The Economics of Amalgamation

Small municipalities in Nova Scotia are asking tough existential questions. Earlier this year three towns voted to dissolve within a five week window: Springhill, Bridgetown, and Hantsport. Hantsport’s decision came as surprise, given their relatively healthy municipal finances, but as one supporter of the motion put it, the decision to amalgamate represented a “forward-looking” and “strategic” choice for the councilors. The trends foreseen by Hantsport come down to basic economics. In particular, two interrelated economic concepts stand out to explain why so many of Nova Scotia’s small towns are facing increasing cost pressures.

Economies of Scale

The kind of services provided by municipalities are all subject to economies of scale to varying degrees: as the scale of service grows, average or per capita costs fall until reaching a sweet spot, beyond which more scale creates rising average costs. Economies of scale are key to understanding the differing levels of market concentration by industry, and is similarly applicable to analyzing the size and concentration of political units.

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A simple way to demonstrate economies of scale in municipalities is to look at how per capita costs of basic services differ depending on scale. For example, providing a town in Nova Scotia with police and fire services, along with other administrative and counsel expenditures, costs on average $683 per capita annually. Scaling these same services up to the county level reduces the per-capita costs of every category, and cuts the annual total nearly in half to $350 per capita. Costs begin to rise again for CBRM and HRM, but never reach the highs of the town average.

These trends align with the academic literature on the subject. Most studies of Canadian municipalities find that economies of scale are mmaximized for police and fire services between a population of 20 and 50 thousand. Out-migration is, therefore, especially damaging to towns below this population range.

The Cost Disease

The cost disease is a concept that was first observed in connection to the arts. The economist William Baumol noted that musical performers were becoming more and more expensive to hire, despite little to no improvement in their productivity. One had to pay more in order to entice the musically skilled away from high productivity growth sectors of the time, such as manufacturing.

The cost disease is a defining feature of our times, as creeping changes in relative cost, and in particular rising costs of labour, force old practices and structures to break down. For instance, having home servants was once commonplace, but today is associated with luxury. For a similar reason, it’s often cheaper to buy a new home appliance than to call in a technician. In schools, teacher salaries continue to rise without matching productivity growth, too, leading to the infeasibility of the small school model and driving organizational consolidation.

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Residential Tax Burden = Total residential tax revenue ÷ Total dwelling units

The cost disease leads to similar consolidation pressures for municipalities. Nova Scotia’s municipal districts tend to have the fastest growing residential tax burdens for two reasons. First, relative to towns, they have smaller tax burdens to begin with, so a given increase implies a faster growth rate. In absolute terms, towns have the largest tax burdens by a long shot. Second, municipal districts have more mandatory expenditures, such as the education contribution, that they have little control over.

There are no short cuts to fighting the cost disease. The options can be grouped into two types: we can either accept much higher proportions of GDP going to cost diseased areas or we can find ways to adapt to changing cost structures by restructuring organizations, boosting labour productivity and finding labour-saving technologies.

Samuel Hammond is an AIMS on Campus Student Fellow who is pursuing a graduate degree in economics at Carleton University. The views expressed are the opinion of the author and not necessarily that of the Atlantic Institute for Market Studies

Against Smoking Bans in “Public Spaces”

In Canada, the government prohibits smoking in “indoor public spaces,” which, according to the law, consist of bars, restaurants, bowling alleys, etc. The term “indoor public spaces,” however, is misleading: they are public only in the sense that there are other people sharing the space, yet, many of these “indoor public spaces” are owned by private individuals. There are several reasons for protecting their right to choose whether they want a smoke-free or smoke-filled establishment.

Many complain that smoking in bars is encouraging to nonsmokers and exposes them to secondhand smoke. There are many reasons why this argument may not hold. For now, though, it is more important to focus on the demonization of smoking. By categorically prohibiting restaurant owners from allowing their customers to smoke inside, the government prevents people from doing something they may want to do, i.e. to smoke in a bar or own a bar that allows smoking). Smoking is not good or bad “in itself,” but, rather, it is only good or bad according to individual preference, including, but not limited to, the tradeoff of overall health for immediate pleasure, the terms of which some individuals would happily agree with. Moreover, there is an enormous amount of information detailing the economic, health, and social harms associated with smoking available to consumers that allows them to choose intelligently.

A popular argument for banning smoking in indoor public spaces pertains to workers’ rights: smoking indoors threatens employee health and welfare and because many workers do not have the convenience of choosing their place of employment–so the argument goes–allowing it forces them to choose between inhaling toxic cigarette fumes and unemployment.

To some extent, indoor smoking harms workers. Does that really justify banning it?

Closer examination of firm behavior demonstrates that it varies based on the economic implications of “safety.” Between 2008 and 2010, 700 construction workers died from workplace injuries in Canada. In addition, 637 individuals died in manufacturing workplaces and 329 in the transportation industry. Although these numbers may seem surprising, the theory of compensating differentials explains why outcomes in some industries differ from those in others.

According to the compensating wage differentials theory, workers are compensated by firms in a number of ways: these include wages, nonwage benefits, and working conditions. Any given individual has a set of preferences between these forms of compensation. A risk adverse employee, for instance, may be willing to give up much of his paycheck for a little more safety. Someone comfortable with risk, however, could be willing to put herself squarely in danger’s way for better pay. That some individuals are comfortable with more risk explains why construction workers, for instance, agree to work in dangerous settings: higher compensation allays most concerns, whereas lower compensation highlights them. Firms need to offer compensation for labour to attract workers—when they decrease safety, labour supply shrinks and forces the firm to boost wages. Thus, there is a positive correlation between risk and compensation. And there is no authoritatively “ideal” level of risk; instead, there is a multitude of individually preferred ones.

Thus, to attract workers, owners of establishments that allow smoking indoors would need to offer wages high enough to distract employees from the health hazard associated with working there (assuming these concerns are present). For some workers, the increase in pay would offset their health concerns. Similarly, restaurant owners must consider whether indoor smoking discourages consumers from eating at their establishment. If there is growing opposition to smoking, for example, restaurant owners must choose between allowing customers to smoke indoors and losing whatever percentage of their customer base that refuses to eat in an establishment that permits indoor smoking.

Examining both consumer and employee perspectives on smoking indoors lead to a common conclusion: laws dictating firm behavior typically enforce an arbitrary standard and ignore individual preferences. Instead, the government should allow property owners to decide what is best for their respective establishments and let people pursue their individual desires freely.

Michael Sullivan is a 2013-2014 Atlantic Institute for Market Studies’ Student Fellow. The views expressed are the opinion of the author and not necessarily the Institute

Debating Revenue-neutral Carbon Taxes

During the 2008 federal election, proposals to implement a federal carbon tax were a major point of contention. Although Canadian voters ultimately rejected the plan, the issue of carbon pricing remains at the forefront of environmental discourse. This is for good reason: climate scientists, having shown conclusively that the earth is warming, now mostly concern themselves with both the size of the effect, in addition to its primary determinants.

In 2007, the Province of British Columbia (BC) successfully implemented a carbon tax with an important feature: revenue neutrality. The government expected to generate nearly $5 billion annually via carbon taxation and, accordingly, it would reduce personal and corporate taxes by an equal amount. This, in effect, slays one substantial criticism of a carbon tax, which is that it amounts to an additional overall tax burden on individuals, families, and firms. In British Columbia, the policy managed to deter purchases of gasoline and other carbon-intensive products by nearly 10 per cent relative to the rest of Canada, without burdening British Columbians with additional taxes.

Granted, those statistics only measure the carbon that British Columbians purchase in BC. They do not consider the stories of weekend lineups at American border towns where Canadians buy cheaper gas now that the price difference is large. This phenomenon may certainly account for some of the change, but it is quite difficult to imagine this effect being substantial. How much gas must a Vancouverite purchase to justify the two-hour drive, plus the wait in line?

Carbon pricing is also part of the discussion in Atlantic Canada.

In a series of papers published in 2009, University of New Brunswick economist Joe Rugger analyzes the environmental and taxation implications of a BC-styled revenue-neutral carbon tax in New Brunswick. The study found that a tax equivalent of 7 cents per liter on gasoline, applied to all forms of fossil fuel, would reduce carbon emissions in the province by roughly 7.5 per cent. This would occur primarily through higher electricity and heating bills, in addition to consumer purchases of gasoline and oil.

Changing carbon consumption occurs because of two opposing forces. First, making gasoline more expensive creates a “price effect” that causes people to shift their consumption away from gas and towards other things. This is what people refer to when they talk about nudging consumer behavior in a direction hoped to be socially beneficial. The second effect is due to the decreased tax burden–the “wealth effect.” Here, income goes up because of a smaller tax burden. People will then tend to consume, on average, slightly more of everything, including carbon. This works in the opposite direction of the price effect. In the case of BC, it became clear that the price effect was larger than the income effect and, therefore, total consumption was less than it would have otherwise been.

This highlights a confusing irony of carbon pricing policy–anything that makes people richer will tend to mean that they consume more carbon. People should continue to prosper; however, the primary objective is reducing carbon consumption. There are also distributional effects that occur based on the form and target of the tax cuts, as well as consumption behavior. This will be the topic of a second blog post.

In sum, Canadians are becoming more environmentally conscious and they recognize the need for not only fiscal, but also ecological, prudence. In this light, carbon-pricing policies are likely to remain in public discourse. By pairing the carbon tax with associated general tax cuts, rendering it revenue neutral, British Columbia’s experiment shows that it is at least possible to deter carbon consumption, while also minimizing harmful economic effects.

With the upcoming New Brunswick election in the fall of 2014, I would not be surprised if this issue arrives on the campaign trail. Considering recent curiosity in New Brunswick about local shale gas development, this policy has the potential to become quite the wedge issue.

Michael Craig is a 2013-2014 Atlantic Institute for Market Studies’ Student Fellow. The views expressed are the opinion of the author and not necessarily the Institute