The Implications of Inequality for Fiscal Federalism: Economic Segregation and Spatial Constraints on Redistribution
34 Pages Posted: 22 Jun 2018
Date Written: June 8, 2018
One of the central questions of public finance is the degree to which government services—and the mechanisms of collecting revenue to finance those services—should be centralized within and across political systems. To date, researchers have worked backwards from different mobility assumptions to inform their assessments of where redistribution properly should occur; I show that this exercise is incomplete without reference to the existing degree of economic concentration.
Over the decades, something of a consensus has formed in this literature that high degrees of residential mobility will undercut—indeed, make near impossible—localities’ efforts to redistribute wealth. This view has been criticized in recent years, on the grounds that for various reasons residents are not perfectly mobile, and thus—all else equal—local governments can engage in some amount of redistribution without risking the sort of “death spiral” predicted by some scholars. But both of these stories overlook or underemphasize an additional important variable: the existing level of resource inequality within the political community.
I use a simple model to show that redistribution task becomes more difficult—indeed, approaches impossibility—as economic inequality increases, regardless of one’s assumptions about levels of mobility by the rich or poor. Economic inequality has an inherent spatial dimension: so long as citizens exhibit anything short of perfect mobility (and perfect responsiveness to redistributive policy), its rise will result in an increasing geographic concentration of fiscal resources wherever states seek to assess domicile-based sources of revenue. This observation complements the existing literature by demonstrating that the case for centralizing mechanisms of revenue collection is not contingent on any given level of mobility within a system, provided that resources are unequally distributed across fiscal units.
This paper suggests that policymakers should respond to rising income inequality by shifting not only the burden but also the site of redistributive taxation. In order to achieve an efficient and equitable allocation of public goods, policymakers should respond to rising income inequality by shifting the site of taxation to occur at widely drawn fiscal units. This can take the form of either by expanding the scope of fiscal boundaries or, alternatively, through larger transfers from higher levels of government (wider fiscal units) to lower, geographically smaller governments. The existence of rising income inequality thus provides support for shifting the site of revenue collection to higher levels of government as a general policy, even as decisionmaking may be retained at local levels.
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