Topic 3: Fiscal Federalism

Question 1

Club good

Answer 1

A good that is either non-rivalrous or partly rivalrous, but for which exclusion by the providers is possible

Question 2

Local public good

Answer 2

A public good or service which is accessible only to those individuals/households in a restricted geographic area (district) - it may be non-rivalrous or partially non-rivalrous within that area (e.g. street lighting, local library)

Question 3

The Tiebout Hypothesis

Answer 3

1. The factors missing from the market for public goods are shopping and competition
2. When public good are provided at the local level, competition will arise because individual can vote with their feet (theoretically costless decision)
3. The threat of exit can induce efficiency in local public goods production

Question 4

Tiebout theorem predictions

Answer 4

Competition across local jurisdictions puts competitive pressure on the provision of local public goods such that:
1. In equilibrium, households will sort themselves in districts according to their taste for the public good (public goods need to reflect tastes of local residents)
2. In each town, the level of local public good is efficient

Question 5

Under Tiebout theorem, as number of districts increases…

Answer 5

within-each locality becomes more homogeneous but across localities become more heterogenous

Question 6

Assumptions of Tiebout model

Answer 6

1. Large number of communities (needed for close match)
2. No externality of the local public goods across communities (otherwise people from other localities would be able to use)
3. Zero mobility cost
4. Perfect information of individuals about the mix of public goods/taxes in each community

Question 7

Why might Tiebout fail?

Answer 7

1. Difficult to vote with feet (income constraint, voting laws)
2. Difficult to control spillovers (prevent access from outside community)

Question 8

Problems with local redistribution

Answer 8

Local redistribution program breaks down as:
1. Poor flock to the city which provides welfare benefits
2. Rich flee to other cities to avoid paying for redistribution
Need tax-benefit linkage to avoid migration

Question 9

Fiscal decentralisation

Answer 9

Delegation of expenditures and taxation powers to lower levels of governments

Question 10

Fiscal centralisation

Answer 10

Delegation of expenditures and taxation powers to upper levels of governments

Question 11

Sources of local authority revenue

Answer 11

1. Council tax (c.50%) - has increased as proportion!
2. Business rates (c.27%)
3. Government grants (c.23%)

Question 12

Matching grant

Answer 12

A grant, of which the amount is tied to the amount of public good spending by the local community (essentially decreased price of spending on public good)

Question 13

Block grant

Answer 13

A grant of some fixed amount with no mandate on how it is to be spent

Question 14

Conditional block grant

Answer 14

A grant of some fixed amount with a mandate that the money be spent in a particular way

Question 15

Effects under matching grant

Answer 15

Income and substitution effects work in same direction for public good spending (positive)

Question 16

Crowd out theory on government grants

Answer 16

A $1,000 increase in private income has the same effect as a $1,000 increase in Fed block grant (both shift the budget in the same way) -> what ultimately matters is the total resources available

Question 17

Effects under block grant

Answer 17

Positive income effect but no substitution effect

Question 18

‘Money is fungible’

Answer 18

only total resources matter for the allocation across private and public goods at the local level (increasingly the case the lower power is devolved)

Question 19

Flypaper effect

Answer 19

No crowd-out of state spending from federal grants and, instead, “money sticks where it lands”

Question 20

Tax price for school equalisation schemes

Answer 20

The amount of revenue a local district would have to raise in order to gain $1 more of spending (with no equalisation tax price is $1 vs. infinite with perfect equalization)

Question 21

Problem with high tax price

Answer 21

creates issues with quality of public good