No abstract

The paper considers a model of a federation with two heterogeneous regions that try to attract the capital by competing in capital income taxes and public investment that enhance the productivity of capital. The regions' choices determine the allocation of capital across the regions and their revenues under a tax sharing scheme. This framework allows for the examination of different approaches to fiscal equalization schemes (Boadway andFlatters, 1982, andWeingast, 2006). We show that tax competition distorts (downwards) public investments and that the equalization grants discourage public investments with a little effect on equilibrium taxes. However, the equalization schemes remain beneficial for the federation and, provided that the degree of asymmetry is small, for each region as well.

This paper studies the relationship between¯scal decentralization and electoral accountability, by analyzing how decentralization impacts upon incentive and selection e®ects, and thus on voter welfare. The model abstracts from features such as public good spillovers or economies of scale, so that absent elections, voters are indi®erent about the¯scal regime. The e®ect of¯scal centralization on voter welfare works through two channels: (i) via its e®ect on the probability of pooling by the bad incumbent; (ii) conditional on the probability of pooling, the extent to which, with centralization, the incumbent can divert rents in some regions without this being detected by voters in other regions (selective rent diversion ). Both these e®ects depend on the information structure; whether voters only observe¯scal policy in their own region, in all regions, or an intermediate case with a uniform tax across all regions. More voter information does not necessarily raise voter welfare, and under some conditions, voter would choose uniform over di®erentiated taxes ex ante to constrain selective rent diversion.¤ We are grateful to the participants of the conference on "Political Economy and Institutional Performance"

The paper considers a model of a federation with two heterogeneous regions that try to attract the capital by competing in capital income taxes and public investment that enhance the productivity of capital. The regions' choices determine the allocation of capital across the regions and their revenues under a tax sharing scheme. This framework allows for the examination of different approaches to fiscal equalization schemes (Boadway andFlatters, 1982, andWeingast, 2006). We show that tax competition distorts (downwards) public investments and that the equalization grants discourage public investments with a little effect on equilibrium taxes. However, the equalization schemes remain beneficial for the federation and, provided that the degree of asymmetry is small, for each region as well.