Fiscal federalism: a survey of the literature

Abstract

There seems to be wide agreement among economists that macroeconomic stabilisation should be left to the central government — whether this be of a state or a supranational federation — while distribution and allocation functions may be exercised at lower levels. The strongest case for decentralisation is made for the allocation function. If there are various forms of public goods which can only be consumed jointly and provided uniformly, then these goods should be supplied at the level at which consumer preferences are relatively homogeneous. This is the essence of Oates’ (1972) decentralisation theorem. Where regional preferences differ, the decentralised provision of public goods brings efficiency gains. Decentralisation would also make it possible to apply the benefit-pricing rule for public services, which is difficult to implement at the highest levels since regional tax discrimination is usually prohibited by federal constitutions. Although the efficient provision of regional public goods could eventually be effected at the central level, this would normally imply information requirements that are difficult to meet, and it would entail costs deriving from uncertainties (Tresch 1981).