Interregional Transfers, Vertical Fiscal Gap and Accountability∗

This paper investigates the effects of two alternative interregional trans-fer systems, an occasionally constitutionally enshrined principle of federations, on political accountability at the provincial level. A two-period, two-province agency model of asymmetric information is studied. In equilibrium provincial reelection rates are higher in the rich than in the poor province, and reelec-tion rates across provinces are higher in the good than in the bad state of the world. Depending on the state of the world a reduction in the scope for graft may increase or decrease reelection rates. While stronger in the rich province, the direction of the effects is the same across provinces. In contrast thereto, variations in the vertical fiscal gap and changes in the degree of interregional redistribution imply that reelection rates move in opposite directions across provinces. There is some evidence that voters are better off with a federal government engaging in provincial public good delivery than with a federal government writing cheques to provincial governments. JEL Classification: H77, D7