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Ex-post redistribution in a federation: Implications for corrective policy

  • Kothenburger, Marko

This paper analyzes whether changes in the timing of equalizing transfers to state governments necessitate an adjustment in federal corrective policy. According to the existing literature (assuming an ex-ante choice of transfers), the corrective grant is equal to the marginal damage/benefit inflicted by externality generation. When the federal government accommodates state finances ex-post, the grant differs in formula from existing prescription. Allocative federal policy corrects state policy incentives twofold. It entails a correction for the distortion in the marginal benefit of state spending (as in earlier literature) and for the distortion in the marginal cost of public funds induced by the ex-post provision of transfers. The required grant rule is generically disproportionate to the equilibrium externality (even with lump-sum taxation). Furthermore, the ex-post provision of transfers is critical for the nature of the equilibrium inefficiency. Equalizing transfers at least partly internalize consumption spill-overs, but simultaneously establishes a new source of inefficiency. As a final result, the existing prescription for allocative federal policy continues to apply if the public good is pure.

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Article provided by Elsevier in its journal Journal of Public Economics.

Volume (Year): 91 (2007)
Issue (Month): 3-4 (April)
Pages: 481-496

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Handle: RePEc:eee:pubeco:v:91:y:2007:i:3-4:p:481-496
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/505578

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