Local public goods, heterogeneous population, voluntary transfers, and constrained efficient allocations

Abstract

The underprovision of public goods and the inefficiency of the migration equilibrium in a federation are widely discussed in the fiscal externality literature. The central authority can solve these problems by using inter-regional transfers. Moreover, it has been shown that an intervention of the central government is not necessary when the individuals are identical with respect to their marginal rate of substitution of private for public goods since local authorities will make efficient transfers to other regions by themselves. This paper, however, shows that an efficient population distribution in a federation is not guaranteed if individuals differ with respect to their marginal benefit from public consumption even if communities make transfers. The paper also demonstrates the importance of the preference revelation by the residence choice.