Utility profits, fiscal illusion, and local public expenditures

The main purpose of this paper has been to examine, theoretically and empirically, the effects of internal subsidization by municipal utilities on local public expenditures and tax burdens. The hypothesis was deduced that internal subsidization severs the link between public benefits received and taxes paid, creating a fiscal illusion that induces consumer-taxpayers to underestimate the actual cost of government. This in turn would lead to larger expenditure levels than would otherwise be forthcoming. This hypothesis was tested statistically with a sample of fifty-two municipalities in the state of New York which use utility profits to subsidize the general fund and sixty-four other municipalities which do not. A reduced form public expenditure model was estimated which included a dummy variable to check for any differences in expenditures, ceteris paribus, between the ‘subsidy cities’ and others. It was found that subsidy cities had larger expenditure levels, all other things equal, which adds support for the main hypothesis. It was also found that while it is possible that utility profits may be substituted for other local revenue sources, in the sample of New York municipalities studied internal subsidization is likely to have stimulated expenditures, leading to an increase in local tax collections. This result adds further support for the main hypothesis. Copyright Martinus Nijhoff Publishers 1982