Public Finance, Foldvary

Anderson Chapter 19

Multilevel Governmental Finance, or Fiscal Federalism

Anderson says that Florida is not sovereign. Really?

Tenth Amendment:

The powers not delegated to the United States by the Constitution, nor prohibited by it to the States, are reserved to the States respectively, or to the people. ”

The Tenth Amendment is similar to an earlier provision of the Articles of Confederation:

"Each state retains its sovereignty, freedom, and independence, and every power, jurisdiction, and right, which is not by this Confederation expressly delegated to the United States, in Congress assembled."

Fiscal federalism: a public finance system with more than one layers of government taxing and spending. It usually involves a fiscal relationship among the levels.

System can be top down, parallel, or bottom up.

The US is a federation.

The state and the federal governments have parallel sovereignty.

Indian nations are semi-sovereign.

Principle of subsidiarity: a governmental function should be performed by the lowest efficient level.

Economies of Scale

What level of provision is best?

The lowest level which has min AC or does not have significant externality.

Garbage collection, policing, education can be local.

They can also be private.

            Many typical municipal services do not show significant economies of scale requiring large-area provision;

such was the conclusion of a study of the municipalities of St. Louis County in Missouri.

It found that increasing returns to community size are dissipated with a community size of 10,000. Hence, small municipalities are not generally at an economic disadvantage relative to metropolitan governments.

            "Fiscal equivalence" means a situation in which government services are fully paid for by the recipients of the benefits,

and the payments equal the perceived value of the benefits.

It is related to the benefit principle of public finance.

With fiscal equivalence, the benefit area coincides with the jurisdiction of the government agency that raises the revenue for that service,

and resources are used more efficiently than if there are uncompensated spillovers.

Long-run trend to centralization of government.

Partly due to economies that large-scale operations can generate.

But mostly political.

Much of state and local spending is dictated by fed gov.

Revenue transfers plus unfunded mandates, without financing.

10th Amendment?

            Coordination of Large Programs

Coordination over a large area needed for highways etc.

Can be bottom-up.


Such as mosquito control can be internalized in a larger area.

The Optimal Sharing Group depends on the economies of scale.

            Intergovernmental Competition and Consumer Choice

Different governments can supply a variety of public goods for a heterogenous population.

Better with local governments.


            Mobility and Intergovernmental Competition

Tiebout model: governments compete for residents and business.

People reveal their preferences from where they live - voting with their feet.

            Other Governments as a Basis for Comparison

Costs and benefits affect land values.

Real estate owners have an incentive to promote governmental efficiency.

Local provision also induces more experimentation.

            The Roles of Different Levels of Government - p. 483.

Highways down, welfare up, interest payments up

            Special Interests and Government Size

Legislators have an incentive to cater to the special interests who provide campaign money.

The public is unaware, so there is a bias for special interests.

            Federalism and Special Interests

Less influence of special interests such as corn subsidies at local level.

            Centralization and the Cartelization of Governments

            Competition in the Public Sector

Competition is beneficial, but how to judge efficiency?

Cartelization prevents competition.

            The Number of Governments

Fewer school districts, more special taxing districts.

            Regulations and Grants

Regulations also cartelize.

Lower level governments abide by the regulations of the higher ones.

Education, highways and drinking age.

            Regulation and Competition

Fed government gets around 10th Amendment with financial power.

            Grants and Competition

Grants reduce cost-benefit motivation.

Makes local government more homogenous.

Categorical grant: with restrictions.

Non-categorical: revenue sharing.

            Intergovernmental Revenue

General grants: can be spent for anything.

General grants can equalize spending when revenue is unequal.

Categorical grants must be spent for some category; most grants.

22% of state revenue from federal government.

34% of local revenue from state and federal governments.

Matching grants reduce local governments’ MC, increasing spending.

            The "flypaper effect" indicates that government grants stick where they land

Budget-maximizing bureaucracies keep the money.

Voters have limited information.

Local governments want the bureaus to have in incentive to get grants.

            Tax Issues and Local Governments

Taxes are paid by Immobile Factors - much of it is at the expense of rent.

A greater burden on the less mobile factors.

Landowners get less rent when their tenants are taxed.

Land values fall.

            Capitalization of Debt

Higher local debt reduces land values.

            Deductibility of State and Local Taxes

State income taxes and real estate taxes are deductible from taxable income for the federal income tax. This reduces the marginal cost of state and local government.

That increases the size of government.