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 τ^d -τ^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.

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