Employment and Wages in the Private and Local Government Sectors in a Centralized Fiscal System

This paper discusses the interaction between the local government and private sector in an institutional context consistent with a centralized fiscal system. Under decentralized wage setting in the private sector, the effects of shocks in the two sectors depend on whether private and local public goods are substitutes or complements in the union utility function. Higher wage markup in the local government sector unambiguously decreases government output while the effect on private sector employment is ambiguous. Higher income taxes have ambiguous effects on local government output. Shocks in the private sector can be reinforced through feedback effects from the local government sector. A shift from decentralized to centralized wage setting in the private sector reduces wages and increases employment in both sectors.