Size, spillovers and soft budget constraints
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- Crivelli, E. & Staal, K. Int Tax Public Finance (2013) 20: 338. doi:10.1007/s10797-012-9230-3
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There is much evidence against the so-called “too big to fail” hypothesis in the case of bailouts to subnational governments. We look at a model where districts of different size provide local public goods with positive spillovers. Matching grants of a central government can induce socially-efficient provision, but districts can still exploit the intervening central government by inducing direct financing. We show that the ability and willingness of a district to induce a bailout and district size are negatively correlated. Furthermore, we argue that these policies can be equilibrium strategies.