Efficiency and Equalization Payments in a Federal System of Government: A Synthesis and Extension of Recent Results

This paper investigates the rationale for a system of equalization transfers in a federal system of government. The existing sources of inefficiency of resource allocation in economies with more than one level of government are synthesized in the framework of a simple decentralized multiprovince model with mobile factors of production. The sources of inefficiency arise, first because migrants respond at the margin to incorrect signals, owing to the phenomena of rent sharing and fiscal exterality, and second because of global rather than local inefficiencies. The model is then extended to consider the role of the federal government in providing intergovernmental transfers in the face of such inefficiencies. In addition to synthesizing the sources of inefficiency in federal models, the equity arguments for equalization are briefly recounted. Efficacite et paiements de perequation dans un systeme federal de gouvernement: synthese et extensions de certains resultats recents. Ce memoire examine la logique qui soustend un systeme de paiements de perequation dans un systeme fdderal de gouverement. Les auteurs utilisent un modele simple d'un systeme multi-provincial decentralise avec des facteurs de production mobiles pour definir les sources d'inefficacite dans l'allocation des ressources dans les dconomies qui possedent plus d'un niveau de gouvernement. Ces inefficacites proviennent de ce que, d'abord, ceux qui se deplacent le font en reponse, a la marge, a des signaux incorrects engendres par le partage de la rente sur la base de la residence et par les phenomenes d'exteralites fiscales; elles sont aussi le resultat d'inefficacites globales plutot que locales. Dans le cadre de ce modele, les auteurs analysent le role du gouvernement federal effectuant des transferts inter-gouverementaux pour corriger ces inefficacites. En plus de presenter une synthese des sources d'inefficacite dans les regimes federaux, les auteurs font un bref rappel en passant a l'ensemble des arguments fondes sur l'equite qu'on utilise pour rationaliser les paiements de perequation. This paper is a linear combination of two papers presented at the May 1982 meetings of the Canadian Economics Association in Halifax entitled 'The case for equalization payments' (by the authors) and 'Recent developments in the theory of regional economic policy in Canada' (by Boadway). The authors are grateful for comments by the discussants Jim Johnson and Baxter MacDonald and by Jack Mintz, Brian Scarfe, Gerard Belanger, David Sewell, Tom Courchene, and the referees. We are especially heavily indebted to Dan Usher for many stimulating comments and suggestions while the work was in progress. Some of the above persons will undoubtedly disagree with the emphasis we have chosen to put on various aspects of the analysis for policy purposes. Support for some of this work has been provided by the Economic Council of Canada and is gratefully acknowledged. Canadian Journal of Economics / Revue Canadienne d'Economique, XV, no. 4 November / novembre 1982. Printed in Canada / Imprimd au Canada. 0008-4085 / 82 / 0000-0613 $01.50 ? 1982 Canadian Economics Association This content downloaded from 207.46. 13.127 on Wed, 12 Oct 2016 04:27:47 UTC All use subject to http://about.jstor. org/terms 614 / Robin Boadway and Frank Flatters