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Fiscal Externalities and Efficient Transfers in a Federation

  • Motohiro Sato
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    This paper investigates properties of the second best allocation in a fiscal federal system in which both federal tax and intergovernmental grants are involved and the taxation is distortionary. Also, optimal federal grants and tax policies in a decentralized fiscal system are examined. Our major findings are: (i) the second best does not require the equalization of marginal cost of public funds across regions in a conventional form; (ii) matching grants based on either the local tax rates or tax revenues should be introduced to internalize the tax externality; and (iii) once lump-sum and matching grants are optimized, federal tax policy becomes redundant so the optimal fiscal gap is indeterminate. Copyright Kluwer Academic Publishers 2000

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    Article provided by Springer in its journal International Tax and Public Finance.

    Volume (Year): 7 (2000)
    Issue (Month): 2 (March)
    Pages: 119-139

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    Handle: RePEc:kap:itaxpf:v:7:y:2000:i:2:p:119-139
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