Financing local public projects

Abstract

This paper studies the financing of local public projects. The setting is a community with durable housing, undeveloped land available for new homes, and population turnover. The community invests in a public project that may be financed with a mix of a tax on current residents and a debt issue. The paper shows that financing with a debt–tax mix is equivalent to pure tax finance coupled with a tax on future development whose proceeds are shared by future residents. This result has three implications. First, Ricardian Equivalence holds if and only if there would be no future development were the project purely tax financed. Second, when Ricardian Equivalence does not hold, the optimal debt level is such that the associated tax on development appropriately internalizes the negative externalities from this development. Third, when Ricardian Equivalence does not hold, the debt level preferred by current residents will be higher than optimal.