Essays in Public Finance and Political Economy

Abstract

This dissertation studies how the interactions between different levels of government influence the distribution of transfers to local governments and local taxation focusing in particular on the role of strategic policy makers.

Chapter 1 examines the distribution of intergovernmental grants and shows that distributing federal funds to local governments through states may increase politically-driven misallocation of funds. I adapt a probabilistic voting model to study the political incentives facing politicians in a setting with three levels of government and compare federal transfers distributed directly to localities versus those passed through states. Using data on federal awards and subawards from the United States, I show that expected higher voter turnout and lower ideological polarization are associated with higher federal and state intergovernmental grants. Applying the empirical estimates to the model yields a measure of politics-driven resource misallocation equal to 1.9 to 5.9 percent of the value of targetable passthrough intergovernmental grants. This shows that intermediated distribution of federal grants increases opportunities for politically motivated misallocation.

Chapter 2, joint with Thomas Brosy, analyzes the effect of falling home prices associated with the Great Recession on local property tax revenues. In order to assess the magnitude of the crisis’ effect on the finances of local governments, we collected data on historical local property tax revenues and assessed values and tax rates for 44 states in the U.S. We leverage this novel dataset to study the two channels through which falling home prices affected property tax revenues: a mechanical channel through which home values affected assessed values, and a policy channel through which policymakers responded to changes in the tax base. We find that the mechanical correlation between home-price changes and assessed values after 2007 was smaller than before the crisis. From the policy side, our analysis shows that negative shocks to the tax base were offset by as much as 80-85 percent on average in the long run by increases in the tax rate. In addition, rate limits played a role in reducing the ability of policymakers to offset negative shocks to the tax base and lead to a bigger decline in revenues. Overall, we find that the effect of the recession on property tax revenues was smaller than assumed but negative and lasting.

Chapter 3 investigates the responses of local governments to a change in threshold for the Single Audit. The U.S. Single Audit is a comprehensive audit undergone by nonfederal entities spending more than 750,000 dollars of federal funds in a fiscal year. Using data on audited entities from the Federal Audit Clearinghouse as well as detailed expenditures data from the Census of Local Governments, I conduct a difference-in-differences analysis exploiting the change in threshold for audit exemption in fiscal year 2015. The estimates suggest that complying with the audit requirements on average increases expenditures directly related to financial administration.