State Aid Formulas and the Local Incentive to Chase (or Shun) Ratables

Most programmes of state aid to local governments in the US are designed to fix problems of interjurisdictional or interpersonal equity, not to address the effect that local tax reliance might have on local land use decisions, such as zoning. As a consequence, little is known about how to design a state aid system that would achieve desirable land use, as opposed to equity, objectives within US states. As a first contribution to this policy literature, the paper compares state aid formulas on their ability to reduce the incentive that local governments have to engage in fiscal zoning and other ratable-oriented behaviour. A set of simulations shows that a state aid formula that guarantees to cover a fixed percentage of local expenditures is preferable to a per capita aid formula in three out of four cases examined and performs better when the level of aid is relatively high. Both types of formula reliably reduce ratable shunning behaviour, but it may take relatively large levels of state aid to curb ratable chasing, due to the increase in local spending caused by the aid itself. The paper ends with a discussion of state aid programmes actually used in New Jersey.