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

  • Holmes, Thomas J.

    (Federal Reserve Bank of Minneapolis)

  • Ohanian, Lee E.

    (Federal Reserve Bank of Minneapolis)

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.

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File URL: http://www.minneapolisfed.org/research/sr/sr501.pdf
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Paper provided by Federal Reserve Bank of Minneapolis in its series Staff Report with number 501.

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Length: 31 pages
Date of creation: 14 Jul 2014
Date of revision:
Handle: RePEc:fip:fedmsr:501
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  1. Dennis Epple & Katherine Schipper, 1981. "Municipal pension funding: A theory and some evidence," Public Choice, Springer, vol. 37(1), pages 141-178, January.
  2. Xavier Gabaix, 1999. "Zipf'S Law For Cities: An Explanation," The Quarterly Journal of Economics, MIT Press, vol. 114(3), pages 739-767, August.
  3. Marco Bassetto & Leslie McGranahan, 2011. "On the Relationship Between Mobility, Population Growth, and Capital Spending in the United States," NBER Working Papers 16970, National Bureau of Economic Research, Inc.
  4. 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.
  5. Inman, Robert P., 1982. "Public employee pensions and the local labor budget," Journal of Public Economics, Elsevier, vol. 19(1), pages 49-71, October.
  6. Joseph Gyourko & Joseph S. Tracy, 1986. "On the Political Economy of Land Value Capitalization and Local Public Sector Rent-Seeking in a Tiebout Model," NBER Working Papers 1919, National Bureau of Economic Research, Inc.
  7. 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.
  8. Thomas Buchmueller & John DiNardo, 1999. "Did Community Rating Induce an Adverse Selection Death Spiral? Evidencefrom New York, Pennsylvania and Connecticut," NBER Working Papers 6872, National Bureau of Economic Research, Inc.
  9. Barro, Robert J, 1979. "On the Determination of the Public Debt," Journal of Political Economy, University of Chicago Press, vol. 87(5), pages 940-71, October.
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