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Efficiency and the optimal direction of federal-state transfers

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  • Robin Boadway
  • Michael Keen

Abstract

It seems to be widely believed that the case for centralising revenue-raising is stronger than that for centralising expenditure decisions, so that federal governments should typically make transfers to lower level "state" governments. This paper argues, however, that pure efficiency considerations may plausibly point in exactly the opposite direction. This arises becauses of a "vertical" fiscal externality: the typical state may neglect the impact that its tax decisions have on the federal tax base. The optimal federal response is to internalise this distortion of state decisions by means of offsetting subsidy on the common tax base, the financing of which may plausibly require transfers from the states.
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Suggested Citation

  • Robin Boadway & Michael Keen, 1996. "Efficiency and the optimal direction of federal-state transfers," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 3(2), pages 137-155, May.
    • Handle: RePEc:kap:itaxpf:v:3:y:1996:i:2:p:137-155
    DOI: 10.1007/BF00399907
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    2. Myers Gordon M. & Papageorgiou Yorgos Y., 1993. "Fiscal Inequivalence, Incentive Equivalence and Pareto Efficiency in a Decentralized Urban Context," Journal of Urban Economics, Elsevier, vol. 33(1), pages 29-47, January.
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    5. Robin Boadway & Michael Keen, 1994. "Efficiency And The Fiscal Gap In Federal Systems," Working Paper 915, Economics Department, Queen's University.
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    Keywords

    fiscal federalism; fiscal gap;

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