Capitalization, decentralization, and intergenerational spillovers in a Tiebout economy with a durable public good

Abstract

We consider an overlapping generations model with a durable local public good (DLPG). We establish a Tiebout theorem (equilibrium exists and is first best) as well as an equal treatment Second Welfare Theorem in this dynamic DLPG economy. We establish conditions, including the Small Jurisdiction assumption, under which local provision of durable public goods results in the full internalization of the intergenerational spillovers that durability entails. In contrast, when durable public goods are provided by the national government, internalization does not take place and underprovision of public goods results. This sets up an institutional trade-off between national and local provision of public goods that balances the relative strength of intergenerational and interjurisdictional spillovers. Our main conclusion is that while capitalization is an effective mechanism to cause agents to internalize intergenerational spillovers, the effectiveness of this mechanism is limited by the degree to which there are more general spillovers across jurisdictions.