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Pay with Promises or Pay as You Go? Lessons from the Death Spiral of Detroit

Author

Listed:
  • Holmes, Thomas J.

    (Federal Reserve Bank of Minneapolis)

  • Ohanian, Lee E.

    (Federal Reserve Bank of Minneapolis)

Abstract

As part of compensation, municipal employees typically receive promises of future benefits. Motivated by the recent bankruptcy of Detroit, we develop a model of the equilibrium size of a city and use it to analyze how pay-with-promises schemes interact with city growth. The paper examines the circumstances under which a death spiral arises, where cutbacks of city services and increases in taxes lead to an exodus of residents, compounding financial distress. The model is put to work to analyze issues such as the welfare effects of having cities absorb pension risk and how unions affect the likelihood of a death spiral.

Suggested Citation

  • Holmes, Thomas J. & Ohanian, Lee E., 2014. "Pay with Promises or Pay as You Go? Lessons from the Death Spiral of Detroit," Staff Report 501, Federal Reserve Bank of Minneapolis.
  • Handle: RePEc:fip:fedmsr:501
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    File URL: http://www.minneapolisfed.org/research/sr/sr501.pdf
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    References listed on IDEAS

    as
    1. Thomas Buchmueller & John Dinardo, 2002. "Did Community Rating Induce an Adverse Selection Death Spiral? Evidence from New York, Pennsylvania, and Connecticut," American Economic Review, American Economic Association, vol. 92(1), pages 280-294, March.
    2. Marco Bassetto & Leslie McGranahan, 2009. "On the relationship between mobility, population growth, and capital spending in the United States," Working Paper Series WP-09-25, Federal Reserve Bank of Chicago.
    3. Barro, Robert J, 1979. "On the Determination of the Public Debt," Journal of Political Economy, University of Chicago Press, vol. 87(5), pages 940-971, October.
    4. Gyourko, Joseph & Tracy, Joseph, 1989. "On the political economy of land value capitalization and local public sector rent seeking in a Tiebout model," Journal of Urban Economics, Elsevier, vol. 26(2), pages 152-173, September.
    5. James A. Schmitz Jr., 2005. "What Determines Productivity? Lessons from the Dramatic Recovery of the U.S. and Canadian Iron Ore Industries Following Their Early 1980s Crisis," Journal of Political Economy, University of Chicago Press, vol. 113(3), pages 582-625, June.
    6. Xavier Gabaix, 1999. "Zipf's Law for Cities: An Explanation," The Quarterly Journal of Economics, Oxford University Press, vol. 114(3), pages 739-767.
    7. Inman, Robert P., 1982. "Public employee pensions and the local labor budget," Journal of Public Economics, Elsevier, vol. 19(1), pages 49-71, October.
    8. Dennis Epple & Katherine Schipper, 1981. "Municipal pension funding: A theory and some evidence," Public Choice, Springer, vol. 37(1), pages 141-178, January.
    9. Gyourko, Joseph & Tracy, Joseph, 1989. "Local public sector rent-seeking and its impact on local land values," Regional Science and Urban Economics, Elsevier, vol. 19(3), pages 493-516, August.
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    More about this item

    Keywords

    City growth; Pay with promises; Death spiral; Defined benefit pension plans; Retiree health benefits; Detroit;

    JEL classification:

    • H20 - Public Economics - - Taxation, Subsidies, and Revenue - - - General
    • H75 - Public Economics - - State and Local Government; Intergovernmental Relations - - - State and Local Government: Health, Education, and Welfare
    • R23 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Household Analysis - - - Regional Migration; Regional Labor Markets; Population
    • R51 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Regional Government Analysis - - - Finance in Urban and Rural Economies

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