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Dress-up contest: a dark side of fiscal decentralization

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  • Ruixin Wang

    ()
    (CentER, Tilburg University)

  • Wendun Wang

    ()
    (Erasmus University Rotterdam)

Abstract

A `dress-up contest' is a competition for the best public image, and fiscal decentralisation can lead to such contests between local governments. In this paper we model the dress-up contest and investigate how it a effects social welfare. We show that yardstick competition (due to fiscal decentralisation) forces local governments to allocate more resources to more visible public goods (such as cash assistance) than less visible goods (such as vendor payments) and thus starts dress-up contests. The resulting distortion of resource allocation causes a structural bias in public expenditure and further hurts social welfare. To empirically verify our theoretical model, we employ U.S. state-level data from 1992 to 2008, and we estimate the panel data model using various econometric approaches. The empirical results provide strong evidence that fiscal decentralisation can lead to distortion in public expenditure arising from dress-up contests. We also find that this distortion increases the regional poverty rate.

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Bibliographic Info

Paper provided by Institut d'Economia de Barcelona (IEB) in its series Working Papers with number 2013/30.

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Length: 37 pages
Date of creation: 2013
Date of revision:
Handle: RePEc:ieb:wpaper:2013/6/doc2013-30

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Keywords: Fiscal decentralization; yardstick competition; dress-up contest; functional coefficient model;

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  1. Besley, Timothy & Case, Anne, 1995. "Incumbent Behavior: Vote-Seeking, Tax-Setting, and Yardstick Competition," American Economic Review, American Economic Association, vol. 85(1), pages 25-45, March.
  2. Bordignon, Massimo & Cerniglia, Floriana & Revelli, Federico, 2004. "Yardstick competition in intergovernmental relationships: theory and empirical predictions," Economics Letters, Elsevier, vol. 83(3), pages 325-333, June.
  3. BELLEFLAMME, Paul & HINDRIKS, Jean, 2002. "Yardstick competition and political agency problems," CORE Discussion Papers 2002029, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  4. Racine, Jeffrey S., 2008. "Nonparametric Econometrics: A Primer," Foundations and Trends(R) in Econometrics, now publishers, vol. 3(1), pages 1-88, March.
  5. Hongbin Cai & Daniel Treisman, 2005. "Does Competition for Capital Discipline Governments? Decentralization, Globalization, and Public Policy," American Economic Review, American Economic Association, vol. 95(3), pages 817-830, June.
  6. Martin Bodenstein & Heinrich Ursprung, 2001. "Political Yardstick Competition, Economic Integration, and Constitutional Choice in a Federation," CESifo Working Paper Series 501, CESifo Group Munich.
  7. Besley, Timothy & Smart, Michael, 2007. "Fiscal restraints and voter welfare," Journal of Public Economics, Elsevier, vol. 91(3-4), pages 755-773, April.
  8. Ben Zissimos & Myrna Wooders, 2003. "Public Good Differentiation and the Intensity of Tax Competition," Vanderbilt University Department of Economics Working Papers 0710, Vanderbilt University Department of Economics.
  9. Mani, Anandi & Mukand, Sharun, 2007. "Democracy, visibility and public good provision," Journal of Development Economics, Elsevier, vol. 83(2), pages 506-529, July.
  10. Janeba, Eckhard & Peters, Wolfgang, 1999. "Tax Evasion, Tax Competition and the Gains from Nondiscrimination: The Case of Interest Taxation in Europe," Economic Journal, Royal Economic Society, vol. 109(452), pages 93-101, January.
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