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Fiscal federalism, jurisdictional competition, and the size of government

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Abstract

Fiscal federalism is commonly held to reduce the size of government, but how does it do so: through shrinking the welfare state, cutting government consumption, or reducing public investment? This paper examines tax competition under fiscal federalism through the lens of imperfect competition theory, derives new empirical implications from different theories of fiscal federalism, and tests those hypotheses with new variables and data. Cross-national statistical results show that jurisdictional competition under fiscal federalism is associated with reductions in the administrative expense of government but not the size of the welfare state. Moreover, the apparent impact of fiscal federalism with a high degree of jurisdictional competition is larger than that estimated in previous research. Once the models have been appropriately specified, the United States is no longer an outlier among high-income democracies on either government consumption or social spending. Close examination of the data reveals that some fiscally federal systems better approximate a “market-preserving model” and others a “capital-privileging” or “state-corroding” model.

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Notes

  1. Recent empirical work tends to find a negative association between government consumption and growth (Fölster and Henrekson 2001; Barro 2001; Afonso and Furceri 2010). Some societies evince stronger preferences for redistribution over growth, leading to larger governments that may be optimal in a broader sense (Mirrlees 1971), but the models aim to control for these preferences.

  2. “Tax exporting”—offloading tax incidence onto nonresidents—is an example of a negative spillover that might cause decentralized systems to have overly high taxation and spending, but its importance is fairly small (Boadway and Shah 2009, 41).

  3. Fiscal federalism should reduce central government spending only when the central government decentralizes policy-setting authority to subcentral governments. Otherwise, if both central and regional governments had fully overlapping competencies, fiscal federalism would constrain only subcentral spending. I am indebted to an anonymous reviewer on this point.

  4. My source for fiscal federalism data ends in 2006.

  5. I also try using OECD data, which yields very similar results.

  6. Fiscal federalism is then aggregated into country-level scores by the following procedure. First, the most autonomous level of regional government is identified. For instance, states in the U.S. are more autonomous than counties, and county scores therefore do not count toward the United States’ score. If autonomy is symmetric in this tier, then the Fiscal federalism score of this regional tier is the score of the country. In some countries, however, some regions enjoy more autonomy than others. For instance, Scotland enjoys more autonomy than English county and metropolitan governments, which are the highest-level governments in England since there is no English regional government. In these cases, the country score is the population-weighted average of the top-tier regional scores.

  7. I have tried various means of weighting the subcomponents without appreciable differences in the estimation results presented below. I have tried eliminating Tax decentralization from the equation to get more years of data, and the results are similar (unsurprisingly, since the correlation between the two measures is 0.89). Finally, I have also tried using multiple imputation to get more years of data, and again, most of the results are quite similar, with one exception on public investment noted below. Many of these estimations are available in the online Appendix.

  8. Regional populations are measured at the earliest year in the panel to reduce endogeneity by which tax competition might affect population flows.

  9. In addition to \(H\) as defined here, I have also tried using the log of a simple count of the number of regional governments, with substantively quite similar results.

  10. Missing within-series values of expenditure and tax decentralization have been linearly interpolated for the estimations reported here. Six observations on tax decentralization are interpolated, and 89 observations on expenditure decentralization are interpolated. An alternative approach is multiple imputation, the results of which are reported in the Appendix.

  11. GDP might be endogenous. The results presented here are robust to the exclusion of GDP.

  12. If a country joins a conflict in a supportive role, then its intensity for that conflict is the conflict’s intensity divided by the number of countries with which it has joined the conflict. However, if the country is the United States, it is accorded the full intensity of each conflict it joins, since the U.S., as military hegemon, has generally contributed vastly more troops to the missions it joins than its allies.

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Correspondence to Jason Sorens.

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Sorens, J. Fiscal federalism, jurisdictional competition, and the size of government. Const Polit Econ 25, 354–375 (2014). https://doi.org/10.1007/s10602-014-9164-0

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  • DOI: https://doi.org/10.1007/s10602-014-9164-0

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