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

Author

Listed:
  • Thomas J. Holmes
  • Lee E. Ohanian

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

  • Thomas J. Holmes & Lee E. Ohanian, 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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    References listed on IDEAS

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    Cited by:

    1. R. Warren Anderson, 2018. "The Detroit Discontinuity," Homo Oeconomicus: Journal of Behavioral and Institutional Economics, Springer, vol. 35(3), pages 167-184, September.

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    Keywords

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    JEL classification:

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

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