Efficient fiscal spending by supranational unions

Jenny Simon and Justin Mattias Valasek

Discussion Papers, Research Unit: Economics of Change from WZB Berlin Social Science Center

Abstract: We use a novel approach to address the question of whether a union of sovereign countries can efficiently raise and allocate a budget, even when members are purely self-interested and participation is voluntary. The main innovation of our model is to explore the link between budget contributions and allocation that arises when countries bargain over union outcomes. This link stems from the distribution of bargaining power being endogenously determined. Generically, it follows that unstructured bargaining gives an inefficient result. We find, however, that efficiency is achieved with fully homogenous countries, and when countries have similar incomes and the union budget is small. Moreover, some redistribution arises endogenously, even though nations are purely self-interested and not forced to participate in the union. A larger union budget, however, entails a tradeoff between equality and efficiency. We also analyze alternative institutions and find that majority rule can improve efficiency if nations who prefer projects with high public good spillovers are endogenously selected to the majority coalition. Exogenous tax rules, such as the linear tax rule in the EU, which is designed to increase efficiency on the contribution margin, can also improve overall efficiency despite decreasing the efficiency of the allocation of funds.

Keywords: International Unions; Efficiency; Public Goods; Redistribution; Federalism; Legislative Bargaining (search for similar items in EconPapers)
JEL-codes: D71 H77 H87 (search for similar items in EconPapers)
Date: 2012
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Related works:
Working Paper: Efficient Fiscal Spending by Supranational Unions (2013)
Working Paper: Efficient Fiscal Spending by Supranational Unions (2012)
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:wzbeoc:spii2012305

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