State aid to communities is used for redistribution and is limited by self-selection - a wealthy household in the taxed community must not benefit from migration into the community of poor households which receives the transfer. In the community of poor households, I show that state aid should subsidize the public services for which an in-migrating wealthy household would buy a private substitute, and should tax housing; it is likely that other public services should also be taxed. However, all aid to the community of wealthy households should be lump-sum. I use these predictions to qualitatively explain the New York State educational aid formula. © 1991.
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