The Prisoner's Dilemma of the Fragmented Metropolis
Re: Cities by Contract, by Gary J. Miller
Cities by Contract, published in 1981, is about municipal annexation and incorporations in Los Angeles County from the 1950s through the 1970s. And it is a fascinating historical document that explains much about Los Angeles. In the massive land rush to Southern California starting in the 1880s, the incorporation of new towns was common. Around 1930, Los Angeles County officials began to see themselves in competition for political power and influence with city governments. In order to keep providing services to populations in unincorporated territory (and therefore have power over jobs) the County Board of Supervisors simply stopped considering applications for incorporation.
The County could not prevent existing municipalities from annexing more territory, but they could prevent new municipalities from forming. City officials protested that since all residents paid county property tax, city dwellers were being forced to subsidize services provided to the growing populations of unincorporated Los Angeles County. The state declined to intervene, the power to consider incorporations remained at the county level, and over the next 20 years, only one community in Los Angeles County successfully incorporated.
Then, in 1954, the unincorporated community of Lakewood began resisting annexation to the city of Long Beach, largely under the leadership of a real estate developer who didn’t want his holdings to be subject to Long Beach’s property tax. A member of the County board of supervisors, also a developer, found a compromise position that could permanently prevent annexation while keeping power and jobs in the hands of the county: Lakewood could incorporate, but contract out services to the county instead of providing their own services. Thus a new boom of municipal incorporations spread across Los Angeles County under the “Lakewood Plan.” This accelerated after California passed a law in 1956 allowing municipal sales taxes. After that point, communities with enough commerce could afford to contract minimal services from the county while levying no municipal property tax.
Economic Choice in a Fragmented Municipality
Much of Cities By Contract is framed as a rebuttal of economist Charles’ Tiebout’s positive case for municipal fragmentation. Miller summarizes Tiebout as follows:
The remarkable claim made by Tiebout is that giving individuals a choice in this way serves not only to reassert individual autonomy but also to restore efficient individual autonomy, that is, the invisible hand. When faced with a choice of jurisdictions, each providing a different mix of public services, the people of a metropolitan area will sort themselves out on the basis of similar tastes for public goods. Given a wide enough range of choice, no individual need live in a jurisdiction where he obtains of a set of services markedly different from what he prefers, and each jurisdiction can efficiently meet the tastes of its homogenous population.
One of Miller’s main theses is that Lakewood Plan cities were a foreshadowing of what was to come with the property tax revolt and Prop 13. In the “voice vs exit,” theory of political dissatisfaction, Prop 13 was an activation of political “voice” against property taxation. The dissatisfaction that led to Prop 13 was foreshadowed with the “exit” option: the Lakewood Plan.
Prop 13 was overwhelmingly supported by high-income, white homeowners, and opposed by renters and those who had public employees in their household. John Kenneth Galbraith called Prop 13, “a revolt of the rich against the poor.” Lakewood Plan cities, at least to begin with, were similarly about the rich escaping paying to provide public goods for those poorer than themselves. By creating socio-economically homogeneous suburbs, citizens who could afford to pay for private goods could choose to pay less for public goods.
The issue with the Tiebout hypothesis is that there is no functional pricing mechanism for public goods in a fragmented metropolis; without adequate signals from prices, market efficiencies can’t arise. Pricing is broken because each municipality gets to hoard its own tax base, even though each municipality’s prosperity is dependent upon the agglomeration effect of the metropolis as a whole. This incentivizes each fragment of the metropolis to pursue what economist James Buchanan called the “rational fiscal strategy.”
The objective for rational fiscal strategy is the maximization of per capita fiscal dividend or surplus. This translates directly into the requirement that all persons who contribute positively to the generation of fiscal surplus be kept within the club… If this is accepted, then the relative emphasis on retaining the high-income, high-wealth residents becomes obvious. If low and middle income-wealth groups withdraw from the fiscal arrangement of the city, net effects on fiscal surplus may be positive rather than negative.
Translated out of polite language: price the poor out, make your town an exclusive club for the rich, and you can afford very nice public goods while keeping taxes relatively low. Because communities of rich people can afford nicer public goods, everyone is incentivized to buy into the most expensive town they can afford, because then more of their public goods are being paid for by their richer neighbors, and their taxes can be kept lower. The Rational Fiscal Strategy actually makes suburban homes a perfect example of a Veblen Good: one for which the demand increases as the price increases.
The incentives that lead to Rational Fiscal Strategy make exclusionary zoning a no-brainer. The easiest way to create an economically homogeneous upper-class town is to mandate that housing be built to a minimum standard that’s only affordable to those residents you want to attract. Large detached dwellings with big yards are fundamentally a form of conspicuous waste. As
puts it in Too Much Yard in My Backyard:The math is simple: the more dirt you need to build a house, the more expensive the total cost of that house will be… where land is expensive, large lot size requirements force would-be homebuyers to pay, literally, for a lot of dirt that they don’t need and possibly can’t afford, regardless of the size of the home.
Yards don’t house people, yet minimum lot size regulations mandate that huge swathes of our housing-crunched cities remain devoted to land that cannot be used for homes.
A municipality being able to afford that waste signals to the affluent: move here and you will get nice public goods without having to subsidize poor people.
Much of the 20th century phenomena of suburbanization, white flight, exclusionary zoning, and perpetual under-production of housing can be understood through the incentives of municipal fragmentation and widespread adoption of the Rational Fiscal Strategy. This is the institution-scale understanding of the “Homevoter Hypothesis.” It’s not that homeowners are ruthless Machiavellian capitalists who are deeply informed about municipal policy, intentionally manufacturing a crippling housing shortage for personal financial gain. It’s that city managers and city councilors intuitively understand that if they don’t pursue the Rational Fiscal Strategy, their neighbors will. If they relax zoning and let in the poor people, the wealthy will revolt by moving to a town where their taxes don’t have to subsidize public goods for poorer neighbors. Through migration, the next town over will get nicer and richer, and their town will get shabbier and poorer. As Miller summarizes Buchanan:
Ultimately, it is as pointless to condemn a city official for following the rational fiscal strategy as it is to condemn a high-income individual from taking advantage of the existence of a city which caters to his needs. Because cities must compete for high-income individuals, as they do for business, these residents must be, along with business, the main beneficiaries of the competition for municipal resources in a fragmented governmental structure.
Under our existing method for municipal funding, there is no way out of this prisoner’s dilemma, and so liberal NIMBYs are not really wrong to rationalize away their complicity in the injustice of the housing shortage. There truly is no way their choices at the local level could have solved the problem. This is why the YIMBY theory of change is that states need to override municipal zoning. The state is capable of making decisions for the common good that municipal officials simply can’t afford to.
When the implications of Rational Fiscal Strategy are unpalatable to people engaging in it, they will adopt a false consciousness to rationalize their policy stances in a frame that aligns more with their view of themselves as good, moral people. I don’t say this is a “hah, gotcha, scumbag!” It’s just how people operate. We all want to think we’re the good guys. This is what Bernard Frieden explains in The Environmental Protection Hustle: “many growth opponents use environmental arguments to mask other motives, such as fear of property tax increases or anxieties about keeping their communities exclusive.”
Miller adds: “To the extent that housing and other development is simply displaced, it probably goes to places that are less regulated, and likely to be farther from jobs and current commercial developments. This means that the individuals who will live in them simply burn more gas to get where they need to go.” This applies at the regional level, where you get further-flung suburbs and super-commuters… and it also applies at the national level, where housing refugees from walkable cities like NYC, SF, and Boston increasingly move to regions that keep housing cheap by building abundant car-centric sprawl: the rapidly growing metro regions of Texas, Florida, North Carolina, Nevada, Arizona, etc..
Through the Rational Fiscal Strategy, municipal fragmentation is inherently a regressive policy choice. The rich get low property taxes and receive superior public goods, while the poor are taxed proportionally more for inferior public goods. Further, the Federal Aid Highway Act of 1956 and other federal subsidies propping up the American automotive industry were further regressive transfer policies, subsidizing those who could afford to buy cars and shiny new houses in brand new suburbs popping up around the country, while dispossessing the poor so their neighborhoods could be bulldozed so the highways could run straight through the city.
The mid-century housing expansion was a massive program of housing abundance to accommodate the Baby Boom. Per capita housing starts reached an all-time high around 1950, and have been on a downward trend ever since. (There was no comparable housing expansion for the echo of that boom, when the Boomers had their own children.)
This massive influx of supply kept housing affordable for the middle class. But it also shaped aesthetic preferences towards suburbia for an entire generation. When all the fancy new housing of a generation came in the suburban form, it was obvious that getting one of those fancy new houses would become a signal of status and success. The desirability of the suburbs only went up as the crime wave of the 1970s and ‘80s set in, turning inner cities into Jane Jacobs’ definition of a slum: a place where people who can afford to leave, do.
This acculturated preference for suburbia has had disastrous environmental consequences, as America’s per capita carbon emissions skyrocketed past those of all our wealthy peer nations, whose more urban populations have notably lower transportation emissions than us. It is no coincidence that our most suburban peers, Canada and Australia, most closely approach our level of waste. Per capita emissions in states with more urbanized populations, like New York, Massachusetts, and California are more comparable to countries like Japan, Germany, or Norway.
Rational Fiscal Strategy for the Central City
Miller’s concluding argument is that our method of municipal revenue collection should be replaced by some kind of state-wide collection and distribution of funds for local services. This might be a good ideal if we were to build the system from the ground up, but in the kludgeocracy we live in, where we have to duct tape solutions onto the existing system, it’s worth considering how we can move in the direction of more environmentally sound development in a world where the prisoner’s dilemma of the Rational Fiscal Strategy is unfortunately our reality.
Cities in the mid-century era tried to copy the Rational Fiscal Strategy of the suburbs by adopting suburban-style exclusionary zoning and requiring more parking, to attract suburbanites back downtown. Exclusionary zoning couldn’t possibly serve this function in the city though, as the city was already full of older and more affordable housing stock. Exclusionary zoning added after the fact could never turn the city into the kind of socio-economically homogeneous bubble that wealthy citizens wanted. Hence, cities escalated to “slum clearance” and “urban renewal” policies designed to push poorer residents out, and clear land for new developments that imitated suburbia, with its wide roads and parking lots. These still were misguided, not only in being morally heinous, but in utterly failing to achieve their objective. Slum clearance would not clear the legacy cities of their long-standing financial obligations to servicing old debt and paying out pensions of generations prior. And incumbent residents will find a way to stay near their community even if they’re poor—whether it is overcrowding into substandard housing, or pitching a tent on the sidewalk. The brand new suburbs had a clean slate for pursuing their exclusionary version of Rational Fiscal Strategy, which legacy cities cannot and should not emulate.
Trickle-down preferences are a well-observed social phenomena: upper middle class people want to copy the wealthy, middle class people want to copy the upper middle class, and so on down the line. So when those with means moved to the suburbs en masse, it became the high-status thing to do. So not only is it the Rational Fiscal Strategy for cities to appeal to wealthy residents, I would argue there is even an environmental imperative for cities to appeal to the wealthy, such that urbanist preferences trickle down culturally. This is already happening to some extent, but massive housing shortages in our most energy-efficient cities are limiting the extent to which these preferences can trickle down. San Francisco may be a great place to live if money is no object, but the city loses too many upper middle class residents to the suburbs, especially as they have children. To the average middle class family, the city becomes associated with the dystopian gap between the ultra-wealthy and the desperately poor. The way for urban preferences to trickle down to the mainstream (the middle class) then, is for the city to focus on retaining the middle class and the upper middle class.
The good news is that legacy cities which retained their older urban fabric have a natural advantage in walkability. Educated people tend to prefer walkable neighborhoods, because it is simply a better way to live. The issue is that walkable neighborhoods are scarce and unaffordable, and they have to compete against the implicit tax subsidies of municipal fragmentation and disproportionate federal subsidy for car commutes from the suburbs.
Alan Ehrenhalt’s book The Great Inversion details how affluent people began moving into the legacy cities again after the urban crime wave subsided in the ‘90s, and many poorer people began moving into suburbs with declining financial positions. From his vantage point in 2012, it looked like millennials were moving to the city for good. In 2020 though, the great COVID migration revealed a lot of millennials with kids, or about to have kids, moving to the suburbs. Many older commentators with an aesthetic and cultural preference for suburbia took this as an opportunity to say, “see, I told you so” and claim that people’s urban preferences were simply a youthful flight of fancy, and real responsible adults with families move to the suburbs. But the better explanation is that a lot of millennial parents preferred the suburbs at their current price levels. Their preference for lower housing costs, lower property taxes, and good public schools (as opposed to struggling public schools or exorbitant private school tuition) overcame their continued preference for urbanism over suburbia.
The mid-century suburban housing expansion was an optimistic and forward-looking program for its time: we believed that the future was bright, and the growing wealth of our descendants was assured. So we built lots of luxury housing. Contemporary anti-development activists often complain about new “luxury” developments being packed full of amenities the average person doesn’t need and can’t afford. But the average person in the mid-century housing boom couldn’t afford a yard and a garage and a car to park in that garage. The houses that upwardly-mobile white boomers grew up in were unprecedentedly luxurious to their parents, who had lived through the depression and war-time rationing. This was real progress, but the generation who doesn’t take it for granted is now dying out.
We see these things as ordinary symbols of middle class life today, but garages and lawns are the tangible legacy of the booming economy of post-war America. New suburbs were the luxury housing of their time. High-rises with floor-to-ceiling windows, in-unit washer and dryer, private balconies, gyms, and rooftop grills are the luxury housing of today. So here’s my case: allowing and encouraging lots of these kinds of “luxury” developments is the rational fiscal strategy for legacy cities in the 21st century, and will make tangible the booming economy that so many people aren’t feeling in their day-to-day lives.
Escalating housing quality should be a natural outcome of a society that is getting richer, as ours is. The fancy new suburbs of the 1950s did not remain unaffordable and exclusive forever. They aged and got shabby, we started taking yards and garages for granted, and the affluent people of the time moved into even newer and fancier housing. These older suburban homes eventually became “naturally occurring affordable housing.” Baked into the skepticism about “luxury housing” is a pessimism that the luxury housing of today will ever become the ordinary, unremarkable, middle class housing of the future. The best time to build a lot of luxury condo towers was 20 years ago. The second best time is now. We especially need more 3+ bedroom units, in order to keep families in the city.
The most affluent will always be able to afford to stay in the city, and part of that comes from being able to afford expensive private school tuition. Beyond the shortage of family-sized housing units, the next crucial step in keeping middle class families in the city is making urban public schools fit their needs better. And the key to that, whether people want to admit it or not, is more educational tracking. In The Sum of Small Things: A Theory of the Aspirational Class, Elizabeth Currid-Halkett points out that the new “meritocratic” elite is spending greater and greater shares of their income on education for their children, out of the anxiety that their children will slip down from their hard-won position on the class ladder. Regardless of how much research reveals that family factors and IQ account for the vast majority of a student’s academic success or failure, not school quality, parents still want their students to be at a school that sorts them into the aspirational class milieu. Even if the “better” school will not make their kid smarter, they are still eager to pay for the privilege of getting their student on the right cultural track. If they can’t afford the private school that will do that, they’ll move to the town that has a public school that does that. So the best way to keep these parents in the city is to make sure their kid will have access to a public school that does that in the city.
Focusing on building new “Affordable Housing” is a red herring. As
explains in his piece Reclaiming Affordable Housing:“Make housing more affordable” becomes “build more affordable housing.”
And while that sounds good, it’s a problem. Because “affordable housing” can mean many things, and what the government means when it says “affordable housing” is not what most voters mean when they demand that housing be more affordable. Voters want housing that’s abundant, high-quality, and affordable (as in inexpensive). But to an elected official or housing bureaucrat, “affordable housing” means housing that’s built under specific government programs, income-restricted, and—in one way or another—subsidized.
In the prisoner’s dilemma of “Rational Fiscal Strategy,” taxing more to subsidize housing for poorer people is the “cooperate” option, when all the suburbs are defecting. If we build enough “luxury housing” in San Francisco, then dated little apartments in old Victorians will become “naturally occurring affordable housing,” just as mid-century suburban tract homes did when we built lots of fancy new McMansions. These old apartments don’t even have in-unit laundry—tech workers would not be displacing the middle class from these shabby apartments if they had better options!
A more urbanized population will emit less carbon, be less lonely, get more physical activity in their day-to-day lives, and become even wealthier from urban agglomeration effects. But much of the US population currently considers urban preferences an affectation of out-of-touch coastal elites. Ironically, the best way for cities to make walkable urbanism accessible and affordable for all is to focus more on the middle class instead of the neediest populations. Urban preferences have already trickled down from the wealthy to much of the upper middle class. If we can make urban preferences normal, then we’ll enter a virtuous cycle where policy reforms to create abundance will become easier and easier.
To break through to the middle class, we first need to fix the perception that urbanism is inherently unaffordable. Preferences aren’t formed in a vacuum: they are informed by prices. We can only make urbanism preferable to the ordinary people when we make it attainable.