Insurance and Incentive Effects of Transfers among Regions: Equity and Efficiency
When productivity shocks across regions are less-than-perfectlycorrelated, there are gains from federation, even if the regionsare identical ex ante. For the federation to provide insurancefor these productivity shocks, it must introduce some sort of“equalizing” transfer programme among regions. But any suchtransfer programme induces a form of moral hazard as well, ifregions still have some control over their own policies. Oneof the implications of this moral hazard is that the progressivityof the overall (regional together with federal) tax system willbe increased when the federal transfer programme is expanded. Copyright Kluwer Academic Publishers 1997
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