The Political Economy of Equalization Transfers

Normative theories of fiscal federalism postulate that intergovernmental transfers should be determined by equity and efficiency considerations, to support local governments in providing differentiated public goods to heterogeneous populations, while ensuring an even distribution of basic services across all regions (Musgrave, 1959, 1983; Oates, 1972; Gramlich, 1977). However, a recent surge of empirical evidence shows that the distribution of transfers across local jurisdictions, and what local governments do with these transfers is heavily influenced by political incentives facing both national and local policy-makers. Although the notion that intergovernmental transfers, like most other public policy issues, are influenced by and interact with political institutions and processes, is far from earth-shattering, until recently there had been little attempt to internalize the political implications when analyzing the role of transfers in equalizing access to basic services for all citizens. However, the new evidence shows that politics has such substantial impact on both the distribution and use of resources for local service delivery that it cannot be avoided nor side-stepped when developing intergovernmental fiscal policies for equalization.