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On Fiscal Illusion in Local Public Finance: Re-Examining Ricardian Equivalence and the Renter Effect

Listed author(s):
  • H. Spencer Banzhaf
  • Wallace E. Oates

We reevaluate fiscal illusion in local public finance. The Ricardian Equivalence Theorem suggests that the financing of a public program using either taxation or debt shouldn’t affect outcomes, because debt is capitalized into property values. In contrast, we show individuals may rationally prefer public debt if governments can borrow on more favorable terms. We also propose a new test for the renter effect: controlling for differences in demand, the renter effect suggests renters prefer property taxes to sales taxes. Using data from U.S. open space referenda, we find that households do prefer debt financing, but find no evidence of the renter effect.

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Article provided by National Tax Association in its journal National Tax Journal.

Volume (Year): 66 (2013)
Issue (Month): 3 (September)
Pages: 511-540

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Handle: RePEc:ntj:journl:v:66:y:2013:i:3:p:511-540
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  3. Kotchen, Matthew J. & Powers, Shawn M., 2006. "Explaining the appearance and success of voter referenda for open-space conservation," Journal of Environmental Economics and Management, Elsevier, vol. 52(1), pages 373-390, July.
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  12. Dollery, Brian E & Worthington, Andrew C, 1996. " The Empirical Analysis of Fiscal Illusion," Journal of Economic Surveys, Wiley Blackwell, vol. 10(3), pages 261-297, September.
  13. Kenneth Y. Chay & Michael Greenstone, 2005. "Does Air Quality Matter? Evidence from the Housing Market," Journal of Political Economy, University of Chicago Press, vol. 113(2), pages 376-424, April.
  14. Leeds, Michael A., 1985. "Property values and pension underfunding in the local public sector," Journal of Urban Economics, Elsevier, vol. 18(1), pages 34-46, July.
  15. Nelson, Erik & Uwasu, Michinori & Polasky, Stephen, 2007. "Voting on open space: What explains the appearance and support of municipal-level open space conservation referenda in the United States?," Ecological Economics, Elsevier, vol. 62(3-4), pages 580-593, May.
  16. Richard Wagner, 1976. "Revenue structure, fiscal illusion, and budgetary choice," Public Choice, Springer, vol. 25(1), pages 45-61, March.
  17. Guido W. Imbens, 2004. "Nonparametric Estimation of Average Treatment Effects Under Exogeneity: A Review," The Review of Economics and Statistics, MIT Press, vol. 86(1), pages 4-29, February.
  18. Oates, Wallace E., 2005. "Property taxation and local public spending: the renter effect," Journal of Urban Economics, Elsevier, vol. 57(3), pages 419-431, May.
  19. Smith, V Kerry & Huang, Ju-Chin, 1995. "Can Markets Value Air Quality? A Meta-analysis of Hedonic Property Value Models," Journal of Political Economy, University of Chicago Press, vol. 103(1), pages 209-227, February.
  20. Oded Palmon & Baron A. Smith, 1998. "New Evidence on Property Tax Capitalization," Journal of Political Economy, University of Chicago Press, vol. 106(5), pages 1099-1128, October.
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  23. David Stadelmann, 2012. "Consequences of Debt Capitalization: Property Ownership and Debt versus Tax Choice," Southern Economic Journal, Southern Economic Association, vol. 78(3), pages 976-998, January.
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