Wednesday, May 24, 2006

Public Finance Concepts for Planners

This blog is advertised as being about “planning” research – in other words, what we wish we knew about how cities work and how we hope to know how to make them work better. Instead, the post before you is more about how to explain what we already know.

Perhaps, as can happen, the one will lead to the other, yet for now I am using it for practice in advance of preparing a teaching report for the Lincoln Institute of Land Policy on public finance concepts for planners. (For strong evidence that purposeful practice makes perfect, and may matter as much or more than raw talent, see the recent NYTimes Magazine Freakonomics column.) As practice, I want to sketch out both the overall design and a few of the key arguments, yet keep it from being too long for the blog. I'll sketch the main points here only, leaving out most details and examples. (December 2006 update: The final version of this report is now available as a Lincoln Working paper here.)

The main difference between this report and a normal course plan is that it will serve as the basis for a workshop, rather than a reading/discussion list. It has to be self-contained, succinct, and practitioner-oriented, with an emphasis on concepts applicable to the job rather than just interesting (or uninteresting) stories with numbers.

Big Picture: Understanding the fiscal implications of planning
The thrust of my charge "is to give planners a public finance framework by which to develop or evaluate various types of plans or planning programs."

Crudely, how does money matter for planning? Can and should we justify or even merely compare plans on some systematic fiscal grounds?

One obvious basis would be their simple spending and revenue implications. That is, how do development plans rank in terms of their local budget impacts? This is a common defense of strategies favoring residential over commercial development, or more elaborate "fiscalization of land use" schemes aimed at beefing up the budget bottom line via land use planning. Less obviously, that approach ignores any number of concrete costs and benefits appearing in other forms, or which may not appear at all yet exist just the same.

For example, elementary budget accounts do not normally reflect equity changes of different kinds, including those related to the incidence of taxes, spending, or regulatory burdens. They never show the efficiency costs of various behavioral distortions, such as those brought about by tax, spending, or regulatory policies that change behaviors in undesirable respects. Neither do budgets show the value of services rendered, especially where these involve providing what economists call public goods or correcting externalities.

All these fiscal impacts matter, often substantially, and yet few are typically well understood by the planners who bring them about. This report is mainly aimed at addressing that knowledge gap by explaining the terms in italics in the previous paragraph.

To do so, I sketch the structure of the finances of government (out-of-pocket expenses, on the one hand, and then how they are paid for), profile the economics of government (how both spending and revenues affect the private economy and general welfare), and thereby explain to professional planners how land use planning especially has budgetary and other fiscal effects. The 1st is cash flow, the 2nd behaviors, and the 3rd how each matters to urban planning.

This gives 6 sections: (1) background, (2) the economic rationale for local government and urban planning, discussions of the fiscal effects of public (3) expenditures, (4) revenues, and (5) regulations, and (6) a closing discussion.

1. Background: Fiscal dimensions of what local governments and planners do
This will motivate the big and small pictures with suggestive numbers, charts and graphs. It will briefly profile trends in public spending (services & facilities,…), revenues (taxes, fees, prices, debt,…), regulations (fiscal zoning, environmental reviews, economic development,…), and intergovernmental relations (fiscal federalism, central/local revenue flows & programs,…).

The idea is partly to show what the student probably already knows, namely that governments provide services and thus use resources, together with some actual trends that may be less familiar. And then to introduce the notion of measuring (a) their value and, relatedly, (b) their economic impacts. And then our options as planners.

2. Why: The public purpose of planning
What is planning and why is it done by the public sector?
(Roles of private markets; examples of market failure -- public goods, externalities, equity issuses; intergovernmental fiscal arrangements,...)

What and why?
Separate this question into two parts: Why have local government at all, and then what are the purposes of planning in those governments?

The favored role of the public sector in a mixed-market economy is to address “market failures” by providing public goods, regulating externalities, and addressing equity problems. (There are also broader macroeconomic and defense roles for higher levels.)

What is market failure?
To explain how private markets fail in some respects, one usually first explains under what conditions (e.g., perfect information, atomistic competition, no spillovers, etc.) and by what criteria they do well (e.g., Pareto optimality), followed by the implications of those conditions failing to hold.

The flip side of this is identifying the conditions required for governments to do right by some standard, and the implications of those conditions not holding. The best version of this I’ve seen is Charles Wolf’s Markets or Governments.

Each is pretty easy to explain, technically. The challenge is that practitioners don’t get very excited, in my experience, over the revelation of a failed condition or two. So they won’t pay attention and absorb the really critical meat of this argument.

The key implication of this set of arguments is that you don’t want to mess with functioning markets (or that you do so at your own peril) yet that you absolutely should mess with failing markets, if you know how. Even conservative economists don’t challenge this logic; they do note that the cost of “correcting” market failure is part of the calculus. That is, making things worse is not making things better.

That seems obvious said that way, but it isn’t if you can’t recognize what markets do well and, instead, simply assume that any intervention to address a problem is all for the good. For example, say homebuilders plot out subdivisions without thinking about traffic issues. The remedy is probably not to force everyone to build housing that can’t be accessed by cars. That solution addresses the underlying externality, but inappropriately bluntly, and nearly everyone ends up worse off.

The next step is to provide specific examples of why markets fail in the form of public goods, externalities, and distributional concerns.

What are public goods?
These are goods and services that have certain technical characteristics. Before listing those, it is worth emphasizing that the word "public" here does not suggest that such goods are or must be provided by the governments. Rather, it means they cause special problems for private market provision, described below.

These two problematic features are usually called nonrivalness and nonexclusiveness. Nonrival goods can be shared. Goods that you can't keep people from using are called nonexcludable. (planning examples here.)

The bottom line is that such goods are difficult to market for a profit. This is so even if these are goods that lots of people would like and are willing to pay for. Their technical characteristics keep suppliers from selling them, and monitoring their sales, in the normal way. So they tend not to provide them at all.

A collective response would work, where a group gets together and agrees to split the cost of a good they will share among themselves. This is a primary rationale for governments, though it can happen without governments. The key element is that collective, group action and coordination is called for. That is what governments do.

What are externalities?
These are goods or actions that impose costs on nonusers -- that are not mediated by markets. They are also called third party impacts, or spillovers, meaning they impose burdens on others who are not party to the negotiated transaction. (planning examples)

What about equity?
Pure, competitive private markets represent the uncoordinated interactions of individual sellers and buyers. They do not account for the social merits of one distribution of resources and opportunities over another. As a society, however, we might agree on some objections to the market outcome. We might, for example, agree that people shouldn't suffer from hunger or that all children have a right to an education, or that housing should meet certain minimum quality standards.

Without going into the details of the political and educational processes that would determine such things, it is reasonably clear that if these social concerns have standing, that, again, some collective approach is implied....

Why public planning?
Land use regulations are mainly designed to address externalities and to provide public goods. (In practice, they also have fundamental distributional functions but since those are less specifically concerned with public finances, I won't focus on those.) The public finance elements of planning mainly lie in its regulatory and project-approval functions....

3. Spending
In this section, we clarify some public spending issues that bear on urban planning, both positive (e.g., incidence and behavioral effects) and normative (e.g., efficiency, equity, welfare measures, free riding, etc.)

Dealing with grand questions first, there are the question of what levels of public goods (e.g., park space) to provide, and then general issues of the incidence and behavioral impacts of such spending.

How much?
The exact same obstacles that keep the private market from doing what it would like to do -- provide things people want -- keep the government from figuring out what exactly to do. It is simply a lot harder to provide public than private goods. (This is another reason why private markets often seem to outperform public agencies; the two sets of tasks are not equally difficult.)

The explanation follows directly from the problem. Markets don’t provide nonexclusive goods – goods where consumption cannot be restricted, such as clean air – because they can’t get people to pay for them. If you can’t control access, you generally can’t force payment. This same feature makes it hard for governments to know how much to provide since individual consumption isn’t observable.

(Hence, the so-called private governments of neighborhood housing associations and private clubs, that impose dues to finance services provided more or less uniformly to all members. In this case, it is not the nonexclusiveness that is the problem so much as nonrivalness.)

4. Revenues
Revenues examples & principles, such as taxes vs prices, incidence measures, distortions, fiscalization of land use, ....

How much to charge?
The other main obstacle to the private provision of public goods, nonrivalness, is similarly unhelpful to public servants with their heart in the right place. Markets don’t provide them efficiently because, after the first user, the marginal cost of provision is zero (or varies with congestion). You can’t cover costs by charging zero unless the first user pays everything. People do not tend to volunteer to be the first user in this situation. (Example: A road, or a park, or an improved road or an improved park.)

Even the textbook solution is sort of complicated. (examples)

How to charge?
And even if the good is somewhat rival, so users do impose costs on each other, the politics of charging congestion fees is no small feat.

5. The Public Finance of Regulatory goals & means
[Fiscal dimensions of regulatory policies, e.g., Regulation for Revenue,...]

One important distinction is between voluntary (incentives) and involuntary (controls). They each have their advantages and disadvantages, as good examples would illustrate.

(A frequently misunderstood issue in this context is whether economists think prices or quantities are better means for targeting behaviors. Martin Weitzman -- a real economist -- published a very important paper in the 1970s saying that, in general, it depends. I’ll talk about this more soon in a separate post based on a draft paper Boarnet and I wrote in the late 1990s, pretentiously yet accurately titled, “How to plan.”)

6. Summary
The importance of principles, flexibility, and creativity in implementation,....

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