The Local Public Finance of Climate Adaptation Investment
The Case of Beach Nourishment
Avon, North Carolina faces a serious beach erosion challenge. Chris Flavelle has written an excellent New York Times piece about the challenge. In this post, I’d like to focus on the local public finance challenge of playing defense against Mother Nature.
In any investment decision, one bears a certain upfront cost in returns for an uncertain stream of future benefits. This dynamic tradeoff arises in deciding whether to buy a new car, to attend Harvard, to move to Fresno, or to get a facelift or to invest in beach nourishment.
An interesting feature of investing in local beach nourishment is that it is a local public good. The same beach dunes protect many nearby homes.
A potential free rider problem arises. Each local home owner would like to receive the benefits of the protection without paying for it! How could this arise? I can think of two scenarios. First, a geographic area may be favored by the Federal Government. President Biden’s government is handing out large sums of $. I can imagine that a politically connected local government official could convince friends in the Federal government to transfer $ to pay for the area’s defense. While this benefits the locals, there is a social cost to these funds. Somebody’s taxes (either now or your children’s taxes) will be raised in the future to pay this debt.
A second way for local residents to have someone else pay for their local defense is to introduce a progressive local tax such that the richest homeowners in the area pay the largest share of the taxes. Imagine a beach community featuring 98 middle classes homes of $200,000 each and 2 homes each worth $10 million dollars.
A $1,000 a year tax on each resident would raise $100,000 in $ to spend on beach protection.
In contrast a .5% new tax on market property value would raise $500 a year from each of the 98 middle class people and $500,000 from each of the two rich people. Add up this new revenue and this yields; 98*500 + 2*500000 = 1049000. It is immediately obvious that this local democracy will vote for the progressive tax because it yields more total revenue and it lowers the average tax bill to the middle class while still paying for the defense.
In a dynamic game, have the two rich home owners “been robbed”? The interesting economics here is whether when they bought their home did they anticipate the extent of the sea level rise challenge? Did they anticipate that the median voter in the area would vote for beach protection by taxing the local rich? If they anticipated this dynamic, then they would have bid less aggressively for the home in the first place.
In real estate markets, people flip “two sided coins”. When home prices rise, the owners of the home are richer. When home prices decline, the owners are poorer. They choose to take on this risk. The opportunity cost is that they could have rented in Avon and invested their money in a diversified mutual fund.
When we bailout coastal home owners, asset owners are implicitly owning “one sided coins”. If home prices rise, they gain and if home prices fall (because of emerging risks) tax payers bail them out. I don’t support this moral hazard economy. We will be better able to adapt to climate change if home buyers are treated as “adults” and have incentives to do their homework about researching emerging risks and if they sense emerging risks that local communities of affected asset owners work together to invest in mutually beneficial local public goods.
I recognize that some will say; “Wait, there are middle class senior citizens who cannot afford to pay from their Social Security pension the new dune climate tax that will pay for the beach nourishment.” This claim is fortunately false. This claim was used in the 1970s to justify California’s Proposition 13 and this capped property taxes for incumbents and this was a huge windfall for mostly white incumbent home owners.
In our age of improved financial markets, there are many ways to obtain a home equity loan. Seniors could use this strategy to extract $ from their home so they can pay their dune nourishment tax. In the language of economics, they are not liquidity constrained.
If the logic of this post appeals to you, read my new 2021 Yale Press book Adapting to Climate Change. This is the microeconomics of adapting to the new challenge.
Selected by Publishers Weekly as one of its Top Ten books in Business and Economics for Spring 2021