Abstract
In our model, the central government sets the tax rate and its share of revenue, while local governments maximize their private benefits, by engaging in two classes of activities. The first one consists of providing public goods which help firms to make more profit, thus enlarging the tax base. The second one consists of extortionary activities. We show that given any initial capital stock, there are corresponding threshold levels of transparency of governance, tenure length, and local government tax share, above which the economy will grow without bound, and below which it will fall into a poverty trap.
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