This document discusses fiscal federalism and problems faced by local governments. It notes that many countries have stratified or tiered systems of government with different levels having taxing powers, which can cause fiscal problems. There are issues around which level of government should fund and provide different services. Local governments face social problems like poverty and declining quality of spending. Their tax bases are often inelastic while expenditures are growing. Rationales for local government systems include matching geographic benefits of public goods to decision-making costs. The Tiebout-Musgrave "layer cake" model proposes that central governments handle stabilization and redistribution while local governments focus on allocation. It is criticized for assuming costless mobility and full knowledge, and for not accounting for external

1. Fiscal Federalism

2. Fiscal problems of local government
• The public sector in many countries is not organized as a
unitary or centralized system.
• It is instead stratified into a number of level of
government having tax raising power.
• In USA and UK tier of local government exist
• Stratified govt. system rise fiscal problem like fiscal
federalism or central/local government problems.
• There is assignment problem that which government will
do which task

3. What is financial relationship
between different level of
government?
Which taxes should be allocated
to which level of government?

4. Social problems of local government
Social hardship
Poverty
Decline in the quality of spending

5. Tax bases are inelastic
The growth in expenditures is not matched by growth in tax
revenues.
The fiscal gap should be filled through local government
finances.

6. Rationale for local government
• Why should there is system of local government
rather than centralized unitary state?
• Federalism depends on geographic extent of benefit
of public goods and cost of decision making
• Fundamental question is” how shall man so organize
his political and economic institution so to limit the
power of individual one another?

7. o It creates danger
o Limiting power through decentralization implies
fragmentation and diversity
o As the size of local government increases ,local public
goods become congested
o Impure public goods can be characterized bya simple
crowding function

8. Mathematically

9. After n * reached ( i.e. capacity constraint) α increases. For pure public goods α=1

10. • Benefits of goods differ from one another that’s why
local government exist.

11. Example

12. TieBout-Musgrave
“Layer-Cake”
Model

13. TieBout-Musgrave “Layer-Cake” Model
It maintains that the stabilization and distribution
functions of the public sector should be discharged by
the central government and that state and local
government should engage in allocation activities.

14. TieBout-Musgrave “Layer-Cake” Model
Tiebout sets out an analysis in which each individual
selects his residential location so as to optimize his
individual consumption of public services provided by
regional governments.
The arguments in favor of central government being
assigned the stabilization role are clear enough.

15. TieBout-Musgrave “Layer-Cake” Model
o It would increase its public spending and reduce its
taxes.
o Local governments are also severely restrained in
their abilities to effect an income redistribution
policy. Such policy requires transfer to be made to
lower income groups in the form of public
expenditures on pensions, unemployment benefits,
subsidies, housing, education.

16. The Tiebout Model

17. • Tiebout suggested that if there were a sufficiently
large number of local communities or jurisdictions,
and if each community offered a different menu of
public goods (expenditures), then each Individual
could be select that local community to live in which
provides a level of public good output corresponding
to this preferences.
The Tiebout Model

18. Assumptions
The following are the major assumptions made by Tiebout:
• Consumer-voters are fully mobile and will move to that community
where their preference patterns, which are set, are best satisfied
• Consumer-voters assumed to have full knowledge of differences
among revenue and expenditures patterns and to react to these
differences
• There are large number of communities in which the consumer-
voters may choose to live
• The population is considered to be living on dividend income
(thereby avoiding employment restrictions)
• The public goods/services supplied do not exhibit any external
economies or diseconomies

19. The Tiebout Model

20. Criticism on The
Tiebout Model

21. Criticism
1. Buchannan and Wagner, 1970, and Buchanan and
Goetz, 1972 said:
“A Tiebout equilibrium is said to exist when no
individual could improve his utility by changing
communities.”
But this is not so. As individuals migrate externalities
are imposed on others.

22. Criticism
2. In practice we live in non-Tiebout worlds. A Tiebout
first-best world is unlikely to exist because without a
Tiebout-type selection process there is no guarantee
that the number of communities is optimal: hence the
outcome will be second best in practice with a small
number of communities.

23. Criticism
3. The model implicitly assumes homogeneous labour,
which is mobile, and land which is fixed. Thus,
homogeneous communities emerge because of
difference in taxes.

24. “Shamaila Zareen” is discussant of
this topic. She will further discuss
this topic in class.