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Public Budget Composition, Fiscal (De)Centralization, and Welfare

32 Pages Posted: 15 Feb 2007  

Calin Arcalean

ESADE Ramon Llull University - Department of Economics

Gerhard Glomm

Indiana University Bloomington - Department of Economics; CESifo (Center for Economic Studies and Ifo Institute)

Ioana C. Schiopu

ESADE Ramon Llull University - Department of Economics

Jens Suedekum

Heinrich-Heine-University Duesseldorf, Duesseldorf Institute for Competition Economics (DICE); Centre for Economic Policy Research (CEPR); CESifo (Center for Economic Studies and Ifo Institute); Institute for the Study of Labor (IZA)

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Date Written: February 15, 2007

Abstract

We present a dynamic two-region model with overlapping generations. There are two types of public expenditure, education and infrastructure funding, and governments decide optimally on budget size (tax rate) and its allocation across the two outlays. Productivity of government infrastructure spending can differ across regions. This assumption follows well established empirical evidence, and highlights regional heterogeneity in a previously unexplored dimension. We study the implications of three different fiscal regimes for capital accumulation and aggregate national welfare. Full centralization of revenue and expenditure decisions is the optimal fiscal arrangement for the country when infrastructure spending productivity is similar across regions. When regional differences exist but are not too large, the partial centralization regime is optimal where the federal government sets a common tax rate, but allows the regional governments to decide on the budget composition. Only when the differences are sufficiently large does full decentralization become the optimal regime. National steady state output is instead highest when the economy is decentralized. This result is consistent with the "Oates conjecture" that fiscal decentralization increases capital accumulation. However, in terms of welfare this result can be reversed.

Keywords: fiscal federalism, capital accumulation, infrastructure, public education

JEL Classification: E6, H5, H7

Suggested Citation

Arcalean, Calin and Glomm, Gerhard and Schiopu, Ioana C. and Suedekum, Jens, Public Budget Composition, Fiscal (De)Centralization, and Welfare (February 15, 2007). CAEPR Working Paper No. 2007-003; IZA Discussion Paper No. 2626. Available at SSRN: https://ssrn.com/abstract=963475

Calin Arcalean (Contact Author)

ESADE Ramon Llull University - Department of Economics ( email )

Av. de Pedralbes, 60-62
Barcelona, 08034
Spain

Gerhard Glomm

Indiana University Bloomington - Department of Economics ( email )

Wylie Hall
Bloomington, IN 47405-6620
United States
812-855-7256 (Phone)

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

Ioana C. Schiopu

ESADE Ramon Llull University - Department of Economics ( email )

Av. de Pedralbes, 60-62
Barcelona, 08034
Spain

HOME PAGE: http://profesores.esade.edu/ioanaschiopu

Jens Südekum

Heinrich-Heine-University Duesseldorf, Duesseldorf Institute for Competition Economics (DICE) ( email )

Universitaetsstr. 1
Duesseldorf, NRW 40225
Germany

Centre for Economic Policy Research (CEPR) ( email )

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

CESifo (Center for Economic Studies and Ifo Institute) ( email )

Poschinger Str. 5
Munich, DE-81679
Germany

Institute for the Study of Labor (IZA)

P.O. Box 7240
Bonn, D-53072
Germany

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