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A Theory of Fiscal Imbalance

  • Robin Boadway
  • Jean-François Tremblay

This paper examines how sequential decision-making by two levels of government can result in fiscal imbalances. Federal-regional transfers serve to equalize the marginal cost of public funds between regions hit by different shocks. The optimal transfers minimize the efficiency cost of taxation in the federation as a whole. The analysis shows how the existence of vertical fiscal externalities, leading regional governments to overprovide public goods, can induce the federal government to create a fiscal imbalance by selecting transfers that differ from the optimal ones. When the federal government can commit to its policies before regional governments select their level of expenditures, the fiscal imbalance will generally be negative. In the absence of commitment, the equilibrium transfer is unambiguously larger than the optimal fiscal gap, resulting in a positive fiscal imbalance.

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Article provided by Mohr Siebeck, Tübingen in its journal FinanzArchiv.

Volume (Year): 62 (2006)
Issue (Month): 1 (March)
Pages: 1-27

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Handle: RePEc:mhr:finarc:urn:sici:0015-2218(200603)62:1_1:atofi_2.0.tx_2-o
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  1. Michael J. Keen & Christos Kotsogiannis, 2002. "Does Federalism Lead to Excessively High Taxes?," American Economic Review, American Economic Association, vol. 92(1), pages 363-370, March.
  2. Walter Hettich & Stanley L. Winer, 1986. "Vertical Imbalance in the Fiscal Systems of Federal States," Canadian Journal of Economics, Canadian Economics Association, vol. 19(4), pages 745-65, November.
  3. R. Boadway & K. Cuff & M. Marchand, 2001. "Equalization and the Decentralization of Revenue-Raising in a Federation," Department of Economics Working Papers 2001-04, McMaster University.
  4. Masayoshi Hayashi & Robin Boadway, 2001. "An empirical analysis of intergovernmental tax interaction: the case of business income taxes in Canada," Canadian Journal of Economics, Canadian Economics Association, vol. 34(2), pages 481-503, May.
  5. David E. Wildasin, 2004. "The Institutions of Federalism: Toward an Analytical Framework," Public Economics 0403006, EconWPA.
  6. Massimo Bordignon & Paolo Manasse & Guido Tabellini, 2001. "Optimal Regional Redistribution under Asymmetric Information," American Economic Review, American Economic Association, vol. 91(3), pages 709-723, June.
  7. Michael Keen & Christos Kotsogiannis, 2003. "Leviathan and Capital Tax Competition in Federations," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 5(2), pages 177-199, 04.
  8. Bev Dahlby, 1996. "Fiscal externalities and the design of intergovernmental grants," International Tax and Public Finance, Springer, vol. 3(3), pages 397-412, July.
  9. Johnson, William R, 1988. "Income Redistribution in a Federal System," American Economic Review, American Economic Association, vol. 78(3), pages 570-73, June.
  10. Robin Boadway & Jean-Francois Tremblay, 2005. "A Theory of Vertical Fiscal Imbalance," Working Papers 2006-04, University of Kentucky, Institute for Federalism and Intergovernmental Relations.
  11. Michael Smart, 1998. "Taxation and Deadweight Loss in a System of Intergovernmental Transfers," Canadian Journal of Economics, Canadian Economics Association, vol. 31(1), pages 189-206, February.
  12. Sam Bucovetsky & Michael Smart, 2006. "The Efficiency Consequences of Local Revenue Equalization: Tax Competition and Tax Distortions," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 8(1), pages 119-144, 01.
  13. Dahlby, Bev & Wilson, Leonard S., 2003. "Vertical fiscal externalities in a federation," Journal of Public Economics, Elsevier, vol. 87(5-6), pages 917-930, May.
  14. B. Dahlby & L. S. Wilson, 1994. "Fiscal Capacity, Tax Effort, and Optimal Equalization Grants," Canadian Journal of Economics, Canadian Economics Association, vol. 27(3), pages 657-72, August.
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