Public Budget Composition, Fiscal(De)Centralization, And Welfare

The authors present a dynamic two-region model with overlapping generations. There are two types of productive public expenditure, education and infrastructure funding, and governments decide optimally on budget size (tax rate) and its allocation across the two outlays. Productivity of government infrastructure spending can differ across regions. This assumption follows well established empirical evidence, and highlights regional heterogeneity in a previously unexplored dimension. They study the implications of three different fiscal regimes for capital accumulation and aggregate national welfare. Full centralization of revenue and expenditure decisions is the optimal fiscal arrangement for the country when infrastructure spending productivity is similar across regions.