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A Theory of Vertical Fiscal Imbalance

  • Robin Boadway

    (Department of Economics, Queen’s University)

  • Jean-Francois Tremblay

    ()

    (Department of Economics, University of Ottawa)

This paper examines how sequential decision-making by two levels of government can result in vertical fiscal imbalances (VFI). Federal-regional transfers serve to equalize the marginal cost of public funds between regions hit by different shocks. The optimal vertical fiscal gap minimizes 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 VFI by selecting transfers that differ from the optimal fiscal gap. When the federal government can commit to its policies before regional governments select their level of expenditures, the VFI will generally be negative. In the absence of commitment, the equilibrium transfer is unambiguously larger than the optimal fiscal gap, resulting in a positive VFI. In an intertemporal setting, the VFI has implications for the sharing of debt between the federal and regional governments.

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File URL: http://ifigr.org/publication/ifir_working_papers/IFIR-WP-2006-04.pdf
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Paper provided by University of Kentucky, Institute for Federalism and Intergovernmental Relations in its series Working Papers with number 2006-04.

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Length: 47 pages
Date of creation: Apr 2005
Date of revision:
Handle: RePEc:ifr:wpaper:2006-04
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  1. David E. Wildasin, 2005. "Fiscal Competition," Working Papers 2005-05, University of Kentucky, Institute for Federalism and Intergovernmental Relations.
  2. Thiess Buettner & David E. Wildasin, 2002. "The Dynamics of Municipal Fiscal Adjustment," CESifo Working Paper Series 649, CESifo Group Munich.
  3. BOADWAY, Robin & MARCHAND, Maurice & VIGNEAULT, Marianne, 1998. "The consequences of overlapping tax bases for redistribution and public spending in a federation," CORE Discussion Papers 1998003, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  4. 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.
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  7. Hendriks, Jean & Lockwood, Ben, 2005. "Decentralization and Electoral Accountability : Incentives, Separation, and Voter Welfare," The Warwick Economics Research Paper Series (TWERPS) 729, University of Warwick, Department of Economics.
  8. Poterba, James M, 1994. "State Responses to Fiscal Crises: The Effects of Budgetary Institutions and Politics," Journal of Political Economy, University of Chicago Press, vol. 102(4), pages 799-821, August.
  9. Boadway, R & Keen, M, 1996. "Efficiency and the optimal direction of federal-state transfers," IFS Working Papers W96/01, Institute for Fiscal Studies.
  10. James Marton & David E. Wildasin, 2006. "State Government Cash and In-kind Benefits: Intergovernmental Fiscal Transfers and Cross-Program Substitution," Working Papers 2006-01, University of Kentucky, Institute for Federalism and Intergovernmental Relations.
  11. Robin Boadway & Jean-Francois Tremblay, 2006. "A Theory of Vertical Fiscal Imbalance," Working Papers 1072, Queen's University, Department of Economics.
  12. 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.
  13. Clifford J. Carrubba & Matthew Gabel & Lacey Murrah & Ryan Clough & Elizabeth Montgomery & Rebecca Schambach, 2005. "National Party Politics and Supranational Politics in the European Union: New Evidence from the European Parliament," Working Papers 2005-04, University of Kentucky, Institute for Federalism and Intergovernmental Relations.
  14. Marko Koethenbuerger, 2003. "Tax Competition in a Fiscal Union with Decentralized Leadership," CESifo Working Paper Series 943, CESifo Group Munich.
  15. David E. Wildasin, 2005. "Global Competition for Mobile Resources: Implications for Equity, Efficiency, and Political Economy," Working Papers 2005-08, University of Kentucky, Institute for Federalism and Intergovernmental Relations.
  16. Bordignon, Massimo & Manasse, Paolo & Tabellini, Guido, 1996. "Optimal Regional Redistribution Under Asymmetric Information," CEPR Discussion Papers 1437, C.E.P.R. Discussion Papers.
  17. Lockwood, Ben, 1999. "Inter-regional insurance," Journal of Public Economics, Elsevier, vol. 72(1), pages 1-37, April.
  18. Matthew Gabel & Kenneth Scheve, 2005. "Estimating the Effect of Elite Communications on Public Opinion Using Instrumental Variables," Working Papers 2005-02, University of Kentucky, Institute for Federalism and Intergovernmental Relations.
  19. J�nos Kornai & Eric Maskin & G�rard Roland, 2003. "Understanding the Soft Budget Constraint," Journal of Economic Literature, American Economic Association, vol. 41(4), pages 1095-1136, December.
  20. Clifford J. Carrubba & Matthew Gabel, 2005. "Do Governments Sway European Court of Justice Decision-making?: Evidence from Government Court Briefs," Working Papers 2005-06, University of Kentucky, Institute for Federalism and Intergovernmental Relations.
  21. Sam Bucovetsky & Michael Smart, 2002. "The Efficiency Consequences of Local Revenue Equalization: Tax Competition and Tax Distortions," CESifo Working Paper Series 767, CESifo Group Munich.
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  24. Michael Keen, 1998. "Vertical Tax Externalities in the Theory of Fiscal Federalism," IMF Staff Papers, Palgrave Macmillan, vol. 45(3), pages 454-485, September.
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  26. William H. Hoyt & J. William Harden, 2005. "MSA Location and the Impact of State Taxes on Employment and Population: A Comparison of Border and Interior MSA's," Working Papers 2005-01, University of Kentucky, Institute for Federalism and Intergovernmental Relations.
  27. Robin Boadway & Motohiro Sato, 2006. "Bureaucratic Advice and Political Governance," Working Papers 1070, Queen's University, Department of Economics.
  28. William Hoyt, 2005. "The Assignment and Division of the Tax Base in a System of Hierarchical Governments," Working Papers 2005-07, University of Kentucky, Institute for Federalism and Intergovernmental Relations.
  29. 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.
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