thus, if firms choose strategies randomly, those that come closest to maximizing profits survive and the others are successively eliminated, so that it looks like firms maximize profits in the end. Similarly, local governments may behave randomly and those who offer "good" tax-services packages will gain population at the expense of others.

There would have to be different incentives to behave "badly" for Tiebout competition not to work, but I don't see them. Probably failing local governments would attempt to learn from thriving ones. I am also unsure whether non-profit competition really is applicable to this case since politicians could be crooked (and probably frequently are) and thereby extract some tax theft from the population, which seems to give them an incentive to increase the tax base.

So to me, the Tiebout Model looks like it is holding up very well. Tiebout thought of it as a graduate student and had it published in 1956, so his brain-child would be 58 years old this year. Every parent should live to see his children, including brain-children, reach that age. It is a tragedy that Tiebout did not. I hope it gave him great satisfaction to imagine how economists and otherwise interested individuals might continue to experience many hours of deep spiritual joy from his work long after his demise which proved so untimely. I know he would not have been wrong.

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