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Federal Fiscal Constitutions ; Part I: Risk Sharing and Moral Hazard

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  • Persson, T.
  • Tabellini, G.

Abstract

Inspired by current European developments, we study equilibrium fiscal policy under alternative constitutional arrangements in a `federation' of countries. There are two levels of government: local and federal. Local policy redistributes across individuals and affects the probability of aggregate shocks, while federal policy shares international risk. Policies are chosen under majority rule. There is a moral-hazard problem: federal risk-sharing can induce local governments to enact policies that increase local risk. We investigate this incentive problem under alternative fiscal constitutions. In particular, we contrast a `horizontally-ordered' federal system like the United States (in which the federal government deals directly with individuals) with a `vertically-ordered' system like the EC (in which the federal government deals with national states). These alternative arrangements are not neutral, in the sense that they create different incentives for policy-makers and voters, and give rise to different political equilibria. A general conclusion is that centralization of functions and power can be welfare improving under appropriate institutions. This conclusion only applies, however, to the moral-hazard problem and a federation where the countries are not too dissimilar.

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Bibliographic Info

Paper provided by Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC) in its series UFAE and IAE Working Papers with number 222.93.

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Length: 37 pages
Date of creation: 1993
Date of revision:
Handle: RePEc:aub:autbar:222.93

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Keywords: tax policy ; risk;

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  1. Alesina, Alberto F & Tabellini, Guido, 1988. "Voting on the Budget Deficit," CEPR Discussion Papers 269, C.E.P.R. Discussion Papers.
  2. Wildasin, David E, 1990. "Budgetary Pressures in the EEC: A Fiscal Federalism Perspective," American Economic Review, American Economic Association, vol. 80(2), pages 69-74, May.
  3. Bureau, Dominique & Champsaur, Paul, 1992. "Fiscal Federalism and European Economic Unification," American Economic Review, American Economic Association, vol. 82(2), pages 88-92, May.
  4. Jewitt, Ian, 1988. "Justifying the First-Order Approach to Principal-Agent Problems," Econometrica, Econometric Society, vol. 56(5), pages 1177-90, September.
  5. Rogoff, Kenneth, 1985. "The Optimal Degree of Commitment to an Intermediate Monetary Target," The Quarterly Journal of Economics, MIT Press, vol. 100(4), pages 1169-89, November.
  6. Sachs, Jeffrey & Sala-i-Martin, Xavier, 1992. "Fiscal Federalism and Optimum Currency Areas: Evidence for Europe from the United States," CEPR Discussion Papers 632, C.E.P.R. Discussion Papers.
  7. Grandmont, Jean-Michel, 1978. "Intermediate Preferences and the Majority Rule," Econometrica, Econometric Society, vol. 46(2), pages 317-30, March.
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Cited by:
  1. Caillaud, B. & Jullien, B. & Picard, P., 1996. "National vs European incentive policies: Bargaining, information and coordination," European Economic Review, Elsevier, vol. 40(1), pages 91-111, January.
  2. Fausto Hernández Trillo & Alberto Díaz Cayeros & Rafael Gamboa González, 2002. "Fiscal Decentralization in Mexico: The Bailout Problem," Research Department Publications 3143, Inter-American Development Bank, Research Department.
  3. Luca Agnello & Ricardo M. Sousa, 2009. "The Determinants of Public Deficit Volatility," NIPE Working Papers 11/2009, NIPE - Universidade do Minho.
  4. Bolton, Patrick & Roland, Gerard & Spolaore, Enrico, 1996. "Economic theories of the break-up and integration of nations," European Economic Review, Elsevier, vol. 40(3-5), pages 697-705, April.
  5. Lejour, A.M., 1995. "Cooperative and competitive policies in the EU: The European Siamese twin?," Discussion Paper 1995-20, Tilburg University, Center for Economic Research.

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