Staff Report, Federal Reserve Bank of New York 186
In this paper, we study the question whether suburbs should help finance the core public services of their central cities. We review three arguments that have been offered in favor of suburbs’ fiscal assistance to their central cities. First, the central city provides public services that benefit suburban residents. Second, the central city may provide redistributive services to low-income central city residents that benefit suburbanites with redistributive preferences for such transfers. For efficiency, suburbanites should contribute toward such services in proportion to the benefits they enjoy. Third, the central city’s private economy may be an efficient production center because of agglomeration economies, that is, increasing returns, in the production of goods and services consumed by suburban residents. Distributive city finances—for example, rent-seeking—may undermine those economies by driving businesses or residents from the city. Suburbanites may wish to contribute toward the costs of such fiscal redistribution if those contributions reduce the number of firms and residents leaving. We examine the effects of suburban transfers in a structural model of a metropolitan economy that is consistent with the last of these explanations and with the city-suburban interdependence literature.