A POLITICAL ECONOMY THEORY OF PARTIAL DECENTRALIZATION

Authors


  • The editor in charge of this paper was Fabrizio Zilibotti.

  • Acknowledgments: We are grateful to Tim Besley, Ernesto Dal Bó, Dennis Epple, Maitreesh Ghatak, Bärd Harstad, Henrik Kleven, Torsten Persson, Andrea Prat, Ken Shotts, Jaume Ventura, Romain Wacziarg, John Wallis, Barry Weingast, David Wildasin, seminar participants at Universitat Pompeu Fabra, UC Berkeley, and Stanford, and the Editor and three anonymous referees for helpful comments. All errors are, of course, our own. Padró is a member of BREAD, CEPR, and NBER.

E-mail addresses: hatfield@stanford.edu (Hatfield); g.padro@lse.ac.uk (Padró i Miquel)

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 chooses to use redistributive capital taxes to provide public goods. The expectation of high capital taxes, however, results in a small capital stock which lowers returns to redistribution. The median voter therefore wants to commit to a lower level of capital taxes. She does so by setting a partial degree of decentralization in the Constitution. The equilibrium degree of decentralization balances the positive effect of tax competition on capital taxes with the loss in redistribution that results. We show that the degree of decentralization is nonmonotonic 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.

Ancillary