Bailouts in a Federation
The recent move towards decentralization in countries such as Spain, Hungary, and South Africa and the difficulties that central governments have had in dealing with fiscal irresponsibility on the part of regional governments in countries such as Argentina, Brazil, and India has made the study of transfer systems one of the most important areas of research in federalism today. A model of a federation is developed in which regional governments act as Nash competitors with each other but are first-movers in a Stackelberg game with the central government. The central government finds that it will maximize its expected votes by increasing transfers as regions borrow. This bail out of regional governments creates a regional soft budget constraint and results in two incentive effects, a common pool effect on tax payments and an opportunity cost effect. The soft budget constraint lowers the opportunity cost of borrowing for the region, but also increases the tax-cost since a portion of the borrowing must be paid for through increased taxes. The common property problem associated with tax payments implies that the increased tax cost must be less than the decrease in the opportunity cost (leading to excessive borrowing) unless the central government increases grants to other regions when it institutes a bailout. Somewhat surprisingly, in the latter case the additional increased taxes may increase costs enough to offset the lower opportunity cost resulting from the bailout, leading to efficient borrowing decisions as in the case of a hard budget constraint. The results are also useful for understanding the empirical estimation of soft budget constraints. Copyright Kluwer Academic Publishers 2002
If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Robin W. Boadway & Frank R. Flatters, 1982. "Efficiency and Equalization Payments in a Federal System of Government: A Synthesis and Extension of Recent Results," Canadian Journal of Economics, Canadian Economics Association, vol. 15(4), pages 613-33, November.
- Wildasin, David E., 1997.
"Externalities and bailouts : hard and soft budget constraints in intergovernmental fiscal relations,"
Policy Research Working Paper Series
1843, The World Bank.
- David E. Wildasin, 2001. "Externalities and Bailouts: Hard and Soft Budget Constraints in Intergovernmental Fiscal Relations," Public Economics 0112002, EconWPA.
- Qian, Yingyi & Roland, Gerard, 1998.
"Federalism and the Soft Budget Constraint,"
American Economic Review,
American Economic Association, vol. 88(5), pages 1143-62, December.
- von Hagen,Juergen, .
"A note on the empirical effectiveness of formal fiscal restraints,"
Discussion Paper Serie B
155, University of Bonn, Germany.
- von Hagen, Jurgen, 1991. "A note on the empirical effectiveness of formal fiscal restraints," Journal of Public Economics, Elsevier, vol. 44(2), pages 199-210, March.
- James M. Poterba & Jürgen von Hagen, 1999. "Fiscal Institutions and Fiscal Performance," NBER Books, National Bureau of Economic Research, Inc, number pote99-1.
- Massimo Bordignon, 2000. "Problems of Soft Budget Constraints in Intergovernmental Relationships: The Case of Italy," Research Department Publications 3099, Inter-American Development Bank, Research Department.
- Caplan, Arthur J. & Cornes, Richard C. & Silva, Emilson C. D., 2000. "Pure public goods and income redistribution in a federation with decentralized leadership and imperfect labor mobility," Journal of Public Economics, Elsevier, vol. 77(2), pages 265-284, August.
- Teresa Garcia-Milà & Timothy J. Goodspeed & Therese J. McGuire, 2001. "Fiscal decentralization policies and sub-national government debt in evolving federations," Economics Working Papers 549, Department of Economics and Business, Universitat Pompeu Fabra, revised May 2002.
- Andres Velasco, 1999. "A Model of Endogenous Fiscal Deficits and Delayed Fiscal Reforms," NBER Chapters, in: Fiscal Institutions and Fiscal Performance, pages 37-58 National Bureau of Economic Research, Inc.
- DelRossi, Alison F. & Inman, Robert P., 1999. "Changing the price of pork: the impact of local cost sharing on legislators' demands for distributive public goods," Journal of Public Economics, Elsevier, vol. 71(2), pages 247-273, February.
- Winer, Stanley L, 1983. "Some Evidence on the Effect of the Separation of Spending and Taxing Decisions," Journal of Political Economy, University of Chicago Press, vol. 91(1), pages 126-40, February.
When requesting a correction, please mention this item's handle: RePEc:kap:itaxpf:v:9:y:2002:i:4:p:409-421. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Sonal Shukla)or (Christopher F. Baum)
If references are entirely missing, you can add them using this form.