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How do local governments decide on public policy in fiscal federalism? Tax vs. expenditure optimization

  • Marko Koethenbuerger


    (University of Copenhagen & CESifo)

Previous literature widely assumes that taxes are optimized in local public finance while expenditures adjust residually. This paper endogenizes the choice of the optimization variable. In particular, it analyzes how federal policy toward local governments influences the way local governments decide on public policy. Unlike the presumption, the paper shows that local governments may choose to optimize over expenditures. The result most notably prevails when federal policy subsidizes local taxation. The results offer a new perspective of the efficiency implications of federal policy toward local governments and, thereby, enable a more precise characterization of local government behaviour in fiscal federalism.

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Paper provided by Institut d'Economia de Barcelona (IEB) in its series Working Papers with number 2010/29.

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Length: 22 pages
Date of creation: 2010
Date of revision:
Handle: RePEc:ieb:wpaper:2010/9/doc2010-29
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