A Few Thoughts on Sorting and Agglomeration

A new article by Joel Kotkin, Mark Schill, and Ryan Streeter on what America can learn from the Midwest reminded me of something that’s been stuck in my craw. Recently, Greg Mankiw wrote a column arguing that competition between local governments can be virtuous:

In choosing where to live, people can compare public services and taxes. They are attracted to towns that use tax dollars wisely. Competition keeps town managers alert. It prevents governments from exerting substantial monopoly power over residents. If people feel that their taxes exceed the value of their public services, they can go elsewhere. They can, as economists put it, vote with their feet.

The argument applies not only to people but also to capital. Because capital is more mobile than labor, competition among governments significantly constrains how capital is taxed. Corporations benefit from various government services, including infrastructure, the protection of property rights and the enforcement of contracts. But if taxes vastly exceed these benefits, businesses can — and often do — move to places offering a better mix of taxes and services.

Matt Yglesias offered a representative reply:

When nobody wants to live someplace, it’s cheap to buy a house there. That’s why it’s cheap to buy a house in Detroit. By contrast, you’ll find that buying a house in Manhattan or San Francisco is extremely expensive. This seems to me to be the overwhelming reason to doubt Greg Mankiw’s contention that high-tax states are bleeding high-income residents.

This is one reason why it is conceptually helpful — but of course extremely hard — to account for fixed assets, like high January temperatures or durable economic agglomerations or an attractive natural landscape. One possibility is that local governments in regions that are home to fixed assets like these are better able to extract rents from residents, as these assets encourage stickiness. I might be somewhat less likely to flee New Jersey’s high taxes if I make my living in the financial sector and proximity to Midtown Manhattan is important to my ability to do my job well, even if I don’t like high taxes.

This does not, however, mean that local governments in amenity-rich regions can tax without limit, because there is always some degree of natural churn in where people choose to live. Moreover, people at the start of their careers, or people who experience some discontinuity such as the loss of a job, are relatively less sticky. So what looks like a durable economic agglomeration might be steadily undermined over a relatively long time horizon. 

High-tax states might not be losing existing high-income residents in significant numbers. But the more interesting question is how many high-income residents they might have attracted if, say, tax policies were identical across all regions. In “The City as a Law and Economic Subject,” my brilliant friend David Schleicher addresses precisely this issue:

Their work argues that people decide to move to cities because of the reduced transportation costs for goods, increased labor market depth, and intellectual spillovers cities provide – that is, individuals and firms locate in cities in order to get the benefits of being near one another. Economically-minded local government law scholars have ignored this burgeoning literature and instead have continued to examine exclusively a separate set of benefits people get from their location decisions, the gains from ‘sorting.’ As analyzed in the well-known Tiebout model, individuals move between local governments in a region in order to receive public policies that fit their preferences.

This paper seeks to develop the framework for a modern law and economic method for analyzing local governmental law. Specifically, it claims that there is an inverse relationship between the gains from agglomeration and sorting. Having many small local governments, and enabling individuals to choose their local public policies by sorting among them, affects the organization and density of people in metropolitan areas, creating movement away from economically-optimal location decisions. Sorting thus reduces agglomerative efficiency. Similarly, the existence of agglomerative gains means that individuals are making location decisions for reasons other than matching their preferences for public policies. Agglomeration therefore causes a reduction in the efficiency of sorting.

Shleicher’s argument could be characterized as anti-Tiebout. Yet there is another way of looking at it. Sorting potentially gives local governments in less amenity-rich regions, like the Midwest (or rather certain parts of the Midwest), a fighting chance to compete with amenity-rich regions. 

Now why would we care that this is true? One reason, as Michael Greve might suggest, is that it is good for entrenched incumbents to face competition from innovative upstarts. Consider the historical decision of frontier states to embrace women’s suffrage — this was a low-cost strategy to attract certain kinds of settlers (e.g., female settlers rich in human capital). 

Yglesias continues:

Mark Thoma has some empirical information on this, but I think the housing price data is really the most important thing to consider. The point is that without denying that if San Francisco somehow achieved a more optimal tax/service mix that would increase demand for San Francisco living, it takes a very outmoded view of the American landscape to say this would lead to more people living in San Francisco. What it would lead to is continuation of the trend whereby high income people displace low-income and middle-class residents. This then actually becomes a reason for voters in high-cost supply-constrained cities to deliberately select a non-optimal tax/service mix in an effort to prevent rich people from outbidding them for a limited stock of houses.

This is a reasonable view, and a good reason to wish that strict land-use regulations had been formally recognized as a form of regulatory takings. Local governments should be constrained in the extent to which they can constrain property rights, e.g., they should have to pay for the privilege. Yet they have a fairly free hand. 

Now Mankiw’s overall argument is that because of population migration we ought to favor decentralization, because decentralization will make it impossible for the government to raise the living standards of the least-fortune people. That strikes me as a morally perverse perspective, so I’m not really sure how a clearer understanding of land use issues would change his thinking. But I think it’s fairly clear that population migration is driven by job availability and housing costs much more than by tax policy changes.

The first half of this paragraph strikes me as an egregious misrepresentation of Mankiw’s point, but you can revisit Mankiw’s column for yourself. The latter half raises an important question: to what extent are job availability and housings costs impacted by local public policy? (Mankiw is, to be clear, talking about all kinds of policymaking at the local level, not just taxes.) I would argue, to the point about fixed assets, etc., that local public policy matters a lot, particularly the cumulative legacy of local public policy. Decisions that San Francisco and New York made in the 19th century continue to have a significant impact. But of course so do policy decisions that are made in our own time.

Reihan Salam — Reihan Salam is executive editor of National Review and a National Review Institute policy fellow.

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