Federalism in an endogenous growth model with tax base sharing and heterogeneous education services

We examine the effects of tax base sharing on the growth path of an economy in which central and regional governments provide heterogeneous educational services (general and specific training) which increase capital productivity. Our focus is the non co-operative game between two overlapping governments - central and regional - whose objective is to maximise their net tax revenues of educational spending (Leviathan hypothesis). We will show that the dispute between centralisation and decentralisation depends on two effects; the first is a "tax effect", which supports centralisation in that tax base sharing leads to overtax the common tax base, and so has a negative effect on the growth path. Second is a "public good effect", which defends decentralisation because the very diversity of central and regional educational services has a beneficial effect on the growth path (educational services are imperfect substitutes and "specific assets" of each level of government). We discuss the virtue of tax base sharing in a federation, as an "incentive scheme" within government's grasp. Copyright RSAI 2005.