Assignment

Short Answer Essay: There are five questions included in this section. You should select three questions to answer. If all five questions have been answered, only the first three will be graded. You should begin each new question on a new page. If you are doing calculations, show your work. Remember that grammar counts and your grade will depend on the quality of your answer, not the quantity.

I. Suppose a state is considering three different types of fiscal limits for local governments in the state--a maximum property tax rate, a limit that property tax revenue may not increase more than population and inflation rate together, or a limit that spending may not increase more than five percent. In each case, the limit may be exceeded by majority vote. Which limit is most restrictive and why? Contrast the three in terms of the sources of allowed increases in taxes or spending and the potential effect on local services.

2. "If the Baumol hypothesis is correct concerning local government finances, and if the price elasticity of demand for local services is inelastic, then we are in trouble--eventually, spending for education, police and fire protection, and sanitation will require half of our incomes." Evaluate
this concern. What changes could occur to prevent this from happening?

3. Suppose your state provides a number of parks with majestic mountains, beautiful beaches, and unspoiled wilderness areas. These parks were acquired and operated in the past using the state's general tax revenue. Now the state proposed to charge a daily entrance fee of $10 per vehicle, with the revenue earmarked for the "state park fund" (to be used for operating expenses, capital improvements, and acquisition of new parks). At a public hearing on the proposal, one citizen complained, "It is unfair to require taxpayers who have paid for these parks with their tax dollars to now also pay a fee to use them." As director of the state parks department, how would you respond to this citizen?

4. Because nonresidents benefit from local government public-safety services, suppose that the federal government offers localities a matching, open-ended categorical grant equal to $1 for $1 of local tax money spent on public safety.

a. What is the effect of this grant on the price of spending for public safety to these localities? How might the grant correct for the spillover problem?

b. Suppose the Central City currently levies a property tax for public safety at a rate of $10 per $1,000 of taxable value on a base of $10 million of taxable property. If the price elasticity of demand for public safety in Central City is 0.2, calculate and explain the expected effect of the grant on public-safety spending, public-safety taxes, and tax rates in Central City. (Show your work.)

5. "Exempting the interest on state and local government bonds from federal income taxation is the lowest cost way for the federal government to subsidize state and local borrowing costs." Evaluate this statement.