Redistribution and Provision of Public Goods in an Economic Federation

This paper concerns redistribution and public good provision in an economic federation with two levels of government: a local government in each locality and a (first mover) central government. Each locality is characterized by two ability‐types, and the ability‐distribution differs across localities. The central government redistributes via a nonlinear income tax and a lump‐sum transfer to each local government, while the local governments use proportional income taxes and provide local public goods. We show how the redistributive role of taxation is combined with a corrective role, and how the central government can implement the second best resource allocation.