Aidt, T. S. and Dutta, J.

Fiscal federalism and electoral accountability

Journal of Public Economic Theory

Vol. 19(1) pp. 38-58 (2017)

Abstract: We evaluate how governance uncertaintyâ€”exemplified by turnout uncertaintyâ€”affects the trade-off between internalization of externalities and political accountability in the design of the fiscal state. We show that centralization only weakens political accountability in the presence of negative externalities. Unlike positive externalities, negative externalities allow federal politicians to extract higher rents. This yields two new insights. First, decentralization can only Pareto dominate centralization in economies with negative externalities. Second, centralization may not be Pareto efficient in economies with positive externalities despite the fact that policy can be tailored to regional taste differences and centralization internalizes the positive externality.

JEL Codes: D720, D780, H410

Author links: Toke Aidt

Publisher's Link: http://onlinelibrary.wiley.com/doi/10.1111/jpet.12179/full