Chapter 4: Spatial Interactions Among Governments
Federico Revelli1 Introduction The theoretical local public finance literature has studied extensively the reasons why local governments might not set their fiscal policies in isolation, but rather tend to interact with neighboring jurisdictions (see chapters in this Handbook). Similar arguments hold for interactions among states within federal countries as well as for fiscal interdependence among nation states at the international level. This chapter aims at illustrating how those theoretical models of intergovernmental fiscal interaction can be implemented empirically. In particular, it reviews the recent empirical literature on intergovernmental fiscal interaction and focuses on the specification and estimation of fiscal interaction models that give rise to a spatial pattern in local government expenditures and revenues. The chapter first groups the existing empirical studies into three broad categories, depending on the assumed channel of interaction (preferences, constraints and expectations), and shows how different theoretical hypotheses of strategic interaction among governments – such as expenditure spillover, tax competition for mobile resources, and yardstick competition – can be implemented empirically in order to ascertain the sign and magnitude of spatial interdependence. Careful analysis of the recent empirical literature shows that estimation of a reduced-form interjurisdictional reaction function might not by itself allow us to discriminate among competing theoretical hypotheses. Consequently, a number of approaches for identifying the theoretical model generating the observed spatial auto-correlation in fiscal variables are outlined, which are based either on auxiliary predictions that can be directly derived from the theory, or on the existence of institutional arrangements or reforms that generate a...
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