NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

A Political Economy Theory of Partial Decentralization

John William Hatfield, Gerard Padró i Miquel

NBER Working Paper No. 14628
Issued in December 2008
NBER Program(s):   PE   POL

We revisit the classic problem of tax competition in the context of federal nations, and derive a positive theory of partial decentralization. A capital poor median voter wants to use capital taxes to provide public goods. This results in redistributive public good provision. As a consequence, when all public goods are provided by the central government, capital taxes and public good provision are high. The expectation of high capital taxes, however, results in a small capital stock which lowers returns to redistribution. The median voter would therefore like to commit to a lower level of capital taxes. Decentralization provides such a commitment: local governments avoid using capital taxes due to the pressure of tax competition. We therefore obtain that the median voter favors a partial degree of decentralization. The equilibrium degree of decentralization is non-monotonic in inequality, increasing in the redistributive efficiency of public good provision, and decreasing in capital productivity. When public goods are heterogeneous in their capacity to transfer funds, all voters agree that goods with high redistributive capacity should be decentralized.

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Published: A POLITICAL ECONOMY THEORY OF PARTIAL DECENTRALIZATION John William Hatfield1, Gerard Padró i Miquel2 Article first published online: 5 MAR 2012 DOI: 10.1111/j.1542-4774.2012.01066.x © 2012 by the European Economic Association Issue Journal of the European Economic Association Journal of the European Economic Association Volume 10, Issue 3, pages 605–633, June 2012

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