Should suburbs help finance their center city's core public services? This is a long-standing policy question in U.S. urban public finance and an issue of no less importance in other countries. Toronto recently merged its financing and governance with its surrounding suburbs. In configuring its new fiscal system, South Africa opted for a form of metropolitan financing that "twins" wealthy suburbs with less wealthy central cities. What are the arguments for suburb-to-city fiscal assistance, or stronger still, suburb plus city fiscal mergers?
Perhaps the most familiar argument is that suburb-to-city assistance corrects for the underprovision of city-produced public goods that benefit suburban residents, such as city subways and buses, airports, and museums.1 When spillovers are significant and suburban residents benefit from city-provided public infrastructure, they should contribute to the financing of such infrastructures. However, efficient financing favors user fees and average cost pricing rather than intergovernmental transfers.2 [End Page 45]
A second familiar argument is that city poverty is a metropolitan-wide concern and suburban residents ought to contribute towards meeting the needs of their city's poor. National programs define a common floor for income support, above which state and local governments can make supplemental contributions. In the presence of redistributive spillover benefits, however, city transfers will be too low relative to the efficient level of redistribution if individuals prefer to redistribute to lower-income households in close geographical proximity.3 While theoretically compelling, this argument lacks a credible mechanism to reveal suburban preferences for redistribution to the inner city poor. To the extent we rely upon the political process to provide a measure of these preferences, current state funding for city poverty may be efficient. Furthermore, if there is a problem, an appropriate fiscal institution— state government—is already in place to correct it.
U.S. mayors have recently advanced a third argument for suburb-to-city fiscal assistance. The mayors argue that suburban residents need an economically vibrant central city to support their own real incomes, claiming, "Economies don't stop at the city's edge."4 The mayors cite the now well-documented positive correlation between the average income of city and suburban residents in U.S. metropolitan areas. Their argument moves beyond correlation to causation, however. They maintain that a weak city economy causes a weak suburban economy and one of the central causes of a weak city economy is weak city public finance. A fiscally weak city has high tax rates and low public services that induce mobile firms and households to leave the city, undermining the city's private economy and thus, the mayors argue, the economy of the region as a whole. Suburb-to-city transfers that strengthen city finances will strengthen the city's economy, which enhances, in turn, suburban residents' private incomes. This paper seeks to evaluate the economic validity of this argument.
In the next section, we outline how weak city finances might adversely affect both city and suburban economic strength. Suburban residents benefit from production advantages due to agglomeration economies within the city that lower the cost of city-produced goods and services. Inefficiencies in the central city's public sector can counteract the benefits of city agglomeration economies by encouraging mobile firms and households to leave the city.Suburban households may prefer to transfer funds to their center cities to protect [End Page 46] city agglomeration economies and maintain low-cost city-produced goods and services that support both city and suburban economic well-being.
The following section provides empirical evidence on these issues. First, we document the close interdependencies between central city and suburban economies for U.S. metropolitan statistical areas (MSAs). We then test for the effects of weak city fiscal institutions—strong public employee unions, weak mayors, poverty obligations, and redistributive tax structures—on city and suburban economies. We find that such institutions reduce the growth of city incomes, populations, and home values. More telling, we find those same city fiscal institutions also slow the growth of suburban incomes, population, and home values. These effects are statistically significant and quantitatively...