It is well known that the behavioral responses of firms and households are central in determining the effectiveness of public programs that seek to redistribute consumption and welfare. In this paper, we extend this literature by including the behavioral response of local governments to the redistributive policy of the central government in a federation. In this paper we develop a political economy model of a federation in which the redistributive policy is characterized by a linear redistributive program of the central government and local governments set commodity taxes to provide a local public good.
The main findings of our paper are the following: first, if the net transfer from the redistributive program is positive for coalition of voters controlling the party in power in some district but the aggregate net transfer from the redistributive program for residents in the district is negative then the size of the local public good in this district of the federation is lower relative the size of the public good for an economy without a centralized redistributive policy. Second, we also identify political and economic conditions that show that if local governments in each district are controlled by parties representing individuals with wage earning abilities below the nationwide average wage earning ability then the redistributive program of the government might induce all local governments to reduce the provision of local public goods in both districts.
The implication of these outcomes is that the attempt of the central government to redistribute welfare from the rich to the poor through public redistribution can be ineffective if the provision of local public goods by local governments falls as a response to the ex-post tax-transfer distribution of income engineered by the redistributive policy of the central government.