PS 6 Local Public Finance II Chapter 7 7 1 Evaluate the following taxes from the standpoint of vertical and horizontal equity a A 25 cent per gallon tax on milk b A tax on stock market transactions c A sales tax on men s clothing d A tax on cigarettes Answers Vertical equity is harmed with any flat tax Horizontal equity is harmed whenever goods that are only consumed by select segments of the population are taxed The effect on horizontal and vertical equity is as follows a Milk taxes are horizontally equitable but not vertically equitable because they have a greater impact on low income families b A tax on stock market transactions is likely to be vertically equitable in that most lower income families do not execute many trades The extent of horizontal equity depends on how uniform the preference for stocks is among individuals with similar incomes The more tastes vary for example between stocks and other forms of investment such as real estate the less horizontally equitable the tax will be c A sales tax on men s clothing is likely to fair poorly on both counts It is likely to be regressive thus not vertically equitable and is also not horizontally equitable in that it falls only on men rather than both genders d A tax on cigarettes is likely to be neither horizontally nor vertically equitable for the same reasons as a tax on men s clothing 7 3 If the marginal propensity to consume in a municipality is 0 8 what is the value of the simple multiplier If a new stadium that adds 30 million in new consumption expenditures is built what is the impact on the economy based on this multiplier Answer The simple multiplier 1 1 MPC In this case with MPC 0 8 the multiplier is 5 An initial expenditure of 30 million would have a final impact of 150 million As a side note the MPC for spending in the local economy is generally much lower than the overall MPC While it is reasonable for a person to spend 80 percent of their income on consumption it is extremely unlikely that they will spend 80 percent of their income on goods and services produced in the local economy Therefore the multiplier for the local economy as well as the total impact on the local economy is likely to be much lower than suggested in this example 7 4 True or False explain your answer The new stadium was entirely privately funded because all the city contributed was a 50 acre site on which to build it Answer False The land donated by the city represents an opportunity cost to the city The same land could have been sold to private interests or used by the municipality for a park or any other public good 7 5 You own a team in San Francisco What does public choice theory say about what you will do if Los Angeles presses the California legislature to underwrite a new stadium in Los Angeles Answer You would have an incentive to lobby your representatives to back the spending bill only if it also includes funding for a new stadium in San Francisco This is an example of logrolling 7 6 Why is the multiplier effect for the Los Angeles Lakers likely to be greater than the multiplier effects for the Sacramento Kings when both are teams in the NBA Answer Los Angeles is much larger than Sacramento so people are more likely to live and shop in Los Angeles than Sacramento As a result the leakages from Los Angeles are much smaller than the leakages from Sacramento and the multiplier is larger 7 7 Your city is committed to raising 100 million for a new arena The mayor suggests putting a tax on taxicab rides since out of towners disproportionately use taxicabs Evaluate the wisdom of this policy decision Answer The tax on taxicab rides shifts the supply curve up by the amount of the tax a fixed amount if there is a fixed tax per ride The price of cab rides rises passing some of the tax on to out of towners However the tax The price rises by less than the amount of the tax from failure of the price to rise by the amount of the tax means that taxicab drivers pay some of the tax If the elasticity of demand for cab rides is large enough the cab drivers may have to pay a substantial amount of the tax If this happens the tax is not a good idea Furthermore the concept of tax fungibility suggests that even if out of towners do pay the majority of the tax this revenue could be used to finance other projects in the city besides the stadium or be used to reduce other taxes paid by local residents and not to to 7 8 Under what circumstances would a city government want to contribute funding for a stadium even if it knows that the revenue it receives will not cover the city s share of operating expenses Answer If the stadium provides indirect benefits to the city in addition to direct economic benefits then a public contribution may be warranted For example a stadium may provide advertising to a city allowing the city to be put on the map A stadium may also serve as an anchor to promote wider economic development Finally a stadium may provide a cultural amenity that makes a city a livable place 7 9 Why might a city want to go into debt as a way to fund a stadium Answer Historically if cities borrowed to build a stadium they could pass some of the cost of a new stadium on to the residents of other cities This is because interest income from municipal bonds is deductible from federal taxes This has two effects First because the income is tax free cities pay lower interest rates on municipal bonds than private companies pay on comparable bonds Second if the holders of municipal bonds pay lower federal taxes taxpayers nationwide must pay higher taxes to make up the lost income The city can thus pay interest rates that are less than the market rates at the expense of residents of other cities who have to pay higher federal taxes Since December 31 1999 however IRS regulations stipulate that cities may no longer issue tax exempt municipal bonds to build professional sports stadiums 7 10 Why would a Super Bowl played in Detroit probably have more of an impact than a Super Bowl played in Miami even if both were to draw the same amount of fans Why would a Super Bowl at Ford Field in Detroit have more of an impact on Detroit than a regular season Detroit Lions game that draws the same number of fans Answer A Super Bowl in Miami would displace many business travelers and vacationers who would have gone to Miami even if there were no Super Bowl This reduces the economic impact of the Super Bowl on Miami s economy Because far fewer people go to Detroit in January the