The welfare effects of intergovernmental grants in an economy with independent jurisdictions

A general equilibrium model is presented of an economy where mobile and immobile households engage in decentralized market behavior and where immobile households control the expenditure and tax policy of each local government, subject to a local budget constraint. It is shown how central government grant policy (which is a formula with lump-sum, matching, and population elements) affects the general equilibrium of the system determined through market and local political decisions. The welfare effects of grants are discussed, with particular emphasis on distortions that may arise at lower levels of decision making that grants may be useful in (partially or completely) correcting.