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Efficiency and the optimal direction of federal-state transfers

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  • Robin Boadway

    (Institute for Fiscal Studies and Queen's University, Ontario)

  • Michael Keen

    (Institute for Fiscal Studies and International Monetary Fund)

Abstract

It seems to be widely believed that the case for centralising revenue-raising is stronger than that for centralising expenditure decisions, so that federal governments should typically make transfers to lower level "state" governments. This paper argues, however, that pure efficiency considerations may plausibly point in exactly the opposite direction. This arises becauses of a "vertical" fiscal externality: the typical state may neglect the impact that its tax decisions have on the federal tax base. The optimal federal response is to internalise this distortion of state decisions by means of offsetting subsidy on the common tax base, the financing of which may plausibly require transfers from the states.

Suggested Citation

  • Robin Boadway & Michael Keen, 1996. "Efficiency and the optimal direction of federal-state transfers," IFS Working Papers W96/01, Institute for Fiscal Studies.
  • Handle: RePEc:ifs:ifsewp:96/01
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    1. Robin W. Boadway & Frank R. Flatters, 1982. "Efficiency and Equalization Payments in a Federal System of Government: A Synthesis and Extension of Recent Results," Canadian Journal of Economics, Canadian Economics Association, vol. 15(4), pages 613-633, November.
    2. Robin Boadway & Michael Keen, 1994. "Efficiency And The Fiscal Gap In Federal Systems," Working Paper 915, Economics Department, Queen's University.
    3. Wellisch, Dietmar, 1994. "Interregional spillovers in the presence of perfect and imperfect household mobility," Journal of Public Economics, Elsevier, vol. 55(2), pages 167-184, October.
    4. Brennan, G. & Pincus, J. J., 1996. "A minimalist model of federal grants and flypaper effects," Journal of Public Economics, Elsevier, vol. 61(2), pages 229-246, August.
    5. A. B. Atkinson & N. H. Stern, 1974. "Pigou, Taxation and Public Goods," Review of Economic Studies, Oxford University Press, vol. 41(1), pages 119-128.
    6. Roger H. Gordon, 1983. "An Optimal Taxation Approach to Fiscal Federalism," The Quarterly Journal of Economics, Oxford University Press, vol. 98(4), pages 567-586.
    7. Russell Krelove, 1992. "Efficient Tax Exporting," Canadian Journal of Economics, Canadian Economics Association, vol. 25(1), pages 145-155, February.
    8. Myers Gordon M. & Papageorgiou Yorgos Y., 1993. "Fiscal Inequivalence, Incentive Equivalence and Pareto Efficiency in a Decentralized Urban Context," Journal of Urban Economics, Elsevier, vol. 33(1), pages 29-47, January.
    9. Boadway, Robin, 1982. "On the Method of Taxation and the Provision of Local Public Goods: Comment," American Economic Review, American Economic Association, vol. 72(4), pages 846-851, September.
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