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Efficiency And The Fiscal Gap In Federal Systems


  • Robin Boadway
  • Michael Keen

    (International Monetary Fund)


This paper investigates the efficiency argument for a vertical fiscal gap in a federation using a simple model of a central government and several identical states. Each level provides a public good to residents within its jurisdiction and finances it by taxing labour income and rents. If labour supply is fixed, there need not be a fiscal gap even if households are perfectly mobile. With variable labour supply, however, decentralized decision-making by the states will generally be inefficient because states' tax policies will affect not only their own revenues but also those of the federal government. If the federal government chooses its budgetary policy first and the states take this policy as given, federal policies can be chosen to replicate the second-best optimum. Moreover, with or without mobile households, second-best optimal federal policy involves negative federal labour tax rates and can plausibly also require a negative fiscal gap, with transfers going from the states to the federal government. Thus, on efficiency grounds, there can be no presumption that inter-governmental transfers should go from higher levels of government to lower.

Suggested Citation

  • Robin Boadway & Michael Keen, 1994. "Efficiency And The Fiscal Gap In Federal Systems," Working Paper 915, Economics Department, Queen's University.
  • Handle: RePEc:qed:wpaper:915

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    Cited by:

    1. Robin Boadway & Michael Keen, 1996. "Efficiency and the optimal direction of federal-state transfers," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 3(2), pages 137-155, May.
    2. Besley, Timothy J. & Rosen, Harvey S., 1998. "Vertical externalities in tax setting: evidence from gasoline and cigarettes," Journal of Public Economics, Elsevier, vol. 70(3), pages 383-398, December.
    3. Parviainen, Seija, 1998. "Redistribution and Risk Sharing in EMU," Discussion Papers 159, VATT Institute for Economic Research.
    4. Bev Dahlby, 1996. "Fiscal externalities and the design of intergovernmental grants," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 3(3), pages 397-412, July.
    5. Madiès, Thierry, 2001. "Fiscalité superposée et externalités fiscales verticales : faut-il reconsidérer le débat entre concurrence et coopération fiscales?," L'Actualité Economique, Société Canadienne de Science Economique, vol. 77(4), pages 593-612, décembre.

    More about this item


    Fiscal Federalism; Fiscal Gap;

    JEL classification:

    • H73 - Public Economics - - State and Local Government; Intergovernmental Relations - - - Interjurisdictional Differentials and Their Effects
    • H77 - Public Economics - - State and Local Government; Intergovernmental Relations - - - Intergovernmental Relations; Federalism
    • H41 - Public Economics - - Publicly Provided Goods - - - Public Goods


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