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Business
Review
Federal Reserve Bank o f Philadelphia
September •October 1992




ISSN 0007-7011

Business
Review
The BUSINESS REVIEW is published by the
Department of Research six times a year. It is
edited by Sarah Burke. Artwork is designed
and produced by Dianne Hallowell under the
direction of Ronald B. Williams. The views
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SEPTEMBER/OCTOBER 1992

CAN PHILADELPHIA ESCAPE ITS
FISCAL CRISIS WITH ANOTHER TAX
INCREASE?
Robert P. Inman
Increased expenditures, eroding tax bases,
labor contracts to be honored—what's a
city to do? The usual response of "raise
taxes" isn't necessarily the right one. In
fact, it's possible that Philadelphia has
"taxed out" its citizens. Robert Inman's
analysis of the city's financial crunch ex­
plains the hows and whys.
CITY AND SUBURBAN GROWTH:
SUBSTITUTES OR COMPLEMENTS?
Richard Voith
Whether it's Grosse Pointe and Detroit or
Philadelphia and Paoli, just how depen­
dent on one another are cities and sub­
urbs? Does central city decline affect
suburban growth? Are suburban house
values influenced by the fortunes of the
city? This article provides an analysis of
these questions, and others, and offers
some convincing answers.

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FEDERAL RESERVE BANK OF PHILADELPHIA

INTRODUCTION

City Problems
and Suburban Reactions
Richard W. Lang*
The relationship between a major city and its
surrounding suburbs is often similar to a lovehate relationship between lovers who feel they
can't live with each other but can't live apart
either. When large cities experience a problem,
whether an increase in crime or a fiscal crisis,
many of its residents and businesses consider
moving to the suburbs. The perspective of
people already living in the suburbs is that the

^Richard W. Lang is Senior Vice President and Director
of Research at the Philadelphia Fed.




city should keep its problems to itself. Often
one hears suburbanites claim that they would
be just as well off without a major city and its
problems living next door to them. The City of
Philadelphia and its surrounding suburbs are
typical in these respects.
During the past few years, the City of Phila­
delphia has been embroiled in a fiscal crisis, as
revenues have fallen far short of the city's
expenditures and its cumulative deficit has
mounted. To aid the city in returning to fiscal
health, the state passed legislation in June 1991
creating the Pennsylvania Intergovernmental
3

BUSINESS REVIEW

Cooperation Authority (PICA), an oversight
body authorized to issue bonds to fund the
city's deficit while it reorganizes its spending
and revenue streams to balance the budget and
repay the PICA borrowing. As part of this
arrangement, the city was required to prepare
a five-year fiscal plan to restore the city to fiscal
health.
One feature of Philadelphia's five-year plan
has surprised some: it does not include in­
creases in the city's major taxes on wages,
property, and businesses. The presumption in
the plan is that major tax increases would be
detrimental to the city's long-term economic
health. This assumption is examined in this
issue's first article by Bob Inman. Inman's
article is the first study to look at the private
costs of raising each of Philadelphia's taxes;
that is, the effect on jobs, property values, and
business revenues and profits of an increase in
taxes on wages, property, or businesses, re­
spectively. In each case, Inman estimates that
any increase in the tax rate from its current level
would seriously reduce the tax base, thereby
limiting the increase in revenues that an in­
crease in each tax rate would yield for the city.
This analysis leads to two major conclusions:
1) Given the magnitude of the budget deficits
facing the city of Philadelphia, the city cannot
close the budget gap with tax increases alone;
the potential increase in tax revenues would
not be large enough to balance the budget.
2) The city could raise some revenues through
tax increases, but the costs to the private sector
would be very high. Inman estimates these
costs in terms of the lost private income of
raising a dollar of revenue for the city: the cost
of lost jobs and wage income; the cost of lower


4


SEPTEMBER/OCTOBER 1992

property values; the cost of lower business
profits. Citizens always have to make a value
judgment about the trade-off between public
tax revenues and private costs. Inman's analy­
sis makes clearer for city residents what such
trade-offs entail.
Historically, higher taxes in a city have spelled
out-migration to the suburbs, which in the
short run yields faster growth of suburban jobs
and income. Although the suburbs obtain this
short-term benefit from out-migration, the sec­
ond article in this issue suggests that over the
long run the decline of a city will mean slower
growth for the entire metropolitan region. Dick
Voith analyzes whether, over the long run,
suburban growth of jobs and income is a substi­
tute for city growth (that is, suburban growth is
at the expense of the city), or whether suburban
and city growth are complements (that is, sub­
urbs have healthy growth when cities do too).
Voith finds that suburbs in metropolitan
areas where cities are declining tend to grow
more slowly than suburbs in areas where cities
are healthy. So although suburbs grow strongly
for a while when cities decline as people and
businesses shift to the suburbs, eventually the
decline of the city is accompanied by slower
growth or stagnation in the suburbs as well.
Suburbs therefore should care about the eco­
nomic health of the city. Voith's conclusion is
that both a city and its suburbs can improve
their long-run economic health by cooperating
to stem the economic decline of the city. In the
Philadelphia metropolitan area in particular,
the residents of the suburbs ought not be indif­
ferent about how the City of Philadelphia solves
its fiscal crisis.

FEDERAL RESERVE BANK OF PHILADELPHIA

Can Philadelphia Escape Its Fiscal
Crisis With Another Tax Increase?
Robert P. Inman*

T

X he current crisis in Philadelphia's public
finances has captured national attention. In the
fall of 1990, what should have been a routine
borrowing to meet city expenditures until an­
ticipated tax revenues could be collected be­
came an international financial embarrassment
as potential lenders and guarantors from the
United States, Europe, and Japan all refused to
lend the city its needed funding. Yet one year

* Robert Inman is a Professor of Finance, Economics, and
Real Estate, University of Pennsylvania, and a Visiting
Scholar, Federal Reserve Bank of Philadelphia. The detailed
comments on an earlier draft of this article by Ted Crone,
Leonard Nakamura, and Richard Voith are much appreci­
ated as is the research assistance of Victoria Coupland and
Andrew Haughwout.




earlier, the city's request for short-term fund­
ing had been eagerly accepted by investors; the
city's short-term debt received the highest rat­
ing from Moody's and Standard and Poor's
and sold at 6.20 percent, well below the national
average yield that year for such short-term
borrowing. In just one year, Philadelphia's
debt went from one of Wall Street's favorites to,
according to Standard and Poor's revised 1990
rating of CCC, a nearly bankrupt credit. What
happened to the city's finances?
On one level the answer is easy. What was
seen as a balanced city budget in 1989 had
become, by the fall of 1990, a budget with an
eventual cumulative deficit of $153.5 million,
roughly 6 percent of the year's anticipated
revenues. Lenders were being asked to give the
5

BUSINESS REVIEW

city an extra $153.5 million dollars, with no
clear assurances that the city had the revenues
to pay them back. In this light it is easy to
understand investors' nervousness.
Understanding exactly why Philadelphia
faced this large deficit in 1990 requires a deeper
look into the underlying forces behind city
spending and city revenues, however. Unex­
pected realities on both sides of the city's bal­
ance sheet produced the deficits of 1990, reali­
ties still at work today, producing a cumulative
city deficit of $248 million for this just com­
pleted fiscal year (1991-92). On the spending
side the city had been asked to shoulder in­
creasing outlays for its lower income house­
holds and for the county court system, expen­
ditures often mandated by federal and state
regulations. We also saw the approval, either
through labor negotiations for city blue and
white collar workers or through arbitration for
police officers and firefighters, of costly labor
contracts running into the summer of 1992.
While city expenditures were running higher
than anticipated, city revenues fell short of
initial expectations. Three factors contributed
to the unexpected slowing of city revenues.
First, the state of Pennsylvania had been less
generous with state assistance than the city's
budget had assumed. Second, the recent reces­
sion ran deeper, and lasted longer, than origi­
nally projected, costing the city anticipated
business, wage income, and property tax rev­
enues. T h ird , p rev io u s in creases in
Philadelphia's taxes, for a city already the high­
est taxed municipality in the metropolitan re­
gion and one of the highest taxed nationally,1
Com parisons of Philadelphia's tax rates on families
show the city's residents to be the highest taxed of all
residents in the five-county area, with overall tax payments
as a percent of resident income of 12.15 percent in Philadel­
phia, compared with average suburban tax payments as a
percent of resident income of 5.98 percent in Bucks County,
5.44 percent in Chester County, 6.62 percent in Delaware
County, and 2.97 percent in Montgomery County.
Nationally, Philadelphia residents earning $25,000 per


6


SEPTEMBER/OCTOBER1992

drove families and businesses from the city,
making the tax system less and less productive
as a revenue-raiser. Unless these tax and spend­
ing realities are addressed with substantive
policy actions, the city will continue to face a
future of fiscal deficits.
This article examines the city's ability to raise
tax rates as one means to close its current
deficits and to avoid fiscal collapse. It first
outlines the general economic theory of tax
revenues, focusing on the important economic
effects that follow when increases in local tax
rates cause residents and businesses to curtail
their taxable activities or, perhaps, even leave
the city. The article then puts this theory to the
test, estimating from historical data the past
effects of changes in city tax rates on the tax base
for property, business, and wage taxes. I find
that for all three taxes, past increases in tax rates
have significantly reduced the city's tax bases.
The section on "Mapping the City's Tax
Revenue Hills" shows that these estimated de­
clines in city tax bases imply a significant offset
in revenues from any increase in tax rates. At
current tax rates the positive effect on revenues
of an increase in rates is significantly reduced
by the negative effect on revenues that follows
from the loss in tax base. Given this hard eco­
nomic reality, the final section asks: can Phila­
delphia escape its current fiscal crisis with a tax
increase? From the evidence presented here,
the answer is no.
UNDERSTANDING THE TAX REVENUE
CURVE:ECONOMICS, NOT ACCOUNTING
As a simple matter of fiscal accounting, tax
revenues flow from taxing some tax base such
as income or property value at a chosen tax rate.

year (approximately the median family income) pay the
third highest tax on income of residents living in our nation's
largest cities. See "Tax Rates and Tax Burdens in the District
of Columbia: A Nationwide Comparison," Government of
the District of Columbia, Department of Finance and Rev­
enue, June 1991.
FEDERAL RESERVE BANK OF PHILADELPHIA

Can Philadelphia Escape Its Fiscal Crisis With Another Tax Increase?

Robert P. Inman

Tax revenues (R) equal tax rate (r) times tax base for example, tennis star Bjorn Borg's move
(B), or R = r x B. It is customary to measure the from Sweden to Monaco. Both of these economic
tax base and therefore revenues in terms of responses to the increases in the tax rate may act
dollars per resident. For example, if the base is to reduce the available tax base per resident. As
resident income and equals $10,000 per resi­ the tax base d eclin es, so too w ill the
dent and the tax rate is .05, revenues will equal government's anticipated revenues.
While increases in tax rates often cause a
$500 per resident ($500 = .05 x $10,000). In this
example, if the government were to double its decline in the government's tax base, reduc­
tax rate to .10 of resident income, then the fiscal tions in tax rates often enhance taxing capacity.
accounting relationship would predict revenues A decrease in a tax on resident incomes might
would double too, increasing to $1000 per resi­ cause residents to work harder and earn more
dent ($1000 = .10 x $10,000). Conversely, if tax and may even induce richer families from out­
rates were to be cut in half, then by R = r x B, side the jurisdiction to relocate. In this case, the
revenues would also fall by half—in our ex­ resulting increase in the tax base helps to raise
ample, to $250 per resident ($250 = .025 x tax revenues above what might have been ini­
$10,000). Under the accounting revenue rela­ tially expected following the tax cut.
The economic relationship between tax rev­
tionship, doubling tax rates doubles revenues,
while halving tax rates will halve revenues. The enues and tax rates allows for possible changes
accounting relationship between revenues and in the tax base engendered by changes in tax
tax rates is therefore a straight line, or a linear rates. Economists specify this relationship by
relationship (Figure 1).
As a matter of fiscal
economics, however, the
FIGURE 1
relationship between tax
Accounting Relationships Between
revenues and tax rates is
Revenues and Rates
not so simple. While the
accounting relationship
holds the tax base (B) con­
stant as we change rates,
the economic relationship
between tax revenues and
rates does not. The eco­
nomic relationship be­
tween revenues and rates
allows the tax base to
change as tax rates are
increased or decreased.
In the example above, the
increase in the tax on residents' incom es m ight
well cause residents to
work less as their incomes
are taxed or even cause
wealthier families to leave
the taxing jurisdiction, as,



7

BUSINESS REVIEW

estimating how changes in rates are likely to
affect tax bases, using economic theories of
how taxpayers respond to such changes. For
example, economists have shown that increases
in taxes on wage incomes cause primary earn­
ers to work fewer hours and some secondary
earners to drop out of the labor market alto­
gether.2 Economists have also established that
taxes on savings and investment income re­
duce savings and investment,3 while taxes on
consumption and sales reduce family spending
on the taxed commodities.4 Finally taxes on
property values, a particularly important rev­
enue source for local governments, will dis­
courage family investments in larger houses
and home improvements and firm investments
in business property.5 In each case these eco­
nomic adjustments cause the base for each tax
to fall when its tax rate is increased.
Importantly, the negative effect of tax rates
on tax base may be even stronger for local
governments. Not only do families and firms
that stay within the community make these
economic adjustments in their work effort, sav­
ings, consumption, and investments, but tax
increases may also cause some families and
businesses to leave the city. If so, the end result
will be a loss of jobs and retail outlets and a loss
in property values, losses whose value may
well exceed the changes in tax base resulting
from the adjustments of those families who
stay behind.6 For economists, the issue is not

2See Hausman (1985) for a survey of the relevant litera­
ture.
3See Boskin (1978), Evans (1983), and Auerbach (1983).
Tax increases are found to reduce savings and investment.
4See Phlips (1974) and Deaton (1977). They find that
increases in commodity taxes reduce demand.
5Rosen (1985) provides an overview of the effects of
taxation and subsidies on housing decisions.
6Grieson (1977, 1980), Gruenstein (1980), and Inman
(1987) provide evidence that higher city taxes drive sales
and employment from the city. Oates (1969) is the standard
reference on the effects of property taxation on house val­
ues. Ladd and Bradbury (1988) and Sexton (1987) also study


8


SEPTEMBER/OCTOBER 1992

whether changes in tax rates change tax
bases—they surely do. The important issue is
by how much.
To answer the question "how much?" econo­
mists estimate statistically the effects of tax
rates on the tax base from the past responses by
taxpayers to changes in rates. The estimated
relationship is described generally by a tax base
equation that measures the negative influence
that tax rates (r) have on tax base (B). This
equation will differ from tax to tax; the wage tax
base is likely to respond to changes in wage tax
rates differently from the way the sales tax base
responds to changes in sales tax rates. For each
tax, however, the base is likely to decline with
increases in the rate and, conversely, to increase
with reductions in the rate. As a consequence of
the economic behavior of families and firms,
tax bases will be inversely related to their rates.
The inverse economic relationship between
tax rates and bases determines each tax's eco­
nomic revenue curve. Like the accounting rev­
enue curve, the economic revenue curve sets
tax revenues (R) equal to tax rate (r) times tax
base (B), but now we allow tax base to adjust to
changes in tax rates. We describe the economic
relationship between tax base and tax rates by
writing B = B(r); thus tax revenues become R =
r x B(r). In contrast to the accounting revenue
curve, which defined revenues as the simple
straight-line relationship of Figure 1, the eco­
nomic revenue curve will be nonlinear, assum­
ing the shape of a "revenue hill." A typical
revenue hill is drawn in Figure 1 as the curve, R
= r x B(r). The revenue hill first rises as tax rates
rise, but since tax base declines as rates in­
crease, we raise less and less revenue for each
incremental increase in tax rates— that is, the
revenue hill flattens. In fact, it is very possible

the effects of property tax rates on taxable property values.
Each of these studies finds that increased taxes depress
housing investment and house values.
FEDERAL RESERVE BANK OF PHILADELPHIA

Can Philadelphia Escape Its Fiscal Crisis With Another Tax Increase?

for the hill to have a peak, the point r* in Figure
1, where a small increase in tax rates reduces the
tax base enough that tax revenues, R, simply
remain constant! The top of the revenue curve
measures the taxing capacity of government. If
tax rates increase still further, the revenue loss
from the decline in the base more than offsets
the revenue-raising capacity of the rate increase.
In the extreme, if tax rates get so high that
people simply stop participating in the taxed
activity, revenues will fall to zero.
The exact shape of each tax's revenue hill
depends on how responsive its base is to changes
in rates. If the tax base responds only margin­
ally to big changes in its tax rate, the revenue hill
will be very steep. It may even appear to rise like
the straight-line accounting relationship, at least
for a while. However, when tax bases respond
noticeably to changes in tax rates, the revenue
hill tends to be flatter, assuming a shape similar
to the revenue hill r x B(r) of Figure 1. If the tax
base is very responsive to tax rate changes, the
revenue hill can be almost flat, perhaps as flat as
the broad dashed-line hill of Figure 1. The more
responsive a tax's base is to changes in its rates,
the less revenue we can raise from that tax.
Numerous studies have estimated the shape
of the economic revenue curve for various taxes.
Arthur Laffer argued in support of President
Reagan's 1981 tax cuts that the national revenue
curve for personal taxes (or the "Laffer curve"
as it became known in the subsequent supplyside debate) peaked to the left of the average
income tax rates at the time and that the Reagan
tax cuts would, according to Laffer's revenue
curve, increase national income tax revenues
(see Laffer, 1977). In fact, the recent history of
federal revenues and a more careful specifica­
tion of the national revenue curve by Donald
Fullerton (1982) have shown Laffer's prediction
to be wrong. For local taxation, Ronald Grieson
(1977) presented evidence that in 1969 New
York City might have been near the top, or even
past, the peak of its revenue curve for business
taxes. Helen Ladd and Katharine Bradbury



Robert P. Inman

(1988), however, provide evidence that for a
large cross-section of U.S. cities in the 1970s tax
rates were well to the left of the peak of their
property tax revenue hills. Douglas HoltzEakin and Harvey Rosen (1990) reached a simi­
lar conclusion for smaller New Jersey govern­
ments, as did I (Inman, 1977) in my study of
Long Island school districts.
No one has yet estimated the tax revenue
curves for the City of Philadelphia, however.7
Given that tax increases are one possible route
to escape our current fiscal crisis, it is impor­
tant to have good measures of each tax's rev­
enue potential. Estimates of Philadelphia's tax
revenue curves are what we need.
DO TAX RATES REDUCE TAX BASE
IN PHILADELPHIA?
Philadelphia uses three different taxes to
raise most of its revenues: a property tax on
residential and business property, levied to
support city and school district spending; busi­
ness taxes on firms' gross receipts and net
income earned within Philadelphia, again lev­
ied to support city and school district spend­
ing; and a wage tax on residents and nonresi­
dents who work within the city, levied to sup­
port city services.
Property taxes in Philadelphia are levied on
residential, commercial, and industrial prop­
erty located within the city. The tax is paid both
to the city and to the school district through
separately levied tax rates on the assessed
value of the property. A property's assessed
value need not equal the property's market
value. However, the tax on market value is the
relevant one for a family's or a firm's economic
decisions. Assessed values are usually deter­

7Studies by Grieson (1980), Gruenstein (1980), and Inman
(1987) have examined the effects of the Philadelphia wage
tax on jobs in Philadelphia, but these studies have not used
the information to calculate the tax revenue curve for wage
taxation.
9

BUSINESS REVIEW

mined at the time of purchase of the property,
but market values are determined every year as
economic circumstances change and proper­
ties become more or less valuable. Since eco­
nomic decisions determine the economic tax
revenue curve, we must examine the effects of
tax rates on the market value of city properties.8
Business taxes in Philadelphia are levied on
the gross receipts (sales) and on the net income
of businesses located in Philadelphia. Taxes on
businesses' gross receipts have included the
city's mercantile license tax and the school
district's general business tax. Both of these
taxes were discontinued in fiscal year 1985 but
were replaced by a portion of the city's new
business privilege tax, which also falls on gross
receipts. Taxes on business incomes include the
city's net profits tax on individually owned
(but not incorporated) businesses, on partner­
ships, and on business associations, and the
city's new tax on net income due from all
businesses (including corporations) as part of
the city's new business privilege tax. Busi­
nesses pay taxes only on that portion of their
activities conducted in Philadelphia according
to an apportionment formula based on a
weighted average of the firm's sales, payroll,
and property in Philadelphia.
The city's wage tax is assessed at the rate of
4.96 percent on the wage income of all residents
of Philadelphia, whether they work within
Philadelphia or not, and at the rate of 4.3125
percent on the wage income of nonresidents
who work within the city. Historically, the
resident and nonresident tax rates were identi­
cal until fiscal year 1984, when the resident rate

8Since we will be examining the effects of tax rates on
market value, we will be using the city and school district's
effective tax rates on market value, defined as the tax rate on
assessed value multiplied by the ratio of assessed value to
market value in the city. For this study, the State Tax
Equalization Board's ratio of assessed value to market value
(called the STEB ratio) for the City of Philadelphia will be
used.


http://fraser.stlouisfed.org/
10
Federal Reserve Bank of St. Louis

SEPTEMBER/OCTOBER 1992

was raised to 4.96 percent but the nonresident
rate remained at 4.3125 percent. Residents and
nonresidents who work within the city have
the tax withheld by their city employers. Resi­
dents who work outside the city are respon­
sible for paying the tax. Collecting tax pay­
ments from city residents working outside the
city has proven difficult.
How do the rates of these taxes affect the tax
base of Philadelphia? The details of a statistical
analysis of the effects of each tax rate on its tax
base are reported in the Appendix. For each of
the three taxes, increases in the tax rates lead to
statistically significant, and quantitatively im­
portant, decreases in their associated tax bases.
For the property tax base, I estimate that an
increase of one percentage point in the com­
bined city and school district effective tax rate
on market value— say, from its current value of
2.48 percent to 3.48 percent—will reduce the
market value of the average Philadelphia prop­
erty by $3961 per resident, a reduction of 25
percent from the estimated (1992) market value
of $16,139 per resident. More realistically, even
a modest increase in the combined tax rate
from 2.48 percent to 2.98 percent— a 20 percent
increase—will reduce market values by 12 per­
cent, or by $1964 per resident. This is the
estimated effect of raising property tax rates
alone on the market value of city properties.
The statistical analysis controls for the separate
influences of the business cycle (rising city
unemployment reduces market values) and
the general trend in city property values over
the past 20 years (upward in real terms as
market values in Philadelphia have risen faster
than inflation); see Property Tax Base Per Resi­
dent page 18 of the Appendix. The economic
decisions negatively affected by an increase in
city and school district property tax rates in­
clude the decision by residents to remain within
the city or to make significant home improve­
ments and by nonresidents to move into the
city. The statistical analysis shows that in­
creases in the city's property tax rate have
FEDERAL RESERVE BANK OF PHILADELPHIA

Can Philadelphia Escape Its Fiscal Crisis With Another Tax Increase?

discouraged such investments within Philadel­
phia. Importantly, the estimated effect of tax
rates on tax base is statistically significant; there
is less than a 1 in 100 chance that the estimated
negative effect of rate on base is really no effect
at all.
Increases in the city's business taxes also
reduce their tax bases. Because of the difficulty
of analyzing many small city business taxes, a
single measure of the city's business tax base
and a single average business tax rate were used
in the statistical analysis. The base is measured
by a revenue-weighted sum of business gross
receipts, business net profits, and business net
income earned within the city. Accordingly, the
business tax rate is a revenue-weighted sum of
the tax rates on gross receipts, on net profits,
and on net income. The analysis shows that a
one percentage point increase in the weighted
average business tax rate, from its current value
of 1.50 percent to 2.50 percent, will reduce the
average business tax base by $3471 per resident,
a 28 percent reduction from the estimated 1992
value of the average business tax base of $12,625
per resident. Even a more modest 20 percent
increase in business tax rates, from 1.5 percent
to 1.8 percent, still has an important economic
effect on the business tax base, reducing the
base by $1041 per resident, or 8.2 percent from
its 1992 value.
Raising business taxes reduces the business
tax base in two ways. First, the tax on a firm's
gross receipts acts like a sales tax, and like a
sales tax, it will reduce firms' sales when passed
on to customers. Second, the taxes on firms'
income discourage firms from locating in the
city or expanding their Philadelphia-based ac­
tivities. These estimated negative effects of busi­
ness tax rates on the business tax base are the
singular effects of tax rates. Again, the statisti­
cal analysis controls for the separate effects of
the business cycle (reducing tax base) and gen­
eral trends in the Philadelphia economy (en­
hancing tax base); see Business Tax Base Per
Resident on page 18 of the Appendix. As with



Robert P. Inman

property taxation, this estimated effect of busi­
ness tax rates on the business tax base is statis­
tically significant; here too there is less than a 1
in 100 chance that the estimated negative effect
of the rate on base is really no effect at all.
Finally, the city's wage tax is shown to have
a statistically significant, and quantitatively
important, negative effect on the city's wage
tax base. The city's wage tax base is the product
of the number of jobs within the city and the
average pay for these employees. Statistical
analysis revealed no significant effect of the city
wage tax on the average employee's salary. The
city's wage tax has driven jobs from Philadel­
phia, however, because the burden of the city's
wage tax falls to an important degree upon the
business firms within the city. When employ­
ees, whether residents or nonresidents, have
the opportunity to work outside the city and
not pay the wage tax, city employers will have
to pay a compensating wage premium to at­
tract employees.9 This compensating wage
premium equals the burden of the wage tax on
Philadelphia businesses. The burden will have
two adverse effects on city employment: it will
induce existing Philadelphia firms to hire fewer
workers than they might have done without the
tax, and it will discourage new firms from
locating in Philadelphia.

9Nonresidents can legally avoid the wage tax by work­
ing outside Philadelphia. To attract these workers back into
Philadelphia, city firms must raise their wages to compen­
sate nonresidents for paying the city wage tax.
Residents can evade the wage tax de facto by not report­
ing wage income to the city when they work outside Phila­
delphia. Precise estimates of such residents' tax avoidance
are not available, but it is thought by city officials to be
significant. From the point of view of economic decision­
making, however, all residents need do is convince their
prospective city employer that they are one of the residents
who do not pay the tax and that they have an offer from a
suburban firm. If they are persuasive, then the city employer
will have to match the suburban wage package that ex­
cludes the wage tax burden. Wages paid to city residents
must therefore rise.
11

BUSINESS REVIEW

How important are these effects? A statisti­
cal analysis of Philadelphia's share of national
employment over the past 21 years estimates
that a 20 percent increase in the city's average
wage tax rate, to 5.952 percent on residents and
to 5.175 on nonresidents, will reduce city em­
ployment by about 80,600 jobs, or by 12.7 per­
cent from current employment levels (see City
Employment and the Wage Tax Base Per Resident
on page 19 of the Appendix).1 This loss in
0
employment will have an important negative
effect on the city's wage tax base. For a 20
percent increase in the average wage tax rate,
the city will suffer a decline in its current wage
tax base of about $1289 per resident, a 12.7
percent fall from the estimated 1992 value of
$10,132 per resident. Again, these estimated
effects of the wage tax on city employment and
tax base are estimated separately from the
effects of the national business cycle on em­
ployment (since estimates are of the effects of
tax rates on the city's share in national employ­
ment) and from the historical downward trend
in city jobs due to economic influences other
than local taxation (e.g., the decline of manufac­
turing). Finally, as with our estimates of the
effects of other city taxes on the tax base, the
estimated effect of the wage tax on employ­
ment is statistically significant; once again there
is less than a 1 in 100 chance that the estimated
negative effect of tax rates on tax base is really
zero.
As large as the estimated negative effects of

10The statistical analysis uses the revenue weighted av­
erage of the resident and nonresident wage tax rates, after
those rates diverged in 1985.1 have repeated the analysis of
the effects of rates on city employment using only the
nonresident tax rate and again using only the resident tax
rate, and the results are nearly identical to those reported
here. I have also tested whether the two rates have had
different effects on employment for the period from 1985
onward, and I could not reject the hypothesis that both rates
reduced city employment. This result is consistent with the
argument that with lax tax enforcement residents can also
shift the city wage tax onto employers; see footnote 9.


12


SEPTEMBER/OCTOBER1992

tax rates on tax bases are for Philadelphia, there
are good economic and statistical reasons to
suspect that even these estimates understate
the true long-run negative effects of rates on
base in Philadelphia today. Because we have
only 20 years of complete data for the three
taxes, it is difficult to estimate very long-run
changes with great precision. The jobs and
families that leave the city as taxes rise are likely
to be the best paying jobs and the wealthier
families. The loss of high wage firms is likely to
discourage educational investments by current
residents and to deter the in-migration of good
jobs and skilled workers in the future. As the
population of the city becomes less skilled,
average wages are likely to decline, and falling
incomes often create additional pressure for
local government services. Rising service de­
mands and falling tax bases means more, not
less, pressure on the city's deficit. These addi­
tional, adverse consequences of tax increases
on the city's economy and budget are not likely
to be fully captured in our 20 years of data.
As a statistical matter too, these estimates of
tax rates on tax base are likely to be conserva­
tive. Not all the possible variables that might
influence city tax base could be included in this
study. While I suspect the bias such omitted
variables might impose on the estimated tax
effects is likely to be small, it is possible to show
as a matter of statistical theory that even if the
omitted variables are important, the direction
of their bias will be toward understating the
true negative effect of rates on base.1* If any­
1
thing, then, the estimates here are conservative
n The key variables which I could not measure precisely
and which are therefore omitted from the estimated tax
base equations are: 1) local government outputs in Phila­
delphia, 2) taxes and government service levels in the
suburbs surrounding Philadelphia, and 3) the stock of Phila­
delphia debt that might demand future tax increases.
Their omission is not serious, however. Their collective
influence on tax base is probably well measured by the
included time-trend variable, TIME, in each tax base equa­
tion. Variation in these omitted variables around their
FEDERAL RESERVE BANK OF PHILADELPHIA

Can Philadelphia Escape Its Fiscal Crisis With Another Tax Increase?

measures of the true, long-run adverse effects
of rising city taxes on the city's tax base.
MAPPING THE CITY'S
TAX REVENUE HILLS
Having estimated the effects of tax rates on
tax base we now can map the city's economic
tax revenue curves, using the relationship R = r
x B(r). The revenue curves are based on current
1992 values for economic trends, city unem­
ployment, and national employment.1 The
2

trend is slight, at least as indicated by various proxy mea­
sures. Public employees per capita, crime rates, school drop­
out rates (as Philadelphia output measures) and suburban
tax rates and suburban school test scores (as measures of
suburban rates and services) either have remained constant
or show smooth trends over the past 20 years; see Inman
(1987). The stock of Philadelphia debt has also shown little
variation over time, except in the last two years of our
sample, FY 1989 and FY 1990, when the city entered its
current fiscal crisis. Re-estimating the equations omitting
these last two years of data did not change the estimated
effects of tax rates on tax bases significantly.
Finally, even if the omitted variables were to prove
important, the direction of the omitted variable bias would
probably be toward understating the true negative effect of
rates on base, implying that Philadelphia is even closer to the
top of its revenue hills. When city tax rates are low, city
services are likely to be low and city debts are likely to be
large. Low services and high debts will tend to reduce city
tax base, therefore biasing the regression coefficients on tax
rates toward zero and away from their true, larger negative
effect. Similarly, if the city competes against improving
suburban services and taxes by lowering its own tax rates,
then low city tax rates will again be associated with low city
tax bases (now because of attractive suburbs), once again
biasing the regression coefficients for tax rates toward zero
and away from their true negative effect. A clear discussion
of the statistics of omitted variable bias can be found in
Kmenta (1971, pp. 392-95).
12When specifying the revenue relationship, I use the
estimated tax base equations that appear in the Appendix,
Do Philadelphia Tax Rates Affect the Philadelphia Tax Base? The
property tax base and the business tax base relationships are
evaluated at current (1992) TIME trend values and a current
city unemployment rate of 8.0 percent. The employment
share relationship is evaluated at current (1992) TIME trend
values and the current (end of 1991) national employment
level of 116,877,000 jobs.




Robert P. Inman

curves will therefore predict the final revenues
the city can expect from increasing or decreas­
ing city tax rates from current 1992 tax rates.
Revenue curves for each of the city's three
major taxes are shown in Figures 2 (Property
Tax Revenues), 3 (Wage Tax Revenues), and 4
(Business Tax Revenues). The city's current tax
rates (shown in the figures by the vertical dashed
line) place us to the left of, but near, the peak of
each revenue hill. Nonetheless, the city's ability
to raise additional revenues from its major
taxes is severely constrained, particularly for
property and wage taxes. The one possible
source of significant new revenues for the city
is business taxes, but this is true only because
the city made a decision in 1984 to significantly
reduce rates and to move business taxes off the
peak of the business tax revenue curve.
For both the property tax and the wage tax,
Philadelphia is currently very near its revenue
capacity. The current combined city and school
district property tax rate on market value is
2.48 percent (shown as the vertical dashed line
in Figure 2), and at this rate, the city and school
district together raise $400 per resident in rev­
enues. The revenue-maximizing tax rate that
would take us to the top of the revenue hill for
property taxation is 3.25 percent, but at that
rate the city and the school district could expect
to raise only $425 per resident (Figure 2). As we
near the top of the property tax revenue hill—
and we are now very near the top—our ability
to raise additional revenues is significantly
curtailed because of the strong negative effects
of tax rates on tax base.1 The loss in property
3

1 A s a statistical matter, it is important to know if the
3
sample range of property tax rates used to estimate the tax
base equation, B(r), includes the top of the revenue hill. If
not, then we can place less confidence in predicted rev­
enues for that maximum tax rate. In fact, for property
taxation, the sample's range of tax rates on the market value
of city properties—from a low of 2.30 to a high of 3.30—does
include the estimated peak for the property tax revenue
curve.
13

BUSINESS REVIEW

FIGURE 2
Property Tax Revenues
Tax Revenue (dollars)
500

Effective Tax Rate (percent)

FIGURE 3
Wage Tax Revenues
Tax Revenue (dollars)
600

FIGURE 4
Business Tax Revenue
Tax Revenue (dollars)
250


14


SEPTEMBER/OCTOBER1992

values is estimated to be $3050 per resident as
the property tax rate rises from 2.48 to 3.25
percent. Today, the maximum additional rev­
enues the city and school district might hope to
raise from increasing the tax on properties are
only about $25 per resident (= $425 - $400). To
raise this revenue, the city sacrifices $3050 per
resident of its property base. Each one dollar of
additional property tax revenues will cost city
residents $122 in reduced property values
(-$3050 in lost valu e/$25 in new revenues =
-$122) or, with current after-tax interest rates of
4 percent per annum, about $5 per year in lost
income for city residents from their home in­
vestments (-$122 x .04 = -$4.88).1
4
The additional revenue potential from the
city's wage tax is also limited. In fact, the city is
nearly at the top of the wage tax revenue hill.
Figure 3 shows the potential wage tax revenues
the city might raise were it to increase the city's
average wage tax rate on residents and non­
residents from its current value of 4.765 per­
cent (raising about $483 per resident) to the
revenue-maximizing average tax rate of 6.0
percent. Raising the wage tax rate to 6.0 per­
cent would bring very little additional tax rev­
enues, however. At an average wage tax rate
of 6.0 percent the city is estimated to raise $503

14This result implies that Philadelphia property taxes
are more than 100 percent capitalized into reduced prop­
erty values as the city nears the top of its property tax
revenue hill. At an annual after-tax interest rate of 4
percent, $1 of additional property taxes would, if fully
capitalized, imply a decline in property values of about $25
per resident (-$1 / .04 = -$25). The estimates here imply a fall
in market value of $122 per resident. The estimated rate of
capitalization as the city moves to the top of its revenue hill
is 4.88 times greater (-$125/-$25 = 4.88) than full capitaliza­
tion. An extra burden of taxation is at work here, causing
property values in Philadelphia to fall by more than simply
the direct burden of taxation. Possible causes of this extra
burden include the observed and anticipated effects of
taxation on property maintenance and, perhaps most im­
portant, negative neighborhood externalities as middle and
upper income families leave the city.
FEDERAL RESERVE BANK OF PHILADELPHIA

Can Philadelphia Escape Its Fiscal Crisis With Another Tax Increase?

per resident, a revenue gain of only $20 per
resident from our current levels ($503 - $483).1
5
Unfortunately, increasing the average wage tax
rate from 4.765 to 6.0 percent is estimated to cost
the city approximately 104,000 private sector
jobs, or 5200 jobs for each $1 per resident of
additional city revenues (-104,000 jobs/$20 in
new revenue = -5200 jobs per dollar). For this $1
of additional wage tax revenue, city residents
bear an economic cost in reduced job opportu­
nities, an annual economic burden valued con­
servatively at $8 per resident.1
6

15Again it is important to examine the range of tax rates
used to estimate the economic relationship B(r) and to com­
pare that range to the implied peak of the revenue curve. The
sample range for the weighted average wage tax rate is from
1.01 percent to 4.765 percent for this study. The sample
range excludes the tax rate that defines the peak of the
revenue hill. However, the revenue curve is very flat near
this peak and very flat around the current rate as well. For
example, a decrease in the current rate from 4.765 percent to
4.25 percent will cost the city only $25 per resident in wage
tax revenues. Since the city's current rates place it so near the
top of its revenue hill, it seems likely that we do have a good
approximation of the revenue adjustment that might occur
as the city moves to the maximum rate, even though that rate
is outside our sample range.
16A precise measure of the value of these lost private
sector jobs is complicated, but a first approximation might
consider what an unemployed resident would pay a job
search firm for finding him or her a "typical" Philadelphia
job, namely one that pays about $25,000 per year. Most job
search firms charge 10 percent of the applicant's first year's
salary. If the search firm gives the applicant one additional
year of employment (i.e., saves the employee a year of
searching), then this would imply an annual willingness to
pay $2500 for each lost job. At this rate, the $1 of additional
wage tax revenues costs Philadelphians 5200 private sector
jobs valued at $2500 per job, or $13 million per year (5200
jobs x $2500/job = $13 million). The added economic cost
per resident of wage taxation is about $8 ($13 m illion/1.586
million residents = $8.20 per resident).
Of course, some residents might follow their jobs, even if
it means commuting to the suburbs or moving outside the
Philadelphia region. For these residents, the loss of a Phila­
delphia job imposes an added commuting burden, conser­
vatively estimated at $10 per day for 250 working days a
year, or $2500 per lost job. For those who relocate, selling a
house and moving to a new area typically results in a loss of




Robert P. Inman

The one set of city taxes that do show poten­
tial to raise significant additional revenues is
city business taxes, but here too there are ad­
verse consequences for tax base. My estimates
show the revenue-maximizing average tax rate
to be 2.50 percent (Figure 4). At that rate,
business taxes would raise approximately $229
per resident. Today's average business tax rate
of 1.50 percent raises about $189 per resident.
Thus in its business taxes the city still has some
revenue potential—namely, the ability to raise
as much as $40 per resident in new revenues.
With a tax increase, however, the business tax
base declines by $3471 per resident, or by about
$87 per resident for each $1 of new business
revenues. This additional loss of $87 per resi­
dent in the city's business tax base has impor­
tant implications for business income, perhaps
reducing profits earned by city businesses by as
much as $8 per resident.1 This is the annual
7
economic cost to residents of one more dollar of
city business tax revenues.
$3000 or more, even for short moves. Again, the cost for each
lost job is about $2500, even if a Philadelphian keeps the job!
Finally, these calculations ignore any wider social costs
from neighborhood decay or increased crime that might
follow from having fewer job opportunities in the city.
17The city's business tax base is composed of gross receipts,
or sales, and business profits. Gross receipts constitute
about 30 percent of the business tax base as measured here,
while business profit is the remaining 70 percent. Today the
return on gross receipts of manufacturing corporations
implies that each dollar of additional sales yields about $.03
of additional profits; see Economic Report o f the President,
February 1992, Table B-89, p. 401. If this relationship be­
tween gross receipts and profits holds true for Philadelphia
firms, then the Philadelphia business tax base will be a fixed
share of Philadelphia business gross receipts, here esti­
mated as: Business Tax Base = .321 x Gross Receipts (Busi­
ness Tax Base - .7 x Profits + .3 x Gross Receipts, where
Profits = .03 x Gross Receipts). A decline of $87 per resident
in the city's business tax base must therefore imply a $271
per resident decline in gross receipts (-$87 = .321 x -$271).
Finally, the $271 per resident fall in gross receipts suggests
a fall in profits for city businesses of about $8 per resident,
assuming each dollar of gross receipts generates $.03 in
business profits (-$271 x .03 = -$8.13).
15

BUSINESS REVIEW

The reason the city now has a significant
revenue potential in business taxes is that it
made a clear decision in 1984 to reduce those
taxes when it discontinued the city's mercan­
tile license tax and the school district's general
business tax. In 1984, the average business tax
rate was 2.01 percent.1 To raise business tax
8
rates to their 1984 levels is to return the city
once again to very near the top of the business
tax revenue hill and to even higher economic
costs from new revenues.
CAN PHILADELPHIA ESCAPE ITS
FISCAL CRISIS WITH A TAX INCREASE?
Current estimates by the new administra­
tion in City Hall predict that the final fiscal
deficit for the current 1992 fiscal year will be
$248.3 million. If no new policy decisions are
made in the coming 1993 fiscal year, either to
control spending or to raise taxes, the expected
annual deficit will be an additional $204 mil­
lion, bringing the cumulative deficit at the end
of FY 1993 to $452.3 million ($248.3 million +
$204 million).1 If no actions are taken in FY
9
18The sample range for the city's and school district's
average tax rate on businesses is from .46 percent to 2.02
percent. In 1983, the year in which business tax rates reached
their historical peak, business tax revenues equalled $183
per capita (1992 dollars). The peak of the business tax
revenue hill in that year occurred at the rate of 2.32 and
would have yielded a maximum revenue of $187 per capita
(1992 dollars). From these calculations, I conclude the
sample range for business taxes has put us close enough to
a historical peak of the revenue curve to feel confident that
the curvature of the hill near today's maximum rate of 2.50
percent, and thus potential revenues, is well estimated.
19See City of Philadelphia, Revised Amended Five-Year
Financial Plan, FY 1992-FY 1996, May 18, 1992, p. 80. The
cumulative deficit from FY 1993 of $452.3 million will be
carried over into FY 1994 to become an additional 20 per­
cent burden on that year's projected revenues of $2292.2
million ($452.3 m illion/$2292.2 million = .197). It is impor­
tant to emphasize that all deficit projections presented here
are based upon the five-year plan's assumption of business
as usual. Thus these deficit projections already assume no addi­
tional wage or benefit increases fo r city employees, no additional
federal or state mandates, and no further reductions in federal or
state grants assistance.


16


SEPTEMBER/OCTOBER 1992

1994 to alter revenue and spending trends, then
the annual deficit is expected to reach $278.3
million in that year, even without contributions
toward the accumulated $452.3 million of prior
IOUs. By the summer of 1994, the new cumula­
tive deficit will have grown to $730.6 million! It
is clear that investors will not lend the city
additional funds if its deficits continue at these
levels. Yet without additional outside funding
the city faces a serious cash shortfall and an
almost certain fiscal collapse. To close these
projected deficits, and thus attract Wall Street
funding, the city must either raise taxes, cut
spending, or both.20*Will a tax increase alone be
sufficient to close anticipated deficits? The
analysis in this article says no.
To eliminate its projected annual deficits
over the coming years, the city must either cut
spending or raise taxes in some combination to
cover the anticipated shortfalls. The deficit pro­
jections assume city tax rates will remain at
their current 1992 values. Therefore if the rev­
enue strategy is to be used, tax rates must be
increased. In the previous section, we have seen
that the maximum potential revenue from an

20Fortunately, the city has been able to avoid an absolute
fiscal collapse through a successful borrowing of $474.55
million. The borrowing was completed through the newly
established Pennsylvania Intergovernmental Cooperation
Authority (PICA), a state-created oversight board to moni­
tor the finances of Philadelphia. The new debt will be used
to repay the existing $248.3 million of cumulative city defi­
cits from prior years, to assist the city with its short-term
cash needs in FY 1993, and to support needed city capital
expenditures. The new debt is secured by guaranteed rev­
enues from the city's residential wage tax. What made this
new borrowing possible was assurances by the new admin­
istration and the PICA board that the city would live within
the balanced budget guidelines of the City of Philadelphia
Five-Year Financial Plan.
It is important to remember that though PICA was able
to successfully borrow funds from Wall Street to cover the
past deficits of $248.3 million, those deficits are not now off
the books. On the contrary, the PICA borrowing simply
moved these cumulated past obligations into the future.
They must still be repaid from city tax revenues.
FEDERAL RESERVE BANK OF PHILADELPHIA

Can Philadelphia Escape Its Fiscal Crisis With Another Tax Increase?

increase in the property tax rate was $25 per
resident. An increase in the wage tax rate is
likely to net the city only $20 per resident.
Finally, an increase in city business taxes would
yield a maximum of $40 per resident. The
maximum revenue the city might expect from
an across-the-board increase in all its major tax
rates is therefore only $85 per resident, or about
$135 million ($85/resident x 1.586 million resi­
dents). I conclude that a tax increase alone can
close only a bit more than 60 percent of the
projected annual deficit of $204 million for FY
1993. This still leaves an annual deficit gap of
$69 million ($204 million - $135 million) for FY
1993. Further, there is no money available for
paying off the nearly $250 million of past city
deficits from the revenue strategy. To avoid
sizable future deficits and to begin to repay its
past obligations, the city must plan and enact
significant expenditure savings too.2
1
While Philadelphia taxes can still raise rev­
enues, and at least make a partial contribution

21The revenue-only strategy will be more effective if the
city's economy moves out of its current recessionary state,
but even under the most optimistic projections for an eco­
nomic recovery, a major deficit remains. I have recalculated
the revenue hills of Figures 2,3, and 4 assuming that the city
and national economies were to return to the very low
unemployment experiences of 1987. If we assume that Phila­
delphia could once again achieve the 1987 unemployment
rate of 5.4 percent— its lowest unemployment rate in 20
years—then the peaks of the revenue hills will rise to $440
dollars per resident for property taxation, to $257 dollars per
resident for business taxation, and to $506 for wage taxation.
Even using these very optimistic revenue projections, the
city still faces an annual deficit gap of $3 million for city
budgets based on no wage or benefit increases. Further,
there are no additional revenues to repay the $250 million of
past city deficits. The thought that Philadelphia might es­
cape its current fiscal crisis simply through an upturn in the
economy is wishful thinking. Even under the best of circum­
stances, major deficits are likely if the city continues with
"business as usual."




Robert P. Inman

toward closing the city's deficit gap through
higher taxes, there remains the final question of
whether this is a prudent long-run fiscal strat­
egy. This analysis indicates that using the tax
strategy is very costly. Raising city tax rates to
their maximum revenue potential costs city
residents more than just their tax payments.
Fiouse values decline, jobs are lost, and busi­
ness sales and profits fall. This study has esti­
mated that each additional $1 per resident of
city revenue will cost that resident approxi­
mately $5 annually because of falling home
values if the property tax is used, or $8 annually
in lost private sector job opportunities if the
wage tax is used, or $8 annually in reduced
business profits if business taxes are increased.
These are the prices city residents must pay for
any tax increase.22 Is the $1 per resident of
additional city revenues and the public services
it can support worth these costs in lost private
incomes? This is the question that Philadel­
phians and their newly elected city govern­
ment must now answer.

22These economic prices for city revenues may seem
high, but two points should be noted here. First, Philadel­
phia is very near the top of its revenue hills where the
adverse incentive effects of taxation are particularly acute.
Most previous studies of the incentive effects of taxation
have been for governments well away from the peaks of
their revenue curves. Philadelphia has been climbing an
uncharted cou rse. Second , and m ost im portant,
Philadelphia's economic losses are, in large measure, some­
one else's economic gains. When jobs leave Philadelphia,
they relocate in other cities. Residents who leave the city,
thereby depressing Philadelphia house values, move to
other locations and drive up property values there. And the
decline in sales by Philadelphia firms is made up nationally
by increased sales by other firms (or branches) outside the
city. Residents' losses are roughly matched by many small
gains spread nationally to nonresidents. The overall eco­
nomic inefficiencies imposed on the national economy from
Philadelphia's high tax rates may be very low, even as the
economic losses to Philadelphians are very high.

17

APPENDIX

DO PHILADELPHIA TAX RATES AFFECT
THE PHILADELPHIA TAX BASE?
To examine the question of whether Philadelphia's tax rates on property, business
activities, and wage income affect the value of the tax base for each of these important taxes,
regression equations were specified and estimated for each of the three tax bases. For each
of the city's three major taxes, an increase in the relevant tax rate was found to have
significantly reduced the value of each tax's taxable base.

PROPERTY TAX BASE PER RESIDENT*
BASE = 24480 + 92.14 x TIME -183.07 x UE -3961.39 x PRATE
(4176.2) ** (52.12)*
(105.13)*
(1394.33)**
The estimated regression coefficients (with their standard errors in parentheses) imply
that for the sample period from 1970-90 (the most complete period for all variables), the real
(inflation adjusted to 1992 dollars) market value per resident of the city's property tax base
(BASE) has an intercept value of $24,480 per resident and has been growing each year at the
rate of $92.14 per resident because of the effects of TIME. Property values have declined
(increased) by $183.07 per resident for each one percentage point increase (decrease) in the
city's unemployment rate, UE. The property tax rate lagged one year to allow for full
economic adjustments (PRATE ) has reduced (increased) the per resident market value of
city property by $3961 for each percentage point increase (reduction) in the tax rate. The
variable PRATE is measured as the sum of the effective property tax rates of the school
district and the city, lagged one fiscal year. The one-year lagged response seems sufficient
to measure the full equilibrium adjustment of property values to changes in tax rates.
Effective rates are measured as the State Tax Equalization Board's rate of assessed property
values to market values (the "STEB rate") multiplied by the school district's and the city's
nominal tax rate on assessed value.
The estimated regression coefficient on PRATE j implies that a 20 percent increase in the
city's effective property tax rate from its current value of 2.48 percent will reduce city
property values by - $1964 per resident (-$3961.39 x (.20 x 2.48)), or by 12 percent from the
estimated 1992 market value of $16,139 per resident.

BUSINESS TAX BASE PER RESIDENT1
*
BASE = 12598 + 266.46 x TIME - 411.69 x UE - 3471.06 x BRATE
(683.4)** (52.71)**
(78.45)**
(1159.76)**
The estimated regression coefficients (standard errors in parentheses) imply that for the
sample period 1967-90 (the most complete period for all variables) the real (inflation
adjusted to 1992 dollars) tax base for city business taxes measured as a weighted average
aSingle (*) or double (**) asterisk by the coefficients' standard error indicates that the estimated
coefficient is statistically different from zero at a .90 (.99) level of confidence— that is, there is less than
a 1 in 10 (1 in 100) chance that the true coefficient value is zero and the variable has no effect on city tax
base.
As measured by the adjusted R2 this regression explains 81 percent of the variation in the market value
per resident of city properties for the sample period, 1970-90. The estimated equation is corrected for
possible serial correlation using a one-period moving average specification for the error term; the
Durbin-Watson statistic for the corrected regression has a value of 2.02, not allowing us to reject the null
hypothesis of no serial correlation.
bAs measured by the adjusted R2 this regression explains 87 percent of the variation in the business
tax base per resident for the sample period, 1967-90. The estimated equation is corrected for possible
serial correlation using a one-period moving average specification for the error terms; the DurbinWatson statistic for the corrected regression has a value of 1.98, not allowing us to reject the null
hypothesis of no serial correlation.




of business gross receipts and business income per resident (BASE) has an intercept value of $12,598
per resident and has been growing at the annual rate of $266.46 per resident because of the effects of
TIME. The business tax base has declined (increased) by $411.69 per resident for each one percentage
point increase (decrease) in the city's unemployment rate, UE. Finally, the business tax base per
resident has declined (increased) by $3471.06 per resident for each one percentage point increase
(decrease) in the one-period lagged average tax rate on business gross receipts and business income,
BRATE r The one-year lagged response seems sufficient to measure the full equilibrium adjustment
of gross receipts and business income to changes in tax rates. The variable BRATE^ is measured as the
revenue weighted sum of each of the city's and school district's taxes on business gross receipts and
business income and is lagged one fiscal year to allow for full economic adjustments to changes in rate.
The estimated regression coefficient on BRATEA implies that a 20 percent increase in the city's
business taxes from their current weighted average value of 1.50 percent is estimated to reduce the
business tax base by -$1041 per resident (- $3471.06 x (.20 x 1.50)), or by 8.2 percent from the estimated
1992 business tax base of $12,625 per resident.

CITY EMPLOYMENT AND THE WAGE TAX BASE PER RESIDENT0
The city's wage tax base is the product of the number of jobs in the city multiplied by the average
wage per employed city worker. Like national wages per worker, the average wage per Philadelphia
worker adjusted for inflation—called the worker's real wage— has proven to be very stable over the
sample period of this study, 1969-90, fluctuating around the sample mean of $23,400 per worker.
Variation in the city's wage tax base must come, therefore, from variations in city employment.
The city's employment relationship is estimated as the city's share of national employment
(EMPSHARE). The specification of employment as EMPSHARE allows us to control for the effects of
the national business cycle on Philadelphia employment. The estimated EMPSHARE relationship for
our sample period, 1969-90 (again the most complete period for all variables), is:
EMPSHARE = .0137 - .00015 x TIME - .00072 x WRATE
(.0003)** (.00003)**
(.00020)**
The estimated regression coefficients (standard errors in parentheses) imply that for our sample
period 1969-90, Philadelphia's share of national employment has an intercept value of .0137 (1.37
Philadelphia workers per 100 U.S. workers) that has been declining over time at the annual rate of
.00015 city workers per U.S. workers because of the effects of TIME. The city's weighted average wage
tax rate lagged one fiscal year, WRATE r reduced (increased) the Philadelphia employment share by
.00072 city workers per U.S. worker for each one percentage point increase (reduction) in the average
tax rate. Because the wage tax rate has changed only four times over our sample period (1970,1972,
1977,1984) the precise time pattern of the response of employment to tax rates cannot be statistically
estimated. The one-period response measured here is likely to be an underestimate of the full
equilibrium response of employment to tax rates. The variable WRATE j is measured as the revenue
weighted sum of the tax rate on nonresident commuters and the tax rate on residents. (The two rates
were identical until 1984, but now differ.)
The estimated regression coefficient on WRATE j implies that a 20 percent increase in the city's
weighted average wage tax rate from its current value o f4.765 percent will reduce Philadelphia's share
of national employment by -.00069 city workers per U.S. worker (.00072 x(.20 x 4.765)), or by 12.7
percent from the estimated 1992 employment share. Multiplying this lost employment share by the
national level of employment in 1992 means a loss of approximately 80,600 Philadelphia jobs. In 1992,
each lost job contributes an average of $25,376 per employee to the city's wage tax base. The total
estimated decline in the city's wage tax base because of the 20 percent increase in the average wage
tax rate therefore equals $2,035 billion (80,600 lost jobs x $25,376/job), or approximately $1289 per
resident ($2,035 billion/1.586 million residents). The $1283 decline in tax base per resident is 12.7
percent of the city's estimated $10,132 wage tax base per resident in 1992.
cAs measured by the adjusted R2 this regression explains 97 percent of the variation in the city's share of national
employment for the sample period, 1969-90. The estimated equation is corrected for possible serial correlation using
a one-period moving average specification for the error terms; the Durbin-Watson statistic for the corrected
regression
 has a value of 1.95, not allowing us to reject the null hypothesis of no serial correlation.



REFERENCES

BUSINESS REVIEW

SEPTEMBER/OCTOBER1992

Auerbach, Alan. "Taxation, Corporate Financial Policy, and the Cost of C ap ital," Journal o f Economic
Literature (Septem ber, 1983).
Boskin, M ichael. "Taxation, Savings, and the Rate of Interest," Journal o f Political Econom y (April, 1978,
Part 2).
Deaton, Angus. "Equity, Efficiency, and the Structure of Indirect T axation," Journal o f Public Economics
(Decem ber, 1977).
Evans, Owen. "Tax Policy, the Interest Elasticity of Savings and Capital Accum ulation: Num erical
Analysis of Theoretical M odels," American Economic Review (June, 1983).
Fullerton, Donald. "O n the Possibility of an Inverse Relationship Between Tax Rates and Governm ent
R evenues," Journal o f Public Economics (October, 1982).
Grieson, Ronald, W illiam Flamovitch, Albert Levenson, and Richard M orgenstem . "The Effect of
Business Taxation on the Location of Industry," Journal o f Urban Economics (April, 1977).
Grieson, Ronald. "Theoretical Analysis and Empirical M easurem ents of the Effects of the Philadel­
phia Incom e T ax," Journal o f Urban Economics (July, 1980).
Gruenstein, John. "Jobs in the City: Can Philadelphia Afford to Raise Taxes?" this Business Review
(M ay /Ju n e, 1980).
H oltz-Eakin, Douglas, and Harvey Rosen. "Federal Deductibility and Local Property Tax Rates,"
m imeo, Princeton University, 1990.
H ausman, Jerry. "Taxes and Labor Supply," in Alan Auerbach and M artin Feldstein, eds., H andbook
o f Public Economics, Volum e I. North-H olland Publishing, 1985.
Inman, Robert. "M icro-fiscal Planning in the Regional Economy: A General Equilibrium A pproach,"
Journal o f Public Economics (April, 1977).
Inman, Robert. "Philadelphia's Fiscal M anagem ent of Economic Transition," in Thom as Luce and
Anita Sum m ers, eds., Local Fiscal Issues in the Philadelphia M etropolitan Area. University of
Pennsylvania Press, 1987.
Km enta, Jan. Elements o f Econometrics. M acm illan Publishing, 1971.
Ladd, Helen, and Katharine Bradbury. "C ity Taxes and Property Tax Bases," N ational Tax Journal
(Decem ber, 1988).
Laffer, Arthur. Statem ent Prepared for the Joint Econom ic Com mittee, M ay 20,1977.
Oates, W allace. "T he Effects of Property Taxes and Local Public Spending on Property V alues,"
Journal o f Political Economy (N ovem ber/D ecem ber, 1969).
Phlips, Louis. Applied Consumption Analysis. North-Holland Publishing, 1974.
Rosen, Harvey. "H ousing Subsidies: Effects on Housing Decisions, Efficiency, and E quity," in Alan
A uerbach and M artin Feldstein, eds., H andbook o f Public Economics, Volum e I. North-Holland
Publishing, 1985.
Sexton, Terri. "Forecasting Property Taxes: A Com parison and Evaluation of M ethods," N ational Tax
Journal (M arch, 1987).


20


FEDERAL RESERVE BANK OF PHILADELPHIA

City and Suburban Growth:
Substitutes or Complements?
Richard Voith*
Over the past three decades, population and
employment have been growing rapidly in sub­
urban areas while most central cities have been
declining or growing slowly. At the same time,
there has been a growing divergence in the per
capita income of city and suburban residents
(Figure 1). Economic and social problems have
become increasingly concentrated in the nation's
urban core.
The rapid growth of the suburbs and the
coincident decline of the cities has led to a

* Richard Voith is a Senior Economist and Research
Adviser in the Urban and Regional Section of the Philadel­
phia Fed's Research Department.




debate over the nature of the relationship be­
tween city and suburban economies. Are their
economies closely interconnected? Do the in­
terests of cities and suburbs coincide? Should
suburban residents be concerned with central
city decline?
One common view is that suburban econo­
mies are completely independent of their cen­
tral city counterparts. This view is reflected in
a Philadelphia Inquirer editorial, July 14,1991:
The lesson of Detroit..is...[that its] suburbs
are doing all right despite the city's demise...
For years cities have tried to use the threat
that if they are allowed to die, they'll take the
suburbs down with them. Increasingly, the
evidence is that this is not true.
21

BUSINESS REVIEW

SEPTEMBER/OCTOBER 1992

or co n v ersely , if
healthy cities result
FIGURE 1
in higher suburban
Real Income per Capita
growth, we might
Northeast and North Central MS As
say that city and
suburban grow th
are complements.
Ebllars
The choice of ap­
p ro p riate p u blic
policies for metro­
politan areas de­
pends crucially on
w hether city and
suburban grow th
are substitutes or
co m p lem en ts. If
they are perfect sub­
stitutes, we need not
be concerned with
central city decline
1960
1970
1980
1987
from an economic
growth perspective,
On the other hand, some believe that central since losses in the city will be offset by gains in
*
city decline will eventually spread to the sur­ the suburbs.1 However, if city growth comple­
rounding suburbs. This view is evident in the ments suburban growth, then declining cities
following quote from The Economist, Novem­ will eventually undermine suburban growth.
In this case, cooperative policies to arrest urban
ber 2,1991:
decline would be desirable.
Nowhere is the separation of [the city and
suburbs] so destructive...as in Detroit...It is SUBSTITUTES OR COMPLEMENTS:
becoming obvious that Detroit's troubles WHAT DOES ECONOMIC THEORY
cannot be contained. Company head hunt­ TELL US?
Communities in a metropolitan area are
ers, even in the distant suburbs, find it diffi­
cult to lure top-notch talent to a place with distinguished from one another by their own
unique features. Communities may stand out
such a negative image.
simply because of the physical aspects of their
The basic issue can be succinctly stated: Do location—it may be hilly or flat, beautiful or
suburbs substitute for cities, or do they comple­ unattractive. Other communities' main attrac­
ment one another? If central city decline results tions may be their proximity to other highly
in higher growth in the surrounding suburbs so valued locations, the beach, for example. Still
that the metropolitan growth rate is unaffected
by where the growth occurs, we might say that
suburban growth is a perfect substitute for
1Even if city decline is offset by suburban growth, social
central city growth. If declining central cities problems associated with declining cities are still an impor­
are associated with slower suburban growth, tant concern.

22


FEDERAL RESERVE BANK OF PHILADELPHIA

City and Suburban Growth: Substitutes or Complements?

other communities may provide excellent pub­
lic services, such as education and recreation
facilities. People and firms locate in neighbor­
hoods with the attributes best suited to their
needs. Of course, their location choices are
limited by the amount they can pay. In general,
people will be willing to pay higher prices for
land in areas with very desirable attributes. In
addition, firms will be willing to pay higher
wages in areas that have attributes that make
the firm more competitive.
The economic theory of location choice says
that the price of land adjusts so that people and
firms do not wish to change locations. Within
a metropolitan area, highly attractive areas tend
to have high land prices so that every one does
not try to move to them. Of course, some
regions are more productive than others and,
hence, have higher wages, but again, land prices
adjust upward in these metropolitan areas so
that everyone does not move to the high wage
regions.2 Net migration occurs when the land
and labor markets are out of equilibrium, mak­
ing one locale within a region more attractive
than another or making one metropolitan area
more attractive than another.
Disequilibrium can be induced by a variety
of factors, including technological change,
change in personal income, and changes in
public policies. For example, improvements in
automotive technology; higher incomes, which
increased the affordability of cars; and public
investments in highways have all worked to­
gether to increase the appeal of the suburbs. In
response, people and firms have moved from

2See Jennifer Roback, "Wages, Rents and the Quality of
Life," Journal o f Political Economy, 90 (1982), pp. 1257-78, for
a discussion of how wages and rents adjust to make workers
and firms indifferent across regions. The Roback framework
can be expanded to examine intrametropolitan differences
in land prices as well. See Richard Voith, "Capitalization of
Local and Regional Attributes into Wages and Rents: Differ­
ences Across Residential, Commercial and Mixed-Use Com­
munities," Journal o f Regional Science, 31 (1991), pp. 127-45.




Richard Voith

the city to the suburbs. According to the
theory, the outmigration should result in lower
city land prices, eventually stemming the out­
flow of people. A new equilibrium should
result in fewer people and lower land prices in
the city.
In this simple view of the world, locations
are good substitutes for one another, and inhib­
iting the adjustment mechanism serves only to
lower regional welfare. Competition between
the city and its suburbs, each pursuing its own
policies independently, yields the most desir­
able outcome for the region. Growth or decline
depends on each community's inherent attrac­
tiveness and on the efficiency of its public
policies. If the suburbs are more attractive than
the city, then central city population decline is
simply a healthy response that results in more
people and firms in the desirable area. Eventu­
ally, migration from the less attractive city to
the suburbs ends because land prices adjust so
that city and suburban areas give equal value
for the dollar.
The simple adjustment mechanism will break
down, however, when the process of migration
affects local and regional attributes. When out­
migration hinders the declining community's
ability to provide basic public services, falling
land prices may not be sufficient to halt the
decline. Further, the decline may have
"spillover" effects that change the attractive­
ness of the entire region.
There are several potential sources of
spillovers. First, some amenities are valued by
people throughout the region, but these ameni­
ties may be tied to a single locality.3 For ex­
ample, a historic site and a waterfront park are
two examples of amenities that cannot be rep­
licated elsewhere. Other amenities, such as a
cultural district or a vibrant, pedestrian-ori­

3See Richard Voith (1991) for a discussion of how re­
gional attributes differ from purely local attributes in their
effect on location decisions.
23

BUSINESS REVIEW

ented city street, may be very difficult, al­
though not impossible, to recreate in a different
location.4 The value of these amenities will be
reflected in land prices throughout the region,
especially in areas with good accessibility to the
amenity. If a declining city provides fewer or
less attractive regionally valued amenities, it
will render the entire region less desirable. The
land value premium enjoyed by suburban neigh­
borhoods with good accessibility to the city will
fall as the value of the city-provided amenity
erodes.
Another source of spillovers is what econo­
mists call agglomeration economies.5 Agglom­
*
eration economies are essentially the benefits
from having many businesses in close proxim­
ity. These agglomeration economies result
from increased availability of business services,
opportunity for face- to-face interactions, and
accessibility to a large labor force through welldeveloped transportation systems that depend
on economies of scale. The compact develop­
ment of cities that is supported by high-density
public transportation systems increases the
opportunities for agglomeration economies. If
city decline results in a decline in agglomera­
tion economies, industries benefiting from them
most are likely to suffer, and if they do move,
they may well choose locations outside the
region with greater agglomeration economies.
Finally, there are social spillover effects of
city decline. Urban decline is frequently asso-

4Cities and suburbs provide very different sets of local
attributes. Suburbs are characterized by widely dispersed
development and privately controlled space, while cities
have dense development with a considerable amount of
publicly accessible space. In the event of city decline, it is
unlikely that city-style amenities would be reproduced in
the suburbs.
5Gerald A. Carlino provides a clear introduction to
agglomeration economies in "Productivity in Cities: Does
City Size Matter?" this Business Review (November/Decem­
ber, 1987), pp. 3-12.


http://fraser.stlouisfed.org/
24
Federal Reserve Bank of St. Louis

SEPTEMBER/OCTOBER 1992

dated with an increasing concentration of lower
income people and a declining ability to fund
needed investments in education and infra­
structure. If city decline results in a concentra­
tion of the population with very little education
and in a deteriorating physical infrastructure,
eventually the decline is likely to impose addi­
tional costs manifested by high crime, poor
health, and unproductive workers. These costs
may initially be borne by the city itself (thus
causing further decline), but ultimately, the
increased costs affect higher levels of govern­
ment and will be unavoidable by other resi­
dents of the region.
The short- and long-run consequences of
these spillover effects are likely to be quite
different. Initially, city decline is likely to re­
duce city amenities, providing further impetus
to move to the suburbs. Thus, in the short run,
urban decline might be associated with subur­
ban growth. Spillovers from city decline, how­
ever, may adversely affect the entire region,
causing people and firms to move to more
desirable regions. Eventually, a new equilib­
rium will be achieved with lower land prices
and fewer people in the metropolitan area. The
resultant equilibrium might be one in which the
city is but a fraction of its former size, and the
suburbs, though larger, are smaller than they
would have been.
Complementarity of city and suburban
growth implies that unfettered competition
between city and suburb resulting in rapid city
decline maybe counterproductive. Public poli­
cies to arrest city decline based on regional
cooperation are desirable, even though they
may not be in the short-run interests of the
suburbs. The benefits of cooperation, however,
may not be readily apparent, since the suburbs
are likely to remain attractive when compared
with the declining city neighborhoods. Only
when compared with the suburbs of other met­
ropolitan areas without declining cities will the
negative effects of urban decline on the suburbs
be evident.
FEDERAL RESERVE BANK OF PHILADELPHIA

City and Suburban Growth: Substitutes or Complements?

Richard Voith

ARE CITIES MORE LIKE SUBSTITUTES
OR COMPLEMENTS?
One way to approach the issue of whether
cities and suburbs are substitutes or comple­
ments is simply to see whether metropolitan
areas with relatively healthy cities have higher
rates of suburban growth relative to metropoli­
tan areas with declining cities. We examine
population and income growth over the past
three decades in 28 metropolitan areas in the
Northeast and North Central regions to see if
suburban population growth and income
growth are positively correlated with city popu­
lation and income growth.6 A positive correla­
tion would suggest that city and suburban
growth are complementary, while no correla­
tion or a negative correlation would suggest
that suburbs are essentially independent of the
city or that they benefit from city decline.
Simple correlations between city and subur­
ban growth must be interpreted with care, how­
ever. Even if city and suburban economies were
not interdependent, their economic performance
might be correlated, since they are subject to
similar external forces. Suppose all metropoli­
tan areas in one region, say the Southwest, were
experiencing a higher rate of growth than those
in another region, say the Northeast, purely
because of regional trends. Then a correlation
would arise between city and suburban growth,
even if they were not interdependent. The
correlation arises because the high growth trend
in the Southwest would result in cities and
suburbs of that region having higher average
growth than those in the Northeast. Thus, we

focus on metropolitan areas in the Northeast
and North Central regions that were subject to
similar external forces.7
Population Growth. City and suburban
population growth rates were positively corre­
lated in the 1970s and 1980s, but not in the
1960s.8 Suburban population growth is plotted
against city population growth for each of the
three decades (Figure 2). During the early
stages of suburbanization in the 1960s, the
negative correlation of -0.57 suggests that sub­
urban growth was substituting for city growth.9
City and suburban growth were negatively
correlated during this period for several rea­
sons. First, the opportunities for growth were
probably greatest in the early years when sub­
urban land was undeveloped and inexpensive.
Second, cities were probably too densely popu­
lated, given the changes in transportation and
communication technology. Finally, the longrun negative consequences of spillovers of ur­
ban decline may not yet have manifested them­
selves.1
0

6The growth rates for the metropolitan areas, cities, and
suburbs are based on the population and income for the
MSA geographic areas as currently defined. In some cases,
additional counties were added to the suburban part of the
metropolitan area. Therefore, adjustments were made in the
1970 and 1960 figures to reflect the geographic areas covered
by the current definitions. In this sample, none of the cities
annexed suburban land or vice versa during the time period
covered.

9Much of the negative correlation between city and
suburban population growth in the 1960s is caused by two
metropolitan areas with high city growth but low suburban
growth. Dropping these cities results in a near zero correla­
tion between city and suburban population growth.




7We did analyze a broader sample of 59 MSAs spread
throughout the U.S. The findings broadly parallel those
presented here. However, city annexation of suburban land
was the rule rather than the exception in southern and
western MSAs, which greatly complicates the analysis.
8In "Do Metropolitan Areas Mean Anything? A Re­
search Note," Journal o f Regional Science, 30 (1990), pp. 41519, Edwin Mills analyzes the correlation between city and
suburban population growth indirectly for the 1960s and
the 1970s on a much broader sample of 229 metropolitan
areas. He found evidence for correlation between city and
suburban growth over the 20-year period but did not ana­
lyze the decades separately.

10Regression analysis suggests that city decline in the
1960s did, in fact, adversely affect suburban growth in the
1970s.
25

BUSINESS REVIEW

SEPTEMBER/OCTOBER 1992

FIGURE 2

Population Growth
I960 -1970

1970 -1980
Suburbs

-20
-30
-30

-25

-20

-15

-10

-5

0 Cities

1980 -1990
Suburbs
30
20

■ 10

-25


http://fraser.stlouisfed.org/
26
Federal Reserve Bank of St. Louis

-20

-15

-10

-5

0

Cities

In both the 1970s
and 1980s, metropoli­
tan areas with rela­
tively high city growth
tended also to have
relatively high subur­
ban grow th. C on­
versely, those with low
city grow th also
tended to have low
suburban growth. The
correlation betw een
city and subu rban
growth was 0.57 in the
1970s and 0.51 in the
1980s. The positive
correlation in these
two decades suggests
that city growth was
co m p lem en tary to
suburban growth dur­
ing this period.1
1
The finding that the
correlation betw een
city and subu rban
p o p u latio n grow th
was strongly positive
in the 1970s and 1980s
but negative in the
1960s runs counter to
many people's expec­
tations. One reason for
the high correlation
between city and sub­
urban
p o p u latio n
growth in the 1970s

n In addition to the posi­
tive correlations, fixed-ef­
fects regression analysis,
which allows for different
trend growth rates across
metropolitan areas, suggests
that city growth comple­
ments suburban growth.

FEDERAL RESERVE BANK OF PHILADELPHIA

City and Suburban Growth: Substitutes or Complements?

Richard Voith

and 1980s is that suburbanization became in­ areas with the greatest city decline was -2.3
creasingly difficult as development drove up percent, compared with the sample average of
land and public infrastructure costs and as 3.2 percent, indicating that urban decline is not
congestion became a problem in the suburbs as
well as the city. Continued suburban growth
12The rankings also indicate that common factors across
has become increasingly dependent on the over­
cities and their suburbs may be important. The top three
all desirability of the region, rather than simply cities in terms of decline— Pittsburgh, Youngstown, and
the lower cost associated with moving into Gary—were all adversely affected by national trends in the
undeveloped and uncongested areas. Metro­ steel industry.
p o lita n areas not
plagued with the prob­
lems associated with
FIGURE 3
declining cities appear
Population Growth Rates
to have had more ro­
1980 -1990
bust suburban growth
in the 1970s and 1980s.
MSA
MSA Growth Suburban Growth City Growth
To show the rela­
Rate Rank
Rate Rank
Rate Rank
tionship among city,
Pittsburgh
-7.31
28
-6.02
28
-12.76
24
suburban, and metro­
Youngstown
27
27
-7.30
-4.56
-17.12
27
p o lita n p o p u latio n
Gary
-5.94
26
-0.59
25
-23.24 28
g row th , we have
Buffalo
4.62
25
-2.61
21
26
-8.31
ranked the sample of
Cleveland
-3.57
24
0.04
23
-11.89
22
metropolitan areas by
Newark, DE
-2.92
24
-16.41
23
-0.05
26
m etro p o lita n area
Detroit
-2.36
22
2.12
21
-14.56 25
-0.44
Toledo
21
11
17
7.23
-6.12
p o p u latio n grow th
Akron
-0.42
20
2.80
20
-6.13
18
rates in the 1980s.
Chicago
19
0.16
7.56
9
-7.37 20
M etro p o lita n area
Milwaukee
2.52
18
5.79
15
-1.40
10
grow th rates and
Syracuse
17
4.89
2.63
18
-3.67
12
rankings along with
2.82
St. Louis
16
6.41
14
-12.39
23
the suburban and city
Philadelphia
2.98
8.02
15
8
-6.08
16
grow th rates and
Rochester
3.21
14
5.66
16
-4.18
13
New York
3.29
13
1.74
22
3.55
3
rankings are shown in
Boston
3.54
3.30
12
19
2.01
6
Figure 3. As the posi­
Cincinnati
11
3.65
7.14
12
-5.55
15
tive correlation would
Albany
4.60
10
5.32
17
-0.63
8
suggest, most metro­
Providence
5.83
9
6.57
4
13
2.50
politan areas that have
Hartford
6.85
8
7.51
10
2.45
5
rapidly declining cit­
Indianapolis
7.14
7
11.36
6
4.33
1
ies also have declining
Allentown
8.06
6
10.59
7
1.34
7
Baltimore
16.52
4
8.31
5
19
-6.46
or slowly growing sub­
Kansas City
9.27
4
14.79
5
-2.88
11
urban areas, while the
14.41
Grand Rapids
3
18.92
2
2
4.00
reverse is true for rap­
Minneapolis
2
15.30
18.66
3
-0.69
9
idly growing metro­
Washington, D. C. 20.69
1
26.95
1
-4.94
14
politan areas.1 The
2
average growth rate of
AVERAGE
3.22
6.65
-5.45
the 10 m etropolitan



27

BUSINESS REVIEW

being offset by growth in the remainder of the
region.
While the rankings in Figure 3 do not show
an ironclad link between central city popula­
tion decline and slow suburban growth, excep­
tions to this rule are relatively uncommon.
Baltimore (which ranked fifth overall, fourth in
suburban growth, and 19th in city growth) was
the only metropolitan area with greater than
average city decline and a suburban growth
rate among the top 10. Detroit, contrary to the
claims by the Inquirer, does not boast robust
growth in the suburbs. Overall, the Detroit
area ranked 22nd in population growth, with a
decline of 2.4 percent. Suburban growth, at 2.1
percent, was very low, while the city suffered
a decline of 14.6 percent. In terms of population
growth, the Detroit metropolitan area is not an
example of robust suburban growth coexisting
with severe urban decline. In fact, Detroit's
suburban growth ranked 21st among our
sample of 28 Northeast and North Central
metropolitan areas.
The Third Federal Reserve District's largest
metropolitan area, Philadelphia, was squarely
in the middle of the pack in terms of population
growth, growing 3.0 percent and ranking 15th.
The city of Philadelphia declined by 6.1 per­
cent, for a rank of 16th, and the suburbs grew
by 8.0 percent, ranking them eighth in popula­
tion growth.1 The Philadelphia suburban
3
growth rate is relatively high because it started
from a low base compared with the size of the
city of Philadelphia. Hence, the suburban
growth rate did not improve the ranking of the
entire metropolitan area as much as one might
expect.
Income. We examined another measure of
the health of a metropolitan area, growth in real
per capita income, which is likely to be as

13Note that even though Philadelphia suburban popula­
tion growth ranked eighth, its 8.02 percent growth was
within a percentage point of the 12th-ranked city.


28


SEPTEMBER/OCTOBER 1992

important to the regional economy as popula­
tion growth. We examined the correlation
between per capita income growth in suburban
areas and central cities. Suburban income
growth is plotted against city income growth in
the 1960s, 1970s, and 1980s in Figure 4. The
pattern is similar to the population findings:
there was little correlation between suburban
and city income growth in the 1960s, but there
was a positive correlation of 0.70 in the 1970s
and a very high correlation of 0.91 in the 1980s.1
4
Metropolitan area income growth rates for
the 1980s are ranked in ascending order in
Figure 5. Clearly, in the 1980s, metropolitan
areas with high city income growth were very
likely to have high suburban income growth,
while those with slow city income growth were
likely to have low suburban income growth.
The Detroit metropolitan area, for example,
ranked 19th in per capita income growth, grow­
ing by only 1.2 percent over seven years. This
is well below the sample average growth of 5.7
percent. Detroit suburban income grew by only
0.4 percent (a rank of 22), while the city income
fell by 0.6 percent (a rank of 23).1 Although
5
suburban Detroit income growth was anemic
relative to other suburbs, it was large enough to
make the suburbs appear increasingly prosper­
ous when compared with the city of Detroit.
Turning to the Philadelphia metropolitan
area, we find that it ranks eighth in overall
income growth, growing 12.0 percent. The
strong suburban growth of 13.1 percent also
ranked eighth among suburban areas. Growth

14The positive correlations evident in the last two dec­
ades occurred despite the fact that high income people
moved to the suburbs faster than low income people, which
would tend to cause a negative correlation.
15The metropolitan percent growth is not simply an
average of the growth rate of suburbs and city because some
lower income people can move from the city to the suburbs,
lowering the suburban growth rate but leaving the metro­
politan rate unchanged.
FEDERAL RESERVE BANK OF PHILADELPHIA

City and Suburban Growth: Substitutes or Complements?

in income in the city
was lower, at 5.6 per­
cent, but this growth
rate was sufficient to
rank the city ninth in
income growth. Phila­
delphia is a good ex­
ample of the general
case, in which suburbs
w ith rapid incom e
growth tend to also
have cities with rela­
tively strong income
growth. Interestingly,
even though Philadel­
phia income growth
was strong relative to
other cities, income
growth in the city was
weak relative to the
growth in its suburbs.
The high rank cor­
relation confirms that
it is unlikely that a met­
ropolitan area's subur­
ban economic perfor­
mance, as measured by
in com e g row th , is
strong relative to other
suburban areas if the
metropolitan area has
declining central city
incomes. With the di­
vergence in suburban
and city incomes, however, resid en ts are
likely to perceive that
the suburban economy
is healthy because sub­
urban income levels
and growth rates are
so much higher than
those of th eir city
neighbors. This dis­
parity masks the dif


Richard Voith

FIGURE 4

Income Growth
I960 -1970

Suburbs
80
70
60
50
40
30 "

20
10
10

20

30

40 Cities

1970 -1980
Suburbs

1980 -1987
Suburbs
30
25
20
15
10
5

0
-5
-10 •
-15
-15

-10

-5

0

5

10

15

20

25

30 Cities

29

BUSINESS REVIEW

SEPTEMBER/OCTOBER 1992

ferences in suburban
income growth across
FIGURE 5
m etrop olitan areas
Income Growth Rates
with growing and de­
1980 -1987
clining cities.
Employment.
MSA
MSA Growth
Suburban Growth
City Growth
Rate Rank
Rate Rank
Rate Rank
Changes in per capita
income affect the rela­
Gary
-10.78
28
-10.05
28
-14.83
28
tive prosperity of city
Youngstown
-8.31
27
27
-9.26
27
-7.55
dwellers and subur­
Cleveland
-1.24
26
-1.62
26
-3.75
26
b an ites. S h ifts in
Pittsburgh
-0.74
-1.47
25
25
2.59
16
population reflect the
Toledo
-0.17
24
0.49
20
24
-1.45
choices of workers in
Milwaukee
0.48
23
1.81
17
-3.69
25
their evaluation of
Chicago
0.50
22
0.19
24
-0.39
22
places to live. Employ­
Akron
21
0.63
0.32
23
19
1.23
Grand Rapids
1.15
20
0.47
21
ment, on the other
1.52
18
Detroit
1.20
19
0.40
22
-0.65
23
hand, is a good indica­
Buffalo
1.71
18
1.15
19
21
0.83
tor of the desirability
Kansas City
17
2.03
1.80
18
3.19
14
of a community from
Rochester
2.60
16
2.10
16
2.93
15
the firm 's point of
Indianapolis
2.89
15
14
3.86
2.04
17
view. We examined
Cincinnati
3.21
14
2.56
15
4.34
12
employment growth
Allentown
3.86
13
4.36
13
1.01
20
in cities and suburbs
St. Louis
5.69
12
4.62
12
5.68
8
during the p eriod
6.54
11
Minneapolis
6.25
11
11
5.38
from 1976 to 1986 and
Syracuse
7.12
10
7.42
10
4.15
13
once again found evi­
Albany
10.72
9
10.82
9
9.61
5
Philadelphia
11.95
8
13.14
dence of co m p le­
8
9
5.60
Washington, D.C. 12.94
7
14.02
6
5.42
10
mentarity. The corre­
Providence
6
13.56
14.27
5
12.89
3
lation betw een city
Baltimore
13.64
5
7
13.18
8.62
6
and suburban employ­
New York
4
14.25
17.94
4
13.61
2
ment growth was 0.7
Newark, DE
18.59
3
19.86
3
7
7.65
during the period.
Hartford
20.11
2
20.99
2
12.69
4
While high correlation
Boston
25.58
1
26.44
1
26.59
1
between city and sub­
urban growth in em­
AVERAGE
5.70
5.93
3.76
p loym ent, incom e,
and population does
not prove that city and suburban growth are
the fortunes of the city (see A Clear Link: Central
complementary, it is uncommon to find sub­ City Employment Growth and Suburban House
urbs that are experiencing robust growth while
Values, p. 32).
the central city is in severe decline. Other
research based on data in the Philadelphia area,
CONCLUSION
In summary, city and suburban population,
however, does provide direct evidence of one
link between the city and suburban economy.
per capita real income, and employment growth
Suburban house values tend to fluctuate with in 28 MSAs in the Northeast and North Central

30


FEDERAL RESERVE BANK OF PHILADELPHIA

City and Suburban Growth: Substitutes or Complements?

regions are positively correlated, suggesting
that cities and suburbs are complements. De­
cline in central cities is likely to be associated
with slow-growing suburbs. Even if the most
acute problems associated with urban decline
do not arise in the suburbs, central city decline
is likely to be a long-run, slow drain on the
economic and social vitality of the region.
The long-run, gradual nature of the negative
effects of urban decline make it difficult to
observe, let alone mobilize support for policies
to prevent urban decline. In particular, the
negative impact may be unrecognized by sub­
urban residents because the suburb is perform­
ing so much better than its declining central city
counterpart. However, suburbs in metropoli­
tan areas with declining cities are likely to be
performing poorly when compared with other
metropolitan areas with healthy cities. Thus,




Richard Voith

suburban residents may perceive themselves as
relatively better off when compared with their
city neighbors, even though their house values
are adversely affected by the city decline.
From a policy perspective, the evidence of
complementarity suggests that both city and
suburb could improve their welfare through
cooperative actions to arrest urban decline.
These actions might include regional financing
of social service programs, regional efforts to
improve educational opportunities for children
in poor-quality school districts, and the elimi­
nation of large differences in local tax rates,
especially taxes on mobile factors such as labor.
Policies that require cooperation to achieve
long-run objectives, however, may be difficult
to forge, since there are likely to be short-run
benefits for suburban areas from central city
decline.

31

A Clear Link

BUSINESS REVIEW

SEPTEMBER/OCTOBER1992

Central City Employment Growth
and Suburban House Values
If complementarity is important, the relative health of the city should have an impact on
suburban housing markets. Expanding opportunities in the central city should increase the
value of properties that are highly accessible to the central city ,a To bring the issue of city and
suburban complementarity into sharper focus, we examined the relationship between
employment growth in the city and house prices in the suburbs.
Using data on nearly 60,000 house sales in Montgomery County, a suburb of Philadel­
phia, we measured how much more people were willing to pay for a house with good access
to downtown Philadelphia compared with similar houses with poor downtown access.b We
measured this "accessibility premium" for each year from 1970 to 1988 and found that the
premium is closely related to the level of growth in employment in the city of Philadelphia.
The figure shows the estimated premium (as a percent of house value) that residents pay
to live in a neighborhood with commuter train service to downtown Philadelphia together
with employment growth in the city .c In general, when Philadelphia employment grew, an
increase in the value of city-accessible suburban housing followed. Conversely, when
employment fell, the premium paid for accessibility fell. Coincident with an employment
decline of 18 percent from 1970 to 1977, the premium fell from more than $12,500 to a little
more than $5500.d In the subsequent seven years, the premium was relatively stable,

aIn "Transportation, Sorting and House Values," ARUEUA Journal, 19 (1991), pp. 117-37, Richard
Voith finds that the aggregate value of accessibility premiums can be very large. He estimates that the
aggregate value of the premium for train accessibility to downtown Philadelphia was almost $1.5 billion
in 1980. An easily readable summary of this study is in the July/August (1991) Business Review, in an
article entitled "Does Access to Center City Still Matter?"
bFor a description of this study, see Richard Voith, "Changing Capitalization of CBD-Oriented
Transportation Systems: Evidence from Philadelphia, 1970-1988," Journal o f Urban Economics (forthcom­
ing). This study is also available as Federal Reserve Bank of Philadelphia Working Paper 91-19.
'Regression analysis indicates that 55 percent of the movement in the premium can be explained by
employment growth alone. The findings presented here are for train accessibility, but the same qualitative
results hold for accessibility by car as well.
dFigures are in 1990 constant dollars.


32


FEDERAL RESERVE BANK OF PHILADELPHIA

City and Suburban Growth: Substitutes or Complements?

Richard Voith

Percent
15

averaging $8930. City employment declined less rapidly, 7.7 percent, but the central business district
(CBD), the major area of employment for suburban commuters, enjoyed relative success during this
period .e
The final four years we examined, 1984-1988, witnessed dramatic growth in the premium for city
accessibility, increasing from $8400 in 1984 to $20,500 in 1988. This period was marked by overall city
employment growth and rapid growth in the CBD. The increased premium for city accessibility
occurred despite dramatic suburban employment growth during this period and despite the
perception reflected in the Inquirer's editorial that events in the city do not affect the suburbs. The link
between suburban house values and city employment is one important aspect of the complementarity
between cities and suburbs.

eSee Anita Summers and Peter Linneman, "Patterns and Processes of Urban Employment Decentralization in the
U.S., 1976-1986," Wharton Real Estate Center Working Paper 75 (1990), University of Pennsylvania. They find that
employment in the Philadelphia CBD grew in the period from 1976 to 1980 and again from 1980 to 1986.




33

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RESERVE BANK OF
PHILADELPHIA
BUSINESS REVIEW Ten Independence Mall, Philadelphia, PA 19106-1574





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