Monday, April 16, 2012

Greg Mankiw's touching faith in Tiebout Equilibrium


Greg Mankiw has an op-ed extolling the benefits of competition between governments (at the local, state, or national level). The basic argument is that competition reduces the ability of governments to redistribute wealth, since whoever is being taxed to pay for the redistribution can just move to somewhere with lower taxes.

Allow me to gripe for a moment. This article seems to make the same assumption that American conservatives and libertarians generally make about government: that government spending is 100% redistribution and 0% public goods provision. Pure transfers, with no contribution to economic efficiency. This assumption is built into conservative-favored macro models and conservative policy discourse alike.

We do not just have governments in order to rob Peter to pay Paul. We have governments because there are things they can provide that the private sector is either unable or unwilling to provide effectively - courts, police, schools, roads, other infrastructure, etc. Conservatives focus so much on redistribution that they tend to ignore this fact, but if you think about it, you'll realize public goods are why we have government in the first place.

So will competing local governments produce the optimal amount of public goods? In general, no. There is a theory about this in public economics, called Tiebout Equilibrium (the model was actually worked out by a guy named Bewley). In general, a bunch of competing local governments will not provide the efficient amount of local public goods - you need a federal government for that. Also, of course, you need a federal government for public goods that aren't localized, like defense, research, interstate highways, and the FBI.

But here's a question that might be of interest to Dr. Mankiw: Does government competition generally lead to bigger government or smaller government? Greg provides the example of international competition to lower corporate tax rates; I agree with this example and I think it's a good thing, but I don't think this is the norm.

Generally, local governments will compete to attract investment. They do this by lower business taxes and less regulation, sure. But they also do this by increasing spending on things like infrastructure and education, in order to provide businesses with the local resources they require. They also offer businesses direct subsidies. Somebody has to pay for those things. Guess who's going to foot the bill? That's right, local taxpayers.

(Aside: Yes, some of the money local governments spend to attract investment is wasted, especially the direct subsidies; see the Tiebout result above. A lot is not wasted, though. Roads and schools are necessary.)

So I think that, in his zeal to attack redistribution, Greg may be overlooking two things here. The first is that the federal government contributes to economic efficiency, not just redistribution. The second is that government competition for business investment will often make government bigger, not smaller. Conservatives should think about both of these points.

(Update: For you econo-nerds, note that there are two questions here: 1) the relative efficiencies of different systems of local-government competition, and 2) the distribution of rents under the various systems. These both depend on a lot of things in general, and there's a huge literature on this. I'm just sketching out a couple ways in which "more competition" might not achieve results to Mankiw's liking...)

56 comments:

  1. and you also need governments to make sure markets are competitive. for example, the DOJ had to intervene to make sure ebook sellers did not collude. Hence, competition among governments could lead to less competition across firms... and a less healthy capitalist system... does that make sense?

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  2. hmmm. what happens when states compete for the provision of military resources? my bazooka is bigger than yours and I can prove it! Boom!

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  3. Anonymous2:10 PM

    "This assumption is built into conservative-favored macro models and conservative policy discourse alike."

    What does Ricardian Equivalence have to do with what you are talking about?

    "Generally, local governments will compete to attract investment. They do this by lower business taxes and less regulation, sure. But they also do this by increasing spending on things like infrastructure and education, in order to provide businesses with the local resources they require. They also offer businesses direct subsidies. Somebody has to pay for those things. Guess who's going to foot the bill? That's right, local taxpayers."

    Isn't Mankiw arguing that this type of behaviour would be punished by easy mobility? If local taxpayers don't want it, then wouldn't they move? I can believe that mobility costs can be high, so there is room for some extraction, but I don't really understand your argument here.

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    1. What does Ricardian Equivalence have to do with what you are talking about?

      In Barro's model, government spending is pure transfer. There is no government capital, as in a Baxter & King (1993) setup.


      Isn't Mankiw arguing that this type of behaviour would be punished by easy mobility? If local taxpayers don't want it, then wouldn't they move?

      Ah, good question! Answer: General equilibrium. If every location is forced to compete in this manner, where will people move to escape it? ;)

      Note that what this part of the discussion is really about is the distribution of rents to people of different income classes under different systems of local-government competition...

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    2. Would evidence spoil the party? Cause in the real world, there's very little evidence people move between jurisdictions to avoid high taxes. And general equilibrium is a beautiful thing, but in fact local governments spend vastly different amounts on efforts to attract businesses. And in the end, the things that tend to successfully attract both people and businesses are not low taxes and high subsidies, but rather things that create a high quality of life - good streets, parks, schools, recreational amenities, etc.

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  4. Your last point is quite evident in China, where localities go hard duking it out, leading to massive state-sponsored malinvestment.

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    1. Yes! Although in China the competition is a bit different than what Mankiw is suggesting, since local govt. officials get promoted based on their region's GDP growth.

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  5. Jsizzlemanizzle4:26 PM

    Ooooooooooooooooohhhhhhhhhh shiiiiiiiiiiiiiiiiiiii mane. Grege Mankiw is gonna lay the smackdown on you

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  6. Ron Ronson4:29 PM

    "We have governments because there are things they can provide that the private sector is either unable or unwilling to provide effectively - courts, police, schools, roads, other infrastructure, etc"

    I can't think of a single thing on that list that the private sector could not (potentially) provide better than than the public sector.

    Take schools: Watch the movie "Waiting for Superman" (http://en.wikipedia.org/wiki/Waiting_for_%22Superman%22) and you will see that when the state provides education it is not providing a public good that the private sector could not provide but using its powers to impose a service that benefits the providers more than it benefits the recipients.

    The same thing could be demonstrated for everything else on the list.

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    1. I can't think of a single thing on that list that the private sector could not (potentially) provide better than than the public sector.

      I think you're completely wrong!

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    2. Anonymous6:05 PM

      Just because the private sector COULD provide better than the public sector does not imply the private sector WOULD provide better than the public sector. Samuellson wasn't arguing that private provision of public goods is suboptimal because private provision is more expensive, he was arguing that private provision of public goods is suboptimal because private providers do not have the incentive to provide the optimal allocation. P = MRS versus P = Sum(MRS) and all that.

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    3. Ditto to this! Smartness.

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    4. privatized police and privatized enforcement. privatized judges. lol. Thats called the mafia.

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    5. Ron Ronson5:55 PM

      "I think you're completely wrong!"

      Nice to see Noah so ready to bring his his wit and incisive thinking into play in dealing with opinions he disagrees with.

      "privatized police and privatized enforcement. privatized judges. lol. Thats called the mafia."

      Couldn't one just as easy say "state police and state enforcement. state judges. lol. Whats the difference between that and the mafia?"

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    6. Yes. The example of private, for-profit prisons is especially compelling.

      Also too - suppose my neighbor wants a paved road, but I am not wiling to pay my part. I guess that's where the pavement ends; and my neighbor does not get to go anywhere, except in an all-terrain vehicle.

      And I'm sure not letting her cross my property! Not without paying a toll.

      Rejecting the commons is a libertarian ideal that makes zero sense in the real world.

      JzB

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    7. Ron Ronson6:29 PM

      It seems like a huge leap to me from believing that some goods ("the commons") are best communally owned to the belief that government monopolies in such things as health, transport, property protection are the best way to deliver goods deemed "public goods".

      I can't think of a single example where basic economics would not lead one to the conclusion that the free market would not deliver a optimal outcome to that of a state-monopoly.

      Obviously people who would prefer to impose there own values on others may well see an advantage in seeking state-sponsorship for their preferences over encouraging free market outcomes.

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    8. Couldn't one just as easy say "state police and state enforcement. state judges. lol. Whats the difference between that and the mafia?"

      Here's one difference: elections. Do you seriously want your ass hauled in to court to see your fate decided by a judge on the payroll of the local plutocrat/kleptocrat/warlord? Why do you think Washington, Jefferson, Franklin, Madison, Adams, Hamilton et al didn't share your faith in private commerce?

      If you took a little time and studied health care markets, to take an apt example, you might not have such simple ideas.

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    9. Ron Ronson9:16 PM

      "Why do you think Washington, Jefferson, Franklin, Madison, Adams, Hamilton et al didn't share your faith in private commerce"

      That is a strange comment. Surely the USA was built on free commerce and there was little public health or education (and even public justice was somewhat patchy) until well into the second century of its existence.

      On the justice issue: It never ceases to amaze me that people have so much faith in such an obviously flawed justice system as we have in the USA. There are close to a million people in jail (many from ethnic minorities) for crimes related to drugs. Its hard to see how free-market justice (based on common law and competitive courts) could in any way do such a bad job of administering impartial justice even if one assumes that such a system would itself be flawed.

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    10. "I can't think of a single example where basic economics would not lead one to the conclusion that the free market would not deliver a optimal outcome to that of a state-monopoly."

      Then why hasn't it happened? Why is there not one single first world nation that got there thanks to private education and transportation? Why does China, with its public education system, achieve better literacy rates than India, which leaves much more to the market? Why is every other first world nation (i.e. those with public health insurance) doing a better job of keeping health care costs under control and not suffering by any measure of health?

      It's one thing to believe that getting government right is difficult. But you believe getting government right is easy, downright trivial really, Somalia almost has it, you just need to not do anything and let everyone else do everything and things will be great. And yet not one nation has managed to get it right and blow by everyone else economically.

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    11. That is a strange comment.

      It may seem strange to you. Not to me. The Constitution establishes a public system of justice. Why do you think that is?

      Heck, why don't you just read the Preamble, for pete's sake.

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    12. Ron Ronson10:00 PM

      did you mean "private justice" and not "private commerce" ?

      If so then you comment makes sense - but makes your last post pretty ironic - accusing me of not reading what you had actually mis-typed !

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  7. "Ah, good question! Answer: General equilibrium. If every location is forced to compete in this manner, where will people move to escape it? ;)"

    Not to mention that the casual invocation of relocation assumes that relocation is casual.

    "But they also do this by increasing spending on things like infrastructure and education, in order to provide businesses with the local resources they require. "

    Spending on education is rather tricky, in such a circumstance, because the benefits take probably well over a decade to realize, and people who are educated can move out (or move in, from places which spent money on education).

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  8. Wonks Anonymous4:37 PM

    I don't know the exact percentage, but I think transfers are a very large portion of government spending, or should I say that public goods are a small portion. Defense is big, but it is highly questionable whether at current margins it is a public good, it may on the margin be a public bad.

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    1. You are correct at the federal level. Probably not so much at the local/state level.

      BUT, notice that a lot of federal transfers (most of Social Security) are really intertemporal transfers - transferring money from your current self to your future self - rather than inter-person transfers (rents).

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    2. implicit in the conservative argument is the notion that transfers do not contribute to the public good.

      I wonder about possible effects on frex: crime rates and general health, and do not wonder at all about the effects on GDP and the economy.

      There may actually be some logic in putting money in the hands of those who have a high propensity to spend. In the post WW II era consumption spending has averaged - and been quite consistent - at about 90% of disposable income.

      http://research.stlouisfed.org/fredgraph.png?g=6pu

      JzB

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  9. Good post. However, I don't like the false dichotomy that is taken for granted between redistribution and goods provision. Under some circumstances redistribution is the provision of a good. Only those who think that market distributions are always better than distributions resulting from deliberate policy choices would believe this.

    And yet we are still feeling the aftermath of a period in which some market allocations of resources proved to be catastrophically terrible.

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    1. Under some circumstances redistribution is the provision of a good.

      A good, yes, but mostly a private good. Different than a public good. Very different.

      Although there may be public-good components of redistribution as well. For example, if it reduces crime.

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    2. I would have to disagree that redistribution provides primarily private goods, Noah. Ongoing redistribution is essential to offset the socially corrosive, economically destabilizing and bizarrely wasteful and unsustainable distributions generated by unregulated private exchange. Every society, even the most economically libertine ones like ours, redistributes wealth continually. They couldn't survive without doing so.

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    3. Dan, the only really important thing is that YOU and your tribe not be involved in the re-distribution. Instead the guys who have the bank, they are going to decide, and your job is to be thankful it is working its way out.

      (note: while typing this I told some guys in China I'm having build something tonight, and they said you are nuts.)

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    4. (note: while typing this I told some guys in China I'm having build something tonight, and they said you are nuts.)

      If I'm looking for an authority on decent, just, democratic society, "some guys in China" is definitely where I'd turn.

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  10. Only those who think that market distributions are always better than distributions resulting from deliberate policy choices would believe this.

    Should have said "would doubt this".

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  11. I've taken on a deceptive article in the UK-based Spectator on Sweden's fabulous tax cuts...

    http://socialmacro.blogspot.com/2012/04/learning-wrong-lesson.html

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  12. Anonymous7:08 PM

    “Guess who's going to foot the bill? That's right, local taxpayers.”
    Not necessarily - http://www.census.gov/prod/2011pubs/cffr-10.pdf

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    1. Anonymous8:03 PM

      A great paper - http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1451268

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  13. Anonymous11:44 PM

    You're really not being fair to Mankiw. Early on he wrote, "For much the same reason, competition among governments leads to better governance. In choosing where to live, people can compare public services and taxes." The argument he's making (which I don't feel is a very good argument, but ...) is that the conservative-liberal gap is the gap between conservatives who appreciate gvt-as-public-goods-provider and liberals who appreciate that PLUS the redistribution aspect. I see the public-goods part very explicit in what he wrote.

    And I think it's hilarious when someone writes of public education as if it's not "remedy many of life’s inequities".

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    1. A) I was talking about what Mankiw seems to think regarding the federal government.

      B) Mankiw's contention that competition leads to better provision of public services is precisely a contention about the optimality of Tiebout equilibrium! Which is the whole point of this post.

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    2. Anonymous2:11 PM

      OK, and I think that's worth thinking about--I guess it was your phrasing in paragraphs 2 & 3 which threw me off.

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  14. "We have governments because there are things they can provide that the private sector is either unable or unwilling to provide effectively - courts, police, schools, roads, other infrastructure, etc."

    There's a total fabrication.

    We have entrepreneurs clawing at doors to provide these services, you spend MORE TIME trying to keep them from participating than you do tugging off public employees.

    Wait, that's the same thing.

    ----

    You need to think Noah.

    The state and govt. itself is born to protect the interests of the guys paying for security.

    That's ALWAYS the deal. Guy with stuff, wants to keep it, hires big guys to protect his stuff. Ever seen any movie with a bad guy?

    THAT is what "government" is spawned from.

    It starts off as a market-value security business for folks footing the bill. And when the chips are really down, it basically head nods back that way. Certain anim- er, public employees are more equal than others.

    So, let's forget the "last resort" crap, you can make that argument when anytime someone wants to compete with govt., we make damn sure it happens.

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    1. False.
      1) Externalities - I'm extremely doubtful that private citizens take into consideration the public/social costs/benefits to their actions. While governments don't do it fantastically, at least it's feasible to include it in their decision making process.
      2) Big push - Sometimes, Silicon Valley just pops up. Sometimes, you need government to incentivize focus on development in one area.
      http://en.wikipedia.org/wiki/Big_push_model
      3) Crime & punishment - See reader's comment on mafia. You can probably hire your own bodyguards, but I hate to see the Montague and Capulet mess we'll get into without laws which are judiciously applied to everyone. Again, just because we don't necessarily do it right doesn't mean it's not a legitimate point. And judges aren't free.
      4) Schools - I'm seeing huge start up costs. I'm not saying impossible to have a free market of schools, but without government funding, I see something more like monopolistic competition, which I'm sure ends up with the unlucky ones as losers.

      I'm all for private entities competing with government, but until you can address all the issues which, at the moment, don't appear to be internalize-able, you need a social planner.

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    2. "I'm all for private entities competing with government,"

      Thank you. And that, as they say, is that.

      You didn't come close to arguing with me.

      My two points:

      1. the formation of govt. you don't argue with.

      2. any extra things you'd like to layer on, after it is born, that;s fine AS LONG AS, it does so under the force of competition.

      Think of it as "do no harm" to private interests that in good faith want to compete to provide services.

      A corollary to this is: govt. jobs are not make work jobs.

      A good example would be the Post Office. Running it like the UAW runs the new GM would save the post office.

      The new GM pay new workers half what old workers make.

      And since we as the state have interests over and above the old postal workers, we should open up competition wide, and also allow the post office to de-unionize right quick.

      In many liberal regards, in order to save public services we have to crush public employee unions.

      -----
      The formation of govt. is interesting because it gives you the proper sense of WHO founds and funds govt.

      Long before govt. starts letting every vote, the funders make sure the thing runs to protect their stuff.

      I find that is helpful as it gives you a better idea of how to run the govt. so that it is stable.

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  15. Oddly, Charles Tiebot's analysis of this question focused mostly on variations among local governments in the provision of public services (note that the title of the piece is "A Pure Theory of Local Public EXPENDITURES"). (which you can read for yourselves here: http://www.spa.ucla.edu/ps/pdf/s99/PS294assign/Tiebout.pdf and make up your own minds.) People who valued public services more highly would tend to move to localities that provided hih levels of the desired public services. He said much less about taxes. And he really did not discuss (in that particular work) the national provision of public services that have no local component. (I, by the way, would include health care in that--no local component--category, but your mileage may vary.) My own take is that he assumed that the federal government would do an adequate job of providing the non-place-specific public services.

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    1. My own take is that he assumed that the federal government would do an adequate job of providing the non-place-specific public services.

      Yes. My point is that Mankiw seems to view local and federal govt.'s as substitutes...he seems to think that allowing more local govt. competition necessitates weakening the federal govt.

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    2. It does.

      Noah, the way it works is this. Say SCOTUS tosses ACA. or the econ crisis gets much much worse.

      There is a real chance that the Blue State elites who pay most or the taxes might wake up and say, "we ought to be keeping this money at home and building smaller utopias here."

      That would be a good thing.

      The more money kept further to the edges, more great enhances the disparities and forces better market realities.

      Say the post off ice shut down, and suddenly daily delivery to rural areas becomes weekly delivery.

      Or we shut down the Rural Utility Service under the USDA. Or end farm subsidies.

      These are devolutions of Federal power which bring market based sanity to cost of living. So even more people need to move closer to the city.

      It also means the different local areas will have more tax dollars to work with, which allows areas to succeed or fail based on their policies.

      So TX kicks the shit out of CA, and CA has to bend and become more like TX.

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    3. "The more money kept further to the edges, more great enhances the disparities and forces better market realities."

      Just like in the Eurozone?

      Aside from a large federal government providing a consistent share of the economy and redistributing from wealthy states to poor ones, is there anything that keeps US states' economies from diverging to the point that Greece and Germany have? We'd still all share a common currency in your proposal. So why is the Eurozone's situation preferable to ours?

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  16. Anonymous6:59 AM

    Exhibit A: Europe.

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    1. Wonks Anonymous1:13 PM

      There's less mobility in Europe due to language differences.

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  17. JustBob8112:02 PM

    You are absolutely right about the obsession of economists with redistribution as the end all and be all of governance. As the meta-institution which chooses most of the other institutions, the willingness or unwillingness of the state to emphasize positive externalities vs the private benefits makes a huge difference.

    Redistribution can consist of giving your supporters no-show make-work jobs, or it can consist of public education. Those have really different social outcomes. If we know anything about economic growth it's that it depends on political and economic institutions that are for the most part provided by government.

    For all the libertarians who think that the state is unnecessary, don't you have to explain why everywhere in human history the really successful states are those that provide these services through the government. Just think about public education. Has there ever been a significant increase in literacy that was based on purely privately provided education?

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    1. 17th century Denmark ?

      Of course, it was church-based, not for profit....

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  18. Has competition between the governments of the EU made governments smaller there? Just asking ...

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  19. Intersting. I'm much less convinced than you that lower corporate tax rates are an unambigiously good thing. What they lead to is deficits; then come the demands that the deficits be paid down through Medicare and SS cuts and even higher taxes on the nonrich-consumption and wage taxes

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  20. Noah,

    I don't think competition between states would necessarily lead to a crash in tax rates. in the interstate taxation literature, there seems to be a substantial amount of room for tax exporting and New Trade Theory to create "races to the top" for tax rates (long explication here: http://www.regjeringen.no/en/archive/Bondeviks-2nd-Government/ministry-of-foreign-affairs/Rapporter-og-planer/2002/tax_competition-a_review_of_the.html?id=260433).

    Second, if you work out a simple partial equilibrium model in which taxation is lump sum, and both labor and capital have an elasticity with respect to the tax rate, you can actually find asymptotes in the result.

    Third, I think your argument on certain public goods actually strengthens the case for decentralization. Under Ricardian equivalence, the only meaningful expenditure, and by corollary tax, policy for local governments is to focus on public goods that improve the marginal return to other factors of production.

    Many of the public goods that you list, such as roads, actually has some pretty interesting counterarguments with regard to whether they traded off with more agglomeration in cities. Research and Development? Well, that's such a pittance of the Federal Budget we can hardly start. I wrote about these issues in the context of a common monetary policy but decentralized fiscal policy here:
    http://synthenomics.blogspot.com/2012/04/fiscal-policy-in-monetary-union.html

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  21. Anonymous9:48 PM

    "The basic argument is that competition reduces the ability of governments to redistribute wealth, since whoever is being taxed to pay for the redistribution can just move to somewhere with lower taxes."

    Sounds like a good reason to minimise competition between governments.

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    1. Agreed. It seems Noah has something against plain redistribution. Maybe he should elaborate ?

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  22. If "In general a bunch of competing local governments will not provide the efficient amount of local public goods - you need a federal government for that" is true, then does this still apply if you simply scale up the argumet.
    Does it follow that "In general a bunch of competing federal governments will not provide the efficient amount of local public goods - you need a world government for that"?

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  23. Laura S.9:26 AM

    In my point of view, the redistribution is not influenced by the level where it is done. There can be made some assumptions - for example the case of US or Canada, where it can work as you described.

    But then we have some deviant cases like Argentina, where the local governments and federal government went on spending spree in the 90s which led the country into the bankruptcy, so neither the central nor the provincial level helped to stabilize the situation.

    What is more important is the relation between the governments and the level of control the central government can have over the provinces.

    You are right with the assumption that each local government will behave differently. This reminds me of work of Putnam, who analysed the local governments in Southern and Northern Italy. Newer example of such behavior can be find in Canada and it´s real estate market: Real Estate Market: Calgary vs Toronto,because it demonstrates different approaches and conditions each province has to challenge. The central government is indeed unable to control the outcome, which differs and creates gaps between the provinces.

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  24. Ron Ronson: "Its hard to see how free-market justice (based on common law and competitive courts) could in any way do such a bad job of administering impartial justice even if one assumes that such a system would itself be flawed."

    Then perhaps a visit to your optometrist is in order, because slavery is much worse, and has been widely practiced - when there is no 'government', when there are competing governments, and when the property owners (slavers) established a 'night watchman' government to secure their property rights.

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