Fiscal externalities in a three-tier structure of government

Abstract

Purpose

Federal systems are often more sophisticated than assumed in the literature. In many cases, at least three tiers of government are involved in federal decision making. The purpose of this paper is to cast some light on this increasingly important issue in fiscal federalism.

Design/methodology/approach

In a model with three tiers of government, the author analyzes corrective policies in the presence of fiscal externalities generated by federal redistribution.

Findings

The author identifies an additional qualitative incentive effect, particularly for intermediate governments. They behave strategically to attract additional redistribution funds from outside, though still using corrective policies to provide investment incentives toward their own regions. The results also suggest that differently from the USA the federal system of the EU may lead to inefficiently low regional investment.

Originality/value

The presented model is a first step toward analyzing strategic behavior and the effect of corrective policies in more complicated federal set ups with three tiers of government involved. This is relevant for federal structures such as Germany or the USA, as well as for government interactions at the international level.

Citation

Kappeler, A. (2014), "Fiscal externalities in a three-tier structure of government", Journal of Economic Studies, Vol. 41 No. 6, pp. 863-880. https://doi.org/10.1108/JES-03-2013-0033