Federal Tax-Transfer Policy and Intergovernmental Pre-Commitment



ping tax base.8 Additionally assuming a pre-commitment ability by the federal government9,
Boadway and Keen and Boadway et al. unravel the irrelevance of decentralized policy making
for resource allocation. With a tax base overlap the federal government replicates the unitary
state outcome by appropriately setting the federal taxes and distributing federally and locally
collected tax revenues across all levels of government (by means of federal transfers). If federal
transfers are missing, Keen and Kotsogiannis show that the federal government in general does
not replicate the unitary state policy outcome. The equilibrium may entail excessively high taxes
on the overlapping tax base. More related to this paper, Hoyt and Jensen (1996) adopt the same
tax assignment as we do. They find a positive welfare effect of a pre-commitment ability by
the federal government. The implications for the efficiency of taxes and public expenditures are
however not elaborated upon.
10

A Stackelberg leadership by lower level governments is equivalent to a common agency model.
States formally act as principals which face a common agent (the federal government). The com-
mon agency approach is initiated by Bernheim and Whinston (1986) and is subsequently applied
to issues of public finance by e.g. Dixit (1996), Dixit et al. (1997), and Rama and Tabellini
(1998). In contrast to our contribution these papers address the interaction between private
agents and the government rather than between different levels of government. Applying the
common agency approach to fiscal federalism, Caplan et al. (2000) analyze local government’s
incentives to contribute to a global public good. Therein, a pre-commitment by states enables
an efficient local policy if the federal government provides transfers so as to equalize
private con-
sumption across states.
11 The current analysis differs from the contribution by adopting a fiscal

8 In some of the contributions rents are taxed at an exogenously given rate. Strategic intergovernmental
interaction takes place in the choice of taxes levied on the overlapping tax base.

9A frequently invoked alternative terminology is “timing of decisions”. We subsequently use the terminology
“pre-commitment”.

10Hoyt (2001) considers decision-making in a federation if the tax bases may only partially overlap. Different
to this paper, neither level of government can pre-commit when selecting policy instruments (simultaneous policy
formation).

11 Koethenbuerger (2004) also adopts a common agency approach to fiscal federalism in which, similar to Caplan



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