Members of the 

U.S. Advisory Commission on Intergovernmental Relations 

(April 1991) 

Private Citizens 

Daniel J. Elazar, Philadelphia, Pennsylvania 

Robert B. Hawkins, Jr., Chairman, San Francisco, California 

Mary Ellen Joyce, Arlington, Virginia 

Members of the U.S. Senate 

Dave Durenberger, Minnesota 

Carl Levin, Michigan 

Charles S. Robb, Virginia 

Members of the U.S. House of Representatives 

Sander M. Levin, Michigan 

Ted Weiss, New York 

Vacancy 

Officers of the Executive Branch, U.S. Government 

Debra Rae Anderson, Deputy Assistant to the President, 

Director of Intergovernmental Affairs 

Samuel K. Skinner, Secretary of Transportation 

Richard L. Thornburgh, Attorney General 

Governors 

John Ashcroft, Missouri 

Booth Gardner, Washington 

George A. Sinner, North Dakota 

Stan Stephens, Montana 

Mayors 

Victor H. Ashe, Knoxville, Tennessee 

Robert M. Isaac, Colorado Springs, Colorado 

Joseph A. Leafe, Norfolk, Virginia 

Vacancy 

Members of State Legislatures 

David E. Nething, North Dakota Senate 

Samuel B. Nunez, Jr., President, Louisiana Senate 

Ted L. Strickland, Colorado Senate 

Elected County Officials 

Harvey Ruvin, Dade County, Florida, County Commission 

Sandra R. Smoley, Sacramento County, California, Board of Supervisors 

James J. Snyder, Cattaraugus County, New Yo&, County Legislature 
Interjurisdictional 

Tax and Policy Competition: 

Good or Bad 

for the Federal System? 

Advisory Commission on 

Intergovernmental Relations 

M-I 77 

April 1991 
U.S. Advisory Commission on 

Intergovernmental Relations 

1111 20th Street, NW 

Suite 2000 

Washington, DC 20575 

(202) 653-5640 

FAX (202) 653-5429 

11 
Abstract 

... 

111 

Interjurisdictional competition has captured public 

attention in recent years, mostly because of highly 

publicized “bidding wars” for job

-producing facilities, 

such as automobile plants. Consequently, competition is 

as controversial as ever. 

Interjurisdictional competition, that is, interstate and 

interlocal competition, has again become a public policy 

issue because cooperative federalism has been jolted by 

the fiscal crisis of the federal government, declining 

federal aid to state and local governments (i.e., from 26.5 

percent of state-local outlays in 1978 to 17.5 percent in 

1990), the effects of federal tax reform on state and local 

governments, regional booms and busts in economic 

activity, interjurisdictional mobility of citizens and business firms, interstate business activity, and heightened 

competition from abroad. All of these factors have 

accentuated the competitive dynamics that are inherent 

in our democratic federal system. 

Twenty years ago, the consensus view of the effects of 

interjurisdictional competition, especially tax competition, was generally negative. Today, however, many 

analysts hold a more benign as well as a broader view of 

interstate and interlocal competition. In this report, 

therefore, the Advisory Commission on Intergovernmental Relations (ACIR) reviews the research on interjurisdictional tax and policy competition that has become 

available since 1981, when the Commission last looked at 

the subject, and examines the extent to which competition 

appears to have harmful or beneficial effects on efficiency 

and equity in the federal system. Some key findings of the 

report are as follows: 

Although the existence of interstate and interlocal competitioe is often noted by observers of American federalism, there 

is no explicit or comprehensive definition of competition 

umonggovenzments. One definition is that competition involves rivalry among governments in which each is trying 

to win some scarce beneficial resource (e.g., a high

-tech 

firm) or is seeking to avoid a particular cost (e.g., a hazardous waste dump). Another definition of interjurisdictional 

competition is the manner in which the free movement of 

goods, services, people, and capital constrains the actions 

of state and local governments (e.g., the ability of a jurisdiction to levy a tax or charge without driving out citizens 

or businesses). 

mere is no definitive evidence that intqhisdictional competition has been increasing in recent years. This lack of evidence is due in part to definitional and measurement 

problems, which make it difficult to determine levels and 

types of Competition. 

Efhorts to use targeted tax incentives to attract mobile industry are still viewed negatively by most public finance experts. Criticism of this form of tax competition rangesfrom 

the argument that it amounts to a zero

-sum game, if not a 

negative

-sum game, for the whole nation to the conclusion that state and local spending on negotiated tax packages often exceeds the benefits derived from new jobs, 

sales, and services. 

Tax competition involves more than targeted tux incentives. It also involves competition with respect to overall 
tax levels, the levels of specific taxes, and the incentives 

and disincentives built into the general tax structure of a 

state or local jurisdiction. 

Interjurisdictional competition, moreovec includes more 

than taxcompetition. It also involves competition in service 

provision, regulation, and other public policy matters. 

Contrary to the traditional view, interjurisdictional competition does not always create pressure to hold down government spending; it also can create pressure on state and local 

governments to increase spending, and therefore to raise taxes 

or charges. To be economically competitive, for example, 

states and localities find it necessary to have systems of 

education and infrastructure that are equal to or better 

than those of their near and distant competitors. 

Interjurisdictional competition, therefore, may be an important regulator of the federal system. Just as market competition produces an economic system responsive to 

consumer demands, interjurisdictional competition can 

produce a government system in which taxes and policies 

are brought into line with citizen preferences. 

At the same time, interjurisdictional competition is not 

always beneficial or always harmful. Costs and benefits vary 

with different types and fields of competition. Certain 

types of competition (e.g., improvements in education 

performance) have beneficial spillovers for neighboring 

jurisdictions, while other types of competition (e.g., lax 

pollution control) have harmful spillovers. 

Interjurisdictional competition does have a tendency to 

reduce state and local reliance on ability-to-pay taxes (eg, a 

progressive income tax). There is pressure to rely on benefit 

taxes, that is, taxes paid by individuals and businesses to 

support those services from which they perceive positive 

benefits. This tendency raises equity issues with respect to 

the ability of state and local jurisdictions to redistribute income and provide services to residents having lesser ability to pay for services. 

Interjurisdictional competition, therefore, involves complex interactions and trade-ofis between efficiency, equity, 

responsiveness, and accountability in the federal system. 

Competitive actions that increase efficiency may decrease 

equity and vice versa. Hence, evaluations of the beneficial 

and harmful effects of competition depend to a great extent on how one weights the values of efficiency, equity, 

responsiveness and accountability, and on how one thinks 

those values can be realized best in the public sector. 

Interjurisdictional competition, however, does not occur 

in a vacuum. The federal government stimulates, impedes, 

and regulates interstate and interlocal competition in numerous ways. Many federal policies-domestic, foreign, and 

military-have advantages and disadvantages for different states and localities. Some observers also argue, for 

example, that federal redistributive policies can encourage more beneficial interjurisdictional competition by allowing its efficiency outcomes to come into play while 

compensating for the ill effects of competition on equity. 

Any evaluation of competition among states and local 

governments must consider the costs and benefits of the alternatives to competition. These alternatives include cooperation, coordination, cooptation, collusion, and coercion. 

Cooperation and coordination are the preferred alternatives in American federalism, although competition, such 

as that in the marketplace, also can produce cooperation 

and coordination. 

Competition and cooperation, therefore, are not mutually 

ewclusive facets of the federal system. Both have a role in a 

healthy and prosperous federal system, and a certain tension 

between them is useful for keeping our eyes fixed on how 

they contribute to the realization of the values of federalism. 

Furthermore, competition and cooperation can work together for certain ends. For example, while states and localities compete individually in the international economy, they 

also cooperate to make the nation as a whole more competitive in the face of global interjurisdictional competition. 

iv 
Acknowledgments 

The principal investigator for this project and author 

of the report is Daphne A. Kenyon, Assistant Professor of 

Economics at Simmons College. The assistance and 

advice of many people also were invaluable in the 

preparation of this report. 

Helpful participants at the September 14, 1987, 

thinkers’ session and the January 22, 1988, critics’ session 

included Wayne Anderson, George Mason University; 

Robert Aten, Office of Regional Economics, US. 

Department of the Treasury; Enid Beaumont, Academy 

for State and Local Government; Gerard Brannon; 

Albert Breton, Department of Economics, University of 

Toronto; William R. Brown, Council of State Chambers of 

Commerce; William G. Colman; Warren Deschenaux, 

Maryland Department of Fiscal Services; James S. 

Dwight, Deloitte, Haskins & Sells; William A. Fischel, 

Department of Economics, Dartmouth College; Fred 

Ferguson, Office of Government Services, Price Waterhouse; Roy Hart, Prince George’s County Office of the 

County Executive; Harold A. Hovey; Susan Lauffer, 

White House Office of Intergovernmental Affairs; E. 

Blaine Liner, The Urban Institute; Michael McKee, 

Quick, Finan; James Martin, National Governors’ Association; William A. Niskanen, Cato Institute; Daniel Payne, 

Virginia Department of Taxation; Andrew Reschovsky, 

Department of Economics, Tufts University; Robert M. 

Schwab, Resources for the Future; Ralph 7abor, National 

Association of Counties; Clifford Tuck, U.S. General 

Accounting Office; Susan White, National Association of 

Counties; Chris Zimmerman, National Conference of State 

Legislatures; and Dennis Zimmerman, Economics Division, 

Congressional Research Service, Library of Congress. 

The joint conference held by ACIR and The Urban 

Institute on March 23 and 24,1988, entitled “Interjurisdictional Tax and Policy Competition: Good or Bad for the 

Federal System?” stimulated a productive exchange of 

ideas, many of which are reflected in this report. 

Participants included Roy W. Bahl, Georgia State University; Albert Breton, University of Toronto; Warren T 

Brookes, Detroit News; John E. Chubb, The Brookings 

Institution; Robert D. Ebel, U.S. ACIR; Daniel J. Elazar, 

Temple University; Ronald C. Fisher, Michigan State 

University; R. Scott Fosler, Committee for Economic 

Development; Steven D. Gold, National Conference of 

State Legislatures; John Kincaid, U.S. ACIR; Helen F. 

Ladd, Duke University; E. Blaine Liner, State Policy 

Center, The Urban Institute; Therese J. McGuire, 

Northwestern University; William A. Niskanen, Cato 

Institute; Dick Netzer, New York University; Nonna A. 

Noto, Congressional Research Service, Library of Congress; Wallace E. Oates, University of Maryland; Robert 

W. Rafuse, Jr., U.S. Department of the Treasury: Andrew 

Reschovsky, Tufts University; Robert W. Schwab, University of Maryland; John Shannon, The Urban Institute; 

Frederick D. Stocker, National Tax Association-Tax 

Institute of America; Robert Tannenwald, Federal Reserve Bank of Boston; and Deil S. Wright, University of 

North Carolina, Chapel Hill. Papers from this conference 

will be published by The Urban Institute Press in mid-1991 

V 
as Competition among States and Local Governments: Ejiciency and Equity in American Federalism. 

This report also benefited from the views expressed at 

the roundtable discussion “Competition: Good or Bad for 

the Federal System?” held by the ACIR on March 25, 

1988. Participants included Albert Breton, University of 

Toronto; Dan R. Bucks, Multistate ?ax Commission; 

Pams N. Glendening, County Executive, Prince George’s 

County, Maryland; William A. Niskanen, Cat0 Institute; 

and Richard D. Pomp, University of Connecticut. 

Timothy J. Goodspeed, U.S. Department of the 

Treasury; Michael Wolkoff, University of Rochester; and 

George A. Sinner, Governor of North Dakota, also 

provided helpful comments. 

Finally, expert supervision at various stages of the 

project was provided by Robert D. Ebel, then Director of 

Government Finance Research at ACIR. 

The Commission and its staff are grateful to 

Professor Kenyon and to all who contributed advice and 

criticism, but, of course, retain full responsibility for the 

content of the report. 

John Kincaid 

Executive Director 

vi 
Contents 

Chapter 1 .-Introduction and Summary of Major Findings ................................................ 

Why Study Interjurisdictional Competition? ............................................................. Research Objectives .................................................................................. Design of the Report ................................................................................. Summary of Major Findings ........................................................................... 

Chapter 2-What Is Interjurisdictional Competition and How Can It Be Measured? ......................... 

Definitions of Competition ............................................................................ Active Rivalry ................................................................................... Implicit Competition ............................................................................. 

Alternatives to Competition ........................................................................... Applying the Economic Concept of Market Competition to Governments .................................. Market Analogy .................................................................................. Competition in Economic Theory .................................................................. TheTiebout Model ............................................................................... Competition as Regulator of the Federal System ..................................................... A Dynamic Theory of Economic Competition ....................................................... The Link between Market Structure. Conduct. and Performance ...................................... Market Failure ................................................................................... 

Factors Affecting the Degree of Competition among Governments ........................................ 

The Relationship between Competition and Diversity .................................................... Measuring the Degree of Interjurisdictional Competition ................................................. Is Interjurisdictional Competition Increasing or Decreasing? .............................................. 

How Competition Is Likely to Vary by Type of Government ............................................... 

Conclusion .......................................................................................... 

Chapter 3-The Federal Government’s Role in Setting the Framework for Interjurisdictional Competition ..... 

The United States Constitution ....................................................................... The Supreme Court ................................................................................. 

Nexus ........................................................................................... Fair Apportionment .............................................................................. Nondiscrimination against Interstate Commerce ..................................................... 

Federal Laws and Regulations ......................................................................... Federal Mandates ................................................................................ Gran ts-in-Aid ....................................................................................... %Expenditures .................................................................................... 

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vii 
Tax Deductibility ................................................................................. Tmx-Exemption for Industrial Development Bonds ................................................... Conclusion .......................................................................................... 

Chapter 4-Arenas in Which Governments Compete: Tax and Service ...................................... 

%x Competition ..................................................................................... Forms of .mX Competition ......................................................................... Level of Business &ation ........................................................................ Effect of ?.ax Levels on Business Location. Employment. and Investment ............................... Effect of Tax Levels on Individuals ................................................................. Competition on a Tax-by-Tax Basis .................................................................. Shifting Taxes Out of State ........................................................................ The Framework for Competition Makes a Difference ................................................. Service Competition .................................................................................. Expenditure Differentials ......................................................................... Effects of Service/Expenditure Differentials ......................................................... The Service/Expenditure Equilibrium .............................................................. The Importance of Spillovers ...................................................................... Conclusion .......................................................................................... 

Chupfer 5-Arenas in Which Governments Compete: Regulation and Economic Development ................. 

Regulatory Competition .............................................................................. Explicit versus Implicit Competition ................................................................ Alternative Views of State Regulatoly Policies ....................................................... Regulation and Interstate Commerce ............................................................... Empirical Evidence on the Effects of Regulations on Interstate Competition for Business ................ Evaluating State and Local Regulatory Policies ...................................................... Competition for Economic Development ............................................................... 

Concerns Regarding Competition for Economic Development ......................................... Types of Economic Development Incentives ......................................................... Evaluating State and Local Economic Development Efforts ........................................... Recent Trends in Economic Development Programs .................................................. Conclusion .......................................................................................... 

Chapter 6-1s Interjurisdictional Competition Good or Bad for the Federal System? ......................... 

Criteria for Evaluation ............................................................................... 

Equity .......................................................................................... Efficiency ....................................................................................... Alternatives to Competition ........................................................................... Literature Review .................................................................................... Government Behavior in the Absence of Interjurisdictional Competition ............................... How Government Behavior Changes with Differing Degrees of Potential Interjurisdictional Competition . . Direct Assessments of the Effects of Interjurisdictional Competition ................................... Conclusion .......................................................................................... 

Bibliography ........................................................................................ 

Figures and Tables 

figure ]-Literature Review: Econometric Studics of the Effects of Tax Differentials ........................ Figure 2-Literature Review: Econometric Studies of the Effects of Spending Differentials ................... Figure 3-Literature Review: Effects of Interjurisdictional Competition on Level of Government Spending ..... 

Table I-Suburban Fragmentation Data for the Largest Urbanized Areas. in Population Rank Order .......... Table 2-A Decade of Adoption of State Fiscal Discipline Mechanisms. 1976-1986 ........................... 

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viii 
Table 3-Distribution of Grants by Region. 1988 and 1978 ................................................. Table 4-% Expenditures Aiding State and Local Governments .......................................... Table 5-Comparing State and Local Tax Burdens in the Washington. DC. Area ............................. Table &Alternative Measures of Business Tax Burdens .................................................. Table 7-Top Marginal Tax Rates for State Personal Income Taxes. Joint Returns. 1985 and 1989 .............. Table &State Rankings on Spending for Education-FY 1988 State-Local Direct Elementary 

and Secondary Education Expenditure ......................................................... Table 9-State Rankings on Spending for Welfare-FY 1988 State-Local Direct Public Welfare Expenditure ... Table 10-State Financial Incentives Used to Promote Economic Development 

Table II-State Programs Promoting Exports ............................................................ Table 12-Estimated Cost-to-Benefit Ratios of Selected Economic Development Incentives .................. 

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ix 
X 
Chapter 1 

Introduction 

and Summary 

of Major Findings 

Almost a decade ago, the U.S. Advisory Commission 

on Intergovernmental Relations investigated the phenomenon of competition among state and local governmen&’ Specifical!y, interstate tax competition was the 

subject of one of a series of reports on disparities in 

regional growth. The major question raised by the 

Commission was “whether federal intervention is needed 

because interstate competition for industry has reached a 

point that is demonstrably adverse to the economic health 

of the states and the nation.”* The 1981 report’s general 

evaluation of tax competition was negative. ACIR argued 

that tax competition could lead to: 

H Inadequate state and local spending; 

rn A shift away from taxes based on ability-to-pay; 

and 

Wasted resources as state efforts to attract 

mobile industry from other states result in a 

”zero-sum game.”’ 

In 1987, ACIR commissioned this report in order to 

take another look at competition among state and local 

governments. The prospectus for the project noted that 

certain public finance analysts are now taking a more 

favorable view of the effects of interjurisdictional competition. For example, Charles McLure has argued that “the 

likely benefits of reducing tax competition are relatively 

slight. . . .On the other hand, the benefits of tax competition are potentially quite imp~rtant.”~ Other public 

finance experts have argued that: 

Just as with competition among private business 

firms, we would normally expect competition 

among government units to have a beneficial 

influence by inducing communities to provide a 

mix of services in line with the preferences of its 

citizens . . . . [Bx competition] is a spur to efficiency because it forces government officials to 

keep benefits in line with taxes paid. It does inhibit 

localities, however, if they wish to tax some 

groups to finance benefits of other groups, a desirable limitation insofar as redistribution is intrinsically a function of the national government. It is 

understandable that local government officials do 

not like tax competition, but the public is probably 

better off because of the discipline it enforces? 

At the same time, some researchers and practitioners 

continue to be critical of the effects of competition among 

state and local governments. For example, Dan Bucks, 

executive director of the Multistate Tax Commission, has 

stated that: 

. . . [I]nterjurisdictional tax competition undermines state tax systems that are fair, reasonable 

and effective., . .Interstate taxcooperationcan 

generate economic benefits, while interstate 

tax competition can produce harmful economic 

results.6 

Why Study Interjurisdictional Competition? 

Other than indications that some public finance 

experts have changed their views over the last decade, why 

is a new study of interjurisdictional competition among 

1 
state and local governments useful? Why is interjurisdictional competition of current interest to policymakers, 

practitioners, and analysts? 

Effortsby states and localities to lure business firms into 

their jurisdictions through the use of economic development 

incentives are as controversial today as they were a decade 

ago. One journalist has labeled this competitive phenomenon the “tax-incentive wars.’”I Concerns about this form of 

interjurisdictional competition include the question of 

whether such efforts merely “rob Peter to benefit Paul,” 

whether state and local governments are forgoing too much 

in tax revenue per job created, and whether the provision of 

special financial incentives for footloose firms constitutes 

fair tax policy for the rest of the business community and for 

individual taxpayers. Policymakers are asking, as ACIR did 

in its last report, whether federal intervention might be 

called for to limit this form of competition among state and 

local governments. 

At the same time, new forms of competition have 

come into public view. Competitive efforts to avoid costs, 

for example, to avoid hosting hazardous and nuclear waste 

sites and power plants or to discourage inmigration of 

homeless persons and welfare recipients are often in the 

news. These competitive efforts, known by the name 

NIMBY (not-in-my-backyard) can frustrate social and 

environmental policies of states and their local governments and the federal government. 

The issue of competition is often raised today in an 

international context. Everyone seems to be concerned 

about the competitive ranking of the U.S. economy? The 

issues of interjurisdictional competition and international 

competitiveness are intertwined: state and local governments have become increasingly active in attracting 

foreign investment and promoting exports of products 

from their states? One question raised is the extent to 

which state and local efforts help or hinder national 

efforts to improve the international competitiveness of 

the U.S. economy. Another issue is whether the heterogeneity of fiscal and regulatory institutions among state 

and local governments in the United States does or will 

constitute a competitive liability in the international arena. If 

so, will greater efforts at state and local harmonization or 

cooperation, instead of competition, be called for?1° 

As the relationship between the federal government 

and state and local governments has changed over the last 

decade, interest in the effects of the changing federal role 

in interjurisdictional competition has grown. For example, 

some state and local government experts predicted that 

enactment of the Tar Reform Act of 1986 would lead to a 

more competitive interjurisdictional environment because 

reduced federal marginal tax rates would result in higher 

effective state and local tax differentials. The notion was 

that as state and local taxes “mattered more,” interjurisdictional tax competition would become more heated. 

There also has been a sea change in federal aid to state 

and local governments. Federal grants-in-aid as a percentage of total state-local outlays fell from 26.5 percent in 1978 

to 17.5 percent in 1990.” To the extent that grants-in-aid 

buttress the relative competitive ability of poorer state and 

local governments, reduced federal aid may make it more 

difficult for the less well-off jurisdictions to compete. 

Finally, there is a wide range of federal, state, or local 

government reform proposals that can be properly 

evaluated only in the light of an understanding of the 

benefits and costs of interjurisdictional competition. The 

Congress, for example, has placed a high-income cap on 

state and local tax deductions allowable under the federal 

individual income tax. Given that federal deductibility of 

state and local taxes tends to mute interjurisdictional tax 

competition, an evaluation of this cap depends on, among 

other considerations, whether one decides tax competition is good or bad for the federal system. State 

governments at various times have considered proposals 

for consolidating local jurisdictions, encouraging joint 

service agreements among neighboring local governments, and loosening property tax and other tax or debt 

limits. Consolidating local jurisdictions and encouraging 

joint service agreements would tend to decrease interlocal 

fiscal competition; loosening tax and debt limits would give 

local governments greater latitude in fiscal competition. 

Each of these proposals should be evaluated in light of the 

benefits and costs of competition among local governments. 

Research Objectives 

This report is intended to be both a review of the 

theoretical and empirical literature on interjurisdictional 

competition and a conceptual exploration of the topic. A 

key objective is to synthesize the research on interjurisdictional competition that has become available since ACIR 

last investigated the issue.12 

One of the most important issues related to interjurisdictional competition is an evaluation of its benefits 

and costs within the American federal system. That is, 

does competition improve efficiency in the public realm 

by minimizing costs for taxpayers while improving the mix 

and quality of public services? Or does competition lead to 

a less equitable system of state and local finance? Is 

competition a zero-sum game, or does it expand public 

benefits for all parties? 

This report focuses on competition among states and 

among local general governments, or interstate and 

interlocal competition. These types of competition will be 

referred to as interjurisdictional competition. Elsewhere, 

certain analysts refer to these forms of competition 

among governments as horizontal intergovernmental 

competition or horizontal competition. 

Competition between the federal government and 

the states and between states and local governments also 

exists. These types of competition have been referred to 

variously as intergovernmental competition, vertical 

intergovernmental competition, or vertical c~mpetition.’~ 

An examination of these forms of competition is beyond 

the scope of this report.’-‘ 

Another topic that is beyond the scope of this report is 

explicit consideration of alternative policy proposals that 

would increase or decrease interjurisdictional competition. 

The major aim of this report is to improve understanding of 

the nature, benefits, and costs of interjurisdictional competi2 
tion. It would require further study, building on this report, 

to evaluate particular policy proposals that would modify the 

extent of interjurisdictional competition. 

Design of the Report 

The next chapter, “What is Interjurisdictional Competition and How Can We Measure It?” addresses these 

and other questions: 

What do we mean by interjurisdictional competition? 

For what are state and local governments competing? 

What are the alternatives to interjurisdictional 

competition? 

To what extent can the economic concepts of 

competition be applied to competition among 

governments? 

Can the same concepts be applied to localities 

and states, or are there significant differences between interlocal and interstate competition? 

rn Can we develop empirical measures of the extent 

of competition? 

rn Can we tell whether competition is increasing or 

decreasing in the American federal system? 

The third chapter examines the federal government’s 

role in setting the framework for interjurisdictional competition. The federal role is broken down into these aspects: the Constitution, the Supreme Court, federal laws 

and regulations, grants-in-aid, and tax expenditures aiding state and local governments. Federal policies affect 

the “rules of the game” for interjurisdictional competition; federal aid affects the relative ability of one government to compete with another. Federal policies also can 

change the incentives that state and local governments 

have for engaging in competitive behavior. 

The next two chapters examine four different types of 

interjurisdictional competition. Chapter 4 focuses on the 

closely related concepts of tax and service competition. 

The chapter identifies several forms of tax competition 

and weaves together two sorts of empirical studies: one 

set that attempts to compare the competitive standing of 

different states or localities by measuring their differing 

effective tax levels, and the other that attempts to 

determine the effects of tax levels on business location, 

employment, and investment. The second half of the 

chapter examines some interstate differentials in expenditure levels, then reviews the available literature on the 

effects of service or expenditure differentials on the 

economic health of states and localities. 

Chapter 5 moves on to regulatory competition and 

competition for economic development. Of the four types 

of interjurisdictional competition examined in this report, 

regulatory competition has been studied the least. 

Divergent views on the effects of state regulatory policies 

on a state’s competitive position are summarized. The 

potential effects of state regulation on interstate commerce are then discussed. A review of the scant empirical 

rn 

rn 

rn 

rn 

evidence on the effects of regulatory policies on interstate 

competition for business follows. 

State and local competition for economic development is the focus of much concern regarding interjurisdictional competition. These concerns are summarized, as 

are the economic development incentives that state and 

local governments use to compete with each other. 

Literature that evaluates the efficacy of state and local 

economic development efforts is reviewed, and some of the 

current trends in economic development are summarized. 

Chapter 6 returns to the major questions that were 

raised at the beginning of this report: 

rn Under what circumstances can interjurisdictional competition be regarded as beneficial or 

detrimental? 

How does interjurisdictional competition affect 

equity and efficiency in the federal system? 

The chapter describes how the understanding of interjurisdictional competition has changed since ACIR last examined this topic. It also notes particular ways in which the 

conventional wisdom regarding the effects of interjurisdictional competition has not changed over the last decade. 

Summary of Major Findings 

rn 

This concluding section of the chapter summarizes 

some of the key findings of the report. 

Although the existence of interstate and interlocal competition is ofen noted by observers of American federalism, 

competition amonggovernments has never been defined in an 

qlicit and comprehensive manner. 

This report offers two alternative definitions of interjurisdictional competition. One definition is that interjurisdictional competition consists of rivalry among 

governments in which each government is trying to win 

some scarce beneficial resource or in which each government is seeking to avoid a particular cost. For example, 

state and local governments compete for industrial plants 

that will provide jobs, for foreign investment, for high-income citizens, and for tourists. An alternative definition 

of interjurisdictional competition is the manner in which 

the free movement of goods, services, people, and capital 

constrains the actions of the independent governments in 

a federal system. An example is the constraint placed on a 

city’s ability to aid the homeless that results from a belief 

that such aid will attract “undesirable” homeless people 

from other jurisdictions and encourage outmigration by “desirable” high-income families who would foot the bill. The 

first notion of interjurisdictional competition can be labeled 

“active rivalry” and the second, “implicit competition.” 

Understanding the nature of interjurisdictional competition is further complicated by the necessary distinction between competitive structure and competitive 

behavior. For example, by analogy with economic theory, 

one can label a metropolitan area with 300 local general 

governments as one with an effectively competitive governmental structure. It is likely, but not certain, that the 

governments in this metropolitan area will exhibit competitive behavior. For example, if these governments were able 

to form a cooperative governmental association that helped 

5 
them to coordinate fiscal and regulatory policies, then these 

governments would not exhibit active rivalry, nor would a 

significant amount of implicit competition exist. 

No definitive evidence was found to indicate that interjurisdictional competition has been increasing in recent years. 

Despite the absence of a generally accepted definition of interjurisdictional competition or a generally accepted measure of the extent of interjurisdictional 

competition, it is not uncommon to find assertions that interstate or interlocal competition has been increasing in 

recent years. Ronald Fisher has attempted to determine 

whether this assertion may be true.15 

Fisher assumed for the sake of measurement that 

interjurisdictional competition limits the degree of fiscal 

diversity that state and local governments can maintain. 

He then calculated several measures of fiscal diversity for 

various years from 1971 to 1986. Contrary to his working 

hypothesis, Fisher did not find that fiscal diversity had 

decreased over the period. In other words, Fisher did not 

find evidence that competition among state and local 

governments has increased over the last two decades. 

There is much more to interjurisdictional competition 

than competing for potentially mobile businesses through the 

use of negotiated tax packages. 

State and local governments compete along several 

dimensions. In addition to tax competition, state and local 

governments are involved in service and regulatory competition. In the service area, one might consider interjurisdictional competition in the areas of education, 

public welfare, and public works infrastructure. In the 

regulatory sphere, right-to-work laws and laws regulating 

workers’ compensation insurance have been identified as 

potentially important to a state’s business climate. 

Furthermore, because taxes pay for services, tax 

competition cannot always be divorced from service 

competition. Thus, in many instances, it is better to speak 

of fiscal competition, which includes both tax and service 

competition. This view, taken to its logical extreme, has 

consumer-voters and business owners and managers 

shopping among communities for the best “package” of 

taxes and services.16 

Even focusing on taxes alone, it is clear that tax 

competition is a broader concept than the crafting of 

special deals for identifiable business firms. The report 

distinguishes among four kinds of tax competition: 

Competition via special tax exemptions, tax 

abatements, and the like. 

Competition with respect to the levels of specific 

taxes. 

Competition with respect to overall tax levels. 

Competition in the attempt to export taxes to 

other state or local governments. 

Evaluation of the results of tax competition will differ depending on which avenue for competition is the focus. For 

example, state policies that try to maintain generally low 

overall tax levels might be viewed more favorably than policies that allow a governor to negotiate on an individual basis 

1. 

2. 

3. 

4. 

with particular chief executive officers. In the fust instance, 

no business firm can claim that a tax “giveaway” has created 

an inequity between an existing and an incoming fm. 

Interjurisdictional competition serves as one regulator of 

the federal system. 

Competition among governments is likely to place 

certain bounds on the actions of the 50 states and more 

than 80,000 local governments in our federal system. For 

example, what constraint prevents one state from levying 

a personal income taxat a 50percent rate, or another from 

offering free college education to all state residents while 

another state abolishes its university system? These are 

extreme examples, but they make a point: interstate competition will tend to narrow, but certainly not eliminate, 

diversity among the states.” 

If one jurisdiction levies too high a taxburden relative to 

others with which it competes for jobs and residents, without 

commensurately higher public services, economic growth 

will be s1owed.l8 Similarly, if a state does not meet minimal 

national standards in its university system, it will have 

trouble attracting industry. The choice of locations that our 

competitive governmental structure presents to individuals 

and businesses constrains the range of policies government 

can adopt because, over time, individuals and businesses can 

“vote with their feet” and move to other jurisdictions. 

Competition has been a key concept in economics 

ever since Adam Smith explained it in the Wealth of 

Nations (1776). According to Smith, competition is the 

force that turns individuals, each acting in his or her own 

self-interest, to benefit society as a whole. The interaction of 

self-interest and competition produces an economic system 

that appears to be regulated by a benign “invisible hand.” 

According to some economists, competition among 

governments may play a role parallel to that of competition in markets.19 Just as market competition produces an 

economic system responsive to consumer needs, interjurisdictional competition can produce a government system 

responsive to voter desires. To some extent, both systems 

appear to be regulated by Smith’s “invisible hand.” 

There is, however, a set of important circumstances in 

which the invisible hand is not benign. These are the 

circumstances of “market failure,” namely, the inability of 

markets to provide certain goods either at all or at the 

most efficient level. An important type of market failure 

arises when an economic activity causes incidental 

benefits or damages to others (“third parties”) and for 

which no mechanism exists to compensate or penalize 

those who initially generate the activity. Air or water 

pollution provides the classic example of such an 

“external” or “spillover” effect .*O 

Just as the analysis of private market competition has 

pointed to externalities as a major cause of market failure, 

the existence of spillovers between governments may 

negate the potential benefits of competition among 

governments. For example, competition among governments may have harmful effects when governments are 

allowed to %port” certain social costs (e.g., pollution or 

the burdens of providing welfare services) to residents of 

other jurisdictions. 

4 
Interjurisdictional competition does not necessarily deIn reviewing the history of state and local revenue sysThe remarkable revenue performance of our 50 

state-local systems since the end of World War I1 

has knocked into a cocked hat the old conventional wisdom-that states and their localities 

were destined to have anemic revenue systems 

because they were “crippled by fears” of intergovernmental competition. , . . As a percent of 

gross national product, state-local own-source 

revenue has risen from 6.6 percent to 12.1 percent [from 1949 to 1987.I2l 

Perceptions of state and local officials also provide evidence 

that competition does not necessarily hold down state-local 

spending or revenues. Pams Glcndening, county executive 

of Prince George’s County, Maryland, has described how 

competition with surrounding counties put pressure on his 

county to improve its school system. In order to pay for this, 

the county raised $100 million in additional revenues.22 

Why did the previous literature maintain that interjurisdictional competition was bound to depress service levels of 

state and local governments? The old consensus focused 

almost totally on the tax side of thc fiscal equation. This led 

to a confused analysis of the results of competition among 

governments. If high-income citizens and businesses cared 

only about the level of taxes they pay, competition would 

appear to lead to an ever lower level of taxation and, 

inevitably, to inadequate service levels.23 

Recent research, which considers both taxes and 

expenditures, provides important additional evidence 

that interjurisdictional competition will not necessarily 

depress state and local service or revenue levels. 

Empirical evidence indicates that although a high tax level 

can reduce the attractiveness of a particular state or local 

government, a high service level (often measured by the 

proxy “expenditure level”) increases the attractiveness of 

that same government. For example, empirical studies of 

capitalization, mobility, and the determinants of state 

economic growth have shown that, holding tax levels 

constant, higher spending on education tends to increase 

property values, attract new residents, and increase the 

rate of state economic gro~th.’~ 

It is important to note, though, that the effects of 

interjurisdictional competition on state and local spending vary by service area. It is possible for interjurisdictional 

competition to promote higher service levels in certain 

areas and to depress service levels in other areas. Even 

those with a generally favorable view of the effects of 

interjurisdictional competition are concerned about the 

effects of such competition on the level of services in 

those areas that are likely to generate significant 

beneficial spillovers (e.g., care for the homeless). 

Current research confirms the tendency for interjurisdictional competition to reduce reliance on ability -to-pay taxes. 

Another traditional concern regarding interjurisdictional tax competition has been that it appeared to pressure state and local governments to turn away from 

press state and local service or revenue levels. 

tems, John Shannon argues that: 

ability-to-pay taxes toward more regressive taxes. Wallace 

Oates and Robert Schwab recently reexamined the effects 

of interjurisdictional fiscal competition on the ability of 

governments to redistribute in~orne.~~They make twoimportant points. 

First, competition among governments produces a 

system in which all local government (and to a lesser 

extent state government) taxes will tend to become 

benefit taxes. That is, in equilibrium, the taxes that 

individuals and businesses pay will tend to equal the 

respective values they place on public services received. 

Thus, in a competitive environment, business taxes are 

unlikely to be used for social programs, parks, or 

education. Business taxes will, however, be of sufficient 

magnitude to pay for such business-specific services as 

police protection, public utilities, and roads. 

The second major point is that any evaluation of this 

tendency for state and local governments to adopt benefit 

taxes depends crucially on what one regards as the proper 

federal role in redistributive policy. If the federal 

government provides the right amount of support for 

low-income households, the state and local fiscal system 

that results from a competitive environment will be 

efficient and will not create inequities. If the federal 

government does not fulfill the redistributive role, 

however, one may be critical of interjurisdictional fiscal 

competition for making it impossible for state and local 

governments to fill that gap. 

Efforts to use tax incentives to attract mobile industry are 

still generally in disfavor among public finance experts. 

Current research on interjurisdictional Competition 

is still generally critical of individually negotiated tax 

packages designed to lure new industry or to retain existing industry. Some of the standard criticisms apparently 

still hold, and, in some cases, these criticisms have been 

buttressed by additional research. 

Dick Netzer’s analysis of the explicit efforts by states 

and localities to influence location decisions of attractive 

business firms through tax incentives concludes that such 

activity is likely to have a negative-sum effect until all 

jurisdictions are offering equal incentive packages, at 

which time, these efforts at economic development 

collectively have a zero-sum effect. He comes to this 

conclusion from the assumption that tax incentives 

merely shift economic activity around, and, in many cases, 

shift the activity from its most productive use to a less 

productive use.26 

Larry Ledebur and William Hamilton take another 

tack in their criticism of state and local tax concessions to 

business. They have done cost-effectiveness studies for a 

variety of such incentives, where the benefits measured 

are those received by the firm, and the costs are the 

opportunity costs borne by the subsidizing government. 

Ledebur and Hamilton conclude that tax concessions are 

not cost-effective. State and local government revenues 

forgone through tax expenditures are greater than 

benefits derived from recipient firms. It is unlikely that 

any form of tax concession can be cost-effective.?’ 

Ledebur and Hamilton’s criticism of tax incentives 

used to attract mobile businesses is even more condemna5 
tory than Netzer’s. According to Netzer, tax incentives are 

a waste of resources from society’s point of view; according 

to Ledebur and Hamilton, tax incentives are likely to be a 

waste of resources for the jurisdiction offering them, too. 

A few analysts note instances in which special tax 

incentives can be sensible. For example, Nonna Ndo 

describes the process a community must go through in an 

economic crisis. She points out the high economic and 

psychic costs incurred by households forced to uproot 

themselves in the search for new jobs. When all these 

costs are accounted for, the benefits of special tax 

concessions may exceed the costs. Noto points out further 

that rigorous analysis must be done to determine when, if 

ever, targeted tax concessions might be preferred to 

general tax cuts. The old consensus focused on the 

inequities of favoring a mobile firm over an immobile one. 

However, if firms differ in the benefits they can offer to 

communities in which they can potentially locate, it is not 

clear that their tax liabilities should not differ also.2s 

Notes 

U.S. Advisory Commission on Intergovernmental Relations, 

Interstate Tau Competition (Washington, DC, 198 1). 

ACIR, Interstate Tmr Competition, p. 1. The report found that, 

“Tax competition between neighboring states has not yet become a serious problem for our federal system,” and that, 

“Short of highly coercive or discriminatory legislation, Congress appears to have no ready means to prohibit states from 

using tax and fiscal measures to try to enhance their individual 

development prospects.” (pp. 4,8) 

Ibid., pp. 9-12. 

Charles E. McLure, Jr., “Tax Competition: Is What’s Good for 

the Private Goose also Good for the Public Gander?” National 

Tar Jorrnial39 (September 1986): 346. 

Edgar K. Browning and Jacqueline M. Browning, Public Finance and the Price System (New York Macmillan Publishing 

Dan R. Bucks, “Tax Competition: Patent Medicine for Eoonomic 

Anxiety,’’ Mihistate Tax Commission Review (May 1988): 1-4. 

’Paul Glastris, “Holdup in the Windy City,” US. News & World 

Report, July 17, 1989, p. 40. 

See the articles in Intergovernmental Perspective 16 (Winter 

See also John M. Kline, “The International Economic Interests of US. States,” and John Kincaid, “The American Governors in International Affairs,” Pirbliirs: The Journal of 

Federalisni 14 (Fall 1984): 81-94, 95-114. 

lo See especially Robert F! Straws, “The EC Challenge to State 

and Local Governments,” Inteqovemmental Perspective 16 

(Winter 1990): 13-14. 

l1 U.S. Advisory Commission on Intergovernmental Relations, 

Significant Featlira of Fiscal Federalisin, 1991 Edition, kbliime 

II (Washington, DC, 1991), Table 21. 

CO., 1983), pp. 468-469. 

1990). 

l2 ACIR, Intentate Tar Competition. 

l3 Some analysts are comfortable defining vertical competition 

as competition among governments at different levels. and 

horizontal competition as competition among governments at 

the same level. Other scholars strenuously object to naming 

levels of government in the federal system. For example, Daniel Elazar states that, “To the extent that those involved in 

American governance now conceive of the American federal 

system as a pyramid with federal, state, and local ‘levels,’ they 

have opened the door to the transformation of cooperative 

federalism into coercive fedemlisrn.” Daniel J. Elazar, “Cooperative Federalism,” in Daphne A. Kenyon and John Kincaid, 

eds., Competition among States and Local Governments: Eficiency and Equity in American Federalism (Washington, DC: 

The Urban Institute Press, 1991) 

l4 Much of the literature on American federalism, particularly 

on cooperative federalism, examines relations between the 

federal government and state governments and, secondarily, 

between the federal government and local governments. Because this review focuses on the topic of interjurisdictional 

competition, most of the literature on cooperative federalism 

is beyond the scope of this report. Examples of this extensive 

literature include Edward B. Convin, “National-State Cooperation: Its Present Possibilities,” Yale Law Jotrmal 46 (1937): 

599-633; Jane Perry Clark, The Rise of a New Federalism: Federd-State Coopemtion in the United States (New York Columbia 

University Press, 1938); Daniel J. Elazar, 77ie American Partnership: Intergoverntnental Coopemtion in the Nineteenth Centirry Unitedstates (Chicago: University of Chicago Press, 1962); 

Daniel J. Elazar et al., eds., Coopemtion and Conflict: Readings 

in American Fedemlisni (Itasca, Illinois: E E. Peacock, 1969). 

Is Ronald C. Fisher, “Intergovernmental Competition: A Summary Perspective and Agenda for Research,” in Daphne A. 

Kenyon and John Kincaid, eds., Competition among Statesand 

Local Governments: Eficienq and Equity in American Fedemlism (Washington, DC: The Urban Institute Press, 1991). 

16Charles Tiebout, ‘A Pure Theory of Local Expenditures,” 

Joumal of Political Economy 64 (1956): 416-424. The Tiebout 

model stipulates a large variety of communities, each offering 

a different package of public services and taxes. On the as- sumption that all private goods are available at the same price, 

the individual selects a site in a manner that balances marginal 

site costs (e.g., housing costs plus taxes) with higher marginal 

evaluation of the public service package. 

I7There are cases that call for federal intervention. For example, 

a state should not be allowed to establish a toxic waste dump 

on top of a neighboring jurisdiction’s underground water sup 

ply. Similarly, the federal government must enforce civil rights 

laws, the commerce clause of the Constitution, antitrust statutes, and the like. 

l8 See Michael Wasylenko and Therese J. McGuire, “Jobs and 

Taxes: The Effect of Business Climate on States’ Employment 

Growth Rates,” National Tmc Journal (December 1985): 497-511. 

19Albert Breton, “Towards a Theory of Competitive Federalism,’’ European Journal of Political Economy (Special Issue) 3 

(1987): 322 Others caution, however, that it is difficult to demonstrate that in fact a relationship exists beheen the taxes whereby 

government services are financed and the demand of any one individual or firm for public services. !k Andrew Reschovsky, 

“How Closely Does State and Local Government Behavior Conform to a Perfectly Competitive Model?” in Daphne A. Kenyon 

and John Kincaid, eds., Competition aniong States and Local 

Governments: Eficiency and Equity in American Federalism 

(Washington, DC: The Urban Institute Press, 1991) 

**These circumstances are discussed in any standard public finance 

textbook See, for example, Harvey S. Rosen, Public Finance, 

Second Edition (J?Iomewood, Illinois: Irwin, 1988) Chapter 7. 

21 John Shannon, “Federalism’s ‘Invisible Regulator’-Interjurisdictional Competition.” in Daphne A. Kenyon and John 

Kincaid. eds., Coinpetition among States and Local Govemi?ietrts: Efticietxy and Eqtrity in Ametican Fedemlist?t (Washington, DC: The Urban Institute Press, 1991). 

22 Parris Glendening, “Protecting Citizens through Appropriate 

Cooperation and Limited Competition,’’ in U.S. Advisory 

Commission on Intergovernmental Relations, Intetjrrrisdic6 
tiotial Competition in the Fedeml System :A Roundtable Disciission (Washington, DC, 1988), p. 9. 

23 For example, the 1981 ACIR report argues, ‘Although some 

tax concessions are self-limiting, the general concept of business tax relief is not. The pressure for an extension of tax concessions to business and individuals need never abate when 

proponents argue that the “tax breaks” do not shift taxes because they promote prosperity for everyone” (Interstate Tar 

Competition, p. 10). 

24 Wasylenko and McGuire conclude that spendingon K-12 education is a strong determinant of employment growth rates in a 

state’s retail trade and finance sectors. They also conclude, 

however, that tax and spqnding variables are not the most important factors likely to determine differential growth rates 

across states; nonfiscal policy factors (e.g., wage levels, energy 

prices, weather, income) are more important. 

25 Wallace E. Oates and Robert M. Schwab, “The Allocative and 

Distributive Implications of Local Fiscal Competition,” in 

Daphne A. Kenyon and John Kincaid, eds., Competition 

among States and Local Governments: Eficiency and Equity in 

American Federalism (Washington, DC: The Urban Institute 

Press, 1991). 

26 Dick Netzer, ‘An Evaluation of Interjurisdictional Competition through Economic Development Incentives,” in Daphne 

A. Kenyon and John Kincaid, eds., Competition among States 

and Local Governments: Efficiency and Equity in American Fedemlism (Washington, DC The Urban Institute Press, 1991). 

27Larry C. Ledebur and William W. Hamilton, “The Failure of 

Tax Concessions as Economic Development Incentives,” in 

Steven D. Gold, ed., Refomling State Tar Systems (Denver: National Conference of State Legislatures, 1986) pp. 112-113. 

28Nonna A. Noto, “Trying to Understand the Economic Development Official’s Dilemma,” in Daphne A. Kenyon and John 

Kincaid, eds., Competition among States and Local Governments: Efficiency and Eqirity in American Fedemlistn (Washington, DC: The Urban Institute Press, 1991). 

7 
8 
Chapter 2 

What Is 

Interjurisdictional 

Competition 

and How 

Can It Be Measured? 

This chapter begins to lay the groundwork for an evaluation of the benefits and costs of interjurisdictional tax and 

policy competition. Basic conceptual questions regarding interjurisdictional competition are examined, such as: 

What is meant by interjurisdictional competition? What are the alternatives to interjurisdictional competition? 

To what extent can the economic concepts of 

market competition be applied to competition 

among governments? 

In what manner does interjurisdictional competition serve to regulate the behavior of state and 

local governments? 

What factors affect the degree of interjurisdictional competition among governments? Are 

there significant differences between interstate 

and interlocal competition? 

Can empirical measures of the extent of interjurisdictional competition be developed? Is competition increasing or decreasing in the American 

federal system? 

One of the findings is that implicit competition 

among state and local governments may be as important 

as active rivalry (e.g., for footloose industry or for the 

tourist dollar), which is the more obvious form of interjurisdictional competition. Economic concepts of competition are used to craft measures of the extent of 

competition among state and local governments. The empirical evidence is inconclusive as to whether interjurisdictional competition in the American federal system has 

been increasing or decreasing over the last few decades. 

Definitions of Competition 

Active Rivalry 

Although the existence of interstate and interlocal 

competition is often noted by observers of American 

federalism, competition among governments has never been 

defined in an explicit and comprehensive manner. One 

definition is that interjurisdictional competition consists of 

rivalry among governments in which each government is 

trying to win some scarce beneficial resource or in which 

each government is seeking to avoid a particular cost. 

This definition can be clarified with a few examples. 

States and localities compete for plants that will provide 

jobs for their citizens, for foreign investment, for highincome citizens, for tourists, and for skilled migrants. In 

the recent past, states and localities competed for federal 

grant money. Two hundred years ago, the original 13 

states competed over ownership of the western territories. For example, in The Federalist, Alexander Hamilton 

describes the fierce competition between Connecticut 

and Pennsylvania over the land at the southern end of 

Lake Erie that is now Ohio. 

State and local governments also compete to avoid 

bearing costs. Two hundred years ago. the states were 

involved in disagreements over who should foot the bill 

for the national debt generated during the war with 

England. An issue of current importance is which states 

will be the recipients of federally created dumps for 

9 
low-level radioactive waste. In metropolitan areas, exclusionary zoning designed to keep out low-income citizens is 

still controversial. 

Although this examination is confined to fiscal and 

regulatory competition among governments, active rivalry 

covers a very broad range of matters. For example, cities 

have been known to compete for sports teams by building 

attractive stadiums or by bidding for team franchises. 

Implicit Competition 

An alternative definition of interjurisdictional competition is the manner in which the free movement of 

goods, services, people, and capital constrains the actions 

of the independent governments in a federal system? 

A simple example involves a central city’s policy 

toward homeless individuals. City residents may prefer a 

generous policy of aiding the homeless, but will be 

constrained in their policy choice because a particularly 

generous policy could attract the homeless from surrounding jurisdictions. Alternatively, the relatively high 

tax levels needed to finance this form of income 

redistribution could drive high-income citizens from the 

central city to outlying suburbs. Furthermore, suburban 

governments would have an incentive to “free ride” on 

the generous policy of the central city. That is, they could 

take advantage of the central city’s public welfare 

spending without having to contribute to the funding. For 

all of these reasons, the central city may be constrained in 

the range of policies toward the homeless it can adopt. 

The first definition of interjurisdictional competition 

emphasizes rivalry and the efforts of states and localities 

to appropriate benefits or shed costs. That definition has 

the advantage of corresponding to our eveqday usage of 

the term “competition,” which we associate closely with 

active rivalry. 

Our definition of “implicit competition,” however, 

has the advantage of being more comprehensive. There 

are probably many examples of situations in which state 

and local government officials do not consciously set out 

to compete, but in which a situation of implicit competition arises inadvertently, such as the example given above 

of the potential repercussions of a central city’s policy of 

aiding the homeless. 

Alternatives to Competition 

In order to understand the nature of governmental 

competition, it is useful to contrast competitive behavior 

with its alternatives. Instead of competing with each 

other, state and local governments can cooperate, 

collude, or be coerced or preempted by the federal 

government.* For example, local governments in a 

metropolitan area can cooperate in financing and constructing a mass transit system that will benefit the entire 

area. 

Collusion is closely related to cooperation, but the 

term has a decidedly negative connotation. Collusion 

implies cooperation with the aim of defrauding some 

outside party. A possible example might be a joint effort 

by a group of neighboring states to raise business taxes at 

the same time so that business firms could not threaten to 

leave one state for its low-tax neighbor. From the business 

perspective, this could be labeled as collusive behavior. 

A third alternative to competition is coercion by the 

federal government. By mandating the provision of 

minimum service levels or the adoption of laws or 

regulations, the federal government can preempt state or 

local government choice and prevent competition. The 

ways in which federal government policies affect competition among state and local governments will be discussed 

more extensively in Chapter 3. 

Related forms of noncompetitive intergovernmental 

relations, which appear to be less important, are coordination and comity. Efforts to coordinate the behavior of 

6Sierent governments imply neaxly tke sxw’oehauiot as 

cooperative efforts-with the difference being that the 

term “coordination” appears to put a greater emphasis on 

order. The term “comity” originally applied to relationships between independent nations. The term connotes 

an attitude of courtesy and the exercise of considerate 

behavior. To the extent that comity relates most closely to 

“good manners” among governments, it could be consistent with certain forms of competition as well as with 

cooperation. 

Before moving to an analysis of the economic theory 

of market competition and of the extent to which that 

theory can be applied to interjurisdictional competition, it 

is important to note that competition coexists with its 

alternatives. This coexistence can be achieved because 

state and local governments operate simultaneously in 

many policy areas. For example, states cooperate in 

matters of tax administration while at the same time 

competing in their decisions regarding tax levels. States 

also can cooperate to promote exports of their products 

even while they compete for foreign investment, 

It also is possible for a group of states or localities to 

cooperate in order to compete more successfully with the 

remaining governments. One recent example is the 

cooperative effort by officials in the District of Columbia, 

Iowa, Kansas, Oregon, Rhode Island, and West Virginia 

in launching a multistate lottery game.3 By pooling lottery 

ticket sales among a group of states, bigger jackpots are 

generated, which in turn produce higher ticket sales and 

greater profits for the states. Because New York and 

Illinois currently offer the largest jackpots, these states 

have expressed concern that the new multistate effort 

could reduce their lottery profits. 

Applying the Economic Concept 

of Market Competition to Governments 

To understand competition among governments, it is 

useful to describe briefly the economic theory of market 

competition and then apply it to the relationship among 

governments in a federal system. 

Competition has been a key concept in economics 

ever since it played a crucial role in Adam Smith’s Wealth 

ofNutions (1776). According to Smith, competition is the 

force that drives individuals, each acting out of self-interest. 

to benefit society as a whole. The interaction of self-interest 

10 
and competition produces an economic system that appears 

to be regulated by a benign “invisible hand.” 

The economic theory of competitive markets has 

been developed considerably since the 1770s. Some of this 

development has involved an analysis of different types of 

markets. Economists usually distinguish among markets 

along a spectrum, from perfect competition, in which 

there are many buyers and sellers, to monopoly or 

monopsony in which there is a single seller or a single 

buyer. This development also has involved an examination of the beneficial results of competition. For example, 

economists have proved that under certain (restrictive) 

circumstances, a competitive economy can produce an 

equilibrium in which no individual can be made better off 

without making someone else worse off. Economists also 

have analyzed the problems with market competition, or 

in their terminology, the circumstances leading to 

“market failure.” In our search for the answer to the 

question of whether interjurisdictional competition is 

good or bad for the federal system, it is natural to ask to 

what extent the economic concepts of market competition 

can apply to relationships among governments. 

Market Analogy 

Before focusing on the specific way in which 

economists use the term “competition,” we must define 

the prior concept of market and note its applicability to 

governments. A market consists of buyers and sellers, 

with the buyers generally referred to as consumers and 

the sellers generally referred to as firms. In applying the 

concept of market to state or local governments, the 

government plays the role of the firm, and the taxpayer-citizen plays the role of the con~umer.~ 

It is readily apparent that in some ways the market 

concept applies well to the relationship between a 

government and its citizens, and in other ways it applies 

poorly. In abstract terms, the relationship of a citizen to a 

state or local government in a federal system is parallel to 

the relationship of a consumer to a firm. The consumer 

purchases goods and services from the firm; the citizen pays 

taxes in order to receive government services. The consumer 

seeks to obtain the mix of goods and services in the 

marketplace that will maximize satisfaction, given a limited 

budget. Consumers will patronize firms that produce 

desired products and that offer those products at the lowest 

prices. Citizens also seek particular “packages” of goods and 

services from their government (e.g., quality education, 

adequate transportation services, and a safe community), 

and they prefer that the government offer the services in 

return for the lowest possible tax burden. If consumers do 

not like the product produced by a certain fm, they can stop 

buying the product. If citizens do not like the quality or the 

costs of goods and services the government provides, one 

option is to move to a different state or locality. @he same 

logic applies to nation-states, which is one reason why free 

societies guarantee the right of emigration.) 

There also are several differences between the two 

types of relationships. Goods and services that a consumer purchases from a firm tend to be “private goods”; that 

is, their consumption does not ordinarily impose substantial “third party” or “spillover” benefits or costs on other 

people. When one buys a piece of furniture, for example, 

that action affects the purchaser’s own comfort but no one 

else’s, so long as the production of the item did not harm 

the general environment. 

Goods and services produced by governments are 

more often “public goods”; that is, they tend to provide 

benefits for more than one individual at a time, and it is 

difficult or impossible to prevent those who do not 

contribute to their financing from benefiting from the 

service. If the police do a particularly good job of 

patrolling a neighborhood, for example, every individual 

in that neighborhood benefits automatically. The usual 

reason given for government provision of public goods is 

that the private market would not be able to provide them 

in the best quantity, if at all, because of the existence of 

the “free riders” who benefit from the good or service but 

do not contribute to its financing. 

A second difference between the relationship of a 

consumer to a firm and the relationship of a citizen to a 

government involves the likely range and ease of 

consumer or citizen choice. Aconsumer setting out to buy 

a jar of peanut butter may be able to choose between a 

half-dozen brands in a single store and, in addition, have a 

half-dozen stores to choose from. An individual in the 

role of local citizen is not likely to have as wide a range of 

choice in government service levels. Even if a metropolitan area has a dozen local governments with different 

school systems, thus providing citizens with a dozen 

choices, “shopping” from one community to another is 

much more difficult than going from store to store 

searching for one’s favorite brand of peanut butter. 

Changing school systems involves moving to a new 

community. It also involves changing one’s entire “package” of local government services at the same time. One 

analogy that has been presented is that shopping among 

local governments is like going to a supermarket and 

having to choose between a dozen already filled shopping 

baskets. Actually, the peanut butter-school system example overemphasizes the difference between some consumer 

and citizen choices. Consumer purchases of homes and 

automobiles, for instance, involve “packages” of attributes 

much as does a citizen’s choice of a town to live in. 

A third difference between the consumer-firm 

relationship and the citizen-government relationship is 

that the usual way in which the consumer obtains a 

product isby shopping among firms. If the product put out 

by one firm is unsatisfactory, the consumer will usually 

switch to another firm. An influential book by Albert 0. 

Hirshman characterizes this mechanism as “e~it.”~ In 

contrast, a common way for a citizen to attempt to 

improve garbage pick-up would be to call and complain to 

the city manager, voice a complaint at a city council 

meeting, or vote against incumbent city councillors at the 

next election. These options are examples of what 

Hirshman has labeled “voice.” 

The voice and exit mechanisms are used in both 

government and private market contexts: it is just that the 

relative reliance on the two mechanisms differs. A 

consumer can complain to a car dealer about a newly 

11 
purchased automobile or call the toll-free number on a 

package of toothpaste to complain about the “new, 

improved’’ taste. However, for most goods or services 

purchased in the private market, consumers are more 

likely to make use of the exit mechanism, that is, to switch 

products if they are dissatisfied. Likewise, citizens can 

move to a different city or state if they are dissatisfied with 

the government services they are getting for their tax 

dollar. In most cases, however, citizens are likely to stay 

where they are and make use of the voice mechanism. 

Competition in Ecoqomic Theory 

As a tool for understanding the behavior of consum- ers and firms, economists often build abstract models or 

theories. These theories are critical in understanding the 

primary forces underlying an economic system, but are 

not meant to describe accurately the details of actual 

market behavior at any particular time or place. 

Economists have found the theory of “perfect 

competition” very useful in understanding the manner in 

which many markets work, such as the agricultural sector 

of our economy. The word “perfect” means that this 

model represents a market that is totally or completely 

competitive. The usual assumptions of the perfectly 

competitive model are: 

1) There are many firms, each small relative to the 

size of the market. 

2) Consumers and firms have full information on 

prices and product characteristics. 

3) Individual firms do not differentiate their prod- ucts from their competitors’; that is, products are 

homogeneous, not differentiated. 

4) Entry into and exit from an industry are relatively 

easy: 

An important implication of these assumptions is that no 

one firm has any control over the price at which it sells its 

product. 

Economists also have built a number of theories of 

market competition that apply in situations in which the 

assumptions of perfect competition do not even approximately hold. At the opposite end of the spectrum from the 

theory of perfect competition is the theory of monopoly 

behavior, in which a single seller is assumed to exist (e.g., 

utilities). In between theories of monopoly and perfect 

competition, economists distinguish between oligopolistially and monopolistically competitive markets. Monopolistic competition is said to hold when there are many 

sellers of a particular product, there is product differentiation, and each firm has some control over its prices. For 

example, the producer of Ivory Snow detergent can set its 

price for detergent somewhat above the average price of 

other detergents with confidence that some loyal customers will still purchase its product. A situation of oligopoly 

presumes that there are a few rival firms. A common 

example of an oligopolistic market is the automobile 

industry. Oligopolists also are generally presumed to have 

some control over their prices. 

In examining the applicability of these various models 

to the American economy, William Shepherd distin- guishes between markets controlled by monopolies or 

oligopolies and those that can be considered “effectively 

competiti~e.”~ According to Shepherd, effectively competitive markets are those with low bamers to entry by 

new firms and for which the top four firms control less 

than 40 percent of the market. Shepherd found that in 

1980 over three-quarters of the U.S. economy could be 

considered effectively competitive. 

In applying the economic theories of market competi- tion to governments, it is clear that many state and local 

government “markets” do not come close to the conditions needed for perfect competition. Although there are 

approximately 40,000 local general governments in the 

United States, in a given metropolitan area in which a 

citizen is located, there may be very few. Both state and 

local governments belong to associations of governments 

and contract with each other; hence, in many cases, they 

do not operate independently. Knowledge is limited both 

on the part of government officials and on the part of 

citizens. Finally, although citizens can “exit” a particular 

government, it is much more difficult for governments 

themselves to enter or leave the “industry.” New local 

general governments can be created only in unincorporated 

areas in certain parts of the country. To a lesser degree, new 

governments can enter a market through consolidation of 

existing governments or through creation of special districts. 

Although perfect competition does not exist with 

respect to either local or state governments in the United 

States, there are few instances of monopoly or oligopoly 

government “markets.” A degree of competition does exist, 

which varies from one part of the country to another. In 

some metropolitan areas, there are quite a few local 

governments. The New York Urbanized Area, for example, 

has 399 local general governments. The structure of such an 

urban area might be labeled “effectively competitive.” Even 

though governments may try to cooperate, many times they 

are unsuccessful. Knowledge may be less than perfect, but 

with the presence of numerous citizens’ groups, quite a bit of 

information is available to the interested citizen. Governments may be unlikely to enter or leave the market in a 

literal sense, but, in a more abstract way, there is mobility of 

governments. After Proposition 13 was approved by 

California voters in 198, a number of governments around 

the country became more restrictive in their fiscal policies. 

In a sense, they “left” the high-spending, high-taxing market 

and “entered” the low-spending low-taxing one. 

The Tiebout Model 

The most important model of competition among 

governments is the Tiebout model, set out in a seminal 

paper in 1956.* According to this model, which applies 

best to suburban governments in a metropolitan area, 

individual consumer-voters can choose among the “packages” of taxes and services offered by the various 

governments in a metropolitan area in much the same way 

that consumers can choose private goods in the competi- tive marketplace. Tiebout’s model was inspired as a 

solution to the problem of providing the optimal level of 

public goods. Economists had proved that in the absence 

12 
of spillovers or other important instances of “market 

failure,” the private market would automatically provide 

the correct quantity of goods and services, but that there 

was no such automatic solution for public goods. Tiebout’s 

model was an attempt to offer a solution for public goods 

provided by local governments. 

The Tiebout model makes the following assumptions 

about local governments: 

Citizens are fully mobile between communities 

and will move to the community that best satisfies 

their preferences. 

Citizens have full knowledge of all community 

characteristics. 

There are many different types of communities 

among which citizens can choose. 

There are no spillovers from one community to 

another (an example of a beneficial spillover is 

the effect on one town of the spraying for mosquitoes done by an adjoining town). 

Jobs do not impose locational constraints on individuals (sometimes described as the assumption 

that all citizens earn dividend income). 

A community’s optimal size, meaning that size 

for which the average cost of producing a particular package of public goods and services is minimized, can be determined. 

Each community endeavors to reach its optimal 

size? 

These assumptions are similar in nature to the assumptions of the perfectly competitive model of market 

competition. A considerable economics literature has 

grown up that extends, criticizes, and tests the Tiebout 

model. In various sections of this report, we will examine 

the extent to which the Tiebout assumptions are applicable to different types of governments and the extent to 

which the Tiebout model helps us understand the nature 

and effects of competition among governments. 

Competition as Regulator of the Federal System 

Another economic concept that can be applied to 

state and local governments is the idea that interjurisdictional competition serves as a hidden regulator of the 

federal system just as the “invisible hand” of the market 

serves to regulate private market decisionmaking. 

One can argue that, just as a change in consumer 

tastes results in a new price-quantity configuration in the 

private markets, so too can a change in voter tastes result 

in a new configuration of state or local government 

policies. During the 1970s, it became apparent that many 

voters were interested in limiting the growth of government spending. Because of the passage in 1978 of 

Proposition 13 in California, a law which continues to be 

one of the most important fiscal limits on local governments, 1978 is generally viewed as a watershed year in 

state tax policymaking. After 1978, state after state 

adopted tax and expenditure limitations and other tools 

for encouraging governmental fiscal discipline. It can be 

13 

argued that, once voters decided that they preferred less 

growth in government spending, state and local government policies gravitated toward a new equilibrium 

characterized by slower growth in the level of government 

services. To the extent that active rivalry or implicit 

competition among governments contributed to this 

change in state and local government policies, interjurisdictional competition can be characterized as inducing 

government responsiveness to citizen demands, or as a 

hidden regulator of state and local government behavior. 

John Shannon is one of the first analysts to examine 

the role of interjurisdictional competition as a regulator 

of the federal system.” Shannon argues that interjurisdictional competition puts pressure on state and local 

governments to hold down taxes at the same time that it 

encourages them to offer attractive public services. He 

uses the analogy of a naval convoy to describe how the 

twin forces of tax and expenditure competition regulate 

the fiscal actions of state governments: 

The behavior of our states resembles 50 ships sailing in a great naval convoy during wartime. The farther any state moves ahead of the convoy on the tax 

side the greater becomes the risk of tax evasion, 

taxpayer revolts, and the loss of economic development to states pursuing more conservative tax and 

spending policies. By the same token, the farther 

any state falls behind the convoy in the public service area the greater becomes the risk that it will 

lose economic development to states providing a 

higher quality of life, especially public education.” 

Shannon argues that some agent must place limits on fiscal diversity in the federal system, and that interjurisdictional competition plays this role. He concludes that 

competition is a more benign regulator of state fiscal behavior than its likely alternative, the federal government. 

One may ask why regulation of state and local 

governments is necessary, given that democratic governments are supposed to be responsive to their electorates. 

Thomas Dye argues that democracy alone is not sufficient to 

make government responsive to citizen desires. His investigation of politics and public policy among the states leads 

him to conclude that party competition is absent in many 

states and that even in states with active party competition, 

this competition does not translate into policy alternatives 

offered to the voter. For these reasons and others, Dye 

argues that competition among governments is a necessary 

auxiliary mechanism for controlling government behavior.I2 

A Dynamic Theory of Economic Competition 

The standard theory of economic competition described above has been criticized as being too static a 

description of market activity. That theory focuses on 

price and quantity of products, but tends to ignore the role 

of innovation and of the entrepreneur. Certain economists who are dissatisfied with the neoclassical approach 

described above have looked back to Joseph Schumpeter’s economic theories to craft a different approach to 

market c~mpetition.’~ 

For example, Reuven Brenner defines market competition as a situation in which “businessmen compete 
with ideas to find a combination of customers and services 

with respect to which they have an advantage over those 

whom they perceive as their competitors.” Brenner would 

have us measure the degree of competition within a market 

by the “fim’s relative rate of innovation, as measured by the 

fraction of sales of new products in the firm’s total 

revenues.”14 Brenner places entrepreneurs, inventions, and 

innovations at the center of his market theories. 

Albert Breton also looks to Schumpeter’s theories 

when analyzing competition among government^.^^ He 

describes politicians as innovators who strive to find new 

tax, expenditure, and regulatory policies that can gain or 

increase the support of their citizens. The threat of 

potential exit by people or capital may motivate politicians 

to adopt particular policy innovations. Breton points to 

the large literature in political science and sociology on 

the diffusion of policy innovations as important evidence 

of competition among state and local governments.lb 

=king a clue from both Breton and Brenner, we 

might measure the degree of competition among governments by the rates at which new policies are adopted. One 

such measure is described below in the section on 

alternative empirical measures of the relative degree of 

interjurisdictional competition. 

The Link between Market Structure, Conduct, 

and Performance 

Industrial organization, an entire field within economics, studies the relationship between market structure and the conduct of firms within that market, and 

finally, the link to industry performance. For example, to 

the extent that a market approximates the assumptions of 

perfect competition, a market is said to exhibit an 

effectively competitive structure. That structure, in turn, 

is associated with particular types of firm behavior. 

Alternatively, an oligopolistic market generally leads to 

particular foms of business conduct and to particular 

characteristics of market performance. 

Economists have found that less competitive market 

structures tend to go hand in hand with higher prices, 

reduced output, and greater inefficiency in production 

(i.e., production at higher than minimum average cost). 

There also is some evidence that competition promotes 

the discovery of new inventions and innovations. It is not 

clear that more competition is always better, however. For 

example, in a fiercely competitive market, entrepreneurs 

may not have the opportunity to gain substantial rewards 

for new inventions. Their competitors may be able to 

enter any new market so quickly that any excess profits are 

quickly driven to zero. For that reason, some analysts have 

argued that a degree of monopoly power is most 

conducive to a high rate of inn~vation.’~ 

As economists have turned their attention beyond 

for-profit firms, they have found market structure to be 

important in the equilibrium outcome in other arenas. For 

example, even though it is often assumed that nonprofit 

organizations seek to maximize output, by analyzing 

nonprofit behavior within a competitive market, it is 

possible to show that competition will force the nonprofit 

firm to act just like a for-profit firm. For example, in 

equilibrium, the nonprofit hospital in a competitive 

market will produce no more output than would a 

for-profit hospital, and again like a for-profit, will produce 

this output at minimum cost.18 This type of result 

naturally leads to the question of whether the structure of 

government “markets” will have an important effect on 

the nature of government policies. In Chapter 6, we 

examine the empirical evidence to date on the relationship between the level of local government spending and 

the structure of local government “markets” in different 

states and metropolitan areas. 

Market Failure 

A final area of economic analysis of competitive 

markets that we will find useful in our evaluation of 

interjurisdictional competition is the concept of “market 

failure.” As mentioned above, economists have shown 

that the private market tends to produce the optimal 

quantity of goods and services except under conditions of 

so-called market fai1~re.l~ Some of these instances of 

market failure include situations of natural monopoly or 

the existence of public goods. Economists also have noted 

that the unassisted private market is unlikely to achieve 

the best distribution of income or to maintain full 

employment with stable prices. In many of these 

instances, government intervention has been called for. 

The type of market failure that will be most important 

in this discussion of competition among governments is 

the existence of beneficial or harmful spillovers. In the 

private market, a beneficial spillover is a side effect with a 

positive effect on individuals who are not parties to the 

market transaction. For example, pollution control equipment installed at a manufacturing plant provides beneficial 

spillovers to neighbors and people downwind of the plant 

who breathe cleaner air. In the absence of legal or political 

pressure, however, the owner has little incentive to take into 

account benefits to others and is unlikely to spend a 

sufficient amount of money on pollution abatement. In 

general, individuals tend to consume too little of goods 

exhibiting beneficial externalities, while business firms tend 

to produce too small a quantity of goods and services 

exhibiting beneficial externalities. The opposite tendency 

holds for the consumption or production of goods and 

services exhibiting harmful spillovers.20 

The types of spillover effects relevant to our analysis 

of interjurisdictional competition are spillovers of government service benefits or costs and the ability of one 

government to “export” taxes to citizens of another 

jurisdiction. An example of the first is the benefit that 

citizens across the country derive from a high-quality system 

of higher education provided by a state whose citizens are 

likely to move to other states during their lifetimes. An 

example of tax exporting is the ability of Nevada to shift 

some of its revenue burden to residents of other states by its 

heavy reliance on taxes with a disproportionate burden on 

tourists (e.g.. gaming and sales taxes).21 

Factors Affecting the Degree of Competition among Governments 

We can use the economic theory of the determinants 

of a competitive market structure to predict what factors 

14 
are likely to increase interjurisdictional competition. At 

the most fundamental level, the degree of competition in 

our federal system will depend on the number of 

governments and on the range of policy variables along 

which they compete (e.g., their range of fiscal and 

regulatory powers). Thus, we expect that, all else being 

equal, competition will be greater among the suburbs in a 

metropolitan area with 50 suburbs than among the 

suburbs in a metropolitan area with five suburbs. 

Likewise, competition among local governments in a state 

where education spending can vary among those governments will tend to be greater than the competition among 

local governments in a state like Hawaii, where public 

elementary and secondary education is provided by the 

state rather than by local governments. 

A further factor affecting the level of competition is 

the potential for new entrants into the governmental 

market. Individuals in metropolitan areas in the United 

States have the option of moving to exurbia, where, at 

some point in the future, a new local government may be 

incorporated. These individuals can look forward to 

choosing the government policies that best suit them in a 

newly formed government. Another important consideration is the adequacy of information provided to individu- als and firms. If citizens of a particular city are not aware 

that a neighboring city provides essentially the same level 

of services for a lower tax rate than their home city, the 

two cities will not be in competition. 

Once individuals and firms have knowledge about 

potential choices, the next consideration is their degree of 

mobility. An individual or the owner of a firm may be 

reluctant to move to a new location for many reasons, 

including family ties, loyalty to the city or state, or 

attachment to the physical surroundings. All of these 

attachments reduce the degree of competition among 

governments. Of course, when considering the mobility of a 

business firm’s assets, such personal ties are not generally 

important, thereby tending to increase capital mobility, all 

else being equal. Mobility also is affected by other factors 

external to individuals or firms. The better the transportation system, all else being equal, the greater the mobility. 

Because the amount of information available to 

citizens and business firms is far greater now than it was 

even a decade ago and ease of mobility has improved 

enormously over the years, competition will tend to be 

increased among governments. As our economy and 

population continue to become more interdependent, 

more governments become potential competitors. 

The focus so far has been on the factors affecting the 

competitive structure of state and local governments. It is 

important to note, however, that there is a distinction 

between a competitive market structure and competitive 

behavior. Even though citizens may have a wide range of 

choice among state governments, if these governments 

act in a conforming way or actively collude with each 

other, competition will be less. For example, if cities in a 

metropolitan area adopt tax-base sharing for new manufacturing or commercial development, interjurisdictional competition for new development will be reduced 

greatly. Whereas market structure can indicate the likely 

degree of competition, market structure alone does not 

determine the degree of competitive behavior. 

How Competition Is Likely to Vary 

by Type of Government 

Now that we have discussed the various factors 

affecting the degree of competition among governments, 

it is a straightforward matter to discuss how competition is 

likely to vary by type of government. This section will 

focus on competitive structure rather than on competitive 

behavior, because of the lack of information on the latter. 

At an elementaly level, because there are more local 

governments than there are states, we expect the degree of 

competition to be greater among local governments than 

among states. Because of mobility and information factors, 

we expect that interjurisdictional competition in sparsely 

populated areas will be less than in densely populated areas. 

If the relevant market area includes all local general 

governments within a certain number of square miles, then 

there will be fewer competitor governments in a sparsely 

populated area than in a densely populated area. 

We expect that central cities and suburbs will be 

competitors, but these two types of governments have 

very different characteristics. Many suburbs can offer 

lower housing costs and lower crime rates, but also fewer 

cultural opportunities and greater commuting burdens. 

Many suburbs are close competitors; that is, they compete 

for the same type of individual or business firm. There 

also are instances in which suburbs purposely differentiate themselves. One suburb may aim for the lowest 

possible tax rate; another may aim for the highest quality 

public schooling. Whether suburban governments offer 

differentiated tax-service packages will depend on the 

degree of heterogeneity of citizen preferences. The more 

heterogeneous are citizen preferences and the more easily 

citizens with different preferences can congregate in a 

particular suburb, the greater will be the extent to which 

suburbs will pursue the product differentiation strategy. 

Special competitive situations arise when a Metropolitan Statistical Area (MSA) includes more than one central 

city and, in addition, spans more than one state. Because 

MSAs are relatively integrated economic units, the availability of information across these metropolitan areas and 

mobility within them are likely to be particularly high. This 

will tend to increase interjurisdictional competition. 

A final type of interjurisdictional competition, interregional competition, is the most difficult to analyze 

because it is likely to be characterized by changing 

coalitions. There is no stable group of regional coalitions 

whose structure can be analyzed in order to determine its 

degree of competitiveness. 

This is well illustrated by the recent competition 

among the states for the location of the federal 

government’s atom smasher known as the superconducting super collider.22 The U.S.Department of Energy has 

estimated that 16,000 contiguous acres will be needed for 

the project. California estimated that the super collider 

could produce a yearly tax windfall for local governments 

in the host state of approximately $1 million. Because of 

the size of the project, its benefits to state and local 

governments may well be regional in nature. 

Before finally settling on a site in Texas, the Energy 

Department considered 42 sites in 25 states. In the 

15 
process, 14 governors cooperated in backing five states 

that they thought had the best chances. For example, 

South Dakota’s governor had support from the governors 

of Iowa, Minnesota, Nebraska, and North Dakota for his 

state’s proposal, appropriately entitled “The Northern 

Plains Super Collider Effort.” As the selection process 

progressed to the choice of finalists, a news article stated, 

“The first round of cooperative state efforts may not be 

the last. Governors indicate they might be willing to form 

new alliances to back the finalist^."^^ 

There are, of course, other kinds of issues that 

generate regional coalitions. During the height of the 

worldwide unitary tax issue, states such as California, 

Montana, North Dakota, and New Hampshire were 

collaborators. In times of an agricultural recession, 

another group of states is likely to join efforts to persuade 

the federal government to provide aid for farmers. There 

are different coalitions during each period of history. 

During the Constitutional Convention, there was an 

extended disagreement between the large states and the 

small states regarding the appropriate type of state 

representation in the U.S. Congress. 

The Relationship between Competition 

and Diversity 

The relationship between interjurisdictional competition and diversity turns out to be quite complex. 

Competitive behavior can imply either a move toward 

diversity or a move toward conformity, depending on 

whether a government is acting in the role of leader or 

follower. This can be illustrated with an historical 

example of interstate tax competition over the imposition 

of death (either estate or inheritance) taxes. Between 

1885 and 1916, most states adopted death taxes.24 As J. 

Richard Aronson and John L. Hilley described subsequent developments: 

In November 1924, by constitutional amendment, [Florida] forbade enactment of either inheritance or income taxes. The purpose of the 

move was only too apparent; by supplementing 

the attractions of its climate with the establishment of a tax haven, Florida hoped to induce rich 

people to choose Florida as their home. Since domicile for the purpose of taxation was easy to establish, the other states had reason to fear the 

migration of estates beyond their jurisdiction. 

Nevada promptly met the threat, or rather imitated Florida, by passing a similar constitutional 

amendment in July 1925; California, which had 

up to this time been the natural competitor of 

Florida as a domicile for retired millionaires, discussed the need for parallel action.*’ 

Florida’s adoption of a constitutional amendment 

banning legislative enactment of inheritance or income 

taxes was an innovative measure, the aim of which was to 

increase the state’s share of high-income individuals. 

Florida’s action also increased the diversity among state tax 

structures. The states that imitated or considered imitating 

Florida were embarking on conforming actions of a competitive nature. Their aim was either to maintain or to enlarge 

their share of the nation’s high-income individuals. Although competitive behavior in the guise of policy innovation may first contribute to fiscal diversity, as other states 

attempt to maintain their competitive position, the competitive behavior of the “catch-up” states reduces diversity.26 

Shannon’s discussion of interjurisdictional tax and 

policy competition looks at the relationship between 

competition and diversity in a different light.27 His convoy 

analogy leads him to argue that interjurisdictional 

competition places limits on how different one state or 

local government can become relative to other governments. He points to New York’s 1987 cuts in income tax 

rates as evidence of the pressure of interstate competition 

on New York’s propensity to levy relatively heavy tax 

burdens and fund a relatively high level of public services. 

Conversely, he uses Mississippi as an example of a state 

with a relatively poorly funded education system that was 

nudged by North Carolina’s example to raise taxes and 

improve funding for education. 

Shannon is looking not so much at the dynamic 

process of interjurisdictional competition as at the 

equilibrium tendencies of the system. His hypothesis will 

tend to be correct in the long run to the extent that 

citizens in different states or localities have similar tastes 

for public services. If citizens of adjoining state or local 

governments do not differ greatly in the government 

services they desire, they can use the performance of 

neighboring governments as a “yardstick” for judging the 

competence and responsiveness of their own governments. 

Such “yardstick” competition in the face of similar preferences for government services on the part of citizens is likely 

to reduce fiscal diversity in the federal system. 

However, if citizen preferences vary substantially, 

governments will tend to diversify as they attempt to 

satisfy the particular tastes of their citizens. At the same 

time, the efficiency of their performance is less susceptible to monitoring through the “yardstick” of other 

governments’ performance. Under these circumstances. the 

equilibrium fiscal pattern resulting from interjurisdictional 

competition will exhibit a significant degree of diversity. 

Measuring the Degree 

of lnterjurisdictional Competition 

Very little research has been done to measure the 

degree of competition among local governments, state 

governments, or regional associations of governments. 

One stimulating piece of research is an analysis by William 

Fischel of the competitive structure for the 25 largest 

urbanized areas in the United States. His purpose was to 

test the applicability of the Tiebout model and determine 

the potential for local governments to act like monopolists in the exercise of their zoning powers.2s 

Fischel’s innovation is an application of a measure of 

market concentration from the industrial organization 

field of economics to local governments. A commonly 

used measure is the four-firm concentration ratio. which 

gives the percentage of the market (usually measured by 

sales) held by the four largest firms in an industry. For 

example, in 1982, the top four breakfast cereal makers 

shipped 86 percent of the nation’s cereal, which makes 

16 
Table 1 

Suburban Fragmentation Data for the Largest Urbanized Areas,’ in Population Rank Order 

Entire Urban Area 

Number of Local Average Population 

Four La-est S uburbs Concentration Ratio2 

Percent Percent Average Land Area 

Urbanized Area Governments3 of Suburbs UA Land Suburban Land (square miles) 

(W (1) (2) (3) (4) (5) 

* 1. NewYork 399 18,796 10% 12% 60.0 

* 2. Los Angeles 104 47,785 6% 10% 25.3 

* 3. Chicago 178 17,342 5% 7% 16.8 

* 4. Philadelphia 166 12,560 11% 13% 20.8 

* 5. Detroit 97 25,616 16% 19% 35.2 

* 6. San Francisco 58 33,525 17% 21% 29.5 

* 7. Boston 78 26,123 11% 12% 19.0 

8. Washington, DC 18 101,469 78% 89% 96.2 

* 9. Cleveland 91 13,423 15% 17% 24.8 

*lo. St. Louis 116 10,963 11% 13% 12.6 

*11. Pittsburgh 180 7,407 12% 14% 18.5 

13. Houston 30 15,395 19% 72% 25.5 

14. Baltimore 4 224,674 75 % 100% 77.1 

* 12. Minneapolis 89 11,016 20% 23% 35.9 

15. Dallas 23 22,467 29% 48% 49.4 

* 16. Milwaukee 41 13,384 30% 38% 34.7 

17. Seattle 29 24,209 50% 69% 52.1 

18. Miami 22 42,133 78% 90% 50.4 

19. San Diego 12 45,854 32% 74% 30.9 

20. Atlanta 26 27,032 51% 74% 55.1 

*21. Cincinnati 79 8,436 14% 19% 12.1 

22. Kansas City 46 13,332 31% 86% 37.9 

*23. Buffalo 26 24,953 28% 35% 15.1 

*24. Denver 25 22,193 21% 31% 15.4 

25. SanJose 15 41,523 27% 47% 18.8 

‘An Urbanized Area is the part of an SMSA with population density exceeding 1,000 per square mile, excluding nonresidential areas. 

For acomplete definition see 1970 CensusofHousing, Voi. 1, Housing Characteristics, AppendixA. Data used are from the 1970 Census. 

’The concentration ratio is the percentage of urbanized area land (or suburban land) occupied by the four largest suburbs. 

3Number of local governments with final zoning authority. 

* Concentration ratio less than 40 percent. 

Source: Table 1 in William A. Fischel, “Is Local Government Structure in Large Urbanized Areas Monopolistic or Competitive?”Nutionul TmJoumul34 (March 1981): 95-104, with minor modifications. 

this a very concentrated, and thus not very competitive, 

industry. In contrast, the top four radio and TV equipment 

firms accounted for only 22 percent of the market, which 

gives this industry an effectively competitive structure.B Recall that William Shepherd classified all industries in which 

the top four firms controlled less than 40 percent of the market as “effectively competitive” in his empirical study of the 

extent of competition in the U.S. economy. 

Fischel calculated a similar measure for Urbanized 

Areas, which are the most densely populated portions of 

SMSAs. Table 1 shows the percentage of total Urbanized 

Area land occupied by the largest four suburbs and, 

alternatively, the percentage of suburban land in the total 

Urbanized Area accounted for by the largest four suburbs. 

Because of his interest in zoning, Fischel limited his 

analysis to those governments with final zoning authority. 

He concludes that only three large Urbanized Areas 

appear to have a monopolistic local government structure: Washington, Baltimore, and Miami.30 For example, 

the Baltimore Urbanized Area has only four suburban 

governments with final zoning authority. Therefore, the 

concentration ratio calculated with respect to suburban 

land is 100 percent. One implication of this finding is that the 

structure of these metropolitan areas lends itself to 

restrictive land-use policies. That is, potentially, individual 

governments can exert significant market control. 

In contrast, Chicago has one of the most competitive 

local government structures. The largest four suburbs 

account for only 5 percent of the total land in the 

Urbanized Area, and only 7 percent of the total suburban 

land in the Urbanized Area. Of the 25 urban areas 

examined by Fischel, 15 have concentration ratios less 

than 40 percent, thus putting them in the category of 

“effectively competitive” The structure of 

17 
governments in these metropolitan areas gives no 

individual government the ability to enforce restrictive 

land use policies. 

One deficiency of the study, which Fischel points out, 

is that it does not account for cooperative arrangements 

among local governments, such as the tax-base sharing 

arrangement in the Minneapolis-St.Pau1 area. Another 

way to state this deficiency is to note that a measure of 

competitive structure has been developed, but that the 

extent of competitive behavior has not been tested. 

A research approach for extending Fischel’s study 

could involve the following steps. First, the computation 

should be limited to either state or local governments. 

Second, the range of policy dimensions must be specified. 

Although Fischel’s analysis focused on local zoning 

powers, most governments with zoning authority are also 

local general governments. To focus on a government 

service not always provided by general governments (e.g., 

education), the analyst would have to count school 

systems and calculate the concentration ratio for the 

largest school districts in each metropolitan area. In order 

to measure the changing degree of competition over time, 

these computations would be required for different years, 

with appropriate adjustments made for the changing market 

definitions. For example, 20 years ago, the suburbs to which 

a Washington, DC, worker could realistically commute were 

fewer than they are today, due to the extension of the 

subway system and improved housing opportunities in the 

suburbs. Therefore, the relevant land area for computing 

most concentration ratios in the Washington, DC, area is 

greater today than it would have been 20 years ago. 

Fischel’s methodology can be used to measure the 

extent of competitiveness built into the structure of a 

group of governments. Chapter 6 summarizes the 

empirical literature that relies on a measure of competitive structure such as Fischel’s to test whether a greater 

degree of potential interjurisdictional competition tends 

to reduce the level of government spending. 

Alternatively, it is possible to rely on Brenner’s 

theories to measure directly the extent of interjurisdictional competitive behavior. Brenner suggests that the 

rate of innovation by business firms in a particular market 

indicates the degree of competition within that market. 

able 2 provides a preliminary application of Brenner’s 

theoy to state governments. For a number of the most 

important recent mechanisms for enforcing state government fml discipline, including tax and expenditure 

limitations, income tax indexation, program evaluation and 

sunset, state reimbursement of mandates on local governments, and tax expenditure reporting, able 2 indicates 

which states adopted such mechanisms from 1976-1986. The 

last column of the table indicatesfor each region theaverage 

proportion of the states adopting this particular set of fiscal 

discipline mechanisms. According to this methodology, the 

western states were the most competitive along the fiscal 

discipline dimension over the last decade, whereas the 

mid-Atlantic states were the least competitive. 

Actually, considerably more research would be 

needed before using such a measure of the spread of 

policy innovations as an indicator of the level of 

competition among given groups of states. Although 

“diffusion research” has contributed at least 45 studies of 

the spread of policy innovations among the American 

states, not much is known about the theory of why states 

adopt policy innovation^.^^ Breton interprets policy 

diffusion as an indication of interjurisdictional competition, but other interpretations also are possible. John 

Chubb, for one, argues that interjurisdictional competition is unlikely to be the primary force behind policy 

diffusion.” Chubb reaches this conclusion because he 

argues that international research fiids the same pattern 

of poliq diffusion across countries as American scholars 

have found across states in the United States, but 

competition across nations for citizens is unlikely to be much 

of a factor in the international arena. 

Is Interjurisdictional Competition Increasing 

or Decreasing? 

Despite the lack of a generally accepted measure of 

the extent of interjurisdictional competition, it is not 

uncommon to find assertions that interstate or interlocal 

competition has been increasing in recent years. Ronald 

Fisher has attempted to determine whether this assertion 

is true.34 Fisher makes use of Shannon’s hypothesis that 

interjurisdictional competition places limits on the degree 

of fiscal diversity that state and local governments can 

maintain. If one makes this assumption regarding the 

relationship between competition and fiscal diversity, one 

can argue that if competition becomes more heated the 

extent of fiscal diversity should decline, and vice versa. 

Fisher calculates one measure of fiscal diversity: the 

coefficient of variation among states for per capita 

state-local expenditures, own-source revenues, and taxes 

for 1971, 1975, 1980, and 1986. Fisher finds that: 

If Alaska is excluded (and Alaska is a clear outlier 

recently), the distribution of per capita fiscal 

characteristics among the states has not really 

changed since 1971. If anything, the interstate 

variation in per capita taxes and own-source revenues has become a bit larger. 

Fisher notes that not all scholars would agree that fiscal diversity should be correlated negatively with the degree of interjurisdictional fiscal competition. However, 

his results lead him to caution observers of state and local 

government that their impression of increasing intejurisdictional competition may be misleading. Their impression may arise not because such competition is increasing 

in some global sense, but because states and localities are 

adopting new competitive techniques (which we notice) 

while abandoning old ones (which we don’t notice). 

Conclusion 

This chapter has examined a number of basic issues 

regarding interjurisdictional tax and policy competition. 

First, the chapter introduced two definitions of interjurisdictional competition-a concept that has not been 

defined in an explicit and comprehensive manner before. 

Adistinction was made between active rivalry and implicit 

competition, and it was argued that implicit competition 

maybe as important as the more visible active rivalry for 

18 
Table 2 

A Decade of Adoption of State Fiscal Discipline Mechanisms, 1976-1986 

~ 

Tax and Program Tax Average 

Region Expenditure Income Tax Evaluation Reimbursement of Expenditure Percent of 

and State Limitation Indexation and Sunset Local Mandates Reports Region Adopting 

New England 

Connecticut 

Maine 

Massachusetts 

New Hampshire 

Rhode Island 

Vermont 

Mid-Atlantic 

Delaware 

Maryland 

New Jersey 

New York 

Pennsylvania 

Great Lakes 

Illinois 

Indiana 

Michigan 

Ohio 

Wisconsin 

Plains 

Iowa 

Kansas 

Minnesota 

Missouri 

Nebraska 

North Dakota 

South Dakota 

Southeast 

Alabama 

Arkansas 

Florida 

Georgia 

Kentucky 

Louisiana 

Mississippi 

North Carolina 

South Carolina 

X 

X 

X X 

X 

X 

X 

X 

X 

X 

X 

X 

43% 

X 

X 

X 

X 

X 

X 

16% 

X 

X 

X 

X 

X 

X 

X 

X 

X 

X 

X 

X 

X X X 

X 

X 

X 

X 

28% 

X 

26% 

X 

X 

X 

25 % 

X 

high-income individuals and job-producing business firms. 

Competition was then contrasted with some of its alternatives, in particular, cooperation, collusion, and coercion. 

Several economic concepts of market competition were 

summarized briefly and, to the extent possible, applied to 

interjurisdictional competition. In applying the economic 

theories of market behavior to relations among state and 

local governments, the role of governments is postulated to 

parallel the role of fms in market competition, and the role 

of citizens parallels the role of consumers. One important 

theme was the extent to which interjurisdictional competition can serve as a regulator of state and local fiscal behavior 

by placing limits on how high a jurisdiction’s taxes may be 

raised, or on how little government can spend for certhn 

public services, such as eduction. 

Based on an analogy with traditional microeconomic 

theory, we argued that the degree of competition among 

governments in a particular geographic area is likely to be 

greater to the extent that there is a greater number of 

governments competing; the formation of new governments 

is possible; information about tax and service levels for the 

various governments is readily available; and individuals, 

goods, services, and capital are mobile. Based on these 

factors, interlocal competition, especially within metropolitan areas, is likely to be greater than interstate competition. 

We summarized an empirical study by William 

Fischel, who attempted to determine whether the 

structure of large urban areas in the United States was 

competitive or monopolistic. Of the 25 urban areas he 

examined, by conventional measures of economic theory, 

15 could be considered to be “effectively competitive,” 

and only three to be essentially monopolistic. 

19 
Table 2 (cont.) 

A Decade of Adoption of State Fiscal Discipline Mechanisms, 1976-1986 

Tax and Program Tax Average 

Region Expenditure Income Tax Evaluation Reimbursement of Expenditure Percent of 

and State Limitation Indexation and Sunset Local Mandates Reports Region Adopting 

Southeast (cont.) 

Tennessee 

Virginia 

West Virginia 

Southwest 

Arizona 

New Mexico 

Oklahoma 

Texas 

Rocky Mountain 

Colorado 

Idaho 

Montana 

Utah 

Wyoming 

Far West 

California 

Nevada 

Oregon 

Washington 

Alaska 

Hawaii 

X 

X 

X 

X 

X 

X 

x 

X 

X 

X 

X 

X 

X 

X 

X 

X 

X 

X 

X 

X 

X 

X 

X 

X 

X 

X 

X 

X 

X 

X 

X 

X 

X 

X 

X 

X 

X 

X 

X 

X 

55% 

X 

X 

45% 

48% 

Notes 

Some of these fiscal discipline mechanisms have since expired. 

Tax and expenditure limitations place limits on growth in state taxes or expenditures. 

Indexing tax brackets, personal exemptions, and standard deductions prevent inflation from pushing taxpayers into higher marginal tax 

Sunset provisions set an automatic termination schedule for government agencies, offices, commissions, or boards. To circumvent sunMandate reimbursement legislation prohibits the state from imposing costly requirements on localities unless the state reimburses them. 

Tax expenditure reports compile a list of tax expenditures appearing in the state tax code. 

Sources: US. Advisory Commission on Intergovernmental Relations, Significant Featuresof Fiscal Federalism, 1985-86 Edition (Washingbrackets. 

sets, legislatures must vote to reauthorize. 

ton, DC, 1986); Karen M. Benker, “More State Budget and Tax Management Tools,” Draft, September 12, 1984. 

This chapter also explored a second approach for 

measuring the degree of interjurisdictional competition 

based on Schumpeter’s economic theories, rather than on 

traditional microeconomic theory. From this approach, 

competitive behavior is observed directly, and the degree of 

competition is measured by the number of policy innovations adopted by a particular state or local government. 

Finally, we addressed the question of whether interjurisdictional competition has been increasing in recent 

years. Both Shannon and Fisher argue that fiscal diversity 

may be inversely related to the degree of fiscal competition. 

Fisher does a simple statistical calculation of the coefficient 

of variation among states of per capita state-local expenditures, own-source revenues, and taxes for various years from 

1971 to 1986. The evidence Fisher presents does not support 

the contention that fiscal competition among states has been 

increasing over the last two decades. 

Having attempted to define and measure and to 

better understand the basic nature of interjurisdictional 

competition, we now turn to a second basic issue in the 

next chapter: in what manner does the federal government set the framework within which state and local 

governments compete? 

Notes 

‘This definition was inspired by comments and notes provided by 

Gerard Brannon in an ACIR critics’ session on a draft of this paper held on January 22, 1988. A third form of interjurisdictional 

competition, not analyzed in this paper, is termed “surrogate intergovernmental competition” by Albert Breton, who states that, 

20 
“if the citizens of a jurisdiction use information about the policies 

implemented in other jurisdictions to gauge and evaluate the performance of their own government, that process will increase 

electoral competition at home and thus incite their governing 

politicians to act to their benefit more than they othenvise would 

do.” See Albert Breton, ’‘me Existence and Stability of Intergovernmental Competition,” in Daphne A. Kenyon and John Kincaid, eds., Competition among States and Local Governments: 

Efjiciency and Equity in American Federalism (Washington, 

DC: The Urban Institute Press, 1991). One might also call this 

form of interjurisdictional competition ‘’yardstick competition.” 

’See also various articles in John Kincaid, ed., ‘%American Federalism: The Third Century,” The Annals of the American 

Academy of Political and Social Science 509 (May 1990): 9-152. 

Andy Oakley, “Big States’ Exit Won’t Spoil Multistate Lotto,” 

City & State, October 1987, p. 32. 

Of course, government provision does not always imply government production. For example, a local government can 

provide daily garbage pick up but contract with a private firm 

to perform the service. The analogy with business firms in the 

private market is their degree of contracting out or their degree of vertical integration. 

A.O. Hirshman, Exit, Voice, and Loyalty (Cambridge: Harvard 

University Press, 1970). 

Karl E. Case and Ray C. Fair, Principlesof Economics (Englewood Cliffs, New Jersey: Prentice Hall, 1989) p. 55. See also 

George J. Stigler, “Perfect Competition, Historically Contemplated,” in George J. Stigler, Essays in tlieHistory of Economics 

(Chicago: University of Chicago Press, 1965), pp. 262-263. 

William G. Shepherd, “Causes of Increased Competition in 

the U.S. Economy, 1939-1980,” Review of Economics and Statistics (November 1982): 613-626. 

8Charles Tiebout, ’A Pure Theory of Local Expenditures,” 

Journal of Political Econonry 64 (1956): 416-424. 

Ibid., p. 419. 

lo John Shannon, “Federalism’s ‘Invisible Regulator’-Interjurisdictional Competition,” in Daphne A. Kenyon and John 

Kincaid, eds., Competition among States and Local Governments: Eficiency and Equity in American Federalism (Washington, DC: The Urban Institute Press, 1991). 

l1 Ibid., p, 8. 

12Thomas R. Dye, American Fedemlism: Compefition among 

Governments (Lexington, Massachusetts: D.C. Heath Co., 

Lexington Books, 1990). 

l3 J.A. Schumpeter, Capitalism, Socialism, and Democracy (New 

York Harper and Row, 1942). 

l4 Reuven Brenner, Rivalry: In Business, Science, among Nations 

(New York Cambridge University Press, 1987), pp. x-xi. 

l5 Albert Breton, “The Existence and Stability of Intergovernmental Competition,” in Daphne A. Kenyon and John Kincaid, eds., Competition among States and Local Governments: 

Efficiency and Equity in Anierican Fedemlism (Washington, 

DC: The Urban Institute Press, 1991). 

l6 See, for example, Robert L. Savage, ed., “Policy Diffusion in a 

Federal System,” Publius: Die Joirnial of Federalism 15 (Fall 

1985): entire issue. 

”Richard G. Lipsey, Peter 0. Steiner, and Douglas D. Purvis, 

Economics (New York: Harper & Row, 1984), p. 315. 

l8 Timothy J. Goodspeed and Daphne A. Kenyon, “The Nonprofit Sector’s Capital Constraint: Does It Provide a Rationale 

for the Tax Exemption Granted to Nonprofit Firms?” draft, 

January 1991. 

l9 In a perfectly competitive market, each firm will produce output up to the point where price equals marginal cost. Since we 

assume that in a perfectly competitive market price indicates 

the marginal benefit to society of producing one more unit of a 

good, and social welfare is maximized when each commodity is 

produced such that its marginal benefit equals its marginal 

cost, the perfectly competitive market produces the optimal 

quantity of goods and services. 

2o In the terminology of economists, spillovers arise when private 

marginal benefits or costs no longer equal social marginal 

benefits or costs. In the pollution control equipment example 

above, the operation of the private market results in investment in pollution control technology such that the private 

marginal benefit equals the marginal cost. However, at the private market equilibrium, social marginal benefits exceed marginal costs, meaning too little is spent on pollution control 

equipment from society’s point of view. 

21 Robert D. Ebel, ed., A Fiscal Agenda for Nevada (Reno and 

Las Vegas: University of Nevada Press, 1990). 

22 Elizabeth Voisin, “Governors Bid Together for Federal Atom 

Smasher,” City & State, October 1987, p. 20. 

23 Ibid. 

24 US. Advisory Commission on Intergovernmental Relations, 

Coordination of State and Fedeml Inheritance, Estate and Gijl 

Tms (Washington, DC, 1961), p. 27. 

25 J. Richard Aronson and John L. Hilley, Financing State and 

Local Governments (Washington, DC: The Brookings Institution, 1986), p. 117. 

26See also Philip J. Grossman, “Fiscal Competition among 

States in Australia: The Demise of Death Duties,” Publius: 

The Journal of Federalism 20 (Fall 1990): 145-159. 

27 Shannon, “Federalism’s Invisible Regulator.” 

28 William A. Fischel, “Is Local Government Structure in Large 

Urbanized Areas Monopolistic or Competitive?” National Tmr 

Journal 34 (March 1981): 95-104. 

US. Department of Commerce, “Concentration Ratios in 

Manufacturing,” 1982 Census of Manufactures (Washington, 

DC, 1983). It is not clear that the choice of four firms was anything more than an arbitrary choice. Rankings can vary depending on whether one calculates a four-firm concentration 

ratio or an eight-firm concentration ratio. I can think of no 

reason to prefer any particular number when applying this 

concept to local government structure, however. 

30 Fischel, in describing Urbanized Areas with few local governments as monopolistic, is using the term monopoly in a more 

general sense than its literal meaning of “single seller.” Others 

might prefer to label the government structures in Washington, Baltimore, and Miami as oligopolistic. 

31 For a related perspective, see U.S. Advisory Commission on 

Intergovernmental Relations, Die Organization of Local Public Economies (Washington, DC, 1987). 

32 See, for example, the review by Robert L. Savage, “Diffusion 

Research Traditions and the Spread of Policy Innovations in a 

Federal System,” Piibliiis: The Journal of Federalism 15 (Fall 

33 John E. Chubb, “How Relevant Is Competition to Government Policymaking?” in Daphne A. Kenyon and John Kincaid, eds., Coinpetif ion among States and Local Governments: 

Eficiency and Equity in American Federalism (Washington, 

DC: The Urban Institute Press. 1991). 

34 Ronald C. Fisher, “Intergovernmental Competition: A Summary Perspective and Agenda for Research.” in Daphne A. 

Kenyon and John Kincaid, eds., Competition among Statesand 

Local Governments: Eficiency and Equity in American Federalism (Washington, DC: The Urban Institute Press, 1991). 

1985): 1-27. 

21 
22 
Chapter 3 

The Federal 

Government’s Role 

in Setting 

the Framework 

for lnterjurisdictional 

Competition 

23 

The United States Constitution, federal laws and regulations, grants-in-aid, and tax expenditures aiding state 

and local governments are part of the framework within 

which state and local governments compete. Federal poli- cies can affect the “rules of the game” for interjurisdictional competition or change the distribution of resources 

among governments and thus affect their relative abilities 

to compete with each other. Federal policies also can 

modify the incentives for state and local governments to 

engage in rivalrous behavior or affect the degree of implicit competition that arises from the free movement of 

products, people, and capital among jurisdictions in the 

face of differing state and local government policies. 

The independent authority of the states and the fact 

that local governments are legal creatures of the states 

make state actions an important part of the framework 

within which local governments compete. State constitu- tions, laws, regulations, and aid to local governments all 

help shape the nature and degree of interlocal competition. 

Due to limitations of research and the diversity among the 

50 states, however, the state role in creating a fmmework for 

competition among local governments will not be addressed 

specifically in this chapter. 

The United States Constitution 

The United States Constitution not only provides the 

basic framework for our federal system of government but 

also sets the stage for relations among states, and to a 

lesser degree among local governments. 

The key provision affecting the relative political 

power of the states is the first article of the Constitution, 

which provides the manner in which the states are 

represented in the Congress. Each state is represented in 

the House of Representatives according to its population, 

but all states are accorded equal representation in the 

Senate. This provision represents the resolution of an 

important controversy that arose during the Constitution- al Convention. The larger states had argued for represen- tation on the basis of population, while the smaller states 

argued for equal representation for each state.’ 

The Constitution also places restraints on the 

competitive tendencies of states in order to create a free 

national market. Specifically, the Constitution prohibits 

states from taxing imports or exports without the consent 

of the Congress. More generally, the commerce clause, 

which gives the federal government the power to 

“regulate Commerce among the several States,” has been 

broadly interpreted as limiting the states’ power to 

interfere with interstate commerce. The Constitution 

also provides for a check on collusion or cooperation 

among the states by prohibiting one state from entering 

into an agreement or compact with another state without 

obtaining the consent of the Congress. 

At the same time, some constitutional provisions 

facilitate or encourage competition. The full faith and 

credit and the privileges and immunities clauses, for 

example, guarantee interjurisdictional mobility, which 

undergirds competition. These clauses also have the 

effect of restraining unfair competition. The provision for 

admitting new states to the Union serves to increase the 

number of jurisdictional competitors, while apportion- ment of the U.S. House of Representatives according to 

population serves to reward states that attract residents2 
The Supreme Court 

Because of the American system of judicial review, 

court cases interpreting the Constitution have been 

extremely important in creating the framework for 

interjurisdictional competition. The evolving interpretations of the commerce clause have generated important 

judicial restraints on interjurisdictional tax competition. 

In the early years, the commerce clause was interpreted as prohibiting nearly all state taxation of interstate 

commerce; consequently, in drafting state laws, distinctions had to be made between goods that were and were 

not involved in interstate c~mmerce.~ This strict interpretation was relaxed over time, and in 1977, the U.S. 

Supreme Court set forth a new interpretation of the 

commerce clause. According to the Court in Complete 

Auto Transit, Inc. v. Brudy, state taxation of interstate 

commerce must pass four tests: 

1) A state may tax only activities with a substantial 

nexus (business connection) within its state. 

2) Only fairly apportioned taxes may be imposed. 

mis test applies in the case of corporate income 

taxes, which are subject to apportionment, but 

not in the case of sales taxes, which are not subject to apportionment.) 

3) The tax must bear a fair relation to the services 

provided by the taxing state. 

4) The tax must not discriminate against interstate 

commerce? 

Discussion of specific cases below will help illustrate the 

application of three of these tests. 

Nexus 

The requirement that a state may tax only activities 

with substantial nexus has been subject to changing, 

sometimes seemingly inconsistent, interpretations by the 

courts in recent years. Much of this controversy has involved 

the application of the use taxes that serve as companions to 

state sales taxes. A use tax, levied by the state of residence, 

applies to purchases made in another state, and is levied at 

the same rate as the sales tax on purchases in the home 

state. States generally are able to collect use taxes only when 

they can require out-of-state businesses to collect them. This 

collection requirement may be imposed only when the 

out-of-state business has substantial nexus within the state. 

Two U.S. Supreme Court cases that illustrate some of 

the fine distinctions that have been made in determining 

whether a business has substantial nexus in a state are Miller 

Brothers Co. v. Marylandand Scripto, Im. v. Carson.s In Miller 

Brothers, the state of Maryland attempted to require Miller 

Brothers, a Delaware retailer, to collect use taxes from 

Maryland residents who purchased items from Miller 

Brothers’ Delaware store. Miller Brothers delivered items 

to Maryland residents using its own trucks or common 

carrier, but the company had no outlet or agents in 

Maryland, .nor did it advertise directly in Maryland. The 

Court ruled that Miller Brothers could not be required to 

collect use taxes from Maryland residents. In his summary, 

Justice Robert H. Jackson argued that there must be “some 

definite link, some minimum connection, between a state 

and the person, property or transaction it seeks to tax.” 

Scripto, Inc. v. Curson involved a similar case in which 

Florida was attempting to require a Georgia merchandising corporation to collect use taxes on purchases made by 

Florida residents. The Georgia corporation had no office, 

property, or agents in Florida. The corporation did 

employ independent sales contractors who traveled to 

Florida to obtain orders, which were then sent back to 

Georgia to be filled. In this case, the Court found that the 

business presence in Florida was substantial enough to 

make the Georgia firm liable to collect use taxes. 

The most important current controversy in the use 

tax area involves whether certain mail-order firms have 

sufficient nexus to be subject to the use tax collection 

requirement. Firms that operate a retail sales outlet in 

many states, such as Sears or Montgomery Ward, are 

required to collect use taxes on all sales made to states in 

which they operate sales outlets. However, firms such as 

L.L. Bean, which do not operate retail sales outlets 

outside of their headquarters state, cannot be required to 

collect use taxes on catalog sales in other states. 

According to ACIR estimates, state and local governments would have collected nearly $2.5 billion in 1988 

(ranging from less than $3.0 million in Wyoming to well over 

$300 million in California) if use taxes had been collected on 

taxable commodities sold through mail-order firms! The 

controlling Supreme Court case is National Bellas Hess, Inc. 

v. fllinois Department of Revenue, which held that a fm 

cannot be required to collect use taxes in a state in which its 

only contact is through the U.S. mail or common carrier? 

Fair Apportionment 

State income taxation of interstate businesses raises 

the problem of how to divide the tax base among the 

various states. A corporation may operate in more than 

one state and sell its products to a number of states. The 

question is: how should the corporation’s income be 

divided among the states in which it has taxable presence? 

The most common practice is to apportion the income tax 

base according to the proportion of the firm’s sales, 

property, and payroll that are located in each state, with 

each of the three factors given equal weight in the 

apportionment formula. If all states were to use such a 

formula, then summing the portions of an interstate firm’s 

tax base subject to taxation in each state would equal the 

total tax base of the firm.8 

In practice, the Supreme Court has allowed the states 

considerable latitude in setting different apportionment 

formulas. The case of Moorman Manufacturing Co. v. Bair 

decided that the single-factor apportionment formula 

adopted by Iowa, in which only sales were considered, was 

constitutional? Under that apportionment formula, a 

manufacturing firm located in Iowa but selling a large 

proportion of its products to other states would be likely to 

be taxed on less than its total income taxbase. This results 

from the interaction between Iowa’s single-factor formula 

and the three-factor allocation formulas used by most other 

states. Iowa would tax this firm relatively lightly because of 

the small fraction of its sales made to Iowa residents, and 

other states would tax this firm relatively lightly because the 

bulk of its property and payroll is located in Iowa. 

24 
Conversely, a manufacturing firm located outside 

Iowa but selling a large proportion of its products to Iowa 

residents would likely be taxed on greater than 100 

percent of its income tax base. Iowa would tax this firm 

relatively heavily because of the high fraction of its sales 

to Iowa residents, as would other states because of the high 

proportion of property and payroll located outside of Iowa. 

Justice Lewis Powell, who dissented from the majority 

opinion of the Court in Moomuuz, argued that “Iowa’s use of 

a single-factor sales formula to apportion the income of 

multistate corporations results in the imposition of a tax 

which discriminates against interstate commerce . . . by 

providing a direct commercial advantage to local business.” 

Nondiscrimfnation against Interstate Commerce 

d 

The fourth requirement of Complete Auto Transit is 

that a tax cannot discriminate against interstate commerce. One example of a state tax practice that has been 

overruled by this Complete Auto Transit test is the 

imposition of a use tax with a larger tax base than its 

companion sales tax. lo At least one observer has argued 

that the Supreme Court has maintained a stricter standard 

of interpretation in the test of nondiscrimination against 

interstate commerce than for the other Complete Auto 

Transitxests.ll For example, the Court has not allowed states 

to adopt taxes that discriminate against interstate commerce 

even if the tax promotes a legitimate state purpose. 

On the other hand, the Supreme Court has allowed 

the states to use a wide variety of tax incentives that may 

have the effect of luring businesses from other states. 

From an economic point of view, it is difficult to 

distinguish between a discriminatory tax imposed on firms 

headquartered out of state and a tax holiday offered to firms 

headquartered in the state. Both appear to have the same 

purpose and, if interstate competition for mobile businesses 

has a zero-sum effect, may have the same outcome. 

Although we have focused on the commerce clause as 

probably the most important provision of the Constitution 

affecting interstate tax competition, interpretations of 

certain other constitutional provisions also have formed 

an important part of the framework within which 

interjurisdictional tax competition takes place. For example, the privileges and immunities clause of the Eourteenth Amendment has been used to invalidate a Nevada 

tax on all individuals leaving the state by public transportation.12 Furthermore, the due process clause of the 

Fourteenth Amendment has been interpreted as prohibiting states from imposing death taxes on property held by 

their citizens in other states.13 

Federal Laws and Regulations 

Federal laws and regulations add further refinement 

to the framework within which state and local governments compete. As in the last section, this examination 

can touch on only a small fraction of the ways in which 

federal laws and regulations affect interjurisdictional competition. Two examples will be discussed. Next, the effect on 

interjurisdictional competition of federal mandates on state 

and local governments will be examined briefly. 

The interaction between a federal law and various 

court cases explains an interesting anomaly in the federal 

framework for interjurisdictional competition. Despite 

the general prohibition of state discrimination against 

interstate commerce, out-of-state insurance companies 

have been discriminated against in two ways relative to 

insurance companies incorporated within a state. First, 

states were able to impose a higher rate of gross premiums 

taxon out-of-state companies than on in-state companies. 

Second, states have been able to impose retaliatory taxes 

on out-of-state companies. 

The basic mechanism of retaliatory taxation is as 

follows. Company B, domiciled in State B but doing 

business in State A, must pay State A the greater of 

1) The total taxes appkable to Company B under 

the gross premiums and other non-retaliatory 

taxes of State A; or 

2) The total taxes applicable under the laws of State 

B to an otherwise identical company domiciled in 

State A and doing business in State B. 

If State B taxes out-of-state companies at a lower rate 

than does State A, then Company B will pay no retaliatory 

taxes. If State B taxes out-of-state companies at a higher 

rate than does State A, then the excess of (2) over (1) is 

defined as the retaliatory tax liability that Company B 

owes to State A. 

The reason why states have been able to discriminate 

against interstate commerce in insurance is that, for a 

number of years, the courts held that insurance was not a 

business involved in interstate commerce, so that the 

Constitution’s commerce clause did not apply. When the 

courts overruled this interpretation, before state taxation 

of insurance was affected, the Congress passed the 1945 

McCarran-Ferguson Act. This act gives states the right to 

regulate the insurance business, and it has enabled them 

to maintain their discriminatory systems for taxing 

insurance companies. 

Recently, insurance companies used the equal protection clause to challenge the practice of levying higher 

state tax rates on out-of-state companies than on in-state 

companies. In Metropolitan Life Insurance Co. v. Ward, the 

U.S. Supreme Court rejected Alabama’s differentially 

high premiums tax on out-of-state insurance com~anies.’~ 

Subsequently, some states have adopted equal tax rates 

for out-of-state and in-state companies, and the matter is 

being litigated in other states.” Nevertheless, the system 

of retaliatory insurance taxes was upheld in a recent 

Supreme Court case.16 

A second example of the way in which federal 

legislation can affect interjurisdictional competition 

involves state excise taxes on cigarettes. Ronald Fisher 

describes how interstate competition has tended to limit 

the interstate diversity in cigarette excise taxation.” 

Because cigarettes are easy to transport, individuals can 

avoid high cigarette taxes in their state of residence by 

traveling to neighboring states to make their purchases, or 

by obtaining untaxed cigarettes from military bases or 

Indian reservations. Of particular concern has been the 

incentive for interstate differentials in cigarette taxation 

to lead to organized smuggling operations. 

25 
In response to state lobbymg and an ACIR study,Is in 

1W8, the Congress passed the Confrubd Cigaretfe Act. This 

law makes it a federal crime to be involved in transactions of 

large amounts of cigarettes (more than 3,000 packs) unless 

state taxes are paid. As Fisher descn’bes: 

This law was then vigorously enforced by the Bureau of Alcohol, Tobacco, and Firearms, a branch 

of the U.S. Treasury. By all accounts, this federal 

intervention, coupled with expanded state enforce- ment activity, greatly curtailed interstate cigarette 

sales to avoid state taxes. . . . In essence, the differ- ences in state excise taxes on cigarettes were able to 

be maintained, and even increased, largely because 

of the assistance of the federal government in preventing evasion of those state tax laws. 

Federal Mandates 

Probably the most visible (and controversial) federal 

laws and regulations affecting state and local govern- ments in recent years have been federal mandates. 

According to ACIR, these take several forms: 

Direct orders (e.g., the wastewater treatment 

standards set by the Clean Water Act). 

Crosscutting requirements, which are requirements generally attached to all federally funded 

programs (e.g., the Davis-Bacon Act, which sets 

minimum wage levels on construction projects 

funded with federal assistance.) 

Crossover sanctions, which threaten the reduction of one type of federal aid if requirements under a second program are not satisfied (e.g., the 

threat to withhold highway construction funds if 

states did not comply with billboard control standards set by the 1965 Highway Beautification Act). 

Partial preemptions, which establish federal 

standards, but which leave discretion to the states 

if they adopt a minimum state standard (e.g., the 

implementation approach for the drinking water 

quality standards set by the Safe Drinking Water 

Act Amendments of 1986.)19 

There are at least two ways in which federal mandates 

might affect interjurisdictional tax and policy competi- tion. Given that mandates are often unfunded or underfunded, the amount of the financial burden imposed on 

state and local governments, as well as the distriiution of 

that burden, is a concern. The relevant question is whether the fiscal impact of unfunded or underfunded federal 

mandates might weaken the ability of less fiscally able 

state and local governments to compete with other jurisdictions. The second concern is whether federal mandates 

might affect interjurisdictional competition by limiting 

the diverse policy choices made by state and local governments in their efforts to compete. 

The evidence is limited regarding the extent and 

pattern of the fml impact of federal mandates on state and 

local governments. One of the few studies of the fiscal 

impact of federal mandates, now ten years old, estimated 

the impact of six unfunded federal mandates (certain 

wastewater treatment requirements, unemployment compensation requirements for state and local employees, 

various bilingual education requirements, the Education of 

AIl Hundicapped Children Act, transit accessibility requirements, and minimum wage requirements) on seven local 

governments (Burlington, Vermont; Alexandria, Viiginia; 

Cincinnati, Ohio; Dallas, Qxas; Seattle, Washington; Newark, New Jersey; and Fhirfax, Vi~ginia).~* The study found 

that the mandates imposed substantial costs on local 

governments-at that time $25 per capita, or roughly equal 

to the per capita revenue received under the now-defunct 

General Revenue Sharing program. The authors also found 

that the fiscal impacts imposed a disproportionately heavy 

burden on the poorer municipalities. 

The evidence is also speculative regarding whether 

federal mandates limit interjurisdictional competition by 

placing limits on important policy dimensions along which 

state and local governmentscompete. In some cases, federal 

mandates appear to limit interjurisdictional competition. 

For example, the minimum-wage requirements imposed by 

the Dais-Bacon Act may limit the extent to which 

governments receiving federal funds can reduce public 

expenditures, and thus tax burdens, by reducing wage costs. 

However, a number of mandates affect dimensions of state 

and local policy that appear less than central to a 

government’s competitive position. For example, national 

limits on the proliferation of billboards are unlikely to affect 

the major ways in which state and local governments 

attempt to compete. In general, federal mandates on state 

and local governments are not as constrainingas some of the 

state mandates that have been imposed on local govern- ments, such as the caps that six states have imposed on total 

general revenue a jurisdiction may raise.2i 

Grants-in-Aid 

The federal government also can affect competition 

among state and local governments through its direct and 

indirect aid programs. Direct aid includes the $115.3 

billion in general-purpose, broad-based, and categorical 

grants provided by the federal government in FY 1988 

(see Table 3). Indirect aid refers to the federal tax 

expenditures that aid state and local governments. 

Grants-in-aid can affect interjurisdictional competition by redistributing resources among state and local 

governments. If grants accomplish a significant amount of 

redistribution from rich to poor jurisdictions, this may 

enable the less fiscally able jurisdictions to compete on a 

more equal basis with other state and local governments. 

Albert Breton has argued that such distribution may 

contribute to the stability of interjurisdictional competition.22 The scenario he has in mind is an urban fiscal crisis 

in which high central-city tax rates cause high-income 

individuals to flee to the suburbs, which then requires the 

city to raise tax rates, which induces more outmigration, 

and so on. By providing federal aid to central cities, the 

hope is to slow down or dampen this process. 

Table 3 describes the distribution of federal grants by 

region for 1978 and 1988. In 1988, the least favored region 

(Arkansas, Louisiana, Oklahoma, New Mexico, and 

Texas) received 18 percent less grant funding per capita 

than the U.S. average, while the most favored region 

26 
Table 3 

Distribution of Grants by Region, 1988 and 1978 

(in billions of dollars) 

Region 

Dollars 

Per Capita 

1988 as Percent of 

Total U.S. Average 

Grants 1988 1978 

1. Maine, Vermont, 

New Hampshire, Massachusetts, 

Connecticut, Rhode Island $7.1 

2. New York, New Jersey, 

Puerto Rim, Virgin Islands 18.8 

3. Virginia, Pennsylvania, Delaware, Maryland, 

West Virginia, District of Columbia 13.1 

4. Kentucky, Tennessee, 

North Carolina, 

South Carolina, 

Georgia, Alabama, 

Mississippi, Florida 17.5 

Ohio, Wisconsin, Minnesota 20.4 

Oklahoma, New Mexico, 

Texas 10.8 

Nebraska 4.8 

North Dakota, South Dakota, 

Utah, Wyoming 4.0 

9. Arizona, California, Nevada, Hawaii, other territories 14.2 

10. Idaho, Oregon, Washington, Alaska 4.7 

United States $115.3 

5. Illinois, Indiana, Michigan, 

6. Arkansas, Louisiana, 

7. Iowa, Kansas, Missouri, 

8. Colorado, Montana, 

118% 

140 

109 

86 

95 

82 

87 

112 

90 

114 

- 

120% 

128 

105 

90 

89 

86 

79 

107 

105 

119 

- 

Source: U.S. Office of Management and Budget, Special Analyses, Budget of the United States Government, Fiscal Ear 

1990, Table H-6. (Preliminary estimates.) 

(New York, New Jersey, Puerto Rico, and the Virgin Islands) received 40 percent more than the U.S. average. A 

comparison with 1978 figures indicates that the range between the most favored and least favored regions has increased over the last decade. Furthermore, the Midwest has 

been gaining grant funds per capita relative to the rest of the 

United States, while the South’s ranking has declined. 

More important than the raw figures showing federal 

grant funds per capita is the record of grant funding 

relative to reasonable measures of fiscal capacity or fiscal 

need. A U.S. Department of the Treasury study used 1983 

federal grant disbursements by state and a number of 

measures of fiscal capacity to determine the degree to 

which federal grants redistribute funds to the more needy 

The study found that there was no statistically 

significant relationship between a state’s total per capita 

federal aid and its fiscal capacity, nor was there a 

statistically significant correlation between per capita 

amounts of most federal aid programs (considered 

individually) and state fiscal capacity. (To be redistributive, there would have to be a significant negative 

relationship between per capita grants and fiscal capacity. 

In other words, states with low levels of fiscal capacity would 

receive relatively high per capita grants while states with 

high levels of f@ capacity would receive relatively low per 

capita grants.) The grant programs that did tend to reduce 

fiscal disparities among the states were Child Nutrition 

Programs, the Special Supplemental Food Program, Reha- bilitation Sewices and Handicapped Research, Appalachian 

Region Development Programs, and Food Stamps. Grants 

that tended to exacerbate fiscal disparities among the states 

were Compensatory Education Programs for the Disadvan- taged, School Assistance in Federally Affected Areas, and 

Lower Income Housing Assistance. 

A more recent study by Robert Tmnnenwald comes to 

a similar conclusion.24 Using 1985federal grant data, and a 

measure of “fiscal comfort” constructed by taking the 

ratio of a measure of fiscal capacity to a measure of fiscal 

need, Tannenwald finds no statistically significant correlation between per capita grant money and fiscal comfort. 

Based on the Treasury and Bnnenwald studies, total 

federal grants appear to have no significant effects on the 

relative resource endowments of fiscally needy and 

fiscally well-off states. 

The evidence regarding the effect of federal grants on 

the relative competitive positions of local governments is 

scant. One of the methodological problems is the fact that 

a large proportion of federal aid to states is passed 

through to local governments, but Census data on federal 

aid to local governments does not include this indirect 

form of federal aid. Another problem is the lack of a 

reliable measure of local government fiscal capacity. 

A U.S. Treasury study of direct federal aid to local 

governments in ten states, using per capita income as a 

measure of fiscal capacity, produced evidence that the aid 

tends to reduce fiscal disparitie~.~~ For all states, per 

capita aid to all local governments by county was 

negatively correlated with per capita income, and for six of 

the states this reIationship was statistically significant. 

Tax Expenditures 

Thx expenditures are the final means by which federal 

actions create a framework for competition among 

governments in the United States. The two major tax 

expenditures aiding state and local governments are 

federal income tax deductibility of state and local income 

and property taxes, and the exclusion from federal income 

taxationof interest on state and local debt. Bble 4 sets out 

estimates of the outlay-equivalents of each of these forms 

of indirect aid. The outlay-equivalent estimates signify 

that once interactions among the tax expenditures are 

taken into account, the federa1 support through these two 

tax expenditures in 1988 was approximately equivalent to 

a direct expenditure program of $42.5 billion. 

Tax Deductibility 

Federal income tax deductibility of state and local 

income and property taxes provides a direct benefit to 

27 
state and local taxpayers who itemize deductions on their 

income tax returns by reducing their federal income tax 

liabilities. Because tax deductibility has indirect beneficial 

effects on the revenue-raising power of state and local 

governments as well, it is generally viewed as a form of 

indirect aid to state and local governments. 

Thx deductibility is likely to have three important 

effects on interjurisdictional competition. First, to the 

extent to which this indirect form of aid to state and local 

governments redistributes resources, it can affect the 

ability of some jurisdictions to compete with others. 

Second, tax deductibility is likely to make it easier for state 

or local governments to rely on relatively progressive 

taxes. This results from the fact that the more progressive 

the tax, the greater the federal tax savings (federal offset) 

from tax deductibility will be. The more progressive the 

taxes, the greater the proportion of the tax burden on 

high-income individuals who are likely to itemize deductions on their federal income tax returns and be subject to 

high federal marginal tax rates. 

Third, mobile citizens will find high-spending and 

taxing jurisdictions relatively more attractive because of 

federal tax deductibility. nble 5 illustrates this point with 

respect to a hypothetical family with a $75,000 income 

deciding where to live in the Washington, DC, area. The 

first column presents the total state and local income, 

sales, property, and auto taxes that the family would have 

been liable for in 1988. The second column takes the 

offset from federal deductibility of state and local income 

and property taxes into account. The figures in the first 

column indicate that the family could apparently save 

$1,716 in annual taxes by locating in Arlington County, 

Virginia ($7,010), rather than in Washington, DC ($8,726). 

However, once federal tax deductibility is taken into 

account, the real tax advantage of moving to Arlington 

County is only $990 ($6,5861 $5,596). As claimed, this 

example illustrates the manner in which tax deductibility 

makes locating in high-taxing and spending jurisdictions 

relatively more attractive. 

Tax-Exemption for Industrial Development Bonds 

Table 4 gives an indication of the wide range of state 

and local debt that can be issued on a tax-exempt basis. 

Because the interest is exempt from federal income 

taxation, state and local governments are able to issue 

debt at lower interest rates than if the interest wassubject 

to federal income taxes. 

Certain categories of state and local debt (often 

referred to as private purpose debt) are issued for 

economic development purposes, not to finance construction of government infrastructure or provision of government services. Specifically, state and local governments 

frequently issue debt at below market interest xates in order 

to provide low-cost financing to businesses located within 

their jurisdictions. The small-issue industrial development 

bond (IDB) program may be the most well known of these 

tax-exempt bond financed economic development devices. 

The first tax-exempt industrial development bond was 

issued in Mississippi in 1936. Since then, annual issues grew 

from $0.1 billion in 1970 to a peak of $18.4 billion in 1985. 

Table 4 

Tax Expenditures Aiding State and Local Governments 

(outlay equivalents, in millions of dollars) 

Description 

Deductibility of: 

Property taxes on owner-occupied homes 

Nonbusiness state and local taxes 

other than on owner-occupied homes 

Exclusion of interest on: 

Public purpose state and local debt 

IDBs for certain energy facilities 

IDBs for pollution control 

and sewage disposal facilities 

Small-issue IDBs 

Owner-occupied mortgage revenue bonds 

State and local debt for rental housing 

Mass commuting vehicle IDBs 

IDBs for airports, docks, and sports 

and convention facilities 

State and local student loan bonds 

State and local debt for private nonprofit 

educational facilities 

State and local debt for private nonprofit 

health facilities 

State and local debt for veterans housing 

Total (after interactions)' 

FY 1990 

$11,240 

20.290 

13,520 

405 

1,830 

2,840 

2,0115 

1,420 

40 

860 

275 

305 

2,725 

295 

22,575 

'The estimate of total tax expenditures reflects interactive effects among the individual items. Therefore the individual 

items cannot be added to obtain a total. 

Source: U.S. Office of Management and Budget, Birdget of the 

United States Government, Fiscal Ear 1991, Table C-1, p. 

A-73. 

Table 5 

Comparing State and Local Tax Burdens 

in the Washington, DC, Area* 

Total State Total State 

and Local and Local Taxes 

Jurisdiction Taxes Net of Federal Offset 

District of Columbia $8,726 $6,586 

Montgomery County, MD 7,901 5,927 

Alexandria, VA 8,585 6,813 

Arlington County, VA 7,010 5,596 

Fairfax County, VA 7,833 6,239 

Range $1,716 $1,429 

Pr. George's County, MD 7,147 5,384 

*Note: These comparisons apply to a hypothetical family of four 

with $75,000 in income in 1988. The taxes taken into account 

are income, sales and use. real estate, and automobile. The as- sumed federal marginal tax rate is 28. 

Source: Author's calculations based on District of Cohrrnbia Tw 

Facts, Fiscal Year 1988. Government of the District of 

Columbia, September 1989, p. 56. 

28 
Because, in effect, the IDB subsidy to economic development is financed by the federal government and imposes 

only indirect costs on state and local governments, there is a 

great incentive favoring state and local adoption. One may 

reasonably conclude that federal tax exemption of industrial 

development bonds encourages state and local governments 

to engage in active rivalry for economic development. 

Conclusion 

This chapter has provided a brief overview of the 

various ways that the federal government sets the 

framework within which state and local governments 

compete. Some federal policies set the “rules of the 

game” for interjurisdictional competition. For example, 

the controlling interpretation of the commerce clause of 

the U.S. Constitution prohibits a state from taxing 

interstate businesses that do not have a substantial 

business connection (nexus) within its boundaries. Other 

federal policies, most importantly grants-in-aid, can 

change the distribution of revenues among governments 

and thus affect their relative abilities to compete with 

each other. The federal law allowing state and local 

governments to issue tax-exempt industrial development 

bonds to aid business firms affects interjurisdictional 

competition by providing a federally financed business 

subsidy that can be used in the competition for economic 

development. Finally, federal policies can affect the 

degree of implicit interjurisdictional competition that 

arises from the free movement of products, people, and 

capital in the face of differing state and local government 

policies. Without federal deductibility of state and Iocal 

taxes, high-taxing and spending jurisdictions would face 

more implicit competition from their lower taxing and 

spending neighbors. Similarly, without the federally 

enforced Conrraband Cigarette Act, states levying high 

rates of cigarette taxation would be under greater 

pressure to lower their tax rates. 

The next two chapters will examine in more detail 

four reasonably distinct types of interjurisdictional competition: tax competition, service competition, regulatory 

competition, and competition for economic development. 

Notes 

‘In contrast, the Canadian Senate does not provide equal representation for each of the provinces. Albert Breton argues 

that the Canadian system of provincial representation aggravates “competitive inequality” among the provincial governments and that the equal state representation in the United 

States Senate provides a superior framework for competition 

among governments. “Supplementary Statement,” in Royal 

Commission on the Economic Union and Development Prospectsfor Canada, Volume 3 (Ottawa, 1985), p. 511. 

For further discussion, see John Kincaid, “The Competitive 

Challenge to Cooperative Federalism,” in Daphne A. Kenyon 

and John‘Kincaid, eds., Competition among States and Local 

Govemmen ts: Eficiency and Equiv in American Federalism 

(Washington, DC The Urban Institute Press, 1991). 

Philip M. Tatarowicz, “Controversial State Tax Issues under 

the Commerce Clause,” Mimeo, Ernst & Whinney, Washington, DC, 1987. The author’s references for this point are 

Brown v. Maryland, 25 U.S. 419 (1827) and Coe v. Errol, 116 

U.S. 517 (1886). 

Miller Brothers Co. v. Maryland 347 US. 340,343 (1954) and 

Scripto, Inc. v. Carson 362 U.S. 207,212 (1960). 

U.S. Advisory Commission on Intergovernmental Relations, 

Estimates of Revenue Potential from State Tmation of Out-ofState Mail Order Sales (Washington, DC, 1987). 

7National Bellas Hess, Inc. v. Illinois Department of Revenue 

386 U.S. 753 (1967). 

‘This discussion follows Ronald C. Fisher, State and Local Public Finance (Glenview, Illinois: Scott, Foreman and Company, 

1988), pp. 221-222. This statement and the discussion that follows make the simplifying assumption that definitions of the 

corporate income tax base do not vary among the states. 

Moorman Manufacturing Co. v. Bair 437 US. 267 (1978). 

loHalliburton Oil Well Cementing Co. v. Reily 373 U.S. 64 

(1 963). 

l1 Tatarowicz, “Controversial State Tax Issues.” 

I2Crandall v. Nevada, 6 Wall. 35 (1868). See also Toomer v. Witsell, 334 U.S. 385 (1948). 

l3 These examples were discussed in “State and Local Tax Law,” 

Harvard Law School, International Tax Program, World Tax 

Series, Tmratioii in the United States, pp. 100-104 (1963). 

l4 Metropolitan Life Insurance Co. v. Ward 105 S.Ct. 1676 (1985). 

l5 Fisher, pp. 230-231. 

I6 Western & Southern Life Insurance Co. v. State Board of 

l7 Fisher, pp. 182-183. 

4Complete Auto Transit, Inc. v. Rrady 430 U.S. 274 (1977). 

Equalization 451 U.S. 651 (1981). 

U.S. Advisory Commission on Intergovernmental Relations, 

Cigarette Bootlegging: A State and Federal Responsibility (Washington, DC, 1977). 

, Regulatory Federalism: Policy, Process, Impact and 

Reform (Washington, DC, 1984), p. 8. 

20Thomas Muller and Michael Fix, “The Impact of Selected 

Federal Actions on Municipal Outlays,” in Government Regulations: Achieving Social and Economic Balance, Volume 5 of 

Special Study on Economic Changes (Washington, DC: US. 

Congress, Joint Economic Committee 1980). See also Michael 

Fix‘s summary of this study in “Observations on Mandating,” 

in Michael Fix and Daphne A. Kenyon, eds., Coping with Mandates: Wiat Are the Alternatives? (Washington, DC: The Urban 

Institute Press, 1990). 

21 See Daphne A. Kenyon, “Reforming State Policies that Affect 

Local Taxing and Borrowing,” in E. Blaine Liner, ed., A Decade of Devolution: Perspectiveson State Local Relations (Washington, DC The Urban Institute Press, 1989)’ 

22Albert Breton, “The Existence and Stability of Intergovemmental Competition,’’ in Daphne A. Kenyon and John Kincaid, eds., Competition among States and Local Governments: 

Eficiency arid Equify in American Federalism (Washington, 

DC: The Urban Institute Press, 1991). 

23 U.S. Department of the Treasury, Office of State and Local Finance, Federal-Stale-Local Fiscal Relations: Report to the President and tlze Congress (Washington, DC, 1985), pp. 197-202. 

The eight measures of fiscal capacity were per capita income, 

twoversions of the representative taxsystem (RTS, ACIRs fiscal capacity measure), the representative revenue system 

(RRS), gross state product (GSP). total taxable resources 

(TTR), RTS adjusted for needs, and TTR adjusted for needs. 

24 Robert Tannenwald, “The Changing Level and Mix of Federal 

Aid to State and Local Governments,” New England Economic Review (May/June 1989): 41-55. 

19 

25 Treasury, Federal-State-Local Fiscal Relations, pp. 202-203. 

29 
30 
Chapter 4 

Arenas 

in Which 

Governments 

Compete: 

Tax and Service 

State and local governments use their varying tax, 

service, regulatory, and economic development policies to 

compete for individuals, businesses, and tax base, whether 

such competition is intentional or unintentional. In this 

chapter, tax and service competition will be addressed. State 

and local competition through regulatory and economic 

development policies will be analyzed in Chapter 5. 

Although we distinguish four different arenas within 

which state and focal governments compete, these arenas 

are closely related. Because taxes pay for services, tax 

levels will be highly correlated with service levels. 

Furthermore, in competing for business firms, states find 

that although firms are concerned about the level of taxes 

they will pay, they also are concerned about key 

regulations, such as right-to-work laws, and certain types 

of services, such as funding for education and public works 

infrastructure. Similarly, mobile individuals will try to 

choose the government with the “package” of government services and taxes they most prefer. 

In the past, interstate taxcompetition was the primary 

focus of interest for those concerned with competition 

among governments. This emphasis on the tax side of the 

equation at the expense of the service side led to much 

mischief in terms of policy advice. Those who warned 

against the evils of “unbridled interstate tax competition” 

sometimes seemed to have forgotten that taxes pay for 

services. Because business firms and individuals have 

strong interests in government services, there is a limit on 

how low taxes can be driven by competition among 

governments. Most people are now aware of this point. 

Because some of the literature examines the tax or 

service side only, and because competition on a tax-by-tax 

basis or competition to export taxes to other jurisdictions 

does not directly involve the service side of the equation, 

this chapter splits the topic of government fiscal competition into the somewhat artificial components of tax 

competition and service competition. 

Some of the questions addressed in this chapter include: 

What forms does tax competition take? What are 

some important forms of service competition? 

How much do the levels of state and local taxes 

on businesses and individuals vary across the 

US? How much do service levels vary? 

What is the current evidence regarding the effects of taxes on the distribution of business activity? What are the effects of differing tax burdens 

on individuals? Of differing service levels? 

Does interjurisdictional competition result in depressed service levels? 

This chapter helps broaden the concept of interjurisdictional competition. It describes different forms of tax 

competition and surveys some of the recent studies of service competition. Recent empirical evidence regarding 

the effects of differential tax burdens on the location of 

business activity is reviewed. Until recently, the consensus 

was that state and local taxes did not matter much in business location decisions. Some of the recent studies re- viewed here challenge that consensus. One of the 

chapter’s more important conclusions is that interjurisdic31 
tional competition does not necessarily depress state and local expenditures; in some cases, it can also create pressure to 

increase spending and thereby to raise taxes. 

Tax Competition 

Forms of Tax Competition 

competition: 

There appear to be at least four separate types of tax 

1) Competition regarding the overdl level of taxation. 

Since jurisdictions compete most actively for busi- ness firms and for high-income individuals, the level of taxation of each of these groups is important. 

2) Competition via special tax exemptions, tax abate- ments, andthe like. This is a major avenue of competition for business firms. Because it falls most 

appropriately into the category of competition for 

economic development, we wd1 examine this type 

of tax competition in the following chapter. 

3) Competition on a tux-by-tmbasis. Even if the overall 

levels of taxation of two competing states are simi- lar, if their tax structures are vely different, they 

may compete for some portions of their tax base. 

4) Competition in the attempt to export tares to other 

states. The potential for tax exporting depends on 

the structure of the state’s economy, patterns of 

tax incidence, the federal tax structure, and federal laws regarding discrimination against 

out-of-state taxpayers. 

The next few sections of this chapter will review the 

empirical evidence regarding the first type of tax competition-competition regarding the overall tax burden on 

businesses and individuals. 

Level of Business Taxation 

One of the most heated arenas of interjurisdictional 

tax competition is for business firm location. Although the 

level of one particular tax, such as the corporate income tax, 

can be a signal regarding the nature of a state’s business 

climate, most chief executive officers are likely to decide on 

the tax advantages of a particular location by examining the 

level of total taxes that would be paid by their business. 

There appears to be neither a great deal of clear 

information regarding how to measure the level of 

business taxes nor a solid consensus on the impact they 

have on firm location. In our review, we begin with the 

most basic empirical studies and then move to more 

complex studies. The question of the appropriate measure of the level of business taxes naturally precedes the 

effort to determine the extent to which tax differentials 

make a difference in the location of business activity. 

The first murky problem is that of tax incidence. It is 

axiomatic in public finance that only people pay taxes. The 

puzzle is which people bear the burden of business 

taxes-consumers, wage earners, or land and/or capital 

owners? Resolution of this problem is important not only 

in assessing the final distributional impact of taxes with an 

initial impact on businesses but in measuring the degree 

of a jurisdiction’s attractiveness to business. For example, 

depending on whether a firm sells its product in a local or 

national market, it will have a very different capability for 

passing tax increases on to consumers. Although a firm is 

likely to resist any type of tax increase, the long-run 

impact will be very different depending on whether the 

firm, for example, can pass a substantial portion of the tax 

on to consumers or will bear the full burden itself. 

Because of the difficulty of resolving the tax incidence 

question, analysts measuring the level of state or local taxes 

on business have narrowed the question to an assessment of 

the level of taxes with an initial impact on business. ACIR 

did such a study for the 50 states and the District of 

Columbia.’ The business taxes included in the aggregate 

measure of taxes with an initial impact on business were 

corporate net-income taxes, real and personal property taxes 

on business, the business portion of general sales and gross 

receipts taxes, insurance taxes, severance taxes, public utility 

gross receipts taxes, occupation and business license taxes, 

and various miscellaneous business taxes. 

According to the ACIR report, the proportion of 

total state and local taxes with an initial impact on 

business in 1977 averaged 30.9 percent for the entire 

United States and ranged from 26.8 percent for the 

Plains states to 39.8 percent for the Southwest.2 

Andrew Reschovsky updated these estimates to 1980 

and found that the percentage of total taxes with an 

initial impact on business had increased ~lightly.~ 

The methodology as well as the estimates of these 

studies are now outdated. For example, Reschovsky assumes 

that the business share of both property taxes and general 

sales and gross receipts taxes were constant between 1977 

and 1980.4 As Steven Gold points out, this casts doubt on 

Reschovsky’s finding that the business share of state and 

local taxes increased slightly from 1977 to 1980.5 Because the 

ACm estimate of the proportion of the sales tax borne by 

business is based on findings in an article published in 1%9, 

the sales tax estimates especially need revision.6 

Another problem with these estimates is that the 

level of taxation as well as the proportion of a state’s taxes 

borne by business are important. In Reschovsky’s 1980 

estimates, Texas imposed 46.4 percent of its total state and 

local taxes on business, while Massachusetts imposed only 

21 percent of its total taxes on busine~s.~ However, 

because Massachusetts is a relatively high-tax state and 

Texas is a low-tax state, these figures give a misleading 

picture of the level of taxes borne bybusiness in each state. 

As Gold points out, the largest state and local tax 

imposed on business is the property tax. The variations in 

local tax rates, assessment practices, and use of selective 

tax abatements make it difficult to measure the business 

property tax burden on a statewide basis. For this reason, 

among others, a more “micro” analysis of state and local 

tax burdens on business appears useful. 

One such micro study is an examination of Oklahoma’s tax climate by Price Waterhouse.s Specific urban 

and rural sites were chosen in Oklahoma and in the 

neighboring states most likely to be competitors (Texas, 

Louisiana, Arkansas, Mississippi, Missouri, New Mexico, 

Colorado, and Kansas). Tax burdens were estimated for 

each site for six different manufacturing industries. The 

taxes included were property, general sales, franchise, 

32 
Table 6 

Alternative Measures of Business Tax Burdens 

~ ~~~ ~ 

Prone* Tax Tx Six-Industrv Avewe Ta X 

Rate As Percent As Percent Effective As Percent 

Jurisdiction (mills) of Average Rate of Average Rates of Average ~~ 

Arkansas Wttle Rock) 

Colorado (Engled) 

Kansas (Kansas City) 

Louisiana (Baton Rouge) 

Mississippi (Jackson) 

Missouri (St. Louis) 

New Mexico (Albuquerque) 

Oklahoma (Oklahoma City) 

Texas (Plano) 

Average 

79.75 

81.82 

153.50 

50.71 

99.60 

105.37 

56.36 

87.92 

13.77 

80.97 

98 

10 1 

190 

63 

123 

130 

109 

17 

m 

6.00 

5.00 

6.73 

8.00 

5.00 

5.00 

7.20 

5.00 

0.00 

5.33 

113 

94 

126 

150 

94 

94 

l35 

94 

0 

22.78 

19.86 

3 1.46 

18.3 1 

21.53 

27.87 

19.49 

20.80 

21.29 

22.60 

10 1 

88 

139 

81 

95 

123 

86 

92 

94 

Note: The six industries included in the calculation of the effective tax rate are food processing, communications equipment, electronic 

components, aircraft, instruments, and optical equipment. The effective tax rate incorporates a number of factors, including the 

property tax assessment ratio, property tax exemptions, sales taxes on business purchases, the franchise tax, corporate income tax 

apportionment, depreciation tax rules, and unemployment insurance taxes. 

Source: Price Waterhouse, ‘fin Evaluation of the Oklahoma Business Climate,” July 10, 1985, pp. 35,67. 

corporation income, and unemployment insurance. 

Assessment ratios, property and sales tax exemptions, apportionment of the corporation income and franchise 

taxes, and treatment of depreciation under the corpora- tion income tax were some of the adjustments included in 

order to compute the tax burden for each site for a given 

size expansion of a manufacturing firm. 

Table 6, which presents some of the results of the 

Price Waterhouse study, also gives an indication of how 

the micro analysis can change conclusions regarding the 

level of business taxes. Plano, Texas, is subject to a 

property tax rate of only 13.77 mills and not subject to 

corporate income tax. In a study that included only the 

gross level of property and corporate income taxes, the 

city would rank far below all of the other competitors in 

terms of its business tax burden. However, by making the 

adjustments to property and corporate tax burdens noted 

above, and by including the burdens of other taxes, Price 

Waterhouse concludes that the six-industly average 

effective tax rate in Plano, Texas, actually exceeds that for 

the sites in Colorado, Louisiana, New Mexico, and 

Oklahoma. The Texas state franchise tax makes the 

largest contribution in raising Plano’s effective tax rate up 

into the range of the tax rates for the other states. 

Effect of Tax Levels on Business Location, 

Employment, and Investment 

In the competition for business, do different state and 

local tax burdens have an effect on location? Until recently, 

the consensus was that taxes did not matter much in those 

decisions. A comprehensive review done in 1984 for a New 

York tax study assessed the literature in this manner: 

In large part, the studies that have been undertaken conclude that state and local taxes have 

little, if any, effect on industrial location decisions. This conclusion emerges both from studies 

that survey decisionmakers and from those which 

analyze actual locational decisions (usually, re- gression studies). Moreover, the most recent studies reaffirm the body of research accumulated 

on this subject over the last three decades? 

There were many reasons why researchers found this 

result plausible. First, empirical evidence showed that 

taxes were a small proportion of the total costs faced by 

business firms. When wage rates and transportation costs 

exceed tax costs by many times, it is conceivable that taxes 

will not play a significant role in business location decisions. 

Second, as noted above, taxes are used to fund 

expenditures on desired services. To the extent that 

relatively high taxes are used to fund relatively extensive 

services, tax levels would not be negatively correlated with 

levels of business activity. 

Furthermore, the federal tax system acts to moderate 

interjurisdictional tax differentials. At the old top federal 

corporate tax rate of 46 percent, a $lO,OOO gross 

differential in state and local business taxes between two 

jurisdictions became an effective differential of $5,100 

Nevertheless, in the several years since the New York 

tax study literature review, the research consensus of the 

previous three decades has been challenged. James Papke 

and Leslie Papke, one of the research teams that has 

found taxes to be an important determinant of the 

distribution of business activity, state: 

[$10,000-(10,000 x .49)]. 

33 
In the last several years . . . the results of a number of econometric studies tend to indicate that 

taxes are a determinant of the geographic distri- bution of business activity, employment and production facilities. . . . Given all the countervailing 

evidence, it would be a mistake to generalize 

from the most recent research efforts, but, on 

balance, it appears the “revisionist” case is ad- vancing; that is, differential tax burdens do influence investment location decisions.lo 

Michael Wasylenko, a researcher who has conducted an 

even more recent literature review, as well as a number of 

his own studies of the effects of fiscal variables on the levels of business activity among the states, is more cautious 

in his assessment of the conclusions one can draw from ex- isting research. He concludes his 1989 review of 17 recent 

studies in this way: 

Despite much recent empirical work on the subject, the cross section evidence on the effects of 

state and local taxes and expenditures on state 

variations in employment and capital outlays 

does not come to a firm conclusion. The empiri- cal results depend on theyear of the analysis, and 

in some cases on the particular measure of the tax 

variable used in the regression. 

Other researchers have turned to pooled cross 

section time series models. While these models 

generally yield statistically significant coefficients on the tax and expenditure variables, the 

coefficients on these variables vary across time 

periods and also across regions.” 

Figure 1 presents in summary form the findings of a 

number of the recent studies of the effects of taxation on 

the distribution of business activity.12 The indicators of 

business activity that the studies seek to explain include 

the location of new branch plants, capital investment per 

worker, the level of state personal income, state employment growth, and percentage change in real value added. 

In only one study are no tax variables found to be significant determinants of the variable to be explained (i.e., 

there was no strong association between taxes and the 

variable to be explained).13 At the other end of the spectrum, the Papke study of the determinants of capital investment per worker provides the firmest evidence that 

taxes do have a statistically significant and large effect on 

the interjurisdictional distribution of business activity 

(i.e., there was a strong association between taxes and the 

distribution of business activity). 

The Papkes’ study is notable in that it employs a more 

precise measure of state and local business tax differentials than those used in previous empirical research.14The 

Papkes’ primary tax variable is a measure of the after-tax 

rate of return on additional business investment, which 

takes into account local property taxes; state and local 

sales taxes; federal, state? and local income taxes, and 

state franchise, gross receipts, and value added taxes. The 

Papkes argue that aggregate measures of the level of 

business taxes (such as ACIRs earlier measure of the 

proportion of total state and local taxes that have an initial 

impact on business) are not appropriate for modeling 

business location decisions because they miss a large part 

of the important variation in business tax levels. 

Most of the other studies summarized in Figure 1 

indicate that for some types of taxes, years, and industry 

groups (but by no means all) taxes do seem to have a 

significant effect on the level and distribution of business 

activity. The two Wasylenko and McGuire studies are of 

particular interest. The 1985 Wasylenko and McGuire 

study found that “effective individual income tax” and 

“trend in tax effort” variables had significantly negative 

effects on the rate of state employment growth over the 

1973 to 1980 period-that is, higher taxes were associated 

with a lower rate of employment growth. The 1987 

McGuire and Wasylenko study did not replicate these 

results, but found that virtually all tax variables were 

statistically insignificant in explaining the state employment growth rate from 1973 to 1977and from 1977 to 1984, 

that is, there was no strong association between taxes and 

state employment growth. 

Effect of Tax Levels on Individuals 

When policymakers worry about the effects of taxes 

on location decisions, they are concerned about the 

potential mobility of high-income citizens as well as of 

business firms. For that reason, among others, the level of 

taxes imposed on individuals by state and local governments is of interest. This section will first look at the tax 

differentials that exist, then explore the studies that have 

attempted to determine whether these differentials matter. 

Providing helpful comparative information on the 

level of individual taxes appears simpler than attempting 

to provide the equivalent information for business firms. 

A major reason is that most economists agree that 

statutory incidence and effective incidence are the same 

for the two largest components of state and local taxes 

with an initial impact on individuals-income taxes and 

property taxes on owner-occupied homes.15 

The District of Columbia makes annual estimates of 

the tax burden imposed on a hypothetical family of four in 

the largest city in each state.I6 Income, property, sales, 

and auto taxes are included in the analysis, and computations are done for families with income levels of $25,000, 

$50,000, $75,000, and $lOO,OOO. 

In 1988, for families at the $25,000 income level, the 

U.S. median level of total state and local taxes was 

$2,078, which amounted to 8.3 percent of family 

income. The hypothetical family of four with $25,000 

income would be subject to the highest state and local 

tax burden in Milwaukee, Wisconsin ($3,425 or 13.7 

percent of income), and the lowest in Anchorage, 

Alaska ($973 or 3.9 percent of income). 

The U.S. median level of total state and local taxes 

for families at the $100,000 income level was computed to 

be $8,796, which was equal to 8.8 percent of family 

income. The hypothetical family of four with $100,000 

income would be subject to the highest state and local tax 

burden in Portland, Oregon ($14,574 or 14.6 percent of 

income), and the lowest in Anchorage, Alaska ($3,313 or 

3.3 percent of income). These figures indicate that the 

34 
Figure 1 

Literature Review Econometric Studies of the Effects of Tax Differentials 

Jurisdiction 

Level 

Variable 

Study to be Explained Tax Variables Results 

Carlton 

11983) 

SMSA 1) Property tax rate 

2) Weighted average of corporation and personal income tax 

Location of new branch plants, Tax variables insignificant 

1967-71 

Plaut & Pluta 

11983) 

State Percentage changes in employment, real value added, and real 

capital stock, 1967-72 and 19n77 

Tax effort is significantly negatively 

related to the percentage change in 

employment the coefficient on the 

property tax variable is pitive and 

significant for all regressions 

1) State corporate income taxes, corporation license tax collections, 

and occupational fees as a percentage of payroll generated by 

“corporate-like” business 

2) Principal components measure of level and progressivity of state 

personal income tax 

3) State sales and gross receipts taxes as a percentage of retail sales 

4) Effective property tax rate 

5) State and local tax effort 

Change in state’s relative corporation income tax rate, lagged 10 

years 

State State employment growth relative to U.S. employment 

growth, 1957-73 

Newman 

[ 1983) 

Tax coefficient is significantly negative for 5 of U industry groups and 

for all regressions pooling industries 

Corporate income tax rate has a 

significantly negative effect; property tax variable is insignificant 

State 1) Business property tax rate 

2) Corporate income tax rate 

Bartik 

(1985) 

New branch locations of 

Forrune 500 firms, 1972-78 

Helms 

(1985) 

State Level of state personal income, 

1965-78 

Property tax and other state and 

local tax variables have significantly negative effects 

1) Property tax as a percentage of income 

2) Other state and local taxes as a percentage of personal income 

3) User fees as a percentage of personal income 

1) Percentage change in overall tax effort, 1967-77 

2) Top nominal corporate income tax rate, 1976 

3) Nominal personal income tax rate at $50.000 income, 1976 

4) Effective average corporate tax rate, 1979 

5) Effective average personal income tax rate, 1977 

6) Percentage of state and local taxes from sales taxes, 1977 

1) Personal tax rate at $50,000 of taxable income 

2) Per capita sales taxes 

3) Maximum corporate tax rate 

4) Effective property tax rate 

Wasylenko & McGuire 

(1985) 

State State employment growth rate, 

1973-80, by industry 

Effective individual income tax 

effort variables have significantly 

negative effects for several industry groups 

McCuire & Wasylenko 

(1987) 

State State employment growth rate, 

1973-77 and 1977-84, by industry 

Virtually all tax variables are 

statistically insignificant 

Papke 

(1987) 

State Capital investment per worker 1) After-tax rate of return (incorporation sales. property taxes) 

2) Effective tax level imposed on all manufacturing enterprises 

3) ACIRs measure of the proportion of state and local taxes with an 

initial impact on business 

After-tax return has a significantly 

jtrong positive effect 
overall level of personal taxation imposed by state and local 

governments varies considerably across the United States. 

One of the largest subsets of the public finance literature testing the effects of these tax-burden differentials is 

the empirical work on the extent of property tax capitalization. In the seminal article, Wallace Oates examines 

the extent of property tax capitalization in 53 suburban 

New Jersey communities as a test of the Tiebout hypothe- sis.” Oates hypothesized that if taxes (and spending) did influence location decisions, then, all else being equal, 

property values would be lower in communities with higher 

property taxes (and higller in communities with a higher lev- el of spending on public education). 

The concept of tax capitalization isbased on the mathematical relationship between a present value and a perpetual annuity: 

V = Yir 

Y = the annual payment and 

r = the applicable interest rate. 

Thus, at an interest rate of 10 percent, an annual 

property tax bill of $500 would impose a present value cost 

of $5,000. Suppose a particular home were subject to an 

increased property tax bill of $500 but the homeowners received no increase in public services in return for their increased tax bill. If property taxes are fully capitalized, the 

value of the home would fall by $5,000. 

Oates found that both property tax levels and spending on education were partially capitalized into property 

values. In a more recent article, Howard Bloom, Helen 

Ladd, and John Yinger review 20 studies of property tax 

capitalization.18 These studies use various estimation procedures and data from different locations and time peri- ods. The conclusion from this literature review is that 

“interjurisdictional property tax variations are between 

halfway and fully capitalized into house values.”1g According to Bloom et al., the major weaknessesof this literature 

are the difficulties in correcting for simultaneity bias, the 

bias that resultsfrom omitting data on other determinantsof 

house values that are correlated with property taxes, and the 

difficulty in determining the appropriate interest rate. 

Another type of study attempts to measure directly 

the effects of tax (and expenditure) differentials on individual migration. Reschovsky used data on household 

moves in the Minneapolis-St. Paul area from customer records of the electric power company to do such a study.20 

His findings corroborated the previous capitalization studies. Household moves were found to be significantly negatively related to tax levels, all else equal, and significantly 

positively related to the total level of community spending 

and to the level of spending on education adjusted to reflect 

variations in school quality. (In other words, households 

were more apt to move to communities with lower taxes, 

higher spending, and higher school quality, all else equal.) 

We now turn to the last two categories of taxcompetition: competition on a tax-by-tax basis and efforts to shift 

taxes to residents of other jurisdictions. 

where V = the present value 

Competition on a Tax-by-Tax Basis 

It is not possible here to do a comprehensive review of 

interstate, much less interlocal, tax competition on a 

tax-by-tax basis. However, two examples will help to indicate the pervasiveness of this form of tax competition. 

Although taxation of cigarette and other tobacco 

products typically accounts for a very small percentage of 

total state taxes (on average, it made up 1.8 percent of all 

state taxes in 1988), the past history of organized crime involvement in cigarette smuggling may continue to make 

state policymakers wary of creating large tax differentials 

relative to other states.21 At present, Texas’ tax on a package of 20 cigarettes is 41 cents, while North Carolina’s tax 

rate is 2 cents. Because an ACIR report on taxation of cigarettes concluded that a 23-cent interstate differential 

“offers a very attractive profit opportunity for organized 

smuggling operations,” competition between states at the 

high end of the range and those at the low end of the range 

on even this minor revenue source may be of concern to 

some policymakers in states such as Texas.22 

Similarly, because Pennsylvania exempts all clothing 

from its general sales tax and Connecticut exempts clothing valued at less than $75, New Jersey legislators may be 

hesitant to repeal the state’s sales tax exemption forclothing, lest its retailers close to state borders lose a substantial volume of sales. This fear is partially substantiated by 

recent research done by William He was able to test 

the determinants of four types of sales in two border areas 

of Tennessee: the Clarksville-Hopkinsville area in westem Tennessee on the Kentucky border and the Tri-Cities 

area in eastern Tennessee bordering on both North Carolina and Virginia. The sales categories he examined were 

furniture, apparel, food for at-home consumption, and 

food for away-from-home consumption. He found that of 

these categories, furniture salesare most sensitive to sales 

tax differences between Tennessee and its neighboring 

states, followed by sales of apparel. An equation that estimates the determinants of total taxable sales predicted 

that a 1 percentage-point increase in Tennessee’s sales tax 

rate would reduce taxable sales in the Clarksville-Hopkinsville area by 3.73 percent and taxable sales in the 

Tri-Cities area by .44 percent. 

Shifting Taxes Out of State 

The final type of tax competition we will examine is 

the attempt by states to shift the burden of taxation to 

nonresident individuals or to out-of-state owners of corporation~.~~ Sometimes, the intention to export taxes is 

made explicit. For example, tax analysis done for the state 

of North Dakota listed “exportability” among the criteria 

for evaluating proposed tax changes. The report asked, 

“To what extent can the tax burden be exported, i.e., 

shifted to nonresident customers or perhaps nonresident 

owners of North Dakota land or ~apital?”~’ When state 

governments attempt to export their taxes to residents of 

other states, they are following a long-standing political 

tradition that “the best tax is the tax the other guy pays.” 

Donald Phares studied tax exporting by U.S. state and 

local governments several years ago and estimated the 

proportion of each type of tax that was likely to be exported. 

He divided tax exporting into two types: tax exporting 

through the federal offset (via federal tax deductibility) and 

price/migration exporting. Phares defined the latter as “the 

spatial shifting of taxes among states due to market condi36 
tions that allow them to be passed on to owners of factors of 

production or consumers of taxed commodities, as reflected 

in higher prices, or due to the movement of taxpayers.”26 

Because of the significant changes that the Tm Reform Act of 1986 made in federal marginal tax rates and 

caused in the proportion of taxpayers itemizing state and 

local tax deductions, Phares’ estimates of the rate of exporting through the federal offset are now outdated. For 

that reason, only Phares’ estimates of each state’s rate of 

pricelmigration exporting are described below. He estimates that the average rate of price/migration state tax 

exporting is 8.5 percent. Nevada, however, manages to export 21.7 percent of its taxes, and Delaware, 22.5 percent, 

while at the other end of the spectrum, South Dakota exports only 4.8 percent of its tax burden. Of course, these 

taxes are exported largely to residents of other states rather than to foreign nationals. States that export a relatively 

high percentage of their taxes have tax mixes that rely on 

highly exportable business or commodities taxes. 

According to Phares, those taxes with the highest average rate of tax exporting are severance taxes (34.7 percent 

exported) and corporation income taxes (43.7 percent exported). He estimates that, on average, the least exportable taxes are tobacco taxes (3.8 percent exported) and 

alcohol taxes (3.8 percent exp~rted).~’ The rate of exportation of any of these taxes can vary considerably, though. 

A state with a large tourism industry is likely to export a 

much higher percentage of its excise taxes on cigarettes 

and alcohol, for example. 

Robert Bnnenwald has computed the most recent 

estimates of the rate of tax exporting through federal 

deductibility of state and local taxes. For 1985, he finds 

that the average rate of tax exporting through deductibility was 14 percent, with a range from 19.3 percent for 

New Jersey to 9.2 percent for South Dakota.= 

Another way for states to export their taxes is to adopt 

special taxes or to make special modifications in their 

taxes. Two examples will be discussed here. In 1971, New 

Hampshire enacted a law that taxed the income earned in 

New Hampshire by nonresidents. New Hampshire residents explicitly were not subject to a state income tax.29 

The Maine taxpayers who sued the state of New Hampshire were not harmed directly because Maine allowed 

them a tax credit for any income taxes paid to other states. 

Nevertheless, the U.S. Supreme Court ruled that New 

Hampshire’s income tax was unconstitutional under the 

privileges and immunities clause of the U.S. Constitution, 

which provides that, “The citizens of each State shall be 

entitled to all Privileges and Immunities of citizens in the 

several 

A second example of tax policy designed to export 

taxes to residents of other states involves discriminatory 

taxation of out-of-state corporations. Under state corporation income taxes, the income of interstate corporations 

must be apportioned among the states. Most states use a 

three-factor formula based on the percentage of payroll, 

property, and sales within the state. In 1977, a single-factor 

formula adopted by Iowa, which relied on sales only, was 

declared unconstitutional by a trial The effect of 

the single-factor formula was to give an advantage to firms 

i 

I 

I 

located in Iowa which sold the bulkof their products out of 

state. The trial court ruled that Iowa’s single-factor formula violated the due process and equal protection 

clauses, and that it also subjected certain corporations to 

multiple taxation. Subsequently, however, both the Iowa Supreme Court and the U.S. Supreme Court upheld the constitutionality of the single-factor formula. 

This action by the Supreme Court sent a signal to 

states that they could modify their apportionment formulas in an attempt to discriminate in favor of in-state firms. 

Since the Supreme Court decision, gradually, 13 states 

adopted formulas that give a greater weight to sales than 

to property or 

The Framework for Competition 

Makes a Difference 

The U.S. Supreme Court’s decision with respect to 

Iowa’s apportionment formula had the indirect effect of 

reducing the uniformity of state corporate taxation. The 

most recent example in which the federal framework appears to have made a difference is one characteristic of 

the recent wave of state tax reform following passage of 

the Tar Reform Act of 1986. 

One important effect of the Tar Reform Act was to increase interjurisdictional tax differentials. As discussed in 

Chapter 3, tax differentials among jurisdictions are muted 

by federal tax deductibility. Prior to the act, a high-income 

household in the 50 percent federal taxbracket that itemized deductions on its federal tax return would benefit 

from a federal offset equal to 50 percent of its nominal 

state and local taxes. If that same household were deciding between locating in two different cities, the effective 

state and local tax differential between the two cities 

would also have been reduced by 50 percent because of 

federal deductibility of state and local taxes. 

After the Tax Refom Act, however, the federal marginal tax rate applicable to the highest income households 

fell from 50 percent to 28 percent. This implies that interjurisdictional tax differentials for the wealthiest families 

are no longer reduced by half, but by 28 percent. Other 

households at lower income levels might no longer itemize deductions on their federal tax returns, and thus face 

an even bigger increase in relevant interjurisdictional tax 

differentials after tax reform. 

Table 7 presents the top marginal tax rates for state 

personal income taxes for 1985 (one year before federal 

tax reform) and for 1989 (by which time states had adjusted 

to the changes imposed by the Ti Refom Act). From 1985 to 

1989,19 states lowered their top personal income tax rates, 

while only three states raised their top tax rates. 

One possible explanation for the many reductions in 

top tax rates involves the concept that fiscal competition 

among the states leads to an equilibrium pattern of state 

tax rates. That is, states can afford to differ in their income 

tax policies, but by only so much. The relatively high-tax 

states are constrained from imposing tax rates above a certain level by the potential for taxes to be negatively capitalized into property values, or by the potential for 

high-income citizens to relocate to lower-tax jurisdictions. 

37 
Table 7 

Top Marginal Tax Rates for State Personal Income Taxes, Joint Returns, 1985 and 1989 

States 

Alabama 

Alaska 

Arizona 

Arkansas 

California 

Colorado 

Connecticut 

Delaware 

Florida 

Georgia 

Hawaii 

Idaho 

Illinois 

Indiana 

Iowa 

Kansas 

Kentucky 

Louisiana 

Maine 

Maryland 

Massachusetts 

Michigan 

Minnesota 

Mississippi 

Missouri 

Montana 

Highest Ton Rate 

Nominal Rate Lowered Raised 

(1985) (1989) Since Since 

(percent) (percent) 1985 1985 

5.00 5.00 

ma. 

8.00 8.00 

7.00 7.00 

11.00 9.30 X 

8.00 5.00 X 

n.a. 

10.7 7.7 X 

n.a. 

6.00 6.00 

11.00 10.00 X 

7.50 8.20 X 

2.50 2.50 

3.00 3.40 X 

13.00 9.98 X 

9.00 5.95 X 

6.00 6.00 

6.00 6.00 

10.00 8.50 X 

5.00 5.00 

10.00/5.00 10.00/5.00 

5.10 4.60 X 

14.00 8.50 X 

5.00 5.00 

6.00 6.00 

11.00 11.00 

States ~~ 

Nebraska 

Nevada 

New Hampshire 

New Jersey 

New Mexico 

New York 

North Carolina 

North Dakota 

Ohio 

Oklahoma 

Oregon 

Pennsylvania 

Rhode Island 

South Carolina 

South Dakota 

Tennessee 

Texas 

Utah 

Vermont 

Virginia 

Washington 

West Virginia 

Wisconsin 

Wyoming 

Total 

X 

Highest Tor, Rate 

Nominal Rate Lowered Raised 

(1985) (1989) Since Since 

(percent) (percent) 1985 1985 

19.00 5.90 X 

n.a. 

n.a. 

3.50 3.50 

7.80 8.50 X 

13.75/9.502 7.50 

7.00 7.00 

9.00 12.00 

9.025 6.90 X 

6.00 6.00 

10.00 9.00 X 

2.35 2.10 X 

23.15 6.43 X 

7.00 7.00 

n.a. 

n.a. 

n.a. 

7.75 7.20 X 

26.50 7.00 X 

5.75 5.75 

n.a. 

13.00 6.50 X 

10.00 6.93 X 

n.a. 

19 3 

n.a. -not applicable 

‘Maximum stated tax rate on earned income and annuities is 5%, and on interest dividends, and capital gains is 10%. 

’Maximum rate on personal service income was 9.5%. 

Notes: States with a limited income tax (Connecticut, New Hampshire, and Tennessee) have been excluded. Neither federal deductibilityofstate and local taxes nor state deductibility of federal taxes hasbeen taken into account. The rates shown do not reflect 

temporary surtaxes. 

Sources: U.S. Advisory Commission on Intergovernmental Relations, Signi’cuntFeatumofFGcd Fededism, 1985-86 Edition (Washington, DC, 1986), pp. 80-85; and 1990 Edition, kI. I (1990), pp. 29,38-39. 

According to this hypothesis, the equilibrium distribution of state income tax rates was disrupted by the federal TaKRefom Act. Because of lower federal marginal tax 

rates, as descriied above, interstate tax differentials effectively increased. It is possible that a number of states lowered their top individual income tax rates in response to the 

Tar fifum Act, and in so doing were able to move toward 

the original pattern of effective interstate tax differentials. 

Another example of the importance of the federal 

framework for tax competition involves the state and local 

taxation of insurance companies. The national system of 

retaliatory taxes, tolerated by the U.S. Supreme Court, 

may well be the reason why most states levy an insurance 

premium tax, rather than another form of tax on insurance comuanies. and whv the most common tax rate is 2 

which it is domiciled. If Minnesota were to raise its premium tax, for example, insurance firms domiciled in Minnesota would not only have to pay higher taxes to Minnesota 

but they would also have to pay higher retaliatory taxes to 

other states. In fact, because of the importance of premiums written out of state, increased retaliatory taxes are 

typically many times greater than the increased tax liability owed to the state that originally raised the tax rate. For 

example, the Minnesota tax study estimated that if Minnesota increased its premium tax by 1 percentage point, 

for every extra $1 that life insurance companiespaid to the 

state, theywould have topay$11.42tootherstatesinadditional retaliatory taxes.33 

Service Competition 

percent. To see why retacatory taxes may have this effect, 

it is important to note that a typical insurance company 

hasalargeproportion of itsbusiness outside of the state in 

It has become increasingly apparent in recent years 

that state and local governments are engaged not only in 

tax competition but in competition over service levels as 

38 
well. A vivid description of current patterns of service 

competition is provided by John Shannon?* 

Shannon describes two patterns of interjurisdictional 

service competition. The first he calls the “pacesetter 

phenomenon.” According to this pattern, high-spending 

state or local governments adopt some innovative public 

sector program (e.g., kindergarten services, heavily subsi- dized community colleges). Proponents of this new public 

service pressure elected representatives in other jurisdictions to adopt the same public service package. As Shan- non states, “The forces of competitive emulation convert 

yesterday’s expensive novelty (or public sector frill) into 

today’s standard budgetary fare.”35 

Shannon calls the other pattern of interjurisdictional 

competition “the catch-up imperative.” In this category, 

he describes the pressure that relatively low-spending 

state and local governments feel to improve their educa- tional and infrastructure systems in order to attract employers and upper income households. 

This “catch up” imperative is dramatically illustrated by the economic development strategies of 

many of the poorest states in the federationMississippi, South Carolina, Arkansas, and Tennessee. In virtually every recent account 

highlighting the resurgence of the states, these 

Southern jurisdictions are cited for their willingness to raise taxes-the price they have to pay to 

keep their educational systems competitive. 

Their leaders are convinced that both their short 

and long range economic development interests 

leave them no alternati~e.’~ 

A review of interjurisdictional competition along 

each type of major state and local service category is beyond the scope of this report. We will focus on three services that are of high interest: education, public welfare, 

and public works infra~tructure.~~ 

Expenditure Diff erentlals 

Although businesses and individuals will be interested in services rather than expenditures, the public sector 

is sorely lacking in adequate measures of output or service 

levels. For that reason, most statistics and empirical work 

substitute “expenditures” for the more theoretically rele- vant “service levels.” 

As’Etbles 8 and 9 show, the range among the states in 

their per capita state and local expenditures on elementary and secondary education and on public welfare is con- siderable. In 1988, Alaska, the state with the highest per 

capita expenditure on education, maintained a level that 

was 241 percent of the U.S. average, while Alabama, the 

lowest spending state, maintained a level only 67 percent 

of the U.S. average. The range of spending on public welfare appears to be slightly less. New York, the highest 

spending state, spent $707 per capita in 1988, or 201 percent of the U.S. average, while Nevada’s per capita spending on public welfare, at 48 percent of the U.S. average, 

was the lowest in the nation. Census data also could be 

used to indicate the range in the states’ levels of expendi- ture on the various categories of public works infrastructure. 

Table 8 

State Rankings on Spending for Education-FY 1988 

State-Local Direct Elementary 

and Secondary Education Expenditure 

Rank State 

Dollars 

Per Capita 

1 

2 

3 

4 

5 

6 

7 

8 

9 

10 

11 

12 

13 

14 

15 

16 

17 

18 

19 

20 

21 

22 

23 

24 

25 

26 

27 

28 

29 

30 

31 

32 

33 

34 

35 

36 

37 

38 

39 

40 

41 

42 

43 

44 

45 

46 

47 

48 

49 

50 

Alaska 

Wyoming 

New York 

New Jersey 

Minnesota 

Wisconsin 

Montana 

Michigan 

Oregon 

Connecticut 

Vermont 

Arizona 

Washington 

Colorado 

Delaware 

Virginia 

Pennsylvania 

Texas 

Ohio 

Maryland 

Georgia 

New Mexico 

Massachusetts 

Maine 

Nebraska 

New Hampshire 

Kansas 

Utah 

California 

North Dakota 

Iowa 

Rhode Island 

West Virginia 

Indiana 

South Carolina 

Nevada 

Florida 

Illinois 

South Dakota 

North Carolina 

Missouri 

Oklahoma 

Mississippi 

Arkansas 

Idaho 

Hawaii 

Louisiana 

Kentucky 

Tennessee 

Alabama 

U.S. Average 

$1,660 

1,122 

934 

828 

799 

786 

785 

783 

779 

774 

765 

75 1 

743 

743 

711 

700 

699 

696 

693 

687 

687 

686 

683 

680 

676 

675 

668 

667 

666 

661 

656 

654 

632 

630 

628 

617 

616 

613 

6 12 

609 

593 

586 

556 

552 

547 

513 

508 

499 

475 

461 

$690 

Source: U.S. Advisory Commission on Intergovernmental Relations, Significant Features of Fiscal Fedemlistn, 1990 Eaition, Volume ZI (Washington, DC, 1990), p. 197. 

39 
Table 9 

State Rankings on Spending for Welfare-FV 1988 

State-Local Direct Public Welfare Expenditure 

Rank State 

~~~ 

Dollars 

Per Capita 

1 

2 

3 

4 

5 

6 

7 

8 

9 

10 

11 

12 

13 

14 

15 

16 

17 

18 

19 

20 

21 

22 

23 

24 

25 

26 

27 

28 

29 

30 

31 

32 

33 

34 

35 

36 

37 

38 

39 

40 

41 

42 

43 

44 

45 

46 

47 

48 

49 

50 

New York 

Alaska 

Massachusetts 

Minnesota 

Rhode Island 

Wisconsin 

Michigan 

Maine 

California 

Ohio 

Connecticut 

Pennsylvania 

New Jersey North Dakota 

Vermont 

Illinois 

Maryland 

Iowa 

Washington 

Montana 

Kentucky 

Tennessee 

Oklahoma 

Hawaii 

Nebraska 

Colorado 

Indiana 

Georgia 

West Virginia 

New Hampshire 

Louisiana 

New Mexico 

Mississippi 

Arizona 

Oregon 

Arkansas 

South Dakota 

Kansas 

Utah 

Missouri 

North Carolina 

Virginia 

Delaware 

Idaho 

Florida 

Wyoming 

South Carolina 

Texas 

Alabama 

Nevada 

$707 

591 

559 

497 

497 

476 

476 

450 

433 

413 

405 

382 

38 1 

365 

354 

343 

336 

3 16 

3 16 

308 

303 

302 

29 1 

288 

273 

27 1 

265 

261 

261 

256 

25 1 

246 

241 

238 

235 

233 

230 

225 

224 

224 

219 

202 

200 

200 

197 

190 

188 

180 

170 

168 

US. Average $352 

Source: U.S. Advisory Commission on Intergovernmental Rela- tions, Significant Feattires of Fiscal Fedemlism, 1990 Edition, Vohrme IZ (Washington, DC, 1990), p. 198. 

Although statistics on per capita spending by each 

state allow us to compare the range in spending among 

the states on a variety of expenditure categories, there are 

great limitations to the usefulness of these statistics. As 

noted above, taxpayers ultimatelyare interested not in the 

level of spending but in the quality of services. The fact 

that one state spends twice as much per capita on education as another state does not necessarily indicate that 

educational output or quality is double that of the second 

state. Factors such as the cost of living and governmental 

efficiency will create a divergence between dollars spent 

and quality of service. Another problem is that the level of 

per capita spending, although a way to compare all types 

of spending using a single statistic, will never be the most 

appropriate statistic for any single expenditure category. 

For example, the level of highway spending might best be 

measured as dollars spent per mile of highway, while the 

level of educational spending might best be measured as 

dollars spent per pupil.36 

Effects of Service/Expenditure Differentials 

The literature estimating the effects of differential 

spending on education, public welfare, and public works 

infrastructure falls into three categories: studies of capitalization, mobility, and state economic growth. There 

have been many more studies of the effects of spending on 

education than on the other two functions. 

In the previous section on tax competition, we ex- plained the approach of capitalization studies and noted 

that Oates found evidence that property taxes and spend- ing on education were partially capitalized into the property values of a group of New Jersey suburbs. Subsequent 

studies have elaborated on this result. Harvey Rosen and 

David Fullerton attempted to measure the extent to 

which differences in the quality of education among local 

governments were capitalized into property values.39 

Rosen and Fullerton reestimated Oates’ equations, 

substituting fourth-grade student achievement test scores 

for Oates’ measure of the level of spending in each community. They found that the equation’s explanatorypower 

was improved by this respecification. This indicates, as suspected, that taxpayers care about the quality of school sys- tems rather than about the level of school spending per se. 

Matthew Edel and Elliot Sclar focus on changes in 

the level of capitalization of education spending in a 

cross-section time-series study of Boston suburbs between 1930 and 1970.40 They find that school spending had 

a positive effect on property values (higher school spending tended to increase property values), but that the degree of this positive impact declined over time. They 

interpret this result as a supply adjustment phenomenon. 

That is, during the “baby boom” years of the 1950s, they 

hypothesize that there was a shortage of Boston suburbs 

with good elementary and secondary education systems, 

leading to a high level of capitalization of education spending into property values as families bid up the price of homes 

in those communities with the good education systems. As 

other suburbs had the opportunity to expand their school 

systems, the degree of capitalization naturally fell. 

Edel and Sclar also examine one component of infrastructure spending-dollars spent on maintenance per 

40 
mile of highway. They found that the level of highway expenditures was not significantly capitalized into property 

values among the Boston suburbs in any time period; that 

is, larger highway expenditures did not tend to increase 

property values. They attribute this in part to the fact that 

highway expenditures are characterized by significant 

spillover benefits. By increasing spending on highways, 

taxpayers in the central Boston suburbs automatically 

provide benefits to commuters from more distant suburbs. By definition, when significant spillover benefits exist, property owners do not benefit from the full amount 

of the public spending. Because they do not benefit from 

all of the expenditure on highways, the level of spending is 

not expected to be reflected in property values. 

Other evidence regarding expenditure competition 

comes from the 20 years of studies on the effects of public 

welfare expenditures on migration patterns. The history 

of this research has been one of increasingly complex 

specification of the theory of interstate and interregional 

migration and increasingly precise measurement of the 

appropriate variables. Richard Cebula, who reviewed this 

literature in 1980, noted that the earliest studies examined the relationship between total interstate migration and welfare levels.4l Most of these studies failed to 

find a significant relationship between public welfare 

spending and migration-public welfare spending was not 

strongly associated with migration. 

The later studies, which used disaggregated data, generally used race as a proxy for income group. Most of these studies found that black migration bore a significantly positive 

relationship to the level of welfare benefits in a state (i.e., 

black migration was associated with higher levels of welfare 

spending), but that white migrationbore a significantly negative relationship to the same variable (i.e., white migration 

was associated with lower levels of welfare spending). 

The most recent studies have incorporated the possibility that the relationship between welfare benefits and 

mobility is bidirectional. That is, not only do levels of welfare benefits affect migration patterns, but migration patterns affect the level of welfare benefits in a state either 

because of the reaction of state officials or because of the 

resulting changes in voter support for welfare payments. 

A recent study by Paul Peterson and Mark Rom provides an example. Their empirical work indicates that 

policymakers take the poverty rate and the potential interstate migration of the poor into account in setting welfare policy. They also find that benefit levels can affect the 

location of the poor. According to their estimates: “Astate 

offering $722 per month in welfare benefits will have a 

poverty rate of 13.6% as opposed to the 12.7% poverty 

rate in a state guaranteeing $476 per month.”42 

This finding, however, does not demonstrate that 

higher benefits attract welfare migrants. It is possible that 

higher benefits reduce work incentives and encourage dependence, thereby increasing the rate of poverty. Alternatively, increasing poverty rates may produce greater 

advocacy on behalf of the poor, thus increasing benefits. 

Several direct, state-specific studies suggest that 

there is relatively little benefit-seeking migration. A 1981 

study in Michigan and a 1986 study in Wisconsin each 

found that only about 3 percent of new applicants for Ad 

to Families with Dependent Children could be said to 

have moved into the state for better benefits.43 A 1986 

study in Minnesota (whose benefits were then the fifth 

highest in the nation) concluded that: 

1) About 19 percent of the newly approved AFDC 

households were newcomers to the state. 

2) Of these newcomers, 58percent had previously 

lived in Minnesota, and one in four came from 

states whose AFDC grants were as high as Minnesota’s. 

3) 6.4 percent of the new AFDC households state- wide may have moved (into the state) because of 

Minnesota’s grants. 

4) “The availability of Minnesota’s AFDC-UP pro- gram did not seem to be an important attraction 

to families moving to Minnesota.” 

(5) The number of low-income households entering 

the state was largely offset by the number leaving. 

(6) While welfare migration was “not having a serious 

impact on state AFDC caseloads,” it was “contniuting to caseload increases in counties bordering 

North and South Dakota and in Hennepin and 

Ramsey counties” (the Twin Cities area).44 

Robert Moffitt has reviewed the literature on interstate welfare migration and has concluded that “the data 

do not reveal a strong effect nationwide.” People move for 

many reasons, “particularly in response to different economic conditions and different individual economic circumstances.” Thus, there is no strong evidence that poor 

persons migrate from state to state to seek higher public 

assistance benefits.45 

The final set of studies, reviewed in Figure 2, ex- amines the effects of spending on state economic growth, 

measured by percentage change in employment, percentage change in real value added, percentage change in real 

capital stock, the level of state personal income, and state 

employment growth rates. Tau variables as well as a number of other variables are also included as determinants of 

state economic growth. 

The results of the variables representing the level of 

education spending appear to be most consistent. Each 

of the four studies reviewed in Figure 2finds that the level 

of spending on education has a positive effect on a state’s 

economic growth- that is, greater spending on education 

was associated with faster economic growth. These studies 

have very different messages regarding the effects of public welfare spending, however. The Plaut and Pluta study 

found that the level of spending on public welfare had a 

positive effect on growth in real capital stock; the Wasylenko and McGuire (1985) study found no statistically significant effect of welfare expenditures on state employment 

growth rates; and the Helms study found that tax- or 

fee-financed increases in transfer payments have a significantly negative effect on the level of state personal income. Only two of the studies estimate the impact of 

spending on public works infrastructure. Helms includes 

41 
P 

N 

Study Expenditure Variables Results 

Plaut & Pluta 

(1983) 

I 

I 

Helms 

(1985) 

- 

Wasylenko & McCuire 

(1985) 

McCuire & Wasylenko 

(1987) 

Jurisdiction 

Level 

State 

State 

State 

State 

Figure 2 

Literature Review: 

Econometric Studies of the Effects of Spending Differentials 

Variable 

to be Explained 

~ ~ 

Percentage changes in employment, real value added, and real 

capital stock, 1967-72 and 

i97m 

State personal income, 

1965-78 

State employment growth rate, 

1973-1980, for six industries: 

manufacturing transportation, 

communication, and public 

utilities; whosesale trade; retail 

trade; finance, insurance, and 

real estate; and services 

State employment growth rate, 

1973-77 and 1977-84, by industry 

~~ 

1) Total state and local education expenditures as a 

percentage of state personal income 

2)Totalstateand localwelfareexpendituresas apercentage 

of state personal income 

Education variable has a significantly 

positive effect on growth in real value 

added and in employment; welfare 

variable has asignificantly positive effect 

on growth in real capital stock 

1) State and local expenditures on public health 

2) State and local expenditures on highways 

3) Local school expenditures 

4) State higher education expenditures 

5) State and local transfer payment expenditures 

6) All other state and local expenditures 

Tax or fee financed increase in transfer 

payments has a significantly negative 

effect on income; tax or fee financed 

increases in other types of state and local 

spending generally have a significantly 

positive effect on state income 

1) State and local expenditure on education as a percentage 

of state income 

2) State and local expenditure on welfare as a percentage 

of state income 

Spending on education has a significantly 

positive effect on overall employment 

growth and on employment growth in the 

retail trade and finance industries; welfare 

expenditures do not have a significant 

effect on employment change in any 

industry 

Per capita state and local expenditures on welfare, highways, 

higher education, and elementary and seconday education 

Highway spending coefficient negative 

and significant in four of six regressions; 

higher education positive and significant 

in two of six regressions; and other 

education negative and signficant in one 

of six regressions 

Source: Cmpilation by author. 
state and local spending on highways as one of his independent variables and finds that such spending has a significantly positive effect on state personal income, all else 

equal. On the other hand, McGuire and Wasylenko (1987) 

find that highway spending has a statistically significant 

and negative effect on state employment growth. 

The Helms study is notable in that it explicitly incorporates a state budget constraint. That is, rather than testing whether various expenditure categories have a 

significant effect on state personal income, the Helms 

study tests whether an increase in spending financed by either taxes or fees has a significant effect on income. For 

example, he finds that a tax-financed increase in transfer 

payments would on average reduce a state’s personal income by 0.12 percent, whereas a tax-financed increase in 

highway spending would increase a state’s personal in- come by 0.05 percent.& This approach is helpful because it 

advances the level of the analysis. It is useful to know that 

education spending has a positive effect on employment 

growth in a state, for example. However, since taxes or 

fees must usually be increased to finance an increase in 

education spending, the more relevant question is whether the combined increase in taxes or fees and the increase 

in spending has a positive effect on the state’s economy. 

The Service/Expenditure Equiiibrlum 

Another interesting result of the Peterson and Rom 

study is their examination of the differences among the 

states in their levels of welfare benefits over time and 

their explanation of these differences. They suggest that 

migration of potential welfare recipients, in combination 

with the reactions of public officials to these migration 

patterns, has a constraining effect on a state’s spending 

for welfare. On the other side, states with liberal (here defined as states willing to support relatively high government spending) political cultures or with relatively high 

levels of political competition and state wealth are subject 

to forces that tend to increase welfare spending. According to Peterson and Rom, the interaction of the forces for 

constraint and for spending contributes to a convergence of 

welfare policies among the states and leads to a long-term 

equilibrium in the pattern of state spending on welfare. 

In 1986, a major study by the U.S. Department of 

Education, A Nation at Risk, sparked interest in problems 

with the nation’s education To some extent, in 

reaction to the concern generated by that report, state 

governments have increased the real level of spending on 

education in recent years.48 It would be interesting to extend Peterson and Rom’s conceptual framework and empirical methodology to state spending on education. This 

research could potentially determine the forces affecting 

the various levels of spending and could test whether 

there is a similar interstate equilibrium on this expenditure dimension. It is possible that the low-spending states 

are being forced to increase their spending by a proportionately greater amount than the high-spending states, 

thereby reducing the range in spending among the states. 

The Importance of Spillovers 

This literature review supports a distinction between 

categories of spending that exhibit beneficial spillovers 

and those that do not. When the residents of a state or locality are able to appropriate the bulk of the benefits from 

a particular category of spending, then this spending is 

likely to increase property values, or to have a positive effect on personal income or employment. The opposite is 

true for those categories of spending exhibiting significant 

benefit spillovers. Both highway and welfare spending provide significant benefits to residents of other comm~nities.~~ 

Most of the benefits of highway spending are received by 

residents of the state, but a larger proportion of the benefits 

of welfare spending spiU over to residents of other states. 

The distinction between spending categories that exhibit beneficial spillovers and those that do not is an important one for interstate and interlocal competition. 

Both states and localities will find it difficult to increase 

spending in areas with significant beneficial spillovers. In 

the absence of grants-in-aid and tax expenditures, each local government would increase spending on wastewater 

treatment, for example, only up to the point at which its 

taxpayers valued the increased benefits as much as the resulting increase in their tax liabilities. This equilibrium 

would be inefficient from society’s point of view, though. 

Wayers in the community are not taking the benefits to 

those outside their community into account. If they could 

be induced to take those external benefits into account, 

they would support the higher level of spending that constitutes the best level from society’s point of view. 

The existence of beneficial spillovers traditionally has 

been a basis for interfering with the forces of interstate 

and interlocal competition. One of the rationales for intergovernmental grants is the existence of spillover benefits. If each additional dollar of wastewater treatment 

were to provide 20 cents in benefits outside the community, for example, the efficient grant would be a matching one 

by which a state government or the federal government 

would pay for the 20 cents generated in external benefits. 

’En expenditures, such as tax deductibility, also have been 

supported on the basis of spending spillovers. Specifically, at 

least one analyst has argued that federal deductibility of 

state and local taxes acts like a matching grant that subsidizes state and local redistributive spending.50 A third alter- native that has been suggested is for communities and states 

to cooperate rather than compete in deciding on expenditure policies that involve important beneficial spill over^.^' 

Conclusion 

State and local governments compete in manyarenas. 

This chapter examined various aspects of tax and service 

competition. 

Four different types of tax competition were distinguished. State and local governments compete with each 

other regarding their overall levels of taxation, with respect to the levels of particular taxes, via special taxprovisions meant to obtain or retain mobile business firms, and 

by attempting to export some portion of their taxes to citizens of other jurisdictions. 

There is no simple measure of the relative level of 

business taxes among the states, nor is there a solid consensus regarding the effects of business taxes on the geographical distribution of business activity within the 

United States. As recently as five years ago, researchers 

43 
had concluded that state and local taxes had little, if any, 

effect on business location decisions. Recently, certain 

scholars have questioned this consensus. At present, 

some researchers maintain that if properly measured in 

empirical work, state and local taxes are found to have a 

statistically significant and strongly negative effect on the 

level of capital investment -that is, there is a strong association between higher taxes and lower capital investment. Another researcher concludes that over some time 

periods and for certain states, taxes do reduce employment or income growth, but for other time periods and 

other states, higher taxes do not have a statistically significant effect on the various measures of business activity. 

Still other researchers continue to maintain that the evidence to date indicates that state and local taxes have 

little, if any, effect on the location of business activity. 

The relative level of state and local taxes on individuals is simpler to measure, in part because the tax incidence 

issues raised are less complex than in the case of business 

taxes. Empirical work indicates that, holding other factors 

equal, relatively high property taxes tend to reduce property values. This is one indication that individuals are 

aware of interjurisdictional tax differences and adjust 

their locatioql decisions in response to these differen- tials. Another piece of evidence is a study of household 

moves within the Minneapolis-St. Paul metropolitan area, 

which concluded that households were more likely to move 

to low-tax than to high-tax communities, all else equal. 

Competition on a tax-by-tax basis as well as competi- tion with respect to overall levels of taxation is apt to take 

place, at least in part, on an implicit basis. State and local 

governments may not deliberately set their overall taxlevels or the levels of particular taxes so as to attract or retain 

businesses or high-income households. Rather, in certain 

instances, state and local policymakers will simply be constrained in their choice of feasible tax policies. For example, 

Tixis legislators may realize that setting cigarette taxes higher than 41 cents a package is inviting bootlegging operations 

as long as North Carolina, a not-too-distant tobam-producing state, continues to tax cigarettes at 2 cents a package. 

Other Texas legislators may even be concerned that the recent tax increase from 26 to 41 cents per pack was excessive 

in the light of the potential for cigarette bootlegging. 

The final type of tax competition reviewed was the efforts of governments to export taxes to other jurisdictions. 

The most recent data indicate a wide range of tax exporting by states (other than through federal deductibility of 

state and local taxes). 

The discussion of tax competition was concluded with 

examples in which the federal framework appears to make 

a difference in the equilibrium pattern of tax rates. Federal deductibility of state and local taxes, which moderates 

effective differentials in state and local income and property taxes, was reduced in value by the 1986 Tar Reform 

Act. Possibly in response to this change, 19 states have reduced their top individual income tax rates since the enactment of federal tax reform. 

Whereas state income tax rates exhibit a considerable 

range even after the Tnx Reform Act (from zero in 

non-income tax states to a top rate of 12percent in North ’ 

Dakota), most states levy an insurance premiums tax at a 2 

percent rate. The reason given for this clustering of state insurance premiums tax rates is the system of state retaliatory 

taxes tolerated by the U.S. Congress and Supreme Court. 

Service competition was then explored, beginning 

with a description of ways in which interjurisdictional 

competition may pressure state and local governments to 

fund additional public services via a “pacesetter” or 

“catch-up” mechanism. Although it was noted that taxpayers are interested in service levels, not spendinglevels, 

the general lack of good measures of public sector output 

frequently made it necessary to rely on data on expenditure levels as proxy measures for service levels. 

Three types of empirical studies provide evidence on 

the effects of state and local spending differentials: capi- talization, mobility, and state economic growth. The studies 

generally indicate that spending on education is positively 

capitalized into property values or increases state economic growth. However, in some studies, spending on 

highways appears to have an insignificant or negative effect on either property values or state economic growth. 

Empirical work on the relation between public welfare 

benefits and the migration of potential welfare recipients 

has not produced clear-cut results. Similarly, the evidence 

regarding the effects of welfare spending on state eco- nomic growth is mixed. 

The discussion of service competition concludes by 

arguing for a distinction between those categories of state 

and local spending that exhibit beneficial spillovers and 

those that do not. According to economic theory (and supported in part by empirical evidence), when the residents 

of a state or locality are able to appropriate the bulk of the 

benefits from a public expenditure, this spending tends to 

increase property values, personal income, and employment. The opposite tends to be true for those categories 

of spending that exhibit significant benefit spillovers, such 

as highway and public welfare expenditures. 

In the next chapter, we examine two more arenasof 

state and local government competition-regulatory 

competition and competition via economic development incentives. 

Notes------ 

’ U.S. Advisory Commission on Intergovernmental Relations, 

Interstate Tax Competition (Washington, DC, March 1981). 

ACIR, Intersrate Tax Competition, Revised Appendix Table A 2 

Andrew Reschovsky, Gregory Topakian, Francoise Carre, Randall Crane, Peter Miller, and Paul Smoke, State Tax Policy: 

Evaluating the Issues (Cambridge, Massachusetts: MIT and 

Harvard University, Joint Center for Urban Studies, 1983), pp. 

Reschonky et al., p. 151. 

Steven D. Gold, “Taxation of Business by American State and 

Local Governments,” Government and Policy 5 (1987): 7-18. ‘ ACIR, Interstate Tar Competition, p. 69, reference to an article 

by Richard E Fryman in the National Tax Journal, June 1969. 

’Reschonky et al., pp. 131-132. 

*‘An Evaluation of Oklahoma Business Climate,” prepared for 

the Oklahoma State Chamber of Commerce and State of 

Oklahoma Department of Economic Development, Price Waterhouse, July 10, 1985. 

131-132. 

44 
’New York State Legislative Tax Study Commission Staff, “Interstate Business Locational Decisions and the Effect of the 

State’s Tax Structure on After-Tax Rates of Return of Manufacturing Firms,” Staff Working Paper, December 31, 1984. 

lo James A. Papke and Leslie E. Papke, “Measuring Differential 

State-Local Tax Liabilities and Their Implications for Business Investment Location,” National Tar Journal 39 (September 1986): 357. 

l1 Robert Carroll and Michael Wasylenko, “The Shifting Fate of 

Fiscal Variables and Their Effect on Economic Development,” in National Tax Association-Tax Institute of America, 

1989 Proceedings of the Eighty-Second Annual Conference (Columbus, Ohio, 1990), p. 289. 

12The studies summarized in Figure 1 are D. Carlton, “The Location and Employment Choices of New Firms: An 

Econometric Model with Discrete and Continuous Endogenous Variables,” The Review of Economics and Statistics 65 

(1983): 440-449; T. R. Plaut and J. E. Pluta, “Business Climate, 

Taxes and Expenditures, and State Industrial Growth in the 

US.” Southern Economic Journal 50 (1983): 99-119; R. J. Newman, “Industry Migration and Growth in the South,” Review of 

Econoniics and Statistics 65 (February 1983): 76-86; T. Bartik, 

“Business Location Decisions in the US.: Estimates of the Effects of Unionization, Taxes and Other Characteristics of 

States,” Jounial of Business and Economic Statistics 3 (1985): 

14-22; L. J. Helms, “The Effect of State and Local Taxes on 

Economic Growth: A Time Series-Cross Section Approach,’’ Review of Economics and Statixtics 67 (November 

1985): 574582; M. Wasylenko and T. McGuire, “Jobs and 

Tves: The Effect of Business Climate on States’ Employment 

Growth Rates,” National Tm Journal 38 (December 1985): 

497-512; L. Papke, “Subnational Taxation and Capital Mobility: Estimates of Tax Price Elasticities,” National Tar Joiinial40 

(June 1987): 191-204; T. McGuire and M. Wasylenko, “Employment Growth and State Government Fiscal Behavior: A 

Report on Economic Development for States from 1973 to 

1984,” report prepared for the New Jersey State and Local Expenditure and Revenue Policy Commission, July 2, 1987. 

l3 D. Carlton, “The Location and Employment Choices of New 

Firms: An Econometric Model with Discrete and Continuous 

Endogenous Variables,” The Review of Econoniics and Statistics 65 (1983). 

l4 Similar results are reported in James A. Papke and Leslie E. 

Papke, “Measuring Differential State-Local Tax Liabilities 

and Their Implications for Business Investment Location,” 

National Tar Jounial39 (September 1986): 357-366. 

l5 Tax capitalization can produce a divergence between the statutory and effective incidence of property taxation of owner oc- cupied homes, though. For example, a household paying 

extraordinarily high property taxes may have been compensated for these tax payments by an especially low purchase 

price. The effects of tax capitalization on incidence are very 

difficult to untangle, however, and are often ignored. 

l6 The following figures were found in Government of the District of Columbia, Department of Finance and Revenue, Office of Economic and Tax Policy, District of Colunibia TarFacts, 

Fiscal Year 1988. 

l7 Wallace E. Oates, “The Effects of Property Taxes and Local 

Spending on Property Valucs: An Empirical Study of Capitalization and the Tiebout Hypothesis,” Jo~nial of Political Econ- 

‘*Howard S. Bloom, Helen E Ladd, and John Yinger, ‘Are 

Property Taxes Capitalized into House Values?” in George R. 

Zodrow, ed., Local Provision of Public Services: The Tiebout 

only 77 (1969): 957-71. 

Model afer Twenty-Five Earn (New York: Academic Press, 

l9 Bloom et al., ‘are Property Taxes Capitalized into House Values?’’ p. 161. 

20Andrew Reschovsky, “Residential Choice and the Local Public Sector: An Alternative Test of the ‘Tiebout Hypothesis’,’’ 

Journal of Urban Economics 6 (1979): 501-520. 

2‘ U.S. Department of Commerce, Bureau of the Census, State 

Government Tar Collections in 1988 (Washington, DC, 1989). 

22 U.S. Advisory Commission on Intergovernmental Relations, 

Cigarette Tux Evasion:A Second Look (Washington, DC, 1985), 

p. 6. 

23 William E Fox, “Tax Structure and the Location of Economic 

Activity along State Borders,” National Tar Journal 39 (December 1986): 387-401. 

24 The same phenomenon exists among local governments, but 

the following section will focus only on state governments in 

order to limit the length of the discussion. 

25 Frederick D. Stocker, “Toward Strengthening North Dakota’s 

Fiscal System,” National Education Association and North 

Dakota Education Association, undated. 

26 Donald Phares, Wlio Pays State and Local Tmes? (Cambridge, 

Massachusetts: Oelgeschlager, Gunn and Hain, 1980), p. 64. 

27 Ibid., p. 67. 

28 Robert Tannenwald, “The Changing Level and Mix of Federal 

Aid to State and Local Governments,” New England Ecoiiotnic Review (May/June 1989): Appendix Table. Unlike previous 

researchers, Tannenwald takes into account federal deductibility of both business and personal taxes. 

29Actually, as described by Jerome R. Hellerstein, “In one of the 

strangest provisions of any tax law in the county, the statute 

also levied a taxon the income of New Hampshire residents on 

income earned outside the state, but immediately nullified its 

effect by another provision that exempts such income from 

tax.” Jerome R. Hellerstein, “State Tax Discrimination against 

Out of Staters,” National Tm Journal 30 (March 1977): 113. 

30A~~tin v. State of New Hampshire, 420 U.S. 656 (1975). 

31 Moorman Manufacturing Co. v. Bair, Polk County Dist. Ct. 

(1977). 

32 Ten states double-weight sales (Connecticut, Florida, Illinois, 

Kentucky, New York, North Carolina, Ohio, Oregon, West 

Virginia, and Wisconsin). Missouri allows double-weighting 

for retailers only. Minnesota gives sales a70% weight. Nebraska is phasing in a single-factor formula based on sales. 1990 

Multistate Corporate Tar Guide (New York Panel Publishers). 

33 William E Fox, “Insurance Taxation in Minnesota,” in Robert 

D. Ebel and Therese J. McGuire, eds., Final Report of the Minnesota Tm Study Commission, Voliinie 2 (St. Paul: Buttenvorth 

Publishers, 1987), p. 276. 

34 John Shannon, “Federalism’s ’Invisible Regulator’-Interjurisdictional Competition,” in Daphne A. Kenyon and John 

Kincaid, eds., Competition among States and Local Govemments: Efliciency and Equity in American Federalism (Washington, DC: The Urban Institute Press, 1991). 

1983), pp. 145-163. 

35 Ibid. 

36 Ibid. 

37P~bli~ works infrastructure includes a wide range of categories. For its report to the President and the Congress on the 

state of the nation’s public works infrastructure, the National 

Council on Public Works Improvement included these categories: roads, streets, highways and bridges; airports and airways; 

mass transit; intermodal aspects of transportation; water projects; water supply; wastewater treatment; and hazardous waste 

management. As will become clear, there is very little solid information regarding the effects of the various components of infra45 
structure on state and lccal competitiveness. National Council on 

Public Works Improvement, The Nation’s Public Works: Executive Siimmm’es of Nine Studies (Washington, DC, 1987). 

38 For discussion of such potential workload measures, see U.S. Advisory Commission on Intergovernmental Relations, Representative Eqvenditures: Addressing the Neglected Dimension of Fiscal 

Capacity, by Robert W. Rafuse, Jr. (Washington, DC, 1990). 

39 Harvey S. Rosen and David I. Fullerton, ‘A Note on Local Tax 

Rates, Public Benefit Levels, and Property Values,” Joirmal of 

Political Economy 85 (1977). 

40 Matthew Edel and Elliot Sclar, “Taxes, Spending, and Property Values: Supply Adjustment in a Tiebout-Oates Model,” 

Journal of Political Econoiny 82 (1974). 

41 Richard J. Cebula, “Voting With One’s Feet: ACritique of the 

Evidence,” Regional Science and Urban Economics 10 (1980) 

42 Paul E. Peterson and Mark C. Rom, ‘American Federalism, 

Welfare Policy, and Residential Choices,” American Political 

Science Review 83 (September 1989): 723. 

43 Michigan Department of Social Services, Final Report on Zmmigration to Michigan by GA and AFDC Applicants (January 

1982) and Wisconsin Expenditure Committee, 7he Migration 

Impact of Wisconsin’s AFDC Benefit Levels, Report of the Welfare Magnet Study Committee, 1986. 

9 1- 107. 

44 Minnesota Office of the Legislative Auditor, Aid to Families 

with Dependent Children (St. Paul, January 1987), pp. 13-20. 

45 Robert Moffitt, “Welfare Reform in the 1990s: The Research 

View,” Intewvernmental Penpective 17 (Spring 1991): 33. 

*L. Jay Helms, “The Effect of State and Local Taxes on Eco- nomic Growth: ATime Series-Cross Section Approach,”&- 

view of Economics and Statistics (1985): 578-9. 

47 US. Department of Education, A Nationat Risk(Washington, 

DC, 1986). 

48 Gary F‘ufka, ‘Teachers Get More Pay and Power in the Wake of 

Reform Movements,” Wall Street Journal, September 21, 1987. 

49 It is important to note that not all benefits of welfare spending 

flow to individuals on welfare. High-income citizens benefit either because they view the welfare system as a form of social 

insurance or because they receive psychic benefits from contributing some of their income to the poor. 

William H. Oakland, “Income Redistribution in a Federal System,” in George R. Zodrow, ed., Local Pmvision of Public Services: The Tiebout Model after Twenty-Five Ears (New York: 

Academic Press, 1983), p. 138. 

51 See, for example, Edward M. Gramlich, “Cooperation and 

Competition in Public Welfare Policies,” Journal of Policy 

Analysis and Management 6 (Spring 1987): 417-431. Gramlich 

argues that “in a wide range of public welfare applications, 

cooperation works better than competition” (p. 428). 

46 
Chapter 5 

Arenas in Which 

Govern men ts 

Compete: 

Regulation 

and Economic 

Development 

Competition among state and local governments is 

not limited to fiscal (tax and service) competition. This 

chapter broadens the discussion to consider regulatoly 

competition and competition for economic development. 

Regulation is perhaps the least addressed arena of interjurisdictional competition. Competition for economic development, however, is probably the most visible, and 

certainly the most contentious, form of competition 

among state and local governments. 

Regulatory Competition 

State and local regulation encompasses a broad set of 

issues. Among otheractivities, the states regulate occupations and professions, labor conditions and compensation, 

and corporate organization and governance. More than 

800 occupations and professions are subject to state regulation.’ Another important form of state economic regulation is regulation of particular industries, such as 

insurance, electric power, gas, and water supply. In addition to economic regulation of specific occupations or industries, states impose a wide spectrum of so-called 

“social regulations” designed to achieve health, safety, 

and environmental objectives. Localities in the United 

States have their own regulatory sphere, including zoning, 

land use controls, and building regulations, among others. 

Because of the great number of state and local regulations, 

their complexity, and the relative lack of previous research 

on interjurisdictional regulatory competition, we will limit 

our focus in this section to a few important themes. 

Explicit versus Implicit Competition 

Some regulatory competition is explicit, such as Delaware’s efforts over the years to attract corporate headquarters or incorporations by imposing the least stringent 

regulations on corporate activities. Nearly half of the 

companies listed on the New York Stock Exchange are incorporated in Delaware.* 

Regulatory competition can also be implicit. Recall 

that we have defined implicit competition as the manner 

in which the free movement of goods, services, people, 

and capital constrains the actions of independent governments in a federal system. Consider the case of state regulation of insurance companies. If a particular state 

legislature acts to reduce allowable premiums or to increase required benefit levels to an extent unmatched by 

other states, eventually the more restrictive state will find 

that its insurance companies will leave to conduct business in the more lenient states. Each state legislature is 

constrained in the range of policies toward insurance 

companies it can adopt, whether or not the state is aware 

that it is in comeetition with the other 49 states. 

Alternative Views of State Regulatory Policies 

The Development Report Card of the States and Vaughan. Pollard, and Dyer’s The Wealth of States provide two, 

nearly opposite, views on state regulatory policies3 The 

Report Card evaluates regulatory policies of the states 

along with a wide array of other policies in its analysis of 

the quality of differing state policy environments as a 

means of promoting a state’s economic future. The Devel47 
opment Report Card adds points to a state’s policy score for 

a number of regulatory policies, including: 

Required competency tests for high school graduation; 

rn Regulations on hazardous waste management 

and disposal that are more comprehensive than 

those mandated by the federal government; 

Requirements that owners selling apropertycertify the absence of hazardous materials on the 

property; 

Prohibition of the use of lead products in drinking 

water systems; and 

rn 

Laws protecting farmers from legal actions against 

certain normally accepted farming practices. 

The Wealth ofstates, on the other hand, focuses on the 

potential that state regulation has for dampening the 

entrepreneurial spirit that is essential to creating wealth 

within a state. Vaughan, Pollard, and Dyer describe how the 

regulation of Occupations can create barriers to entering a 

profession or prevent competition among existing businesses. They advocate a reevaluation of much of traditional 

state regulation in order to promote economic development. 

Some of their recommendations to policymakers include: 

Review state Occupational licensing to identlfy opportunities for divesting state responsibilities to private boards or for eliminating all requirements. 

rn 

rn Identify regulatory barriers to the provision of 

services, such as health care and day care. 

Establish carefully monitored demonstration 

projects to determine the effects of relaxing or 

reforming reg~lations.~ 

One policy that both the Development Report Card and 

The Wealth of States agree on is the importance of streamlining state regulations, reducing the paperwork imposed 

on individuals and business, and establishing “one-stop” 

permitting centers when possible. 

Regulation and Interstate Commerce 

Regulatory activities of the states also raise issues of 

interference with interstate commerce. Under what circumstances do state regulatory policies conflict with the 

commerce clause, which limits states’ power to interfere 

with interstate commerce? Two topics of recent interest 

are state regulation of hostile takeovers and the effects of 

varying state product liability laws. 

State legislatures are motivated to restrict hostile 

takeovers by the desire to retain the jobs the state already 

has, and to court footloose corporations that might consider moving their headquarters to a state that provides 

corporate management with strong protection against 

hostile takeovers. For example, in Pennsylvania, which recently enacted the nation’s most stringent antitakeover 

legislation: 

State legislators are still smarting over an attempt 

by Mr. Pickens in 1984 to acquire Pittsburgh-based 

Gulf Oil Corp. His maneuvers ultimately drove the 

company into the arms of Chevron Corp. of San 

FranciscO. As a result, Pittsburgh lost 1,500jobsand 

a valued corporate re~ident.~ 

Until 1987, the states played a small role in regulating 

takeovers because of limitations imposed by U.S. Supreme Court decisions. In 1982, the Supreme Court ruled 

that an Illinois law that attempted to limit hostile takeovers was unconstitutional because it posed a substantial 

impediment to interstate commerce, and was in conflict 

with the Williams Act because it favored the interests of 

management over the interests of shareholders and issuers of tender offerse6 

In April 1987, the Supreme Court reversed its previous stance when it upheld an Indiana act that (1) gives 

existing stockholders greater voting rights than new stockholders and (2) increases the required time for completing 

a take~ver.~ Since then, other states have passed more 

stringent laws limiting hostile takeovers, and the U.S. Supreme Court has declined to take up the issue again8 Now 

that 39 states have enacted some form of antitakeoverlegislation, the de facto national policy on corporate takeovers has been set by the states? 

A second state regulatory arena that raises the issue 

of interference with interstate commerce is product-liability 

laws. In its examination of the liability insurance crisis, the 

National Governors’ Association (NGA) focused on the 

deleterious effects of inconsistent state product- liability laws.l0 The NGA testimony before the Congress notes 

that it is difficult for national manufacturers to be informed 

of, much less to comply with, the differing standards among 

the states. It also is difficult for manufacturers to assess risk 

in each of the different environments. Because NGA concluded that these difficulties impede interstate and foreign 

commerce, it called for the Congress to enact a federal uniform product-liability code.11 

Actually, the governors’ concerns about state regulatory policies go far beyond their worries about conflicting 

state product-liability laws. In their examination of the 

barriers to international economic competitiveness of the 

United States, the governors have advocated “the establishment of national rules and standards, by federal preemption of state and lql authority if necessary, in a wide range 

of economically relevant policy fields, such as banking, insurance, telecommunications, transportation, product safety 

and liability, and environmental protection.”12 

Empirical Evidence on the Effects of Regulations 

on interstate Competition for Business 

A few of the studies reviewed earlier in the context of 

interjurisdictional tax and service competition incorporated 

some measure of regulatory competition in their research. 

In addition to measures of state and local tax burdens, 

the Price Waterhouse study of Oklahoma’s business climate includes in its analysis two state regulation^.'^ These 

regulations are laws regarding workers’ compensation insurance and right-to-work laws. 

Right-to-work laws prohibit contracts that make 

union membership a condition of employment. The implication is that unions in right-to-work states have less power than in states without these laws. Right-to-work laws 

have been passed by a number of states. 

48 
Workers’ compensation is a state-regulated form of 

employee insurance, required of most employers in each 

state. The employer generally pays for this insurance by purchasing a policy from an insurance carrier. The costs vary by 

state because the states impose different requirements for 

coverage, eligibility, and benefit levels. Price Waterhouse 

adds the cost of workers’ compensation to the cost of sales, 

property, and other taxes in its comparison of the various po- tential sites for business location. 

The econometric evidence regarding the effects on 

business location of these and other state regulations is 

meager in comparison with the evidence presented in the 

previous chapter regarding the effects of differing state 

and local tax and expenditure levels. Several recent studies 

of the determinants of the distribution of business activity 

include no regulatory variable^.'^ The studies that include 

regulatory variables show mixed results. 

In a study that attempts to determine the cause of relatively rapid growth in the southern and southwestern regions of the United States in the 196Os, Robert Newman 

includes a variable representing enactment of right-to-work 

laws as a proxy for a favorable business ~limate.’~ Newman’s 

data are for 13 industq groups by state for the periods 

1957-63 and 1965-73. In nearly all of his regressions, he finds 

that the presence of right-to-work laws has a significantly 

positive effect on industry growth, which supports his working hypothesis. In other words, industry growth tends to be 

greater for states with right-to-work laws. 

Neither Dennis Carlton nor Thomas Plaut and Joseph Pluta find such definitive results.i6 Carlton constructs a business-climate index from 16 different factors. 

The regulatory factors he includes are right-to-work laws, 

state minimum wage laws, state fair-employment practice 

codes, and statewide industrial noise-abatement laws. In 

none of his regressions did his proxy for a favorable business climate have a significant positive effect on industrial 

location; that is, industrial location was not associated 

with his measures of a favorable business climate. Plaut 

and Pluta construct a variable indicating the presence and 

activity of unions from several factors, including an indicator of right-to-work laws. Plaut and Pluta find that industry is strongly attracted to states with a low level of union 

activity; however, because their approach combines the 

effects of other factors along with the presence of 

right-to-work laws, it is not possible to detehnine the magnitude of the impact that right-to-work laws ?alone have on 

industrial 10cation.’~ 

Evaluating State and Local Regulatory Policies 

In order to evaluate regulatory competition among 

state and local governments, it is first necessary to examine 

the results of their efforts at regulation. So far, the effects of 

only certain types of regulations have been examined. 

Several studies have examined the effects of municipal zoning ordinances. All large cities in the United States 

except Houston have a zoning ordinance. The basic structure of such an ordinance is that a municipality is divided 

into mutually exclusive districts within which land use, 

height, bulk, and setback regulations are imposed. Generally, only one type of use is permitted per district. For example, certain districts are reserved for commercial use of 

particular types and others for different densities of residential development. 

Several studies also have been done on the effects of 

zoning. The “new view” of the effects of municipal zoning 

is that zoning’sprimary effect is to restrict growth, thereby 

raising housing prices within municipalities and metropolitan areas.” As William Fischel argues, the next problem 

is an evaluation of the relative value of the benefits and 

costs of these higher housing prices. For both empirical 

and theoretical reasons, Fischel argues that, in most 

cases, with respect to housing, the costs outweigh the 

benefits, implying that zoning ordinances, on the whole, 

are too re~trictive.’~ 

During the past 20 years, there has been a virtual revolution in business regulation by the federal government, 

with deregulation enacted, for example, in the airline, 

mail, cable television, and savings and loan industries. 

Some of the deregulatory initiatives have been successful, 

others have not. Because of the wide range of important 

regulations imposed by state and local governments, a 

similar rethinking of state and local regulatory policies 

should be considered, keeping in mind the opening statement of the 1989 Economic Report of the President that, 

“Government regulation can have a dramatic effect on 

economic growth and productivity.”20 

Competition for Economic Development 

Because competition for economic development incorporates aspects of tax, service, and regulatory competition, we have saved that discussion for last. First, we will 

highlight some of the concerns regarding competition for 

economic development, then provide an overview of 

some of the most important incentives that state and local 

governments have adopted to maintain or improve their 

competitive positions. A discussion of the manner in 

which competition for economic development can be 

characterized as either a “zero sum” or “negative sum 

game” follows. Some of the most recent innovations in 

economic development make use of less obviously competitive strategies and may even turn economic development policies of competing jurisdictions into a “positive 

sum game.” This section concludes with a discussion of 

several important trends. 

Concerns Regarding Competition 

for Economic Development 

Competition among states and localities to capture 

the footloose business firm or the potential business expansion in order to create or maintain jobs for the jurisdiction’sconstituents has been going on for at least the last 50 

years. Dick Netzer dates the start of “smokestack chasing” 

to Mississippi’s “Balance Agriculture with Industry” program, which was established in 1936.21 

ACIR’s last study of interjurisdictional cornpetition 

was motivated by policymakers’ concerns about such activity. As the 1981 study stated at the outset: 

There is a persistent concern that tax-based competition for people, capital, and jobs will reach 

the point where many state policymakers will feel 

49 
obliged to pursue a “beggar thy neighbor” strategy. . . . [This study inquires] whether federal intervention is needed because interstate 

competition for industry has reached a point that 

is demonstrably adverse to the economic health 

of the states and the nation.22 

Recent examples that raise questions regarding the 

efficacy of interjurisdictional competition for economic 

development include the following: 

In 1978, Volkswagen received almost $100 million in 

fbancial incentives when it decided to build a plant in 

New Scranton, Pennsylvania. Ten years later, Volkswagen 

closed what turned out to be an unprofitable plant.23 

A recent study of the costs of the financial incentives 

usedby statesand localities toattract newautoplantsconcluded that the “incentive cost per job” ranged from 

$3,904 (for a Honda plant in Marysville, Ohio) to $108,333 

(for a Toyota plant in Scott County, Kentucky).24 

New York’s use of the investment tax credit, one of 

the most popular economic development tax incentives, 

has been described as follows. The measure was adopted 

in 1969 without an estimate of the potential revenue loss, 

which turned out to amount to over $660 million by 1983. 

Until 1985, New York’s investment tax credit, “which 

costs more than the budgets of most state agencies-received’less review and analysis than did explicit spending 

programs that cost a million dollars or less.”2s 

When Hoffman Estates, Illinois, was able to entice 

Sears Merchandising Group away from downtown Chicago 

with an incentive package of free land, worker retraining, 

infrastructure, and tax abatements worth $240 million, 

US. News & World Report called Chicago “the latest loser 

in the tax-incentive wars.”26 At least one public official has 

called state competition for economic development “obscene. . . . Free enterprise isn’t free anymore, you’ve got to 

buy it.”*’ 

Despite the criticisms of state competition for economic 

development that have been raised by policymakers, journalists, and economic analysts, all indications are that the 

number of economic development incentives has been 

growing. The National Association of State Development 

Agencies (NASDA) estimates that the average state eco- nomic development agency budget grew from $2.1 million 

in 1970 to $19.7 million in 1988.28 

Types of Economic Development Incentives 

The number of different state and local economic development incentives currently employed is so great that a 

recent 50-state survey by NASDA that concentrated 

mainly on state financial incentives ran to almost 700 

pages.B The wide array of economic development incentives can be divided into several major categories: direct 

financial incentives (e.g., grants, loans), special tax exemptions, special programs (e.g., technical and support 

services, research and development programs), aspects of 

the legal and regulatory climate, and combinations of incentives from these categories (e.g., enterprise zones). 

Two recent inventories of economic development 

programs are useful to describe the major state financial 

incentives to promote economic development in general 

Wble 10) and to promote exports (’Ihble ll).30 According 

to NASDA, in 1986,14 states had grant programs that sup- ported economic development. One of those states, Ala- bama, has established an industrial development 

authority to make grants that will pay a portion of the site 

improvement costs for industrial firms. These grants are 

not made directly to industry, but to localities or industrial 

development boards, which presumably pass on the bulk of 

these benefits to particular firms. In 1985, Alabama issued 70 

such grants for a total expenditure of $1.6 million.31 

There are several mechanisms by which states and localities can enable businesses to obtain financing at a be- low-market interest rate. More than half of the states 

have direct loan programs. Many of these programs are 

established as revolving funds, and most require some 

proportion of the financing to be private.32 Another third 

of the states provide loan guarantee programs. Both of 

these loan programs are especially attractive to small and 

medium-size businesses, 

An important federally subsidized device is the ability 

to issue tax-exempt industrial development bonds (IDBs), 

used in 49 states in 1986. Because those who purchase 

such bonds do not have to pay federal income tax on the 

Table 10 

State Financial Incentives Used 

to Promote Economic Development 

Program Number of States 

Direct Financial Incentives 

Grants 14 

Loans 27 

Loan guarantees 16 

Industrial development bonds 49 

Industrial development bond guarantees 9 

Umbrella bonds 15 

State-funded or state-chartered equity 

/venture capital corporations 8 

Customized industrial training 42 

Tax Exemptions, Deductions, Credits 

by Favored Activity 

Business inventory 35 

Energy and fuel conservation measures 37 

Goods in transit 42 

Industrial fuels and raw materials 43 

Industrial machinery and equipment 42 

Research and development 14 

Pollution control equipment 40 

Tax Exemptions, Deductions, Credits 

by Type of Favored Treatment 

Investment tax credit 20 

Job creation tax credit 17 

Property tax abatement 31 

Source: National Association of State Development Agencies, Directory of Iticentives for Business Investment and 

Development in the United States: A State-bystate Giride, 

2nd Edition (Washington, DC: The Urban Institute 

Press, 1986.) 

50 
Table 11 

State Programs Promoting Exports 

Program and Description Number of States 

Foreign trade offices 42 

Foreign offices run by the state 

to promote exports 

Export finance 15 

Export credit or credit guarantees 

Export product directories 38 

Publications about products made 

by in-state firms that are available for export 

Counseling services 45 

Counseling on export procedures, sources 

of legal assistance 

’lkade seminars 49 

Seminars teaching skills needed to export 

(e.g., financing, licensing) 

’lkade leads 33 

Efforts to develop overseas sales leads 

and deliver them to appropriate companies 

Foreign buyer matching 44 

Efforts to match local companies 

with visiting foreign buyers 

Efforts to identify overseas agents 

and distributors for in-state businesses 

Overseas agentldistributor identification 42 

Source: Corporation for Enterprise Development, The 1989 Development Report Card for the Stattv (bhshington, M3,1989). 

~ 

interest, state and local governments can issue the bonds 

at lower interest rates than otherwise would be possible. 

Due to rapid growth in the issuance of tax-exempt bonds, 

the federal government took action to limit their future 

volume in the Tar Reform Act of 1986 by putting industrial 

development bonds under a tighter state-by-state volume 

cap. However, the Congress extended the sunset on the 

industrial development bond program in the 1986 Tax&- 

form Act, and again in 1989 and 1990.” 

Two related capital subsidy programs are industrial 

development bond guarantees, provided in nine states, 

and umbrella bond programs, offered in 15 states. North 

Dakota’s Industrial Development Revenue Bond Guar- antee program, for example, permits the state’s economic 

development commission to guarantee the principal and 

interest on industrial development bonds issued for certain development projects in order to expand the market 

for placing such bonds.34 Umbrella bonds combine the financing of several projects into a pooled debt issue. This 

device enables small businesses that would otherwise be 

ineligible for industrial development bond financing to 

have access to such below-market financing. 

States also have provided capital subsidies to businesses in the form of equity investments. States either 

charter an agency or authorize private nonprofit organizations to make capital investments in particular types of 

business firms. For example, the Massachusetts Technolo- gy Development Copration (MTDC) is an independent 

public agency chartered to provide capital to young, high 

technology fms that are unable to obtain capital from con- ventional sources and that are likely to provide a significant 

number of jobs within the state. Since it began in 1976, the 

h4TDC has invested over $7 million in such businesses.35 

States also provide subsidies for research and devel- opment and for training. One of the most popular of such 

programs is customized industrial training, which has 

been adopted by 42 states. 

Thx incentives provide indirect financial support for 

business firms. Firms receive a reduction in the state and 

local taxes they would otherwise owe, generally because 

of firm expenditures on certain favored activities, such as 

pollution control equipment or research and development. Table 10 provides a summary of such incentives, by 

type of favored activity (e.g.. pollution control equipment) 

and favored treatment (e.g., property tax abatement).36 

It is important to note that the benefits of state and local 

tax incentives are shared between the business fms and the 

federal treasury, creating a sort of reverse federal revenue 

sharing program. This results from the fact that state and local taxes are generally deductible in computing federal in- come tax liabiliv the greater the tax abatement incentives, 

the lower the fm’s state and local tax liability, and thus the 

higher the taxes paid by the fm to the federal government. 

The enterprise zone is another category of general 

economic development incentive program. Enterprise 

zones, which have been considered by the federal government for some time, are used by22 states. The New Jersey 

Urban Enterprise Zone Program offers a wide range of in- centives for zones designated in ten distressed communities. These incentives include major tax benefits: 

employee tax credits applicable to the state’s franchise 

tax, sales tax exemptions for purchases of tangible person- al property and for purchases of building materials and 

supplies used in business improvements, authorized reductions in sales tax rates for certain zones, and awardsfor 

employment of certain new employees. Other benefitsinclude preferential treatment for state and local grant pro- grams, potential exemption from certain regulations, and 

availability of employee training program^.^' 

We now turn to one of the newest arenas of state eco- nomic development activity-state efforts to promote exports of state products, foreign investment, and foreign 

tourism. Some 42 states maintain about 120 economic de- velopment offices in foreign countries to promote export~.~~ Some of the other initiatives used to promote 

state exports to foreign countries include financing aid, 

publication of export product directories, counseling services, trade seminars, identification of trade leads, efforts 

to match in-state companieswith potential foreign buyers, 

and efforts to identify overseas agents and distributors for 

in-state businesses (see Table ll).39 

Evaluating State and Local 

Economic Development Efforts 

The wide range of even the subset of total state and 

local economic development incentives surveyed above 

51 
should warn the reader of the difficulty of conducting an 

overall evaluation of state and local economic development efforts. Ideally, each state or local government con- sidering a particular economic development device should 

carry out its own benefit-cost analysis of the proposal be- cause there is no substitute for analysis of the facts of a 

particular case. Nevertheless, we will attempt to summa- rize some of the conclusions of experts in the economic 

development field. First, we will look at some of the evidence that indicates that state and local competition for 

economic development generally constitutes a “zero 

sum” or “negative sum” game. 

Economic Development as a Zero Sum or Negative 

Sum Game. A negative sum game is a game in which if I 

win, you lose (or vice versa.) Depending on the circumstances, economic development incentives may simply 

shift economic activity from one jurisdiction to another. 

When the governors of two states are pitted against each 

other in a battle toobtaina6,000 employeemanufacturing 

plant, the governors are most likely to be engaged in a 

zero sum game. From the national standpoint, their competition is a waste of resources, and because it takes resources to compete for the economic development, one 

can characterize the “game” as a “negative sum game.” 

Competition for economic development also can be 

characterized asa negative sum game when such competition results in business locations that are economically inefficient. Suppose that the costs of production for the 

hypothetical 6,000 employee manufacturing plant were $1 

million per year lower in state A than in state B, and that 

all other production or marketing differences in the two 

potential locations were of negligible importance. State B 

might be able to craft an incentive package to lure the 

plant to its state, if the package were worth more than $1 

million per year. However, from a societal point of view, 

the victory would result in a $1 million per year waste of 

resources-clearly a negative sum game. 

Several experts conclude that state and local efforts 

to compete for industry and jobs constitute a zero sum or 

negative sum game. Dick Netzer reviews the theoretical 

and empirical evidence of state policies carried out specifically for economic development purposes and concludes: 

. . . economic development incentives are, for the 

most part, neither very good nor very bad from 

the standpoint of efficient resource allocation in 

the economy. With all the imperfections, the offering of incentives does not represent a fall from 

grace, but neither does competition in this form 

operate in ways that truly parallel the efficiencycreating operations of private competitive markets. Given the low cost-effectiveness of most 

[economic development instruments], there is 

little national impact, only a waste of local resources in most cases.4o 

A second level of evaluation, alluded to above, is 

whether economic development incentives are cost effective from the point of view of the jurisdiction employing 

them. In the example above, the governor of state B might 

prefer to help the country while helping his constituents, 

but he might be willing to settle for an economic development strategy that provided jobs for his constituents if the 

alternative was to do nothing. 

As it turns out, it is very difficult to evaluate the Cost 

effectiveness of economic development incentives. A large 

part of the analysis is inherently defective because the basic 

data are probably subject to bias. If a firm receiving a tax 

break is asked about the probable number of jobs it will 

create in return for the tax incentive, it has every incentive to 

inflate the number, in the absence of a system that would 

hold the firm accountable several years down the road. Likewise, evaluation by economic development agencies should 

not be taken at face value because it will be in the interest of 

the agency to present success stories, not failures. 

Economists often use regression analysis for empirical work, but data limitations prevent the methodology 

from being very useful in analyzing the effectiveness of 

economic development incentives. The problem with using this tool to test the effectiveness of economic development incentives is that there are too many types of 

programs to examine, with too many variations in their design, among the 50 states. Regression analysis is inherently 

limited in testing the effectiveness of such specific and detailed incentives among the state government^.^^ 

One approach to examining the effectiveness of economic development incentives from a state or local, rather than from a national, view, is to do simulations of the 

costs and benefits to plausible hypothetical firms that enable the researcher to estimate the cost effectiveness of 

various incentives. Larry Ledebur and William Hamilton 

have attempted such an analysis of selected development 

 incentive^.^^ Ledebur and Hamilton compute the ratio of 

the cost to the government to the direct benefit received 

by the hypothetical firm. In order to be cost effective, the 

computed ratio has to be less than 1 (otherwise costs exceed 

benefits). The smaller the cost-benefit ratio, the better. 

Table 12 presents the Ledebur-Hamilton results for a 

low-profit firm (or small business). From the standpoint of 

the state offering the incentive, only industrial develop- ment bonds and loan guarantees appear to be cost effec- tive (have ratios less than 1). State benefits provided to a 

business firm can increase federal tax liability, though. 

This occurs for all incentive programs listed in Table 12, 

except for the industrial development bond program. 

Thus, when both the state and the federal government are 

taken into account, the only economic development incentive that remains cost effective is a loan guarantee pro- gram (and that program remains cost effective only if 

the default rate remains below 40 percent). Because of the 

costs imposed on federal taxpayers as a whole, when the 

federal impact is taken into account, the industrial development bond program changes from a device that appears 

to be cost effective (with a state score of 0.18) to the least 

cost-effective program considered (with a combined statefederal score of 2.19; that is. costs are more than double 

 benefit^.)'^ 

There are several reasons why the Lcdebur-Hamilton results are plausible. One can list numerous factors 

that are likely to reduce the benefits of economic development incentives or increase their costs: 

52 
Table 12 

Estimated Cost-to-Benefit Ratios 

of Selected Economic Development Incentives 

Cost to Government/ 

Direct Benefit to Firm 

Incentive State Federal Combined 

IDBs 0.18 2.01 2.19 

Direct loan subsidy 1.47 -0.33 1.14 

Loan guarantee 0.79 - 0.79 

Subsidized equipment 2.36 -1.11 1.25 

Subsidized land 1.58 -0.58 1.00 

Subsidized plant 2.40 -1.40 1.00 

Tax abatement 1.42 -0.42 1.00 

Note: An incentive is cost effective if the ratio of the cost to 

government to the direct benefit to firm is less than one. 

Asszmiptioru: Hypothetical low-profit firms face a federal corporate income tax rate of 20% and an average state corporate 

income tax of 5%. States do not allow deduction of federal 

income taxes. Firms have a default rate of 22 percent. 

Source: Larry C. Ledebur and William W. Hamilton, “The Failure of Tax Concessions as Economic Development In- centives,” in Steven D. Gold, ed., Reforming State Tm 

Systems (Denver: National Conference of State Legislatures, December 1986), pp. 110-14. 

As Ledebur and Hamilton note, the benefits of 

an incentive are reduced when the firm receiving 

the incentive has to pay higher federal income 

taxes as a result. 

It is generally difficult to target the marginal 

firms. Whenever an economic development incentive is provided to a firm that would have located (or remained) in a community anyway, the 

benefits created are zero. 

Any new industry attracted may increase public 

sector costs. Those costs may not have been taken into account in the decision to provide the economic development incentive. 

Tax incentives may become capitalized into the 

value of the state or locality’s property. That is, 

land prices may rise by enough to make up for 

much of the tax abatement provided. 

Each of these points raises questions about the potential 

effectiveness of economic development incentives, even 

when considered from the point of view of the offering jurisdiction only. 

Another issue is the equity consequences of selected 

tax abatements or economic development incentives. The 

question is how previously existing businesses in Hoffman 

Estates feel about the multi-million dollar package offered to the newcomer Sears. Generous economic development incentives do not necessarily make for a good 

business climate when existing business firms end up paying higher taxes than do newcomers. 

There is no simple correction for this problem either. 

Suppose a local government extends its generous economic 

development package to any existing firm that seriously considers relocating to another community. This may sound like 

an improvement in equity, but it also produces an incentive 

for firms to consider moving out of the community. 

It may be evident by now that a preponderance of the 

evidence and judgment regarding state and local competition for economic development is that such activity is generally not cost effective from the point of view of the 

offering government or the nation as a whole. In the next 

section, we turn to a discussion of some reasons why competition for economic development might be efficient and 

of economic development policies that are not intentionally competitive, and which may be wealth creating rather 

than wealth redistributing. 

Economic Development as a Positive Sum Game. 

When can economic development incentives benefit both 

the offering jurisdiction and the nation as a whole? Alternatively, if economic development incentives cannot produce a 

positive sum game, can other economic development policies benefit both the individual jurisdiction and the nation? 

Although the strong consensus of the academic community is that economic development incentives create a 

zero or negative sum game for the nation as a whole, and 

often work to the detriment of the jurisdiction providing 

such incentives as well, there are a few dissenting voices. 

Nonna Noto argues in favor of examining state and local 

government economic development polices within a dynamic rather than a static context.44 She reminds us that 

local and regional economies go through boom and bust 

cycles, and that labor is often an immobile factor of production. Noto argues that members of a community are 

willing to make concessions to retain businesses in order 

to maintain their way of life. She argues further that in 

such a situation local economic development incentives 

maybe as efficient an adjustment mechanism, or more efficient, than declining property values and wages. 

Donald Baum has formalized a similar argument in a 

set of economic models.4s Under some assumptions, economic development incentives produce the result that 

most analysts agree on: tax subsidies to business reduce 

economic efficiency in the economy as a whole and transfer income from labor to owners of capital. However, if 

Baum considers a situation in which the community offering an economic development subsidy is experiencing unemployment, then tax subsidies to attract business may 

increase both local and national welfare. 

Other analysts do not argue that state and local competition for economic development through the use of development incentives can potentially provide national 

benefits. They argue that there are other policies for promoting economic development, policies that can promote 

both local and national welfare. 

Economists have long argued that government action 

taken in the face of “market failure” can improve social 

welfare. Matthew N. Murray reminds us that market failures that can be alleviated by judicious economic develop53 
ment policies exist because of spillover effects, such as in 

the case of education and technological development, and 

because of the existence of imperfect information, such as 

lack of knowledge regarding potential foreign 

Economic development policies that increase support for 

education or technological development, or that provide 

information crucial to business development can then 

benefit both the jurisdiction enacting these policies and 

the nation as a whole. Although the future trend is far 

from clear, there are some indications that more economic development policies of this type, rather than the zero 

or negative sum game type, are being adopted by states. 

Recent Trends 

in Economic Development Programs 

In January 1990, Governor Roy Romer of Colorado 

released a five-year economic development strategic 

plan, emphasizing five strategies, in this order: 

Building a world-class education system for Coloradans; 

Creating quality jobs through expanded business op- portunities; 

Strengthening the capacity of rural communities to 

become more competitive; 

Protecting Colorado’s unique environment; and 

Building the necessary infrastructure to facilitate 

commerce.47 

The plan contains 45 initiatives designed to carry out 

these five development strategies; only three of those key 

initiatives appear to follow the “old model” of providing 

economic development incentives to lure business into 

Colorado. Three of the strategies could be characterized 

as getting the state back to the basics: concentrating on 

education, infrastructure, and the environment. 

Colorado’s economic development plan exemplifies 

some of the more encouraging trends in state and local poLicies. In recent years, state and local governments have 

moved away from an emphasis on industrial recruiting and 

have broadened their concept of economic development to 

include concentration on basic state problems, such as edu- cation and infrastructure. There also has been more emphasis on using strategic plans to improve the quality of 

economic development programs.48 

Another promising trend emerging in state and local 

economic development policies is a move to make economic development policies more accountable. Accountability has been a problem in economic development 

programs, especially in the case of tax abatements or negotiated tax reduction packages. Direct grants to business firms 

are subject to the appropriations process, which makes expenditures public and forces spending priorities to compete 

with each other. The accountability of tax incentives suffers 

because of their nature as ‘bck door spending,” which taxpayers tend not to view as costing resources. 

Illinois, for example, has recently completed a comprehensive review of its state development programs, directed by the state’s auditor general.” Although it has 

limitations (e.g., it omits tax expenditures for economic 

development from consideration), the report raises issues 

that it would be useful to address in every state or locality 

with an active program for attracting or retaining industries 

that create jobs. The audit has provoked a heated debate 

about how much the state should spend per “job created.” 

Frequent suggestions for improving the accountability of state and local economic development programs include estimating and publishing data on tax revenue 

forgone due to economicdevelopment tax incentives, per- forming benefit-cost analyses of particular economic development devices, and imposing “clawback” provisions 

that require business firms to pay back some proportion of 

a tax rebate if “job-creation” falls substantially short of 

projections. Although it is tempting for some business 

firms, economic development officials, and politicians to 

resist such changes, only by creating accountability for 

economic development programs will taxpayers be assured of getting their money’s worth. 

Conclusion 

This chapter concludes the review of arenas in 

which state and local governments compete. Regulato- ry policies could have significant effects on a state or local government’s economic health. However, the 

regulatory arena has until now received much less at- tention than state and local fiscal competition or competition for economic development. 

Awide range of financial incentives provided by state 

and local governments to stimulate economic development was reviewed. The bulk of expert opinion appears to 

be that the present uses of many economic development 

incentives (e.g., tax abatements) can be counterproductive from the standpoint of the offering government and 

the nation as a whole. Some of the newer approaches to 

state and local economic development that move beyond 

traditional industrial recruiting and the use of tax abatements may indicate that state and local economicdevelopment efforts will increasingly constitute a “positive sum 

game.” These trends include an emphasis on the basics of 

state government (especially education), use of strategic 

plans to guide economic development efforts, and a move to 

make economic development programs more accountable. 

In the next chapter, we turn to the question raised at 

the outset of this report: is interjurisdictional tax and 

policy competition good or bad for the federal system? 

Notes 

Frances Stokes Berry, “State Regulation of Occupations and 

Professions,” The Book of the States, 1986-87 Edition (Lexington, Kentucky: Council of State Governments, 1986). p. 379. 

*Milo Geyelin and Vindu €! Goel, “Pennsylvania Legislators 

Gird to Battle over Bill that Could Become Stiffest Anti-Takeover Law,” Wall Stmet Jo~rrnal, December 20, 1989. 

Corporation for Enterprise Development, The 1989 Development Report Card for the States (Washington, DC, 1989); and 

Roger Vaughan, Robert Pollard, and Barbara Dyer, 7he 

Weulth of Stares (Washington. DC: Council of State Planning 

Agencies, 1984). 

Geyelin and Goel, “Pennsylvania Legislators , . .”; Vindu I? 

Goel, “Pennsylvania’s New Anti-Takeover Law Fuels Controversy, Faces Fight in Court,” Wall Street Joimal, April 30, 1990. 

4Vaughan et al., Vie Wealth of States, p. 60. 

54 
Lynn E. Browne and Eric S. Rosengren, “Should States Restrict Takeovers?” New England Economic Review (July/August 1987): 15. 

7CTS Corp. v. Dynamics Corp. of America, 107 S.Ct. 1637 

(1987); David A. Vise and Steve Coll, “Investment Banks, 

Business at Odds on Takeover Laws: Preemption of States at 

Issue,” Wahington Post, September 27, 1987; Eric S. Rosengren, “State Restrictions of Hostile Takeovers,” Publius: 7he 

Journal of Federalism 18 (Summer 1988): 67-79. 

Stephen Wermiel, “Supreme Court Declines to Review Law in 

Wisconsin Curbing Hostile Takeovers,” Wall Street Journal, 

November 7, 1989. 

CBS Nightly News, January 16, 1990. 

lo Testimony of Richard B. Geltman, Staff Director, Committee 

on Economic Development and Technological Innovation, 

National Governors’ Association, before the Subcommittee 

on Consumers, Committee on Commerce, Science and Transportation, United States Senate, September 25, 1987. 

l1 An alternative, of course, would be for the states to adopt uniform product-liability laws, perhaps with the aid of the Uniform Law Commissioners. The problem with that approach, 

as the record of the Commissioners shows, is that it is difficult 

to get every state to adopt a particular uniform or model act. 

See, for example, Table 8.1, “Record of Passage of Uniform 

Acts,” and Table 8.2, “Record of Passage of Model Acts,” in 

John M. McCabe, “Uniform State Laws: 1984-85,” in The 

Book of the States, 1986-87 Edition (Lexington, Kentucky: 

Council of State Governments, 1986), pp. 324-331. 

l2 John Kincaid, “Implications of Constituent Diplomacy for the 

European Communities,” paper prepared for the Annual 

Conference of the International Association of Centers for 

Federal Studies and the Comparative Federalism and Federation Research Committee, College of Europe, Groupe Coudenberg, Bruges, Belgium, October 26-29, 1989. 

l3 Price Waterhouse, “An Evaluation of the Oklahoma Business 

Climate,” July 10, 1985. 

14This includes L Jay Helms, “The Effect of State and Local 

Taxes on Economic Growth A Time Series-Cross Section 

Approach,” Review of Economics and Statistics 67 (November 

1985): 574-582; Michael A. Wasylenko and Therese J. 

McGuire, “Jobs and Taxes: The Effect of Business Climate on 

States’ Employment Growth Rates,” National Tar Journal 38 

(December 1985): 497-512; and James A. Papke and Leslie E. 

Papke, “Measuring Differential State-Local Tax Liabilities 

and Their Implications for Business Investment Location,” 

National Tar Journal 39 (September 1986): 357-366. 

l5 Robert J. Newman, “Industry Migration and Growth in the 

South,” The Review of Economics and Statistics (February 

l6 Dennis W. Carlton, “Why Do New Firms Locate Where They 

Do: An EconometricModel,” in William G. Wheaton, ed., Interregional Movements and Regional Growth, COUPE Papers 

on Public Economics, (Washington, DC: The Urban Institute), pp. 13-50; and Thomas R. Plaut and Joseph E. Pluta, 

“Business Climate, Taxes and Expenditures, and State Industrial Growth in the United States,” Southern Economic Journal 

”Plaut and Pluta use a principal components index to measure 

the presence and activity of unions. 

“Three of the most prolific authors in this area are Robert Ellickson, William Fischel, and Robert Nelson. The “new view” 

was first argued persuasively by Robert H. Nelson in Zoning 

and Properly Rights (Cambridge, Massachusetts: MIT Press, 

1977, and then by William Fischel in several articles and in his 

1983): 76-86. 

51 (July 1983): 99-119. 

book The Economics of Zoning Laws (Baltimore: Johns Hop 

kins University Press, 1985). 

l9 Fischel, The Economicsof Zoning Laws, p. 249. For an example 

of a benefitcost analysis of zoning in one geographic area, see 

George E. Peterson, “The Influence of Zoning Regulations 

on Land and Housing Prices,” Urban Institute Working Paper, 

July 1974. 

*‘Chapter 5, “Rethinking Regulation,” Economic Report of the 

President, 1989, p. 187. 

21 Dick Netzer, ‘An Evaluation of Interjurisdictional Competition through Economic Development Incentives,” in Daphne 

A. Kenyon and John Kincaid, eds., Competition among States 

and Local Governments: Eficiency and Equity in American Fedemlism (Washington, DC: The Urban Institute Press, 1991). 

22 U.S. Advisory Commission on Intergovernmental Relations, 

Interstate Tm Competition (Washington, DC, 1981). p. 1. 

23 Paul Glastris, “Holdup in the Windy City,” US. News & Wodd 

Report, July 17, 1989, p. 41. 

24 From Douglas F? Woodward, ’llie New Competitors. as quoted 

in Georgina Fiordalisi, “Did Kentucky Pay Too Much for Toyota Plant?” City & State. June 19, 1989, p. 13. 

25 Richard D. Pomp, “State Tax Expenditure Budgets-And Be- yond,” in Steven D. Gold, ed., The Unfinished Agenda for Tar 

Reform (Denver: National Conference of State Legislatures, 

1988), p. 66. 

26 Glastris, “Holdup in the Windy City,” p. 40. 

27 Governor George A. Sinner of North Dakota, at meeting of 

the U.S. Advisory Commission on Intergovernmental Relations, September 29, 1989. 

28 NASDA Expenditure and Salary Survey. 

29 National Association of State Development Agencies. Directory of Incentives for Birsiness Investment and Development in 

the United States. 2nd Edition (Washington, DC: The Urban 

Institute Press, 1986). 

30 In a recent issue of State Policy Reports (November 1989, pp. 

DW), Hal Hovey lists and describes several recent inventories of economic development programs: 

National Association of State Development Agencies, 

Directory of Incentives for Business Investment and Development in the States:A State-by-State Guide. 2nd Edition (Washington, DC The Urban Institute Press, 

1986), 687 pages. 

Northeast-Midwest Institute, The Guide to State and 

Federal Resources for Economic Development (Washington, DC, 1988), 394 pages. 

Council of State Governments, The States and Business 

Incentives: An Inventory of Tar and Financial Incentive 

Programs (Lexington, Kentucky: Council of State Governments, 1989), 113 pages. 

National Council for Urban Economic Development, 

A Salute to Imaginative Economic Development PIVgrams, 123 pages. This report highlights 45, mostly local, innovative economic development programs. 

Conway Data, Site Selection Handbook (Norcross, 

Georgia, periodically). This publication surveys 225 localities in addition to the 50 states. 

1) 

2) 

3) 

4) 

5) 

31 NASDA, Directory of Incentives, p. 36. 

31 Ibicl., p. 5. 

33 See also U.S. Advisory Commission on Intergovernmental Relations, The Volume Cap on Tar-fiempt Private-Activity Bonds: 

State and Local Experience in 1989 (Washington, DC, 1990). 

34NASDA, Directory of Incentives, p. 484. 

351bid., p. 288-289. 

55 
36The items in the table are not meant to be comprehensive. For 

example, exemptions from sales and use taxes are not listed 

separately “by type of favored treatment,” but are included in 

the tax exemptions “by favored activity.” Furthermore, there is 

some overlap between the two types of tax exemptions. For example, Indiana provides an exemption from property taxation 

for air and water pollution control facilities, which may be 

counted under both the “property tax abatement” and ‘‘pollution control equipment” headings. 

37 NASDA, Directory of Incentives, pp. 429-430. 

38 Corporation for Enterprise Development, The 1989 Development Report Card for the States, p. 93. See also John Kincaid, 

“State Offices in Europe,” Comparative State Politics Newsletter 6 (August 1985): 22-28. 

39 See also US. Advisory Commission on Intergovernmental 

Relations, State and Local Governments in the International 

Arena (Washington, DC, 1991). 

40 Netzer, ‘An Evaluation of Interjurisdictional Competition.” 

41 In econometric terms, there are not sufficient degrees of freedom or a sufficient number of observations to be able to test 

the effectiveness of the great number of economic development devices among the states. For more on this topic, see 

Dick Netzer, “State Tax Policy and Economic Development: 

What Should Governors Do When Economists Tell Them 

Nothing Works?” New Yo& Affairs 9 (1986): 19-36. 

42 Larry C. Ledebur and William W. Hamilton, “The Failure of 

Tax Concessions as Economic Development Incentives,” in 

Steven D. Gold, Reforming State Tau Systems (Denver: National Conference of State Legislatures, 1988), p. 113. 

43 Ledebur and Hamilton explicitly decline to use a multiplier to 

take into account the indirect benefits that would flow to other 

businesses in the community. In their experience, adding indirect benefits seldom turns a program that is rated not cost effective into a cost-effective one. 

44N~nna A. Noto, “Trying to Understand the Economic Development Official’s Dilemma,” in Daphne A. Kenyon and John 

Kincaid, eds., Competition among States and Local Governments: Eficiency and Equity in Anierican Fedemlism (Washington, DC The Urban Institute Press, 1991). 

45D~nald N. Baum, “The Economic Effects of State and Local 

Business Incentives,” Land Economics 63 (November 1987). 

46Matthew N. Murray, “The Incentives Game: Win, Lose or 

Draw?” in National Tax Association-Tax Institute of America, 

1989 Pmceedings of the Eidity-Second Anniial Conference (Columbus, Ohio, 1990), pp. 268-274. 

” Die 1995 Report: The Drafr Five-Year Econoinic Development 

Strategic Plan, Governor Roy Romer, presented to the 1990 

General Assembly, prepared by the Office of State Planning 

and Budget, Denver, Colorado. 

48 For an elaboration on this theme, see R. Scott Fosler, “Promising Approaches to State Economic Development,” in National Tax Association-Tax Institute of America, 1988 Proceedings 

ofrhe Ekhty-First Annual Conference, (Columbus, Ohio, 1989), 

49 Management and Program Audit of the Department of Commerce and Commiinity AfJairs Economic Development Pro- gmrns, Illinois Auditor General, Springfield, reviewed in State 

Poiicy Reports 7 (November 1989): 19-22. 

pp. 45-52. 

56 
Chapter 6 

Is lnterjurisdictional 

Competition Good 

or Bad 

for the 

Federal System? 

This chapter summarizes the results of the previous 

chapters and reviews additional literature in order to address 

the overall question of whether competition among state 

and local governments is good or bad for the federal system. 

Not surprisingly, one cannot characterize interjurisdictional competition as simply as this question implies. In 

some instances, competition among governments has 

beneficial results; in other circumstances, competition 

has harmful results. One aim of this chapter is to distinguish between those sets of circumstances. 

An evaluation of the effects of competition among governments depends on the criteria chosen and the relative 

emphasis placed on each criterion. An evaluation of interjurisdictional competition also depends crucially on the alternatives-for example, consolidated governments, federal 

regulation, or compacts among state and local governments. 

Certain theoretical and empirical studies are reviewed that will be helpful in the evaluation-first. the ev- idence regarding government behavior in the absence of 

interjurisdictional competition; then, empirical studies 

that compare the fiscal behavior of state and local governments with differing degrees of potential competition. 

Theoretical studies that attempt to determine the effects 

of interjurisdictional competition under differing governmental institutions also are reviewed. 

The conclusion summarizes the findings of the report 

regarding the beneficial and harmful effects of interjurisdictional competition. In a number of ways, the consensus 

regarding interjurisdictional competition has changed in 

recent years. Adecade or two ago, analysts appeared to be 

uniformly critical of interjurisdictional competition. 

Wy, there is generally a more favorable assessment of at 

least certain aspects of competition among governments. 

Although recent research has left some of the standard criticisms against interjurisdictional competition intact, it also 

has provided evidence that under certain circumstances interjurisdictional competition can have beneficial results. 

Criteria for Evaluation 

The criteria chosen for evaluating interjurisdictional 

competition will be equity and efficiency, by which economists typically evaluate any public policy. Because this 

chapter’s key question is whether interjurisdictional competition is good or bad for the federalsystem, this raises the 

issue of whether the usual economists’ criteria are relevant in this particular context. Should the same criteria be 

used when judging what is good or bad for the federal system as economists use when they are judging what is good or 

bad for the individual agent in the economy? Indeed, the use 

of the same criteria is appropriate because the federal system of government is meant to maximize the welfare of the 

individual citizen, as the economic system is meant to maximize the welfare of the individual economic agent.’ 

Equity 

The criterion of equity can be evaluated according to 

two alternative principles: ability to pay and benefit. In practice, government policies are evaluated by some mixture of 

the two, with the relative reliance on each varying over time. 

An ability-to-pay approach argues that individuals 

with equal abilities to pay should pay equal taxes (horizon57 
tal equity) and individuals with greater abilities to pay 

taxes should pay more than individuals with lesser abilities 

to pay taxes (vertical equity.) In evaluating the horizontal eq- uity of an income tax, for example, one would ask whether 

two individuals with equal incomes are subject to the Same 

tax liability. In the context of examining the effects of interjurisdictional competition, one relevant question is whether 

two otherwise identical individuals who live in two different 

states are subject to the same net fiscal burden for the same 

services. A second relevant question is whether otherwise 

identical individuals or business firms within a jurisdiction 

are subject to the same fiscal arrangements. 

There is a wide range of opinion regarding what con- stitutes a vertically equitable tax system. Some individuals 

support extensive use of progressive taxation and expen- diture policies that favor the poor; others reject progressive taxation‘ and support only those expenditure policies 

that provide a minimal “safety net” for the poor. Depending on the individual’s value system, one might or might 

not conclude that interjurisdictional competition had 

harmful effects if it reduced the progressivity of the fiscal 

policies of governments in the federal system. 

The second framework for judging equity is the benefit principle. In the context of tax policy,’the benefit principle 

states that individuals should pay taxes in proportion to the 

benefits they receive from government services. When 

applied to fiscal policies in a federal system, the benefit principle would give high marks to a system that taxed individuals and businesses in proportion to the benefits these entities 

received from state or local governments. Furthermore, 

within the benefit principle framework, there would be no 

automatic presumption in support of progressive tax policies 

or expenditure policies favoring the poor. 

Efficiency 

An efficient governmental system has two key com- ponents: provision of the optimal quantity and mix of government services, and use of the least costly input mix and 

technology to produce that mix of government services. 

When both components of efficiency are satisfied, then 

Pareto optimality is achieved. Pareto optimality is a situa- tion in which it is impossible to make one individual better 

off without making another worse off. If there were some 

waste of resources in the economy, by definition there 

would not be a Pareto optimum because it would be possible to stop wasting resources and make at least one indi- vidual better off without making any individual worse off. 

Most noneconomists find the second aspect of efficien- cy the most understandable: the production of government 

services at minimum cost. At least one study suggests that 

nonprofit firms and governments are less likely to achieve 

least-cost production than are profit-making firms.* 

The first component of efficiency, the production of 

the optimal quantity and mix of government services, in- volves controversial issues regarding the appropriate size 

of the government sector and the appropriate level of 

spending on particular services. Citizens in any state or 

local jurisdiction will prefer different amounts of government spending. Because all citizens in a given jurisdiction 

tend to receive approximately the same level of government services, inevitably, some people will think that government spending is excessive and others will think that it 

is inadequate. According to the economist’s analytical 

framework, however, there is a single optimal level of spending-the level at which the sum of the additional benefits 

generated for all citizens is qua3 to the marginal cost of pro- duction? In some cases, this will be the level of government 

spending demanded by the median voter of the jurisdiction, 

that is, the level at which half of the citizens would prefer 

more spending and half would prefer less pend ding.^ 

Now that the criteria of equity and efficiency have 

been defined, it is important to note that, as in nearly all 

attempts to maximize more than one criterion, trade-offs 

will have to be made. Adoption of a particular policy 

change may increase equity and decrease efficiency, or 

vice versa. In those cases, one cannot judge whether the 

policy is an improvement unless one decides to weight equity or efficiency more heavily. 

This study will not attempt to place relative weights on 

these two criteria. It is important to note, however, that the 

trade-off between the achievement of equity and efficiency 

is critical in evaluating the effects of interjurisdictional competition. Part of the reason for the currently more benign 

evaluation of interjurisdictional competition appears to be 

the changed political climate in which somewhat more value 

is placed on efficiency than was the case two decades ago. 

Alternatives to Competition 

The alternatives to competition are not usually ad- dressed adequately in evaluating competition among state 

and local governments. Evaluation is likely to produce different results depending on whether the alternative to 

competition is cooperation among states or imposition of 

federal mandates, for example, and, for local govern- ments, whether the relevant alternative is consolidation 

of local governments or equalizing grants from the federal 

or state governments. 

In some cases, analysts may posit an alternative to interjurisdictional competition that is unrealistic. For example, proposing that state and local governments simply 

cooperate rather than compete is unrealistic. First, it is 

very difficult for a large group of actors to make and enforce 

an anticompetitive compact. The reason is that a diverse 

group is likely to have competing as well as common goals. 

The temporary success of the OPEC cartel in limiting oil 

production in order to raise its joint profits is a case in point. 

Second, even if the majority of state and local governmentscould agree to prohibit one type of competition, it is 

likely that another type would take its place. Suppose 

state governments agreed not to use special tax concessions in the future as an economic development device. 

What would prevent the relatively low-taxstates from taking advantage of their low-tax status to attract footloose 

business firms? Or, given the multiplicity of economic de- velopment devices, what would keep states from turning 

their emphasis to enterprise zones. grants, loans, customized industrial training, or any number of other devices to 

compete for business firms?’ 

John Kincaid has suggested a need to distinguish between mediated and unmediated interjurisdictional com- petition. He defines mediated competition as that which 

58 
occurs through the use of third-party government institutions, such as interstate competition for federal dollars in 

the Congress. Unmediated competition is the kind of 

“free-market” competition analyzed in this report. Kincaid argues that there often may be an inverse relationship between mediated and unmediated competition. In 

particular, if severe restrictions were placed on unmediated interstate tax and policy competition, then me- diated competition would likely increase as states would 

shift their competitive energies to the federal government 

in search of federal aid and otherbenefits. Thus, attempts 

to induce cooperation may displace competition to the 

Congress, where the outcomes of interjurisdictional competition are not necessarily more efficient or equitable 

than unmediated interjurisdictional competition.6 

Literature Review 

There is very little literature that evaluates the overall effects of interjurisdictional competition. This is not 

surprising, given the complexity of the question. Competition among states and local governments would need to be 

examined, as well as the dimensions along which governmentscompete (e.g., fiscal vs. regulatory). It also wouldbe 

advisable to take account of int~~~urisdictionalcompetition 

because competitive elections within jurisdictions may 

perform some of the same functions as interjurisdictional 

competition. That is, competition among local political 

parties and candidates may help make local government 

more responsive to voters just as the threat of exit tends to 

make local government responsive to its citizens’ concerns. Furthermore, intergovernmental relationships 

among the federal, state, and local governments can have 

important effects on interjurisdictional competition. Fi- nally, the effects of interjurisdictional competition on 

both efficiency and equity should be taken into account. 

Although there is not much explicit evaluation of the 

effects of interjurisdictional competition, there is a great 

deal of literature relevant to such an evaluation. 

The next section begins by considering studies of gov- ernment behavior in the absence of interjurisdictional 

competition. If governments act so as to maximize the 

welfare of their citizens in the absence of interjurisdictional competition, then the opportunity for such compe- tition to provide benefits for the federal system will be 

reduced significantly. Next, the growing literature on the 

effects of local government fragmentation and of restric- tions on the formation of new local governments on the 

performance of those governments will be reviewed. 

Some of the theoretical literature that attempts to illumi- nate the essential nature of interjurisdictional competi- tion will also be examined. 

Government Behavior 

in the Absence of Interjurisdictional Competition 

If governments are not automatically responsive to 

voter wishes, then competition among governments can 

be a potentially important force for encouraging greater 

responsiveness. As described in Chapter 2, governments 

may respond to their citizens because of pressure from citizen “voice” or “exit,” Citizens may influence the actions 

of their representatives by complaining at public hearings, 

signing petitions, voting for different candidates, and so 

on (the voice mechanism). Alternatively, citizens may 

“vote with theirfeet,” that is, move to a nearby community 

to obtain the public service-tax package they prefer (the 

exit mechanism). To the extent that the voice mechanism 

does not make state and local governments sufficientlyresponsive to their constituents, the exit mechanism may 

play an important role. 

In recent years, both the growth of the public choice 

school and the trend toward fiscal restraint have contributed to the idea that interjurisdictional competition may 

be helpful in making governments more responsive to 

their citizens. The essence of public choice is the application 

of economic models to the understanding of politics. One of 

the most important principles of the public choice school is 

that the achievement of successful public policy requires an 

understanding not only of the circumstances under which 

the free market does and does not function effectively but 

also of how effectively governments function. 

Economists working in the public choice field have 

developed influential models of “government failure,” or 

models that indicate that government policies may not 

produce optimal results for their constituents. One of the 

best known models is William Niskanen’s theory that the 

goal of a bureaucrat is to maximize the size of his or her 

budget.’ When this assumption holds, the normal tendency of government will be to overspend. Geoffrey Brennan 

and James Buchanan have developed a similar theory of 

government behavior that has become known as the Leviathan Hypothesis.* Their theory is that government naturally seeks to maximize revenues and exploit citizens 

through excessive rates of taxation. 

The empirical literature that examines the behavior 

of state and local governments contains some studies that 

support a public choice view of government behavior, and 

some studies that do not support such a view. 

The level of government spending is probably the 

characteristic of government behavior that has received 

the most attention, as well as generated the most controversy. As noted in this chapter, in some cases, the optimal 

level of government spending is that preferred by the median voter. In other words, even though no government 

can satisfy the diverse tastes of all its citizens, under some 

circumstances, the optimal level of government spending 

is the level that half the citizens say is excessive and the 

other half view as inadequate. 

Many studies of state and local government fiscal decisions have relied on a “median voter” model. According 

to that approach, political competition within jurisdictions 

forces public officials to choose policies that conform to 

the preferences of the median voter. Thomas Borcherding and Robert Deacon were among the first to obtain 

promising empirical results from this model? ‘To the extent that the median voter model is successful in describing state or local government fiscal decisionmaking, 

concern for government failure is lessened. 

Despite frequent use of the median voter model in 

empirical work on state and local governments, analystsof 

local government fiscal decisionmaking have some impor59 
tant reservations about the model’s applicability. One 

reason for these reservations stems from the 1970s tax revolt. If state and local governments had been responsive 

to the median voter, it is argued, voters would not have 

supported tax and expenditure limitations. In direct contradiction to the median voter model, there was nearly a decade of active consideration and passage of mechanisms to 

force fiscal discipline on state and local governments.10 

Another flaw in the median voter model is its inability 

to account for the so-called “flypaper effect.”” The flypaper effect refers to the fact that lump-sum grants to state 

and local governments increase public expenditure by 

more than an equivalent increase in the income of thejurisdiction’s residents. As Ronald Fisher notes, “The results of a number of studies show that although $1 of 

increased income is expected to increase subnational government expenditure by about $.05 to $.lo, $1 in 

lump-sum grant appears to increase expenditure by $.25 

to $SO.”’* The flypaper effect got its name from the tendency of money to “stick where it hits.” If a government 

were truly responsive to voter interests, some argue, it 

should increase spending on government services by the 

same amount whether the increase in income was received directly by the voters or by the government. 

Alternative models of government behavior that assume the natural tendency of state and local governments 

is to overspend have received some support. One of the 

best known efforts is the work on an “agenda setting” 

model by Thomas Romer and Howard R~senthal.’~ According to their model, the objective of government bureaucrats, in this case school district boards, is to 

maximize the size of their budgets. Because they set the 

agenda for school referenda, they present voters with a 

choice between too much or too little spending. Faced 

with this unattractive choice, voters choose the lesser of 

two evils and approve a level of spending that exceeds the 

level preferred by the median voter. Romer and Rosenthal have found support for their model in studies of 

school districts in Oregon and in New York. 

How Government Behavior Changes 

with Differing Degrees 

of Potential Interjurisdictional Competition 

In Chapter 2, it was noted that economists typically 

link the performance of an industry to the structure of 

that industry. In general, economists find that the more 

competitive the industry, the better the market performance (ie., the lower the prices, the closer output is to the 

optimal level, and the lower the average costs of production.) The government analogy implied by the Tiebout 

model is that the more competitive the government structure, the more responsive state and local governments 

should be to the desires of citizens. 

The discussion in Chapter 2 also hypothesized that 

competition among governments was likely to be greater 

the greater the number of governments competing with 

each other. Thus, it was asserted that competition should 

be greater in a metropolitan area with 50 suburbs than in a 

metropolitan area with only five suburbs. Fischel’s measure of competition among local governments, based on 

four-firm concentration ratios commonly used in the field 

of industrial organization, was also described. 

A small literature has begun to use similar measures 

of competition among local governments to test whether potential competition tends to reduce government spending. 

Figure 3 summarizes the results of six of these studies.14 As 

Wallace Oates notes in his recent review article, although 

there are some contradictions among the findings, there also 

are some consistencies. It is particularly interesting that the 

balance of evidence supports a negative relationship between the potential for interjurisdictional competition 

(which Oates refers to as fragmentation) and the level of 

public spending. This is the opposite of the result that Oates 

found in his last empirical study of the matter.l5 

Of the six empirical studies summarized in Figure 3, statistically significant results indicating that a competitive interjurisdictional structure tends to have a restraining effect 

on the size of the public sector are found for three studies 

examining competition within a county or within an SMSA 

(e.g., DiLorenzo, Eberts and Gronberg, and Zax). A further 

fmding is that the potential for competition among local 

general governments appears to have a restraining effect on 

government spending, but potential competition among special district governments appears to increase total government spending. This latter result is not surprising when 

viewed within the context of the Tiebout model. Citizens 

may use the exit mechanism when dissatisfied with the performance of local general governments, but will be much 

less likely to relocate because of dissatisfaction with the level 

of a single service. In addition, local general governments 

sometimes support the creation of special districts in order 

to get around tax or spending limitations. 

One of the six studies produces results contradicting 

the Leviathan hypothesis: Forbes and Zampelli find a positive and statistically significant relationship between the 

number of counties within an SMSA and the size of the 

local public sector. According to Forbes and Zampelli, 

the greater the number of countiesin an SMSA, the larger 

the size of the public sector. The number of counties within an SMSA is their measure of potential intercounty 

competition.16Two other studies find no statistically significant effect of interlocal competition within a state on total 

government spending. As Oates argues, this is not surprising 

because <’voting with one’s feet” across an entire state is likely to be of limited irnp~rtance.’~ 

Before exploring the next type of empirical study, a note 

is in order regarding the relationship between the level of 

local government spending and the degree of potential com- petition among some group of local governments. Even 

though most of the current evidence indicates a negative relationship between level of government spending and degree of potential interjurisdictional competition-that is, 

spending tends to go down as potential competition goes 

up-no current study has established that government 

spending is generally pushed to a level that isbeyond the optimum. Thus, even finding a negative relationship between 

level of government spending and degree of potential interjurisdictional competition provides less than complete support for the Leviathan hypothesis. 

A related literature examines the effects on the level 

of government spending of barriers to entry by local gov60 
Figure 3 

Literature Review: 

Effects of Interjurisdictional Competition on Level of Government Spending 

Study 

Type of Interjurisdictional 

Competition Measure of Interjurisdictional Competition Results 

2 concentration ratios: 

1) Percentage of total government expenditures in county 

areas accounted for by 4 largest jurisdictions 

2) Percentage of total own-tax revenues raised by 4 

jurisdictions with highest Own-tax revenues 

I I I 

Mixed results, but on the whole a positive correlation between 

concentration and cost of government services 

Dilorenzo 

(1983) 

Interlocal competition, competition 

among local governments 

Intracounty 

Average population per local government unit; average No statistically significant results for equation involving all local 

population per local general government governments; for local general governments, only an inverse 

relationship between public sector size and population per 

government unit 

Eberts & Gronberg 

(1988) 

I I I 

I I 

Interlocal competition (general Total number of local government units, number of local Increased fragmentation of local general governments within 

governments or special districts) governments normalized by population size, number of SMSAs or counties decreases government expenditure as a 

within SMSAs, counties and states local governments normalized by land area percentage of pemnal income; the opposite holds for special 

districts; within states, no statistically sigmficant results 

Oates 

(1985) 

Forbes & Zampelli 

(1989) 

Interlocal competition within a I Number of local governments within a state 

state 

Intercounty competition 

Insignificant negative relationship between total state-local 

receipts as a fraction of personal income and number of 

governments in a state 

~~ 

Zax 

(1989) 

I I I 

I I 

~ ~~~~~ 

Intracounty competition among Governments per square mile, both general and single Total own-source revenue of all governments as share of county 

local governments Purpose personal income negatively related to general governments per 

square mile, but positively related to special district governments 

per square mile 

Nelson 

(1987) 

Number of counties in an SMSA Number of counties in an SMSA has a positive and statistically 

significant impact on the size of the public sector 

Source: Compiled by author 
ernments and of local government ability to annex unincorporated land.18 The working hypotheses are that the 

ability to annex land should increase a local government’s 

fiscal power, and thus tend to increase the level of local 

government spending, and that the greater the barriers to 

entry of new local governments, the higher the level of 

government spending. An example of a barrier to entry is 

the existence of Local Agency Formation Commissions in 

most California counties that have the power to reject the 

proposed incorporation of a new city in an unincorporated 

area. This empirical literature is inspired by economic analysis of market functioning, in which economists have found 

that barriers to entry and greater market power tend to increase price levels and to reduce efficiency in production. 

A recent study by Rodolfo Gonzalez and Stephen 

Mehay examines these hypotheses for 24 governments in 

southern and western ~tates.’~ Gonzalez and Mehay try to 

distinguish between states that have significant legal barriers to local incorporation and states that do not. They use 

information on the legal petition, referendum, and majority 

voting requirements for municipal incorporation to construct the barrier-to-entry variable.20 Gonzalez and Mehay 

use the ratio of population annexed to total population 

growth of the city during the previous decade to measure the 

gain in a municipality’s fiscal power through annexation. 

Gonzalez and Mehay find a statistically significant 

positive relationship between higher annexation rates and 

greater barriers to entry and the level of government 

spending; that is, spending tends to be higher where there 

are more annexations and greater barriers to entry. They 

find a significant negative relationship between the ratio 

of the number of municipalities in the county to the land 

area and the level of public spending; that is, there tends 

to be lower spending where there are more municipalities. 

Direct Assessments of the Effects 

of Interjurisdictional Competition 

A separate body of theoretical literature attempts to 

assess the virtues and shortcomings of interjurisdictional 

competition. Some of the papers create rigorous mathematical models; others provide a broader but less rigorous 

analysis of the tendencies of interjurisdict ional competition. 

Albert Breton has been developing a nonmathematical theory of competitive federalism over the past few years. 

Although he directs his attention to Canada, much of hisdiscussion is applicable to federalism in the United States. At 

the core of his theory is a notion of entrepreneurial competition among governments. Although Breton’s approach uses 

economic analysis of market competition as a model, his 

theory is not based on neoclassical economics but on the 

classical economics of Adam Smith and the theories of 

economic development of Joseph Schumpeter. 

Breton’s assessment of the effects of interjurisdictional competition begins with the market analogy: 

Markets, when they are well structured and competitive, do a good job over the longer term in allocating resources in ways that maximize the well 

being of the population. . . . What is less accepted, 

but an idea in which I nonetheless believe just as 

strongly, is that governments, when they are well 

structured and competitive, do just as good a job 

as markets, and like them over the longer term, 

allocate resources in ways that maximize the 

well-being of people.21 

John Shannon argues that at any time the forces of 

interjurisdictional competition limit the extent to which a 

state can levy taxes in excess of its competitor states or can 

skimp on public services.22 He argues that, despite its 

shortcomings vis-a-vis treatment of the poorer states, interjurisdictional competition provides a valuable service 

in regulating the federal system and that: 

The interests of our federal system are well 

served by leaving this delicate and critical task of 

setting the outer limits of intergovernmental diversity where it now resides . . . because the light 

and “invisible hands” of tax and public service 

competition are clearly preferable to the heavy 

and visible hand of Wa~hington.~~ 

Other efforts to evaluate the effects of interjurisdictional competition work within formal economic models. 

Tivo papers by Wallace Oates and Robert Schwab will be 

summarized briefly here. In the first paper, entitled “Economic Competition among Jurisdictions: Efficiency Enhancing or Distortion Inducing?” Oates and Schwab build 

a model that has a number of jurisdictions, with individuals living and working in the same jurisdi~tion.~~ Therole 

of government is to set the tax level and to regulate the 

quality of the environment. Capital is mobile between jurisdictions, but individuals are not. Oates and Schwab experiment with different specifications of their model to 

determine the conditions under which competition 

among governments is efficient, in the sense that it would 

be impossible to make one consumer better off without 

making another worse off. 

Oates and Schwab find that under one specification 

competition among jurisdictions produces an efficient 

outcome, but under other specifications competition is inefficient. Specifically, when jurisdictions are constrained 

to tax capital, competition will lead to a socially excessive 

level of pollution. They also find that when community 

politicians are budget-maximizers, competition among 

communities leads to an inefficient outcome. 

In a later paper, “The Allocative and Distributive Implications of Local Fiscal Competition,” Oates and 

Schwab build avariant of their first model to examine both 

efficiency and equity aspects of interjurisdictional competiti~n.~’ Again, they assume that capital, not labor, is mo- bile among jurisdictions. Jurisdictions compete for the 

mobile capital stock by lowering taxes and providing public services, such as police and fire protection, that are 

needed by business firms. 

Oates and Schwab find that interjurisdictional competition is efficient; that is, no one could be made better 

off without someone else being made worse off. Furthermore, interjurisdictional competition forces all local taxes 

to become benefit taxes. Individuals and businesses pay 

taxes equal to the benefits they receive from government 

services. No redistribution from business to individuals is 

possible. Whether this is good or bad, Oates and Schwab 

argue, depends crucially on whether the federal govern62 
ment is performing adequately in its redistributive role. If 

the federal government is not fulfilling that role, they argue, some limits on interjurisdictional competition maybe 

required to enable state and local governments to accomplish some part of the redistniutive function.% 

Therese McGuire examines the effects of interjurisdictional competition by building two alternative models, 

one meant to be most applicable to competition among local 

governments, which she labels a ‘Tiebout model,” and one 

meant to be most applicable to competition among states, 

which she labels a “destructive competition model.”27 

The effects of interjurisdictional competition that 

McGuire derives from her Tiebout model corroborate the 

conclusions of the second Oates-Schwab model. Interjurisdictional competition is beneficial because it produces efficiency: the best mix of government goods and 

services is produced at the lowest cost. As in the second 

Oatesand Schwab model, the taxes levied by local governments are benefit taxes. 

In McGuire’s destructive competition model, individuals within states want to redistribute income from 

high-income to low-income individuals, and they levy ability-to-pay taxes in order to accomplish this. She argues 

that this model is more applicable to state governments 

than is her Tiebout model because of the redistributive 

nature of a significant proportion of state government services, and the fact that state taxes are more nearly based 

on ability to pay than are the property taxes that are the 

mainstay of local government finance. 

In the destructive competition model, because 

high-income citizens have an incentive to relocate from 

jurisdictions levying relatively progressive taxes, the intended redistribution of income is frustrated. In equilibrium, the best mix of government goods and services is not 

provided. Specifically, state citizens are unable to achieve 

the degree of redistribution of income they desire. 

McGuire goes on to discuss alternative federal policies 

that could mitigate the results of destructive interstate 

competition, such as federal grants-in-aid or federal restrictions on state tax structures. 

The papers by Oates and Schwab, and McGuire constitute a tiny fraction of the theoretical literature that 

builds on Tiebout’s original paper to assess the efficiency 

properties of interjurisdictional competition.28 Most of 

this literature attempts to determine alternative sets of conditions under which the output of government goods and 

services in a competitive governmental market will constitute a Pareto optimum (i.e., it is not possible to make one 

person better off without making someone else worse off). 

One major theme of this literature is that the conditions under which a competitive governmental structure 

will lead to a Pareto optimum are considerably more stringent than the conditions necessary for achieving a Pareto 

optimum in the private market. In order to achieve a Pareto optimum in the governmental market, there must be an 

optimal number of communities, an optimal allocation of 

individuals among the communities, and an optimal level 

of spending on government goods and services within 

each community. There are many possible reasons that 

may prevent simultaneous achievement of these three 

necessary conditions. 

This literature will not be reviewed further here because of its complexity and its limited policy relevance. In 

essence, most of the literature compares the efficiency 

properties of interjurisdictional competition with the effi- ciency properties of the standard model of perfect compe- tition in the market economy. It does not examine the 

properties of interjurisdictional competition relative to alternative institutional structures for state and local governments, which would be more relevant to this study. As 

noted earlier, the question of whether interjurisdictional 

competition is good or bad for the federal system cannot 

be answered without postulating a reasonable alternative 

to interjurisdictional competition. 

Conclusion 

The literature reviewed in this chapter, as well as in 

previous chapters, will now be brought to bear on the cen- tral question of this report: is interjurisdictional competi- tion good or bad for the federal system? Some of this 

study’s findings regarding the effects of interjurisdictional 

competition are different from the consensus of a decade 

or two ago, but in other respects, recent research has reaffirmed long-standing conclusions about interjurisdictional competition. 

Current research confirms the tendency for interjurisdictional competition to reduce reliance on ability -to-pay taxes. 

This was shown most clearly in the Oates and Schwab 

model described earlier in this chapter. In equilibrium, 

the taxes that businesses and individuals pay are equal to 

the respective values they place on public services re- ceived; that is, state and local taxes will be benefit taxes. In 

a competitive environment, therefore, business taxes are 

unlikely to be used to fund social programs or education. 

Business taxes will, however, be high enough to pay for 

services provided for businesses, such as police protection, 

public utilities, and highways. Likewise, high-income individuals will tend to be taxed in proportion to the benefits they 

receive from their local governments. High-income individuals will not tend to be subject to taxes that exceed the bene- fits they receive in order to fund tax or service programs that 

redistribute income to low-income individuals. 

Although the benefit tax result sounds much like a 

common criticism of the effectsof interjurisdictionalcompetition made ten years ago, today, the assessment of this 

result is much less negative. First, there is no longer an 

automatic presumption that good tax policy consists of 

levying a substantial amount of taxes on businesses (in ex- cess of services businesses receive) either because of presumed progressivity of business taxes or because of the 

idea that businesses as well as individuals should pay their 

fair share of taxes. This change arises in large part from 

contributions to the theory of state business tax incidence.2g Second, there appears to be less emphasis on eq- uity relative to efficiency than there was a decade ago. 

Finally, there appears to be more interest in relying on the 

benefit principle, rather than the ability-to-pay principle, 

for judging the equity of public policies. 

Efforts to use tax incentives to attract mobile industry are 

stillgenerally in disfavor. Current research on interjurisdic63 
tional competition for economic development (reviewed 

in Chapter 5) is still generally critical of individually nego- tiated tax packages designed to lure new industry or retain 

existing industry. Theoretical research has argued that such 

competition may have the characteristics of a negative-sum 

game (everybody ultimately loses). Empirid research has 

buttressed the theoretical research by concluding that the 

cost effectiveness for the offering government for most 

types of special tax incentives is very low. The few dissent- ing voices point to the traumas when a state or local gov- ernment goes through an economic crisis. In certain cases, 

such as severe recessions, special tax concessions to retain 

a key industry may constitute reasonable public policy. 

Interjurisdictional competition does not necessarily depress the provision of state and local services. In some cases, it 

can createpressure to increase service levels, and therefore to 

increase revenues. The literature reviewed in Chapter 4 

first stressed the link between taxes and service levels. It 

then reviewed evidence that spending on certain state and 

local services, such as education (the only available proxy 

for the level of services), tended to increase property val- ues, attract migrants, and increase state economic growth. 

State or local governments operating in a competitive environment, then, would be motivated to provide a higher 

level, rather than a lower level, of these services. 

The review argued in favor of distinguishing among 

services that exhibit beneficial spillovers (external benefits to third parties) and those that do not. According to 

economic theory (and supported, in part, by the empirical 

evidence), when the residents of a state or locality are able 

to appropriate the bulk of the benefits from a public expenditure, this spending tends to increase property values, personal income, and employment. The opposite 

tends to hold true for those categories of spending that exhibit significant beneficial spillovers, such as highway and 

public welfare expenditures. 

A separate empirical literature, also relevant to 

whether interjurisdictional competition will tend to depress state and local service levels, was reviewed in this 

chapter. This literature examines the relationship between state or local government spending and the degree 

of potential interjurisdictional competition as measured 

by the degree of fragmentation of the governmental structure. The bulk of empirical evidence at this point indicates 

that a competitive local government structure (e.g., more 

general local governments in a metropolitan area rather 

than less) leads to a lower level of government spending. Although the authors of some of these studies interpret the 

empirical results as indicating that interjurisdictional competition is necessary to combat the tendency for governments 

to overspend in its absence, this conclusion is based on weak 

foundations. None of this literature has determined the optimal level of government spending much less documented 

that the potential for interjurisdictional competition tends to 

reduce government spending toward the optimum. 

It is appropriate to judge the effects of interjurisdictional 

competition according to whether they are equitable or eflcient. Furthermore, any evaluation of competition among 

state and local governments will depend on the alternative to 

competition. Neither of these guidelines makes it simple to 

determine whether interjurisdictional competition is 

good or bad for the federal system. There are alternative 

definitions of equity and two important components of ef- ficiency. Furthermore, in some cases, additional efficien- cy can be gained only at the expense of a loss in equity, or 

vice versa. Much of the literature that purports to analyze 

the effects of interjurisdictional competition, especially 

the theoretical literature, compares the effects of interjurisdictional competition to the effects of competition in 

a market economy. This type of analysis is of limited help 

in determining whether interjurisdictional competition is 

preferable to a particular alternative. 

Unlike thesituation a decade ago, when the assessment of 

interjurisdictional competition was almost uniformly negative, today, certain aspects of interjurisdictional tax and policy 

competition generally receive a more favorable assessment. 

Two decades ago, few observers spoke of any merits of 

competition among governments. For example, George 

Break concluded in his classic 1967 text that: 

Active tax competition . . . tends to produce ei- ther a generally low level of state-local tax effort 

or a state-local tax structure with strong regres- sive features. Paradoxically, the more widespread it 

is, the more likely it is to produce these debilitating 

fiscal effects without creating the stimulating eco- nomic effects sought by the tax competit~rs.~~ 

Adecade ago, ACIR spoke of the need to “protect against 

unbridled tax competition” and asked, “How does one tell 

when interstate tax competition is seriously damaging the 

federal 

Today, certain aspects of interjurisdictional tax and 

policy competition receive a more favorable assessment. 

The benefits of interjurisdictional competition are recognized along with its costs. The more positive assessment 

arises from two sources-growth in research indicating 

the potential benefits of such competition and changes in 

public opinion, especially about fiscal matters. 

New research, most of which was reviewed earlier in 

this chapter, takes several forms. First, evidence that state 

and local governments have not always been sufficiently 

responsive to their citizens lends credibility to the argu- ment that interjurisdictional competition may be an important supplement to intrajurisdictional political 

competition. Theoretical literature using explicit eco- nomic models has contributed examples in which inter- jurisdictional competition leads to maximum efficiency, 

or to a situation in which it is impossible to make one person better off without making another worse off. Some of 

the less formal theoretical literature, such as the work of 

Albert Breton, has concluded that the general tendency 

of interjurisdictional competition is beneficial. Both Breton and Shannon argue that interjurisdictional competition 

serves as one regulator of the federal system and that under 

some circumstances this regulator has benign results. 

None of this literature, however, concludes that interjurisdictional competition provides beneficial results 

for all types of competition in all circumstances. The mar- ket analogy, for example, argues that just as there are im- portant instances of market failure in our predominantly 

free market economy, there also are likely to be instances 

64 
in which interjurisdictional competition produces less 

than benign results. An important type of market failure, 

called an “external” or “spillover” effect, arises when an 

economic activity causes incidental benefits or damages to 

others (“third parties”) and for which no mechanism exists 

for compensating or penalizing those who initially generate the activity. The existence of spillovers among govern- ments, just as the existence of spillovers in the market 

economy, tends to have harmful effects. For example, competition among governments has harmful effects for the federal system when governments are allowed to “export” 

certain social costs to residents of other jurisdictions. 

To some extent, the more benign evaluation of interjurisdictional competition arises from changing publicvalues. In the equity-efficiency trade-off, efficiency now 

receives more emphasis and equity, less emphasis relative 

to two decades ago. To the extent that the revised asses- sment of interjurisdictional competition arises from the 

changed climate of public opinion, however, one should 

be wary. It is the nature of public opinion to go through 

cycles. If the relative weights currently placed on the two 

criteria of equity and efficiency were to be reversed, there 

might be a somewhat different assessment of the benefits 

and costs of interjurisdictional tax and policy competition. 

NoteIn early drafts, we incorporated a third criterion: viability of 

the states and of the substate governmental systems that make 

up the federal system. After receiving criticism at the critics’ 

session and after giving the matter more thought, we decided 

to eliminate this criterion. We decided that it was more appropnate to evaluate the results of a governmental system from the 

viewpoint of the citizens who are to be served by that system than 

from the viewpoint of the officials of the existing governments. 

’Armen A. Alchian and Harold Demsetz, “Production, Information Costs, and Economic Organization,” American Economic Review 62 (1972): 777-795. 

This is known as the Samuelson condition. Paul A. Samuelson, 

“The Pure Theory of Public Expenditure,”RevkofEconomics and Statistics 36 (November 1955): 387-389. 

4See, for example, the discussion in Randall G. Holcombe, 

“Concepts of Public Sector Equilibrium,” National Tar Jozrmal 

33 (March 1980): 77-88. Holcombe proves that the level of government spending demanded by the median voter of a jurisdiction will also be the optimal spending level when this 

condition holds: the median voter’s tax share is the same proportionof the sum of all voters’ marginal tax shares as his 

or her marginal valuation of public goods is of the sum of the 

community’s marginal valuations. 

Both Hal Hovey and Lany White point out that eliminating or 

reducing competition among governments is a very difficult 

task. See Larry White, “Should Competition to Attract New 

Investment Be Restricted?” Public Afluirs 9 (1986): 6-18; and 

Harold Hovey, “Curbing Interstate Tax Competition,’’ Sfate 

Policy Reports 5 (May 13,1987): 4-9. 

John Kincaid, “The Competitive Challenge to Cooperative 

Federalism,” in Daphne A. Kenyon and John Kincaid, eds., 

Competition aniong States arid Local Governments: Eficiency 

arid Equity in Anterican Federalisin (Washington, DC: The Urban Institute Press, 1991). 

William A. Niskanen, Birreaucmcy and Representative Govemment (Chicago: Aldine-Atherton, 1971). 

Geoffrey Brennan and James Buchanan, 77ie Power to Tm: 

Analytical Foundation of a Fiscal Constitiition (New York: 

Cambridge University Press, 1980). 

’Thomas E. Borcherding and Robert T. Deacon, “The Demand for the Services of Non-Federal Governments,” Amen‘- 

can Economic Review 62 (December 1972): 891-901. Another 

important early article was Theodore C. Bergstrom and Robert I? Goodman, “Private Demands for Public Goods,”Amen‘- 

can Economic Review 63 (June 1973): 280-296. 

lo See also US. Advisory Commission on Intergovernmental 

Relations, Fiscal Discipline in the Federal System: National Refoim and the Experience of the States (Washington, DC, 1987). 

I’ For reviews of the evidence of the flypaper effect see Ronald 

C. Fisher, “Income and Grant Effects on Local Expenditure: 

The Flypaper Effect and Other Difficulties,” Jorrnial of Urban 

Economics 12 (November 1982): 324-345; and Robert I? Inman, “The Fiscal Performance of Local Governments: An Interpretive Review,” in Peter Mieszkowski and Mahlon 

Straszheim, eds., Cirmnt Issiies in Ui6an Econornics (Baltimore: Johns Hopkins University Press, 1979). pp. 270-321. 

l2 Ronald C. Fisher, State and Local Pirblic Firiance (Glenview, 

Illinois: Scott, Foresman and Company, 1988), p. 359. 

l3 Thomas Romer and Howard Rosenthal, “Bureaucrats versus 

Voters: On the Political Economy of Resource Allocation by 

Direct Democracy,” Quartedy Journal of Economics (November 1979); and Thomas Romer, Howard Rosenthal, and Vincent G. Munley, “Economic Incentives and Political 

Institutions: Spending and Voting in School Budget Referenda,” National Bureau of Economic Research Working Paper, 

No. 2406, October 1987. 

I4Thornas J. DiLorenzo, “Empirical Competition and Political 

Competition: An Empirical Note,” Public Choice 40 (1983): 

203-209; Wallace E. Oates, “Searching for Leviathan,” American Economic Review 75 (September 1985): 748-757; Michael 

A. Nelson, “Searching for Leviathan: Comment and Extension,” American Economic Review 77 (March 1987): 198-204; 

Randall W Eberts and Timothy J. Gronberg, “Can Competition 

among Local Governments Constrain Government Spending?” 

Economic Review 24 (1988): 2-9; Kevin E Forbes and Ernest M. 

Zampelli, “Is Leviathan a Mythical Beast?” Anterican Economic 

Review 79 (June 1989): 587-596; Jeffrey S. Zax, “Is There a Leviathan in Your Neighborhood?” American Economic Review 79 

(June 1989): W567. 

l5 Wallace E. Oates, “Searching for Leviathan: A Reply and 

Some Further Reflections,” American Economic Review 79 

(June 1989): 578-583. 

16Forbes and Zampelli, “Is Leviathan a Mythical Beast?” 

l7 Oates, “Searching for Leviathan: A Reply and Some Further 

Reflections.” 

l8 D. Martin and R. Wagner, “The Institutional Framework for 

Municipal Incorporation: An Economic Analysis of Local 

Agency Formation Commissions in California,” Journal of Law 

and Economics 21 (December 1975): 661684; and D. Martin, 

“Entry Restrictions and Expenditure Effects in the Local Government Market,” Annals of Regional Science 14 (1980): 12-22 

l9 Rodolfo A. Gonzalez and Stephen L. Mehay, “Municipal Annexation and Local Monopoly Power,” Pitblic Choice 52 

‘O’I‘he dummy variable Gonzalez and Mehay construct to measure state differences in barriers to entry by new local governments is separate from the variable they use to measure power 

of annexation. In some other research, these two phenomena 

are not independent. For example, California’s Local Agency 

Formation Commissions examined in the research by Martin 

and Wagner have the power to accept or reject annexation as 

(1987): 245-255. 

65 
well as incorporation of new local governments. Martin and 

Wagner, “The Institutional Framework for Municipal Incor- poration.” 

”Albert Breton, “Towards a Theory of Competitive Federalism,” European Joumal of Political Economy (Special Issue) 3 

(1987): 322. See also Breton’s comments in US. Advisory 

Commission on Intergovernmental Relations, Interjuirdictional Competition in the Federal System: A Roundtable Discussion (Washington, DC, 1988). 

22 John Shannon, “Federalism’s ‘Invisible Regulator’ -1nterjurisdictional Competition,” in Daphne A. Kenyon and John 

Kincaid, eds., Competition among States and Local Governments: Eficiency and Equity in American Federalism (Washing- ton, DC The Urban Institute Press, 1991). 

23 Ibid. 

24 Wallace E. Oates and Robert M. Schwab, “Economic Competition among Jurisdictions: Efficiency Enhancing or Distortion In- ducing?” Journal ofPublic Economics 35 (April 1988): 333-354. 

25 Wallace E. Oates and Robert M. Schwab, “The Allocative and 

Distributive Implications of Local Fiscal Competition,’’ in 

Daphne A. Kenyon and John Kincaid, eds., Competition 

among States and Local Governments: Eficiency and Equity in 

American Federalism (Washington, DC The Urban Institute 

Press, 1991). 

26A few other papers attempt to determine whether competition 

among governments leads to an efficient result. For example, 

John Wilson has two recent papers in which he uses economic 

theory from the international trade literature to build models 

of trade among competitive governments in a federal system. 

Depending on the specification of his model, Wilson can find 

that competition among governments is either efficient or inefficient. John Douglas Wilson, “Trade, Capital Mobility, and 

Tax Competition,” Journal of Political Economy 95 (August 

1987): 835-856; and “Trade in a Tiebout Economy,” American 

Economic Review 77 (June 1987): 431-441. 

27Therese J. McGuire, “Federal Aid to States and Localities and 

the Appropriate Competitive Framework,” in Daphne A. 

Kenyon and John Kincaid, eds., Competition among Statesand 

Local Governments: Eficiency and Equity in American Fedemlism (Washington, DC: The Urban Institute Press, 1991). 

28 For two good reviews of this literature see Joseph E. Stiglitz, 

“The Theory of Local Public Goods Twenty-Five Years after 

Tiebout: A Perspective,” in George R. zodrow, ed., Localprovision of Public Services: The Tiebout Model after Twenty-Five 

Ym(NewYork Academic Press, 1983), pp. 17-53; and Antho- ny B. Atkinson and Joseph E. Stiglitz, Lectures on Public Economics (New Ymk: McGraw-Hill, lm), pp. 519-551. 

29 See especially Charles E. Mchre, Jr., “The Elusive Incidence 

of the Corporate Income Tax: The State Case,” Public Finance 

Quartedy 9 (October 1981): 395-413; and for a discussion of the 

McLure article and related research, see Fisher, State and Local Public Finance, pp. 226-228. 

30George E Break, Intergovernmental Fiscal Relations in the 

United States (Washington, DC: The Brooking Institution, 

31 The criteria ACIR put forth for judging whether interstate tax 

competition WBS seriously damaging the federal system were 

that: (1)somestatesmustbelosing jobs and capital investment 

to other states because of high tax levels; and (2) the losing 

states are unable to stop the exodus over a reasonable period 

of time because of the hardships that wuld be caused by the 

necessary tax andservice cutbacks. U.S. Advisory Commission 

on Intergovernmental Relations, Interstute Tax Competition 

(Washington, DC, lW), pp. 4-5. 

1967), pp. 23-24. 

66 
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U.S. Advisory Commission on Intergovernmental Relations 

Significant Features of Fiscal Federalism. 1991 Edition. Volume I. M.176. 1991. 180 pp ......................... 

The Structure of State Aid to Elementary and Secondary Education. M.175. 1990. 72 pp ........................ 

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Changing Public Attitudes on Governments and Taxes: 1990. S.19. 1990. 40 pp ................................. 

1988 Fiscal Capacity and Effort. M.170. 1990. 160 pp ........................................................ 

State Constitutional Law: Cases and Materials. 1990-91 Supplement. M.172. 1990. 56 pp .................... 

Intergovernmental Regulation of Telecommunications. A.115. 1990. 48 pp ..................................... 

The Volume Cap for Tax-Exempt Private-Activity Bonds: State and Local Experience in 1989. M.171. 1990. 36 pp . . 

Significant Features of Fiscal Federalism. 1990 Edition. Volume I. M.169. 1990. 152 pp ......................... Volume 11. M.169.11. 1990. 280 pp ..................................................................... 

State and Local Initiatives on Productivity. Technology. and Innovation. A.114. 1990. 180 pp ..................... 

Local Revenue Diversification: Rural Economies. SR.13. 1990. 60 pp .......................................... 

State Taxation of Banks: Issues and Options. M.168. 1989. 48 pp ............................................. 

A Catalog of Federal Grant-in-Aid Programs to State and Local Governments: Grants Funded FY 1989. 

Local Revenue Diversification: Local Sales Taxes. SR.12. 1989. 56 pp ......................................... 

State Constitutions in the Federal System: Selected Issues and Opportunities for State Initiatives. 

Residential Community Associations: Questions and Answers for Public Officials. M.166. 1989. 40 pp ............. 

Residential Community Associations: Private Governments in the Intergovernmental System? 

Readings in Federalism-Perspectives on a Decade of Change. SR.ll. 1989. 128 pp ............................. 

Disability Rights Mandates: Federal and State Compliance with Employment Protections 

Hearings on Constitutional Reform of Federalism: Statements by State and Local 

Government Association Representatives. M.164.1989. 60 pp ............................................ 

State and Federal Regulation of Banking: A Roundtable Discussion. M.162. 1988. 36 pp ......................... 

Assisting the Homeless: State and Local Responses in an Era of Limited Resources. 

M.161. 1988. 160pp ................................................................................. 

Devolution of Federal Aid Highway Programs: Cases in State-Local Relations and Issues in State Law. 

M.160. 1988.60~~ .................................................................................. 

M.167. 1989. 40 pp .................................................................................. 

A.113. 1989.128~~ .................................................................................. 

A.112. 1989. 128 pp .................................................................................. 

and Architectural Bamer Removal. A.111. 1989. 136 pp ................................................. 

State Regulations of Banks in an Era of Deregulation. A.llO. 1988. 36 pp ...................................... 

State Constitutional Law: Cases and Materials. M.159. 1988. 480 pp .......................................... 

Local Revenue Diversification: Local Income Taxes. SR.lO. 1988. 52 pp ........................................ 

Interjurisdictional Competition in the Federal System: A Roundtable Discussion. M.157. 1988. 32 pp .............. 

State-Local Highway Consultation and Cooperation: The Perspective of State Legislators. SR.9. 1988. 54 pp ...... 

Is Constitutional Reform Necessary to Reinvigorate Federalism? A Roundtable Discussion. M.154. 1987. 39 pp .... 

Devolving Selected Federal-Aid Highway Programs and Revenue Bases: A Critical Appraisal. A.108. 1987. 56 pp ... 

Metropolitan Organization: The St . Louis Case. M.158. 1988. 176 pp .......................................... 

The Organization of Local Public Economies. A.109.1987. 64 pp ............................................. 

Local Revenue Diversification: User Charges. SR.6. 1987.64 pp .............................................. 

Federalism and the Constitution: A Symposium on Garcia. M.152. 1987. 88 pp ................................. 

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