Product Differentiation and Public Education

Beginning with Tiebout (1956), numerous studies have argued that we should expect to see differences in public services among localities as a result of people “voting with their feet”. Here, we consider differentiation in public services as a way of reducing competition among localities (cities). If cities finance their public services with a property tax that generates “tax competition”, we find that adoption of quality differentiation in the public services will change the amount of services provided. If the cities maximize property values, this means a reduction in the level of public services provided for both the city that provides high quality as well as with low quality. The reduction in public services in both cities means that under certain conditions property values in both cities can increase. Thus in a two-stage game of adoption, we can observe quality differentiation in the services when the property tax is used. This is in sharp contrast to the case with a head tax in which we should never observe this type of differentiation. We believe quality differentiation might be particularly relevant to the provision of primary and secondary education. We argue that the extent of the differentiation in the quality and type of educational services provided among school districts might be in part a response to the detrimental effects of tax competition rather than entirely a “Tiebout-like” response to differences in tastes. JEL Classifications: H71, I22