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Efficiency and the Fiscal Gap in Federal Systems

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  • Robin W. Boadway
  • Michael Keen

Abstract

This paper investigates the efficiency argument for a vertical fiscal gap in a federation using a simple model of a central government and several identical states. Each level provides a public good to residents within its jurisdiction and finances it by taxing labour income and rents. If labour supply is fixed, there need not be a fiscal gap even if households are perfectly mobile. With variable labour supply, however, decentralized decision-making by the states will generally be inefficient because states' tax policies will affect not only their own revenues but also those of the federal government. If the federal government chooses its budgetary policy first and the states take this policy as given, federal policies can be chosen to replicate the second-best optimum. Moreover, with or without mobile households, second-best optimal federal policy involves negative federal labour tax rates and can plausibly also require a negative fiscal gap, with transfers going from the states to the federal government. Thus, on efficiency grounds, there can be no presumption that inter-governmental transfers should go from higher levels of government to lower.

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File URL: http://qed.econ.queensu.ca/working_papers/papers/qed_wp_915.pdf
File Function: First version 1994
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Bibliographic Info

Paper provided by Queen's University, Department of Economics in its series Working Papers with number 915.

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Length: 27 pages
Date of creation: Nov 1994
Date of revision:
Handle: RePEc:qed:wpaper:915

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Related research

Keywords: Fiscal Gap; Fiscal Federalism;

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Cited by:
  1. Bev Dahlby, 1996. "Fiscal externalities and the design of intergovernmental grants," International Tax and Public Finance, Springer, vol. 3(3), pages 397-412, July.
  2. Robin Boadway and Michael Keen, . "Efficiency and the Optimal Direction of Federal-State Transfers," Economics Discussion Papers 445, University of Essex, Department of Economics.
  3. Besley, Timothy J. & Rosen, Harvey S., 1998. "Vertical externalities in tax setting: evidence from gasoline and cigarettes," Journal of Public Economics, Elsevier, vol. 70(3), pages 383-398, December.
  4. Seija Parviainen, 1998. "Redistribution and Risk Sharing in EMU," Discussion Papers 159, Government Institute for Economic Research Finland (VATT).
  5. Madiès, Thierry, 2001. "Fiscalité superposée et externalités fiscales verticales : faut-il reconsidérer le débat entre concurrence et coopération fiscales?," L'Actualité Economique, Société Canadienne de Science Economique, vol. 77(4), pages 593-612, décembre.

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