Decentralization with porous borders: public production in a federation with tax competition and spillovers

Abstract

We analyze the strategic interaction of regional and federal governments using a model that includes fiscal externalities in the form of interregional capital tax competition and technical externalities in the form of interregional spillovers. The federal government aims to correct for these inefficiencies using a transfer system. If the regional governments are policy leaders (such that federal policy is set conditional on regional choices), they will internalize both fiscal and technical externalities but free-ride on the transfer system. Efficiency can be achieved by introducing a second transfer scheme that is independent of regional public production. If the federal government sets its policy first and can commit itself to it, the outcome is efficient only if matching grants are used that are financed outside of the transfer system.

The welfare costs of Tiebout sorting with true public goods

“…spills back"(Bloch & Zenginobuz 2015, Armbruster & Hintermann 2018. Jurisdictional choice externality as a function of spillovers and congestion…”

“…For the special case of positive spillovers that are proportional to a fixed capital stock,Ogawa & Wildasin (2009) show that local policy choices are efficient. However, if capital supply is elastic, the decrease in spillovers from other regions is smaller, making it optimal for regional governments to choose tax rates that are lower than what would be socially optimal(Eichner & Runkel 2012) Armbruster & Hintermann (2018). add a federal government and discuss the conditions under which the outcome is efficient.…”