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Economic Risk and Political Risk in Fiscal Unions

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Author Info
Alberto Alesina
Roberto Perotti

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Abstract

A fiscal program that redistributes income from rich to poor individuals indirectly redistributes tax revenues from regions hit by a favorable shock to regions hit by an unfavorable one. Centralized fiscal redistribution has therefore been advocated as a way to insure individuals against region-specific shocks. In this paper, we argue that a centralized fiscal policy, while reducing the uncertainty on the tax base, creates uncertainty on the tax rate. This occurs because regions hit by different shocks have contrasting interests on the choice of the policy instrument. Using a simple model with two regions and linear taxes, we show that the higher uncertainty on the policy instrument might more than offset the lower uncertainty on the tax base, thus making a majority of agents in each region worse off in a centralized regime. The model is a special case of a more general idea. Heterogeneous entities can reap numerous advantages from integration: mutual insurance (on which we focus), economies of scale, more bargaining power are only a few of them. However, at the same time the same process of integration can increase the unpredictability of any endogenous policy, because more diverse entities participate in the decision-making process, and therefore the opportunities for disagreement increase. In principle, this second effect might offset the advantages of integration.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 4992.

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Date of creation: Jan 1995
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Handle: RePEc:nbr:nberwo:4992

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  1. Alberto Alesina & Ignazio Angeloni & Federico Etro, 2001. "The Political Economy of International Unions," Harvard Institute of Economic Research Working Papers 1939, Harvard - Institute of Economic Research. [Downloadable!]
    Other versions:
  2. Toshihiro Ihori & Martin McGuire, 2006. "Patterns of Non-exponential Growth of Macroeconomic Models: Two-parameter Poisson-Dirichlet Models," CIRJE F-Series CIRJE-F-450, CIRJE, Faculty of Economics, University of Tokyo. [Downloadable!]
  3. Toshihiro Ihori, 1998. "An Economic Analysis of Public Transfers," CIRJE F-Series CIRJE-F-18, CIRJE, Faculty of Economics, University of Tokyo. [Downloadable!]
  4. Marco Celentani & J. Ignacio Conde-Ruiz & Klaus Desmet, . "Endogenous Policy Leads to Inefficient Risk Sharing," Working Papers 2003-08, FEDEA. [Downloadable!]
    Other versions:
  5. Kollintzas, Tryphon & Philippopoulos, Apostolis & Vassilatos, Vanghelis, 1999. "Normative Aspects of Fiscal Policy in an Economic Union: a Review," CEPR Discussion Papers 2212, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
  6. Antonio Sciala' & Paolo Liberati, 2008. "The impact of economic openness on the vertical structure of the public sector," "Marco Fanno" Working Papers 0085, Dipartimento di Scienze Economiche "Marco Fanno". [Downloadable!]
  7. Fidrmuc, J. & Horvath, J., 1998. "Stability of monetary unions : lessons from the break-up of Czechoslovakia," Discussion Paper 74, Tilburg University, Center for Economic Research. [Downloadable!]
    Other versions:
  8. Traub, Stefan, 2003. "Federalism, Freedom of Movement, and Fiscal Equalization," Economics Working Papers 2003,06, Christian-Albrechts-University of Kiel, Department of Economics. [Downloadable!]
  9. Ignacio Ortuño Ortín & Klaus Desmet, 2006. "Rational Underdevelopment," Working Papers. Serie AD 2006-12, Instituto Valenciano de Investigaciones Económicas, S.A. (Ivie). [Downloadable!]
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  10. S. Bucovetsky, 1997. "Insurance and Incentive Effects of Transfers among Regions: Equity and Efficiency," International Tax and Public Finance, Springer, vol. 4(4), pages 463-483, November. [Downloadable!] (restricted)
  11. Stegarescu, Dan, 2004. "Economic Integration and Fiscal Decentralization : Evidence from OECD Countries," ZEW Discussion Papers 04-86, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research. [Downloadable!]
  12. Fidrmuc, Jan, 1999. "Stochastic Shocks and Incentives for (Dis)Integration," CEPR Discussion Papers 2104, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
  13. Kenneth M. Kletzer, . "Macroeconomic Stabilization with a Common Currency:," EPRU Working Paper Series 97-22, Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics. [Downloadable!]
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