Interregional Disparities in Productivity and the Choice of Fiscal Regime

Two districts with divergent productivity levels engage in policy-making on the provision of local public goods that enhance future income and hence create a dynamic linkage across periods. The policy choices of district representatives are derived under alternative fiscal systems, and the problem of system selection is examined. It is shown that a decentralized system is more likely to be selected in a more equal society. On the other hand, when a great deal of benefit spills over from a local public good, or when policy makers are expected to care solely about the immediate effects of their decisions on their districts, a centralized system is more likely to be selected.