A Political Economy Theory of Partial Decentralization

44 Pages Posted: 15 Jan 2009 Last revised: 30 Jan 2009

See all articles by John William Hatfield

John William Hatfield

University of Texas at Austin

Gerard Padró i Miquel

London School of Economics & Political Science (LSE); National Bureau of Economic Research (NBER)

Date Written: December 2008

Abstract

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.

Suggested Citation

Hatfield, John William and Padro i Miquel, Gerard, A Political Economy Theory of Partial Decentralization (December 2008). NBER Working Paper No. w14628. Available at SSRN: https://ssrn.com/abstract=1327250

John William Hatfield

University of Texas at Austin ( email )

Austin, TX 78712
United States

Gerard Padro i Miquel (Contact Author)

London School of Economics & Political Science (LSE) ( email )

Houghton Street
London, WC2A 2AE
United Kingdom

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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