Friday, November 25, 2011

Federal income tax is the enemy of urbanism

Finishing my dissertation this year has forced me to come out of my troll-cave and interact a lot more with my econ department. And that has been a very good thing! There is so much cool economics going on at the University of Michigan that I didn't even know about that I've decided to start blogging about it.

Today's interesting nugget comes from UMich prof David Albouy, for whom I briefly worked as a research assistant a few years back. A lot of David's work is in urban economics, which - although I decided not to do my dissertation on it - is an area dear to my heart. I view the deterioration of America's big cities over the past 40 years as a national tragedy, especially after seeing how well big cities work in countries like Japan and Korea. Fortunately, urban economists like Albouy and Ed Glaeser have been leading an intellectual charge for more urban-friendly policies. 

David has zeroed in on one way in which our government stacks the deck against cities: Income tax. Here's the original paper, and here's a recent writeup in the New York Times. The basic idea is this: Income tax rates are based only on your dollar income, not on how much purchasing power your income represents. Since prices (especially housing prices) are higher in big cities, an income of, say, $60,000 will buy you a lot less in San Francisco than it will in College Station, Texas. But someone who earns $60,000 will pay the same taxes in SF as she would in College Station. This provides a big incentive to move from the big city to a small town.

The point is not just that this is unfair (as the Times article contends), but that it's inefficient for our economy. Why? Because people are productive when they live in big cities. Take a worker out of San Francisco and plunk her down in College Station, and chances are that she will add less value to the economy. 

There are several reasons that this is true. The first is transport costs; if our hypothetical worker makes Christmas tree ornaments for a living, then if she lives in San Francisco, she's going to be very near to a whole lot of paying customers. But if she lives in College Station, she's going to have to ship a lot of her Christmas ornaments to customers in Houston (two hours away) or Dallas (three hours away). That costs money, and reduces the worker's productivity. Transport costs are probably the reason we have cities in the first place.

Another reason is knowledge spillovers. A lot of cities are "industrial clusters". If our Christmas tree ornament maker lives in SF, she will be smack dab in the middle of the center of the U.S. technology industry. This means that she may hang out with engineers who will teach her how to design ornaments more efficiently using powerful software, or how to find customers and suppliers more effectively using the Web. And she may also interact with a bunch of art and design people, for whom SF is also somewhat of a mecca. That will also tend to increase her productivity, by keeping her on top of new trends and ideas in the design world.

So when the federal government levees the same percentage tax on San Franciscans that it levees on people in College Station, it is discouraging high productivity. Just how much this hurts our economy is anybody's guess, though David Albouy takes a crack at an estimate in his paper; the numbers come out substantial, though not huge. But the policy implication is clear: one way to help reverse America's urban decay, and to boost our economy over the long term, would be to tax people in big cities at lower rates.


  1. Is this more than an ordinary special case of the point that taxes distort incentives? Presumably living in a city is expensive because there are scarce resources involved. (For example, groceries are more expensive because the grocer's rent is higher because there's more competition for limited space.) "Living in a city" is a choice that has costs and benefits, and part of the benefits come in the form of higher productivity, which is reflected in higher income. Is it qualitatively different in any special way from, for example, "investing in human capital?" If we are going to have lower tax rates for city dwellers, should we also have lower tax rates for college graduates? Or for people with jobs that pay well because they're difficult or dangerous? Does it really make sense to try to undo on a piecemeal basis an inefficiency that is inherent in marginal income taxation?

  2. Andy, I suggest you go ask that to Peter Diamond. ;)

    The point about city productivity is that it comes from a positive externality. We want to subsidize that.

  3. I suppose my question would be that you note the better condition of large urban centers in other nations. Don't they have progressive income taxes also? Why the better results?

  4. Before using income tax to optimise housing distribution by means of an apparent distortion, why not just undistort transport pricing? The US is an extreme case of subsidised road-petrol transport.

  5. So ... how does this help Detroit, again?

  6. Anonymous5:25 PM

    I can't imagine that this would work over the long term. Wouldn't the lower marginal tax rate attract more people to the city, thereby raising rents and other costs? Cities already tend to be over populated given the benefits of living in a city. Wouldn't this encourage even more overpopulated cities?

  7. For once I completely and absolutely disagree. What you say sounds like pure and ideological non-sense. To prove this you can look into, say, Germany which, given its population of over 80m has only 5 or 6 cities with population over 1m and at the same time has a world-class manufacturing economy.

  8. I'm not sure I follow your logic here. Yes, housing costs more in SF than rural Texas, but it's a qualitatively different good--part of what I'm buying with my higher rent is the opportunity to live in San Francisco, which I (and many others, judging by the demand) consider preferable to living in some other location with lower costs of living. High demand and low supply mean high prices, but that doesn't argue for a subsidy--living in SF is a luxury good. I understand the argument for removing supply restrictions--the height limit in Washington DC, which is my home city, is especially onerous--but not favorable treatment in the tax code.

  9. Anonymous11:06 AM

    What Dan Miller said. Also, the tax system is a hugely inefficient means of reallocation - read 'blunt instrument'. So tax on income and redistribute via amenities paid for via government expenditures, e.g. transit systems, subsidized housing, ...

    You could fill in a lot of other liberal redistributive expenditures/purchase here. Yglesias had a different answer -- even in the expensive cities there are places where rents are cheap. They just happen to have lots of poor people and suffer from lack of amenities (safety, connections to the rest of the rich community).

    The political redistibution of government spending suffers in the US from government capture via the Senate where cities are largely disenfranchised by the big empty states in the middle of the continent, which see themselves as the epitomy of self-reliant, self-made economies, regardless of the net tax flow that in large part keeps them afloat and connected to the rich, blue coastal and Great Lakes states.

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    Compared to the USA, Germany is more like two large states put together; you can move goods by truck across the country in what? 12 hours? In the USA it's 72 (using two drivers).

  11. Anonymous8:30 AM

    I think Alphonse is right: we over-subsidize auto transport. We also under-subsidize mass transit and public education in the big cities. We probably have higher crime in the big cities. I think that's the reason for the differences between cities in the US and elsewhere.

  12. @ -"I view the deterioration of America's big cities over the past 40 years as a national tragedy, especially after seeing how well big cities work in countries like Japan and Korea."

    Maybe our large metropolitan areas would be better if they decentralized even further, what would be left of them at their centers I mean. After all we are not all alike. Me, I'd like a part-time job in the country (make that a small country town) and so would a lot of other Americans (roughly half a generation ago). Think choice.

  13. Anonymous1:50 AM

    Please read Christopher Alexander's critique of New Urbanism:

    As a critic of libertarians, I hope you aren't overly shocked at Alexander's description of the extreme intolerance of establishment liberals in academia, they play a central role in the justification of imperial state-capitalism's "orthodoxies".

    Since it does not appear that U. Mich. offers a PhD program in common sense, I'll point out the following.

    Big cities are where most of the tax-supported big infrastructure is, so it seems to make sense that the people that benefit most from that infrastructure would pay for it.

    Detroit is victim to global economics. The ;iberal/progressive industrial middle classes thought they could benefit from making a "new deal" with the corporations, and it no longer works. The natural opposition to corporations, small, independent family farms, were destroyed by the liberals (via public education) when they allied with the plutocrats to build a large industrial/suburban middle class. And now you are attempting to further punish small town (agricultural) people! Absurd. You do not appear to have ever lived in a small agricultural town, much less worked on a farm, otherwise you would understand pervasive rural and small town poverty.

    Most, but not all, american cities are ugly because americans forgot how to appreciate certain aspects of pre-industrial society.

    Fly over europe and you see an organic pattern that (mostly) follows the landscape and nature.

    Fly over america and you see lines and grids.

    The linear american pattern (started by railroad monopolists!) is "efficient" in industrial terms, but it ignores the aesthetic and spiritual parts of life. It is now increasingly incapable of basic morals, or a sense of basic human decency.