Federal Tax-Transfer Policy and Intergovernmental Pre-Commitment

CESifo Working Paper No. 2054

Federal Tax-Transfer Policy and

Intergovernmental Pre-Commitment

Abstract

Federal and state governments often differ in the capacity to pre-commit to expenditure and
tax policy. Whether the implied sequence of public decisions has any efficiency implications
is the subject of this paper. We resort to a setting which contrary to most of the literature does
not exhibit a perfect tax-base overlap. We show that a federal government's pre-commitment
capacity is welfare-improving. Efficiency, however, does not improve over all decision
margins. The welfare-increasing policy entails a more distorted level of public consumption.
Moreover, welfare may also improve if local governments are able to pre-commit towards the
upper level. The rationale is that although federal transfers are formally unconditional they
nevertheless entail a tax-price effect; thereby potentially counteracting incentives to engage in
a “race to the bottom” in fiscal competition among local governments.

JEL Code: H71, H23, H10.

Keywords: fiscal federalism, commitment, transfer policy, tax competition, common agency.

Marko Koethenbuerger

Center for Economic Studies and CESifo
at the University of Munich
Schackstr. 4

80539 Munich

Germany

[email protected]

I am grateful to numerous conference and seminar participants for constructive comments.

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