Fiscal federalism, local public works and corruption

Martin Besfamille

CREPP Working Papers from Centre de Recherche en Economie Publique et de la Population (CREPP) (Research Center on Public and Population Economics) HEC-Management School, University of Liège

Abstract: In ¯fiscal federal systems, local public works that generate spillovers are often ¯nanced by transfers from higher levels of government. In this article, we consider a governmental hierarchy composed by a Federal and a Local Government. The former delegates to the latter the task of ¯nding a ¯rm to undertake a local public work. As the Local Government has more information about the e±ciency of the firm, it communicates its private information to the Federal Government which decides the way to fund the project. If side-contracts between the local authority and the ¯rm in charge with constructing the project are feasible, di®erent stakes for collusion may arise. The Local Government can overstate the e±ciency of the ¯rm to obtain extra rents or can also understate it, to ensure the e®ective undertaking of the project. In order to ¯nd the optimal allocations, we derive a \Collusion-Proofness" property which states that, in order to maximize its expected welfare, the Federal Government can restrict to o®er collusion-proof contracts. These contracts indicate the transfers between the Federal Government, the local authority and the ¯rm of constructors. Finally we characterize the distortions set to attenuate the resulting implementation costs. They concern the cost of the project and the decision about its e®ective undertaking. The most important result of this article is that the undertaking of useless projects, at an in°ated cost, is an optimal response of the Federal Government to the threat of collusion between the local authorities and the firm of constructors.

Date: 2000
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Working Paper: Fiscal Federalism, Local Public Works and Corruption (2000)
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