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An Analysis of the Effects of Fiscal Equalisation in a Two-Region Simulation Model

Author

Listed:
  • Nicolaas Groenewold

    (Department of Economics, The University of Western Australia)

  • Alfred J Hagger

    (School of Economics, University of Tasmania)

Abstract

This paper is concerned primarily with the economic and welfare consequences of federal redistributive grants. We use a model which has two regions, each with households, firms and regional governments as well as a federal government. The households, firms and regional governments are all optimizers – households maximize utility, firms maximize profits and we assume that regional governments are empire-builders in that they choose their expenditure and tax levels so as to maximise total expenditure – the size of their empire. Labour is free to move between regions in response to utility differences and does so until such differences have been eliminated. Inter-regional migration, interregional trade flows and federal government redistribution are the main sources of interconnectedness between the two regions. The model is linearised in log-differences and simulated using a calibration based on Australian state-level data. We find that the welfare effect of intergovernmental transfers is trivial but that all other variables of interest change substantially – consumption, employment, prices, taxes, wages, output and government expenditure. Finally, the signs of the effects of a federal transfer are not affected by the empire-building behaviour of regional governments although the magnitude of the effects is generally dampened.

Suggested Citation

  • Nicolaas Groenewold & Alfred J Hagger, 2005. "An Analysis of the Effects of Fiscal Equalisation in a Two-Region Simulation Model," Economics Discussion / Working Papers 05-04, The University of Western Australia, Department of Economics.
    • Handle: RePEc:uwa:wpaper:05-04
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    References listed on IDEAS

    as
    1. Robin W. Boadway & Frank R. Flatters, 1982. "Efficiency and Equalization Payments in a Federal System of Government: A Synthesis and Extension of Recent Results," Canadian Journal of Economics, Canadian Economics Association, vol. 15(4), pages 613-633, November.
    2. Wildasin, David E., 1988. "Nash equilibria in models of fiscal competition," Journal of Public Economics, Elsevier, vol. 35(2), pages 229-240, March.
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