Fiscal Federalism and Electoral Accountability

We evaluate how governance uncertainty ñexempliÖed by turnout uncertainty - affects the trade off between internalization of externalities and political accountability in the design of the fiscal state. We show that centralization only weakens political accountability in the presence of negative externalities. Unlike positive externalities, negative externalities allow federal politicians to extract higher rents. This yields two new insights. First, decentralization can only Pareto dominate centralization in economies with negative externalities. Second, centralization may not be Pareto efficient in economies with positive externalities despite the fact that pol- icy can be tailored to regional taste differences and centralization internalizes the positive externality.This research was supported by a grant from the Barcelona Institute of Economics (IEB) under its research programme in Fiscal Federalism