Lecture 8 - Decentralisation of government

Question 1

What is the purpose of decentralised gov? Cite 4 theories with authors

Answer 1

• Tiebout: provision of local public goods
• Oates: maximisation of social welfare better than central gov, except when spillover effects
• Brennan & Buchanan: constraining expansionary tendencies of gov due to more accountability (people can move if unhappy with decisions such as level of taxes)
• Salmon: competition stimulates efficiency as residents can compare their DG with others

Question 2

Tiebout paper - 3 key ideas

Answer 2

1. Local PGs provide an alternative solution to the preference revelation problem for PGs
2. With local PGs, pop mobility matches individuals to their preferred level of PGs provision (and taxes)
3. people ‘vote with their feet’, communities are homogenous in terms of their prefs for public goods

Question 3

Requirements for Tiebout mechanism to work (5)

Answer 3

I. zero cost of mobility
II. ‘enough’ communities
III. choice of residence determines consumption of PGs (you can’t benefit from state A’s high quality of PGs while paying low taxes in state B)
IV. choice of residence independent of employment (no need to change jobs)
V. lump-sum local taxes (like a membership)

Question 4

Do Tiebout’s requirements match reality?

Answer 4

I. No, mobility is costly
II. Not in UK, possibly in US because of small local govs
III. No, lots of spillovers (e.g. roads, libraries, galleries)
IV. Probably true in big cities, not elsewhere
V. No, usually related to property values

Question 5

Reasons why homogenous communities may not be desirable (2)

Answer 5

1. No mix of skills (e.g. no plumber in community A but lots in B) although Tiebout sidesteps by allowing people to reside and work in different places
2. May be inefficient producers of public goods because heterogeneous communities can be larger and thus spread the costs more efficiently such as through a contribution tax, where people with high (low) pref for PGs pay more (less).

Question 6

Factors favouring LARGER units of government (not 4, 3)

Answer 6

1. costs spread across more people
2. possible economies of scale with private goods and impure public goods
3. less spillovers, benefits are more internalised

Question 7

Factors favouring SMALLER units of government

Answer 7

1. better match of population’s preferences

2. less congestion

Question 8

Explanations for the Flypaper effect

Answer 8

1. Niskanen: bureaucrats interested in maximising their budgets, grant = windfall to their office, not going to pass it onto citizens
2. Oates: fiscal illusion, voters don’t realise a grant to their local gov is like an increase in their income
3. King: median voter’s preferences are such that poor taxpayers’ income should not fall below some threshold, grant relaxes this constraint so MV can choose to increase L

Question 9

Properties of local taxes (3)

Answer 9

1) crucial for accountability of local gov -> voters should pay full cost of marginal local spending (expect when spillovers)
2) fiscal imbalance: matters less that they cover the entire cost of local spending
3) highly-redistributive taxes are unsuitable bc they might lead to movement and thus polarisation of communities

Question 10

Functions of central government grants

Answer 10

1) Revenue adequacy, i.e. budget to finance sub-national services and investments
2) Marginal subsidy: covering costs of services w/ spillover effects (eg. road maintenance)
3) Equalisation: ensuring all local govs can provide same set of services -> concern for equity/prevent inefficient pop movements

Question 11

Matching grant - definition + result

Answer 11

Central gov contributes a given percentage of the cost of local public spending.
-> induces higher consumption of L (substitution effect), local gov would be better off with a lump-sum grant

Question 12

Flypaper effect - result

Answer 12

Local public spending increases b/n 25cts and $1 for each additional $1 in grant

Question 13

2 forms of resource equalisation

Answer 13

1) Equalise fiscal capacity: lump sum grant so all areas can set a specified tax rate for a specified level of per capita spending
2) Equalise fiscal potential: ensure all LGs face the same t for each chosen level of S

Question 14

Why resource equalisation? (2)

Answer 14

1) Equity: one shouldn’t face different local tax bills for the same level of local services, in different areas
2) Efficiency: reason #1 may push people to move to areas with high tax bases, accentuating the imbalance