Working Paper Series, Department of Economics, Uppsala University
No 2004:15:
Redistribution, In-Kind Transfers and Matching Grants when the Federal Government Lacks Information on Local Costs
Sören Blomquist ()
and Luca Micheletto
Abstract: Recent literature on optimal nonlinear taxation has shown
that in models with a single level of government public provision of
private goods can help redistribution by mitigating self-selection
constraints. The aim of the present paper is to extend the analysis to a
fiscal federalism setting with two levels of government. To accomplish this
goal we start by explicitly modelling the informational asymmetry that in
our framework motivates decentralization in the first place: the lower
level is able to observe the local costs of production, which vary across
localities, but the central level does not. Then, using an extended version
of the optimal income taxation model with two ability types, we show that
even though it is the lower level that is responsible for the public
provision of private goods, in-kind transfers can still help the federal
level to redistribute between high- and low skilled individuals. Finally,
we characterize the optimal marginal tax rates, which take a different form
from that of a unitary model, and the optimal matching grants. The latter,
in particular, have a very different structure than the one derived in
previous fiscal federalism studies. We also find that it is vital to model
informational asymmetries between the central and the local level
explicitly. Models where the informational asymmetry is not explicit might
have very little to say about decentralization in economies where the local
level has an informational advantage over the central level.
Keywords: Optimal taxation; in-kind transfers; public provision of day care; fiscal federalism; (follow links to similar papers)
JEL-Codes: H21; H42; H77; (follow links to similar papers)
34 pages, October 18, 2004
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