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