FindingAug 12, 2019

Income Growth and the Distributional Effects of Urban Spatial Sorting

Victor Couture, Cecile Gaubert, Jessie Handbury, Erik Hurst
Housing prices have increased in many downtowns, and amenities have improved. The increase in downtown housing prices has driven poorer households out of downtowns. This phenomenon is reflective not only of rising income inequality, but also well-being inequality.

Since 1970, lower-income households have tended to live downtown more than middle-income households, which typically live in the suburbs. Also, on average, as households gain more income, they are more inclined to live downtown. This has long been the case and is illustrated by the U-shaped curve in Figure 1. However, as the blue line in Figure 1 reveals, something new has occurred over time that has made that U shape more pronounced: There are more wealthy households, and they are moving downtown.

What are the effects of this phenomenon? To answer that question, the authors built a model that explains spatial sorting (or where people choose to live) within a city. This model has two key features: households make residential choices based on their income, and neighborhoods change as those households rearrange themselves. For example, wealthier households not only make choices based on public amenities (like parks and schools), but also proximity to private amenities (like restaurants and entertainment venues).

Figure 1: Downtown Residential Income Propensity
Note: Table uses Census data on family income

If wealthier people move to a particular neighborhood in growing numbers, the quality of both types of amenities are likely to improve—public amenities because of increased property tax revenue, and private amenities because households have more to spend. Regarding private amenities, developers in the authors’ model build neighborhoods based on household demands, which results in differentiated neighborhoods from which households can choose to live. Households weigh the cost of living (housing, taxes, commuting, for example), with the benefits, including public and private amenities. If they value high-end restaurants and proximity to the opera hall, and they can afford the relatively higher cost of living, then households in this model will choose to live in those neighborhoods. Likewise, households that value such amenities differently will choose to live in other neighborhoods.

When it comes to the question of whether and how rising incomes of the rich can explain neighborhood change in downtowns between 1990 and 2014, the model offers a clear answer: The rising rich are primarily responsible for the changing sorting patterns by income. An influx of high-income households increases the relative demand for high-quality neighborhoods, which puts upward pressure on housing prices. This upward pressure on housing prices affects other downtown neighborhoods, presenting poorer households (who are mostly renters) with a choice: Stay in their neighborhoods and pay higher rent for amenities that they don’t necessarily value, or move to the suburbs. The rich not only get richer, but there are more of them and they enjoy a better lifestyle, while the poor, who find their income stretched by rising housing costs or who are forced to move, experience a drop in well-being.