Political Competition and the (In)Effectiveness of Redistribution in a Federation

We analyze politico-economic conditions in which the effectiveness of public redistribution might be low in a federation. In our economy, the central government redistributes income while local governments provide a pro poor public good. If local public spending falls due to the ex-post tax-transfer distribution of income engineered by the central government then public redistribution might be less effective in redistributing welfare. In this paper we address this issue. Our main findings are: first, if the party on power represents voters with a labor wage below the average wage and the aggregate net transfer from the redistributive program is negative for residents in the locality then public spending falls in this district. Second, if local governments of all districts are controlled by parties representing voters with high marginal utilities of income and labor wages below the nationwide average wage then public redistribution induces all local governments to reduce spending.