Do the Subnational Governments Choose Expenditure or Revenue? A Political Economy Approach

In this study, we explore the tax-expenditure behavior of sub na-tional governments in a federal economy with interregional grants. Here, local public goods are produced through federally funds and (costly) local revenues, and have inter-jurisdictional spillover e¤ects. Sub national governments can choose either revenue or expenditure to maximise their bene\u85t. The direction and magnitude of federal fund ow (that determine the local provision of public goods as well as the choice of optimizing instrument) are inuenced by the re-election prob-ability of the parties in power at the federal and provincial levels. We endogenise the policy choice (trevenue or expenditure) and show that, in presence of politics (modeled through a simple probabilistic voting environment), such a choice may bear a one-to-one relationship with the political identity of the province. E-Mail