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Efficient fiscal spending by supranational unions

  • Simon, Jenny
  • Valasek, Justin Mattias

We use a novel approach to address the question of whether a union of sovereign countries can efficiently raise and allocate a budget, even when members are purely self-interested and participation is voluntary. The main innovation of our model is to explore the link between budget contributions and allocation that arises when countries bargain over union outcomes. This link stems from the distribution of bargaining power being endogenously determined. Generically, it follows that unstructured bargaining gives an inefficient result. We find, however, that efficiency is achieved with fully homogenous countries, and when countries have similar incomes and the union budget is small. Moreover, some redistribution arises endogenously, even though nations are purely self-interested and not forced to participate in the union. A larger union budget, however, entails a tradeoff between equality and efficiency. We also analyze alternative institutions and find that majority rule can improve efficiency if nations who prefer projects with high public good spillovers are endogenously selected to the majority coalition. Exogenous tax rules, such as the linear tax rule in the EU, which is designed to increase efficiency on the contribution margin, can also improve overall efficiency despite decreasing the efficiency of the allocation of funds.

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Paper provided by Social Science Research Center Berlin (WZB) in its series Discussion Papers, Research Unit: Economics of Change with number SP II 2012-305.

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Date of creation: 2012
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Handle: RePEc:zbw:wzbeoc:spii2012305
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  1. Nash, John, 1950. "The Bargaining Problem," Econometrica, Econometric Society, vol. 18(2), pages 155-162, April.
  2. Philippe Aghion & Patrick Bolton, 2003. "Incomplete Social Contracts," Journal of the European Economic Association, MIT Press, vol. 1(1), pages 38-67, 03.
  3. Giovanni Maggi & Massimo Morelli, 2003. "Self Enforcing Voting in International Organizations," NBER Working Papers 10102, National Bureau of Economic Research, Inc.
  4. Conley, John P. & Wilkie, Simon, 1996. "An Extension of the Nash Bargaining Solution to Nonconvex Problems," Games and Economic Behavior, Elsevier, vol. 13(1), pages 26-38, March.
  5. Lockwood, Ben, 1998. "Distributive Politics and the Costs of Centralization," CEPR Discussion Papers 2046, C.E.P.R. Discussion Papers.
  6. B�rd Harstad, 2005. "Majority Rules and Incentives," The Quarterly Journal of Economics, MIT Press, vol. 120(4), pages 1535-1568, November.
  7. Besley, Timothy & Coate, Stephen, 2003. "Centralized versus decentralized provision of local public goods: a political economy approach," Journal of Public Economics, Elsevier, vol. 87(12), pages 2611-2637, December.
  8. Bård Harstad, 2007. "Harmonization and Side Payments in Political Cooperation," American Economic Review, American Economic Association, vol. 97(3), pages 871-889, June.
  9. Mas-Colell, Andreu & Whinston, Michael D. & Green, Jerry R., 1995. "Microeconomic Theory," OUP Catalogue, Oxford University Press, number 9780195102680, March.
  10. Lin Zhou, 1997. "The Nash Bargaining Theory with Non-Convex Problems," Econometrica, Econometric Society, vol. 65(3), pages 681-686, May.
  11. Herrero, Maria Jose, 1989. "The nash program: Non-convex bargaining problems," Journal of Economic Theory, Elsevier, vol. 49(2), pages 266-277, December.
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