Standing Tiebout on his head : Tax capitalization and the monopoly power of local governments ∗

Much of the public finance literature argues that local governments behave competitively due to residents’ ease of exit and entry. The model presented here challenges this widespread conclusion. Though it is costless to relocate to another locality, the presence of tax capitalization makes it impossible for land-owners to avoid monopolistic pricing of public services by moving; land-owners can only choose between paying the tax directly, or paying it indirectly in the form of a lower sale value for their housing if they exit. In consequence, the only real check on local governments comes through imperfectly functioning electoral channels.