Prague Economic Papers 2022, 31(5):347-376 | DOI: 10.18267/j.pep.813

Fiscal Decentralization, Political Heterogeneity and Welfare

Erkmen Giray Aslim ORCID...a, Bilin Neyapti ORCID...b
a Seidman College of Business, Department of Economics, Grand Valley State University, MI USA
b Bilkent University, Department of Economics, Bilkent, Ankara, Turkey

This paper contributes to the literature on fiscal decentralization by presenting a formal model of the interaction between the central and local governments (CG and LGs, respectively) where LGs may differ in their degree of political alignment with CG. The non-cooperative optimal behaviour of the agents reveals that optimal tax increases with the extent of fiscal decentralization (FD), political unison and spillovers across localities, while LGs' optimal tax collection effort is negatively associated with all of these parameters. The first novel finding of our study is that both welfare peaks and income distribution are more equitable at a lower level of FD in the case of spillovers than in the case of no spillovers, which supports the decentralization theorem. The second novel finding is that both the amount of redistributable income and central government utility increase with the degree of political unison.

Keywords: Fiscal decentralization; fiscal efficiency; welfare
JEL classification: H71, H72

Received: October 29, 2021; Revised: July 21, 2022; Accepted: August 9, 2022; Published: December 5, 2022  Show citation

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Giray Aslim, E., & Neyapti, B. (2022). Fiscal Decentralization, Political Heterogeneity and Welfare. Prague Economic Papers, 31(5), 347-376. doi: 10.18267/j.pep.813
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