Externalities

INTRODUCTION

Zoning can be an adaptive control tool. It attempts to simplify, categorize and ultimately codify what has already occurred and what is yet to take place. It is the result of a community trying to making sense of a prohibitively complex, and constantly evolving process. Zoning can be a static tool that tends to use the communities goals of what makes the city healthy, safe, and prosperous from a rather small time period. But healthy cities are dynamic, and thus the zoning process is never fully complete. Zoning that quickly adapts can more efficiently allow the city to evolve. Yet an overly adaptive zoning code begins to unravel the certainties that give it much of its power and legitimacy — namely serving the interests of existing users by protecting property values and preserving community character. The power to preserve or adapt could be desirable to an extent, if it actually achieved these goals at minimal cost.

Economists have long argued that market exchange – where the choices of individuals reflect their own values and firms make choices to maximize their profits – will lead to an efficient allocation of scarce resources. Efficiency in this sense requires that individual buyers and sellers cannot affect the price at which exchange takes place in a market. In addition, markets must exist for all goods. If these conditions are met, markets are competitive and complete and there will be an efficient allocation of resources. In reality, these conditions are rarely met.

Sometimes the benefits of consuming a good may not accrue solely to the consumer. Others may also benefit. This is the case of positive externalities. Conversely, an individual or group may not be the sole bearer of the costs of a use or the producing a good – and a negative externality arises where the community bears a cost of producing that particular use of good which is greater than the private cost. Even if there are no market failures, the workings of the economy may produce a distribution of benefits that is perceived as inequitable. Often, this is because of the unequal distribution of wealth and of unequal opportunities.

An externality may be said to exist whenever a decision made by an individual or group has effects on others not involved in the decision. That is to say, an externality occurs whenever some activity imposes spillover costs or benefits on persons not directly involved in the activity of interest.

Negative externalities, or external diseconomies, are costs that flow outside of market transactions. Noise, air pollution, congestion, water pollution, and visual pollution, as well as blocked or otherwise altered natural light, are examples of negative externalities that lower (industrial) uses might impose on higher use (residential) land. Thus, with cumulative zoning, each zone that produces negative externalities can injure the uses in all higher zones and, in turn, can be injured by negative externalities produced in the lower zones. A resulting problem is that, in the presence of externalities that flow primarily in one direction, the market’s allocation of land to various uses will be inefficient.

The kind of market failures noted above provide the necessary conditions for public action. But public action needs to be informed when working on the effective design of public policies.

Zoning is a complex and controversial process involving competing values. An example is a property owner imposes an aesthetic externality on a neighbor by painting a fence on the shared property line hot pink and the neighbor imposes a burden on the property owner by being sensitive to the color. While most people favor reducing negative externalities affecting their enjoyment or the value of their property, there is some disagreement as to what constitutes a negative externality that needs regulating. So most people look to government intervention and the assumed consensus process to eliminate, limit, or internalize negative externalities. In addition to looking to government intervention to eliminate negative externalities, most people want government to enact rules that will encourage positive externalities, such as large yards or tree-lined streets.

ISSUES

“Externality zoning” is zoning which is in response to the phenomenon that one person’s use of land may have external effects-positive or negative-on the uses of neighboring land. The City’s zoning is cumulative, or hierarchical, all land uses are placed somewhere in a hierarchy. So called higher uses (residential) are allowed to locate in lower use zones (industrial), but not vice versa. This form of zoning is based on the belief that negative externalities flow primarily in one direction, from lower to higher land uses.

The main objective of this type of zoning is to reduce the total social cost of externality generating uses. For example, if a user (industrial) produces negative externalities which affect another user (residential), then externality zoning could restrict industrial users to a number of contiguous parcels of land reserved for such a use. This could reduce the harmful external effects of the industrial uses by minimizing the length of the boundary between conflicting uses. An industrial user, such as Madison Kipp, whose residential neighbors regularly complain about environmental issues would benefit from spatial separation and/or limited boundaries with residential uses.

Boundary effects concern the impact that higher use areas suffer from their proximity to lower use areas. Scale effects suggest that the quantity of land in the lower use affects higher uses equally throughout the relevant area; boundary effects suggest that the impact is limited spatially to a boundary strip. If negative externalities do not travel very far, then boundary effects are the more important determinant of efficient land use.

Furthermore, the definition of an optimal externality zoning policy is one which produces an economically efficient (Pareto Optimal) allocation of resources. For example, if for simplicity we neglect spatial considerations in the location of industry and assume that land is similar in quality, the optimal policy in the above example might segregate industry in a compact area and would locate this area in order to minimize its boundary with residential areas.

One of the main problems of land use is the question of the optimal use of a specific site. This should be combined with the most profitable use of that specific site. To address this problem the concept of the highest and best use is applied. The most profitable use of a site will be that which provides the highest residual to that piece of land. The residual may be calculated by subtracting the conversion cost from the present value of that piece of land. The residual may vary depending whether the site is used as a parking lot or a grocery store. The highest and best use is not necessarily the most socially desirable use because various negative and positive spillovers may arise from different land uses. The most profitable use may be to erect a grocery store on a specific site although it may not be the best in a social and ethical sense.

 “Fiscal zoning” will be defined to mean zoning which creates a different pattern of land use than externality zoning because policy-makers have an objective other than economic efficiency. For example, assume that a suburban community desires local public services of a high quality but also desires a low property tax rate. Such a community might zone vacant land in large lots for high-value commercial uses because it believes that owners of commercial developments will pay more property taxes than the cost of providing additional public services to meet their needs. In such circumstances, the possibility that a community’s vacant land might be better suited to apartments than to commercial uses would make no difference to the community. It would prefer that the land remain vacant to its being used for apartment buildings, since such a use is seen as a fiscal drain on the community. An optimal fiscal zoning policy can be defined only with reference to the community’s objectives but it will not in general lead to the same pattern of land use as would an optimal externality zoning policy.