Central Control of Regional Budgets: Theory with Applications to Russia

Abstract

Motivated by the Russian experience, this paper examines the implications of imposing central control on the budgetary activities of a subnational government. In a multi-task principal–agent model, the center cannot monitor directly the informal budgetary operations of a region, but it can exert control over a formal regional budget and impose limited costs on informal behavior. Imperfect control of subnational budgets may increase social welfare but only at the expense of higher taxation, lower output, and a strong orientation of regional policies toward rent-seeking. Imposing costs on regions may be counterproductive, particularly in the presence of corruption. J. Comp. Econ., March 2002, 30(1), pp. 51–75. Organization for Economic Cooperation and Development (OECD), 2, Rue André Pascal, 75775 Paris Cedex 16, France. © 2002 Elsevier Science (USA).Journal of Economic Literature Classification Numbers: H11, H39, H77, D83.