In virtually every country, the public sector transfers huge amounts across regions and localities. On some cases, specially designed institutions and programmes, like the intergovernmental fiscal equalization schemes in federal states, can organize the regional transfers. In others, these transfers can evolve from a general government programme such as a centralized and tax-financed social insurance system. Whatever their nature, the inter-regional transfers are huge and central both to the current process of integration, as observed in Germany and elsewhere in Europe, and to the process of disintegration in Belgium, Canada, Italy and the former Soviet Union.

In Discussion Paper No. 1142, Research Fellows Torsten Persson and Guido Tabellini study the political and economic determinants of inter-regional public transfers. They point to an important difference between two alternative federal fiscal constitutions. Employing a stylized model of a federation consisting of two regions, the paper shows that inter-regional transfers can be determined either by a federation-wide vote over a centralized social insurance system, or by bargaining over intergovernmental transfers. When regions are asymmetric, the federal social insurance system leads to a larger fiscal program. If a rich set of fiscal instruments is available, it is possible to keep separate the risk sharing and redistributive aspects of federal policy even if regions are different. In this case everyone agrees that an efficient risk-sharing arrangement should provide full regional insurance, even though there is a natural disagreement over how to redistribute resources across regions. Separation of risk sharing and redistribution requires that the federal policy is fully contingent on all aggregate states of nature. The main contribution of the paper is that it clarifies how this trade-off is resolved in political equilibrium under alternative fiscal constitutions.

Federal Fiscal Constitutions. Part II: Risk Sharing and Redistribution
Torsten Persson and Guido Tabellini

Discussion Paper No. 1142, February 1995 (IM)