Crime and Racial Composition in Contiguous Communities as Negative Externalities: Prejudiced Household's Evaluation of Crime Rate and Segregation Nearby Reduces Housing Values and Tax Revenues

Abstract . How the level of amenities in surrounding communities affects the residential location decisions of households is considered. The amenities specifically taken into account are the crime and racial composition of the household's community and the contiguous communities. The theory of the household's valuation of neighborhood amenities through a housing value equation is expanded to include how the household's valuation of amenities is affected by the amenities in surrounding areas. An empirical model using data for 71 suburban communities in the Chicago Standard Metropolitan Statistical Area is specified to measure the simultaneous interaction between housing values, crime, and police effort. A revenue equation is included to determine how the household's valuation of crime and racial composition could affect the community's revenue-raising ability. The empirical results indicate that the crime and racial composition of surrounding communities as well as within the household's community have a statistically significant negative effect on housing values. While the magnitude of the effect is small, the empirical results suggest that households consider the crime rate and racial composition of surrounding communities as negative externalities.