Sorting and voting: A review of the literature on urban public finance

This chapter reviews the literature on the boundary between urban economics and local public finance, defined as research that considers both a housing market and the market for local public services. The first part of the chapter considers positive theories. This part presents the consensus model of the allocation of households to jurisdictions, which is built on bid functions and household sorting, as well as alternative approaches to this issue. It also examines models of local tax and spending decisions, which exhibit no consensus, and reviews research in which both housing and local fiscal variables are endogenous. The second part of the chapter considers empirical research, with a focus on tax and service capitalization, on household heterogeneity within jurisdictions, and on the impact of zoning. The third part considers normative theories about a decentralized system of local governments. This part examines the extent to which such a system leads to an efficient allocation of households to communities or efficient local public service levels, and it discusses the fairness of local public spending. This review shows that the bidding/sorting framework is strongly supported by the evidence and has wide applicability in countries with decentralized governmental systems. In contrast, models of local public service determination depend on institutional detail, and their connections with housing markets have been largely unexplored in empirical work. Ever since Tiebout (1956), many scholars have argued that decentralized local governments have efficiency advantages over centralized forms. However, a general treatment of this issue identifies four key sources of inefficiency even in a decentralized system: misallocation of households to communities, the property tax, public service capitalization and heterogeneity. Few policies to eliminate these sources of inefficiency have yet been identified. Finally, this review explores the equity implications of household sorting and other features of a decentralized system.