Scandinavian Working Papers in Economics

Umeå Economic Studies,
Umeå University, Department of Economics

No 516: Fiscal Externalities and Asymmetric Information in an Economic Federation

Thomas Aronsson () and Magnus Wikström ()
Additional contact information
Thomas Aronsson: Department of Economics, Umeå University, Postal: S 901 87 Umeå, Sweden
Magnus Wikström: Department of Economics, Umeå University, Postal: S 901 87 Umeå, Sweden

Abstract: This paper analyzes optimal taxation and provision of public goods in an economy where tax and expenditure decisions are being made by both central and local governments. The main contribution of the paper is to address the implications of informational asymmetries, such that the central government cannot fully observe differences in local preferences. In case the differences across localities only refer to their preferences for local public goods, we show how the central government can implement the socially optimal resource allocation by means of subsidizing local provision of the federal (or central) public good. We also examine the welfare effects of such subsidies, when the socially optimal resource allocation is not a feasible policy option.

Keywords: Fiscal externalities; informational asymmetries: optimal taxation and provision of public goods

JEL-codes: D61; D62; D82; H21; H71; H77

20 pages, October 15, 1999

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