Putting a Price Tag on Government

By Robbie Shell

Whether he’s looking into Philadelphia’s tax policy, resource allocation for South Africa’s provincial governments or the European Union’s debt policy, Professor Robert Inman makes sure everyone knows the costs and consequences of their decisions.

When Robert Inman was in graduate school at Harvard in the 1960s, he and a group of students, all of whom had played college basketball, formed a semi-professional basketball team. The idea was both to keep in shape and to earn money on weekends by competing against other semi-pro teams in the Boston area.

Inman graduated and the group disbanded but not, as it turned out, for good. In 1990, Inman — professor of finance, economics, and public policy and management — received a call from one of his former teammates with news of an Amateur Athletic Union (AAU)-sponsored national basketball tournament organized according to age. Was Inman game to play in a tournament for men 45 years and older? Inman was, as were three others from the original team and an additional six players from cities around the U.S. Two members of the newly-formed 45 + team had played pro ball: Wali Jones, former starting point guard for the Philadelphia ‘76ers, and Barry Clemens, former forward for the New York Knicks.

That spring Inman’s team won the national tournament. In 1992, ’94 and ’97 they won the age 50 and over national tournament and last year in Portland, Oregon — in a tournament sponsored by Nike that was advertised around the globe — they clinched the age 55 and over world title. The competition included other U.S. teams, former members of the Soviet Union Olympic team, and players from Australia, Germany, the Netherlands, Brazil, Uruguay and Guam, among other places.

“We won the gold medal,” says Inman, a two-time AAU Master’s All-American. “It’s all a lot of fun … I get a number of little injuries, but fortunately the knees are still good.”

So what does this have to do with Inman’s reputation as one of the foremost authorities on public finance? Or, more specifically, with his work on the City of Philadelphia’s fiscal crisis, the South African government’s new constitution or the European Union’s debt policy?

Not much, except that it’s a classic Inman story line — achieving excellence in an area where long-standing commitment and concentrated effort have brought very visible results, whether it’s winning a basketball tournament as the team’s second-highest scoring forward or setting up a system to fund provincial governments in a country 8,000 miles away.

Practically speaking, what Inman does in much of his research and consulting is put price tags on the tax and spending strategies of state, local and federal governments. Government outlays — for health care, social insurance, unemployment insurance, roads, education, police protection, telecommunications, etc. — account for 40 to 60 percent of the national economy, he says. Given those figures, it’s clear that the management, or mismanagement, of taxpayers’ money can have a dramatic impact on businesses, consumers, cities, suburbs, school districts and other stakeholders.

In dealing with the 400-pound gorilla of government spending, “the question is how should taxes and debt on the financing side be handled in a way that does the least damage to the private economy, i.e. that will have the fewest disincentives on how hard you work, how much you save, where you live, how profitably you can operate your business and so forth,” says Inman. “I want to minimize those adverse effects and then spend the money in the most productive way possible.”

Suppose the city of Philadelphia wants to raise the non-resident wage tax. “I’ll say go ahead but it will cost you ‘x’ number of jobs,” says Inman. Or suppose the European Union wants to grant Italy unlimited borrowing authority. “I’ll point out that the consequences of that are ‘x’ higher interest rates. In South Africa, suppose the government wants to tax capital income. I’ll say okay but the decision will result in an exodus of capital stock.

“In the end I try to price out the tax side, measure the benefits side and then help decision makers think through the balancing of benefits and costs.”

Seventeen years ago, the city of Philadelphia offered Inman a unique opportunity to showcase his research on public finance. In 1982, at a time when Philadelphia’s taxes were the highest in the region and third highest in the U.S. and when local labor unions were clamoring for ever higher wages and better benefits, Inman was brought in as a consultant to study the city’s fiscal condition. By interpreting available statistical data on Philadelphia’s tax structure, Inman was able to show how spiraling labor costs had forced the city to keep raising taxes, which in turn had helped drive away employers and families, which in turn necessitated even higher taxes, which only added to the exodus, and so on.

Inman did similar studies in 1984, 1986 and 1988, but no one paid much attention to them until the fiscal crisis hit in 1990. “That fall, what should have been a routine borrowing to meet city expenditures until anticipated tax revenues could be collected became an international financial embarrassment,” says Inman. “Potential lenders and guarantors from the U.S., Europe and Japan all refused to lend the city its needed funding.” Philadelphia suddenly found itself facing a budget deficit of $153.5 million.

What had happened? In 1992 Inman, working with the new Rendell administration, was able to document that during the last 12 years, taxes had been raised a total of 18 times and, as a result, the city had lost approximately 125,000 jobs. “We had gone from 900,000 jobs in the mid 1970s to 700,000 by the early ‘90s,” Inman says. Some of those job losses would have occurred anyway due to the shift to a service sector and the demographic trend of more firms migrating to southern states. But the majority of those losses were caused by the tax structure. “We re-documented it in 1994, 1996 and 1998,” Inman says. “We made it very clear that the mess we had gotten ourselves into in 1990 was due to a large degree to rising costs — primarily labor but also welfare — and rising taxes.”

The Rendell administration early on decided that holding the line on taxes, and eventually reducing them, would be a centerpiece of their administrative policy. They specifically zeroed in on two particularly damaging taxes, the non-resident wage tax and the gross receipts tax. Inman showed that the non-resident wage tax caused a number of downtown professional firms to move back-office operations out to the suburbs where suburban residential employees could avoid the tax. He also documented how the gross receipts tax unfairly targeted small companies, many of whom were barely breaking even, because it taxed total sales rather than profits. As a result, many small businesses were moving out of the city or choosing not to locate there in the first place. “Rendell focused on lowering these two taxes, finally pointing Philadelphia’s tax strategy in the right direction,” Inman says.

If Inman’s work in the field of public finance can help Philadelphia, what about other cities in the U.S.? Is there a paradigm, or analytic model, that can be applied elsewhere with the same results? Inman thinks there is. He and three former graduate students — one a professor at Princeton, one at the University of Houston and another at the University of Minnesota — have already replicated the Philadelphia study in New York, Houston and Minneapolis, with similar outcomes. “Philadelphia is not unique,” says Inman. “It’s important for local governments to understand that bad tax management has very specific implications for their place in the regional and national economies.”

On November 18, 1993, South African negotiators representing both the previous apartheid government and the African National Congress (ANC) agreed to an interim constitution creating a non-racial, multiparty democratic government. The following month a special session of the South African Parliament approved this constitution, and in the country’s first democratic election, Nelson Mandela was voted president on April 27, 1994.

Later that year, nine new provinces (or states) were established in South Africa, each with a democratically elected premier and legislature.

In early 1994, Inman “received a phone call out of the blue from a person at the World Bank who had been contacted by the ANC leadership. He asked me whether, based on my research on how to pay for services through decentralized government, I could come over to South Africa and help design a way to allocate resources under the new constitution.”

Inman and two others, including a former professor of his who is now at the University of Toronto, flew to Johannesburg in April, just days after Mandela had been elected. The three met with the leadership of the ANC and also with the Financial and Fiscal Commission (FFC), a group of 18 accountants, economists, and lawyers set up by the interim constitution as a public finance oversight and review board. The FCC’s role was to make recommendations on fiscal policy to the new parliament, to provincial legislatures and to local authorities.

“Under the apartheid government, paying for and financing services had been highly centralized,” notes Inman. “When the ANC came in it was clear that there would be a major reallocation of resources away from the white elite neighborhoods toward the broad-based communities as a whole. Basically the ANC was planning to take money out of the wealthier communities through taxation and allocate it to the poorer communities through spending programs.

“Part of the original agreement between Mandela and [former South African president F.W.] De Klerk had been that the conservative white bureaucracy would not be dismantled,” Inman adds. “It took the ANC about two minutes to realize they could not implement the policies they wanted through this centralized administrative structure. Since the constitution had set up new provincial governments, the ANC decided to use these entities as an important delivery mechanism for their reallocation policies — in other words to use the provincial and local governments for the financing and provision of local services. They asked for assistance on how this might best be done.”

Inman met with the FCC in May 1994 and “started brainstorming. I came home that summer and wrote a memo to the two men running the FFC saying that if I were in your situation, here is what I would do. In September I went back to South Africa to attend a meeting of the FFC. They essentially pointed to my memo and said, ‘let’s do it.’ Quite a shock for an academic. We took the conceptual framework and spent approximately 100 hours over the next two weeks turning the theory into a practical structure of financing for the provinces. The full commission then unanimously approved it, the national legislature eventually adopted the commission’s proposal and the new permanent constitution signed off on it as well.”

Inman and his team had worked out the type and amount of taxes to be collected; a program for what monies should be paid from one level of government to the other for specific services including health care, education and rural area projects; and a financing system for welfare services. “We were creating the appropriate incentives for people to spend money wisely, a blueprint for how to send the money around, where to take it from and what or whom to give it to,” says Inman.

“What we didn’t do is tell people how to spend the money. We said, ‘if you allocate this amount of funding to education, here is the return you will get.’ ‘If you spend this amount of money on roads, you will get this amount of return.’ ‘If you decide on this tax, it will cost you this much in Rand.’ We didn’t say, ‘take this money for education and spend it on books,’ or ‘use this health care allocation to hire more nurses.’ Those decisions belong to South Africa’s elected leaders.”

Inman’s plan was implemented on the provincial level in 1996-97. He is now assisting the government in designing financing structures for South Africa’s largest city governments. A blueprint for the financing of Cape Town was finished in 1997 and another for Johannesburg last month. Still on the list are Durban and Pretoria.

In Inman’s office is a letter from South African president Nelson Mandela written last October and thanking Inman for helping to arrange a semester of business courses for two ANC members. One of those visitors, Ketso Gordhan, has recently been appointed CEO of the Johannesburg Metropolitan Government. “It’s a wonderful letter,” says Inman, “and it shows just how personable Mandela is. At the end of the correspondence he congratulates us for having once again been chosen the number one business school.”

In 1996, Inman and a colleague analyzed current debt behavior of U.S. states in an effort to determine whether balanced budget rules can in fact act as a brake on deficit behavior. (U.S. state governments, with the exception of Vermont, are required to balance their general fund budget in each fiscal year.)

Inman’s study, based on deficit spending data from 1970 to 1991, found that these balanced budget rules are indeed effective provided they satisfy three conditions: The rules must be based on ex post accounting (i.e. budget officials have to show at the end of the fiscal year that income from taxes does not exceed spending); must be constitutionally-grounded (i.e. can’t be changed except by referendum or two/thirds majority vote of the legislature); and must be enforced by an independent political body with significant penalties for non-compliance. “States that did not meet these criteria were running deficits five to ten percent larger than those that were,” says Inman. Put another way, in states where these conditions were met, the chance of an annual deficit fell from one in four to one in ten.

In one of those interesting, almost serendipitous, connections that Inman seems to experience on a surprisingly regular basis, his study was picked up by a German research group involved in the development of balanced budget rules for the Economic Monetary Union. A prohibition against excessive deficits over the long run had been a key issue in the debate over entrance into the EU for a number of years.

Specifically, countries seeking admission to the EU are required to meet four criteria. The first three criteria are targets for inflation, exchange rate and interest rate performance — all designed to force monetary stability, Inman says.

The fourth criterion seeks to ensure price stability by requiring that a member country’s overall budget deficit for each fiscal year be equal to or below 3 percent of GDP and that the stock of gross public debt be equal to or less than 60 percent of GDP.

Deficits clearly have to be kept under control for several reasons, says Inman: First, if a country’s level of public debt becomes unsustainable, other members could be politically obligated to bail out a member in crisis; second, a failure to effect a bail-out could lead to a community-wide banking and financial crisis. Third, excessive borrowing by one member could raise government interest rates elsewhere in the Community.

For all these reasons, Inman says, the incentive existed for EMU members to regulate each other’s deficit behaviors through an EMU-imposed and enforced balanced budget rule.

In June 1996, Inman was invited to a forum in Kiel, Germany, with a group of academics, politicians and bankers from all over Europe. The meeting was attended by the deputy director of the Center for European Policy Studies in Brussels who subsequently adopted Inman’s conceptual framework and, with Inman’s support, used it to argue against the deficit rules that had already been proposed for the EU.

Inman and his colleague concluded that the EU’s balanced budget rules fell short of being a fully effective deficit constraint because they failed to meet the third criterion that Inman had laid out in his paper on U.S. debt behavior: they lacked a real enforcement mechanism that would set in motion clearly specified sanctions against the offending country once a certain deficit threshold had been passed. (In the U.S. the usual sanction for excessive deficits is the transfer of budget authority from the profligate legislature to a court or independent agency.)

Furthermore, EU member countries which run very large deficits — “so large that they pose a threat to EU price stability” — should after review be excluded from the economic policy-making bodies of the EMU. “The bottom line is that you have to have a credible penalty at the back end in order to ensure compliance,” says Inman.

Inman, who grew up in Chicago, earned three degrees from Harvard: a BA in economics, a master’s in education and a PhD in economics. “Initially I had wanted to teach high school, but after I worked at Harvard for two years as an admissions and financial aid officer, I became interested in universities,” says Inman, who is the father of two sons, ages 26 and 29, both of whom are Penn grads and both of whom beat him regularly in family basketball games. “My boss told me that if I wanted a job at a university I would have to get a PhD.” Inman wrote his dissertation on the public financing of education. In 1971 he joined Penn as an assistant professor of public policy and economics, and in 1981 moved over to Wharton as a professor of finance, economics and public policy and management.

His research, which focuses on public finance, political economy and urban fiscal policy, tends to show up in an unusually wide variety of venues. For example:

  • A 1998 Business Week item cited a study co-authored by Inman called “Changing the Price of Pork: The Impact of Local Cost Sharing on Legislators’ Demands for Distributive Public Goods.” The paper, published for the National Bureau of Economic Research, analyzed a 1986 law that required local governments to pay for a larger share of big water projects. The law resulted in a 35 percent drop in overall spending, along with a 48 percent drop in federal outlays to the states.“Before 1986, mayors, governors, commissioners and others would routinely ask their local congressional representatives for a new dam, water harbor or whatever, and then the representative would insert it in the water bill and the federal government would pay for virtually all of it,” says Inman. “The 1986 bill required local governments to cover 30 to 50 percent of these costs. All of a sudden, these requests either stopped or were directed to much smaller projects … Simply stated, the message is that if someone gives you something for free you want a lot of it. If you have to pay for a portion of that something, you want less.”
  • In 1997, a report entitled “Do Immigrants Impose a Net Fiscal Burden?” — written by Inman while he was a National Academy of Sciences panelist advising Congress on U.S. immigration policy — received extensive coverage in the New York Times and other news organizations. “Immigration has always been a highly politicized issue,” says Inman. “What we did was bring some systematic thinking to the numbers debate as to the true fiscal cost that immigrants impose on a community. For example, we showed that California taxpayers really do bear a disproportionate burden because of the large influx of low-skilled immigrants into the state. This is now an accepted fact. Before this study it wasn’t. So the debate can now turn to the substantive question of whether or not we should give assistance to states that may be unfairly burdened by our national immigration policy.”
  • In 1995, Inman completed a study called “Do You Know How Much Money Is in Your Public Purse?” which analyzed, among other things, the California state pension system. “I looked at the subject of hidden debt — i.e. the practice of city and state governments borrowing money without letting the taxpayers really know what is going on. Pensions are a classic example,” Inman says. “There are no federal rules that protect the funding of state plans. That has led to states borrowing money to pay for current services against the money that they should be saving for their public employee pension plan. The result is that many state’s pension plans are seriously underfunded.”
  • Inman has consulted with dozens of businesses and organizations, ranging from the RAND Corp. and the U.S. Department of Education to the National Multiple Sclerosis Society, the City of Bridgeport, Conn., and the Federal Reserve Bank of Philadelphia. He has been a visiting professor at Stanford, Berkeley, Chulalongkorn University in Thailand and Australian National University and is currently an associate member of the Institute of Fiscal and Monetary Policy, Ministry of Finance, Japan. He has recently been awarded the Fulbright’s Florence Chair to give lectures on political economy at the European University Institute in Florence, Italy.

In the midst of this diversity of interests, research projects and practical applications, Inman sees “a reassuring consistency to all my work, which is that I have always sought to bring economists and political scientists together to debate all the issues that we have talked about. So now economists are more interested in the political process, and political scientists are more interested in the economic implications of public policy. To have been part of this intellectual evolution, this coming together of two disciplines, has been enormously satisfying.

“But there is always more to do. Just as I have been striving to develop a behavioral theory of public finance, my colleagues in the finance department are developing behavioral theories of corporate finance. There is a useful intellectual merger here. The goal should be a single, encompassing view for how all organizations — public or private — can best raise and invest resources for the long-term.”

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