On Fiscal Federalism under Democracy

Nobuo Akai () and Kazuhiko Mikami
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Kazuhiko Mikami: Department of Applied Economics, University of Hyogo

No CIRJE-F-313, CIRJE F-Series from CIRJE, Faculty of Economics, University of Tokyo

Abstract: In his seminal work on fiscal federalism, Oates (1972) addressed the socalled Decentralization Theorem, which states that, if such factors as scale economies and spillovers are left out of consideration, a decentralized system is always more efficient than a centralized system for the supply of local public goods. Based on his analytical framework, we contrarily show that a centralized system is at times more efficient than a decentralized system under a democratic decision rule (Proposition 2). The key to such a possibility is the interests of minorities that may be sacrificed in each lower district under decentralization. That is, when the majority adopts an extreme policy that is far from minorities' tastes in a lower district under decentralization, if instead a moderate policy which is closer to minorities' tastes were chosen under centralization, then the interests of minorities would be saved. As a result, centralization could attain higher social welfare than decentralization.

Pages: 18 pages
Date: 2005-01
New Economics Papers: this item is included in nep-pub
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