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

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  • Julio López-Laborda

    (Department of Public Economics, University of Zaragoza)

  • Antoni Zabalza

    (Department of Economic Analysis, University of Valencia)

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/transfers 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. 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 transfers for own regional taxes always raises the provision of the regional public good. Our model yields the so called “flypaper effect” with no need to appeal to the existence of “fiscal illusion” by the part of the individual. We nevertheless find that “fiscal illusion” increases the elasticity of public good provision with respect to transfers, and we suggest two potentially refutable hypotheses to identify the existence of this phenomenon.

Suggested Citation

  • Julio López-Laborda & Antoni Zabalza, 2012. "Intergovernmental Fiscal Relations: the Efficiency Effect of Taxes, Transfers and Fiscal Illusion," International Center for Public Policy Working Paper Series, at AYSPS, GSU paper1229, International Center for Public Policy, Andrew Young School of Policy Studies, Georgia State University.
    • Handle: RePEc:ays:ispwps:paper1229
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    References listed on IDEAS

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    1. Jorge Martinez-Vazquez & Cristian Sepulveda, 2012. "Toward a More General Theory of Revenue Assignments," International Center for Public Policy Working Paper Series, at AYSPS, GSU paper1231, International Center for Public Policy, Andrew Young School of Policy Studies, Georgia State University.
    2. Robin Boadway & Anwar Shah, 2007. "Intergovernmental Fiscal Transfers : Principles and Practice," World Bank Publications - Books, The World Bank Group, number 7171, April.
    3. Roy Bahl & Musharraf Cyan, 2011. "Tax Assignment: Does the Practice Match the Theory?," Environment and Planning C, , vol. 29(2), pages 264-280, April.
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    5. Antoni Zabalza & Julio López-Laborda, 2011. "The new Spanish system of intergovernmental transfers," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 18(6), pages 750-786, December.
    6. Mr. Ehtisham Ahmad & Mr. Giorgio Brosio & Mr. Vito Tanzi, 2008. "Local Service Provision in Selected OECD Countries: Do Decentralized Operations Work Better?," IMF Working Papers 2008/067, International Monetary Fund.
    7. Bird, Richard M., 1993. "Threading the Fiscal Labyrinth: Some Issues in Fiscal Decentralization," National Tax Journal, National Tax Association;National Tax Journal, vol. 46(2), pages 207-227, June.
    8. Bev Dahlby, 2008. "The Marginal Cost of Public Funds: Theory and Applications," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262042509, December.
    9. Gramlich, Edward M, 1969. "State and Local Governments and Their Budget Constraint," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 10(2), pages 163-182, June.
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    11. Fisher, Ronald C., 1982. "Income and grant effects on local expenditure: The flypaper effect and other difficulties," Journal of Urban Economics, Elsevier, vol. 12(3), pages 324-345, November.
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    Cited by:

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    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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