FISCAL DECENTRALIZATION WITH REGIONAL REDISTRIBUTION AND RISK SHARING

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					   FISCAL DECENTRALIZATION WITH
    REGIONAL REDISTRIBUTION AND
            RISK SHARING

                    Marianne Vigneault
                 Department of Economics
                    Bishop’s University
                    2600 College Street
                Sherbrooke, Quebec, Canada
                         J1M 1Z7

ABSTRACT
         The paper examines the incentive effects of intergovern-
mental transfers on regional government spending levels in a mul-
ti-period model. The focus is on the repeated strategic interaction
between the regional and federal governments and the exploration
of the factors influencing the federal government’s incentive to
create soft budget constraints. The paper models the time-path of
regional government spending when regional governments face
uncertainty in regard to the federal government’s ability to commit
to its announced transfer scheme. The results show that in the
presence of small shocks to regional endowments, the softness of
regional government budget constraints increases over time if the
federal government has a known finite mandate. Large shocks,
however, can result in discrete changes in regional government
spending that persist for the remainder of the federal government’s
mandate. The paper also shows how the time-path of regional gov-
ernment spending depends on the discount rate, the time horizon,
and the regional governments’ prior uncertainty regarding the
federal government’s commitment ability.

JEL classification: H30, H77
Keywords: Commitment, Intergovernmental Transfers,
Soft Budget Constraint

1. INTRODUCTION

       In most federations, a primary responsibility of
the federal government is to implement a system of in-

Public Finance and Management
Volume 10, Number 1, pp. 48-79
2010
PFM 10/1                                                            49


terregional transfers. Interregional transfers can serve
both to redistribute income from rich to poor regions
and to sta
				
DOCUMENT INFO
Description: The paper examines the incentive effects of intergovernmental transfers on regional government spending levels in a multi-period model. The focus is on the repeated strategic interaction between the regional and federal governments and the exploration of the factors influencing the federal government's incentive to create soft budget constraints. The paper models the time-path of regional government spending when regional governments face uncertainty in regard to the federal government's ability to commit to its announced transfer scheme. The results show that in the presence of small shocks to regional endowments, the softness of regional government budget constraints increases over time if the federal government has a known finite mandate. Large shocks, however, can result in discrete changes in regional government spending that persist for the remainder of the federal government's mandate. The paper also shows how the time-path of regional government spending depends on the discount rate, the time horizon, and the regional governments' prior uncertainty regarding the federal government's commitment ability. [PUBLICATION ABSTRACT]
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