CAPITALIZATION OF LOCAL PUBLIC SERVICES INTO HOUSE VALUES

Mohamed H. HAMADEH

Capitalization of local public services and property taxes into house values has been at the center of local public finance literature for three decades. The topic has been motivated by Tiebout's (1956) famous article which argued that households shop for communities just like they shop for any good or service. They compare the different fiscal packages in the different jurisdictions and make their location decisions accordingly. Researchers have used this argument made by Tiebout to advance the capitalization theory. Oates (1969) asserted that households end up competing with each other for the jurisdictions that provide better service/tax packages. This competition results in higher demand for housing in some jurisdictions and lower demand in others. So variations in the fiscal packages result in variations in house values. As such, service capitalization exists whenever better public services in one neighborhood results in higher house value in that neighborhood, other things being equal. The debate that started with Oates continues to occupy a significant space in economic literature.

When we talk about service capitalization, the service in question is local. In other words, members of one jurisdiction cannot benefit of another jurisdiction's services. A household located in one locality cannot send its children to schools located in another locality. To reap the benefits of the services provided by one jurisdiction, one has to live in that jurisdiction. That is why we do not expect federal taxes and services to code and receive the same federal services, then federal services and taxes are not capitalized into house values.

While there is a wealth of literature that tried to measure service capitalization, it often came as a "byproduct” of estimating tax capitalization. In a lot of cases, researchers did not give enough thought to their choices of public service variables. Most studies, for example, followed Oates’s (1969 and 1973) pioneering work and used expenditures as measure for service quality. This choice does not necessarily capture the quality of public service. Higher expenditures do not cesessarily translate into better public sevices. They could result from waste and inefficiency. Higher input prices or environmental factors as will be explained later in greater detail. The use of expenditures, for example. Rewards inefficient jurisdictions by treating their inefficiency as aproductive contribution to the quality of public service.

 This study tries to close this gap in the literature. It carefully derives a public service quality index from an estimated cost model. In the first chapter. I will provide a literature review that discusses the major contributions on this topic since Oates (1969) famous work. The chapter highlights the strengths and weaknesses of each article in some detail. The second chapter estimates the public service quality index out of an estimated educational cost equation. The cost equation controls for differences in efficiency, input prices and environmental factors. So, it recognizes that not all additional expenditures on education lead to better quality. I applied the study to 172 school districts in Georgia, thus generating an index for educational quality for Georgia school districts. To construct the index, the coefficients of the educational outcomes in the cost equation are used as the index weights. Chapter three discusses the theory of capitalization and then uses the estimated index in an hedonic equation with median house value as the dependent variable. I tried to control for as many housing and neighborbood characteristics as possible in order to minimize any omitted variable bias, but given the aggregated nature of my data, this proved to be a much more difficult task that originally envisioned. However the number and quality of the control variables are reasonable.

 Finally, chapter five estimates the demand for education and measures the different elasticities of demand: price elasticity, income elasticity and state aid elasticity. ­The demand equation controls for cost and efficiency something many previous studies failed to do.