A new study by University of Michigan economist and MPI associate David Albouy, published in the Journal of Political Economy, finds that workers in expensive cities – including those in the Rustbelt and even hard-hit Detroit – pay a disproportionate share of federal taxes. Overall, urbanites pay 27 percent more in federal income taxes than workers with similar skills in a small city or rural area. Here’s a summary of the study.

“Workers in cities are generally paid higher wages than similarly skilled workers in smaller towns, so they’re taxed at higher rates. That may sound fair, until one considers the higher cost of living in cities, which means those higher wages don’t provide any extra buying power. The federal income tax system doesn’t account for cost of living. So the effect is that workers in expensive cities like New York, Los Angeles and Chicago pay more in taxes even though their real income is essentially the same as workers in smaller, cheaper places.

“The extra burden wouldn’t be so excessive if more federal tax dollars were returned to urban areas in the form of higher federal spending. But according to Albouy’s research, that’s not the case. His data show that more federal dollars are actually spent in rural areas, despite the fact that cities send far more cash to Washington. The net effect of all this is a transfer of $269 million from workers in high-cost areas to workers in lower cost rural areas in 2008 alone.

“Over the long haul, Albouy says, the larger tax burden causes workers to flee large urban centers in the Northeast and settle in less expensive places in the South. So to some extent, it may have been the federal tax system that put the rust on the rust belt.

“Detroit is a perfect example of a city that gets the short end of the stick.

“With its high wage levels, Detroit was, until recently, contributing far more in federal revenues per capita than most other places for over one hundred years,” Albouy said. The recent federal bailout to Detroit automakers “is peanuts relative to the extra billions the city has poured into Washington over the 20th Century.”

“Albouy says that city folk shouldn’t expect relief from this system anytime soon.

“Highly taxed areas tend to be in large cities inside of populous states, which have low Congressional representation per capita, making the prospect of reform daunting,” he writes.

The full study is here (PDF).

Even with the bursting of the housing bubble, it still costs a whole lot more to live in some places than others. New York City, Washington, D.C., L.A., and San Francisco, for example, remain much more expensive than most other U.S. cities and regions. But why?

There’s the old real estate adage: location, location, location – people pay more to be in more central and better places. But that still begs the question of what makes certain places better?

The clustering of people and firms in cities, as Jane Jacobs and Robert Lucas famously have written, surely plays a role. And successful cities seem to speed up productivity and innovation benefiting from faster rates of urban metabolism: New Yorkers, it’s often said, talk faster and walk faster than others. Some cities also benefit from higher quality of life – warm, sunny climates, great coastlines, greater scenery – and amenities like great cultural institutions and restaurants – which enable them to attract affluent, ambitious, and talented people. How to parse the relative effects of productivity and quality of life?

Fascinating new research by David Albouy of the University of Michigan does just that, creating new measures of quality of life and looking closely at the relationship between productivity and amenities. He finds that amenities really matter to the location decisions of people, and that there is a relationship between productivity and quality of life. San Francisco, L.A., New York, and Boston are some of the cities that sit atop his list of high quality of life, high productivity places.

US News and World Report has a nice summary of his research. A paper on measuring quality of life is here; another examining the relationship between quality of life and productivity, here.

In the United States, workers in cities offering above-average nominal
wages — cities with high productivity, low quality-of-life, or
inefficient housing sectors — pay 30 percent more in federal taxes
than otherwise identical workers in cities offering below-average
wages. According to simulation results, federal taxes lower long-run
employment levels in high-wage areas by 15 percent and land and housing
prices by 25 and 4 percent, leading to locational inefficiencies
costing 0.28 percent of income, or $34 billion in 2005. Indexing taxes
to local wage-levels eliminates these locational inefficiencies. Tax
deductions index taxes partially to local cost-of-living and improve
locational efficiency.

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