The effects of fiscal equalisation in a model with endogenous regional governments: an analysis in a two-region numerical model
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Groenewold, N and Hagger, AJ, The effects of fiscal equalisation in a model with endogenous regional governments: an analysis in a two-region numerical model, The Annals of Regional Science, 41, (2) pp. 353-374. ISSN 0570-1864 (2007) [Refereed Article]
This paper is concerned primarily with the economic and welfare consequences of federal redistributive grants. We use a model which has two regions, each with households, firms and regional governments as well as a federal government. Private agents are (utility and profit) maximisers and we assume that regional governments are empire-builders in that they choose their expenditure and tax levels so as to maximise total expenditure - the size of their empire. Labour is free to move between regions in response to utility differences and does so until such differences have been eliminated. Inter-regional migration, inter-regional trade flows and federal government redistribution are the main sources of interconnectedness between the two regions. The model is linearised in log-differences and simulated using a calibration based on Australian state-level data. We find that the welfare effect of intergovernmental transfers is trivial but that all other variables of interest change substantially - consumption, employment, prices, taxes, wages, output and government expenditure. Finally, the signs of the effects of a federal transfer are not affected by the empire-building behaviour of regional governments although the magnitude of the effects is generally dampened. © Springer-Verlag 2006.
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