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Efficient fiscal spending by supranational unions

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  • Simon, Jenny
  • Valasek, Justin Mattias

Abstract

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.

Suggested Citation

  • Simon, Jenny & Valasek, Justin Mattias, 2012. "Efficient fiscal spending by supranational unions," Discussion Papers, Research Unit: Economics of Change SP II 2012-305, Social Science Research Center Berlin (WZB).
  • Handle: RePEc:zbw:wzbeoc:spii2012305
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    References listed on IDEAS

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    More about this item

    Keywords

    International Unions; Efficiency; Public Goods; Redistribution; Federalism; Legislative Bargaining;

    JEL classification:

    • H77 - Public Economics - - State and Local Government; Intergovernmental Relations - - - Intergovernmental Relations; Federalism
    • H87 - Public Economics - - Miscellaneous Issues - - - International Fiscal Issues; International Public Goods
    • D71 - Microeconomics - - Analysis of Collective Decision-Making - - - Social Choice; Clubs; Committees; Associations

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