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Intergovernmental Fiscal Relations: The Efficiency Effect of Taxes, Transfers, and Fiscal Illusion

Author

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  • Julio López-Laborda

    (Department of Public Economics, University of Zaragoza, Gran Vía, 2, 50005-Zaragoza, Spain)

  • Antoni Zabalza

    (Department of Economic Analysis, University of Valencia, Campus dels Tarongers, 46022-Valencia, Spain)

Abstract

The purpose of this paper is to evaluate the efficiency cost of transfers. To this end, we develop a model of individual demand decisions about the provision of a regional public good that encompasses a continuum of tax—transfer scenarios to finance regional public expenditure. We assume that individuals have identical quasi-linear preferences defined over private consumption and the regional public good, that endowment income varies between individuals and regions, and that regions have different predetermined sizes. In an economy-wide resource constrained framework we show that, despite its simplicity, this model is capable of discriminating the efficiency properties of the different scenarios considered, and that the substitution of matching transfers for own-regional taxes always raises the provision of the regional public good, despite the resource-constrained nature of the exercise. The model allows very easily the analysis of equalising transfers, which we show to be distorting only when a matching element is present. We also find that, when transfers have a matching element, ‘fiscal illusion’ increases the elasticity of public good provision with respect to transfers, and suggest a potentially refutable hypothesis to identify the existence of this phenomenon.

Suggested Citation

  • Julio López-Laborda & Antoni Zabalza, 2015. "Intergovernmental Fiscal Relations: The Efficiency Effect of Taxes, Transfers, and Fiscal Illusion," Environment and Planning C, , vol. 33(1), pages 136-162, February.
    • Handle: RePEc:sae:envirc:v:33:y:2015:i:1:p:136-162
    DOI: 10.1068/c12284r
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    References listed on IDEAS

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    1. Salvador Barrios & Diego Martínez-López, 2017. "Fiscal equalization schemes and subcentral government borrowing," Chapters, in: Naoyuki Yoshino & Peter J. Morgan (ed.), Central and Local Government Relations in Asia, chapter 4, pages 130-160, Edward Elgar Publishing.
    2. Zhengyuan Wu & Qifeng Gu & Jianqiu Zeng, 2023. "Research on the Mechanism of Transfer Payment Policy on Resource Dependence of Resource-Depleted Cities," Sustainability, MDPI, vol. 15(11), pages 1-28, June.

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