Cities in Fiscal Equalization

Redistributive grants schemes, such as fiscal equalization, are a common characteristic of local public finance in several countries. However, large and small jurisdictions are treated differently by the respective fiscal equalization schemes that often tend to favour larger jurisdictions. This paper provides a theoretical analysis showing that efficiency considerations might justify a preferential treatment of large jurisdictions. More specifically, we show that an efficient grant scheme would enable large jurisdictions such as cities to provide more public services. Under some conditions, the resulting budget of cities will exceed that of small towns in per-capita terms. Moreover, in a setting with local capital taxation we find that an efficient equalization scheme would also allow cities to retain a larger share of own funds.