Are we getting value for money?:Improving the transparency of subnational government performance

Citizens pay taxes in order to enjoy public services. But because they do not know the public production function, it is hard for them to assess whether they are getting value for money. Political yardstick competition, based on a comparison of public services and tax rates with those in nearby jurisdictions, can provide voters with a useful instrument to help solve this asymmetric information problem. However, is has been shown that fiscal disparities bias this yardstick. A politician in a fiscally advantaged jurisdiction can perform badly and still compare favorably, even if his neighbors perform well. An incumbent in a fiscally disadvantaged jurisdiction may be unable to avoid a bad reputation, even when performing well. This paper derives the characteristics of a fiscal equalization scheme that removes this yardstick bias. It turns out that currently used fiscal equalization systems do not remove the yardstick bias except under restrictive assumptions