On Ricardian Equivalence in Local Public Finance

Banzhaf , H. Spencer; Oates, Wallace E.

doi:10.2139/ssrn.1248002

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On Ricardian Equivalence in Local Public Finance

34 Pages Posted: 23 Aug 2008

See all articles by H. Spencer Banzhaf

H. Spencer Banzhaf

North Carolina State University - Department of Agricultural & Resource Economics; PERC - Property and Environment Research Center; National Bureau of Economic Research (NBER)

Wallace E. Oates

University of Maryland - Department of Economics; Resources for the Future

Date Written: June 25, 2008

Abstract

The Ricardian Equivalence Theorem establishes a set of conditions under which the form of finance of a public program (tax or debt finance) has no effects on any substantive outcomes. Following Barro (1974), the theorem has typically been formulated in the context of a national government in an intergenerational model of altruistic individuals, in which the impact of debt finance is offset by increased private saving. However, Ricardian equivalence can also be established in a setting of local public finance. Here, its rationale is entirely different. It results not from altruistic behavior, but from the operation of local land markets under which local fiscal differentials are capitalized into local property values. In this paper, we provide a proof of this latter form of Ricardian equivalence in terms of a simple multi-period model of local government finance. We then explore its relevance to local public finance. We find that it is quite restrictive in certain respects. In particular, in the U.S, context, where the interest income from state and local bonds is exempt from federal income taxation, we argue that rational behavior may be inconsistent with Ricardian equivalence. Finally, after reviewing some earlier evidence, we present some new findings from an econometric analysis of local referenda in the U.S. for the conservation of open space that reveal a preference on the part of electorate for local bond finance over tax finance.

Keywords: Ricardian Equivalence, Taxes, Debt, Open Space, Conservation

JEL Classification: H20, H31, H40, Q38

Suggested Citation: Suggested Citation

Banzhaf, H. Spencer and Oates, Wallace, On Ricardian Equivalence in Local Public Finance (June 25, 2008). Available at SSRN: https://ssrn.com/abstract=1248002 or http://dx.doi.org/10.2139/ssrn.1248002