Federal Tax-Transfer Policy and Intergovernmental Pre-Commitment



of the theorem since the selfish kids only partly act in the interest of the parent. The kids’
strategic incentives increase welfare, but do not yield efficiency.

For α > 0 the decentralized leadership game is related to the literature on the Samaritan
Dilemma. State governments strategically lower their own fiscal effort anticipating the “altruis-
tic” preference of the federal government to provide transfers when locally collected tax revenues
decline. The inability of the federal government to commit not to help states out establishes a
Samaritan Dilemma in our framework.

Additionally, when α > 0, the result resembles the Tragedy of the Commons here developed
in the context of fiscal federalism. The federal budget constitutes a common pool resource which
is over-utilized by lower level governments. The tax differential
τd N > 0 reflects the incentive
to shift some of the burden of financing local expenditures to residents of the neighboring state
(via uniform labor taxation).
28

It is also informative to compare the federal policy outcomes with the traditional tax com-
petition outcome (Zodrow and Mieszkowski, 1986); i.e. an equilibrium in which the federal gov-
ernment exogenously does not intervene (
τ ≡ 0 and {si 0}i=1,2). Straightforwardly, invoking
a revealed preference argument, the federal government improves upon the traditional tax com-
petition outcome both with simultaneous decision-making and with a federal pre-commitment
capacity. A state pre-commitment capacity generates higher welfare than tax competition only
if the tax base elasticity is not too low. Concretely, if
e = 0.5 welfare in the tax competi-
tion equilibrium is lower than in the equilibrium with a state pre-commitment. The reason is
that 0
.5 is the threshold value pertaining to the welfare comparison with simultaneous decision-
making, which improves upon the tax competition outcome. The argument implies that the

28 See also the literature on pork-barrel spending (Weingast et al., 1981). They assume that the cost of providing
local services is shared nationally by all taxpayers. Local governments over-provide public services which reflects
the possibility to export some of the tax burden to non-residents. In deriving the result they do not resort to an
optimizing federal government.

23



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