Theory of Public Finance in a Federal State

By Dietmar Wellisch | Go to book overview

CHAPTER 8
Decentralized Redistribution Policy

In addition to its allocative function, the government must redistribute income between poor and rich households in order to ensure a fair income distribution. Here, the question once again arises of how to delegate this function to different governmental levels. The prevailing view is that redistribution policy is best administered by the central government (see Stigler 1957; Musgrave 1971; Oates 1972; Brown and Oates 1987). According to this opinion, decentralized redistribution policy causes some kind of adverse selection. It is argued that regional redistribution programs (a) attract poor households from neighboring regions by increasing their net income via transfers and (b) repel rich households, who have to pay for the program. From the viewpoint of a single region, the marginal costs of providing additional transfer payments to poor residents exceed the social marginal costs, since other regions benefit from the induced migration responses by losing beneficiaries of and gaining contributors to their welfare system. However, this is not taken into account by the region that enacts the program. As the analysis of Chapter 3 reveals, perfect interregional competition for mobile households results in a policy optimum where regional governments have no incentive to redistribute income among the owners of mobile and immobile factors of production. This adverse selection problem arises to a far less pronounced extent when the redistribution function is assigned to the central government, since the degree of household mobility decreases with the size of the jurisdiction.

There is another, quite different opinion on this problem. Pauly (1973) rejects the idea of assigning the redistribution branch of the government to the central level. He argues that only a regional responsibility for redistribution policy can be Pareto-efficient. If rich households are altruistic and are interested in the well-being of their poor neighbors, then only diverse regional redistribution programs can be efficient, since regional preferences for redistribution differ among rich households living in different regions-at least in general. Redistributive payments derived from altruistic motives can be regarded as a local public good, so the same problems arise as with a central provision of local

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