Theory of Public Finance in a Federal State

This chapter studies whether a decentralization of certain government functions can better protect the interests of future generations than a central responsibility. It concentrates on two areas of government activities-environmental and public debt policies. According to orthodox neoclassical reasoning, public debt policies and the control over long-lived pollutants are related by the joint problem of intergenerational externalities. Currently living generations extend their consumption at the expense of their descendants, since they tend to ignore the costs which their descendants must bear without being asked to do so. Longlived pollutants and debt differ only in that the former results in technological externalities and the latter in fiscal externalities.¹ However, owing to this difference, each issue must be treated analytically as a separate problem.

An implicit and rarely recognized assumption of the externality problem is that future generations cannot escape the undue burden: they cannot emigrate because the economy is assumed to be closed. The purpose of this chapter is instead to allow for migration and to analyze the externality problem from the perspective of regional economics. Emissions will only harm the local environment and debt will always refer to the local jurisdiction. Regions are small and households are perfectly mobile. Households live for two periods. They are mobile when young and stick to their locational choice when old.² The basic question then arises: Do regional authorities have any incentive to internalize intergenerational externalities caused by the emission of long-lived pollutants and by local public debt? In other words, are regional governments better qualified to take the interests of future generations into account than their national counterpart?

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