Financing Cities

Cities and their surrounding suburban neighborhoods are economic growth agents. Not only do they provide public goods to satisfy the needs of urban residents, but they also supply local infrastructure to facilitate local and regional economic development. As Robert P. Inman argues in this paper, urban services and infrastructure must be efficiently provided; if they are not, the city’s economy will suffer from labor and capital flight, causing losses in productivity. Cities need to create the right incentives for service providers to pay close attention to the preferences of households and firms and the efficient provision of public goods. Inman discusses three conditions for achieving this goal.

First, city managers must get their fiscal responsibilities right. They should provide services that the private market cannot provide efficiently due to large fixed costs and benefit spillovers. These services include education for general skills, local transit and roadways, sanitation, and public safety. Income redistribution and internalization of spillovers that have significant spatial scale should not be included in the agendas of city governments.

Second, local service provision and taxation must be connected. Inman argues that cities should not collect non-residential commuter taxes, local retail sales taxes, or business income (or gross receipts) taxes to fund residential services. Rather residential wage taxes and user fees should be used to finance residential services. Ideally, a business land tax and user fees should be used to finance business services. For infrastructure services, long-term debt financing is the right tool.

Third, city governance matters. Cities need managerial control over their workers to avoid the monopoly power of public unions over local service provision. A strong mayor who can discipline narrow-interest politics and labor unions may, however, make inefficient fiscal choices. Council governance could be an alternative institutional arrangement, but might also create political gridlock. In either case, citizens must be motivated to remove from office officials who waste tax dollars. Implicit in Inman’s discussion is that city governance reform could enhance efficiency, allowing cities to provide the same level of local services at lower costs. As more believe “a crisis is a terrible thing to waste,” the current fiscal crisis may create an opportunity for city officials to re-examine their spending and revenue-generating practices.

This paper was presented at the Lincoln Institute’s Land Policy Conference of 2009 and is Chapter 2 of the book Municipal Revenues and Land Policies.