Household Mobility and Local Government Finance in U.S. Cities

In this paper, we examine how household mobility is affected by the choice of local government finance method (taxation versus debt finance) for U.S. cities. We develop a discrete time dynamic optimization model that implies the optimal strategy for a resident household is to remain in the city during periods of debt finance and move out when future tax liabilities come due. The optimal strategy for households outside the city is to avoid moving into a city that is paying off past debt with high current taxes. To investigate the degree to which tax and debt policy affect household relocation decisions we estimate empirical models of in- and out-migration for a panel dataset of 150 Fiscally Standardized Cities between 2007 and 2012. Results indicate that although both increases in debt finance and taxes are associated with greater out-migration, the tax effects are much stronger. Further, higher current taxes have large negative effects on in-migration whereas debt finance has insignificant effects. The importance of these results is that the equivalence of taxation and debt finance suggested by the Ricardian Equivalence Theorem does not hold for U.S. cities. The observed difference is due to the greater salience of taxes relative to the implied future tax liabilities associated with debt financing. The lack of equivalence follows directly from optimizing behavior with full current information in the presence of household mobility.