BU EC 385 - PS#6: Local Public Finance II

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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 cigarettesAnswers: 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 price rises by less than the amount of the tax, from to and not to tax. The 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.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

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