Tuesday, August 29, 2006

Urban Sprawl (Part 2)

Reasons 5 through 9:


Economist Charles Tiebout pioneered the idea that local units of government compete with each other for citizens. Specifically, he argued that local officials put forward packages of services in return for a given tax level, in the hope of attracting people and capital to their communities. This theory is supported by empirical evidence suggesting that people respond to service packages. Although it is often suggested that people seek to avoid taxes at all costs, work by Therese McGwire, Michael Wayselenko, and others has shown that people do prefer communities with better services, and tend to move to cities that provide the services they want at the lowest possible tax costs.
This competition puts newer cities at an advantage relative to their older counterparts. First, old cities’ infrastructures tend to be old and often inadequate, and replacing infrastructure is very expensive. Newer cities can offer better infrastructure at lower cost. Second, and perhaps more importantly, newer cities have often used land regulation to prevent the construction of low-priced housing. Old cities, on the other hand, have large amounts of old (low-priced) housing, which tends to attract low-income owners and tenants. Low-income people, who require a disproportionately large share of public services, are therefore concentrated in central cities. This concentration of individuals drawing on public resources puts central cities at a fiscal disadvantage as they try to offer “middle-class” benefits.
Newer cities, on the other hand, can provide these services at lower levels of taxes. Lower taxes attract the middle class, a migration that further increases the concentration of poverty in the older cities, which in turn worsens the older cities’ competitive position. Edward Glaeser argues that, because of this middle class exodus, higher levels of government (perhaps the federal government) should take responsibility for income redistribution and social services spending if older central cities are ever to become more competitive.
To make matters worse, older cities have often been run by politicians who are overtly hostile to private development in their jurisdictions’ central areas. This hostility stands in contrast to newer cities, which provide low tax rates on industrial parks and use tax-increment financing (TIF) to stimulate business development. Older cities are already at a fiscal disadvantage relative their less aged counterparts. But when the political class that runs an older city erects hoops (such as “pay-to-play” in Philadelphia) through which businesses must jump before they are allowed to develop, the fiscal disadvantages of the community grow even larger and harm the city and its residents.


Racial discrimination remains a central fact in U.S. housing markets; the statistical evidence, while in itself not conclusive, is nevertheless overwhelming. Leaving aside, for the moment, the moral repugnance of discrimination, discriminatory behavior is harmful because it generates perverse incentives, thus producing economically unappealing outcomes. One unwanted outcome is unnecessary sprawl. For example, “white flight,” by definition, requires development of land that would not be developed absent race related behavior. And while discrimination may have become a less pervasive element of individual minority group members’ treatment in the housing arena, the rising share of minorities in American society means that discrimination could become an increasingly destructive feature of the housing market in the years to come.
Consequently, one of the most important things that governments wishing to attack sprawl can do is to vigilantly and strictly enforce fair housing laws. After more than 30 years of federal fair housing laws, we still observe widespread patterns of discrimination and segregation, as numerous credible studies have shown. As time passes, it becomes clearer that testing is likely the only effective mechanism for enforcement. Testing involves sending equally financially qualified white and minority buyers and tenants into the housing market, and determining whether they are disparately treated. Disparate treatment implies discrimination, and thus is illegal. Putting widespread testing into practice is a severe and expensive means of enforcing fair housing laws, but if we, as a society, are serious about eliminating the blot of housing discrimination, we must do something serious in response.


From at least one perspective, redeveloping at the city center always has a disadvantage relative to new development at the urban periphery: the cost of land assembly. Suppose that a company is considering where to locate a new manufacturing facility. If it can get zoning approval from the local government to develop at the periphery, then the company can negotiate an option to purchase from one landowner, typically a farmer. If the farmer will not sell at a price that is agreeable, then the developer of the facility can find another place to locate. By contrast, city centers tend to be characterized by any small parcels owned by different people. As a result, the owners of the last few parcels needed by a developer have monopoly power in setting price. Once the developer has bought the majority of parcels she needs, she may not be in a position to walk away from outrageous asking prices sought by a few holdout owners whose land is needed for the assembly to be complete. The periphery has another substantial advantage over the central city: property on the periphery is generally environmentally “clean,” while central city parcels often require costly environmental cleanups.


Federal tax policy has generally favored development on the periphery of cities. A striking example is the mortgage loan interest deduction (MID), which lets a household deduct home loan interest from ordinary income in determining its federal income tax liability. The MID is a residual part of the original tax laws; it was not designed to stimulate housing: the original 1913 federal income tax code allowed for deducting all consumer interest. It was the Tax Reform Act of 1986 that phased out consumer interest deductions, with one prominent exception: interest on a home mortgage loan. [Ed note: Add note here to update the state of MID.]
Yet the MID has done little to promote home ownership. The reason is that for those at the margin of home owning, the MID is not worth very much. Someone who pays little in property and state income tax might find that, even with the MID, the standard deduction is more valuable than itemization. Even for those who itemize, the MID can have little value, because the typical marginal federal income tax rate for low to moderate income families is 10 percent: each dollar paid in home mortgage loan interest is worth a mere 10 cents in tax relief. Contrast this situation with that faced by those higher up the income scale, where each dollar of deduction is worth between 25 cents and 45 cents, depending on the marginal tax rate. Of course, households with higher incomes are likely to own their homes regardless of the tax treatment of mortgage loan interest. Note that in Canada and Australia, countries without mortgage loan interest deductions, home ownership rates are quite similar to the rate in the United States.
On the other hand, the MID encourages high-income households to buy more expensive homes than they otherwise would, because the size of the implicit subsidy increases for costlier residences, up to a point (interest can be deducted only on up to $1.1 million of home loan debt). More expensive houses generally sit on larger lots than do less expensive homes. The tax code’s encouragement for buying relatively expensive houses therefore contributes to sprawl.
The tax treatment of parking had a more subtle effect. A firm on the Chicago periphery, where land was relatively cheap, could pave some acreage and provide free parking for its employees, a benefit on which users pay no income tax. Workers in the Loop, on the other hand, typically paid to park, a cost the IRS viewed as personal and therefore not deductible. (Parking in major downtown areas is uniformly expensive since the opportunity cost of land is too high to allow workers to park cheaply.) All things being equal, the suburban employee is better off. The implication was that the tax treatment of parking gives firms incentives to locate on the periphery, where land is cheap, rather than in city centers. This incentive was largely neutralized with the Tax Act of 1998, which went into effect in 1999.


I have already discussed how newer communities use land use regulation to prevent settlement by low income households, and how this activity contributes to sprawl. But even seemingly innocuous land use regulations can cause more land to be used than is necessary to house a given number of people. These regulations fall into a variety of categories, including setback, minimum lot size, street width, and, ironically, green space requirements. Simply put, all of these policies reduce the number of housing units that can be placed within a particular land area, in turn reducing population density, which, perforce, creates sprawl. World Bank planner Alain Bertaud has shown how seemingly small changes in these regulations can have a large impact on the number of housing units that can be fit into a particular land mass.


Sprawl has a variety of causes, some benign and others malignant. If policy makers are truly concerned about the malignant underpinnings of sprawl—discrimination, fiscal zoning, transportation that imposes social costs, federal tax policy, and regulations that needlessly consume land for residential development—then they will deal with these causes directly. Otherwise, we will know that they, and their voting constituents, are content with the way things are.


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